Tuesday, June 16, 2009

AAZPB - Australand ASSETS at a running yield of 15%?

Now for something completely different.  The investment bankerteers have been drumming up support for the property trust sector recently as they and their trading bank buddies try to deleverage the sector by slipping the syringe into investors for more capital.  It seems to be working as every day a new property trust shuffles up for another $1bn.  It's a cloak and dagger operation as such raisings are to the benefit of the conspirators gathered around each victim - at the expense of the retail (and ultimately institutional investors) in the trusts.

Enough of the rant...a property company that I have had a long history with is Australand and I figured it was time to have a look at their preferred securities on issue (the Australand ASSETS - hereafter known by their ASX code AAZPB)

Australand is a property developer with strengths in the commercial, industrial and residential sectors.  They were an early adopter of the stapled security model and as a consequence have built a sizable and diversified investment portfolio.  The AAZPB have the following characteristics:

Type: Floating rate security
Coupon: 90 day BBSW + 4.80% (eg. current bills ~3.25% + 4.8% = 8.05%)
Ranking: Subordinated to senior debt
Maturity: Perpetual
Payment: Quarterly (non-cumulative and unfranked)
Size:  2,750,000 on issue (market cap at $53 per security is $145m) 
Conversion: Principally at the issuers option (at a 2.5% discount)

Now its a smallish issue which means its illiquid whether getting in or out which is a negative.  But that yield of around 15% (ie. $8.05 on $53 market price) looks attractive on the face of it.  How do we assess the relative risk/reward?

For a start, looking at the outright risk side of things, what is the probability that Australand will not make a distribution payment, or worse still, the risk that it goes kapput.

Risks to AAZPB's distributions
To get a sense of Australand's cashflows - which after all are used to pay distributions - in its 2008 financial year (its year end is December) its operations generated $430m in cash ($485m in 2007) - while it invested $673m in new developments, property etc ($428m in 2007).  The cash shortfall in 2008 was financed by an entitlement issue in ALZ's stapled securities that provided around $460m.  In effect this capital raising also financed the distributions on its stapled securities and on the AAZPB's.  The conclusion - absent a requirement to repay debt or an absolute implosion in operating earnings, Australand can manage its free cashflow by cutting back on new acquisitions.  My understanding is that management have stated that they will be net sellers of property this financial year.  That's a tick.

In relation to operating performance, Australand's guidance for the 2009 year is for a fall in operating income of around 30%.  That would put operating profit at around $120m (from $175m in 2008).  While not a good trend (though hardly surprising given the economic climate), its business will continue to be profitable and, from this perspective, cashflow positive.

Key to its cashflow stability is its portfolio of investment properties.  As at 31 December 2008, Australand owned 76 properties with a value of approximately $2.3bn.  The occupancy rate on these properties was ~99% and the average lease expiry was 6.6 years (with rents stepping up by 3.3% per annum).  The average cap rate on the portfolio was 7.54% (7.75% for industrial and 7.25% for office).  At the end of the day, it is the cashflows from these properties that are used underwrite the payment of distributions.  In 2008, net income from the property investment division was $134m.

So how does this all add up for AAZPB distributions.  In the same way that management of Australand note that interest cover was 2.7 times for the year to 31 Dec 2008, let's look at AAZPB distribution cover...Uh, sorry, that's just guess work without more information from management.  But we can get some comfort.

Management have stated that they expect a distribution of 6 cents per ALZ stapled security for 2009 (3c each half).  Now on 1.7bn ALZ securities on issue, that is a potential distribution of $100m.  The distribution on the AAZPB's, assuming a rate of 8% is $22m.  Even if the rate were to climb back to 10% (inflation concerns take hold), the payment is $27m.  That's broadly a 4 to 1 ratio.  Given that there can be no distributions on ALZ securities, unless the distribution on AAZPB's has been made we can, as I say, draw some comfort.

Risks to Australand's viability
Australand has around $1.6bn in debt.  ~$1bn of this matures in 2010.  In this fragile market, the absolute scale of the refinancing is a significant hurdle to overcome.  But it is hardly an untenable position.  Australand's gearing ratio under its debt facilities appears to be measured by Total Liabilities to Total Assets (adjusted for cash).  The limit is 55%, where at the year end balance date it was 47%.

To get a sense of the sensitivity of this covenant to changes in property values, lets assume:

Net Rental income in 2009: $166m plus 3.3% escalation = $171m
At 8.5% average cap rate: Values properties at $2.0bn plus development assets $0.1bn = $2.1bn
Gearing ratio: ~51%

This effectively assumes $200m in writedowns (on a 1% move out in cap rates).  It ignores any cash balance, and assumes no management of inventories or receivables.  In short, it's relatively conservative.  And it still leaves headroom under the covenant.  I'm not saying that cap rates will not move out further than this scenario over time - but it is unlikely that they will be ratcheted up by even 1% in this calender year (based on recent performance of valuation companies - ever wondered why direct property lags the listed market?)

My guess is that the banks will step up to refinance the $950m in CMBS due to mature next June.  They have shown a propensity to simply charge more rather than saying no and bringing the whole house down.  In any event, the refinancing risk falls on the ordinary equity holders - as they will need to fund any shortfall.  Given CapitaLand owns 59% of the equity of Australand, they are highly unlikely to jeopardize this investment.  More likely that they will step up and underwrite an another entitlement issue - maybe take the whole thing private.  In any event, that would be a good thing for AAZPB investors.

In short, it is unlikely that the banks will be running Australand for the foreseeable future.

I'm relatively comfortable with the investment proposition for AAZPB's from an outright "will-I-get-my-money-back" risk.

From a relative risk/return perspective, if you consider that the bank floating rate hybrids are trading at running yields between 4.5% and 6% (and yields to maturity closer to 8%), then a outright running yield for a perpetual, illiquid but otherwise sound credit of around 15% seems about right.  It also compares favourably to a running yield of ~11.4% on the Multiplex Sites (MXUPA).

The next ex-date is 24 June 09 - for the coupon of $1.97 per security.  I'm inclined to put a park some cash in these securities at $53.00.  


  1. Nice analysis of AAZPB. I for one can't understand how the market values it at $53 (I actually invested in a few at $43, but it has been even lower). The elephant in the room is the CMBS due for refinancing this month (or next?). Like you say, the banks are still providing credit, just at a much higher price, so I am pretty sure the company will be able to refinance - once this happens you would think AAZPB should trade more around $65 or so, given it's risk profile and the current state of the market.

    The other factor is Capitaland - I wonder what their aim is in maintaining a large majority shareholding? A complete takeover by Capitaland would be a bonus for AAZPB as I am pretty sure it is redeemable for par in the event of an acquisition event.

    I see you own CEU, be prepared to be very patient for that one...!

  2. Cheers Justin. My view is that Capitaland isn't going to walk away and that a complete takeover is a reasonable probability going into the CMBS maturity in June next year. It's a double edged sword for AAZPB. Their presence is supportive to the credit. On the flip side, my read of the terms of issue is that in the event of a change of control the redemption of the securities is at the option of the issuer. It could end up being similar to MXUPA - a kind of orphan issue in a private company.

  3. Ah...MXUPA, another little gem. I don't know if you follow it very closely but management has given one or two very subtle hints that it may not be around following reset in April next year. I would imagine that Brookfield could refinance at a relatively lower cost than that carried by MXUPA.

    If you haven't already, I recommend you spend a little bit of time looking at MXUPA, I think it is as interesting a deal as AAZPB, if not better.

  4. Thanks for the tip. I'll hop to it post haste...

  5. Nice move by AAZPB today - up 17% at the moment.

    Actually, finding value in the hybrid market is not that easy anymore, the run up in prices has been quite something.