• Hyflux Membrane is a concern
• Unit price rally since initiation
• Fair value decreased to S$0.55

Total Returns of 9.8% Since Our Initiation

Since our initiation on 14 Dec 2018, ESR-REIT has posted total returns of 9.76%, vs. the Straits Times Index’s 7.41%. ESR-REIT continues to trade at a discount to industrial REITs that also have large industrial portfolios, but this has narrowed significantly since our initiation.

As at 9 Apr’s close, the REIT is currently trading at 1.17x P/B (versus the 1.33x average of its large portfolio peers), and a dividend yield of 7.0% FY19F yield (vs. the 5.7% current yield of its large portfolio peers).

Hyflux Membrane Issue Is a Concern, But There Are Mitigating Factors

We note that Hyflux Membrane is one of ESRREIT’s top 10 tenants, accounting for ~3.5% of the total rental income for Dec 2018 and ~7.2% of distributable income for 4Q18. In recent months, exposure to this tenant has become a concern given Hyflux’s filing for bankruptcy protection.

While we continue to monitor the situation, we identify a couple of mitigating factors for ESR-REIT:

1. Hyflux Membrane has not defaulted in its rental payments,
2. should Hyflux’s business remain intact after the restructuring, we believe there is still a good chance that Hyflux Membrane will continue to rent its current premises (8 Tuas South Lane),
3. the asset is within an established industrial area and ESR-REIT has been receiving leasing interest and enquiries for the space, and
4. ESR-REIT presently holds security deposits worth three months of rental income, which have yet to be drawn down.

That said, in the case of a default, we believe the asset will be subject to JTC anchor tenant rules which may be onerous to fulfill.

Adjustments Made to Fair Value

We update our property forecasts to account for a potential Hyflux Membrane rental default. Having assumed a Hyflux Membrane default after 1Q19, a full drawdown in the security deposit and a gradual recovery in occupancy thereafter, our fair value drops from S$0.575 to S$0.55.

Looking ahead, we look forward to a bottoming in industrial rents in 2019, though towards the latter half of the year given the backend-loaded supply injection last year. As mentioned in our last report, we remain a little wary on ESRREIT’s relatively high gearing ratio of 41.9%, which we believe increases the risk of a dilutive equity financing.

Given the unit price rally since our last update, we downgrade ESR-REIT from Buy to HOLD.

Source: OCBC Research - 10 Apr 2019