Sabana Shari'ah Compliant REIT - DBS Research 2020-07-17: In The Big League


Sabana Shari'ah Compliant REIT - In The Big League

  • Proposed merger with ESR REIT to add c.9.2% to Sabana REIT's FY20F DPU.
  • Enlarged REIT can realise synergies through lower borrowing cost and a focused Sponsor.
  • Potential EPRA NAREIT inclusion post-merger may help in P/NAV re-rating to large cap peers’ valuation.
  • Upgrade Sabana REIT to BUY with Target Price of S$0.40 pegged to 0.94x ESR REIT's target price.

Sabana REIT's revenue and NPI dips expectedly due to COVID-19

  • Sabana REIT (SGX:M1GU)'s 1H20 revenue and NPI were down 6.7% and 15.5% y-o-y to S$34.3m and S$20.9m respectively. See Sabana REIT Announcements.
  • Support measures (such as rental waivers) rolled out to assist tenants through this difficult period and master lease expiries at 10 Changi South Street 2 and 3A Joo Koon Circle in 2H19 led to the decline
  • Distributable income declined by 23.3 y-o-y to S$11.1m. However, DPU fell by a steeper 65.7% to 0.47 Scts as Sabana REIT decided to retain 55.0% of distributable income in light of COVID-19 uncertainties. See Sabana REIT Dividend History.
  • Moving forward, 2H20 revenue and NPI may improve as support measures including rental waivers taper off.
  • We have revised revenue and NPI projections down to factor the impact of COVID-19.

Operating metrics see slight improvement

  • Sabana REIT's portfolio occupancy rose to 77.3% from 75.4% in 4Q19 as a result of improved occupancies at 15 Jalan Kilang Barat and a new anchor tenant at 3A Joo Koon Circle. Weighted average portfolio lease term to expiry decreased slightly to 2.7 years.
  • 151 Lorong Chuan to experience delays as a result of the circuit breaker. Phase 1 is now expected to be completed in 1Q21.
  • Leasing demand for 151 Lorong Chuan remains strong with most tenants retained by Sabana REIT despite the ongoing AEI. Additionally, c.36.0% of space for retail and F&B stores have been pre-committed with c.5.2% pending issuance of lease agreements. Another 40.0% of space is in advanced negotiations.

Higher gearing

  • Sabana REIT's gearing rose to 33.7% from 31.1% in 4Q19, while weighted average debt maturity declined to 1.6 years from 2.1 years. Sabana REIT’s gearing remains at the lower range among its peers.
  • If the proposed merger between ESR REIT (SGX:J91U) and Sabana REIT goes through, the enlarged REIT will see gearing rise to 41.7%. That said, following the MAS decision to raise the gearing limit to 50%, the enlarged REIT will have increased balance sheet leeway.

Merger with ESR – Sabana to unlock true value of portfolio

  • The proposed merger of Sabana REIT and ESR REIT will be done at a gross exchange ratio of 0.94 and an implied offer price of S$0.377 representing c.26% discount to NAV. While the implied pricing based on EV/GFA of c.S$163psf may seem more beneficial for ESR REIT, significant investment still needs to be made to upgrade the portfolio.
  • Overall, we believe the merger is positive for Sabana REIT.
    1. In the short-term, deal is DPU accretive. We estimate that the merger would bring about FY20F DPU accretion of c.9.2% from Sabana REIT’s current FY20F DPU of 2.56 Scts.
    2. EPRA NAREIT inclusion in sight. Additionally, the enlarged REIT will be prime candidate for inclusion in the FTSE EPRA NAREIT Index as the enlarged portfolio size of S$1.8bn meets the index’s regular entry threshold of c.S$1.3bn. Inclusion in the index will boost liquidity of the enlarged REIT and increase visibility.
    3. Synergies realised in the longer term. The pro forma cost of debt of the enlarged REIT would be c.3.3%, significantly lower than Sabana REIT’s current 3.8%. This would enable Sabana REIT to tap on its unutilised GFA more cost effectively as financing costs for AEI decreases. Additionally, the Sponsor, ESR Cayman, will be more focused on supporting the enlarge REIT as opposed to being split between ESR REIT and Sabana REIT.
    4. Sabana REIT to finally unlock true value of its portfolio. Sabana REIT has historically been trading at a discount to NAV with the 5-year mean discount to NAV at c.26.4%. We observe that a significant gap exists between the P/NAV of large-cap industrial S-REITS (average: c.1.3x) compared to its mid-cap peers. Post-merger, the enlarged REIT could see its P/NAV re-rate towards its larger peers.

Upgrade Sabana REIT to BUY with Target Price of S$0.40.

Singapore Research Team DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-07-17
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