Ann: June 2022 Valuation Update and June Quarter Distribution, page-10

I thought I will do a more detailed analysis of CLW and address some major headwinds, we all agree that CLW is a quality REIT with blue chip tenants and long WALE. If they managed to survive CoVid with 100% rent collection, then we can confidently say that rent will keep on coming in for the next decade.

The major problem or uncertainty we are facing now with CLW are mainly 2 issues:

1. Rate Expansion which will lead to NTA drop, making the REIT breach its LVR and loan covenants, hence resulting in deep discounted capital raising in the worst possible credit cycle.

2. Interest rate rise sharply which will cause interest repayments to go up significantly and hence lessen the dividend paid to shareholders.

Out of the 2 above, the rate expansion and how much and quickly interest rate will rise is beyond the management’s control and hence little they can do about it. However, the biggest concern is capital management as deep value capital raises can destroy shareholder value instantly and make it hard to recover.

After reading through their report, I have noticed that CLW has mentioned debt and equity capital management as a key risk, to address this, they have now a variety source of lenders that they can get loans from, ranging from domestic to international banks as well as issuing bonds at an attractive rate. This is vastly different to GFC when REITs generally have a very limited source of lenders (mostly domestic banks)

Also worth mentioning is the length of their loans, back in GFC 2008, most loans has a maturity length of 2-3 years, this time, they are 5 years plus. I have noticed that the majority of CLW’s debt are due in 2027, with some smaller debt due in 2024, I’m sure that during this period, the management can definitely get a feel of the debt market and its liquidity and make their judgements based on market conditions. It is not like CLW needs to refinance all debt in 3 years time, the debt expires in stages and with the quality of their portfolio, they can surely do something about it.

Now let’s do some comparisons to GFC.

1. Debt level, back then REITs such as Macquarie Countrywide; Babcock & Brown Japan Trust all carried a debt level of 60%. Such leverage level are now non-existent. CLW with the quality of its portfolio, certainly can cope with a slightly higher debt, hence 40% is not without its risks but it is manageable.

2. Sudden withdraw of liquidity, back in 2008, liquidity almost dried over a very short period of time and anything related to REITs are viewed as toxic. This time we know what is coming or possibly coming and have some time to plan for it. Liquidity won’t disappear overnight.

3. ICR, the interest coverage ratio is now higher compared to 2008, this is due to the low interest rate we are paying at the moment so is subject to change, but how quickly the rate will rise is anyone’s guess. RBA did state that the rate of rise is dependent on data coming in at their monthly meetings, hence if market does slow down, so will the rate of rise.

4. Hedging, the amount of debt that’s hedged now is higher compared to 2008, with CLW’s portfolio over 50% of the debt is hedged. This level of hedging in tandem with a significant increase in the quality of management of debt has meant that income certainty in the sector has been enhanced.

5. There is a big disconnect between the listed and unlisted commercial market, if risk does get high, CLW with their quality of buildings/tenant can certain sell some properties at NTA or above book value and pay back some debt to lower their risk. Plus 50% of their portfolio is linked to CPI increase and other 50% fixed increase, so as long as interest rate doesn't go up too rapidly, our income will be protected.

All these points plus CLW trading at such discount makes it a good buy, the management certainly has time to plan it out and freeze of liquidity overnight is not going to happen. How the share price will move over the next year or two is beyond anyone’s guess. But I think we will be ok look back 10 years from now.