SPH REIT (SGX: SK6U), the owner of well-known local retail malls Pargaon and Clementi Mall, closed at S$0.945 per unit yesterday. But, is SPH REIT really worth S$0.945 a unit? Asked another way, is the value of SPH REIT on a per unit basis really around the neighbourhood of S$0.945? The art of value Estimating the value of a REIT is a big aspect of investing and a REIT’s value should be a key deciding factor for investors when it comes to making an investing decision. There are two main ways for investors to estimate the value of a REIT. One method works forward, where an investor will try…
SPH REIT (SGX: SK6U), the owner of well-known local retail malls Pargaon and Clementi Mall, closed at S$0.945 per unit yesterday.
But, is SPH REIT really worth S$0.945 a unit? Asked another way, is the value of SPH REIT on a per unit basis really around the neighbourhood of S$0.945?
The art of value
Estimating the value of a REIT is a big aspect of investing and a REIT’s value should be a key deciding factor for investors when it comes to making an investing decision.
There are two main ways for investors to estimate the value of a REIT. One method works forward, where an investor will try to estimate the growth rates that a REIT will achieve in important financial metrics like its distributions per unit.
The other works backward, where we can look at a REIT’s current price and work out how much growth the market’s expecting the trust to achieve. From there, we can determine if the market’s expectations are reasonable or ridiculous.
In this example, we’d be using a variant of a simple dividend discount model called the Gordon Growth Model to figure out the market’s expectation of SPH REIT’s future growth in distributions.
A dividend discount model is meant to value a company based on the total amount of dividends that the firm would distribute to its shareholders from now till kingdom come; the Gordon Growth Model simply adds in a factor to account for a company’s future growth in dividends. The formula for the Gordon Growth Model is shown below:
Share Price = Expected Dividend Per Share One Year From Now / (Discount Rate – Dividend Growth Rate)
SPH REIT’s annual distribution for the fiscal year ended 31 August 2014 (FY2014) was 5.99 cents per unit. Let’s assume, just for the sake of this exercise, that the trust’s distributions for FY2015 will be its current annualised distribution of 5.44 cents per unit.
As for the Discount Rate, the textbook method, which follows the Capital Asset Pricing Model (it’s perfectly acceptable not to follow the CAPM when trying to estimate the value of a stock, but I’d still use the model in here for the sake of completeness), is to incorporate the risk-free rate as well as the beta of SPH REIT.
The risk-free rate is normally taken to be the 10-year government bond yield; currently, the yield on a 10-year Singapore government bond is 2.75% and so, that shall be our risk-free rate.
Meanwhile, the beta of any stock is simply a measure of a stock’s volatility in relation to a broad market index; in SPH REIT’s case, as the trust still does not have a long enough listing history (the trust was listed only in July 2013), we will assume it to be as volatile as the general market. In other words, its beta is 1.
With the explanations out of the way, here’s how the formula for the Discount Rate looks like:
Discount Rate = Risk Free Rate + Beta (Market Return – Risk Free Rate)
You’d notice that there’s one last variable in the Discount Rate formula which I have not discussed, and that is the Market Return. I’d do this now.
The Market Return is simply the long-term return of the stock market as a whole. In this exercise, I’d be using the long-run return of the SDPR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Since its inception in April 2002, the SPDR STI ETF has generated a total return (inclusive of reinvested dividends) of 7.11%.
So, when we input all the relevant figures into the Discount Rate formula, we’d end up with a Discount Rate of 7.11% for SPH REIT.
The next thing we have to do now is to punch all the numbers we have obtained so far into the Gordon Growth Model. This is what we’d end up with:
0.945 = 0.0544 / (0.0711 – Dividend Growth Rate)
As you can see, the only variable now that’s unknown in the Gordon Growth Model is SPH REIT’s future growth in distributions. After some basic arithmetic, we thus arrive at the conclusion that the market expects SPH REIT to be able to grow its distributions at an average pace of 1.35% per year over the long-term future.
So what’s the value?
We can then use the expected growth rate of 1.35% and compare it against our own assessment of what SPH REIT may be able to achieve.
So, based on all the above assumptions, if you expect SPH REIT to be able to grow its distributions at a faster clip than 1.35% annually, the trust will be undervalued at S$0.945. But, if you’re not confident at all about SPH REIT’s growth and think that its future distributions will step up at a much slower pace, then S$0.945 might be too high a price to pay.
Although what I’ve shown is just one of the many methods that we can use to value a REIT or a company, it is still a useful exercise in helping us understand the meaning behind the price of a stock.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.