• Maintain BUY, new SGD0.60 Target Price from SGD0.61, 11% upside with 8% FY20F yield.
• ESR-REIT's 3Q19/9M19 DPU is in line. (See ESR REIT Dividend History)
• Despite the challenging industrial market, ESR-REIT managed to grow its portfolio and DPU, and generate positive rental growth. Upside potential lies in asset enhancement opportunities. With its scale and well-diversified positioning across all industrial segments in Singapore, we believe its stock is undervalued, at 1.1x FY19F P/BV.

3Q DPU Down Marginally by 0.4%Y-o-y

• ESR-REIT (SGX:J91U)'s revenue/NPI (3Q) grew 92%/101% on the back of the merger last year. Distributable income included a capital gain of SGD4.6m (+84% y-o-y) and 100% management fees in units, offsetting some of the impact of the recent unit placement – with some proceeds being funnelled towards future AEIs. See ESR REIT Announcements.
• It still has about SGD67m in divestment gains which can be used to buffer any near-term earnings volatility.

Strong Leasing Momentum (3Q), YTD Rental Reversion of +0.6%

• About 1.4m sqf of industrial space was leased in 3Q, which was more than double the leases signed in 1H19. About 7%/17% of leases by rental income are due for renewal in 4Q19/2020, for which we expect flattish rental reversions.

Hyflux Exposure Reduced to 3%, Tenant Still Paying Rental

• ESR-REIT signed on a new tenant, P-Way Construction & Engineering Pte Ltd, at 8 Tuas South Lane – thereby reducing its Hyflux (SGX:600) exposure to 3% (2Q19: 3.6%). Hyflux is still paying rental and management has ~3 months of rental guaranteed. We believe the potential impact of a Hyflux default is mitigated.

Acquisition Completed, Asset Enhancement Works to Commence Soon

• ESR-REIT has completed its acquisition of a 49% stake in PTC Logistics Hub, and is awaiting final approvals from the authorities to redevelop ~0.3m sqf at 7000 Ang Mo Kio Ave 5.
• Gearing post acquisition and fund-raising stands at 40.1%, leaving little debt headroom for future acquisitions.

Industrial Market Stabilising But Outlook Remains Murky

• Based on JTC’s latest report (3Q19) industrial rental rates edged up by 0.1% y-o-y (flattish q-o-q), indicating that rental rates are reaching a floor. Among the industrial sub-segments, business parks and hi-tech industries remain the bright spot – also where ESR-REIT has the bulk of exposure (44% of AUM).
• While industrial supply is expected to jump to 1.9m sqm for 2020 (46% higher than the average supply in 2016-2019), about one-third of supply is for single tenants for their own use, while another 36% is meant for the replacement for lessees affected by JTC’s industrial revolution programme.
• Overall, we expect industrial rental rates to remain flattish for FY19-20, barring further worsening trade tensions.

We Trim FY19-20F DPU by 1-2%

• We trim FY19-20F DPU by 1-2% to reflect the recent unit placement and acquisitions. Our Target Price has been adjusted accordingly. (see ESR REIT Share Price; ESR REIT Target Price)

Source: RHB Invest Research - 29 Oct 2019