After Falling 25% In A Year, Is Sabana Shariah Compliant REIT Possibly A Cheap REIT Now?

Sabana Shariah Compliant REIT (SGX: M1GU) closed at S$0.755 per unit yesterday. This comes after the REIT had fallen by a quarter over the past 12 months.

After the big decline, is the real estate investment trust, which owns 23 industrial and logistics properties in Singapore, possibly a cheap REIT at a price of S$0.755? That’s something we’d find out below.

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) and/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 in distribution the market’s expecting Sabana Shariah Compliant REIT to achieve.

A dividend discount model is meant to value a company based on the total amount of dividends that the firm would distribute to 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)

Sabana Shariah Compliant REIT’s annual DPU for its fiscal year ended 31 December 2014 (FY2014) was 7.33 Singapore cents, down by a hefty 21.9% compared to the year before. In the first-half of 2015, the REIT’s DPU came in at 3.58 cents. If that number’s annualised, we’d be looking at a DPU of 7.16 cents for the whole of 2015. It seems reasonable (given that it’s lower than the DPU seen in 2014), so let’s stick with the figure in this exercise.

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 Sabana Shariah Compliant 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 around 2.4% 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 Sabana Shariah Compliant REIT’s case, data taken from investing research outfit Morningstar has the beta figure pegged at 0.58.

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 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 5.13% for Sabana Shariah Compliant 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:

0.755 = (0.0716) / (0.0513 – Dividend Growth Rate)

As you can see, the only variable that’s now unknown in the Gordon Growth Model is Sabana Shariah Compliant REIT’s future growth in distribution. Some basic arithmetic will bring us to the conclusion that the market expects Sabana Shariah Compliant REIT to be able to grow its distributions at an average pace of (-4.4%) per year over the long-term future.

So what’s the value?

The expected growth rate of (-4.4%) can then be used to compare with our own assessment of what Sabana Shariah Compliant REIT may be able to achieve. Some historical perspective can be useful here: From FY2012 to FY2014, Sabana Shariah Compliant REIT’s DPU has shrank at an annual pace of 11.1%.

So, based on all the above assumptions, if you expect Sabana Shariah Compliant REIT to be able to grow its distributions at a faster clip than (-4.5%) annually, the trust will be undervalued at S$0.755. But, if you’re not confident at all about Sabana Shariah Compliant REIT’s future and think that its future distributions will shrink at a steeper pace, then S$0.755 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 contributor Stanley Lim doesn’t own shares in any companies mentioned.