IAM Capital Markets View
Based in Melbourne, Capital Alliance Investment Group (CAIG) has a revenue mix which comprises hotel income, development profits from residential construction, as well as rental income from commercial assets. Not only did this provide a good buffer throughout COVID-19, but it smoothed out cashflow — which can be lumpy in the development business as costs and debts are incurred without any income generation. CAIG is in a great position being an investor and a developer, providing cashflow stability and cashflow upside.
We take comfort from the strength in asset valuations which have remained solid through COVID-19. As at FY22, valuations would need to fall by over 19% to breach the CAIG Covenant Group Loan-to-Value (LVR) covenant of 70%. Note: investors are also protected by an asset LVR covenant of 60% for construction facilities (and other residual stock lending) to provide bondholders control over the level of gearing permitted.
The security package comprises share security over three special purpose vehicles (SPVs), which include three hotels (all operational – AC Hotels, Marriott Docklands, and Peppers Docklands) and two future development sites (one a fully-leased office – King Street and the other a vacant site – South West Towers).
In our view, while this is a high-risk bond within the non-investment grade space, there are significant mitigants via creditor protections which make this an attractive investment over FY23 and beyond. The management team also have a strong history of execution on projects within approved budgets and timelines as well as the shareholder base being very supportive. As hotel conditions normalise an occupancy / average daily room rates (ADR) ramp up, the company should begin generating positive EBITDA.
Business Performance and Asset Valuations
There have been no new market valuations received since the last review. However, the valuations that are “current” account for the worst activity during COVID-19. Since last valuations, all hotels have produced trading activity which has outperformed from an occupancy / average daily room rate perspective.
Note: Both the Marriott Docklands and AC Hotels operate on hotel management agreement (HMA) which are subject to a minimum gross operating profit (GOP). Peppers Docklands operates on a lease agreement providing a minimum base rent.
In terms of occupancy across the three hotels, as at 30 October 2022:
- Marriott Docklands has achieved an average occupancy rate of 48%, with October 2022 at 65%. [forecasted occupancy was 39%] Note that January and February 2022 were impacted heavily by the Omicron outbreak.
- AC Hotels has only been operational for 6 months – but has achieved an average occupancy rate of above 50%, with October 2022 at 62% [forecasted occupancy was 47%]
- Peppers Docklands has achieved an average occupancy rate of 53% for the year, with October 2022 at 71%.
We should point out that the average daily room rate (ADR) has increased due to both inflation and aggregate demand (i.e., new hotel bookings post COVID-19). CAIG can adjust pricing daily considering the inflationary dynamics. The forward booking profile is also looking favourable heading into calendar year 2023.
Marriott Docklands achieved an ADR of $270 and AC Hotels of $223. Refer below slide for more information on hotel performance.
Source: CAIG management presentation
As required under the reporting requirements per Conditions 8.11
Table 1: Covenant Gearing Ratio (Condition 8.5)
Net debt excludes shareholder loans, which are treated as equity, and cash. This is how the covenant calculation works. Note, this differs from the total and net debt calculated at a Capital Alliance Group level. On a conservative basis, there is around 5-10% upside in market valuations across the hotel assets which would provide further support for bondholders.
Table 2: Total Tangible Assets (Adjusted) (Condition 8.6)
Based on consolidated entities – Capital Alliance Group
In terms of the FY22 financials, the sales revenue increased due to the Marriott Docklands and AC Hotels (residences) development profits which were booked.
Management has been focused on selling apartment stock in a controlled manner given the underlying interest rate and housing environment. Where apartments have not been sold, management has leased these out to earn additional other income. Importantly, apartment prices and margins have been maintained, with no discounts having to be applied (aside from general incentives which are common in the apartment market). As auction clearance rates and the property market recovers, management will look to release more apartment stock. The market is benefitting from favourable supply dynamics where there are not a lot of residential builds (or additional supply) as funding has been hard to achieve due to pre-sales.
Over FY23, as hotel conditions normalise, hotel income should be a larger share of the sales bucket. Assuming 70% occupancy rates and constant average daily room rates, then hotel income would constitute well above AUD20mn pa.
In relation to interest costs, this increased due to Marriott Docklands and AC Hotels (residences) and related construction loans. There are also residual stock facilities at both these (residences) which are aggregated up into borrowings at the head company level.
Source: CAIG unaudited management accounts
The two key projects for the company requiring capital are the vacant site – South West Towers and Dandenong [note: Dandenong assets will not be held on the consolidated balance sheet above given there will be separate SPVs]. South West Towers is likely to go ahead in calendar year 2023 with Dandenong Stage 1 in calendar year 2024. The company remains high levered, but recovery on hotel assets is very good versus other forms of collateral.
South West Towers – Planning permit application was lodged in September 2022 for a 210-room hotel, 133 serviced apartments as well commercial space including a convention centre. Note: there is a hotel management agreement (HMA) that has been executed with TFE Hotels. A builder will need to be chosen from approved builder list. Total cost will be around AUD240m, of which funding will likely be obtained from CAIG’s bank syndicate and new equity.
Dandenong – Stage 1 community consultations are underway in conjunction with Development Victoria. The project is tracking in line with the scheduled timeline, with master plan submissions due prior to Christmas. Stage 1 town planning / DA has been signed and approved. Total cost for Stage 1 is still being completed. Funding will be obtained from CAIG’s bank syndicate / new equity / shareholder loans / new bond debt.
Source: CAIG unaudited management accounts
Capital Alliance Investment Group (CAIG) is a Melbourne-based, vertically integrated real estate provider, that combines activities of development, ownership and property management. CAIG has a track record of ~$700mn in developed projects since 2012 and has a further $2bn in pipeline opportunities.
The CAIG Covenant Group contains the majority assets and cashflow, however it excludes the ~$1.5bn Revitalising Central Dandenong (RCD) project. The security pool is primarily residual equity capital (100%) of CAIG’s subsidiaries, excluding Capital Alliance Dandenong and its special purpose vehicle (SPV) subsidiaries.
CAIG have a good track record as a real estate development and hotel sector operator. As expected, CAIG’s revenue and asset profile is concentrated in Melbourne. CAIG are looking to increase revenue diversity across segments (development, hotels, office, retail, property management, and serviced apartments) going forward.
The operating business consists of hotels which benefit from agreements which are either: (1) rent-like in nature (i.e., fixed amount); or (2) contain temporary shortfall benefits where a minimum operating profit is not generated. The agreements are with solid counterparties, including the Marriott and AccorHotels respectively.
The real estate development business places it on a high growth path. CAIG needs to recycle capital to execute on its pipeline. Timely project execution and apartment sales are both key to releasing capital. The group’s major project on the horizon is the Revitalising Central Dandenong (RCD) project which is broken into seven stages. Capex forecasts for the whole project are $677mn in total, with $142m of a cash outflow expected to bring Stage 1 to completion in Calendar Year 2025.
Broader CAIG Group versus the CAIG Covenant Group
Summary of the Notes – CAPAAU 10% 10/21/25
CAIG through its finance company Capital Alliance Au Pty Ltd (the Issuer) raised $23mn via a Holdco Secured Note. The purpose of the transaction was to fund property development costs and CAIG’s development pipeline, including the ~$1.5bn Revitalising Central Dandenong (RCD) project. The finance company is wholly owned by CAIG. The notes are secured against the assets and undertakings of the Issuer in addition to the share capital (100%) of CAIG’s subsidiaries, excluding Capital Alliance Dandenong and its special purpose vehicle (SPV) subsidiaries.
Final maturity of the notes is October 2025, however CAIG has the right (but not the obligation) to redeem some or all the notes prior to maturity. CAIG may redeem the notes on October 2022 at $103, October 2023 at $102 or October 2024 at $101. In addition, a Change of Control Event or sale of all, or substantially all CAIG’s assets, would trigger a redemption to noteholders in full.
Noteholders are protected by a Director Guarantee (CAIG’s CEO, Mr Mo Han Du), Interest Service Reserve Account (one coupon payment worth on the bonds) and a supportive covenant package, including a Covenant Gearing ratio less than 70% (see Condition 8.5), Event of Default triggers and penalty interest, and a Negative Pledge in relation to the Group and each subsidiary.