AIMS AMP (AAREIT SP) - Maybank Kim Eng 2017-05-25: Redeveloping Trust

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AIMS AMP CAP INDUSTRIAL REIT O5RU.SI

AIMS AMP (AAREIT SP) - Redeveloping Trust

Initiate at BUY, fourth largest industrial REIT 

• AIMS AMP Capital Industrial REIT (AAREIT) ranks as Singapore’s fourth largest industrial REIT on AUM with its 27 warehouse, light industrial and business park assets, leveraged to recovering sector fundamentals, in our view. 
• We see DPU support from master lease rental step-ups and rising contribution from a first build-to-suit project mitigating near-term industrial over-supply pressures, and estimate its under-utilised portfolio GFA profile adds further 5% growth optionality from asset rejuvenation initiatives. 
• Initiate at BUY.

Sound transformation post-MI-REIT recapitalisation 

• AAREIT has executed well after its recapitalisation in late 2009 to deliver steady revenue and NPI growth at 16.0% and 12.7% CAGR respectively to FY16. 
• NAV growth at 10% 7-year CAGR to FY17 has been led by acquisitions and asset redevelopment, while its diversified portfolio is geared towards improving sector fundamentals, as we approach the tail-end of industrial over-supply in 2017. 
• We see DPU support from master lease step-ups, with contribution from a first build-to-suit (BTS) facility from 2H 2017 mitigating near-term negative rental reversion pressures.

5% DPU optionality on under-utilised portfolio GFA 

• AAREIT has added 1.8m sqft of GFA from redevelopment initiatives since FY12, representing 27% of its portfolio. We see further asset rejuvenation opportunities, especially with gearing at 36.1%, the lowest among the small-cap industrial REITs. 
• With 9% of its portfolio GFA still under-utilised as at end-Mar 2017, we estimate this could generate 5% DPU growth from additional AEI/redevelopment projects.

DDM-based TP set at SGD1.60 

• AAREIT’s shares have pulled back following its recent exclusion from the MSCI Singapore small-cap index, and now trade close to 1sd below 5-year historical yield. 
• We initiate at BUY, and see 8% dividend yield support to our DDM-based TP of SGD1.60, which suggests 21% total return upside.
• Key risks for AAREIT are its weaker industrial sub-segment exposure, and tenant concentration.

About AAREIT 

Fourth largest industrial REIT 

• AA-REIT, renamed from MacarthurCook Industrial REIT (MI-REIT) following a recapitalisation in late 2009, is Singapore’s fourth largest industrial REIT on AUM.
• AAREIT’s sponsors are AIMS Financial (AIMS), a diversified financial services group founded by George Wang and headquartered in Sydney, Australia, and AMP Capital, a global multi-asset investment manager. Both sponsors manage the REIT through a 50:50 JV.

Portfolio spans industrial spectrum 

• AAREIT owns 27 properties with a total 627k sqm in NLA, diversified across warehouses, factories and a business park.
• Warehouses form the bulk of its portfolio at 71% of NLA and 63% of FY17 gross rental income. AAREIT’s largest portfolio asset is a 5-storey ramp-up warehouse and logistics facility at 20 Gul Way which forms 24.5% of its NLA, and is under a master lease to CWT.
• Light industrial buildings form 26% of AAREIT’s NLA and 30% of its gross rental income. We expect contributions to rise from a 21,530 sqm build-to-suit (BTS) facility for contract manufacturer, Beyonics, from 2H 2017.
• AAREIT’s 1A International Business Park accounts for the last 3% of its NLA and 8% of gross rental income. It also has a 49% stake in Optus Centre, an A Grade business park in NSW Australia, which was valued at AUD445m as at end Mar 2017.

Sound transformation post-MI REIT recapitalisation 

Steady growth from FY10-16 

• Following its recapitalisation in late 2009, revenue grew at a 16.0% CAGR from FY10 to FY16, with NPI up a 12.7% CAGR, with growth on the back of redevelopment efforts, given that its last acquisition (at Woodlands) was announced in Feb 2011. 
• FY17 revenue and NPI declined 3% YoY despite a higher occupancy of 94.6% from 93.4% because of overall sector weakness.
• AAREIT has driven NAV growth at 10.0% CAGR from FY10-17 to SGD888m, through SGD440m in acquisitions - mainly a 49% stake in the Optus Centre - and SGD319m of AEI and redevelopment projects.

Near-term sector pressures… 

• We expect factory and warehouse space to grow at 2-3% per annum this year, representing 4.4% and 9.7% of their respective total stocks. Both landlords have nonetheless been offering more incentives towards tenant retention, as evidenced by the pick-up in occupancies for most S-REITs.
• We forecast 1-3% declines in factory and warehouse rents for 2017E, before potential 1-2% improvements in 2018E.
• Although business park rents have been resilient, we expect spot rent upside to be limited. This is given the relatively high vacancy rates at older business park assets, which could experience some rent pressure.
• We also believe that the drops in Grade A office rents could stem the tide of tenants relocating to business parks. As such, we expect rents for business park space to grow.

… but supply should ease next year 

• We see the tail-end of a supply surge (since 2014) this year. Some 2.4m sqm of the total 4.4m sqm in new industrial space (under construction or planning, and projected to complete over the next four years) will be completed in 2017, with only 2.0m sqm to remain in sight until 2021.
• Within the sub-segments, we believe business park space offers the best visibility, given their lack of new supply in 2017, and fully pre-committed new space for 2018 and 2020.

Demand support from improving macros 

• On the demand side, Singapore’s manufacturing sector appears to be sustaining its growth trajectory, given the visible momentum in positive macroeconomic indicators. Manufacturing PMI was 51.1 in Apr 2017, its eighth consecutive month of expansion. Industrial production expanded 10% YoY in Mar 2017, underpinned by a 38% YoY increase in the electronics cluster and 13% YoY increase in precision engineering.
• Business expectations in 1Q17 continued to improve, with a 7% net weighted balance of firms surveyed by the EDB more upbeat on the manufacturing sector for the period Apr 2017 to Sep 2017. This was up from 2% in 4Q16. Importantly, this optimism is sustained by the electronics cluster, with a weighted balance of 16% expecting market conditions to improve further in 2017.
• Growth in manufacturing and trade tends to stimulate demand for industrial space. Industrial leasing rose for a third consecutive quarter, albeit only by 1.1% YoY in 1Q17. This marked a turnaround from four quarters of decline from 3Q15 to 2Q16. We see further upticks alongside improved business sentiment. This should strengthen pre-commitments for upcoming factory and warehouse supply Our economists have raised their GDP growth forecasts to 3.0% (from 2.5%) for 2017E and 2.4% (from 2.3%) for 2018E (see report dated 12 May titled A Broadening Growth Recovery). 
• What appeared to be a narrowly-based electronics and transport & storage services led recovery late last year is broadening out this year, including to financial, business and wholesale trade services, with momentum from this trade recovery continuing to support growth for the rest of the year. 

Government to remain constructive 

• With industrial rents and prices down 0.8% QoQ and 2.1% QoQ respectively in 1Q17 - rents 12.3% down from their peak in 2Q14 and back to their 2012 levels, we expect the government to remain constructive on the industrial sector until there is clearer assurance on a broader manufacturing growth trajectory, given the earlier supply surge. We see possible fine-tuning in fiscal support for SME tenants, which could further ease pressures on industrial landlords.
• 1Q17 business park and warehouse vacancies already improved QoQ to 16.0% and 10.1% respectively, while factory vacancy rose to 10.5%.
• Occupancy was healthy across the industrial REITs, with AREIT’s Singapore occupancy flat at 90.2% as improvements in Singapore were negated by a decline in Australia. Mapletree Industrial Trust MINT’s occupancy improved to 93.1% on the strength of its hi-tech buildings and business parks. Mapletree Logistics Trust MLT’s Singapore occupancy was up to 93.9% from 93.5%, with weaker asset conversion pressures. AAREIT, like its large cap REIT peers, reported better occupancy QoQ.
• Rental reversions for large cap industrial REITs were positive in the Mar 2017 quarter. Singapore rental reversions were up 3.2% for AREIT and 0.4% for MLT, while MINT’s reversions were negative because of its stackup/ramp-up properties. Reversions for the smaller industrial REITs were negative, while AAREIT’s positive 0.6% came from the renewal of a 10-year lease at its Ang Mo Kio property. 

DPU support for AAREIT 

• Although near-term rental reversions could be negative for AAREIT, we see DPU support from its master lease rental step-ups, and contribution from its first BTS facility for Beyonics at Marsiling Lane from 2H 2017.

5% DPU optionality on under-utilised portfolio GFA 

AEI and redevelopment pipeline 

• AAREIT in Jul 2011 announced its first redevelopment of 20 Gul Way for SGD155m in phases. The first phase involved converting 10 single-storey buildings into a 5-storey ramp-up warehouse. After the redevelopment, the asset was master-leased to CWT for four years for its middle floors, and five years for its ground and fifth floors.
• In Phases 2E and 3 from Jun 2013, it added about 497k sqft of GFA for SGD77.2m. Another master lease was signed with CWT on similar terms: five years and two months for ground-floor space and 32 months for space on the second to fifth floors.
• AAREIT in Jan 2013 embarked on its second redevelopment project at 103 Defu Lane 10. It converted a 2-storey warehouse and its adjoining 3-storey building into a 6-storey industrial facility. This doubled its GFA from 97,367 sqft to 202,901 sqft and plot ratio from 1.2 to 2.5.
• AAREIT further announced the redevelopment of 30 Tuas West Road and 8 & 10 Tuas Avenue 20 in FY16. Its SGD41.7m AEI at 30 Tuas West Road was completed in Dec 2016. This entailed the conversion of two 3-storey detached industrial buildings into a purpose-built 5-storey ramp-up warehouse and boosted its boosting GFA by 80% to about 288k sqft. This has been fully leased to CWT as a single master tenant. Annual rental income is projected to rise four-fold to SGD4.15m from 1Q18.
• Upon completion in 2H 2017, 8 & 10 Tuas Avenue 20 will mark AAREIT’s fourth redevelopment project. Two adjoining 2-storey detached industrial plots will be rebuilt into a 3-storey multi-use industrial facility with ramp and cargo lift access. This would render them suitable for production and warehouse usage, and could potentially jack up their GFA by 35% to about 160k sqft.
• The above projects should add 1.8m sqft of industrial space for AAREIT or 27% of its portfolio. On its own estimates, they should generate S$28.6m in additional rental income.

Second best growth potential, after MINT 

• AAREIT has the lowest gearing amongst small-cap industrial REITs. We see ample debt headroom for the redevelopment of more properties.
• Some 758.5k sqft of its portfolio GFA was under-utilised as at end-Mar 2017. We estimate that seven of its nine light industrial and warehouse properties - excluding 2 Ang Mo Kio Street 65 and 8 Senoko South Road as their master leases were recently extended by 5-7 years - could add about 7.5% to its portfolio NLA, assuming 85% efficiency.
• We estimate a total development cost of SGD200m, assuming SGD150psf in construction costs. This could raise gearing to 43%, still below the 45% regulatory limit.
• We believe AAREIT affords the second best growth optionality from AEI/ redevelopment opportunities, after MINT. Gross development value (GDV) of these projects could potentially add 9% to its asset base and SGD0.6cts or 5% to its FY19/20 DPUs, on our estimates.

Valuation & Recommendation 

S-REIT valuations well-supported 

• S-REITs are sensitive to interest rates, with higher interest rates negative for their share prices. However, we believe that risks have been sufficiently priced in. Their current yield of 6.0% is 390bp above the 10-year Singapore government bond yields of 2.1% and close to the historical average of 400bp. They trade at 0.99x P/BV vs their long term average of 1.04x. Valuations have been stable over the long term, with narrow deviations from their average.
• We see undemanding valuations, given a potential sector recovery and DPU upside from any acquisitions and redevelopment which have not been priced in.
• Against other developed markets, we also see value. S-REITs command the highest yields and the second-widest spreads over their respective 10-year govt bond yields, after the H-SREITs.

Bottom-up selection 

• We expect industrial REITs with strong balance sheets and visible growth sources to outperform peers. 
• We think AAREIT’s returns on capital have the best scope for improvement from asset rejuvenation, given its low leverage and debt headroom.

Initiate at BUY, SGD1.60 TP 

• Our TP of SGD1.60 is based on a DDM model. We utilize a DDM-based valuation methodology for REITs given the reliance on underlying asset cashflows as a significant return component. 
• Key assumptions in our valuation for AAREIT include a risk-free rate of 2.5%, a market risk premium of 6.5% against our beta assumptions.

Risks 

Low asset diversification, portfolio skewed to weaker sub-segments 

• AAREIT has substantial exposure to the logistics and warehousing industry, which are facing relatively more challenging near-term supply pressures, as compared to business parks.

Tenant concentration risks 

• AAREIT’s top ten tenants in aggregate contribute about 60% of its gross rental income with its largest tenant CWT also the master lessee of its largest asset at 20 Gul Way, and accounting for 20% of its gross rental income. 
• Overall, contribution from CWT could fall as its staggered leases expire, even as its master leases commence at 30 Tuas West Road.

Chua Su Tye Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-05-25

Maybank Kim Eng SGX Stock Analyst Report BUY Initiate BUY 1.60 Same 1.60