I think one of the largest shareholder of Saizen Reit (Argyle Street Management) is wrong in their opinion.  They lobbied for the management in the recently completed AGM, to disperse Saizen Reit’s huge cash reserves as dividend to “enhance” share holder’s value. The full write up on Strait Times can be found below. I don’t think that is the right call.

Why I think it is not a good idea? You have a dig a little deeper to understand their business model :

Saizen unique loan structure

Unlike other Singapore based Reits, Saizen Reits actually pays down the principles of their loan with each payment. I talked about this before here. What this means is that their repayment amount is higher thus less distribution for shareholder. But they make use of this arrangement to get more cheap cash to make up the actual distribution if they are not paying down the principle. Take a look at the below write up about their distribution arrangement. Currently they are paying ~41% ($0.26) of their DPU from the cash reserve. If they pay out their cash reserves all at once, the DPU will be less certain. Meaning it will be a lot less. Investors of Reits like regular dividend payment. If there is any dip in Dividend yield, investors will not hesitate to sell their shares.

How much cash do they have before running out?

They currently have S$61M cash. But not all can be touched. About 1/3 of them are in  locked up in Singapore Bank or for local expenses. That leaves about S$40M in Yen. If they want to use similar amount of cash to top up the dividend pay out, they will need to set aside about S$36M, which mean, their cash reserve is just enough for one more round of distribution. So that is why I say, the management should keep the cash reserve to help it to maintain good stable yield for the longer term investors.

But how about the other risk factors?

The biggest current risk for this company is the depreciation of the Yen. Yen has weaken 20% in FY12 and we will see the trend continue through the next few years. This trend is mainly due to PM Abe pushing for looser fiscal policy to pull Japan out of the depression. And from what I am hearing from the management and my Japanese friends, it is working. Asset class have been raising slowly and there is a sense of optimism in the land of the raising sun. So what does that mean to Saizen Reit? Well, it means credit will remain cheap for now (totally insulated from the tapering happening in US) and very likely property value will go up. With better optimism among the citizens, we should expect wages to go up thus  more money for rental payment. In fact Saizen Reit management reported seeing an uptick of rental rate revision in the last quarter. This is the first time in many years.

So to invest or not to invest?

If you ask me, this Reit’s fundamental is pretty strong. Good cash, unique loan payment model, have unencumbered properties as buffer, discount to NAV, management is buying back shares etc. All looks good to me. But I will not enter at this point of time. the reason? The management is proposing a 5 to 1 consolation exercise. Which means, if you have 5 shares now you will wake up on Nov 5th to see only 1. Yes the price will also go up X5, but past history does tell us that most of time when consolidation happens,  the value drops immediately after the ex date. Depending on the sentiment of the market, company with good fundamental will eventually move back up. So my strategy is to sell some now and watch for the dip after consolidation and load up again.

If I were the management

I would take full advantage of the loose fiscal policy in Japan to take up more loans to buy units. Chances that asset value will increase thus lowering the debt ratio. Because that is the only way that Saizen Reit can grow. They can’t increase the rent too much (Japan have consumer law that prevent adjustment of home rental rate if they are current customers) and they can’t increase the occupancy rate any further. The only thing that is holding them back from purchase is the debt to asset ratio. They are at 38% now but they actually can go up to 60% legally (since they have credit rating) . So I say, “Go forth and multiply!”

Article from Straits times:

Enhance Saizen Reit’s value, says unitholder

Argyle Street Management says large cash hoard can be put to better use Published on Nov 01, 2013

By Mok Fei Fei

Argyle is arguing that the sum is high compared to Saizen’s competitors here and in Japan, whose average cash-to-market capitalisation ratio stands at 4.6 per cent.”Saizen’s cash position appears excessively high,” said Argyle in a letter earlier this week.The unitholder wants the Reit’s manager, Japan Residential Assets Manager (JRAM), to consider distributing a significant portion of its cash balance to shareholders through a special dividend.This, Argyle said, would help to maintain an efficient capital structure for Saizen.

Given the improvement in the outlook for Japan’s real estate sector, the unitholder is also calling on Saizen’s manager to explore potential portfolio property sales or mergers and acquisitions.Specifically, it suggested the appointment of an investment bank to help the manager look at ways to enhance unitholder value.”A significant valuation gap exists between Saizen and its peers,” Argyle said in the letter.

JRAM executive director Raymond Wong told The Straits Times yesterday that the manager has agreed to look at the recommendations and to consider all options. “The management is always committed to doing the best. We welcome all views, it is our job to look into all the ways to enhance shareholder value,” he said.Argyle issued its call ahead of Saizen’s extraordinary general meeting held on Wednesday.

Two resolutions – for unit consolidation and to renew the manager’s unit buy-back mandate – were passed overwhelmingly by Saizen’s unitholders. Argyle supported both resolutions.Saizen’s units ended unchanged yesterday at 18.3 cents.

feimok@sph.com.sg