ESR-REIT - CIMB Research 2017-10-18: First Shot Out

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ESR-REIT J91U.SI

ESR-REIT - First Shot Out

• ESR-REIT (EREIT) has entered into an option agreement with Hyflux to acquire 8 Tuas South Lane for S$95m, marking the inaugural transaction for the newly-branded EREIT.
• Overall, we are positive on the acquisition given the DPU-accretion, though we are also cognisant of risks further down the road.
• Pending completion of the acquisition, we keep our estimates and Hold rating.

Proposed acquisition of 8 Tuas South Lane

• EREIT has entered into an option agreement with Hyflux (HYF SP, NR) to acquire 8 Tuas South Lane (together with the mechanical and electrical equipment) for a purchase consideration of S$95m. Hyflux will then leaseback most of the space for 15 years. This potential acquisition would mark the inaugural transaction for EREIT since ESR became the majority shareholder of its manager in Jan 2017.
• For the acquisition to materialise, one key condition is that JTC (Singapore’s industrial landlord and regulator) has to confirm that Hyflux has fulfilled the requisite fixed investment criteria; and that JTC would grant a further land lease term of 15-16 years for the property.
• The property has a GFA (gross floor area) of c.72.6k sqm and remaining land tenure of c.20 years. The property comprises five detached factories (used for producing membranes and steel structures), an 8-storey warehouse and four blocks of dormitory buildings. It is located near Tuas Biomedical Park, and next to Singapore’s future global and international maritime hub – Tuas Megaport.
• The estimated total cost of the acquisition is S$111m, comprising
  1. the consideration of S$95m,
  2. estimated upfront land premium payable to JTC for the balance of the first 30-year lease term of S$11.4m,
  3. stamp duties of c.S$3.2m, and
  4. S$1.4m in transaction costs.
• Including upfront land premium payable for the unexpired lease term of 35.4 years, an independent valuer (Edmund Tie & Company (SEA) Pte Ltd) has valued the property at S$115m (using income approach), implying that EREIT’s purchase price was at a somewhat wide discount ( > 5%). We suspect that valuation of the property could be lower if we were to use a direct comparison approach.

Funding for the acquisition has yet to be confirmed. 

• However, assuming all-debt financing, the manager has guided that 2016 pro forma DPU (assuming that EREIT completed the acquisition at the beginning of 2016) would increase by 8.5%. Initial NPI yield is guided at 6.5%.
• As at Sep 2017, EREIT’s gearing stood at 36.7%, with all-in borrowing cost at 3.73% p.a. Assuming a 40% cap on gearing, we estimate that EREIT would have available debt headroom of S$75m. The REIT is also in the process of divesting 23 Woodlands Terrace (c.S$17.7m) and 87 Defu Lane 10 (S$17.5m); and sales proceeds could be used to fund the acquisition.

Our view: the good and the bad

• The positives are
  1. long lease tenure of 15 years which would increase EREIT’s WALE (weighted average lease expiry) from 3.4 years to 4.2 years;
  2. quality tenant covenant in Hyflux and
  3. potential DPU-accretion. Post-acquisition, we estimate that Hyflux would become EREIT’s top three tenants.
• The negatives are
  1. the property’s short land lease expiry;
  2. specialised asset which could reduce optionality for the REIT; and
  3. potential capex requirements since EREIT owns the mechanical and electrical equipment. 
• Overall, we are positive on the acquisition given the potential DPU-accretion, though we are also cognisant of risks further down the road.

Hold maintained

• Pending completion of the acquisition, we keep our estimates, DDM-based TP and Hold rating. 
• Management continues to scour for acquisition opportunities to take EREIT to the next stage of growth. We believe that potential game-changing acquisitions would have a significant bearing on the unit price (from both upside and downside perspectives). Until then, we believe that the unit price would trade sideways.

YEO Zhi Bin CIMB Research | LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2017-10-18

CIMB Research SGX Stock Analyst Report HOLD Maintain HOLD 0.570 Same 0.570