EC World REIT - DBS Research 2022-07-12: A Bargain Despite Refinancing Hurdles

• Against the backdrop of rising debt levels and home prices in China, the government introduced a new policy in October 2020 to slow credit growth among property developers. Dubbed the “three red lines” policy, there are limits on debt-to-equity, debt-to-cash, and debt-to-assets growth levels. The new regulations resulted in a tightening of credit to property developers, and while EC World REIT (SGX:BWCU) is not in the residential property sector, lenders have become much more cautious in giving out property loans.
• Earlier in FY21, EC World REIT was in discussions with its Sponsor in relation to a potential transaction to divest its entire portfolio, but as the transaction did not materialise, the discussions ended on 28 December 2021. EC World REIT had only managed to begin loan renewal negotiations thereafter, and the tightening credit market surrounding property-related firms was also one of the likely reasons for the delay in refinancing its offshore loans that were due at the end of May 2022. It was only on 1 June 2022 that EC World REIT managed to obtain an 11-month extension for its offshore loans, and the extension expires on 30 April 2023, together with its onshore loans.
• As part of the loan extension, the Sponsor took an undertaking to commence refinancing of the offshore facilities immediately and to also ensure that at least 25% of the outstanding facilities are repaid by 31 December 2022.
• Subsequently on 29 June 2022, EC World REIT announced the extension of its onshore loans to 30 April 2023. Similar to the terms for its offshore loan extension, the Sponsor also took an undertaking to commence refinancing of the facilities immediately and ensure that at least 25% of the facilities are repaid by 31 December 2022.

MOU for sale of two EC World REIT's properties

• EC World REIT's Manager has since entered into a non-binding memorandum of understanding (MOU) with its Sponsor to explore a potential divestment of Beigang Logistics Stage 1 and Chongxian Port Logistics. The bulk of the proceeds from the divestments would then be used to repay loans as stated in the loan extension undertaking.
• Based on our estimates, the minimum amount of loans to be repaid by 31 December 2022 is ~S$176.9m (25% of total outstanding loans of S$707.6m). As the combined valuation of the two properties as at 31 December 2021 was ~S$432.8m, we expect the divestments to generate more than the required amount to pare down 25% of outstanding loans.
• After accounting for taxes and transaction costs for the divestments (assumed to be 25% of the value), EC World REIT would have excess funds of ~S$150m after repaying the loans as stipulated in the terms of the extension of the loan facilities.
• As both assets are slated to be divested before 31 December 2022, they will be subject to a revaluation exercise before that. Given that this will be divestment to a subsidiary of the Sponsor, it is an interested party transaction and will require approval from EC World REIT's unitholders at an EGM.
• With parts of China still in lockdowns from a new wave of COVID-19 outbreak, and both properties having less than 2.5 years remaining on their master leases (subsidiaries of the Sponsor), EC World REIT could argue that valuations of the properties could have fallen below their previous valuations in FY21. We look at possible scenarios for the divestment of both properties at book value, and at a 10% and 20% discount to book valuations.

Impact on NAV and DPU post-divestment

• Assuming the divestment of the two properties take place and after the repayment of ~S$176.9m of outstanding loan facilities -
  • Our first scenario assumes that the remaining cash proceeds is repaid to unitholders through a capital distribution.
    • This would lead to a reduction in EC World REIT's NAV from its current S$0.93. Again, depending on the proceeds raised from the divestments, it would affect the amount of capital distributions, and thus lower the NAV by varying amounts.
    • This scenario assumes that all the remaining proceeds from the divestment and repayment of 25% of the loan are distributed back to unitholders.
    • Our estimates below assume that EC World REIT’s NAV would firstly be reduced by the amount of taxes and transaction fees paid in relation to the divestment. Secondly, the NAV would be lowered again through the capital distribution of the remaining proceeds,
  • In our second scenario, we assumed that EC World REIT utilises part of the remaining proceeds to do a share buyback and lower the number of outstanding shares in the market.
    • In this scenario, we assumed that EC World REIT does a share buyback of 100m units at an average price of S$0.50 per share (total value of S$50m). Based on our estimates, a share buyback would lead to a smaller impact on NAV and volatility of DPU as compared to the earlier scenario of a capital distribution.
    • However, the effectiveness of a share buyback relies on the Manager’s ability to amass the 100m units from the market at current prices given EC World REIT’s relatively low trading liquidity.

EC World REIT’s share price has over-corrected

• Since the beginning of this year, EC World REIT's share price has fallen by more than 46%, and it is currently trading at more than 55% discount to current NAV. This was likely due to calling off the divestment of its entire portfolio to its Sponsor at the end of 2021, followed by concerns on its ability to refinance its loans.
• Given the current developments, we agree that a correction in EC World REIT's share price is warranted especially as we expect its NAV to decline post the divestment of the two properties. However, as illustrated by the two scenarios above, EC World REIT's share price is trading a level that is way below its revised NAV (post divestments). Even if we assume the divestments are done at 10% or 20% discounts to latest book value, we still believe that its share price has over-corrected.

Opportunity to bargain hunt?

• Based on EC World REIT’s historical trading price trend, the shares typically trade at a 10%-15% discount to NAV. Applying this same discount to its revised NAV according to the various scenarios, it looks like that the recent share price correction has been overdone.
• Current EC World REIT's share price implies discounts of between 33%-51% to its revised NAV, and we believe that this presents an opportunity to bargain hunt.