ESR-REIT - CIMB Research 2018-04-23: 1Q18 Acquisition Boost; Scope For Capital Recycling

ESR-REIT J91U.SI

ESR-REIT - 1q18: Acquisition Boost; Scope For Capital Recycling

ESR-REIT's 1Q18 DPU of 0.847 Scts (-15.6% y-o-y) was below our and consensus expectations at 20% of our full-year forecast. The negative variance came from a lower-than-expected NPI margin.
Assuming the new units were only entitled to distributable income from 28 Mar to 31 Mar, adjusted 1Q18 DPU was stable (+0.4% y-o-y).
While 2H18 could remain soft due to MTB conversion of 16 Tai Seng, the acquisitions in 2017 and effective capital recycling could help to mitigate some of the weakness.

Valuations remain constructive, with the REIT trading at 7% FY18F yield and 0.9x current P/BV. A successful merger with VIT could catalyse the stock. Maintain ADD.

ESR-REIT's 1Q18 distributable income rose 2.4% y-o-y as full-quarter contributions from 7000 Ang Mo Kio (7000 AMK) and 8 Tuas South Lane (the acquisitions) more than offset MTB conversions at 21B Senoko Loop (1Q18) and 3 Pioneer Sector 3 (3Q17), four divestments since 1Q17 as well as lower underlying occupancies.
However, 1Q18 DPU fell 15.6% y-o-y due mainly to new units issued in relation to the preferential offer. If we adjusted for the timing difference, 1Q18 DPU was stable (+0.4% y-o-y).

ESR-REIT renewed/signed c.400k sq ft of leases in 1Q18, with an encouraging average rental reversion of -0.2% (FY17: -15.8%, 1Q17: -18.9%). We believe that this signals that the industry is bottoming. Tenant retention rate was 70.7%.
During the quarter, ESR-REIT also successfully renewed 28 Woodlands Loop’s master lease. Portfolio occupancy climbed 1.2% pts q-o-q to 94.2%. Occupancy for 7000 AMK grew 2.3% pts q-o-q to 94.2%.

Looking ahead, 18.1% of GRI (gross rental income) is up for renewal for the remainder of 2018. With 28 Woodlands Loop renewed, the proportion of STBs (single-tenanted buildings) was reduced from 7.2% to 6% as at end-1Q18.
We note that the Noble master lease (16 Tai Seng), which contributes to 4.7% of GRI, will be converted to MTB (multi- tenanted building) when it expires in 2H18. Also, there could be a temporary income vacuum for 21B Senoko Loop, which contributed to 2.4% GRI in FY17.

ESR-REIT has initiated an AEI for 30 Marsling Industrial (a general industrial building) so as to facilitate the addition of two quality tenants (Aptiv, a global tech company, and FormFactor, a Nasdaq-listed company).
ESR-REIT has secured long leases with these tenants; the addition will boost the occupancy of the property to 100% for a 5-year period (end-17: 82%). The AEI is expected to cost c.S$10m-12m and is scheduled for completion in 1Q19. Post AEI, the asset is expected to generate c.6% NPI yield.

With the completion of the preferential offering in 28 Mar (262.8m new units were issued, raising gross proceeds of S$141.9m), gearing was pared down from 39.6% to 30%. Assuming a 40% cap, we estimate ESR-REIT has debt headroom of c.S$270m for further capital redeployment.
We note that cost of debt rose 20bp q-o-q to 3.75% as 4Q17 had a higher proportion of revolving credit facility. ESR-REIT’s stabilised cost of debt is c.3.7%.

We cut our FY18F-20F DPU by 8-9.7% as we were over-optimistic on the REIT’s NPI margin.
Our DDM-based Target Price accordingly drops to S$0.60. Nonetheless, the two acquisitions made in 2017 and effective capital recycling could help to mitigate some of the softness.
Valuations remain constructive with ESR-REIT trading at 7% FY18F yield and 0.9x current P/BV. A successful merger with VIT (not rated) could also re-rate the stock.
Downside risks are weaker-than-expected organic growth and higher rate hikes.

YEO Zhi Bin CIMB Research | LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2018-04-23

SGX Stock Analyst Report ADD Maintain ADD 0.6 Down 0.640