Ascendas REIT - Phillip Securities 2017-07-14: Growth Through Rebalancing, Stability Through Diversification

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ASCENDAS REAL ESTATE INV TRUST A17U.SI

Ascendas REIT - Growth Through Rebalancing, Stability Through Diversification

• Established and well-diversified platform, with a track-record of growing DPU.
• Singapore Industrial rents expected to bottom by 2018.
• Initiate coverage with Accumulate rating and $2.86 target price.
• Initiating with Accumulate rating and DDM valuation of $2.86. 

What's New

• We like Ascendas Real Estate Investment Trust (A-REIT) for its track record of growing YoY distributions to Unitholders, active capital recycling, repositioning of portfolio mix and stability through its well-diversified portfolio. 
• Our dividend discount model (DDM) valuation represents an implied 1.35x multiple over FY18e net-asset-value.

Investment Merits 

Largest Industrial REIT with an improving outlook for Industrial rents. 

• Oversupply of Industrial space is a concern, but supply is tapering in 2018. Taking the tapering supply in context with the uptick in Industrial activity leads us to believe that rents to bottom by 2018.

A ready pipeline of Industrial space from Sponsor. 

• A-REIT's Sponsor does not grant a right of first refusal (ROFR) portfolio. Nonetheless, A-REIT has access to the Sponsor's pipeline of over S$1 billion of Business & Science Park properties in Singapore.

Sizeable Australian platform, tapping on favourable outlook. 

• Australia is expected to experience positive gross domestic product (GDP) growth in 2017. Outlook is robust for leasing demand of industrial properties in Sydney and Melbourne, underpinned by population growth and retail trade. 76% of the Australia platform by valuation is located in Sydney and Melbourne.

Relatively low gearing affords debt headroom for inorganic growth. 

• A-REIT's 3.0% cost of debt is lower than median of 3.4% among peers as at end-March 2017.
• Aggregate leverage of 33.8% affords ample debt headroom to grow the portfolio by 20%.

Attractive distribution yield. 

• A-REIT offers an attractive FY18e forward dividend yield of about 6.1%.

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REIT Snapshot 

• Ascendas Real Estate Investment Trust (A-REIT) is the largest REIT in the S-REIT universe by market capitalisation, and it was the first Industrial REIT to be listed. 
• Backed by Sponsor, Ascendas-Singbridge Group, which is 51:49 jointly-owned by Temasek Holdings and JTC Corporation. The Sponsor has a 30 year track record in the industry and with a pipeline to over S$1 billion of Business and Science Park properties in Singapore. 
• The Manager, Ascendas Funds Management (S) Limited (AFM), is a wholly-owned subsidiary of the Sponsor and has a three-pronged strategy of 
  1. proactive portfolio management, 
  2. disciplined value-adding investments and 
  3. prudent capital & risk management. 
• HSBC Institutional Trust Services (Singapore) Limited is the Trustee. The property portfolio is held in a trust by the Trustee. The Trustee is responsible for the safe custody of the assets on behalf of Unitholders.
• Singapore portfolio valued at S$8.57 billion as at end-March 2017 consists of 3.03 million sq m of lettable area. The portfolio of 103 properties is diversified across five property types: 
  1. Business & Science park properties, 
  2. Integrated development, amenities & retail properties (IDAR), 
  3. Hi-specification industrial properties & data centres, 
  4. Light industrial properties & flatted factories and 
  5. Logistics & Distribution centres.
• Australia portfolio valued at S$1.31 billion as at end-March 2017 consists of 692,000 sq m of lettable area. The portfolio holds 27 Logistics & Distribution centres and one Business Park property.

Investment Thesis – Established and diversified platform that continues delivering returns 

• We view A-REIT as an established platform that has delivered growth through active portfolio rebalancing and achieved stability through portfolio diversification. 
• DPU has grown at a 3.0% CAGR over the last five years, from 13.6 cents in FY12 to 15.7 cents in FY17. 
• A-REIT has rebalanced its geographical footprint by gaining a foothold in Australia and exiting from China. The portfolio remains diversified across asset type, lease structure and tenant trade sector.

Achieving stability through portfolio diversification 

Diversification by geography and property type 

• The portfolio is currently split between Singapore and Australia. Singapore remains the home base, while the Australia assets make up 14% of total portfolio value. Australia is attractive for its freehold land status and market transparency. A-REIT had divested its three China properties during FY17.
• The Singapore portfolio is diversified across the five property types of: 
  1. Business and Science Park properties, 
  2. Integrated development, amenities & retail (IDAR) properties, 
  3. High-specifications industrial properties and data centres, 
  4. Light industrial properties and flatted factories, and lastly, 
  5. Logistics & Distribution centres.
• The Australia portfolio consists of only Logistics & Distribution centres and one Business park property.

Diversification by number of properties 

• A-REIT has 131 properties in its portfolio as at end-March 2017. The largest contribution to the portfolio's monthly gross revenue from any property is 5.4%. 
• Consequently, A-REIT is not heavily dependent on the income from any single property in its portfolio. The largest contribution to gross revenue is attributable to the property located at 8, 10, 12 Kallang Avenue known as Aperia. Aperia is an Integrated development, amenities & retail (IDAR) property consisting of two Business towers connected to a three-storey Retail mall.

Diversification by tenant trade sector and individual tenants 

• A-REIT's tenants span across more than 20 trade sectors. A-REIT's portfolio does not have a majority exposure to any particular trade sector. The largest exposure comes from the third-party logistics (3PL) and freight forwarding segment, accounting for 10.6% of monthly gross revenue. At the same time, A-REIT's 10 largest tenants account for 20.8% of portfolio gross revenue, with Singapore Telecommunications Ltd being the largest at 4.8%.
• Consequently, A-REIT's portfolio experiences low single-customer concentration risk.

Delivering growth through active portfolio rebalancing 

Rebalancing the Singapore portfolio through inorganic growth 

• A-REIT boasts a portfolio that has "low exposure to manufacturing". The manager's strategy has been to reposition the portfolio to cater to higher-value manufacturing activities and non-manufacturing activities. A recent acquisition was of a Business & Science Park asset, while a recent divestment announced was for a Light Industrial building / warehouse. 
• The Singapore portfolio is currently weighted 65% by valuation towards Business & Science Park properties, Hi-specifications industrial properties and data centres.
  • Expanded its exposure to Business & Science Park properties through 12, 14 and 16 Science Park Drive (DNV/DSO). 
    A-REIT acquired the property in Singapore Science Park 1 for S$420 million. The acquisition of the three buildings under a single land title was completed on 16 February 2017, and partially contributed to 4Q FY17 results. The property is fully leased, with DSO National Laboratories occupying two of the buildings, and DNV GL Singapore Pte Ltd occupying the third building. The weighted average lease expiry (WALE) for the property is for 16.5 years, which is considerably longer than the typical industrial lease and also longer than A-REIT's portfolio WALE of 4.3 years.
  • Ongoing re-development and AEI projects.
    A-REIT is currently redeveloping two assets in Singapore – 20 Tuas Avenue 1 and 50 Kallang Avenue. In addition, The Gemini (a Science Park 2 property) is currently undergoing asset enhancement initiative (AEI). The AEI at The Gemini follows the AEI completed at the other buildings within the cluster (The Aries-Sparkle). The Gemini remains income producing for the duration of the AEI project.
  • Recycling of capital through divestments.
    Recent divestments in Singapore were Four Acres Singapore (completed 29 April 2016) and 10 Woodlands Link (completed 12 July 2017). Four Acres Singapore was a build-tosuit (BTS) project and the property was divested to Unilever for S$34.0 million, which is higher than the development cost of S$30.8 million. 10 Woodlands Link (Light Industrial building / warehouse) was divested for S$19.3 million, which is higher than the original purchase price of S$12.0 million.

Made a sizeable investment in the Australian platform 

• A-REIT's foray into Australia was in 2015 through an initial platform of 26 Logistics properties across Sydney, Brisbane, Melbourne and Perth. The platform was acquired from GIC and Frasers Property Australia Pty Limited for A$1.01 billion and completed over two Phases. Phase One consisted 10 properties and was completed on 23 October 2015 (3Q FY16); Phase Two was completed on 18 November 2015 (3Q FY16).
• Since the initial platform, the Australian portfolio has grown to A$1.26 billion with the addition of two Logistics facilities and a Business Park property.

Properties of comparable yield that are on freehold land 

• Yields in Australia (6.42%) are comparable to that in Singapore (6.27%), but the key difference is that the properties are on freehold land. This is in direct contrast to industrial land in Singapore, which is allocated by the government at shorter tenures – typically 25 or 30 years of land lease. The Singapore portfolio has a weighted average land lease expiry of 46.5 years as at end-March 2017.

Acquisition of Logistics Property in Dandenong South, Melbourne after FY17 

• The forward purchase of the logistics property, Stage 4, Power Park Estate was announced on 9 Sep 2016 for A$24.8 million (S$26.5 million). The acquisition was completed on 3 April 2017 (1Q FY18) with 68% occupancy.

Exited from China platform in FY17 

• A-REIT had three China properties which were divested during FY17. This will be a negative impact in FY18, due to absence of contribution from the properties.

Took profit at a good price and realising investment gains 

• The properties were divested at capitalisation rates of 5% and realised gains of about S$196.5 million over original cost.

Valuation Method: Dividend Discount Model (DDM) 

Absolute valuation

• The DDM is an appropriate method to value A-REIT as most of its cash flow is paid out to Unitholders through dividends. A-REIT has consistently paid out 100% of its distributions.
• We derive a valuation of S$2.86 from our DDM valuation.

Sources of growth in FY18 

• Inorganic growth in gross revenue from contributions by two Australian acquisitions completed in 2Q FY17 (197-201 Coward Street, Sydney) and 1Q FY18 (Stage 4, Power Park Estate, Melbourne) and one in Singapore in 4Q FY17 (12, 14, 16 Science Park Drive); offset by absence of China portfolio and Four Acres Singapore which were divested in FY17, and 10 Woodlands Link which was divested in July 2017.
• Organic growth is expected to be muted as the Singapore portfolio – which is 87% of the REIT's overall portfolio by valuation – is currently facing an oversupply situation.
• Adverse impact on Distribution per Unit (DPU) due to dilutive conversion of Exchangeable Collateralised Securities (ECS), which increased the number of issued units by ~10% during FY17.

Peer Comparison 

• While we value A-REIT using a DDM, we compare it on a relative valuation basis against its peers. We have excluded Keppel DC REIT and EC World REIT from the comparison table as they hold a portfolio consisting exclusively of data centres and warehouses exclusively in China, respectively.

Larger capitalised REITs tend to trade at a premium 

• A-REIT is trading above the sector average P/NAV multiple. Among peers, the larger capitalised REITs tend to trade at a premium to their book value.

Historically, A-REIT had traded at a discount to book value only once 

• The only time that A-REIT had traded below its trailing NAV was during the tail-end of the global financial crisis (GFC) in 2008/2009. Since then, A-REIT has never traded at a discount to its book value again. 
• The lowest P/NAV multiple it has ever traded to was 1.08x.

Investment Risks 

Protracted uncertainty in business sentiment. 

• Cautious outlook from tenants and reluctance to renew leases or expand would result in muted demand for space and put pressure on rent.

Disorderly interest rate hikes. 

• A faster than expected hike in interest rates would put pressure on cost of debt and negatively impact income available for distribution.

Australia portfolio faces two key risks. 

• Unfavourable changes to the withholding tax regime and concentration in Logistics & Distribution facilities.

Richard Leow Phillip Securities | http://www.poems.com.sg/ 2017-07-14

Phillip Securities SGX Stock Analyst Report ACCUMULATE Initiate ACCUMULATE 2.86 Same 2.86