Market Commentary

US stocks rise amid continued boost from earnings reports

• US stocks climbed on Tuesday as major companies continued to report strong third-quarter earnings, easing concerns that persistent Covid-19 cases and rising costs would derail corporate America’s profit recovery.

• The S&P 500 added 0.7% to 4,519.63, rising for a fifth straight day. The Dow Jones Industrial Average gained 0.6%, to 35,457.31. The Nasdaq Composite advanced 0.7% to 15,129.09.

• The Dow and the S&P 500 now sit less than 1% from their respective all-time highs.

• So far, 82% of S&P 500 companies that have reported earnings beat expectations, according to FactSet. Taking into account these reports and estimates for those to come, third-quarter profit growth will come in at 30%, according to FactSet.

Signs that companies were managing inflationary pressures would prompt investors to top up on equities, analysts said, especially as bond markets remained vulnerable to central banks’ monetary tightening signals.

• In bond markets, the yield on the 10-year US Treasury note rose to 1.64%, its highest trading level since May.

• Minutes from the Federal Reserve’s latest meeting suggested the US central bank might begin reducing its US$120 billion a month of coronavirus-driven bond purchases as soon as next month. Financial markets are also pricing in the first pandemic-era rate rise from the central bank for September next year.

• Supply chain bottlenecks and the rising cost of energy, food and rents have kept US headline consumer price inflation higher than 5% for four months. But in the minutes of their latest meeting, Fed policymakers continued to describe the surge as “transitory”.

• Meanwhile, Bitcoin prices were inching closer to their all-time high as a landmark ETF from ProShares tracking Bitcoin futures began trading Tuesday. The leading crypto was up to around as high as US$62,230.

• Overseas, the Stoxx 600 was 0.3% higher. European stocks have recovered some ground after slumping.

• in September on concern that central bankers would need to raise interest rates in response to a spike in energy prices and broader inflation. Investors are now looking to company earnings commentary for clues on the impact of higher prices on profits and the messages have been reassuring.

• Asian equities gained, buoyed by a rebound in technology shares listed in Hong Kong and elsewhere in the region. The Straits Times Index rose 0.79% to 3,199.01 points.

• Chinese stocks showed signs of recovery from the range-bound trading pattern so far this month. The benchmark Shanghai Composite Index rose 0.7% while the blue-chip CSI 300 led gains with almost 1% rise.

Research Ideas

ESR REIT (EREIT SP) Size matters

• Proposed merger of ESR-REIT and ARA LOGOS Logistics Trust
• Scheme consideration of SGD0.95 for each ALOG unit
• Accept the offer

Proposed merger via a combination of cash and new units in ESR REIT

ESR-REIT announced jointly with ARA LOGOS Logistics Trust (ALOG) a proposed merger of the two REITs by way of a trust scheme of arrangement. ESR-REIT will acquire all units of ALOG via a combination of cash and new units in ESR-REIT. The total consideration for the proposed merger is ~SGD1.4b based on the scheme consideration of SGD0.95 for each ALOG unit (SGD0.095 in cash + 1.6765 new ESR-REIT units at SGD0.51). Upon approval and completion, the newly formed REIT will be renamed as ESR-LOGOS REIT (E-LOG).

DPU accretive on a pro forma FY20 basis

The proposed merger is expected to be DPU accretive with pro-forma FY20 DPU increasing 5.8% and 8.2% for ESR-REIT and ALOG respectively, mainly attributable to lower financing cost and payment of upfront land premium. Post-merger, ESR-REIT’s gearing will increase slightly from 41.6% to 42.1% while NAV will be diluted by 6.4% on a pro-forma basis.

Creating a leading new economy and future ready APAC S REIT

ESR-REIT’s total assets is expected to grow by 59% to SGD5.4b with a diversified portfolio of 87 properties across Singapore and Australia post-merger. With an enlarged scale, E-LOG could tap on its sponsor’s strong network and rich pipeline in logistics/warehouse and high-specs industrial properties (i.e. new economy) to undertake sizeable acquisitions and larger asset enhancement initiatives to accelerate E-LOG’s growth and transformation into a leading new economy and future-ready APAC S-REIT. Moreover, E-LOG will benefit from lower tenant concentration risks (no single tenant will account for more than 4.6% of E-LOG’s gross rental income), lower cost of debt, longer weighted average debt expiry of 3.4 years (from 2.6 years), longer WALE of 3.2 years (from 2.8 years), and access to wider pools of capital.

Accept the offer

The proposed merger is conditional upon the completion of ESR Cayman and ARA Asset Management’s merger and requires both ESR-REIT and ALOG’s unitholders’ approvals at EGM which will be held in early Jan 2022. Upon approval, the transaction is expected to complete in Feb 2022 and ALOG will be delisted after completion. We are largely positive on this proposed merger, given the importance of scale in the REITs sector with potentially better trading liquidity, lower cost of capital and greater feasibility to acquire larger properties to drive inorganic growth. We recommend unitholders of ESR-REIT to ACCEPT THE OFFER. Pending for approval at EGM, we maintain our estimates but lower our cost of equity assumption to 7.3% to reflect a better operating environment, our fair value estimate correspondingly increases from SGD0.48 to SGD0.51.

ESG Updates

ESR REIT’s environment score trails its peers due to fewer green-certified buildings in its portfolio relative to peers. However, its human capital development ranks higher than industry average, with comprehensive employee development efforts including strong managerial and leadership development training initiatives. BUY. (Chu Peng)

Keppel DC REIT (KDCREIT SP) Still primed for growth

• More favourable entry point following share price underperformance
• Stepping up its acquisition activities
• Trim fair value to SGD3.15

More favourable entry point with YTD share price underperformance

Keppel DC REIT (KDCREIT) has seen total returns of -6.9% over the past three months and -11.8% YTD, underperforming the FTSE Straits Times REIT Index’s -2.0% and +4.8% total returns during the same period, respectively. Besides the broader rotation to cyclicals and value stocks and recent softening in share prices of global REITs due to the spike in 10-year US Treasury yield, we believe KDCREIT’s recent proposal to acquire its maiden data centre facility in Guangdong, China, might have caused some cautiousness among investors given the regulatory uncertainties in China. Since KDCREIT also has a right-of-first-refusal on another five data centres in Guangdong from the same vendor it is buying this data centre from, this could have raised questions on how aggressively KDCREIT is intending to scale up its presence in China. To mitigate this, the data centre which KDCREIT is proposing to acquire comes with a long triple-net lease and KDCREIT will also not have access to the data held within the servers (mitigates data privacy concerns). Following this correction and taking into account our revised forecasts (elaborated below), KDCREIT is trading at FY22F distribution yield of 4.2% (as at 18 Oct 2021 close), which is close to its 3-year average of 4.3%.

Inorganic growth activities picking up

Although KDCREIT carried out a pre-emptive equity fund raising exercise in Aug, it subsequently announced on 6 Sep the acquisition of a freehold property with two data centre buildings in Eindhoven, the Netherlands, for EUR37.2m (~SGD59.9m). This acquisition comprises two shell and core data centre buildings and a warehouse and ancillary office building within the site, has a long WALE of 8.5 years by rental income, and comes with an initial NPI yield of ~5.7%. KDCREIT also finalised an agreement to invest SGD89.7m into bonds and preference shares to be issued by NetCo, a newly incorporated unit of M1. In return, KDCREIT will receive SGD11m (comprising both principal and interest) each year for 15 years without assuming any operational and management risks. Although some investors would have preferred KDCREIT to focus solely on data centre assets, we believe the stability of income from this investment, expected positive DPU accretion and relatively small capital outlay relative to KDCREIT’s asset size makes this transaction worthwhile.

Fair value lowered slightly to SGD3.15

After factoring in the aforementioned acquisitions and the recent proposed divestment of iseek Data Centre in Australia, we trim our FY21F and FY22F DPU forecasts by 1.3% and 0.4%, respectively. Consequently, our fair value estimate moves from SGD3.19 to SGD3.15.

ESG Updates

KDCREIT has adopted strong compliance mechanisms such as employee trainings and audits of ethics standards. The former includes training and development programmes, such as Keppel Young Leaders and Advanced Leadership. KDCREIT also regularly engages with employees through satisfaction surveys and focuses on improving the health and wellness of its personnel. Management has earmarked its commitment to address climate change issues, as illustrated by it being a signatory of the Climate Neutral Data Centre Pact. KDCREIT also said that it will utilise green energy, where available, at its data centres. BUY. (Research Team)