Embassy REIT: Is this "Blackstone" promoted REIT is real diamond?

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The Q1 results announcements came at 1.30 PM today and hence market had time to digest. Q1 DPU on expected lines and one of the hang ups of last qtr - no guidance is also addressed. The full year guidance is given but the lower end of it, if it gets there, will be ugly I feel.
Here are the results and investor presentation

https://www.bseindia.com/xml-data/corpfiling/AttachLive/76fb3544-786c-464f-ac29-b482c305503e.pdf

DPU is 5.38 (break up in page 1 of results page)

The Yield table , with updated Q1 numbers of Embassy and Mindspace…for others, it is from Q1 of last year since they are yet to annouce (remember that I compute this for running 4 qtrs)

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PS - I exited Embassy recently.

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Thanks for the update and disclosure. May I know any specific reason which led you to exit?

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Harsh,Reasons are specific to me

  1. For my tax, surcharge bracket, the post tax yield of less than 7%, does not provide factor of safety. You can argue, where else I can get this…but I want the yield, without loss of capital as well and more on this, in the point below.
  2. I feel that the new range for price (between the DPU announcement period, to ex-record sell off lows has shifted from 325-305 in the past to 305-290 now and if there is any more bad news, like a tenant vacating somewhere, it may even reach 270s). I have seen that the price swings happen with very little volume and within the same day, the drop is as much as 6-10 Rs. By the same token, the price also increases with little volume of buys (example, a 10k purchase, can move this by 5 Rs in 5 mins) but it is unable to sustain this.
    Take the behavior last few days. We have the DPU announcement done and there is still time to acquire before the record date (to get the DPU) but from the peaks of past 325, it is struggling to cross the peak of 310 and easily goes back to 302, in the same day…so, I am a big believer in yield, without even a hypothetical paper loss in capital and that assurance feel is not there in Embassy for me. (Mind you, invits like PG Invit have fallen into the same rut…even the indefatigable Indigrid, with all their acquisition plans and credible management, is in the same rut).
    So, I plan to buy only at safe price, where the capital loss won’t be there, even in paper. Will this notional loss go away, when the interest rate hikes pauses/reverses and the glory days are back? maybe yes but that is a quarter or 2 away and in the meanwhile, we may have a revisit of 270-290 range again !! and that is my fear that forced me to take, what I can.
    If the market turns around, this is not going to on steroids…given attractive opportunities elsewhere, I made a choice.
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Hi

Q1 results for both Mindspace and Embassy seem good and the reaction to global office space tends seem to be over played here in India. Another thing that I have been considering the discount to NAV.

As per investor presentation for Singapore Mindspace has shown NAV as on Mar-23 to be Rs.371.9 (not sure why not mentioned in the Q1 earnings release).

Embassy Reit NAV as per annual report on Mar23 is Rs.394.88.

Both REITS are trading at strong discount to NAV and historically when this has been the case the medium term price should correct closer to NAV?

Thanks

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Look at the yield table above…in those prices, the post tax yield will be in high 5.xxs …not an attractive proposition by any means…higher prices closer to NAV, does not mean higher DPU. DPU is dictated by cash flow & Unless DPU catches up and yields come close to expectations, prices may not budge (IMHO)

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DPU can be cyclical based on various situations but NAV signifies real value of assets so one should take both the parameters in view before buying and selling instead of looking at any one in isolation…

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Yes. They go together but with the revenue guidance locked in & available ((20.5-22) and it being lower than the glory years of the past) in front of us, and with 3 quarters left in the year, there is possibility of price being in the range, I have said above. When they get to DPU of 23-24 and above, price can inch up but not before.

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When considering investments in REITs, it’s essential to adopt a long-term perspective, focusing on years and decades rather than quarters.

In this context, aiming for an annual return of 7% through DPU and expecting asset price appreciation at 5% per year per unit seems reasonable.

It’s worth noting that during periods of 5% annual asset price appreciation, there might be times when the stock price remains stagnant for years.

Looking at the historical performance of REITs in the US, they have demonstrated comparable returns to equity investments, and conducting back testing on such data can offer valuable insights for future possibilities, especially in a growing economy like India.

These factors make investing in REITs a promising option for the long term.

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@dd1474
Hi Dhiraj,

It would be helpful if you can share your views on:

  1. About Embassy after distribution guidance of Rs 20.5 - 22 for FY24?
  2. Why is Embassy not able to increase distribution since last 4 years (Distribution has been hovering between Rs 20-22 since inception - FY20)?
    One reason I can figure out is, that they got away with Zero coupon debt recently which increased interest outflow, but that not explains it all. What could be other reasons?
    I see that their average Lease rates have increased (from ~Rs 55 per sq ft in FY20 to ~Rs 75 per sq ft in FY23, predominantly in Bangalore market) but still it has not translated to higher distribution.
    Can you share some insights?
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@Amit2saxena

First thanks for seeking my view. I feel there is transition in business model of Embassy REIT which is affected by internal as well as external factors. Let me list same as per my understanding:

1) Internal factors:

a) Promoter selling:

Currently both the promoter group of Embassy REIT, Embassy as well Blackstone are facing tough weather, particularly Embassy group, which resulted in liquidation of their holding in last 6-12 months. That has increased supply as well as Negative perception in market about Embassy group. Secondly, even Blackstone Group global REIT facing some problem in other markets (like frozen liquidation of units) along with some sale of units as also added uncertainty and negative perception about Embassy REIT promoters in my opinion.

b) Change in KMP

With last 18-24 months, Embassy REIT has seen 3 MD/CEO. The existing CEO has also liquidated his holding in Embassy REIT which further added negative perception (and rightly so) in my view.

c) No Guidance in Q4FY23 Con call:

Not giving guidance on Q4FY23 Earning call for FY2024 further added uncertainty to investor mind as it raised concern about business outlook for FY2024. Although management, in Q1FY24 earning call given Guidance, it is still to reach highest distribution of past. Enclosed is table of Quarter wise distribution of Embassy REIT.

Even at Midpoint 21.25 per unit for FY24, the guidance given is lowest in last 5-year history. That is also after adding multiple assets in the portfolio.

d) Change in business income

During last two years, share of hotel business has gone up materially due to opening up post COVID. However, margin in hotel business is almost 40-50% of Commercial office space. Other thing being same, increase in Office lease income would directly add to NCDF from NOI, in case of hotel, it is much lesser addition to NCDF.

2) External factors:

a) Exit by large client

The revenue as well occupancy adversely affected by exit of large client. Further, work from home has reduced demand from IT services for office space. The company has definitely put efforts to move to increased client in GCC space which is likely to show very high growth in Indian office market in General, and in Bengaluru in particular in my view. However, the lower demand from IT services resulted in very high space, while Global Captive are testing Indian market with lower initial demand and would peak up demand for office space in next 3-5 years.

b) Global REIT market concern

Globally, occupancy and rent in REIT market has declined post COVID. That has resulted in negative perception for Indian REIR as well

c) SEZ related issue

SEZ units vacated by IT services are not being able to be absorb due to lower demand. That factor has affected industry as well Embassy REIT. While management is trying to address this by denotification, but it still takes long time resulting in higher vacancy rates.

d) Increase in global and domestic interest rate

While interest rate increased resulted in higher interest cost on existing debt for Embassy REIT, increase in Global interest rate also improved attractiveness for other investment avenue for Global institutional investors. Further, the company modernisation and capitalisation of new office space and hotels, have hit Profits and cashflow, occupancy and benefit of same would materialise over 2-3 years’ time.

e) Budget 2024

Budget 2024 announced that Capital redemption from REIT and Invite would be subject to marginal income tax of investors, which was otherwise considered as not taxable by investor. While subsequent amendment did address this issue and clarify tax structure, damage was already done about uncertainty of tax structure of InvIT/REIT units.

All above factors have contributed to decline in distribution and price of Embassy REIT. Embassy REIT among my Top 2 Debt portfolio investment. I see most of negative development have already played out and expected further 6-12 months of challenging environment. However, if Global Captive demand pick up and Interest rate stabilise, I think this may be best time to invest in Embassy REIT from 5-7 years perspective. Since, I already have very large existing position, I would personally wait and watch before adding further investment.

Disclosure: In case of any further development on promoter concerns/KMP exit, I may completely exit from Embassy REIT without informing forum. So, reader shall do their own due diligence and take their own decision. My track record in forecasting is poor as best pathetic in reality. My view may be biased due to my holding. Not SEBI registered advisor.

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The crucial factor between NAV & Free cash flow (and hence DPU)…There are assets in development all the time and they all add the NAV but does not necessarily mean, they translate to cash flow, the very next month (SEZ vacancy for example). There is a lag effect as well and this can be several quarters. Add the fact that a lot of Debt is locked in at fixed rate (and hence falling interest rate won’t really matter, unless they have the power to negotiate for an interest rate reset). Given all the above, they have been diligent on what they can chew in the guidance and I doubt very much whether anything will drastically change in FY25 too

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Interesting commentary from the new CEO on re-rating once the interest rates movement stabilize
Also the focus on GCCs. the IT industry slowdown and hybrid work models remain an unknown variable though. in two minds to add more however already have a significantly high allocation so in wait and watch mode

https://www.financialexpress.com/industry/indian-reits-will-re-rate-once-the-volatility-subsides-aravind-maiya/3190153/

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Another interesting commentary from the new CEO. The thumbnail is misleading (typical of news channels) however looks like there are some green shoots emerging on the office space growth potential especially with GCCs coming in. He has clearly called out the lag between NOI growth and DPU due to interest rate hikes and working capital requirements for this year

Specifically on Embassy, the fact that they are Bengaluru heavy could be a double edged sword. I hope they diversify a bit out of just one micro market especially given the city’s dismal public infrastructure. Office utilization is clearly an upward trend and the city is a hub for all things tech. Whether it will reach 90% levels is yet to be seen with WFH and flexi work. Also like the hotels play here as an enabler for a total business ecosystem

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When i first looked at REITs few years back at Embassy listing, I checked exactly same point and was excited at REIT opportunity in a growing economy like India.

Infact in various time frames in US, REITs have performed better than equity as well (dividends extra).

However I had to unfortunately give Indian REITs a pass because of the sponsors/promoters in India. These have so far either been real estate builders or PEs looking for exit.

If probably Tata or even Mukesh Ambani or promter of such status and quality are commited sponsors of REIT, then its a great opportunity…cannot say same with other sponsors as this is a capital intensive space amd capital allocation for future acquisitions is extremely important…

These are just my views and I may be wrong in my assessments. Would be happy to hear others views around this again after frw years of everyones experience of REITs in Indian context. Thanks

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@Investor_No_1 . Just a limited view. few aspects to keep in mind

  1. Reits are a relatively new product/asset class in the Indian context. It continues to evolve as all stakeholders (sponsor, reit manager, sebi, investors etc) get comfortable with it
  2. The regulations are itself evolving as sebi tweaks it to encourage more investor participation
  3. The taxation rules continue to evolve as well
  4. Indian reits except the recent nexus select are all office focused. The office space was hit by the double whammy of lockdown and interest rates. The US office market has faced similar challenges
  5. US brought it’s first REIT regulation I think in the 1960s so over 40-50 years of fine-tuning

REITs are long term asset classes, it will take a while before they stabilize and attract a wider investor interest as more get listed from other categories too (e.g. warehouses etc)

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But isn’t Brrokfield a professional asset management company globally and not a builder.

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Total Distribution for FY23 - Rs 2060 Cr.

In Consolidated P&L statement, I understand only depreciation and amortization are non- cash expenses , all others are cash expenses.

So, profit after tax for the year (Rs 505 Cr) + Depreciation (Rs 916 Cr) + Amortization (Rs 211 Cr)
= Rs 1632 Cr , should roughly match NDCF / Distribution (Rs 2060 Cr)

However, there is a gap of ~Rs 428 Cr ( Rs 2060 Cr - Rs 1632 Cr) between distribution and cash profit.

Part of the reason is Embassy Golflink, that’s 50% owned by REIT and hence only the corresponding profit comes P&L, and not the depreciation. But that still does not explains gap of 428 Cr.

What am I missing here. @dd1474 Sir, if you can help?

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Hi Amit,

Offering opinion per my understanding.

I think you are trying to arrive at cash flow from operations (CFO) by adding non-cash expenses back to PAT. However, I think we also need to consider changes in working capital to get to CFO. Please refer to the screenshot which shows CFO of 2565 crore.

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The relationship between CFO and NDCF is not straightforward. Request @dd1474 to guide.

Warm regards,
Mahesh

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Hi Mahesh, thanks for your inputs.

I am trying to arrive at NDCF (Net Distributable Cash Flow) from PAT. My calculations are rough, but should majorly explain NDCF from PAT.

I am not trying to derive CFO, however, agree, working capital changes will have impact on NDCF.

However, I see working capital changes are small, and cannot explain movement of 400+ Cr.

Similarly, as explained in my previous post, Embassy golf Links is not part of P&L (only proportional profit of 50% equity is added to P&L), so NDCF would be higher. Hiwever, Alagain 400+ Cr is big number to justify the movement.

May there are more factors which we are not able to catch.

@dd1474 please share your views

Amit

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