Treasury China Trust (OCBC)

Not Rated
Current Price: S$2.10

Diversification into China's tier-2 cities

Betting on China. We recently visited TCT's commercial assets in Shanghai and Qingdao, including the newly acquired Central Avenue Mall and pending Huai Hai Mall (midst of acquisition with settlement no later than 30 Jun). We observe that TCT has over time evolved its strategy in China, which used to focus on commercial assets and development projects in tier-1 cities such as Beijing and Shanghai . Recently, it has concentrated on regional expansion into tier-2 cities, including developing a large-scale retail property at the Laoshan district of Qingdao with the Trio group. TCT is also actively looking at deals in Xi'an in Shangxi province, forming a strategic partnership with the Ginwa Group to tap the emerging retail market in central and west China.

Three key advantages. We observed that TCT has three key advantages in China. First, TCT is listed as a business trust instead of a REIT, with the more flexible structure of 30% development cap and 45% gearing limit, as stipulated in its trust deed. The development component sets TCT apart from REITs which have little development exposure (10% deposited proper ty max) . TCT is thus bet ter posi t ioned to achieve accretive-yields due to cost savings from vertical integration. It is also not bounded by investment constraints, such as at least 75% of assets must be invested in income-producing properties. Secondly, TCT is upscaling its tenant mix from mostly low-mid tier to mid-high end retailers, which provide income uplift. Presently, some of its existing leases are well below prevailing market rates. For example, the anchor tenant Parkson, at City Centre, is paying only RMB1.73 psqm/day (average rate is RMB6 psqm/day). With the completion of the City Centre extension, Parkson will be vacating the property in 2012, whi le Marks and Spencer was roped in as the replacing tenant on a 10+5 years lease. On TCT's debt portfolio, 85% is USD-denominated but 100% of its revenue is in RMB. TCT thus enjoys low borrowing costs, while the likely RMB appreciation in the mid to long term provides further forex upside.

Supply overhang remains. According to DTZ, there is an anticipated supply of new office space in Shanghai, amounting to about 100% of existing stock in 2011-2014. Likewise, highend retail space is expected to increase by another 50% from 2011 to 2013. The large new supply is expected to drag down overall occupancy rates and intensify the "winners/losers" divide among the Shanghai properties. Oversupply and inflation risks (dampening demand) remain our top concerns for the trust and we expect management to consciously address these as the trust grows in asset size. We do NOT have a rating for TCT presently.

Background
About TCT. Operational in China since 2005 and listed on the SGX in June 2010, Treasury China Trust (TCT) is the first Singapore listed business trust focusing on commercial real estate in China, with AUM in excess of RMB 11.5b (S$2.2b) and a quality of portfolio of more than 800,000 sqm of office and retail properties comprising four income producing assets and three development assets, administered by a team of 80 professionals. TCT aims to position itself as a "total return vehicle", with a combination of recurring income from existing portfolio as well as potential upside from selected development properties. Shareholders' value can emanate from both organic growth as well as capital appreciation. Embedded in TCT's Trust Deed are the following corporate structures to impose various disciplines:
1) Minimum of 80% of net distributable income to be distributed in the first three years
2) Maximum gearing cap of 45% (based on total assets)
3) Maximum development cap of 30% of total assets

The trust also has the option of distributing income from net distributable income and realized and unrealized gains from asset enhancement - allowing the entity to share gains from development appreciation or sale and/or reinvest the returns into higher growth potential assets. TCT has undertaken to pay out minimum 80% of its net rental income for the first three years and 50% thereafter. The looser financial disciplines allow TCT to be more flexible, which is the key to its "Total Return Vehicle" strategy.

SWOT Analysis
Strengths:
- Experience as owner, manager and developer of commercial real estate in China. TCT has successfully carried out various asset enhancement initiatives, improved tenant profiles and achieved positive rental reversions, especially from legacy leases in its existing assets.
- Flexible corporate structure as a listed business trust (vis-à-vis a REIT)
- Strong corporate governance
- Exposure to RMB which provides 100% of TCT's revenue base and the associated benefits of its likely appreciation in the mid to long term.
- Connected advisory board (senior executives of China's SOE), who can assist with navigating and resolving any governmental and regulatory issues that may arise.

Weakness:
- Over-reliance on the Shanghai property market
- "Diffused" positioning in the market (involves in Office, Retail and Industrial Real Estate)
- Concentration risk on the City Centre asset (accounts for 71% of 1Q11 NPI)
- TCT's stock is thinly traded, which inherently increases share price volatility (partly because TCT was listed on SGX by introduction, with not many analysts covering it).

Opportunities:
- Ride on China's robust economic growth
- Exposure to appreciating RMB (revenue) and depreciating USD (borrowings)
- Success in Shanghai provides jumping off points to other central and western markets in China
- ROFR to acquire any income producing commercial real estate or development land in Greater China sourced by sponsor (Treasury Holdings Group)

Threats:
- Supply overhang in Shanghai - Increased competition
- Inflation risk
- Regulatory risk - More tightening measures from the Chinese government
- Further credit tightening in China which will increase RMB borrowing costs