As one of the fastest expanding economies, China’s exceptional growth is only overshadowed by the phenomenal boom in its e-commerce market. The astronomical rise of China’s e-commerce story is driven by its millennial and mobile-centric consumers. According to data from Analysys, China’s e-commerce market is now about three times the size of US, with total online retail sales estimated to be more than US$970 billion in 2017.
Though China has already become the world’s largest e-commerce market, what we are already seeing may only be the beginning. For one, China has more than 750 million internet users, just slightly more than 50 percent of its 1.4 billion population. Comparatively, the US has a much higher proportion of internet users, at almost 80 percent of its population. The difference suggests significant room for the Chinese e-commerce market to grow as Chinese citizens continue to adopt the use of the internet at dizzying speed.
That is notwithstanding the 500 over million (and growing) middle-class consumers with rising disposable income shaping and fueling the economy. While China’s e-commerce remains a clear growth story, there appears to be underinvestment made in e-commerce-focused logistics assets, suggesting the corresponding potential rewards are being overlooked.
Looking to reap this potential reward is EC World REIT, the only S-REIT listed here that owns e-commerce logistics and specialised logistics properties in China. Shares Investment had the opportunity to meet with the management to find out more about the operating environment for e-commerce logistics assets in China.
Riding Favourable Tailwinds
China’s retail e-commerce market size is projected to grow to Rmb9.4 trillion (US$1.4 trillion) in 2020, indicating a five-year compound annual growth rate of 19 percent from 2015. Supporting and making China’s e-commerce a success is none other than the physical logistic infrastructure.
A logistic revolution is taking place in China. Buy something online and most likely, packets will be delivered at the door step in just a day or two. Unlike traditional warehouses that are mostly meant for storage for bulky parcels, e-commerce warehouses are specialised at processing small “ticket” items. The “pick-and-pack” operations are why e-commerce logistics centres run on a much higher turnover rate.
But as Chinese online retail sales continue to soar, growth in Chinese e-commerce logistics assets need to keep up in pace. For one, the per-capita warehouse area in China measures only 0.6 square meter (sqm) compared to the US which measures about 7.6 sqm per capita. The difference in warehouse density suggests that the Chinese logistic market is overwhelmingly undersupplied, despite demand outpacing the US.
The current operating condition plays favourably for e-commerce logistics asset owners in China like EC World REIT, as rental rates are kept buoyant by continued demand and supply constraints.
The bulk of EC World REIT’s portfolio is located in Hangzhou City in China. Home to e-commerce giant Alibaba, Hangzhou is also known as the capital of e-commerce with a Gross Domestic Product (GDP) of Rmb1.3 trillion in 2017. Bolstering the city’s income is none other than its e-commerce industry, which grew at a breakneck pace of 36.6 percent, according to Hangzhou Bureau of Statistics.
EC World REIT’s Hangzhou properties include: Chongxian Port Investment, Chongxian Port Logistics, Fu Zhuo Industrial, Stage 1 Properties of Bei Gang Logistics, Fu Heng and Hengde Logistics, a specialised warehouse for the storage of tobacco leaves (US$2 billion) for China Tobacco (a State-Owned Enterprise).
Over in Wuhan city, EC World REIT Mei Luo Te property was the REIT’s maiden acquisition since its listing in 2017. Acquired in April 2018 at Rmb145 million, the property houses some of China’s largest e-commerce players such as JD.com and DangDang. JD.com has a market capitalisation of over US$70 billion on the US Nasdaq Exchange. Notwithstanding that, boding well for the REIT, Wuhan’s economy is also growing at a faster rate than the China’s national average. In 2017, Wuhan’s GDP grew 12.6 percent to Rmb 1.3 trillion compared to the national average of 6.9 percent.
(Source: EC World REIT)
Behind EC World REIT is reputable Chinese warehouse developer Forchn Holdings Group (Forchn), a co-founder of Alibaba’s logistics arm Cainiao. The sponsor owns 42.2 percent in EC World REIT.
The sponsor’s Cainiao foray helped to establish an open, transparent and shared data platform for e-commerce businesses and logistics companies in China. The experience also helped Forchn to develop an integrated smart warehouse logistics proprietary services platform – RuYiCang.
Unlike most S-REITs that operate as a landlord, EC World REIT’s management of business processes, systems and operation fulfillments are overseen by RuYiCang, which also happen to be the master tenant. The operator earns processing fees from its services to some of the world’s largest brands such as P&G, Pepsi, Alibaba, JD.com and vipshop.com. This symbiotic relationship ensures rental income stability for EC World REIT and investors alike.
(Source: EC World REIT)
Headroom To Fund Growth
One of the concerns we raised about EC World REIT is its short weighted average lease (WALE) profile. By net lease area, and assuming Mei Luo Te has been injected, the REIT’s WALE measured 2.9 years as at 31 December 2017. In comparison, larger industrial S-REITs like Ascendas REIT and Fraser Logistics and Industrial Trust have much longer WALE profile of four to six years.
To that, the management of EC World REIT explained that lease contracts for e-commerce focused logistics assets are typically much shorter, especially in China. This is because, given the supply constraints, asset owners have stronger asking power and more incentive to negotiate for higher rental rates. In fact, management has intimated that it has to turn away some lower margin customers at some of its properties.
This underpins the strong outlook for the e-commerce industry. Going forward, the group could be looking to acquire more properties to tap that growth. As at 1Q18, EC World REIT has a total debt to asset ratio of just 28.5 percent, significantly below the 45-percent threshold for S-REITs. This leaves significant financial headroom of approximately $250 million or about Rmb1.2 billion for the REIT to take on more debt to fund acquisitions.
In the pipeline, EC World REIT has the Rights of First Refusal (ROFR) on two e-commerce focused logistics properties, aggregating a gross floor area of 316,420 sqm. The potential enlarged portfolio could expand by 42.3 percent to 1,064,759 sqm in gross floor area.
Notwithstanding that, in April 2018, Forchn Holdings signed a partnership agreement with Singaporean Logistics Provider YCH Group. The latest development gives EC World REIT the exclusive rights to purchase 13 logistics real estate assets from YCH Group, which operates in 16 countries in Southeast Asia. Should any potential acquisition be completed, EC World REIT would increase its footprint beyond China, along the Belt and Road corridor.
Lucrative Yield At Large Bargain
In spite of its investment merits, the unit price of EC World REIT has been beaten down for the past year, since peaking at $0.81. Currently, the REIT is changing hands at just $0.72 per unit, translating to a price-to-book value of 0.78 times. In other words, the REIT is trading at a discount of 22.6 percent discount.
Based on the FY17 distribution per unit (DPU) of 6.025 Singapore cents, the indicative yield is about 8.4 percent, assuming DPU is maintained. This makes EC World REIT one of the highest-yielding counters listed on Singapore Exchange. So why is the unit price languishing?
Amidst rising trade tensions between US and China, investors are worried about the implications on EC World REIT, especially its port facilities which is highly dependent on international trade. However, the large discount may seem a little unwarranted and may pose to be a margin of safety large enough for investors.