• ESR-REIT's Share Price has tumbled 43% over last one month (vs S-REITs -30%, see SREIT Share Price Performance) amidst a global market sell-off. Despite overall market gloom, we see its two key strengths ie pure-play exposure to the Singapore industrial sector (which has remained resilient through market cycles), and supportive/capable sponsor.
• While near term share price movement remains unpredictable, we see its value emerging at 0.7x P/BV.

Industrial Sector Most Resilient Among Various REIT Asset Class

• Key reasons being the inability to carry out operations remotely for the majority of industrial sectors, lower rental base, and substitution choices for industrial tenants and longer lease tenures (ESR-REIT’s WALE – 3.8 years).
• The manufacturing sector still forms the backbone of Singapore’s economy, accounting for 21% of the country’s GDP in 2019 and we believe the Government has various policy measures and tools at its disposal to support the industrial sector should the economy enter into a recession.

A Diversified Tenant Base Mitigates Potential Tenant Defaults

• ESR-REIT (SGX:J91U) derives income from 328 tenants across > 15 different trade sectors, with logistics (28%), info-comm & technology (13%), and manufacturing (12%) being the largest three. Based on our discussions with management, there has been no tenant default or an increase in late payments so far.
• Management has also been constantly engaging with its Top 10 tenants (30% of rental income) and is currently monitoring the ongoing developments across various industrial sectors. Hyflux (SGX:600) (3% of rental income), one of the Top 10 tenants, has also been paying rent so far.

High Gearing But 100% Unencumbered Assets

• ESR-REIT’s gearing of 41.5% is among the highest in sector. However, asset values need to fall by > SGD 200m or > 7% from the current level before a potential breach of ESR-REIT’s gearing threshold of 45% occurs.
• Even in the worst case where such an event occurs, we believe the REIT’s sponsor will potentially step in and underwrite any potential equity fund raising.
• In terms of debt maturity, ESR-REIT has already secured commitments for the SGD160m loan expiring this year at a lower interest cost, which should bring down the overall borrowing costs by 20bps. The next debt maturity is only in 2H21.

A Supportive Sponsor

• ESR-REIT’s sponsor, ESR Cayman (1821 HK), has a strong pan-Asian industrial sector experience and manages an AUM of > USD20bn across six countries. The sponsor has also been showing its commitment to the REIT by backstopping recent equity fund raisings.

DPU and Valuation Changes

• Our FY20F-22F DPU are lowered by 7-9% assuming lower rents and occupancies. We also raise our COE assumptions by 100bps, factoring in higher market risk premiums.
• Key risks remain a prolonged recession and sharp spike in tenant defaults.

Source: RHB Invest Research - 19 Mar 2020