Broker's take: OCBC Investment Research downgrades ESR-Reit to 'hold'

OCBC Investment Research has downgraded its recommendation of ESR-Reit to "hold" due to a rally in the industrial Reit's (real estate investment trust) unit price since the brokerage initiated coverage in December 2018.

The fair value estimate for the Reit was also lowered from 57.5 Singapore cents to 55 cents, in light of concerns surrounding Hyflux's filing for bankruptcy protection, as its subsidiary Hyflux Membrane is one of ESR-Reit's main tenants. Hyflux Membrane accounted for around 3.5 per cent of the total rental income for December 2018 and about 7.2 per cent of distributable income for Q4 2018.

As at 11.07am, ESR-Reit units were trading at 53.5 Singapore cents, down 0.5 cent or 0.9 per cent.

Since initiating coverage on Dec 14, 2018, OCBC said the Reit has posted a total return of 9.76 per cent compared to the Straits Times Index's 7.41 per cent.

Moreover, OCBC analyst Deborah Ong noted: "ESR-Reit continues to trade at a discount to industrial Reits that also have large industrial portfolios, but this has narrowed significantly since our initiation."

By the brokerage's estimates, as at market's close on April 9, the Reit was trading at a price-to-book ratio of 1.17 times compared to its large portfolio peers average of 1.33 times. ESR-Reit also has a higher estimated dividend yield for fiscal 2019 than its larger portfolio peers.

On the rental income from Hyflux Membrane's tenancy at 8 Tuas South Lane, Ms Ong said there are mitigating factors for the Reit.

This includes the Hyflux subsidiary not having defaulted on its rental payments, and the belief that Hyflux Membrane will continue to rent the 8 Tuas South Lane premises should Hyflux's business remain intact after the restructuring. ESR-Reit presently holds security deposits of three months of rental income, which have yet to be drawn down.

The Reit has also been receiving interest and equiries for the 8 Tuas South Lane premises.

However, in the case of a default, OCBC said that the asset will be "subject to JTC anchor tenant rules which may be onerous to fulfil".

Ms Ong said: "Looking ahead, we look forward to a bottoming in industrial rents in 2019, though towards the latter half of the year given the backend-loaded supply injection last year."

The brokerage remains "a little wary on ESR-Reit's relatively high gearing ratio of 41.9 per cent, which we believe increases the risk of a dilutive equity financing".