ESR-REIT - DBS Research 2021-07-26: Acquisitions & AEIs To Drive Earnings

ESR-REIT (SGX:J91U) | SGinvestors.io ESR-REIT (SGX:J91U)

ESR-REIT - Acquisitions & AEIs To Drive Earnings

  • ESR-REIT (SGX:J91U)'s 1H21 DPU of 1.554 cents in line with estimates; reflecting stabilisation in earnings.
  • Completed maiden overseas acquisition; future growth also expected to be focused on overseas assets.
  • Trading at very attractive yields in excess of 7% that are significantly higher than its industrial S-REIT peers.
  • Maintain BUY with higher target price of S$0.53.

ESR-REIT's 1H21 results highlights

1H21 DPU increased 14.5% y-o-y

  • ESR-REIT's 1H21 NPI increased 8.4% y-o-y to S$87.0m
    • Absence of income retention done in 1H20 for the COVID-19 rental rebates (1H20: S$4.6m)
    • Lower property expenses also contributed to higher NPI
  • 1H21 DPU of 1.554 cents is a 14.5% increase y-o-y
    • In line with our projections.

Higher portfolio occupancy of 91.7%

  • Portfolio occupancy improved 0.9% q-o-q to 91.7%
    • Contributed by new leases and expansion of tenants in the electronics and logistics sectors
  • A total of 1.08m sqft of leases were secured in 1H21
    • New leases: 500,600 sqft (46.1%)
    • Renewal leases: 585,600 sqft (53.6%)
  • Only 10.4% of leases will be due to expire in 2H21
    • More than 7% of these leases are in advanced negotiations to be renewed
  • Leasing interest continued to come from the technology, media, e-commerce and general warehousing sectors

Negative year-to-date rental reversions of 1.6%

  • Although rental reversions in 2Q21 was still a slight negative of 0.2%, it is a drastic improvement from the -5.0% in the previous quarter
  • On a year-to-date basis, rental reversions were negative at 1.6%
    • Negative reversions were mainly due to renewals with larger tenants in the business parks
  • On the other hand, positive rental reversions came from the high-specs, logistics and general industrial sectors

Completed accretive acquisitions and maiden entry in Australia

  • S$119.6m acquisition of 46A Tanjong Penjuru
    • Further upside potential with the conversion of more space into temperature-controlled warehouses
  • Completed their maiden overseas acquisition from its Sponsor; S$62.4m for a 10% stake in the Australian portfolio
    • More than 55% of leases are master-leases with built-in annual rental escalations of 2.5-3.0%
  • Embarking on S$79.2m AEI works at two properties to increase GFA
    • Add 29,000 sqft of GFA at 16 Tai Seng Street
    • Add 265,000 sqft of GFA at 7000 Ang Mo Kio Ave 5
    • Yield on cost for both AEIs are expected to be ~7.1%
  • Successfully raised S$150m through a private placement and preferential offering
    • To partially fund acquisitions and AEIs
  • Divested two lower yielding properties to raise S$53.0m
  • Transactions to create ~1% accretion to DPU

Slight improvement in borrowing costs

  • All loans due to expire in FY21 have been refinanced
    • All-in borrowing costs improved 0.3% to 3.24%
  • Expect further savings in borrowing costs when its interest rate hedge expires in October 2021
  • Gearing has temporarily increased to 42.8%, but will revert to 41.3% once the preferential offering is completed.

Yields that are difficult to ignore

  • Maiden foray overseas and enlarged logistics footprint ESR-REIT recently completed the acquisition of 46A Tanjong Penjuru and the 10% stake in the Australian Portfolio (EALP). The EALP acquisition marks ESR-REIT’s first foray outside of Singapore and we believe that there will be more overseas acquisitions to come, given its Sponsor’s portfolio throughout the region. Although only accounting for ~2% of its portfolio, EALP helps to allay some of the concerns on ESR-REIT’s portfolio remaining land tenure.
  • In our view, ESR-REIT’s foray into Australia was perfectly timed as cap rates for Australian industrial properties continue to compress aggressively. Acquired at an initial yield of ~6.8%, the portfolio could create further upside when the development properties (two properties) are completed by the end of the year.
  • Its recently completed acquisition of 46A Tanjong Penjuru also expands ESR-REIT’s logistics properties footprint. Logistics properties in the Penjuru precinct have been seeing very robust demand and rental growth. We believe that this modern ramp-up facility will augment ESR-REIT’s portfolio and there are plans to convert more of the space into temperature-controlled warehouses that are short in supply currently. Based on current market conditions, the conversion into temperature-controlled warehousing will create a more than 20% upside to rental rates.

AEIs to drive organic growth

  • In conjunction with its recent acquisitions and AEIs, ESR-REIT announced the divestment of two older and lower yielding assets. Both 3C Toh Guan Road East and 11 Serangoon North Ave 5 were divested for a total consideration of S$53.0m, a 5.0% premium to its latest valuations. The divestment is only expected to be completed in October or November 2021, and the proceeds will be redeployed to fund its AEIs.
  • With the AEI works at ESR BizPark @ Changi completed in 1Q21, it will help the property remain defensive and support its current rental rates. The conversion of 19 Tai Seng Avenue into a high-specs building is on track for completion in 3Q21, and committed occupancy is at 63% currently. We understand that the property continues to receive a steady stream of enquiries and pre-committed occupancy could hit the 80% levels in the coming weeks.
  • Together with its recent acquisitions, ESR-REIT also announced plans to carry out S$79.2m worth of AEIs at 16 Tai Send Street and 7000 Ang Mo Kio Ave 5. When completed, both AEIs will create an additional ~294,000 sqft. of GFA, and the yield on cost is forecasted to be ~7.1% (~S$5.6m in additional revenue).
  • Enlarged platform to open doors for further growth Having steadily grown its portfolio over the years, we have seen ESR-REIT benefiting from the capital management front.
  • During the quarter, ESR-REIT managed to further lower its borrowing costs by ~30bps to an all-in interest rate of 3.24% currently. We understand that there is room for further savings when an interest rate hedge comes due in October 2021. Its enlarged portfolio and larger market cap has also opened the doors for more alternative sources of funding at potentially more favourable terms.
  • In addition to more favourable funding options, the enlarged market cap has also placed ESR-REIT as a potential candidate for the FTSE EPRA NAREIT Index come September (following the relaxation of the index’s entry requirements). This not only creates a catalyst for EREIT’s share price, but could lead to other positive knock-on effects like improved trading liquidity and lowering of cost of capital.

Resilient portfolio calls for a tightening of yields

  • As the COVID-19 outbreak drags on, ESR-REIT’s earnings may be exposed to some downside. However, as demonstrated in FY20, industrial landlords were far less impacted by the pandemic and they have outperformed the other property segments. Like many of its peers, ESR-REIT took the prudent approach to retain part of its income for provisions and cash flow purposes. However, unlike its peers, ESR-REIT still has a sizeable amount of this retained earnings at its perusal.
  • Of the S$10.1m retained in FY20, ~S$2.1m remains unutilised to date. As we enter into the second tightening of COVID-19 safe distancing measures in FY21, ESR-REIT can tap on this S$2.1m to even out any temporary dip in earnings or provide for rental rebates for affected tenants, such as those in F&B.

Our thoughts

  • While ESR-REIT's Share Price has inched up over the past month following the news of a possible inclusion into the FTSE EPRE NAREIT Index, we project a still very attractive forward yield ~7.2% for FY21. While many of its large cap industrial S-REIT peers have seen dividend yields compress to 3.8%-5.2%, ESR-REIT’s 7.2% yield seems to have been overlooked.
  • Compared to the weighted average dividend yields of large-cap industrial S-REITs, ESR-REIT is trading at a 2.5% dividend yield spread, which we believe has room for compression.
  • We acknowledge that ESR-REIT may be trading at such a wide spread due to its relatively high leverage and concentration of assets in Singapore. However, we believe that this is a comfortable range that it has been trading at historically. As its entire portfolio is unencumbered, the REIT has financial flexibility to manoeuvre around its leverage. Given how cap rates for industrial properties in Singapore and Australia have compressed, we also do not foresee any significant changes in portfolio valuations in the medium term.
  • ESR-REIT also benefits from the large acquisition pipeline from its Sponsor (AUM of ~US$30bn), providing the REIT with the much-needed access to quality overseas properties. We understand that a large majority of its Sponsor’s pipeline are logistics properties (more than 95% of its AUM), and this would enable ESR-REIT to build up its logistics property exposure meaningfully.
  • We anticipate some upside to ESR-REIT’s 2H21 earnings as the income contribution from 46A Tanjong Penjuru and EALP will come online from 3Q21 onwards. With that, we roll forward our DCF-based valuation as we cast our gaze towards FY22, when the full-year contribution from its recent acquisitions will start to contribute.
  • We maintain our BUY recommendation with a higher target price of S$0.53.
  • See

Dale LAI DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2021-07-26
SGX Stock Analyst Report BUY MAINTAIN BUY 0.53 UP 0.450