SG Industrial REITs - OCBC Investment 2018-05-24: The Next Big Thing

SGinvestors.io

CACHE LOGISTICS TRUST SGX:K2LU VIVA INDUSTRIAL TRUST SGX:T8B SOILBUILD BUSINESS SPACE REIT SGX:SV3U ESR-REIT SGX:J91U

SG Industrial REITs - The Next Big Thing

• The 4th largest industrial REIT?
• A look at the proposed merger.
• Rotate from CACHE to VIT.

To have and to hold: Attractive for both sides of the aisle?

• We find the terms of the proposed merger between Viva Industrial Trust (VIT) and ESR-REIT attractive for VIT unitholders. 
• In effect, each VIT unit is to receive S$0.096 in cash and 1.6 new ESR-REIT units. We estimate that the fair value of these new ESR-REIT units (i.e. units of the merged entity) should lie at ~S$0.53 each.
• Overall, our estimate translates into an aggregate value of at least S$0.942 – including the S$0.096 in cash – for each VIT unit, which is ~6% above VIT’s closing price of S$0.885 as at 23 May. While we do not cover ESR-REIT, we believe their unitholders also stand to benefit from the merger. The estimate of a S$0.53 fair value post-merger is ~4% above that of ESR-REIT’s closing price of S$0.51 on 23 May. 
• While this S$0.53 estimate is below the current Bloomberg consensus fair value estimate of S$0.59 for the stand-alone ESR-REIT, we note that there are positive catalysts particular to the merger scenario:
  1. a P/B revaluation post- merger and
  2. operational and financial synergies,
  as discussed below.

A big baby is born: Further revaluation potential of up to 10%

• Should the merger be successful, the new entity will become the 4th largest industrial S-REIT by asset size. By virtue of its size alone, we see the potential for an upward revaluation of the REIT post-merger.
• As at 23 May’s close, large-cap industrial REITs are trading at higher P/B valuations (1.10x to 1.33x) compared to small to mid-cap industrial REITs (0.72x to 1.17x). In particular, in terms of asset size and portfolio composition, we believe the closest comparable for the enlarged ESR-REIT would be Mapletree Industrial Trust (MINT). Notwithstanding this, investors’ familiarity with Mapletree vs. Warburg Pincus-backed ESR may mean that the merged entity could trade at a discount relative to MINT’s P/B valuation of 1.33x.
• Overall, we believe that the combined entity could eventually trade at around a ~1.25x P/B, around 10% higher than the ~1.14x P/B our S$0.53 estimate currently implies. Beyond this chance of a revaluation, we note opportunities for operational and financial synergies that can be gained from the merger. See report appendix for more details.

Preparing for the future: Switch from CACHE to VIT

• Within the small-mid cap REITs space under OIR’s coverage, we recommend switching holdings from Cache Logistics Trust (CACHE) [HOLD; FV: S$0.83] to Viva Industrial Trust [ACCEPT THE OFFER], given their 23 May closing prices. We are also positive on Soilbuild Business Space REIT [BUY; FV: S$0.71], but see fewer catalysts in the near horizon compared to VIT. We do not cover ESR- REIT.
• Given that S-REITs valuations remain stretched, we encourage investors to remain selective in their holdings within the space.

A Look At The Terms & Valuations

Arriving at the ~S$0.53 fair value for each unit of the merged ESR-REIT

• This estimate is based on our fair value of Viva Industrial Trust (S$0.90) and on the Bloomberg consensus target prices for ESR-REIT since we do not cover the latter. Adjustments are also made for the cash consideration to be paid.

Exhibit: A look at fair values

REIT	Fair value per unit (S$)	No. of units (m)	Fair value multiplied by No. of units (S$m)
Viva Industrial Trust (stand-alone)	S$0.90 fair value   (our own)	975.8m	S$878.2m
ESR-REIT (stand-alone)	S$0.59 fair value consensus (based on Bloomberg consensus, not covered by OIR)	1583.7m	S$934.4m
ESR-REIT (post-merger)	S$0.53 estimate (S$1,662.7M divided by 3145.0M) Potential to be higher given the synergies from merger	3145.0m (1583.7 + 1.6 * 975.8)	S$1,662.7m (Sum of the above minus S$0.096/unit cash consideration to be paid out to VIT unitholders)

Source: REIT Managers, Bloomberg, OIR

Larger REITs tend to trade at perceptibly higher P/B valuations

• As at 23 May’s close, large-cap industrial REITs are trading at higher P/B valuations (1.10x to 1.33x) compared to small to mid-cap industrial REITs (0.72x to 1.17x). Should the merger be successful, we believe that the enlarged entity could trade at a higher valuation than the 1.14x P/B currently implied by the S$0.53 estimate above. 
• Mapletree Industrial Trust (MINT), which we see as potentially the closest comparable to the enlarged ESR-REIT, currently trades at 1.33x P/B.

KEY BENEFITS OF THE MERGED ENTITY VS VIT

Much larger portfolio.

• Total portfolio size would increase from S$1.3b (VIT) to S$3.0b (VIT and ESR-REIT). The enlarged entity would be the fourth largest industrial S-REIT. Having a larger portfolio would provide greater diversification and add resilience to the REIT’s operational performance. i.e. sudden tenant defaults and master lease conversions would likely matter less when the portfolio is sizeable.
• Assuming the market cap also increases to above S$1b (which is an explicit mandate for several institutional funds), this would also make the REIT an investable asset to more investors.

Dilutes impact of VIT’s fall-off in income support in 2019.

• Should the merger go through, the fall off in income support will be “spread” across a larger base of distributable income.

Reduces land lease to expiry in next 20 years.

• The impact of VIT’s short land lease at Viva Business Park will be reduced as a result of the merger.

Access to cheaper financing.

• The merged REIT will have access to cheaper financing given that its portfolio will be 100% unencumbered compared to 8% for VIT’s current portfolio.

Deborah Ong OCBC Investment | https://www.iocbc.com/ 2018-05-24

SGX Stock Analyst Report HOLD Maintain HOLD 0.830 Same 0.830

ACCEPT OFFER Maintain ACCEPT OFFER 0.900 Same 0.900

BUY Maintain BUY 0.710 Same 0.710