ESR-REIT - OCBC Investment 2020-07-17: Size Matters

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ESR-REIT (SGX:J91U)

ESR-REIT - Size Matters 

• ESR REIT's 1HFY20 results impacted by weak operating environment.
• Proposed merger with Sabana REIT (SGX:M1GU).
• Accept the offer.

ESR REIT's DPU fell 34%/42% for 2Q/1H FY20

• ESR REIT (SGX:J91U)’s 1HFY20 gross revenue and net property income fell 11.5% y-o-y and 16.8% y-o-y to S$113.8m and S$80.2m respectively. This was dragged by
  1. lease conversion from single to multi-tenancy;
  2. provisions for rental rebates in view of Covid-19;
  3. non-renewals and downsizing by certain tenants;
  4. absence of capital gains distribution; and
  5. retention of S$7m of distributable income in 1QFY20 for prudent cash flow management.
• ESR REIT's 2QFY20 and 1HFY20 DPU fell 34% y-o-y and 42% to 0.662 S cent and 1.162 S cents respectively, which came in below our expectations.
• Portfolio occupancy remained healthy at 91.1% (+0.6 ppt q-o-q), which was above JTC’s average of 89.2%. YTD rental reversions were -4.3% as this was weighed by the lease renewal of an anchor tenant. As at 30 Jun 2020, tenant retention rate was 85.7% (-1.7ppt q-o-q) with 8.8% of leases by rental income due to expire in 2H20.

Terms of the proposed merger

• Separately, ESR REIT and Sabana REIT jointly announced a proposed merger by way of a trust scheme of arrangement which will result in the combined entity becoming the 4th largest industrial S-REIT by GFA market share and 5th largest developer-backed industrial S-REIT with an asset value of S$4.1b. The combination will add Sabana REIT’s 18 properties in Singapore to ESR REIT's portfolio, creating an enlarged portfolio of 75 properties.
• The scheme will see ESR REIT acquiring all units of Sabana REIT at a gross exchange ratio of 0.94x. Each Sabana REIT unitholder will receive 94 ESR REIT consideration units for 100 Sabana REIT units held. Total acquisition cost is estimated to be ~S$777.4m.
• ESR REIT also entered into a S$460m unsecured loan facility agreement which will be used to fund the costs relating to the merger.

DPU and NAV accretive to ESR-REIT’s unitholders

• The pro forma annualised DPU for ESR REIT would have increased 3.5% from 2.718 S cents to 2.812 S cents and the pro forma annualised DPU for Sabana REIT would have increased 12.9% from 2.342 S cents to 2.643 cents in 1HFY20. The accretion in DPU is largely due to lower debt restructuring cost at 2.5% p.a. for Sabana REIT’s borrowings, land rent savings after paying upfront land premiums and management fees in units.
• On a pro forma basis, ESR REIT’s NAV per unit is expected to increase 5.2% to 43.2 S cents but gearing would stay flat from 41.8% to 41.7% as at 30 Jun 2020. Management explained that the gearing would stay neutral as their calculations took into account the costs relating to planned AEIs, upfront land premium and transaction costs of the merger.
• The proposed merger is pending approval at a court hearing (Sep) and EGM (Oct) and is expected to be completed by 4Q20. We deem the merger to be largely positive for ESR REIT and would recommend voting in support of the merger at ESR REIT’s EGM.
• Our fair value remains at S$0.49, which has not incorporated the proposed merger.
• See ESR REIT Share Price; ESR REIT Target Price; ESR REIT Analyst Reports; ESR REIT Dividend History; ESR REIT Announcements; ESR REIT Latest News.

OCBC Research Team OCBC Investment Research | https://www.iocbc.com/ 2020-07-17

SGX Stock Analyst Report BUY MAINTAIN BUY 0.49 DOWN 0.600