September 10, 2021

First-leg of a re-rating

Re-rating thesis playing out; maintain BUY

Our initiation thesis on 16 Aug ’21 was based on a confluence of three key factors that would drive a re-rating, the first of which has been realised. ESR-REIT (EREIT) was included within the FTSE EPRA Nareit Global Developed Index effective 6th Sept ’21. The market’s strong reaction postannouncement (on 1 st Sept ’21) reaffirms our view that EREIT is ripe for a re-rating, with its units breaking the key SGD0.480 resistance level the day after. Overall, we see this event as a step in the right direction. That said, we maintain our view that it alone is insufficient to drive a convincing rerating. Focus is now on 2H21/2022 earnings, where we will be looking out for confirmation of strong industrial tailwinds translating into fundamental growth (via rental reversions and occupancies). We maintain our estimates and reiterate BUY with street-high DDM-based TP of SGD0.55.

FTSE Nareit inclusion a step in the right direction

Our key take-away from the event is EREIT’s ripeness for a re-rating. EREIT’s units appreciated the most intra-day post announcement (+11% from prev. close to intra-day high) vs. its peers ALLT (+6%) and AAREIT (+4%). In our view, this suggests the market agrees that EREIT’s valuations (FY21E 6.1% yield; 1.10x P/B) are undemanding relative to ALLT (5.9%; 1.36x) and AAREIT (6.6%; 1.02x).

But not sufficient to drive a convincing re-rating

EREITs units have re-traced since the post-announcement run-up. We believe a full re-rating to MKE’s valuation of 1.24x FY22E P/B and exit yield of 5.7% (based on TP of SGD0.55) will only be realised upon confirmation of our thesis, which will become more apparent after 2H21 earnings.

Look to 2H21 earnings as the next catalyst

Fundamentally, we are looking for: 1) strong logistics sector tailwinds translating to stronger rental reversions 2) better than expected general industrial/business park segmental performance and 3) execution of its strategy to pivot into more future-proof assets. We again highlight that MKE’s base case estimates are based solely on core DPU and exclude any potential capital distributions, thereby erring on the side of conservatism. This contrasts with the street, which is c.5.3% above MKE’s FY21 estimate and pencilling in a higher FY21E DPU of SGD3.1c.

Value Proposition

§ Singapore SMID industrial REIT offering the highest total DPU yield+growth profile in the sector (+11.5%).

§ Potential index inclusion (FTSE NAREIT) a near-term catalyst to drive re-rating. This follows recent easing of index rules.

§ Material portfolio exposure to logistics/warehousing (25.2% of 2Q21 GRI) and high-spec (15.6%) assets, set to capitalize on the sector’s buoyant demand.

§ Negative perception of high general industrial exposure (31.4% of 2Q21 GRI) overplayed, some of its assets are holding up well relative to sector trends.

§ Management is pivoting away from general industrial (plans to reduce exposure to 25% by 2023) and into high-spec assets (targets 25%) via acquisitions, re-developments and AEI’s.

§ Strong sponsor. ESR Cayman is set to become the largest APAC real asset fund manager (USD130b of AUM; 2x the size of next largest manager), with deep roots in PRC, JP, KR, SG, AU and IN and access to blue-chip new economy tenants.

Financial Metrics

§ DPUs to recover in FY21 as we re-base our figures in absence of material rental rebates in FY20 and strong rental reversions within its logistics segment (FY21E: +3%).

§ Expect occupancies to remain steady 91.1-92.4% in the future and for DPU growth to be driven by pivot to logistics and high-spec segments (MKE FY23E: ~45% of GRI).

§ Refinanced all debt expiring in FY21, with new WADE of 2.6 years and reduced interest cost of 3.21% (4Q20: 3.54%).

Price Drivers

1. Jan-17: ESR Cayman becomes second largest shareholder after exercise of options (@SGD0.70/unit) to acquire additional 10.65% stake in Cambridge Industrial Trust.

2. May-18: Announced merger with Viva Industrial Trust (VIT) at SGD0.96/VIT unit (paid 10% in cash; remainder in new ESR shares at SGD0.54/unit) to create fourth largest industrial S-REIT with SGD3b AUM.

3. Jul-20: Announced merger with Sabana REIT (SBREIT) via share swap (0.94x exchange ratio) to raise portfolio size and trading liquidity. Rejected by SBREIT unitholders (in Dec-20) due to disagreement of valuation.

4. May-21: Announced maiden overseas acquisition – 10% stake in ESR Australia’s AUD1b logistics portfolio for AUD60.5m at 6.7% cap rate, fully funded via debt. Also raised SGD100m via private placement (SGD0.372/unit) for acquisition of new logistics asset (46A Tanjong Penjuru). Planned to raise additional SGD50m via preferential offer in Aug-21.

Swing Factors

Upside

§ Earlier-than-expected pick-up in overall leasing demand, driving improvements in both occupancy and rental reversions.

§ Signing of new tenants to backfill Changi Business Park.

§ Sooner than expected completion of AEI’s at its 7000 AMK and Tai Seng properties and/or stronger leasing demand.

§ Accretive acquisitions.

Downside

§ Slowdown in economic activity reducing demand for industrial assets, resulting in lower occupancy and rents.

§ Termination of long-term leases causing loss of income.

§ Weaker-than-expected leasing demand for business parks and general industrial assets, given sizeable exposure.

§ Sharper-than-expected rise in interest rates could increase cost of debt and negatively impact earnings.

BUY by Maybank Kim Eng Securities Research. Share price closed at $0.485.