The Motley Fool

Why ESR-REIT’s Future Dividends Are At Risk

ESR-REIT’s (SGX: J91U) share price of S$0.52 right now gives it a high dividend yield of 7.7%, based on its trailing dividend of 4.02 Singapore cents per share. In fact, ESR-REIT’s dividend yield ranks as one of the highest among the real estate investment trusts (REITs) in Singapore’s stock market. (Technically, a REIT has a unit price, not a share price, and it doles out a distribution, not a dividend – but let’s not split hairs here!)

But if you’re an investor in ESR-REIT, or are attracted to it for its high dividend yield, then you should be aware of the risks involved with its future dividends. Here are two that I see.

Business background

ESR-REIT has a focus on industrial real estate and currently has a portfolio of 56 properties in Singapore that are located close to our country’s major transportation hubs and within the key industrial zones.

The 56 properties are collectively worth S$3.0 billion as of 30 June 2019 and belong to four categories: Business parks; high-specification buildings; logistics/warehouse facilities; and general industrial buildings.

The REIT’s current portfolio was built when the previous ESR-REIT merged with Viva Industrial Trust, a Singapore-listed REIT, in October 2018. Prior to the merger, ESR-REIT’s portfolio was worth S$1.7 billion. 

Reason 1: History of falling distributable income and DPU

The table below shows ESR-REIT’s distributable income and dividend per share, or distribution per unit (DPU), from 2012 to 2018. Both metrics grew from 2012 to 2014, only to then fall. In 2017, the REIT’s distributable income and DPU were 20% and 23% lower than in 2014, respectively – this is a poor track record. There was a big jump in distributable income in 2018 partly because of the aforementioned merger with Viva Industrial Trust, but the DPU only inched up by 0.1%.

Source: ESR-REIT annual reports

To ESR-REIT’s credit, it appears to have turned the corner in the first half of 2019, with its distributable income up 118.7% from a year ago to S$64.0 million and DPU increasing by 8.8% to 2.011 cents. Even after stripping away one-off gains (largely from the sale of properties), ESR-REIT’s DPU for the first half of 2019 would still be up by 5.3% from a year ago.

But what’s also troubling about ESR-REIT’s track record with its distributable income and DPU is the second reason behind my wariness with the REIT’s dividends in the future: A deterioration in its financial health.  

Reason 2: Weakening financial health

When assessing a REIT, there are three important areas to look at that can give us clues on its financial health: The gearing ratio, the interest coverage ratio, and the debt-maturity profile.

The gearing ratio, which is the ratio of total debt to assets, tell us how much financial risk a REIT is taking on. From 2014 to 2018, ESR-REIT’s gearing ratio increased from 34.8% to 42.0%. Earlier, I mentioned that ESR-REIT’s DPU declined significantly over the same period. So despite the use of more debt, the REIT failed to grow its portfolio intelligently, resulting in much lower DPU for its investors.

At the same time, ESR-REIT’s interest coverage ratio fell from 5.2 in 2014 to 4.0 in 2018. The interest coverage ratio tells us how much room for error a REIT has in using its income to service the interest payments on its borrowings – in general, the lower the ratio, the worse the situation is.

ESR-REIT’s gearing ratio improved in the first half of 2019 to 39%, but even then, this is still too near the gearing-ceiling of 45% put in place by the Monetary Authority of Singapore for Singapore-listed REITs. Moreover, the interest coverage ratio had continued to deteriorate, coming in at just 3.5 as of 30 June 2019.

Coming to the debt-maturity profile, if a REIT has a concentrated profile, where a lot of debt is maturing in a narrow span of time, it is facing high refinancing-risk. This is unfortunately the case with ESR-REIT. As of 30 June 2019, 32.7% of the REIT’s total debt of S$1.19 billion will come due in 2023. The good news is that the REIT has a number of years to fix the situation before it has to repay a huge chunk of its debt. 

The Foolish bottom line

When investing in REITs, it’s easy to be tempted by a REIT’s high dividend yield. But it’s important to look beneath the hood at a REIT’s financials to understand if there are any risks to its future dividend. In the case of ESR-REIT, it has a poor track record in growing its distributable income and DPU, and its financial health appears to be weakening. These are important risks to watch. 

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore writer Chong Ser Jing does not own shares in any companies mentioned.