Why AREIT is your safe long-term bet
An amateur stock pitch on Ayala Real Estate Investment Trust (AREIT, Inc.)
Product Description & Investment Thesis
Let’s say you’re in your early 30s with a medium-risk appetite. You’re a long-term investor whose goal is to save up for your retirement within the next 30 to 40 years. If you find yourself in this situation, one of the many paths you can tread to take you to your goal is that you take a long position on AREIT, Inc. (AREIT), a real estate company established in the Philippines.
AREIT is traded in the Philippine Stock Exchange (PSE) and is in the Office REITs industry, real estate sector, with a Market Capitalization of P39.078 billion and Outstanding Shares of 1.03 billion.
AREIT, which is a local real estate investment trust (REIT), completed an initial public offering (IPO) of around P13.6 billion, named by Asiamoney 2021 as the Most Outstanding IPO in the Philippines. Its earnings are forecasted to grow by an average of 18.6% per year for the next 3 years and have outperformed most stocks amid the rocky waves of the COVID-19 pandemic. It is trading significantly below fair value by around 79.5% and is forecasted to grow at a stable upward pace of 18.6% in annual earnings growth, which makes it a safe albeit competitive investment, capable of securely raking in substantial profit in the long term as the country continues to build local infrastructure along with the Business Process Outsourcing (BPO) industry.
Company Background
AREIT was incorporated on September 4, 2006, as a real estate company. It was originally known as “One Dela Rosa Property Development, Inc.” before recently changing its name to the present one on April 12, 2019. At present, it has expanded by investing in the properties of its sponsor, Ayala Land, and was launched in 2020 as the first REIT company in the Philippines. According to Ayala Land, AREIT is a new asset class that provides investors with dividend-based income, inflation protection, and portfolio diversification. Moreover, the company delivers excellent real estate and investment strategies that create sustainable value to all its stakeholders and aims to be the premier and leading REIT in the Philippines with a balanced portfolio providing stable returns and long-term growth. As of September 20, 2021, the company’s portfolio consists of three commercial buildings in Makati City, namely Solaris One, Ayala North Exchange, McKinley Exchange, Teleperformance Cebu, Ayala Land Mall — Pasig, and has recently acquired, through a 7-year lease, a sprawling 9.8 hectares (24 acres) of land in Laguna Technopark, a province south of Metro Manila.
The legal framework for the establishment of REITs in the Philippines has been in place since the passing of the Real Estate Investment Trust Act of 2009 (Republic Act №9856) back on the 17th of December, 2009. However, because of restrictive tax policies and high friction costs, the setting up of REITs in the country largely discouraged local and foreign incorporators. 11 years later, after REIT regulations were relaxed in January 2020, Ayala Land announced a month after that its subsidiary AREIT has filed a REIT offering to the Philippine Securities and Exchange Commission (SEC).
AREIT had its IPO in the PSE on August 13, 2020, amid the height of the pandemic, becoming the first listed REIT in the Philippines. The company had recorded an income of P1.1 billion during the January to September 2020 period, which is reportedly three percent higher than its REIT plan. Currently, it is headed by Jose Emmanuel H. Jalandoni as Chairman, who is also a Senior Vice President for Ayala Land and Chairman of several other related firms, and holds a Bachelor of Science degree in Legal Management from the Ateneo de Manila University and a Master’s in Business Administration from the Asian Institute of Management. He shares the helm of the company’s leadership with Carol T. Mills, AREIT President, Chief Executive Officer & Director, who is also serving as the President of AyalaLand Offices along with a number of other institutions. She holds a Bachelor of Science degree in Business Administration from the University of the Philippines Diliman as well as a Master of Business Administration degree from Dartmouth College in the United States.
Business Model
REITs work just like any other corporation. They need capital. AREIT is a publicly-traded real estate investment trust which gains its capital from public funding, otherwise known as the IPO. The people who buy AREIT’s shares and IPO are essentially investing in the corporation’s income-generating real estate properties. The real estate ownership of REITs is managed like stock portfolios. External funds from the IPO raise capital that enables AREIT to buy real estate, develop, and manage it, with the clear end goal of generating profits. From these profits are generated income, and a major portion of said income must be distributed to the shareholders on a regular basis. In a nutshell, AREIT makes money from the properties they purchase by renting, leasing, or selling them.
REITs work just like any other corporation. They need capital. AREIT is a publicly-traded real estate investment trust which gains its capital from public funding, otherwise known as the IPO. The people who buy AREIT’s shares and IPO are essentially investing in the corporation’s income-generating real estate properties. The real estate ownership of REITs is managed like stock portfolios. External funds from the IPO raise capital that enables AREIT to buy real estate, develop, and manage it, with the clear end goal of generating profits. From these profits are generated income, and a major portion of said income must be distributed to the shareholders on a regular basis. In a nutshell, AREIT makes money from the properties they purchase by renting, leasing, or selling them.
Industry Analysis
The local industry for REITs been established a little over a decade ago, but its growth and expansion then has been stunted by tight government regulations. As an attempt to boost this industry, the government has revised its stringent policies, which has resulted in a major influx of public interest for the new investment product. It is a rising industry in the Philippines, which warrants the fact that there exists not much competition.
AREIT is one of the first few REITs in the country, being the first one to be publicly listed under Ayala Land since 2020. As of March 2021, the second REIT under Double Dragon debuted at the PSE, and FILREIT has just been debuted in the same exchange last August 12 of this year. There are subsequent reports of other leading real estate companies planning to list their REITs on the PSE. It will take some time before we see significant progress in the property sector, but until then, the government will have to continue attracting investors by amplifying and improving the benefits that come with establishing REITs.
It is relatively difficult to enter the industry without having a firm foothold in the real estate industry. In order to qualify as a REIT in the Philippines, at least 75% of the deposited property must be income-generating and at least 90% of distributable income must be paid out as dividends to investors. The company must be registered with the SEC as a stock corporation with a minimum paid-up capital of 300 million. It must be listed with an Exchange and, upon listing, have at least 1000 public shareholders each owning at the minimum 50 shares and which, in aggregate, own at least ⅓ of the outstanding capital stock of said REIT. In terms of management, at least one-third or two, whichever is higher, of the board of directors shall be independent directors. It must appoint an independent Fund Manager and Property Manager, and all of its direct stakeholders (directors, officers, fund managers, property managers, distributors, and other REIT participants) must qualify under the fit and proper rule. Since the industry is still growing, there is not much competition in the REIT trade, at least for now. Currently, there are only three publicly listed REITs in the Philippines, and with its Reinvestment Plan mentioned earlier, AREIT has been innovating rapidly with its projects in a zealous attempt to get past the negative economic effects of the pandemic.
As a real estate company, AREIT has numerous suppliers for its construction projects’ raw materials. The threat of suppliers in the Philippine Real Estate industry is high, as there are many factors that affect the bargaining power of suppliers which may trickle down negative effects to the overall profitability of the firm. Banks and other private capital firms have an effect on this industry as well. Additionally, property owners have the power to control the cost of real estate. Commercial estate, which forms a large part of its portfolio, is significantly more expensive than residential real estate. The construction industry influences this industry as a result of material costs, wages, and also financing. Investors also bear influence on publicly traded real estate trusts. If they are not satisfied with company management, the market price will decrease, influencing equity, and so on.
The bargaining power of customers is low due to two primary reasons: low competition of key players in the industry, and high product differentiation. Because of the industry’s low bargaining power of customers, AREIT can be more flexible in terms of increasing or decreasing its price range. There are only a handful of publicly listed REITs in the Philippines, and a little more prospects who are seeking SEC registration. As a pioneering brand of REIT in the Philippines, it has taken a major headstart in developing its asset class for the benefit of its investors. Similarly, it can be said that AREIT stands out as a product in the real estate trust industry, as well as the greater real estate industry. It is like investing in multiple properties without actually having to shoulder the maintenance costs of said properties.
There is also little to no threat of substitutes in the REIT industry. Investors may opt to invest directly in real estate companies or other investment vehicles, but AREIT as the pioneering REIT gives it a significant advantage over other competitors.
Competitive Analysis
AREIT services mainly commercial construction projects particularly the BPO industry of the Philippines, which carries over a strong trend in the office leasing sector. The office leasing sector is a defensive segment in the property sector, but also largely promising due to the resurgence of the local BPO industry. Based on a study by global research firm Everest Group, the call center and business process outsourcing industry expects average annual growth of 2.7% to 3.2% until 2022. In perspective, they are performing exceptionally well amid many companies struggling to make ends meet. The Philippines BPO industry has taken wider strides amid the COVID-19 pandemic and has largely contributed to the Philippine economy trying to keep afloat. There is much reason to expect sustainable growth from the BPO industry as the country continues to be recognized as the call center capital of the world, according to several independent advisory reports such as the Kearney Global Services Location Index and the Tholons Global Innovation Index.
Investors should be wary of the long-term benefits of investing in AREIT, as they are one of the main beneficiaries of this profitable trend. According to experts, the Philippine outsourcing services will cover 15% of the total global outsourcing market by 2022. The BPO industry is also projected to grow 9% every year for the next 5 years.
The above graph shows the projected annual revenue and earnings growth by financial analysts from Simply Wall Street. It can be seen that AREIT shows promising indicators of substantial growth of earnings at 18.6%, being at par with the industry’s projected annual earnings growth at 16.9% albeit slower than the Philippine market’s projected growth at 22.8%. While the projected annual revenue growth of AREIT is stronger than the market by 1.7%, it is forecasted to grow slower than 20% per year. Moreover, its Return on Equity is forecasted to be high in 3 years' time at 20.2%. This means that the company’s managers are efficiently using its shareholders' money to generate profits, and has the potential to grow even further in 3 years' time.
It is also worth mentioning that its sponsor, Ayala Land, is one of the more prominent real estate companies well known for establishing and developing the Philippines’ first modern Central Business District, Makati City. With reputable experience in the industry, its managers are sure to navigate the firm into being a successful pioneering REIT.
Financial Analysis
Balance sheet
AREIT’s financial strength ratios show that the company is currently leveraging debt at safe levels in order to create more wealth. There is an evident increase in both assets and liabilities, with emphasis on the relatively more drastic increase of liabilities, owing to the fact that the company has been paying out dividends despite loss-making due to the pandemic. Operating cash flows are positive, which reiterates the fact that AREIT is covering its debts well. A good indicator is that the company’s interest payments on debt are well covered by the EBIT. In sum, the company is identified to be financially stable as the current debt-to-equity ratio is well below the 40% acceptable mark.
Income Statement
AREIT’s Income Statement from the Previous Year to the Current Year indicates that the company is doing okay in terms of managing income. Both Gross Revenue and Expense have increased. What is noticeable is that Gross Expenses have increased greater than Gross Revenues, which is a consistent observation as the company has indeed incurred more expenses in the past year due to the stringent lockdown measures.
Cash Flow Statement
AREIT’s Net Operating Cash Flows show healthy signs of the continuous inflow of cash in its income-generating assets. Since AREIT is currently building its asset class, cash from investing activities is significantly low, dropping to more than 1000%. AREIT is a long-term investment, which means that all its returns will reap fruit in the coming decades. Cash from financing activities has seen a strong recovery of around 124%, particularly due to the amount of investor confidence and positive sentiment towards AREIT as a profitable investment product, although this has yet to be sustained in the coming periods. The net change in cash has dropped from last year by 165% since AREIT is low on cash for its dynamic investments activities.
Investment Risks
As with any investment, there also come risks when investing in AREIT. One good instance is the current pandemic-caused economic downturn. When the economic situation is stagnant, productivity dwindles, and investors become less confident to invest in the Philippines. This affects the volume of trades, which in turn diminishes market capitalization, inevitably pulling down the stock price. In theory, if the COVID-19 situation worsens to the point where productivity reaches dangerously low levels, then by the same principle mentioned, AREIT would also be affected as its assets would then be unable to generate profits.
Market volatility is also another investment risk that investors should watch out for. It is important that investors keep a watchful eye on the state of the local and global economy because whatever happens in these spheres can possibly affect the stock market. The Global Financial Crisis in 2008 is a good example of an unexpected negative turn of events that went bad for a lot of investors who did not expect to lose so much after underestimating the importance of keeping oneself in the loop.
Reader discretion is advised as this is not financial advice. Please reach the author for any disputed facts.
Sources
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