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Broker's take: Sabana Reit upgraded to 'buy' on proposed 'safe abode' merger

THE proposed merger with ESR-Reit offers Sabana Shari'ah Compliant Industrial Real Estate Investment Trust (Sabana Reit) a "safe abode" in these uncertain times, said DBS Group Research on Friday, as it upgraded Sabana Reit to "buy" from "hold".

The research house also lowered its target price for Sabana Reit to S$0.40, from S$0.48 previously. This is pegged to 0.94 times of its target price for ESR-Reit, which is now S$0.43 with its "buy" call maintained.

As at 11.54am on Friday, Sabana Reit was trading at S$0.38, up S$0.02 or 5.6 per cent, while ESR-Reit gained S$0.01 or 2.6 per cent to S$0.40.

The two trusts are taking another crack at a union after earlier talks in 2017 fell through, seeking to build a bigger entity to stave off headwinds in a post-Covid world. Announced on Thursday, the proposed merger, if approved by unitholders, will see ESR-Reit acquiring all Sabana units for new units in ESR-Reit at a gross exchange ratio of 0.94 time.

Analyst Derek Tan noted that after the consolidation, the enlarged entity will become one of the largest industrial Singapore Reits (S-Reits) by asset size, with about S$4.1 billion in assets.

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His estimates showed that the merger will add about 9.2 per cent to Sabana's estimated FY20 distribution per unit (DPU), driven by the trust benefiting from synergies.

In particular, the enlarged Reit will have a lower borrowing cost of about 3.3 per cent, compared with Sabana's 3.8 per cent cost of debt, Mr Tan wrote.

The potential marriage with ESR-Reit will also allow Sabana to "finally" unlock the true value of its portfolio, DBS noted. Sabana has historically traded at a discount to net asset value (NAV), with the five-year mean discount to NAV at about 26.4 per cent.

"A significant gap exists between the P/NAV (price to NAV ratio) of large-cap (average: 1.3 times) and mid-cap industrial S-Reits," Mr Tan said. 

"Post-merger, the enlarged Reit's P/NAV could re-rate closer to its larger peers. This is especially so considering that the enlarged Reit will be a prime candidate for inclusion into the FTSE EPRA NAREIT Index, which could boost the liquidity and visibility of the Reit in the future," he added.

In another report, DBS analysts Dale Lai and Mr Tan wrote that the unitholders of the enlarged entity will "enjoy a more stable and diversified earnings base" with a greater focus on higher-specification and logistics properties, which are expected to be resilient in a post-pandemic world.

Based on DBS's FY21 estimates, the deal is 3.4 per cent accretive to ESR-Reit's DPU and 18.7 per cent accretive to Sabana's DPU, fuelled by the lower overall cost of debt and higher gearing of about 42.5 per cent.

"We like that the enlarged Reit has the financial flexibility to potentially execute on about 2.2 million square feet of unutilised gross floor area that may be tapped on in the future given its higher development and debt headroom," Mr Lai and Mr Tan said.

Unitholders of Sabana will benefit from being part of a bigger family, they added. Although the implied office price of 37.7 Singapore cents is at a 26 per cent discount to NAV, it will be an attractive trade-off for Sabana unitholders as they can ride on the longer-term growth prospects of a larger developer-backed Reit.

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