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

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.

Second sizeable acquisition in two months 

  • 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.

A good acquisition, in our view… 

  • 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.

… with potential upside from developing un-utilised plot ratio 

  • 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.

Funding structure of the acquisition; raising equity to part-fund 

  • 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.

Increase FY18F-19F DPU by 2.9-3.0%; upgrade to Add 

  • 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 

  • 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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