DBS Group Research analysts Dale Lai and Derek Tan have downgraded their recommendation on EC World REIT to “fully valued” from “buy” after REIT announced that it may face a potential delay on its divestments.
The analysts have also lowered their target price to 40 cents from 55 cents following the announcement.
On Nov 20, the REIT manager announced that the transaction financing documents pertaining to the proposed divestment of Stage 1 Properties of Bei Gang Logistics and Chongxian Port Logistics were not entered into even though the transaction financing long-stop date had passed.
The delay was attributed to the “stringent Covid-19 controls” and events in October 2022, namely the PRC National Day holiday in early October 2022 and the Twentieth National Congress of the Communist Party of China, says the REIT manager.
Further to its statement, the REIT manager assured unitholders that the entry into the transaction financing is not a condition precedent to the proposed divestment.
The failure to enter into the transaction financing is not grounds for termination for the purchasers under the equity purchase agreement, it adds.
However, the failure may affect the REIT’s ability to divest the properties by Dec 31.
To Lai and Tan, the delay in the divestments could lead to a breach by the REIT’s lenders to refinance both offshore and onshore loans due on April 30, 2023.
“It was previously believed that EC World REIT was on track to complete the divestments of Beigang Logistics Stage 1 and Chongxian Port Logistics by the end of this year. The divestments were necessary for EC World REIT to raise funds to repay at least 25% of its outstanding debt ($707.6 million), and the preconditions set by its lenders before it would refinance EC World REIT’s loans due to expire on April 30, 2023,” they say.
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“If the lenders do not agree on a further loan extension, or if the proposed divestments fall through, we believe EC World REIT will have to conduct a rights offering to raise capital for the refinancing of its loans,” the analysts note, stating that this is the “worst case scenario” for the REIT.
"Doing so will be severely dilutive to existing unitholders, especially given they are currently already trading at a steep discount to [the REIT’s] net asset value or NAV (around 37% discount to NAV). Moreover, current market conditions may make it even more difficult to raise capital,” they add.
As such, they have adjusted their target price and recommendation to “account for this uncertainty”.
“With the proposed divestments, the pro forma NAV of EC World REIT will fall to 78.16 cents,” say Lai and Tan. “We also took into account that EC World REIT has historically been trading at a P/NAV multiple of [around] 0.8x, and applied a further -2 standard deviation or s.d. (to account for the uncertainties in refinancing).”
Further to their report, the analysts note that the sale of the assets, which total about $432.8 million at last valuation, the funds received by the REIT will be “more than sufficient” to pare down its loans, which is at around 25% by the end of December this year.
A special dividend to unitholders may also be paid out, the analysts surmise.
“Given that it’s an interested party transaction (IPT), we envision unitholders only accepting a deal that is valued close to NAV,” they write.
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All is not lost to Lai and Tan, however, who note that rental escalations ranging from 1.0% to 2.5% built into the REIT’s master leases ensures organic growth in its earnings.
Moreover, multi-tenanted assets that cater to the fast-growing logistics industry also have the potential to deliver revenue growth, they point out.
In their estimates, the analysts have also assumed a “slight increase” in all-in financing costs when maturing loans are refinanced in 2023, an addition to the one-off pre-termination compensation to be paid in FY2022.
As at 11.55am, units in EC World REIT are trading 2.5 cents lower or 5.16% down at 46 cents.
