Is Mapletree Commercial Trust An Undervalued REIT?

Mapletree Commercial Trust (SGX: N2IU), an owner of commercial/retail properties in Singapore (its portfolio includes VivoCity and the PSA Building), closed at S$1.25 per unit on Tuesday.

Is Mapletree Commercial Trust undervalued at that price? Let’s find out.

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 distribution 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.

Moving backwards

In this example, we’d be using a variant of a simple dividend discount model called the Gordon Growth Model to figure out how much growth the market’s expecting from Mapletree Commercial Trust’s future 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 in 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)

Mapletree Commercial Trust’s annual distribution for its fiscal year ended 31 March 2015 (FY2015) was 8.00 Singapore cents per unit, the same as a year ago. Given the REIT’s 3.0% year-on-year growth in distribution for the first-quarter of FY2016, let’s assume that the overall distribution for FY2016 will also be 3% higher than that seen in FY2015. This puts the number at 8.24 Singapore cents per unit.

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 Mapletree 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 2.65% 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 Mapletree Commercial Trust’s case, data taken from investing research outfit Morningstar has the beta figure pegged at 1.21.

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 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 8.05% for Mapletree 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:

1.25 = (0.0824) / (0.0805 – Dividend Growth Rate)

As you can see, the only variable now that’s unknown in the Gordon Growth Model is Mapletree Commercial Trust’s future growth in distributions. After some basic arithmetic based on the equation just above, the conclusion is that the market expects Mapletree Commercial Trust to be able to grow its distributions at an average pace of 1.46% per year over the long-term future.

So what’s the value?

The expected growth rate of 1.46% can then be used to compare against our own assessment of what Mapletree Commercial Trust may be able to achieve. Interestingly, Mapletree Commercial Trust has grown its DPU at a compound rate of 11.0% per year from FY2013 to FY2015.

So, based on all the above assumptions, if you expect Mapletree Commercial Trust to be able to grow its distribution at a faster clip than 1.46% annually, the trust will be undervalued at S$1.25. But, if you’re not confident at all about Mapletree Commercial Trust’s growth and think that its future distributions will step up at a much slower pace, then S$1.25 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.