ESR-REIT - CIMB Research 2017-12-14: Buoyed By Acquisitions; Upgrade To Add

ESR-REIT J91U.SI

ESR-REIT - Buoyed By Acquisitions; Upgrade To Add

On the back of its two recent accretive-acquisitions as well as evident sponsor commitment, we are able to visualise ESR-REIT’s growth trajectory more clearly now.
We raise our FY18F-19F DPU by 2.9-3.0% and upgrade the stock from Hold to Add, with a higher DDM-based TP of S$0.63. We project total returns of 20% in FY18F.
ESR-REIT has completed its second sizable acquisition in two months. It acquired 80% of 7000 Ang Mo Kio for S$240m or 6.5% initial NPI yield. Post equity fund raising, the manager expects gearing to come down to 33.2%.

We turn constructive on ESR-REIT in view of its
1. relative valuations,
2. effective portfolio reconstitution and sponsor support, and
3. inorganic growth from acquisitions.

ESR-REIT today completed the accretive-acquisition of 80% of 7000 Ang Mo Kio, a high specifications industrial building, for S$240m or 6.5% initial NPI yield. The vendor was Ho Lee Group, a local construction group. Put and call options are also in place for ESR-REIT to acquire the remaining 20% of the property in the next 12 months.
This acquisition follows the proposed acquisition of 8 Tuas Lane on 18 Oct, also completed today.
Post acquisitions, ESR-REIT’s asset under management (AUM) rose to S$1.75bn from S$1.33bn.

The Ang Mo Kio acquisition improves portfolio quality in terms of weighted average lease expiry (WALE), land lease and rent expiry profiles as well as tenant diversification.
The property, located in Serangoon North Industrial Estate, comprises a 6-storey production block and a 5-storey ancillary office block. It has a NLA of 834.8k sq ft and occupancy of 91.9%. It has eight tenants, including Heptagon Micro Optics, Starhub and a high-value added manufacturer - we estimate the trio account for > 60% of its gross rental income.

Additionally, the property has a WALE of 5.5 years, extending ESR-REIT’s portfolio WALE from 3.4 years to 4.2 years.
The asset has minimal leases expiring in the near term. The property has a land lease of 9+30 years, which would increase portfolio land tenure from 33.1 years to 34 years.
Lastly, the property has a un-utilised plot ratio of 0.8 (where a carpark is currently located) which translates into potential additional GFA of c.495k sq ft.

The acquisition also removes potential negative carry from the 4.6% S$150m perpetual securities (perps) issued in Nov 2017. Part of the proceeds was used to acquire 8 Tuas Lane (total acquisition cost: S$111m), which we note has annual rent step-ups.
We assume ESR-REIT would issue 236m new units at S$0.53/unit (S$125m) to fund c.50% of 7000 Ang Mo Kio, utilise the perps' remaining c.S$32m to fund 13%, and use c.S$26m from recent divestments to fund 10%. The remaining 27% would be funded by debt.

Factoring in the two acquisitions, the S$150m perps and the potential equity issuance in 2018F, we raise our FY18F-19F DPU by 2.9-3.0%. Our DDM-based TP rises to S$0.63 on higher LTG (1.5% from 1%).
ESR-REIT has been a laggard, gaining 3.7% YTD vs. FSTREI’s 19%.
We are also buoyed by its effective portfolio reconstitution and commitment by sponsor.
With ESR-REIT at the tail-end of its multi-tenant building (MTB) conversion and inorganic growth from acquisitions, we forecast 5.7% DPU growth for FY18F. Upgrade to Add.

Downside risks to our call could come from challenging industrials and unfavourable acquisitions.

YEO Zhi Bin CIMB Research | LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2017-12-14

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