ESR-REIT - DBS Research 2020-04-24: Provision Instead Of Expansion

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ESR-REIT (SGX:J91U)

ESR-REIT - Provision Instead Of Expansion

• Provisions to earnings in 1Q20 to account for rental rebates and deferment.
• S$7m in distributable income has been retained as a prudent measure to tackle two months of shutdown due to Circuit Breaker measures.
• Moderation to FY20 organic growth due to suspension of AEI and redevelopment plans amidst the COVID-19 pandemic.

ESR-REIT 1Q20 earnings lowered by provisions and income retention

• As a precautionary measure, some provisions to income were made in 1Q20 coupled with the retention of S$7m in distributable income.
• ESR REIT (SGX:J91U)'s revenue declined 7.5% q-o-q to S$57.8m due mainly to conversion of two single-tenanted properties into multi-tenanted properties and provision for rental rebates.
• ESR REIT's 1Q20 DPU of 0.50 Scts is a 50% q-o-q decline; payout ratio fell to 72%.
  • Amount retained is based on the approach to provide for rent deferrals and rebates for up to 10% of tenants; retail/F&B tenants make up close to 7.5% of ESR REIT’s portfolio.
  • Absence of capital distributions in 1Q20; S$5.6m in capital distributions were paid out in 4Q19.
  • More than S$60m remaining for capital distribution but ESR REIT will only pay it out to supplement income from assets that are going through AEIs/redevelopments.
  • As there are currently no AEIs/redevelopments, ESR REIT has decided not to tap on any capital distribution.
• Without the retention in distributable income, DPU would have been 0.697 Scts.
  • Expect the same level of distribution retention in the next quarter due to extension of Circuit Breaker.
  • Any unutilised portion of retained income will be paid out once operations return to normalcy.
• Percentage of late rental payments remains stable at 2%; has been at this level over the past few years.
  • Based on stress testing done by ESR REIT, approximately 25% of revenues each quarter is required for working capital and financing.
  • ESR REIT will only face cash flow problems if more than 75% of tenants defer their rents.

Portfolio performance remains healthy despite challenging operating landscape

• ESR REIT's Portfolio occupancy remained stable at 90.5% (no change q-o-q) with a healthy tenant retention rate of 87.1%.
• The two single-tenanted properties that have been converted into multi-tenanted leases currently have occupancies of 88.9% and 100%. We expect an increase in income from these two properties that have been converted (13 Jalan Terusan and 30 Teban Gardens).
• 900,000 sqft of NLA in renewals and new leases were signed in 1Q20, slight dip in rental reversion of 0.1%.
• Bulk of remaining 12.6% of leases expiring in FY20 will be in 2Q20 and 3Q20.
  • Already in advanced negotiations with close to 9% of the 12.6% leases expiring, and rent reviews for these leases are expected to remain flat.
  • May see some weakness in rent reviews going forward, especially the single-tenanted leases that are due to expire.
• More than 50% of industrial tenants still remain operational during this Circuit Breaker period.
• A very healthy portfolio average security deposit of 5.5 months; provide protection for ESR REIT in the event of any rental defaults.
• Except for AEI works that are ongoing at UE BizHUB, all other AEI/redevelopment plans for FY20 have been put on hold amidst this COVID-19 pandemic.

Stable credit metrics boosted by new MAS guidelines

• ESR REIT's gearing inched up q-o-q from 41.5% to 41.7%.
  • All-in cost of debt improved from 3.92% in 4Q19, to 3.81% in 1Q20.
  • Interest coverage ratio remains healthy at 3.35x.
• The refinancing of the entire S$160m of MTN expiring in FY20 has already been pre-committed.
  • Expect further savings in financing costs with all-in cost of borrowings to improve to 3.7% after refinancing.
  • Weighted average debt expiry to also improve from the current 2.4 years to 2.9 years.

Our thoughts

• In our revised forecasts, we have taken on a more conservative approach to rental occupancy rates. We have factored in some negative rental reversions for multi-tenanted leases, as well as lower occupancy rates in FY20. We believe that the full brunt of the Circuit Breaker measures will only be felt in 2Q20, before these restrictions are gradually lifted in 3Q20.
• We understand that ESR REIT will be shelving all AEI/redevelopment plans for FY20, except UE BizHub which is already ongoing. As such, we have also delayed our expectations of organic growth in the near future, and the only main upside to earnings this year will be potential cost savings in borrowings.
• On the M&A front, ESR REIT will also likely hold back until there is more clarity and stability in the economic landscape.
• Despite the muted outlook in earnings, we take comfort in ESR REIT’s relatively manageable rent expiries (9% of 12.6% lease expiries already in advanced negotiations) this year as well as having completed all refinancing needs. The increase in gearing limits set by the MAS will also lift the overhang on ESR REIT’s relatively high gearing currently, and minimise the risk of any fund-raising in FY20.
• See ESR REIT Share Price; ESR REIT Target Price; ESR REIT Analyst Reports; ESR REIT Dividend History; ESR REIT Announcements; ESR REIT Latest News.
• Our Target Price has been cut to S$0.43, but we maintain our BUY call on ESR REIT due to the 26% potential upside in share price from current levels.

Dale LAI DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-04-24

SGX Stock Analyst Report BUY MAINTAIN BUY 0.43 DOWN 0.590