I have discussed some points that an investor can examine when looking at REITs in my previous post. Now, I shall proceed to more points of consideration.
Assessing integrity of management and how unitholder friendly are they?
As with assessing all company managements, be it management of REITs or other companies, it is most important above other forms of measurements to look at integrity and shareholder friendliness. No matter how profitable a company has been managed, as long as the management does not show convincing integrity and shareholder friendliness, it is a matter of time that things may go wrong. We have heard so many times of accounting frauds and bad corporate governance. I will rather look for steady management that show integrity and shareholder friendliness. Such management may not always be the most promising in terms of profitability compared to their competition, but at least I know my invested money is in good hands of an honest and capable management that always considers shareholders' interests in all management decisions they make.
How does one identify such managements? Read what key management figures (chairman, CEO, etc.) say about their company in their annual reports. It is important not just to look at one year's annual report. One should follow through the statements of management figures over a good number of years to get an idea of the management. It is not difficult to judge a management's character if one is patient enough to read what they said over the years. A management that always seems to talk big in their annual reports, praising their performance, even finding ways to talk up their performance and hide their short-comings in a bad financial year may be showing fanfare. Is the company really performing up to what they claim? I always look at annual reports with healthy skepticism. Anyway, as in all human nature, which management will want to report bad things in an annual report to their disadavantage? However, I look out for management that report as honestly as possible their yearly performance. I look out especially for management that is bold to admit mistakes and take actions to correct over their mistakes mentioned in their annual reports. I also look out for managements that mean what they say and always follow up on what they say. Such managements of companies walk their talk and is likely to be dependable and honest in their dealings with not just shareholders but also their customers. Even if they should not carry out a project mentioned in their annual reports, they will state clearly any reasons even if admiting any oversight when planning for a particular project.
In a nutshell, look for candidness in the management that mean what they say and is bold to admit and correct over their mistakes. Such candidness show that the management is sincere and serious about doing their best in running their business. Showy fanfare that does not follow through with practical actions taken are just like wind blowing in the air.
Assessing profitability of a REIT
One can look at trends over a good number of years (e.g. 10 years) on the different figures such as gross revenue, net property income, distributions paid to unitholders to get an idea on the profitability of a REIT. Look for a general rising trend in such metrics over the years to ensure consistency in the profitability of the REIT. Such figures can be found in the annual reports of REITs.
Looking at net asset value per unit of a REIT
Net asset value (NAV) attributable to unitholders = Total assets - Total liabilities
All the above figures of total assets and total liabilities can be found in the balance sheet of the financial statement. Even net asset value per unit ($) is found in the summary financial statement of REITs, so there is no need to go through any calculations. The above mathematical calculation is for reference purposes.
What does NAV per unit ($) tell? It is a theoretical breakup value of a REIT, that is if the REIT were to cease to be viable, and it is completely broken up and after selling all it's assets (mainly made up of properties) and paying all it's liabilities, the net asset value per unit ($) is the amount of money that can potentially be returned to it's unitholders. For example, if NAV per unit of ABC REIT is $0.50 per unit, unitholders can expect to receive back $0.50 per unit upon breaking up of the REIT when it ceases to be viable anymore. When viewing NAV per unit ($), it is not to be taken literally since it is at best only a theoretical estimated value that unitholders can expect to get. Properties may not be sold at their valuations and usually in such drastic situations of dissolving a REIT, properties tend to be sold at drastic discount over a short-term to meet the liability obligations. So, treat NAV per unit with a pinch of salt. Nevertheless, it is always good to hold units at steep discount to their NAV per unit to gain a sufficient margin of safety.
Looking at other metrics of measurement for REITs
Earnings per unit growth and distribution per unit growth
Ideally, earnings per unit (EPU) and distribution per unit (DPU) should see growth over a good number of years. A consistent growth means the REIT is generating growth in earnings and distributions over the years. As an investor of REIT, stabiltity of and growth in distributions is paramount. A thing to note is that EPU and DPU may decrease for a particular year if there is any issuance of rights, private placement of units and other forms of increase in number of units, so an investor should investigate carefully the reason for any dip in a particular year's EPU and DPU.
Gearing or aggregate leverage ratio (%)
I have already discussed in previous post that a gearing of 40 plus % is on the high end for a REIT. One should not dismiss a REIT as an invesment candidate based on high gearing alone. One should also examine whether the loans of a REIT is due anytime soon (e.g. less than a year) which may have added risk and also the potential of a REIT being able to refnance it's loans based on a track record of securing refiancing successfully (sometimes based on having a strong sponsor's backing).
Interest coverage ratio
Interest coverage ratio is a metric to determine how easy a company or REIT can pay interest on outstanding loans/ debts.
It is important for a company or REIT to be able to pay interest on loans outstanding in order to maintain the loan agreement failing which the lender can take legal action against the company or REIT. Inability or delay in paying interest on loans may reflect badly on the company or REIT's credit worthiness, and maybe a red flag for more problems to come. An interest coverage ratio higher than 1.5 is desired (the higher the better).
Interest rate on borrowings/ loans
Interest rate on borrowings = (Cost of borrowings / Total borrowings) X 100%
A REIT that can consistently secure lower interest rate than other peers in similar REIT asset class and also lower than market interest rate suggests lesser cost of borrowings and potentially higher distributions to be paid to it's unitholders.
Discussion points:- Always look out for honest and capable management of companies or REITs that are shareholder friendly.
Look for general rising trends over a good number of years (e.g. 10 years) on the different figures such as gross revenue, net property income, distributions paid to unitholders to get an idea on the profitability of a REIT.
Invest at below NAV per unit of a REIT to gain a margin of safety.
Look for consistent growth in EPU and DPU. Examine carefully the reason for a dip in EPU and DPU for any particular year to ensure it is not due to any disadvantegous situation facing a REIT.
Interest coverage ratio is a metric to determine how easy a company or REIT can pay interest on outstanding loans/ debts. An interest coverage ratio higher than 1.5 is desired (the higher the better).
Look for REITs with a low interest rate on borrowings. Lower interest rate on borrowings suggest potential for higher distributions to their unitholders.
I shall discuss more on rights issue in future post. To be continued........
Posts
No comments:
Post a Comment