SINGAPORE (Apr 10): ESR-REIT has been downgraded to “hold” from “buy” previously by OCBC Investment Research with a decreased fair value of 55 cents from 57.5 cents, on the back of lower returns and concerns regarding Hyflux Membrane.

The research house initiated its coverage on ESR-REIT on Dec 14, 2018 and the stock has since posted total returns of 9.76%, compared to the Straits Times Index’s 7.41%. It still continues to trade at a discount to industrial REITs that also have large portfolios, but this has narrowed significantly since the research house’s initiation.

ESR-REIT also has a relatively high net gearing ratio of 41.9%, which increases its risk of a dilutive equity financing.

At yesterday’s close, the REIT traded at 1.17 times price-to-book, compared to the 1.33 times average of its large portfolio peers. It also has a dividend yield of 7.0% FY19 yield.

In a Wednesday report, analyst Deborah Ong says, “We note that Hyflux Membrane is one of ESR-REIT’s top 10 tenants, accounting for about 3.5% of the total rental income for Dec 2018 and about 7.2% of distributable income for 4Q18.”

Recently, Hyflux has filed for bankruptcy protection. And the analyst has expressed her concerns about ESR-REIT’s exposure to Hyflux. Hyflux Membrane is one of ESR-REIT’s top 10 tenants, accounting for about 3.5% of the total rental income for Dec 2018 and about 7.2% of distributable income for 4Q18.

With this, Ong has identified several mitigating factors for ESR-REIT:

  • Hyflux Membrane has not defaulted in its rental payments
  • Should Hyflux’s business remain intact after the restructuring, she believes there is still a good chance that Hyflux Membrane will continue to rent its current premises (8 Tuas South Lane)
  • The asset is within an established industrial area and ESR-REIT has been receiving leasing interest and enquiries for the space
  • 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 fulfil,” adds Ong.

Nonetheless, property forecasts have been updated to account for a potential Hyflux Membrane rental default.

Looking ahead, a bottoming in industrial rents in 2019 is to be expected, though towards the latter half of the year given the backend-loaded supply injection last year.

Units in ESR-REIT closed at 53 cents on Wednesday.