Is ESR-REIT’s 15% Yield Too Good To Be True?

ESR-REIT (SGX: J91U) is a Singapore based real estate investment trust. It has a market capitalisation of $946 million as of 20 Mar. Its predecessor was Cambridge Industrial Trust, which changed its name after e-Shang Redwood bought a majority stake in the REIT back in 2017.

ESR merged with Viva Industrial Trust in a $1.5 billion deal which saw ESR issued new units to buy over all of Viva’s shares. This created one of Singapore’s largest industrial property trusts with $3 billion worth of assets. 

ESR asset size relative to other industrial REITs. Source: Ascendas REIT 2019 Global Real Estate Conference presentation slide

ESR has been hammered in the recent market drop triggered by the Covid-19 outbreak. Its share price dropped from $0.54 in early-Mar to $0.27 on 20 Mar, a 50% fall. 

Can ESR survive the current crisis with its enlarged portfolio and Singapore-focused assets? 

Property Portfolio

ESR owns 57 properties worth $3.04 billion. Its properties are located in major industrial areas such as Jurong/Tuas, Tai Seng/Ubi, and International Business Park at Jurong East. General Industrial assets contribute one-third of rental income, while business parks, logistic assets and high-specs industrial make up the rest. 

Source: ESR 4Q 2019 results presentation

The portfolio has a sizable portion of assets that are single-tenanted. Portfolio occupancy stood at 90.5% as of end-2019, slightly higher than JTC average. 

While ESR has 328 tenants, the top ten tenants account for 30% of its total rental income. Its top ten tenants are a mixture of international advanced manufacturing firms, local medium enterprises, and international logistic firms. Do note that Hyflux Ltd is one of the top tenants with a 3% share of total rental income. Hyflux has fallen into bankruptcy back in 2019.

Source: ESR 4Q 2019 results presentation

The asset portfolio has a well-staggered lease expiry. In the coming three financial years, the maximum amount of lease renewable in a year is not more than 20.5% of rental income. 

Source: ESR 4Q 2019 results presentation

Profit and Loss

ESR recorded a revenue 61.3% higher than FY2018 due to the merger with Viva Industrial Trust. Net property income and distributable income increased by a similar percentage.

However, due to the increase in the total number of units arising from share issuance for Viva’s merger, distribution per unit grew by a much smaller percentage. If we just look at 4Q 2019, distribution per unit fell marginally.  

Source: ESR 4Q 2019 results presentation

Balance Sheet and Gearing

With a total debt of $1.2 billion, ESR’s gearing ratio is 41.5%. As this is very close to the regulatory cap of 45%, ESR has little room to raise debt for acquisition. In comparison, its peers such as Mapletree Industrial Trust and Aims Amp Capital Industrial Trust have a gearing ratio of 34.1% and 35.2%. 

Source: ESR 4Q 2019 results presentation

Another issue to note is that ESR issued $150 million perpetual securities that distributes a 4.6% annual returns to owners. This is excluded from the calculation of gearing as it is classified as equity. Hence the actual financing cost of ESR is likely to be higher. 

Its interest coverage ratio of 3.7 seems fair, but may not have sufficient safety buffer in the current market conditions. 

Asset Enhancement Initiative

ESR’s largest property by value, the UE BizHub East, is currently undergoing upgrading. The property will remain fully operational during upgrading, hence revenue impact is limited. On track for completion in 1Q 2021, the refreshed property would command higher rental and contribute to ESR’s top line growth.   

Historical Performance

I extracted several key financial metrics from ESR’s past results for easier analysis. 

Its revenue showed a fluctuating trend other than last year when it was boosted by the merger with Viva. Net property margin has been trending down until last year when it increased to 74%. We can see a similar pattern for distribution per unit as well. 

The broad picture suggests that ESR was not properly managed back in its Cambridge Trust days. The situation has improved in the past two years after new management came on board following the new majority owner in e-Shang Redwood.  

Source: Self-compiled from annual reports

Sponsor

ESR-REIT’s sponsor, ESR Group, is one of Asia’s largest logistic asset developers and owners listed on the Hong Kong exchange. It owns properties in China, Japan, South Korea, Singapore, Australia, and India. As of June 2019, its assets are worth more than US$20 billion with a floor area of 15 million square metres. 

You can find out more about the sponsor here. 

Valuation

With a current share price of $0.27, ESR dividend yield is 15.2%. The yield is extremely high but it is caused by the depressed share price. All is well if ESR can maintain or grow its distribution in the future. If its future distribution drops due to worsening fundamentals, the share price is likely to fall further resulting in capital loss.   

ESR’s net asset value (NAV) per unit is $0.433 thus giving the REIT a price to NAV ratio of 0.62.

Conclusion

ESR-REIT currently boasts an unusually high yield and a strong sponsor which supports its growth and future asset acquisitions. It showed improvements in the past two years’ earnings boosted by merger with Viva.

However, ESR has a high gearing ratio and a fairly low interest coverage ratio that weakens its capital management. It also has a high tenant concentration with the top ten tenants contributing 30% of gross rental. 

Investors who buy ESR shares now must conduct thorough research and be clear about the risks involved. Buying its shares based on high yield alone is not encouraged as it would likely result in losses.

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