Yield Investing versus traditional Value Investing
Motivation
No one doubts that the current economic crisis is one of the worse the world experience since the great depression in the 1930s. However, the silver lining is that it brings one of the greatest investment opportunities too. I remember $20,000 is not even sufficient to buy one lot of DBS or UOB, now this same amount can buy one lot each of DBS, UOB and OCBC (with some to spare if not because of the rally on friday).
I had wrote before that market price always lag (not lead) fundamental changes. Even though stock market are generally forward looking, and can stage a sustained rebound months before the real economy turn around, fundamentals must improved first before that happens. But I have yet to see any improvement in fundamentals. Many companies, across varying industries, are either seeing substantial drop in profits or making losses (due to heavy overheads or intangible asset write-downs).
Thus, other than waiting and grabbing shares of firms going way below their (deteriorating) fundamentals, is there any alternatives?
Yield Investing
I began to toy with a new the idea after I bought in First Ship Lease Trust (FSLT) and Cambridge Industrial Trust (CIT). Despite the volatility (generally downwards) of their share prices and that of other shares in my portfolio, both paid generally consistent and substantial dividends. I recall my target cost of capital was about 15% compounded annual returns, so that I can double my investment approximately 5 in years. Both could easily exceed this expectation solely on dividend payout (even after factoring reduced payouts).
Given the uncertain economic outlook, spare cash might not be easy to come by as I need to set aside cash for more rainy days ahead (thus no longer money I can afford to lose). My source of funds to grab bargains shrunk substantially as a result. Fortunately my quarterly dividend income come in nicely to fill the gap.
As a result, why don't I increase my dividend yielding equities using whatever limited spare cash I can squeeze and use the regular payout to fund my bargain hunting on good businesses going below their value? Unless there is a specular recovery of the share prices of all companies across the board, I am sure the dividend income will come in time to grab a few still neglected by the market.
Criteria for Yield Investing
Not all high yielding equities (predominantly Business Trusts such as REITS and Shipping Trust) are suitable for yield investing. There are a few criteria to meet which are derived from the objective of yield investing:
To provide sustainable, regular, and frequent dividend income.
Thus the criteria are:
- Low volatility in business revenue, cash flow, payout policy and consequently payout, i.e. distribution per unit (DPU)
- Simple and understandable business model
- Sustainable business model
- Relatively high yield (>20%)
FSLT and CIT easily met the 4 criteria with their clear and simple business model (buying assets and lease them on long term binding contracts) and sustainable DPUs. I was tempted to just invest in FSLT given it's current yield is in excess of 40% but I had to be rational and act with prudence. I need to diverify to ensure a sustainble and regular dividend income stream.
My Watchlist
Going forward, my current targets are Pacific Shipping Trust (PST) and Hyflux Water Trust (HWT). PST is simple, easy to understand and able to sustain its DPU. I had already talked about PST and will just discuss more on HWT.
HWT had long term concessions to run water treatment plants in China and revenue should be fairly stable so long as they are able to meet certain minimum treatment volume, though current economic climate could threaten the demand when companies pull out of the industrial zones the plants operate in. A greater concern arises on the yield itself. At last done price of 29 cents, the yield is about an annualised 19.24%. But the DPU for 2008 and 2009 included a 31.5% waiver from the sponsors who still hold on to some HWT units (i.e. giving up their dividend entitlements). Discounting the waiver, the actual yield would have been merely 13.2%. Further reducing its attractiveness, is the fact that the payout is only half yearly, compared to quarterly for REITs and shipping trust.
However, I see the long term prospects (and dividend) of HWT. If not due to the ongoing credit crunch, HWT could have raised more funds to take over more water treatment assets from Hyflux to boost its revenue stream (and dividend). Thus, if the price is right, I will consider getting some HWT to further strengthen my dividend income.
Conclusion
In a time where cash is king and conserving cash is key for short term survival, I must not lose sight of my long term objective and risk underinvesting for the future. In the midst of my resource planning, I came up with the concept of yield investing to fund my long term investing needs. Anyway, this should only work now as such ridiculously high yields will be a thing of the past when the economy recovers.
Labels: My Thoughts on Investment
posted by Market Uncle at
09:27
16 Comments:
Uncle, I have the exact same thoughts (though diff watchlist). However, I would like to sound some caution on CIT:
CIT's bank borrowing interest is now 7.2%, which is 2.12 times FY08. In FY08, a total of 12.42m is paid on interest. As such, additional borrowing cost = 13.91m.
If everything else remains the same (ie. no tenant defaults, no rental reduction), this will result in a yield of only 16.6% based on a price of 22.5c. Not too bad, but can we expect no defaults/rental reduction?
The other discomfort I have with CIT is that the new loan terms are not exactly disclosed. Given their high leverage (D/E = 0.623) and the impending property val impairment, it's possible that the loan has LTV convenants that will be breached, hence the possibility of a rights issue.
I did similar analysis on other REITs, and found none that will paying >= 20% (with a reasonable good chance).
In short, this strategy requires one to truly dig in and compute the expected yield, rather than looking at trailing yield. Still, I think it's a prudent move to guard against a prolonged recession.
Good luck! :)
- Market Nephew
Hi,
I had already factored in the higher expected borrowing cost when I got CIT again:
http://market-uncle.blogspot.com/search/label/Cambridge%20Industrial%20Trust
Since then, the effective interest rate had been revised upwards to 7.2 from 6.6%. The management expected a 1.2 cents reduction in annual DPU. Based on last quartely payout of 1.373 cents, the yield is still 19%, i.e. (1.373 X 4 - 1.2)/22.5. Base on last done, its 20%.
But that's management's estimation. On my estimation, see blog link above, the expected annual DPU is around 4.0 cts, on 22.5 cents, yield is 17.8%, on last done, yield is 18.6%. Still very impressive.
(Working:
Debt: 390.1m
Effective interest: 7.2%
Current quarterly interest: ~$3m
Additional borrowing cost: 7.2% x 390.1 - 3m x 4 = 16m
Quarterly distributable income: 12m
No. of outstanding shares: 796.4m
Estimated DPU on higher interest:
[12m x 4 - 16m ]/796.4 = 4cts)
As for loan terms, the preliminary terms given in the results presentation is the loan-to-value covenant of 55% (compared to debt-to-asset value now of 37.8%). Interest cover factoring higher interest rate is about 2.2 times (just about current interest cover loan covenant). Thus I do agree loan covenants could be breached and do expect a high possibility of rights issue (same goes to FSLT).
As for rental income, I'd think these are fairly stable given the its long outstanding leases. And since these are outlying industrial estates, I'd assume the rents are not crazy sky high kind seen in down town office rents. So the chance of default should not be as great.
For my strategy, I do agree with getting high yield equities based on forward looking estimation rather than historical returns. That's why I got CIT and FSLT.
Hi Uncle, I got a lower yield becos the I base the DPU on Q408 distributable income (10.9m).
Plugging that into your calculations, the yield stands at (10.9 x 4 - 16)/796.4 = 3.47c, assuming no rental defaults/reduction going forward (I'm less optimistic than u, but one man's meat is another's poison).
Thanks for the tip on the LTV covenant in the presentation. I missed that.
- Nephew
Hi,
4Q's net distributable income was lower by a million or two due to a few non-recurring items:
1) higher property tax of 0.5m (should be lower for FY2009
2) $0.8m expensed for shariah compliant certification (previously capitalised)
3) $0.2m written off for professional fees incurred in relation to aborted projects.
Anyway, I do agree with you on being more conservative and hence on the yield you've arrived, just marginally over the 15% cost of capital I require, quite off the 20% desired by my yield strategy.
I also agree its difficult to find a sustainable forward yield exceeding 20% in the REITs. (So far only the shipping trust can achieve that, due to the risk involved)
a new interesting twist to FSLT dividend.
It seems that for holders opting for DRPS, there is a 10% discount on issue price.
As such, arbitrage may take place, inwhich holders opt for 100% scrip election and then sell it on open market.
Let see how efficient the market really is on the few trading days after 27th.
Hi DESA,
How do you know the new units are given at a 10% discount?
http://fsltrust.listedcompany.com/newsroom/20090421_Guide_to_FSL_Trust_DRS_1.pdf
The EGM approved a 10% max discount.
If that happen, all big boys will max out their DRPS entitlement, and do a sales on the same day of announcement, thus pocketing the discount ( and getting the distribution at an earlier date)
Assuming discount = 10%, this implied that the sale and convert will net the investor (before transaction cost) an 11% gain. Assuming an average of 2% transaction cost, this still represents a risk free 9% of the DPU of USD0.0245
REITS and Business TRUSTS are yield vehicles, period. People do not invest for capital gains but for yield and the quarterly payout.
As the units are issued with immediate vesting and will rank parri passu, I fail to see how such DRS scheme will encourage holders to keep it and not arbitrage the discount immediately! Unless of course, they adopt a view that there may be a re-rating down the road.
Vested before it became a penny stock
Hi desa,
FSLT will XD on Monday, 27th. Based on last closed price on friday (last day of CD), 0.435 SGD or about 0.292 USD (1.49 SGD to 1 USD), 2.45 cts USD DPU translates to about 8.39%.
Given the fact the discount is capped at 10% during the EGM, I'll assume the discount will be at least 8.39% from last close price before XD.
Thus, there might not be arbitrage opportunity at all if FSLT after XD actually drops below 0.292 - 0.0245 = 0.2675 USD or 0.3986 SGD. I'll actually think it could drop more than that based on past experience (price after XD usually drops more than dividend given).
Under current economic climate with limited visibility and poor sentiment, I'll think quite a number of people will actually opt for cash instead of units. Cash is king now. For me, I'll prefer to take new units for this quarter and see how things go from here. How about you?
Hello,
Long paragraph from the circular issued in Sep 08 abt the DRS
The issue price of a Unit, which shall for the purpose of calculating the number of Units to
be allotted and issued as fully paid to Participating Unitholders, pursuant to the Distribution
Reinvestment Scheme, be an amount in US$ determined by the Trustee-Manager (the
“Relevant Amount”), which Relevant Amount shall not be set at more than 10% discount to,
nor shall it exceed, the volume-weighted average traded price per Unit for all trades on the
SGX-ST for each of the Market Days during the period commencing on the day on which the
Units are first quoted Ex-Distribution on the SGX-ST after the announcement of the
Distribution and ending on the Books Closure Date (“Price Determination Period”). In the event that there is no trading in the Units during the Price Determination Period, the Relevant
Amount shall not exceed the volume-weighted average traded price per Unit for all trades on
the SGX-ST, for each of the Market Days during a period to be determined by the Trustee-
Manager prior to the announcement of the application of the Distribution Reinvestment
Scheme to such Distribution.
hi dsea,
Please correct me if I'm wrong, from the para, it only state the cap on the discount and the how the discounted price could be set in the event there's insufficient trade.
Thus, how the market price goes after XD is still anybody's guess. I'd think there really shouldn't be much a arbitrage opportunity.
Hello
My literal interpretation is that the discount is applied after XD....."....shall not be set at more than 10% discount to,
nor shall it exceed, the volume-weighted average traded price per Unit for all trades on the
SGX-ST for each of the Market Days during the period commencing on the day on which the
Units are first quoted Ex-Distribution ..."
+++++
As such, if your intention is to receive cash, it is better opt for DRS as essentially, by opting for DRS, and selling your current holding, you are pocketing the discount.
Simplistically, if a portfolio of 50lots FSLT, dividend received is SGD1837.5
Even if we assume an XD price of SGD0.39, and assuming a DRS price of SGD0.355 (8.97% discount), the number of DRS shares issued would be 1837.5/.355 = 5176 shares.
The value of the shares issued is thus 5176 x .39 = SGD2018 (if you sell at SGD.39)
+++++
After one opt for DRS, whether one hold it or sell it, it depends on ones perspective of long term view of FSLT.
To lock in the arbitrage profits, one would originally have to intention of collecting the quarterly dividends, but would do the circuitous route of collecting the DRP Shares and selling them.
Hi dsea,
Oops sorry, you are right, I didn't read properly, the price determination is XD to book closure, not before.
In that case, the 8+% discount I calculated earlier no longer applies.
Looking at the dates again, XD is 27th April, discounted price is released on 30th april and new shares are only credited on 29th May.
For those taking cash, the amount to be expected is unchanged.
For those opting for shares, their profit/(loss) will still be uncertain.
Look it this way:
1) No matter how low FSLT drops after XD, the discounted price will be lower still. So there will always be an immediate 'paper gain'.
2) By either 29th May or before, I assume FSLT will announce the take up rate, i.e. now many new shares will be created.
3) By mere fact of dilution, FSLT shares will undergo another round of adjustments after the news is announced. Theoretically, depending on the take up rate, the enlarged share pool will result in dilution in share price. Money is taken out of the system but yet there are more shares to divide the remaining value of the company.
4) Thus the 'paper gain' above will be reduced after the announcement of the take up rate. It will be further adjusted after 29th May. If most tried to sell together on or after 29th (depending on when the shares are credited), the 'fire' sale will erode whatever 'gain' that remains?
Please correct me on my analysis above. Thanks for highlighting the DRS gain, I almost published an article on this and will have got all my analysis wrong. Thanks thanks!
Hello,
I reckon the dilution to be about 9.2% (back of envelope calcultaion) IF ALL shareholders subscribe to the DRS.
A few interesting questions get thrown up
1) Can the TRUST Manager grow the DPU by 9.2% to manage the dilution? I doubt so, as revenue of FSLT and other Biz Trusts are locked in sometime ago.
2) If that is the case, can we then assume that the SPONSOR (ie., the major shareholder will not go for DRS? Then, what is the intention of the major shareholders. (whatever they do, it has to be declared and it has a signalling effect of their intention, whatever they may have said)
Note that the TRUST Manager already pocketed fees in the form of mgt fees.
The sponsor owns a large percentage of the TRUST, and if they are willing to take DRS, it indicates that they perceive that the TRUST is undervalued.
If they take out in the form of cash (look, Business TRUSTS and REITS are yield vehicles, no matter what you say), it may indicate that they view that their cash could be invested better elsewhere.
In conclusion, for retail investor....
we just need to decide on the following.
a) Do we want the quarterly payout?
If yes, go to b); (NB : The default option is cash only)
If no, Subscribe to DRS System and keep the additional shares that you acquire at a few percentage discount off market price.
b) Do you want extra few percentage point,
if yes, got to go through hassle of acquiring via DRS and selling within the 3 day period the estimated # of shares.
if no, no action needed, you will receive your cash from the quarterly payout as it is the default option.
PS : I am not worried abt dilution of NTA. I don't use it to value Biz Trust. I look at prospective yields.
Hello
Your comment "No matter how low FSLT drops after XD, the discounted price will be lower still. So there will always be an immediate 'paper gain'."
Mine : Agree. But we can monetise by selling the estimated qty within the "Price Determination Period"
Your Comment : By either 29th May or before, I assume FSLT will announce the take up rate, i.e. now many new shares will be created.
Mine : I shld think so. No mention in their circular.
Your comment :
i) By mere fact of dilution, FSLT shares will undergo another round of adjustments after the news is announced. Theoretically, depending on the take up rate, the enlarged share pool will result in dilution in share price.
ii) Money is taken out of the system but yet there are more shares to divide the remaining value of the company.
Mine : I have broken your comment into 2 parts.
Comment i is logical. I agree on the dilution.
Comment ii is erroneous. If you take DRS shares, you do not take cash. As such, the funds stays in the Business TRUSTS.
As mentioned, I am not worried abt the retail investors decisions. (afterall, we probably make up only 10-15%. I am more concerned abt the SPONSOR and their related parties : I think they hold 35% to 45%.
Your comment : Thus the 'paper gain' above will be reduced after the announcement of the take up rate. It will be further adjusted after 29th May. If most tried to sell together on or after 29th (depending on when the shares are credited), the 'fire' sale will erode whatever 'gain' that remains?
Mine : Agree to some extent. As such, if we want to monetise the discount inherent in the DRS, then we have to sell at the PRICE DETERMINATION PERIOD to lock in the discount. That is why I call it an arbitrage.
I forgot to add.
In conclusion,
1) see what the big boys are doing and ;
2) whether the managers can grow the DPU to match the dilution
Hi dsea,
I kind of like this discussion :). Always like to learn more.
I fully agree with you on what the big boys do. Action speaks louder than words. Their take up rate will be the key on the perceived worth of FSLT.
On your comment "...But we can monetise by selling the estimated qty within the "Price Determination Period..." ... hmm, ok, I get what you mean... but it will also mean the 'fire sale' will start earlier than I thought, oops.
On my comment "...Money is taken out of the system but yet there are more shares to divide the remaining value of the company..." and your reply "...If you take DRS shares, you do not take cash. As such, the funds stays in the Business TRUSTS...". No, cash not paid out in dividend is used to pay off bank loans. Whether to shareholders or to banks, money will have left FSLT by the same amount.
On your comment ..."Can the TRUST Manager grow the DPU by 9.2% to manage the dilution? I doubt so, as revenue of FSLT and other Biz Trusts are locked in sometime ago...". I fully agree. Depending on take up rate, the DPU will keep dropping.
But we must bear in mine that the reason of this exercise (DRS, voluntary prepayment of loan etc) are for FSLT to improve its financial position.
The DPU (and corresponding yield) will be hurt in the near future. So long as the mgt can make use of the better financial position to re-capture DPU accretive deals again after the financial storm have past, shareholders (especially those who opt for shares) will stand to gain.
Hence 'logically', it make sense to take up shares instead of cash. But in order for the above financial position improvement coup to succeed, it really require most if not all shareholders to opt for shares. And since as you've pointed out correctly, the sponsors must lead with an example.
Thus I'll opt for shares first for this quarter and see how things turn out, not for quick arbitrage opportunity, but a hopefully better future after the financial crisis ends.
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