ESR-REIT - DBS Research 2020-10-30: Forging Ahead To Leave COVID-19 Behind

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ESR-REIT (SGX:J91U)

ESR-REIT - Forging Ahead To Leave COVID-19 Behind

• ESR-REIT's revenues and NPI increased 1.7% and 3.0% q-o-q in 3Q20 as portfolio stabilises.
• S$3.5m in retained income to be distributed in 3Q20: another S$3.5m remains to be returned in 4Q20.
• Conversion of 19 Tai Seng Avenue to a high-spec industrial property to drive organic growth in FY21.
• Awaiting regulatory approvals on proposed merger with Sabana REIT; EGM to follow.

ESR-REIT's portfolio operations have stabilised

• ESR-REIT (SGX:J91U)'s 3Q20 revenue increased 1.7% q-o-q to S$56.9m mainly due to commencement of new leases.
• 3Q20 NPI increased 3.0% q-o-q to S$40.4m. See ESR-REIT's Announcements.
• On a y-o-y basis, both revenues and NPI decreased due to conversions of single to multi tenancies at five properties, non-renewals and downsizing of tenants, as well as rental rebates given c. 40% of the decline is attributed to the ongoing conversion of master leases, c.27% of the decline attributed to retail tenants downsizing or restructuring of leases due to the COVID-19 pandemic, while the rest is attributed to rental rebates.
• Rental collection remains healthy at 94%, consistent with pre-COVID-19 levels.

50% of retained income has been returned

• S$3.5m of retained income to be distributed in 3Q20; c.50% of income retained previously.
  • S$7.0m of income was retained in 1Q20 in light of the COVID-19 pandemic.
  • S$3.5m in retained income remains to be distributed in 4Q20.
• ESR-REIT's 3Q20 DPU of 0.798 cents including payment of retained income.
  • Core DPU of 0.700 cents, and 0.098 cents from payment of retained income.
  • Core DPU was 5.7% higher q-o-q.

Slight improvement in gearing

• ESR-REIT's gearing improved marginally in 3Q20 to 41.6%. Interest coverage ratio improved to 3.6x.
• Enjoyed some interest savings as cost of debt was reduced to 3.5%.
• No refinancing requirements until June 2021.
  • S$193m of borrowings will mature in FY21.
  • S$160m of the FY21 loans is from the merger of Viva Industrial Trust that will expire in October 2021; expect some interest savings when refinanced.

Healthy leasing demand

• Strong tenant retention rate of 85.0% year-to-date. 829,000 sqft of leases renewed and signed in 3Q20.
  • 585,000 sqft of leases were renewed.
  • New leases of 244,000 sqft were signed.
  • Continues to see demand from pharmaceutical and precision engineering sectors, as well as firms wanting to stockpile.
• Despite a year-to-date rental reversion of -0.2% in 3Q20, it is a significant improvement from the year-to-date rental reversion of -4.3% in 2Q20.
• ESR-REIT's Portfolio occupancy inched down marginally q-o-q from 91.1% to 90.8%.
• 3Q20 portfolio WALE of 3.0 years, a q-o-q decline of 0.4 years. Decline in WALE mainly due to restructuring of a major retail lease.
• Only 5.3% of ESR-REIT's leases remain to be renewed for the rest of FY20.
  • Advanced negotiations with 4.4% of these leases and tenants have indicated intentions to renew.
  • Expect overall rental reversions in FY20 to be flat-to-slightly negative.
• For FY21, 20.1% of ESR-REIT's leases will be due for renewal.
  • Room for some positive rental reversions even at current asking rents.
  • Notwithstanding the fact that there may be some weaknesses at the older “legacy” logistics assets in the portfolio.

Resumption of organic growth trajectory

• With most activities resuming, ESR-REIT has commenced AEI works and redevelopments. AEI at UE BizHub EAST has resumed and is expected to be completed in 1Q21
• Commenced redevelopment of 19 Tai Seng Avenue to convert property to high-spec industrial; expected completion in 2H21. Redevelopment to cost c.S$9.0m, likely to be a multi-tenanted property that appeals to the pharmaceutical and precision engineering tenants.
• Potential to redevelop another two or three assets in FY21 to drive organic growth.
• Likely to be conversion of general industrial properties to high-spec properties.
• Redevelopments of these properties are estimated to cost c.S$80m; likely to be funded by divestment of non-core assets.

Our views on ESR-REIT

• Portfolio operations have stabilised and ESR-REIT has begun returning unutilised retained income. Likely to return the remaining c.S$3.5m of retained income in 4Q20.
• Portfolio occupancies remain healthy with continued demand for stockpiling and tenants from the pharmaceutical precision engineering sectors.
• Awaiting further updates on proposed merger with Sabana REIT (SGX:M1GU).
  • ESR-REIT is waiting for regulatory approvals before proceeding with the circulation of scheme documents that are necessary for the EGM.
  • Given the delays, the proposed merger is likely to only be completed in FY21 at the earliest.
• ESR-REIT and Sabana REIT are trading at a 1-to-1 ratio currently (ESR REIT Share Price and Sabana REIT Share Price are currently S$0.35); implying market may have second thoughts on the proposed merger as exchange ratio is 1 Sabana REIT unit : 0.94 ESR-REIT unit.
• In addition to the proposed merger, ESR-REIT will continue to keep a lookout for growth opportunities in Singapore and overseas. There are still other opportunities in the pipeline that ESR-REIT can pursue if merger does not go through
• We continue to like ESR-REIT for its speed in ramping up its portfolio performance amid the ongoing COVID-19 pandemic. Management’s track record of carrying out acquisitions and unlocking value through redevelopments gives us confidence in earnings growth going forward.
• See ESR REIT Share Price; ESR REIT Target Price; ESR REIT Analyst Reports; ESR REIT Dividend History; ESR REIT Announcements; ESR REIT Latest News. 

Dale LAI DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-10-30

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