SINGAPORE (May 15): While DBS analysts Dale Lai and Derek Tan expect demand and rental rates for industrial real estate to moderate and possibly turn slightly negative in 2020, they have maintained their “buy” call on AIMS APAC REIT (AAREIT) due to strong organic growth. 

“Organic growth from the commencement of rental payments from the recently redeveloped 3 Tuas Ave 2 would help mitigate weakness in the overall portfolio. Having also embarked on the conversion of master lease assets into multi-tenancies early, improvement in rental contributions from the three converted assets should support earnings in the near term,” they noted in a broker’s report on 14 May 2020. 

DBS's Lai and Tan have reduced the REIT's target price to $1.40 from $1.50 with a 19% upside. It assumes a terminal growth rate of 1.5%, with occupancy and rental rates for 2020 moderated to account for Covid-19. 

AAREIT had a positive FY20, with income increasing 13.5% y-o-y to $89.1 million due to income from 51 Marsiling Road and the newly acquired Boardriders Asia Pacific HQ in Brisbane. The latter comes with a 12-year master lease with headline yield of 7.8% and annual rental escalation of 3%. Property expenses also fell $9.8 million y-o-y due to adoption of FRS116 as well as property tax refund of S$2.3m for its 20 Gul Way property. 

The REIT would have met Lai and Tan’s predictions for distribution per unit (DPU) had it not retained $2.9 million of its Australian income to boost cash flow -- 17% of distributable income. DPU for 4Q20 (predicted to be 2.40 cents) came in at 2 cents while that for FY20 (predicted to be 9.90 cents) was 9.50 cents. This was despite a 4.2% y-o-y reduction in 4Q20 revenue owing to the conversion of its master lease assets. Forward DPU yield is expected to be 8.4%. 

Nine out of AAREIT’s 27 properties are still covered by master lease arrangements with staggered expiries in the coming years. Not only has this helped stabilise earnings and DPU, but also provides investors more income certainty and visibility in the medium term.

Another source of AAREIT’s resilience is its strong cash flow, with its aggregate leverage (A/L) standing below around 34.8% as of 31 March 2020 -- far below MAS’s 50% gearing limit. The company has also fully committed to refinancing a $157 million due in FY21, with a $181 million committed bank facility remaining undrawn. Its interest coverage ratio is a healthy 4.3x and weighted average debt maturity will be extended to 3.3 years post-refinancing. 

“We believe that there remains capacity for management to utilise its debt headroom for further redevelopment/greenfield projects or acquisitions,” says Lai and Tan. Nevertheless, Covid-19 uncertainty has seen the company hold off non-critical capital expenditure like asset enhancement initiatives (AEI) and redevelopment plans, though the former along with long-term acquisitions remain on the cards once the pandemic has blown over somewhat. Surpluses in unutilised retained earnings and property tax rebates will be passed back to the consumer. 

“AAREIT has made three divestments to date – all of which were transacted above book value, with divestment premiums of between 2.1% and 27.7%. Capitalising on the robust real estate secondary market values, we believe that this will remain a relevant strategy for the REIT going forward,” remarked the analysts. 

AAREIT has also renewed more than 30,000 square meters of space in 4Q20, signing seven new leases and renewing 15 (4.6% of which are non-performing assets) with a consistent 89.4% occupancy rate. With 20.2% of leases expiring in FY21, the company is confident of renewing a large proportion of them, with renewals expected to be slightly flat if not negative. Enjoying a weighted average lease expiry (WALE) of around 4.3 years (industry average is 3.5 years) will provide income stability and locked-in demand to ride out the Covid-19 storm. 

Price correction, Lai and Tan believe, creates opportunities for consolidation among industrial REITS, with AAREIT being a particularly attractive target for acquisition owing to its fragmented ownership structure. It also enjoys 500,000 square feet of untapped ground floor area (GFA) at 3 Tuas Avenue 2 that can boost net asset value by around 8%, with seven other assets also possessing unmaximised plot ratios ripe for development. Acquisition would give the REIT an implied yield (NPI/EV) of 7.1%, placing it in the upper-end of its peer range of 5.1-6.6%.

“Judging by AAREIT’s track record, we believe that it will likely pursue complete redevelopment opportunities in favour of a more resilient, higher-spec portfolio – including data centres (if feasible),” comment Lai and Tan. They predict that AAREIT’s RNAV would rise around 6% to approximately $1,013 as opposed to its reported NAV of $955 million in FY20. 

Key risks for AAREIT include shorter land tenures in Singapore vis-a-vis freehold sites in Australia and Europe in spite of higher yield premiums and negative rental reversionary trends arising from an underperforming economy. While interest rate risk does somewhat threaten AAREIT’s prospects, Lai and Tan note that the company has hedged more than 80% of its interest costs into fixed rates as well as actively diversified funding sources, consequently mitigating the potential for such problems arising. 

As at 11.24am, shares in AAREIT are trading flat at $1.18.