Frasers Commercial Trust (SGX: ND8U), a real estate investment trust with a focus on commercial properties in both Singapore and Australia, closed at $1.37 last Friday. But, is Frasers Commercial Trust really worth S$1.37 a unit? Asked another way, is the value of Frasers Commercial Trust on a per unit basis really around the neighbourhood of S$1.37? The art of value 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, in that an investor will try to estimate the growth…
Frasers Commercial Trust (SGX: ND8U), a real estate investment trust with a focus on commercial properties in both Singapore and Australia, closed at $1.37 last Friday.
But, is Frasers Commercial Trust really worth S$1.37 a unit? Asked another way, is the value of Frasers Commercial Trust on a per unit basis really around the neighbourhood of S$1.37?
The art of value
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, in that an investor will try to estimate the growth rates that a REIT will achieve in important financial metrics like its distributions per unit (DPU) or net asset value per unit.
The other works backward, in that we can look at a REIT’s current price and work out how much growth the market’s expecting the trust to achieve. From that, 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 Frasers Commercial Trust’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 shareholders from now till perpetuity; 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)
Frasers Commercial Trust’s annual distribution for the fiscal year ended 30 Sep 2014 (FY2014) was 8.51 cents per unit, up 8.69% from the distribution of 7.83 cents per unit a year ago. Looking at the REIT’s distributions for the first three quarters of FY2015, it looks like the REIT will have an even stronger year this year. If we annualise Frasers Commercial Trust’s distributions based on what it has paid out for the first three quarters of FY2015, the REIT will have an estimated distribution of 9.59 cents per unit for the whole of FY2015.
As for the Discount Rate, the textbook method – which follows the Capital Asset Pricing Model (it’s perfectly acceptable to not 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 Frasers Commercial Trust.
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 around 2.7% 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 Frasers Commercial Trust’s case, data taken from investing research outfit Morningstar has its beta figure pegged at 0.84.
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.
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 the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Since its inception in April 2002, the SPDR STI ETF has generated a total annual 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 6.4% for Frasers Commercial Trust.
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:
1.37 = 0.0959 / (0.064 – Distribution Growth Rate)
As you can see, the only variable that’s now unknown in the Gordon Growth Model is Frasers Commercial Trust’s future growth in distributions. After some basic arithmetic, we thus arrive at the conclusion that the market expects Frasers Commercial Trust to be able to grow its DPU at an average pace of (-0.6%) per year over the long-term future.
So what’s the value?
We can then use the expected growth rate of (-0.6%) and compare it against our own assessment of what Frasers Commercial Trust may be able to achieve. Interestingly, Frasers Commercial Trust has been growing its DPU at a compound rate of 11% per year from FY2010 to FY2014.
So, based on all the above assumptions and data, if you expect Frasers Commercial Trust to be able to grow its future distributions at a faster clip than (-0.6%) annually, the trust will be undervalued at S$1.37. But, if you’re not confident at all about Frasers Commercial Trust’s growth and think that its future distributions will step up at a much slower pace or even decline, then S$1.37 might be too high a price to pay.
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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.