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Yuexiu Real Estate Investment Trust is a HK$17b mid-cap, real estate investment trust (REIT) based in Wanchai, Hong Kong. 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. I’ll take you through some of the key metrics you should use in order to properly assess 405.
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A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT's main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much 405 actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For 405, its FFO of CN¥775m makes up 53% of its gross profit, which means over a third of its earnings are high-quality and recurring.
Robust financial health can be measured using a common metric in the REIT investing world, FFO-to-debt. The calculation roughly estimates how long it will take for 405 to repay debt on its balance sheet, which gives us insight into how much risk is associated with having that level of debt on its books. With a ratio of 5.6%, the credit rating agency Standard & Poor would consider this as aggressive risk. This would take 405 18 years to pay off using just operating income, which is a long time, and risk increases with time. But realistically, companies have many levers to pull in order to pay back their debt, beyond operating income alone.
Next, interest coverage ratio shows how many times 405’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 1.61x, 405 is not generating an appropriate amount of cash from its borrowings. Typically, a ratio of greater than 3x is seen as safe.
I also use FFO to look at 405's valuation relative to other REITs in Hong Kong by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. In 405’s case its P/FFO is 19.15x, compared to the long-term industry average of 16.5x, meaning that it is slightly overvalued.
Next Steps:
As a REIT, Yuexiu Real Estate Investment Trust offers some unique characteristics which could help diversify your portfolio. However, before you decide on whether or not to invest in 405, I highly recommend taking a look at other aspects of the stock to consider: