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Macau Property Opportunities Fund Limited is a UK£78m small-cap, real estate investment trust (REIT) based in Saint Peter Port, Guernsey. REITs are basically a portfolio of income-producing real estate investments, which are owned and operated by management of that trust company. They have to meet certain requirements in order to become a REIT, meaning they should be analyzed a different way. In this commentary, I'll take you through some of the things I look at when assessing MPO.
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REIT investors should be familiar with the term Fund from Operations (FFO) – a REIT’s main source of cash flow from its day-to-day business activities. FFO is a higher quality measure of earnings because it takes out the impact of non-recurring sales and non-cash items such as depreciation. These items can distort the bottom line and not necessarily reflective of MPO’s daily operations. For MPO, its FFO of US$105m makes up 122% of its gross profit, which means the majority of its earnings are high-quality and recurring.
MPO's financial stability can be gauged by seeing how much its FFO generated each year can cover its total amount of debt. The higher the coverage, the less risky MPO is, broadly speaking, to have debt on its books. The metric I'll be using, FFO-to-debt, also estimates the time it will take for the company to repay its debt with its FFO. With a ratio of 71%, the credit rating agency Standard & Poor would consider this as minimal risk. This would take MPO around a year to pay off using operating income alone, which is reasonable, given that long term debt is a multi-year commitment.
I also look at MPO's interest coverage ratio, which demonstrates how many times its earnings can cover its yearly interest expense. This is similar to the concept above, but looks at the upcoming obligations. The ratio is typically calculated using EBIT, but for a REIT stock, it's better to use FFO divided by net interest. With an interest coverage ratio of 19.23x, its safe to say MPO is producing more than enough funds to cover its upcoming payments.
In terms of valuing MPO, FFO can also be used as a form of relative valuation. Instead of the P/E ratio, P/FFO is used instead, which is very common for REIT stocks. MPO's price-to-FFO is 0.91x, compared to the long-term industry average of 16.5x, meaning that it is highly undervalued
Next Steps:
In this article, I've taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Macau Property Opportunities Fund can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing: