Financial Adviser: 5 Things Every Investor Needs to Know About Manny Villar's Premier Island Power REIT's IPO and How to Profit from It

Premiere Island Power REIT (PSE: PREIT) will be the eight company that will go public this year after it obtained approval from regulators to raise up to P2.4 billion in an initial public offering.

PREIT will sell up to 1.6 billion secondary shares owned by S.I Power Corp and Camotes Island Power Generation Corp, representing 48.96 percent of the company, at P1.50 per share.

PREIT initially planned to raise up to P3.2 billion at P2.00 per share but had to cut its offering price last week by 25 percent to improve market demand.

At the revised offering price of P1.50 per share, PREIT will become the smallest REIT company in the sector with a projected market capitalization of only P4.9 billion.

Previously, the smallest REIT IPO was Vista Land’s REIT company, VistaREIT (PSE: VREIT), which was listed early this year at market capitalization of P13.1 billion.

The offering period of shares will run from November 28 to December 5 with a target listing date on December 15, 2022.

PREIT will also be the eight real estate investment trust (REIT) in the country after the Implementing Rules and Regulations (IRR) of the REIT Law of 2009 were approved by regulators in 2020.

Under the new law, a REIT company is required to distribute at least 90 percent of its distributable income as dividends. In exchange, a REIT can claim the dividends as allowable deductions against its taxable income, making it practically tax-free.

Because of the strict guidelines on dividends, REITs provide a steady stream of income to investors, unlike ordinary stocks which do not pay regular dividends.

REITs can also offer competitive dividend yields against preferred stocks because of its ability to expand and grow its income base, resulting to long-term share price appreciation.

But like any investment, not all REITs are created equal.

Some REITs may be riskier than the others because they have less predictable income stream due to their asset quality or financial condition.

If you are planning to buy REIT stocks, it is important that you are not only buying it for the dividend yield. You must also understand the business of the company.

When you know the fundamentals, you will also have a better handle of the risk and return that you can expect from investing in an REIT.

Here are the top five things every investor needs to know about VREIT’s IPO:

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1| Know the background of the company

PREIT became a REIT company after its sponsor, Prime Asset Ventures, through its subsidiaries, S.I Power Corp and Camotes Island Power Generation Corp, transferred a portfolio of land, buildings and power plant assets via a property-for-share swap transaction.

PREIT is envisioned to be the power and infrastructure REIT platform of Prime Asset Ventures, the investment holding company that is majority owned and controlled by the family of business tycoon and former senator Manny Villar.

Prime Asset Ventures holds significant investments in four core industries such as power systems infrastructure, water distribution technologies, information technology broadcasting and entertainment.

The properties transferred by Prime Asset Ventures to PREIT, which were valued at P8.67 billion are leased back to its subsidiaries, S.I Power Corp and Camotes Island Power Generation Corp.

2| Know the assets of the business

PREIT leases two parcels of land in Siquijor with a collective area of 12,478 square meters to S.I Power Corp, along with a building that houses its operating stations and a set of heavy fuel oil-fired power plants with a total capacity of 12.8 MW.

PREIT also leases a 16,406.5 square meter parcel of land in Cebu to Camotes Island Power Generation Corp together with a building that accommodates its powerhouse stations.

All properties leased to both companies of Prime Asset Ventures are covered by a guaranteed annual base lease with a possible upward adjustment depending on their revenue performance.

The revenues of S.I Power Corp and Camotes Island Power are derived from their respective offtake agreements with distribution utilities for the sale of electricity generated.

S.I Power Corp has an existing power supply agreements with the province of Siquijor for 20 years, while Camotes Island Power Corp has a supply agreement with Camotes Electric Cooperative, Inc for 15 years.

Camotes Electric Cooperative is a duly enfranchised electric cooperative that services the municipalities of Camotes, Poro, San Francisco and Tudela in the province of Cebu.

PREIT intends to expand its portfolio by acquiring more properties from Prime Asset Ventures that are related to power generation.

Prime Asset Ventures is currently constructing three solar farms that are located in Bataan and Camarines Norte with a total capacity of 76 MW. It is also in the process of acquiring more sites in Pangasinan, Nueva Ecija, Bulacan and Isabela.

3| Know the financials of the company

Based on the carve out combined income statement of the assets transferred to PREIT, total rental revenues had hardly increased from P409 million in 2019 to P400 million in 2021.

But gross margins have been improving significantly, rising from 14.5 percent in 2018 to 28.9 percent in 2021, as cost of sales declined over the years.

Because of this, net income of PREIT more than tripled in two years from P25.6 million in 2019 to P75.2 million in 2021.

This year, the pro-forma net income of PREIT as of May 2022 was already P113 million on total rental revenue of P245 million. If we will annualize this, net income for this year should reach about P271 million.

PREIT enjoys a strong balance sheet with zero debt ratio with a return on equity ratio of 18 percent based on the financials of 2021.

Given its zero-debt position, PREIT could leverage its equity position by borrowing up to P12 billion assuming a debt-to-equity ratio of 1.5 times, to finance its asset acquisition growth in the future.

4| Know the net asset value of the company

One of the best ways to analyze an REIT is its net asset value (NAV). Similar to Price-to-Book (PB) ratio, the NAV is used to measure the market value of a REIT’s holdings, net of its liabilities.

PREIT’s investment properties have been appraised at P7.7 billion. Minus payables of P153 million, we can derive PREIT’s net asset value at P3.3 billion or P2.74 per share.

At the IPO price of P1.50 per share, current pricing of the stock offers a 45 percent discount against its net asset value per share.

PREIT’s Price-to-NAV ratio at 0.55, which is the lowest in the REIT sector where the average Price-to-NAV ratio is at 0.78.

PREIT compares favorably to the top three cheapest REIT stocks today in terms of Price-to-NAV ratio today.

These are Megaworld REIT (PSE: MREIT), which has a ratio of 0.57, followed by Filinvest REIT (PSE: FILRT) at 0.63 and Double Dragon REIT (PSE: DDMPR) at 0.65.

If we price PREIT equal to the sector’s average Price-to-NAV ratio at 0.78, we should expect the stock to trade up to P2.14 per share, which offers a potential 42 percent return.

But REIT stocks do not typically trade based on NAV alone. There are other factors that we need to consider in pricing a REIT and one of them is the dividend yield.

5| Know the dividend yield of the offer

5| Know the dividend yield of the offer PREIT expects to earn a net income of P481 million for next year, which translates into adjusted funds from operations (AFFO) of P471 million also, representing 100 percent dividend payout ratio.

If we divide PREIT’s projected AFFO of P471 million by its shares outstanding of 3.3 billion shares, we will get dividend per share of P0.1434. At P0.1434 per share dividend for 2023, PREIT’s prospective dividend yield at IPO price of P1.50 per share shall be 9.6 percent.

At this yield, PREIT’s dividend yield will be higher than the REIT sector’s average dividend yield of 7.9 percent.

While this may look relatively attractive, investors may demand higher premium on REIT stocks given the high interest rate environment.

To price PREIT at today’s risk, we can use the current interest rate of the 10-year Philippine bond yield at 7.03 percent as reference. Adding standard risk premium of 5 percent, we will derive opportunity cost of 12.03 percent.

If we use this cost as discount rate to price PREIT, we can simply divide PREIT’s prospective dividend yield of P0.1434 by 12.03 percent to get target share price of P1.19 per share.

Unless inflation and interest rates start to fall, it will be good to wait and buy PREIT at lower price to maximize dividend yield