Sasseur REIT: Participate In China’s Thriving Outlet Mall Industry With This IPO

Sasseur REIT, a Shanghai-based operator of outlet malls in China, is seeking a mainboard listing on SGX in what is set to be the first major IPO in Singapore this year.

China's outlet industry is expected to sustain its strong growth momentum and surpass the US to become the world's largest outlet market.

Its portfolio of four outlet malls are strategically located in fast-growing Tier-2 cities that have strong economic potential and expanding middle class populations.

Sasseur REIT has an attractive return potential of about 7.5% distribution yield in 2018.

It will also benefit from the presence of a strong sponsor and a solid pipeline of assets that could potentially be injected into Sasseur REIT.

Given the increasing popularity of outlet malls and rising consumer purchasing power, China's outlet mall industry looks poised for strong growth ahead. Investors who want a piece of the action can consider taking part in the upcoming Sasseur REIT initial public offering (IPO).

Sasseur REIT, a Shanghai-based operator of outlet malls in China, is seeking a mainboard listing on SGX in what is set to be the first major IPO in Singapore this year. The REIT is backed by strong cornerstone investors such as e-commerce giant JD.com and CKK Holdings (owner of Charles & Keith), and will be the first outlet mall REIT to be listed in Asia.

The IPO could raise about SGD 500 million, and Sasseur REIT is expected to have a market capitalisation of approximately SGD 900 million upon its debut. The REIT also promises a high distribution yield of about 7.5% in 2018.

Outlet Malls Thriving In China

China's outlet industry has developed rapidly since the first outlet mall commenced operations approximately 15 years ago, with total outlet sales revenue increasing from RMB 16.8 billion in 2012 to RMB 49.1 in 2016 (Figure 1), representing a compound annual growth rate (CAGR) of about 30.8%.

Figure 1: Rapid Growth In Outlet Sales Revenue Since 2012

Yet, despite its fast growth, China's outlet industry is still not able to meet the strong demand from Chinese consumers. In 2016, the industry had an addressable market size of RMB 79.7 billion, while the sales revenue of China's outlet industry was RMB 49.1 billion, indicating a supply gap of RMB 30.6 billion.

As China shifts to a consumption-driven economic model, the outlet industry is expected to sustain its strong growth momentum, with outlet sales forecasted to hit RMB 640.2 billion by 2030 (that's an impressive 20.1% CAGR from 2016 – 2030), surpassing the US to become the world's largest outlet market.

For a country with China's population and spending power, there are relatively few factory outlet malls. Its outlet mall penetration rate (measured by outlet mall GFA per 100 residents) remains low relative to that of developed economies such as the US, Europe and Japan, suggesting immense room for further market expansion, as outlet spending per capita grows closer to that of developed markets (Table 1). Moreover, a rising middle class and an increasing preference for well-known luxury brands amongst Chinese consumers are trends that will likely boost future demand for luxury products.

Table 1: China Outlet Industry Has Room For Expansion

Strong Sponsor Presence and Strategic Shareholders

The sponsor group (Sasseur Group) is one of the leading premium outlet mall groups in China (Table 2), with extensive experience and strong retail capabilities that Sasseur REIT can capitalise on to enhance its portfolio. Its business approach goes beyond conventional retail, incorporating mall architecture and various lifestyle elements into its luxury product offerings.

This experiential shopping concept differentiates itself from the competition and also helps attract more footfall by providing a wide range of services, such as food outlets, children care centres and entertainment facilities, that cater to a diverse group of shoppers, including individuals, families and tourists.

Table 2: Largest Outlet Mall Operators In China

Notably, the sponsor group is supported by strategic shareholders, such as L Catterton Asia (a private equity firm backed by LVMH Group) and Ping An Real Estate (the real estate arm of Ping An Insurance Group, one of the largest insurance companies in China). Sasseur REIT can leverage on the extensive networks of its sponsor's strategic shareholders for potential third-party asset acquisition opportunities.

Assets Strategically Located In Fast-Growing Cities

Sasseur REIT aims to capitalise on China's growing preference for higher-quality luxury items by investing in a diversified portfolio of income-producing premium outlet malls. It will have an initial portfolio of four properties (Table 3), all of which will be managed by an appointed entrusted manager (Sasseur Shanghai, a wholly-owned unit of the sponsor group).

Table 3: Sasseur REIT's Asset Portfolio

The outlet malls are strategically located in fast-growing Tier-2 cities that have strong economic potential and expanding middle class populations, and are also well-supported by the transportation infrastructure in their respective cities. Each outlet mall has its own distinct architectural style that complements the retail experience and various lifestyle elements to create an integrated destination shopping venue (Figures 2 – 3). Sasseur also has a first-mover advantage in these cities.

Figure 2: Distinct Architectural Style For Each Outlet Mall

Figure 3: Hefei Outlet Houses The Largest Cinema In East China

Active Asset Management Maximises Portfolio Potential

The portfolio, valued at approximately SGD 1.5 billion (as of 30 September 2017), has an aggregate net lettable area (NLA) of about 304,573.1 sqm and an average occupancy rate of 91.8%. Its weighted average lease to expiry (WALE) by NLA is relatively short at 3.2 years (1.2 years by rental income) as most of the lease agreements are short-term in nature, typically about 12 months. The leases are also primarily sales-based, whereby the rent is determined based on an agreed percentage of tenants' turnover (Figure 4).

Figure 4: Property Income Is Predominantly Sales-Driven

As the bulk of the property income is sales-driven, the properties require active management. In this aspect, Sasseur REIT will certainly benefit from the experience and track record of the entrusted manager, who usually works in close collaboration with the tenants on areas such as retail strategy and inventory management to help them drive sales.

If a particular tenant is not generating sufficient sales revenue, the manager will work closely with the tenant and may propose changes to the rental arrangement in order to improve its takings. The manager may also choose not to renew its lease and replace the underperforming tenant with other prospective tenants from its database.

The cultivation of a good working relationship with its tenants and the flexibility to adjust the tenant mix (courtesy of the short-term leases) ensure that the portfolio is managed in an optimal manner that drives turnover growth, which in turn increases Sasseur REIT's property income.

Attractive Return Potential With Strong Sponsor Pipeline

Sasseur REIT offers investors an attractive distribution yield of about 7.50% in 2018 (7.82% in 2019), higher than most of its other listed peers in the China retail space (Table 4). Based on its offering price of SGD 0.80, Sasseur REIT trades at a slight premium to its net asset value.

While this may be an indication that its current valuations are perhaps on the upper end of the value scale compared to its peers, it is worth noting that the fundamentals of the outlet mall industry is vastly different from traditional retail. As such, we believe Sasseur REIT's higher P/NAV ratio is justified due to the strong growth potential of the outlet mall industry.

Table 4: Valuations of China Retail REITs And Business Trusts

With a healthy gearing ratio of 35.0% and a debt headroom of about SGD 166 million before it hits the 45% gearing limit, Sasseur REIT has the flexibility to make further yield-accretive acquisitions. The right of first refusal (ROFR) option provided by its sponsor allows Sasseur REIT to leverage on group synergies to obtain new assets.

There are currently five outlet malls in the sponsor pipeline that could potentially be injected into Sasseur REIT. Assuming Sasseur REIT acquires full interest in these properties, the aggregate GFA of the portfolio will expand by approximately 0.7 million sqm – that's almost triple the GFA of the initial four outlet malls.

Stability of Distributable Income

To ensure that unitholders receive distributions with a certain level of stability, Sasseur REIT's distributable income will come from rental payments that comprise a fixed and variable component. The guaranteed fixed component has a built-in annual escalation of 3.0% that provides downside protection to unitholders, while the variable component, which is pegged to a percentage of total sales, enables unitholders to participate in any potential upside from the four outlet malls in the future (Figure 5).

Figure 5: Forecasted Rental Income For Next Two Years

To sweeten the deal for unitholders, there is also a minimum rent condition at the portfolio level, under which the entrusted manager will ensure that the total rental payments received by Sasseur REIT will not be less than a stipulated amount over the next ten years (SGD 95.9 million for 2018, SGD 124 million for subsequent years).

The minimum rent condition will only fall away if the portfolio achieves the minimum rent for two consecutive years starting from 2018. The good news for unitholders? They are at least guaranteed to receive the indicative distribution yields of about 7.50% and 7.82% in 2018 and 2019 respectively.

Potential Pitfalls To Look Out For

While China's outlet mall industry is an exciting area to be in, the success of Sasseur REIT is ultimately dependent on the property performance and the management capabilities of the entrusted manager, both of which are potential risks that can affect Sasseur REIT's distributable income. Moreover, some of the portfolio properties (Hefei and Kunming outlets) are relatively new, and may take some time to stabilise and mature, a process that typically takes about 8 years.

Furthermore, unitholders should note that Sasseur REIT is exposed to interest rate risk as its borrowings are primarily variable rate instruments. In a rising interest rate environment, Sasseur REIT may incur higher debt servicing costs, which is expected to put downward pressure on distributable income.

That said, investors may be heartened to know that they are investing in Sasseur REIT alongside a blockbuster list of cornerstone investors that include e-commerce giant JD.com, CKK Holdings, Bangkok Life Assurance (a leading life insurance company in Thailand), Credit Suisse, DBS Bank and Entrepolis (private investment holding company of Dr Robert Yap, executive chairman of YCH Group).

Correction: An earlier version of this article incorrectly stated that the P/NAV of Sasseur REIT is 0.60. It is not. Sasseur REIT's P/NAV ratio is about 1.02. We apologise for the mistake.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.