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Since the acquisition of ARA Asset Management, ESR Group’s (“ESR”) transformation has shown results, particularly in its focus into New Economy Assets and prioritising its Fund Management business. While it might be hampered by the ongoing high interest rates, disciplined capital management will allow for the improvement of ESR’s credit profile.

FY23 Performance Highlights

For the year ended 31 December 2023 (“FY23”), ESR recorded weaker earnings compared to the previous year, despite higher revenue. While ESR’s revenue grew by 8% year-on-year (“YoY”), both EBITDA and PATMI (profit after tax and minority interest) saw significant declines of 32.2% and 59.8% respectively.

This downturn in performance can be attributed to several factors. Firstly, there had been lower fair value gains and absence of one-off disposal gains in FY23, resulting in other income and gains falling from USD 510m (FY22) to USD 376m (FY23). Additionally, the Group incurred losses from joint ventures and associates for the year, falling from a gain of USD 223m (FY22) to USD -20m (FY23). Lastly, ESR’s PATMI was further weighed by higher interest rates, leading to an increase in overall finance costs from USD 222m to USD 313m.

Furthermore, ESR anticipates full integration with the acquired ARA Asset Management (“ARA”) and LOGOS Property Management (“LOGOS”) to be attained by 2025. Synergies with LOGOS are expected to enhance ESR's capabilities as a New Economy Asset Manager in Australia and New Zealand (“ANZ”). The ANZ development pipeline is currently the largest in ESR's portfolio, with the company poised to become the second-largest New Economy Manager in the region by Assets Under Management (AUM). Additionally, ESR foresees further cost efficiencies arising from the integration, with USD 35 million in savings identified since the acquisition of ARA.

While we do not see growth drivers emerging beyond the focus on New Economy Assets, the upcoming developments will help with improving its capital structure and reduce cost. Revenue growth should be well-supported, albeit slow, given positive rental reversions within New Economy segment and an expanding AUM.

ESR’s performance weakened on the backdrop of a challenging macroeconomic environment, largely due to persistently high interest rates. However, as major benchmark rates likely have peaked, we anticipate minimal further impacts on ESR’s profitability.

Chart 1
ESR’s performance over past years (in USD m)

Two things we like about the ESR business

1. We are encouraged by continued growth in Fund Management (“FM”) revenue and EBITDA. ESR has seen a shift from its previous three-pronged approach towards its business (investment, development and management of real estate properties) and increasingly focus on fund management to derive fee income. ESR noted that fee-related asset under management (“AUM”) has grown by 6.3% YoY, while FM EBITDA now accounts for nearly 60% of ESR’s total segmental EBITDA (of its three business segments), a significant increase from 21% since its Initial Public Offering in 2019. In FY23, FM EBITDA (including “promote fees”) grew by 8.9% YoY, which is a remarkable CAGR of 57% since 2020.

The stability provided by fee income contrasts favourably with the volatility of fair value gains on ESR's assets, particularly amid interest rate fluctuations. This growing source of income underscores ESR's development trajectory and is likely to play an increasingly prominent role in the company's earnings going forward.

2. ESR's focus on New Economy Assets has proven beneficial, demonstrating resilience amidst economic uncertainty. Rental reversion remained positive at 8.2% for the overall portfolio, and even higher at 14.3% excluding assets in China. Vacancy rates remain low – with overall portfolio occupancy at 91%, and 98% when excluding China. This strategic emphasis on New Economy Assets reflects positively in ESR's results and aligns well with evolving market dynamics.

ESR’s credit profile

Table 1
ESR balance sheet figures and credit metrics

(in USD m)	Dec-22	Jun-23	Dec-23
Cash	1,807	1,126	1,002
Total Debt	5,497	5,629	5,980
Net Debt	3,690	4,503	4,978
Net Debt to Total Assets	22.8%	27.6%	30.7%
Gearing	29.7%	34.8%	38.4%
Net Debt to Equity	40.4%	49.4%	57.0%
Weighted Average Interest	4.2%	5.6%	5.3%
Sources: Company presentation, iFAST Compilations.

ESR’s credit profile may experience a slightly deterioration, but upcoming plans to pay down its debt should allow the Group to see a rebound from here.

The deterioration in ESR’s credit profile primarily stems from a reduction in cash reserves coupled an increase in debt. Cash and cash equivalents notably decreased as compared to the previous year, falling from USD 1,807m (FY22) to USD 1,002m (FY23) – primarily used for the funding of projects and new investments. Concurrently, total debt rose from USD 5,497m (FY22) to USD 5,980m (FY23) for similar purposes, leading to an escalation in various debt-related credit metrics for ESR.

However, we believe the Group will face little issues in securing financing and to be able to maintain its average interest – despite the prevailing environment of increasing interest rates in FY23. ESR's creditworthiness, underscored by its AA- (stable) rating from Japan Credit Rating Agency, has facilitated access to the Japanese Yen debt market, where it successfully issued a total of JPY 30b at rates below its weighted average interest cost. Additionally, ESR boasts a AAA (stable) rating from China Chengxin International Credit Rating Agency, enhancing its ability to secure favorable funding within the Chinese debt markets, if necessary.

ESR will be optimising its balance sheet by selling down assets for syndication and divesting non-core assets in 2024. Thus far, they have announced a total of USD1.2b worth of assets intended to be sold and planned out another USD 1.5b to 2.0b for the next twelve months.

An example of ESR's balance sheet optimisation is the establishment of an upcoming Real Estate Investment Trust in China (“C-REIT”). The C-REIT, which has received approval-in-principle from relevant authorities, is likely to be listed by the end of the first half of 2024. ESR plans to sell USD 0.4b worth of assets to the C-REIT after its listing, representing a substantial portion of the assets earmarked for sell-down. In addition to this, ESR aims to divest another USD 0.8b worth of assets in China. We believe this will help ESR’s overall portfolio given the lower rental reversion and occupancies observed in the region.

Across the announced and planned sales, ESR expects to obtain net proceeds of estimated USD 2.1b. Most critically, USD 2.0b from the net proceeds will be spent on paying down existing debts, thereby improving the overall debt profile. Currently, the gearing ratio stands at 30.7%, but ESR anticipates this to fall to approximately 25.0% by end-2024 and approximately 20.0% after completing the optimisation. The reduction in debt is projected to provide annual interest savings of USD 40m at a 25% gearing ratio, and USD 100m at a 20% gearing ratio.

With ESR's intention to utilize proceeds from balance sheet optimisation to repay debt, we believe its credit profile will improve from here. This strategic move is expected to not only bolster ESR's financial standing but also curtail its overall finance expenses. Meanwhile, should ESR require additional liquidity, its credit ratings allow it to tap into the Japanese and Chinese markets, offering access to funding sources potentially at lower costs compared to alternative debt markets.

Recommendations

Table 2
ESR SGD Issuances

Issues	Ask Price	Yield to Call/ Maturity	Years to Call/ Maturity	Remarks
ESRCAY 5.100% 26Feb2025 Corp (SGD)	100.25	- / 4.83%	- / 0.82	-
ESRCAY 5.650% Perpetual Corp (SGD)	98.90	6.28% / -	1.83 / -	Reset Date: 02 Mar 2026 and every 5 years thereafter Reset Rate: Prevailing 5-year SOR + Initial Spread (4.73%) + Step Up Margin (200 bps from 02 Mar 2026)
ARASP 5.650% Perpetual Corp (SGD)	98.687	6.12% (next reset)/ -	3.87 (next reset) / -	Reset Date = 14 March 2028 & every 10 years thereafter Reset Rate = Prevailing SGD 10Y SOR plus the Initial Spread (3.128%) plus the Distribution Step-up (300 bps)
ARASP 5.600% Perpetual Corp (SGD)	98.25	6.40% / -	2.34 / -	Reset Date = 04 Sep 2026 & every 7 years thereafter Reset Rate = Prevailing SGD 7Y SOR + the Distribution Step-up (300 bps) + Initial Spread (4.06%)
Sources: Bloomberg Finance L.P., Bondsupermart, iFAST Compilations. Data as of 2 May 2024.

ESRCAY 5.100% 26Feb2025 Corp (SGD) stands out among all SGD bond offerings with its attractive 4.83% yield to maturity. Despite lacking ratings from the three major agencies, ESR remains as a quality issuer in our view and quite unlikely to face liquidity issues in making interest payments or redeeming its issuances. The 2025 paper compares well against the Singapore T-bills – providing a good reward for the additional credit risk to undertake, while having a similarly short duration. The paper currently offers a spread of 110 bps and 123 bps against the 6-month and 1-year T-bills respectively as of 2 May 2024. We believe the ESRCAY 2025 paper will be a great option for investors considering short-duration choices.

On the other hand, ESR’s perpetual securities (“perps”) stands out as all of its current perps offer a step-up margin upon reset. In general, for perps, we advocate investors to exercise caution due to the non-call risk amid elevated interest rates. However, the presence of step-up margins (see Table 2) enhances the likelihood of a call on the reset date. In the event of a non-call and the perps reset, investors would still benefit from the high coupons as the embedded step-up margin kicks in. With that said, we believe investors should exercise prudence when investing in perps.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in ESRCAY 5.100% 26Feb2025 Corp (SGD) and ESRCAY 5.650% Perpetual Corp (SGD), and the analyst who produced this report holds a NIL position in the abovementioned securities.