Brief Equities Bottom-Up: Manulife US REIT (MUST SP): Strong FY18 NPI Growth Led by Acquisitions and more

In this briefing:

1. Manulife US REIT (MUST SP): Strong FY18 NPI Growth Led by Acquisitions
2. Shimadzu (7701 JP): 3Q Results Suggest a Trading Range
3. Olympus: 3QFY03/19 Profits Decline on the Back of Litigation Related Costs
4. Cypress Semiconductor. The Perfect Acquisition Target.

1. Manulife US REIT (MUST SP): Strong FY18 NPI Growth Led by Acquisitions

Manulife Us Reit (MUST SP) announced a 3.6% year-on-year (y-o-y) growth in adjusted DPU to 6.05 US cents for financial year ended 31 December 2018 (FY18).  Net property income (NPI) for FY18 grew 55.4% y-o-y to US$90.7mn, beating our forecast by 15%. Distributable income grew 51.9% y-o-y to US$71.0mn, mainly due to contributions from the four office properties acquired in 2017 (Plaza and Exchange in New Jersey) and 2018 (Penn in Washington D.C. and Phipps in Atlanta).  The 2H18 distribution of 3.04 US cents per unit will be paid on 29 March 2019. The book closure date is 19 February 2019.

Strong occupancy rate and rental escalation continue to support organic growth

MUST continued to maintain high portfolio occupancy rate of 96.7% and long weighted average lease expiry (WALE) by net lettable area (NLA) of 5.8 years. Leases signed in FY18 resulted in positive rental reversions of 8.9%. Moving forward, the leases expiring in 2019 are minimal while 60.7% of the portfolio’s leases by NLA will only expire in 2023 and beyond. As the majority of MUST’s leases by gross rental income have rental escalations averaging 2.5% p.a., MUST’s gross revenue will continue to enjoy stable organic growth. In addition, MUST’s properties are Class A and Trophy assets in cities where future supply are limited. Majority of its properties have passing rents below market rents, which further supports organic rental growth.

Potential acquisitions remain as key catalysts

MUST’s balance sheet remains strong (aggregate leverage at 37.2%) and it has additional debt headroom of about US$209mn before hitting the maximum regulatory gearing limit of 45%. As its unit price had rebounded from a low in 4Q18, the discount to net asset value (NAV) was removed. Currently trading at about 1.07x P/NAV, MUST may see greater opportunities for potential yield-accretive acquisitions.    

Proposed US Tax Act, 267A Regulations no material impact

The 267A Regulations are still in proposed form but the manager expects that the proposed regulations and the proposed Bardados tax changes will not have any material impact on the net tangible asset (NTA) and DPU of MUST.

Maintain “Buy” with fair value of US$1.04/unit

Valuations remain attractive with FY19F and FY20F yield of 7.1% and 7.2%. From its lowest point of 69.5 US cents in 4Q18, MUST’s unit price had rebounded about 23%, outperforming the FTSE ST Real Estate Investment Trusts Index. We maintain our BUY recommendation with a higher fair value of US$1.04, implying a 21% upside from the current price (coverage initiated on 16 Nov 2018). Reversing from a position of discount to net asset value to the current 1.07x P/NAV, , MUST may see greater opportunities in making yield-accretive acquisitions. Fair value is derived based on the dividend discount model with a required rate of return of 9% (using U.S. 10-year risk free rate of 2.64%) and a terminal growth rate of 1.5%.

2. Shimadzu (7701 JP): 3Q Results Suggest a Trading Range

Shimadzu’s 3Q results were good enough to reassure long-term investors, but not good enough to be called a buy signal. Sales and operating profit were up 4.5% and 4.6% year-on-year, respectively, in the three months to December, an improvement over 2Q but well below the double-digit increases recorded in 1Q and last fiscal year.  Forex losses and other factors led to a 2.2% decline in net profit. 

Sales were up in Japan, Europe and Asia ex-Japan and ex-China, but down in America,  China and Other Regions. Sales of core Analytical & Measuring Instruments were up 2.4%, operating profit on those sales was up 4.1% and the operating margin rose to +15.4% from +15.1% the previous year.

Sales of Industrial Machinery were down 5.7%, but operating profit on those sales was up 2.7% and the division generated a +9.7% operating margin vs. +9.0% the previous year. Sales of turbo-molecular pumps, primarily to semiconductor equipment makers, were down 14.3%.

Medical System sales were up 10.6% and the division generated a +1.5% operating margin vs. + 0.1% the previous year. Aircraft Equipment sales were up 12.1% but the division made a -0.5% operating loss vs. +1.2% profit the previous year. 

At ¥2,659 (Friday, February 8 closing price), the shares are selling at 24x our EPS estimate for FY Mar-19 and 12x EV/EBITDA. The five-year historical P/E range is 13x – 30x, the EV/EBITDA range is 6x – 16x. Over the next several quarters, we expect continued weakness in Industrial Machinery to offset single-digit growth in Instruments, keeping overall growth low. 

3. Olympus: 3QFY03/19 Profits Decline on the Back of Litigation Related Costs

Olympus Corporation (7733 JP) reported its 3QFY03/19 results on Friday (08^th February) after markets closed. The third quarter revenue dropped 1.7% YoY while operating profit declined by a significant 21.5% YoY, which was 12% below consensus estimates. The operating profit margin for the quarter was 8.8% compared to 11.1% for the same period last year.

The cumulative nine-month results were not impressive either. Although revenue saw a marginal improvement of 1.6% YoY, operating profit declined by 66%, resulting in a 700 basis point decline in operating margin, which fell to just 3.5%. Revenue and operating profit missed consensus estimates by 0.4% and 10.4%, respectively.

The company shares are currently trading at JPY4,645 per share which we believe is overvalued based on our EV/EBIT valuation. The premium is not justified given the governance related issues and the scandals currently faced by the company. Further, Olympus’ financial performance has been disappointing recently, and the company’s largest segment is growing only at single-digits and the Imaging business continues to drag on company revenue and margins. The share price gained nearly 38% since the beginning of the year following the company’s announcement to transform its business and improve governance. In our view the potential for a transformation in governance and business practices is already fully-discounted in the share price.

4. Cypress Semiconductor. The Perfect Acquisition Target.

There’s a lot to like about Cypress Semiconductor. Since taking the helm back in August 2016, CEO Hassane El-Khoury has led the company through a series of strategic realignments as part of his Cypress 3.0 initiative. While some of those moves were initially counterintuitive, they are now proving prescient as the company demonstrates far more resilience in the face of the current downturn compared to any period in its history.

Cypress offers exposure to the high growth automotive and IoT markets, industrial and consumer to a slightly lesser degree. Their product portfolio is the #1 market leader in new fewer than seven key segments, up from #3 just two years ago. On the latest earnings call, the company reported annual revenues of $2.48 billion for 2018, a 7% YoY increase. The company’s financial model targets a growth CAGR of 7-9% through 2021 and is well on track to achieve that goal. 

Like many of its peers, last year’s downturn saw Cypress share price fall more than 30% from its 52-week high at the trough. Currently, after a 6.63% rise on the back of solid earnings and reasonable outlook, its stock currently trades at $14.79, a 21.6% discount to the 52-week high. It also comes with an impressive dividend yield of 3.5% annualized as of December 31’st 2018.

We believe that the company would be an excellent acquisition target for the likes of Qualcomm whose failed bid for NXP last year thwarted its attempt to expand into the market for automotive semiconductors. We expect any such takeover offer would instantly add ~30% to the company’s share price.