Get acquainted with business trusts

The buying into of this asset class by retail investors is expected to remain slow. -myp
Mon, Feb 14, 2011
My paper
By Reico Wong

THE lacklustre business trust market here has no doubt received a much needed boost with the recent announcement of the expected listing of Asian tycoon Li Ka Shing's Hutchison Port Holdings Trust (HPH Trust) on the Singapore Exchange.

Hutchison's proposal to list its spin-off in Singapore, rather than its Hong Kong home ground, has not only led analysts to be optimistic that the market here will see the emergence of more of such business trusts, but also fuelled hopes that more retail investors will buy into this asset class.

"In a low interest-rate environment like the current one, instruments paying a decent and stable yield with a reasonable risk profile are attractive to investors.

This is a key advantage of real-estate investment trusts (Reits) and business trusts," said Mr George Lee, OCBC Bank's head of group investment banking.

"They also provide investors with an avenue to invest in large capital or infrastructure assets that are not always accessible to smaller investors."

While business trusts as an investment vehicle certainly offer various key advantages, the buying into of this asset class by retail investors is expected to remain slow.

The current six listed non-property- related business trusts - generally dominated by the shipping and infrastructure sectors - have largely been neglected by investors due to a lack of awareness, despite their debut in Singapore back in 2007, according to experts.

Business trusts are essentially run as business enterprises operated by a trustee manager, but with a hybrid structure that combines elements of a company with those of a unit trust.
Investors hold units rather than shares, and provide financing to the trust.
In turn, they receive regular income generated by the operation of the underlying assets.

Experts say investors are generally not familiar with how business trusts should be assessed as a unique asset class.

Mr Suvro Sarkar, an infrastructure and industrials analyst with DBS Vickers Securities, pointed out that the assessment of a business trust's performance is unlike that of normal companies, where the key criterion for judgment is based on price to earnings multiples and earnings growth.

"In the case of business trusts, we would be looking at factors like the quantum and stability of distributions, future income distribution per unit (DPU) growth potential, as well as the proper management of various risks, such as those pertaining to credit, counterparty and funding," he said.
"As long as cash flows are stable and predictable, and growth is decent (inflation plus desired spread), business trust investors should be satisfied."

Business trusts with a diverse source of cash flows, combined with a good track record in managing and investing their assets, are also strongly recommended.

This is especially in the case of trusts with assets that are often subjected to cyclical volatility.
Mr Lee explained that, as the trusts have been positioned as dividend plays, they are obliged to pay out a large portion of operating cash flows as dividends, which often leave little buffer for debt repayment and limited flexibility for capital management.

"High interest payments can also limit the distributable income available to investors, thereby putting DPU at risk," he said.

He added that the challenge for shipping trusts, in particular, is to secure high-quality counterparties and still make a yield-accretive acquisition.

Such difficulties were faced by Rickmers Maritime Trust, First Ship Lease Trust (FSL) and Pacific Shipping Trust (PST) over the last 11/2 years.

Of the three, only PST has truly managed to successfully overcome its troubles, with its share price outperforming market expectations to rise by about 37 per cent in the last year. Meanwhile, Rickmers remained largely flat and FSL was down by about 25 per cent.

Mr Sarkar said that, in general, business trusts' share-price valuations are expected to be higher than those of Reits, providing dividend yields of between 7 per cent and 10 per cent in the near term.

"But capital growth will likely be limited to a maximum of 10 per cent per year, unless the trusts are able to resolve the problem of stretched balance sheets and actually deliver some DPU growth," he said.

DBS has "hold" calls on Rickmers, FSL and CitySpring Infrastructure Trust. It noted that CitySpring had overpaid for acquisitions, and high gearing - at both the asset and group levels - have also led it to raise additional equity to reduce borrowing.

The inherent nature of City- Spring's assets are stable, but the lack of any acquisition or growth story - coupled with regulatory risk over the liberalisation of the City Gas network and an unresolved dispute involving its Australian asset, Basslink - has created an overhang on the share price, said OCBC.

A positive outlook for PST remains, with "buy" calls recommended.

Analysts say PST's balance sheet has improved substantially and that it has the capacity to drive acquisition- led growth.

"PST's three rounds of acquisitions last year should start to contribute from next year onwards.
They have been very conservative in their distribution policy and have the buffer to increase distributions by increasing the payout ratio at their discretion," said DBS.

Overall, the performance of business trusts as an asset class is expected to be relatively stable.
"Better quality sponsors with solid mature assets will be required to list in Singapore to really attract investors," Mr Sarkar added.