EC World REIT - DBS Research 2019-02-21: Boon From E-Commerce Boom

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EC WORLD REIT (SGX:BWCU)

EC World REIT - Boon From E-Commerce Boom

• Specialised logistics operator with growing China e-commerce footprint, also setting its sights on high-potential ASEAN market.
• Anchored by stable leases, offering above-average yields north of 8%.
• Low gearing signals acquisition capacity, with GFA of nearly 500,000 sqm in its ROFR pipeline.
• Initiate with BUY and Target Price of S$0.86.

Scaling the e-commerce ladder.

• EC World REIT (SGX:BWCU), a diversified logistics operator, is in the midst of scaling up its e-commerce business, which has taken the group beyond Hangzhou into Wuhan. It typically derives a substantial c.70% of revenue from master leases, which provides a high level of income certainty with visibility of growth.

Building a firm acquisition pipeline.

• Sponsored by China-based property group Forchn Group and through its recent strategic initiative with leading logistics operator, YCH Group, EC World REIT has acquired a substantial ROFR pipeline of over 500,000 sqm in GFA, comprising Fu Zhou E-commerce Properties in Hangzhou (China) and potentially 13 warehouse assets across Asia.
• Given ample debt capacity, we believe that an acquisition may be on the horizon, which has yet to be factored into our estimates.

Underappreciated stock trading at attractive valuations.

• While our BUY call is premised on the successful extension of its master lease at end-2020 – a key overhang on the stock, we believe that at current prices, the risk-to-reward ratio has turned favourable.
• Given the slack in underlying occupancy at Bei Gang Stage 1, our scenario analysis implies a fair value of S$0.70 with FY21F yield of 7.5% if the extension does not materialise, which suggests limited downside. Conversely, the successful extension of master leases would be a key re-rating catalyst for EC World REIT.

Scaling the E-Commerce Ladder

• EC World REIT owns a diversified portfolio of income-generating logistics assets in Hangzhou and Wuhan, which includes
  1. Chongxian Port Investment,
  2. Chongxian Port Logistics,
  3. Fu Zhuo Industrial,
  4. Stage 1 properties of Bei Gang Logistics,
  5. Fu Heng Warehouse,
  6. Hengde Logistics, and
  7. Wuhan Mei Luo Te.
• Broadly classified into three logistics segments: Port, E-commerce and Specialised Logistics, these assets have a combined NLA of 747,173 sqm and valuation of RMB6,693m (based on average of independent valuations by Savills and Colliers as at 31 December 2017).
• For the nine months ended September 2018, Port Logistics segment was the biggest contributor to Gross Rental Income (46.5%), followed by E-Commerce Logistics (38.1%).
• Ranked as the top inland port in Hangzhou for the transportation of steel products since 2011, Chongxian Port Investment alone accounted for a third of EC World REIT’s AUM and GRI, despite only making up c.15% of total NLA. With the addition of Wuhan MeiLuoTe in April 2018 – EC World REIT’s maiden acquisition post listing, E-commerce and Specialised Logistics now account for c. 68.1% of portfolio NLA vs 64.8% a year ago.

Broad, high-quality tenant base with diversity in end-markets.

• Including the three properties under the master lease agreement, the end-users of the portfolio’s assets can be broadly classified into the five following categories:
  • Delivery, logistics and distribution (such as port operators, warehouse operators and tenants and third-party logistics providers);
  • Provision of e-commerce services (such as B2B and B2C online operators, O2O showrooms, intermediary service providers, start-up incubators);
  • Industrial (such as state-owned tobacco company, steel product manufacturers and traders);
  • Trading; and
  • Others (including conglomerate, telecommunication, transport services and real estate)
• The broad mix of trade sectors ensures diversification and reduces dependence of the portfolio's assets on the performance of any single trade sector. As at 31 December 2017, no single trade sector nor tenant contributed more than 41.0% of the portfolio’s gross rental income (GRI).
• Refer to the PDF report attached for highlights of EC World REIT's property portfolios. 

Strong Earnings Visibility

Master lease agreements offer higher degree of income certainty.

• Three out of seven of EC World REIT’s portfolio properties – Chongxian Port Investment, Stage 1 Properties of Bei Gang Logistics, and Fu Heng Warehouse, are currently backed by direct and indirect master leases to the Sponsor.
• While underlying rents and occupancies catch up, we believe that EC World REIT’s lease structure offers investors a higher degree of income certainty, with visibility on growth from built-in rental escalations. For FY19F, we estimate that EC World REIT would derive c.69% of its gross rental income from master leases, with the remaining c.31% to be derived from multi-tenanted properties.

Multi-tenanted properties also showing signs of stabilisation.

• Excluding Wuhan MeiLuoTe, we note that contributions from EC World REIT’s portfolio of multi-tenanted properties have improved marginally over time and if sustained, could help drive further upside to rents and ultimately, distributions to Unitholders.

Average WALE of 2.2 – 2.3 years.

• As at 30 September 2018, the weighted average lease expiry (WALE) by committed NLA and GRI were 2.2 and 2.3 years respectively. This mainly reflects the master lease expiries that are coming through in 2020, which if successfully renewed, will help alleviate market concerns on earnings risks over the medium term, removing stock overhang.

Extension of master leases, currently set to expire in 2020, a key catalyst for the REIT.

• According to the Manager, underlying gross revenue for EC World REIT in FY17 was c.15.8% lower at S$77m compared to S$91.4m under the master lease structure. Further, with master leases due to expire at end-2020, we believe that the Manager may be in active discussions with the Sponsor regarding possible extensions.
• Our base case assumes the successful extension of the master lease at expiring rent levels. Failing which, may result in a c.7.7% cut in FY21F DPU vs FY20F, given the gap between master lease vs underlying rents – which we estimate to be c.5% across the master-leased properties and current slack in occupancy at Bei Gang Stage 1. At current prices, implies favourable risk-reward ratio given attractive implied yields of 7.5%.

Rising E-Commerce Proposition

Riding the Chinese e-commerce boom.

• Based on research by Analysys Consulting, we estimate that the deal size of China’s online retail market grew rapidly at c.58% CAGR from c.RMB0.25tr in 2009 to c.RMB3.95tr in 2015. The total value of online retail sales in China is expected to exceed RMB9.4tr in 2020.

Favourable government policies support further growth...

• Examples of government policies and initiatives that could benefit the e-commerce industry include:
  • “The Internet Plus” action plan announced by Premier Li in March 2015, which envisages the integration of mobile internet, cloud computing, big data, and the Internet of Things with modern manufacturing, in order to encourage the development of e-commerce, industrial networks, and internet banking domestically.
  • “The Master Plan of Medium and Long-term Development of Logistics Industry” in 2014 which establishes the tone for developing a favourable environment for growth in the logistics industry; and
  • “One Belt One Road” initiative in 2013 which aims at building the Silk Road Economic Belt and Maritime Silk Road in the 21st century, providing the logistics industry an opportunity to go beyond borders to participate in international economic cooperation.
• With greater policy support from the central government in recent years, we remain positive on the growth prospects of the Chinese e-commerce market in the foreseeable future.

Likewise, the e-commerce services industry also benefits as it rides on the coattails of the booming e-commerce market.

• The continuous expansion of the online retail market and further industrial development has played an active and leading role in the development of supporting industries and the e-commerce service industry, which can be broadly categorised into:
  • Supporting services, including payment, logistics, express deliveries, credit authentication, etc.
  • Derivative services, including store decoration, data services, training and consultation, etc.
• Analysys Consulting estimates that in 2015, the size of the Chinese e-commerce service industry reached RMB910bn and could almost quadruple to RMB3.6tr by 2020.

Shift towards integrated e-commerce hubs.

• The boom in the e-commerce market and e-commerce service industry has led to an increase in demand for integrated e-commerce hubs with facilities that cater seamlessly to both online and offline business needs.

However, there remains a shortage of compatible logistics facilities and eco-systems in China.

• Quality logistics facilities and support are fundamental in ensuring the smooth operations of e-commerce and account for approximately 3- 5% of the margin from e-commerce business. Although recent developments in the Chinese logistics sector have been geared towards the construction of high-quality warehouses, the current supply of quality logistics facilities continues to lag significantly behind demand.
• Statistics show that warehouse rental rates in key Chinese cities grew between 1% and 12% CAGR over the past 12 years, with Hangzhou coming in closer to the upper end at c.8% p.a. on average. Going forward, DBS Research predicts that coastal cities in Yangtze River Delta and Jing-Jin-Ji are expected to lead rental growth, while Wuhan is likely to see flattish rentals in the immediate term.

Attractive exposure to Hangzhou, one of the largest e-commerce hubs in China.

• Riding on strong government support, Hangzhou has developed its e-commerce industry swiftly. Today, some of the largest online retail portals (such as Alibaba Group) are headquartered in Hangzhou, alongside some 470,000 online business entities.
• According to Colliers, retail sales in Hangzhou reached RMB430.2bn in 2017 with a CAGR of c.30% over 2013- 2017. This has helped to fast-track the development of third-party logistics. Notably the volume of express service deliveries grew at nearly 50% CAGR over 2013-2017 to approximately 2.3bn pieces in 2017.
• As EC World REIT enjoys a market catchment area covering some of the most active Chinese cities in e-commerce (such as Shanghai, Ningbo, Jinhua and Yiwu), we believe its e-commerce assets – Stage 1 Properties at Bei Gang Logistics and Fu Heng Warehouse in Hangzhou – are well-positioned to ride the local e-commerce industry’s rapid growth.

Timely entry into Wuhan, as rents bottom out.

• We believe that the acquisition of Wuhan MeiLuoTe has come at an opportune time, reinforcing its rising e-commerce proposition as rents recover on the back of the cut in industrial land supply.
• In addition to Wuhan’s strong economic fundamentals (the local economy expanded by c.8% in 2017), the rise of Wuhan as a major logistics player in China also bodes well for future demand for quality spaces, further supporting rents.

Reputable and Supportive Sponsor – Forchn Group

The Sponsor of EC World REIT is Forchn Holdings Group Co., Ltd., (“Forchn Group”).

• Forchn Group is a Shanghai-based investment holding company and is a diversified enterprise group specialising in real estate, industrial, e-commerce, manufacturing, logistics, health and finance sectors.
• The Sponsor is an established operator of port facilities in China with over 20 years of experience, and has both constructed and operated the Chongxian Port facility, which is recognised as a key construction project by the China government. Forchn Group has partnered with Fosun Group in the real estate industry to establish a joint venture, Orient Merchant Construction & Development Co., Ltd., which has invested in, developed, operated and managed key projects such as Dongyang China Woodcarving Culture Expo City, Hangzhou New World, and Fuyang Fucheng International.
• The Sponsor expanded its operations into the e-commerce segment about eight years ago through the launch of Ruyicang (如意仓), an integrated smart warehouse logistics services platform.
• As one of the founding members of the joint venture, Cainiao Network Technology Co. Ltd (菜鸟网络科技有限公司 ), was formed by the Alibaba Group and leading e-retailers and logistics service providers,. Forchn Group has also successfully established its presence in the e-commerce logistics sector. The joint venture operates the China Smart Logistics Network (中国智能物流骨 干网), which was established with hopes of transforming China’s logistics infrastructure through the creation of an open, transparent and shared data platform to serve e-commerce businesses, logistics companies, warehouse companies, third-party logistics service providers and supply chain managers in China.
• More recently, the Sponsor acquired Hangzhou Fuchun Resort in 2016 and launched Gongwang Health (公望健康) in 2017 through an alliance with the Zhejiang University of Traditional Chinese Medicine and Taiwan Tiancheng Medical, marking its foray into the Health and Wellness sector.
• The Sponsor’s interest in EC World REIT is aligned through ownership of a c.44% stake in the REIT. We think that EC World REIT stands to benefit from the Sponsor, Forchn Group’s diversified businesses, market reach, industrial knowledge and business networks across the port, logistics and e-commerce sectors.

Acquisition opportunities via the Sponsor.

• The Sponsor has been actively building a pipeline of properties for the REIT to acquire in the medium term.
• In October 2018, EC World REIT decided against exercising its Right of First Refusal (ROFR) for Bei Gang Stage 2 properties, likely due to near-term infrastructural challenges for the sub-market. However, we note that as at end-2018, a ROFR pipeline with total GFA of over 200,000 sqm – Fu Zhou E- commerce Properties, remains available.
• Fu Zhou E-Commerce Properties is a purpose-built facility, specifically designed to cater to the demand of the e-commerce industry, and currently operated and managed by RuYiCang.
• Owing to its strategic location next to existing e-commerce logistics asset, Fu Heng Warehouse, we believe that the Manager will be keen on acquiring the asset when the opportunity arises, unlocking operating synergies for the REIT.
• If the acquisition materialises, we believe that the Manager will likely pursue a master-leased structure back to the Sponsor given the asset’s core function within the Forchn Group.
• Refer to the PDF report attached for details on the EC World REIT's key management team. 

Coveted Alliance with YCH Group to Foster New Growth Opportunities Ahead

An extension into ASEAN with a like-minded partner.

• On 24 April 2018, Forchn Holdings, EC World REIT’s sponsor, inked a partnership agreement with YCH Group (YCH), a leading supply chain and logistics company with a presence in over 100 key cities across 16 countries, including China, India, ASEAN, Australia and Korea.
• Aimed at capturing opportunities along China’s belt and road initiative, three key strategic initiatives were highlighted under the framework agreement:
  1. ROFR pipeline of 13 YCH logistics assets in Asia
     • Totalling more than 280,000 sqm of GFA with an estimated value of S$400m, YCH's pipeline assets represent c.43.1% and at least 30% of EC World REIT’s current portfolio GFA and value respectively. If successful, this will mark the group’s first foray out of China into ASEAN, furthering its reach in Asia.
     • Plans to structure the acquisitions via a sale-and-leaseback model ensures income certainty. Alignment of interest between the two parties will also be streamlined via the transfer of a significant stake with board representation in the Manager of EC World REIT to YCH.
  2. Launch of US$150m Forchn-YCH Belt Road Initiative Logistics Read Estate Private Equity Fund
     • Completed in the second half of 2018, the fund will leverage on Forchn’s strong track record of real estate investment and development in China and YCH’s extensive experience in B2B and B2C to uncover attractive development and acquisition opportunities of logistics warehouses in key cities in Southeast Asia and China.
     • Following positive response from institutional investors, the Sponsor announced plans in January 2019 to launch a second, larger fund and is currently eyeing opportunities in Indonesia and Vietnam, among others.
  3. Leveraging on mutual competencies to capture opportunities in Southeast Asia
     • Under the MOU, YCH will introduce its proprietary supply management technologies and collaborate with Ruyicang, Forchn’s e-commerce logistics subsidiary, to explore joint offerings of e-commerce and omni-channel logistics services in the ASEAN and China region.

Valuation

Initiate with target price of S$0.86.

• We initiate coverage on EC World REIT with a DCF-based target price of S$0.86, implying c.24% potential return based on current EC World REIT share prices.
• The recent run-up in S-REIT share prices has brought average sector yields down to c.6.0%. However, with investors on the lookout for alternative names, we see value for EC World REIT at current prices.
• Current yield of c.8.2% serves as a good support level, in our opinion, with potential to surprise on the upside if the REIT utilises its lowly geared balance sheet and makes an acquisition.
• Refer to the PDF report attached for EC World REIT's financial analysis details.

Derek TAN DBS Group Research | Carmen TAY DBS Research | https://www.dbsvickers.com/ 2019-02-21

SGX Stock Analyst Report BUY INITIATE BUY 0.86 SAME 0.86