ESR REIT - DBS Research 2017-07-17: Waiting For A New Chapter To Unfold

ESR REIT - DBS Vickers 2017-07-17: Waiting For A New Chapter To Unfold ESR-REIT J91U.SI

ESR REIT - Waiting For A New Chapter To Unfold

  • ESR REIT's 2Q17 DPU down 11.3% y-o-y due to loss of efficiency on conversion from single- to multi-tenants.
  • Divestment of two non-core assets will reduce gearing from 38% to 35%.
  • Downgrade to HOLD as TP is reached.
  • More clarity needed on synergistic benefits that new Sponsor brings to drive valuations higher.

DOWNGRADE TO HOLD, awaiting clarity on the new roadmap.

  • With a new sponsor in place, we remain optimistic about ESR REIT’s ability to access growth initiatives that new Sponsor Eshang Redwood offers. But we believe that this has been priced in at current valuations (P/NAV and yield) which is at historical average level, till more clarity is seen to drive valuations higher. 
  • Given limited upside to our Target Price since our upgrade in early 2017, we downgrade ESR REIT to a HOLD.

WHERE WE DIFFER: DBS’ earnings estimates are more conservative; potential cut in consensus estimates could pressure near-term share price. 

  • The manager has taken the right steps to maintain a stable occupancy rate and is trading off by lowering rents and thus more downside in DPUs is expected. We continue to see conversion from single- to multi-tenant properties to result in more downside to DPUs in the immediate term. 
  • Our numbers are slightly below consensus and we believe that might add pressure to the REIT’s share price if consensus continues to cut estimates. 
  • A surprise might come from the potential redevelopment of divestment proceeds to new acquisition opportunities.

POTENTIAL CATALYST: Clarity on the roadmap from the new Sponsor. 

  • We believe that market will start to price in premiums to NAVs once we have clarity on the roadmap put forth by Sponsor and the REIT, which might mean diversifying overseas.
  • One of the immediate benefits is the ability to be more active in acquisitions, given a potentially more significant pipeline of deal opportunities. A potential wildcard will be a proposed consolidation within the mid-cap industrial REIT space, which should lift valuations, in our view. See details in the report Catalyst Abound.

2Q17 RESULTS: Lease Conversion Continues To Pull Down Performance 

  • Rebranding to ESR-REIT. The REIT announced the change of its name from Cambridge Industrial Trust to ESR-REIT, effective from 12 June 2017, to strengthen its alignment with its Sponsor, ESR. 
  • We believe the rebranding is more than a simple name-changing exercise, as it integrates with the Sponsor’s corporate identity and signifies the Sponsor’s commitment to the REIT, following the Sponsor’s increase of its stake in the REIT since February 2017.

Lease conversion from single- to multi-tenancy continued to pull down performance. 

  • 1Q17 gross revenue was S$27.7m, down 2.2% y-o-y. NPI decreased by 9.2% to S$19.2m. This was mainly due to loss of efficiency from several lease conversions from single- to multi-tenanted as well as divestment of properties. 
  • Single- vs multi-tenanted properties by rental income dropped to 41% vs 59%, compared to 44% vs 56% a year ago. DPU was 0.956 Scts, down 11.3% y-o-y.

Tenancy conversion at two assets dragged down rental reversion. 

  • Over 1H2017, lease expiry concentration was reduced from 21.5% to 14.8%. Leases from three out of the five single-tenanted buildings were renewed with two assets being converted to multi-tenancy properties. 
  • Rental reversion rate was a glaring -18.3%, and the two assets converted from single- to multi-tenancy accounted for 80% of such low reversion rate.

Continued divestment of non-core assets will pare down gearing. 

  • Following the proposed divestment of 55 Ubi Avenue 3 (sales consideration of S$22.1m, target completion date 3Q17), the REIT has further proposed the divestment of two more assets, namely 23 Woodlands Terrace and 87 Defu Lane 10, with sales consideration of S$17.7m (2.8% above valuation) and S$17.5m (0.6% above valuation), respectively, and targeted completion in 4Q17 and 3Q17. Assuming all divestment proceeds are used to pay off debt, its gearing ratio could fall from the current 37.9% to 35.0-35.5%. 
  • After removing earnings from these two divestment assets, we forecast FY18F DPU to drop by around 1.5%.

DRP switched on. 

  • The Manager has determined that the distribution reinvestment plan (DRP) will apply to the distribution for the period from 1 April 2017 to 30 June 2017, with a 2% discount to the market price. The pricing of the DRP units will be announced on 24 July 2017. 
  • We believe the DRP will have an insignificant impact on either the stock price or distribution. However, this may be a signal of the REIT ability to accumulate cash on the balance sheet which might be used opportunistically.


Downgrade to HOLD. 

  • We upgraded the stock from HOLD to BUY in January 2017 after the REIT’s lacklustre performance in 2016 and the announcement of the new Sponsor whom we believed would remove some of the overhanging risk. Since then, the stock price of ESR-REIT has moved up over 10% from S$0.54 to our target price S$0.60. 
  • While we are still optimistic about the REIT’s prospects, renewed by its Sponsor, we have decided to maintain our Target Price and downgrade our recommendation to HOLD, pending more pointers on a clearer roadmap for growth.

Recap of new sponsor ESR. 


Lease conversion from single- to multi-tenant. 

  • The unfavourable rental reversion resulting from the ongoing conversion of tenancy may bring downside surprises.

Singapore Research Team DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2017-07-17
DBS Vickers SGX Stock Analyst Report HOLD Downgrade BUY 0.60 Same 0.60