ESR-LOGOS REIT - DBS Research 2022-10-14: Into The Land Of The Rising Sun; Portfolio Rejuvenation To Drive Growth

ESR-LOGOS REIT - Into The Land Of The Rising Sun; Portfolio Rejuvenation To Drive Growth

  • ESR-LOGOS REIT (SGX:J91U) just received an overwhelming approval (EGM was just held on 12 October 2022) for the proposed acquisition of its ESR Sakura Distribution Centre for S$183.5m (including the 12-month rental support) from its sponsor.
    • The property is a 5-storey logistics property in Sakura City, Chiba Prefecture in Tokyo, and the purchase consideration is ~21.8% lower than the market comparable in the Chiba Prefecture. It has a total NLA of more than 877,300sqft and it currently has an occupancy of 75%.
    • The 25% vacancy was due to a tenant that vacated the property to consolidate its operations into its own built-to-suit facility in May 2022. Prior to this, the property has always been fully occupied over the past five years.
    • Given the strong demand-supply dynamics of the logistics market in the Chiba Prefecture, ESR-LOGOS REIT is confident of backfilling these vacancies in the near term.
  • Although ESR-LOGOS REIT provided two possible scenarios to fund the acquisition, we firmly believe that the manager will fund the acquisition entirely on debt, given its current high cost of capital which makes an equity fund raising scenario to be tough to execute, in our view.
  • Given how the share price of S-REITs have corrected in recent weeks, we believe ESR-LOGOS REIT will not proceed with the alternative scenario that requires equity fundraising to raise ~S$75m and lead to significant NAV dilution.
  • With the debt-funded option, the acquisition is projected to generate a ~2.9% accretion to ESR-LOGOS REIT's DPU. Concurrently, gearing is expected to inch up to ~42%, and we believe that it can be brought down gradually with the future divestment of non-core and lower yielding assets, which will be value accretive to ESR-LOGOS REIT.
  • Since its successful merger with ARA LOGOS Logistics Trust in April 2022, ESR-LOGOS REIT has already divested three lower yielding assets to raise more than S$132m. It has also identified several other non-core assets that they could potentially divest to raise a further S$400m.

Tackling the two main bugbears

Decaying land tenure of ESR-LOGOS REIT’s portfolio.

  • Previously, ESR-LOGOS REIT benefitted from being a pureplay industrial S-REIT that appeals to investors looking to gain exposure to Singapore’s industrial sector. However, the short land tenures of Singapore industrial properties also meant that its portfolio’s land tenure will decay with time. ESR-LOGOS REIT began addressing this concern back in mid-2021 through the acquisition of stakes in freehold properties in Australia.
  • With the acquisition of the Sakura Distribution Centre, the proportion of freehold assets in ESR-LOGOS REIT’s portfolio will increase to ~8.2%. The remaining land lease tenure of ESR-LOGOS REIT’s portfolio will also increase by ~6.0% to 40.8 years.

Fears of economic slowdown and impact to industrial sector.

  • Historically, based on our observation of occupancy rates, we found that logistics properties tend to remain more resilient during economic slowdowns and outperform other industrial property segments.
  • Following the merger with ARA LOGOS Logistics Trust earlier in the year, ESR-LOGOS REIT’s exposure to logistics facilities doubled. Its concentration of logistics facilities will be further enhanced with the acquisition of the Sakura Distribution Centre. Post the acquisition, ~51.8% of ESR-LOGOS REIT’s portfolio will consist of logistics facilities. The support from its sponsor on this deal and further possible pipeline opportunities also demonstrates its commitment to ESR-LOGOS REIT and opens the doors for further access to a ~US$2.0bn portfolio of logistics facilities in the pipeline.
  • Diversifying its footprint into one of the largest logistics markets in APAC, ESR-LOGOS REIT has the opportunity to ride on the strong fundamentals of the logistics sector in Japan. The strong supply and demand dynamics are expected to drive positive rental growth in the near to medium term.
  • Gross rents in Greater Tokyo continue to be driven by a tighter market environment and low vacancy rates, especially in Chiba Bay, where the Sakura Distribution Centre is located. With Japan having a very limited stock of modern logistics facilities (only ~13% of total supply), modern assets with superior specifications such as the Sakura Distribution Centre increasingly stand out and appeal to tenants.

Do current valuations capture ESR-LOGOS REIT’s transformation?

  • Over the past few weeks, S-REITs' share price have undergone a correction owing to rising interest rates impacting its returns. Currently, ESR-LOGOS REIT's share price trades at a P/NAV multiple of ~0.96x, and at a forward dividend yield of more than 8.5%. Looking at its historical trading performance, such levels may not be unheard of, especially during major economic crises such as the Global Financial Crisis, Euro Debt Crisis, Flash Crash in 2015, and most recently, the initial outbreak of COVID-19, we believe that there are key differences this time round, which warrant a higher valuation multiple.
    • Firstly, given ESR-LOGOS REIT’s rejuvenated portfolio and transition into a larger-cap industrial REIT, we believe it is currently trading at a very attractive level, especially given its portfolio’s outsized exposure to logistics facilities and potential for further growth through its sponsor’s pipeline. Even when compared to the Taper Tantrum period in 2013, ESR-LOGOS REIT was still trading just above NAV.
    • Although ESR-LOGOS REIT’s gearing may seem relatively high at ~42.0%, its capital management metrics are better than before. Its entire portfolio is unencumbered, and ~70% of its portfolio is hedged to fixed rates. Based on our estimates, ESR-LOGOS REIT also currently has a very healthy ICR of approximately 3x.
  • We have refreshed our projections to assume that the divestment of 49 Pandan Road and 2 Jalan Kilang Barat will be completed by the end of FY22, and the acquisition of the Sakura Distribution Centre will only begin contributing income in the beginning of FY23. We have also taken the opportunity to assume that ESR-LOGOS REIT’s all-in cost of financing will creep up by ~55bps over the next three years.
  • Despite the adjustments and revised estimates, we believe ESR-LOGOS REIT offers a very attractive yield at the current levels and that there is room for some earnings growth over the next few years, even with higher financing costs. As such, we will be maintaining our BUY recommendation on ESR-LOGOS REIT with an unchanged target price of S$0.50.

Above is the excerpt from report by DBS Group Research.
Clients of DBS may access the full report in PDF @

Dale LAI DBS Group Research | Derek TAN DBS Research | 2022-10-14

Read also DBS's most recent report:
2022-10-27 ESR-LOGOS REIT - Positive Rental Reversions Maintained.

Price targets by other brokers at ESR-LOGOS REIT Target Prices.
Listing of research reports at ESR-LOGOS REIT Analyst Reports.

Relevant links:
ESR-LOGOS REIT Share Price History,
ESR-LOGOS REIT Announcements,
ESR-LOGOS REIT Dividends & Corporate Actions,
ESR-LOGOS REIT News Articles

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