MACARTHURCOOK Industrial Reit is the smallest industrial S-Reit with 12 quality Singapore properties set for steady contractual rental growth. We expect a re-rating once the manager demonstrates its ability to execute on acquisitions, which should amplify distribution per unit (DPU) growth on a small asset base and low gearing.

We initiate coverage with an Overweight (V) rating and target price of $1.57, implying 30.7 per cent total return potential.

Expect amplified DPU growth via acquisitions on a small asset base and low gearing. With a visible pipeline of over $150 million, MI-Reit aims to grow its assets by up to $500 million per annum over the next three years, implying a CAGR (compounded annual growth rate) of 79 per cent to end-FY10. We believe this target is achievable, given the asset-light trend in a fragmented industrial real estate environment and the company’s ability to tap into the networks of its parent and strategic partner.

With an initial gearing of 8.7 per cent and the ability to gear up to 60 per cent of gross assets (on receiving a credit rating from Moody’s), we estimate MI-Reit could acquire some $400 million of assets purely by debt, which could add 46 per cent to its FY08f DPU.

The portfolio has a weighted lease term to expiry of 6.7 years and occupancy of 100 per cent as at April 2007, with built-in weighted average rental escalation of 3.4 per cent per annum for the first four years. We believe MI-Reit could benefit from potential industry consolidation, in the event that the S-Reit takeover code is formalised in the medium term.

Target price of $1.57 including acquisition premium: We see this as an undervalued S-Reit trading at a large discount to its peers. Our target price comprises a base case DDM value of $1.22 on its existing portfolio, on an 8.0 per cent cost of equity and an acquisition premium of $0.35 assuming $500 million of acquisitions over FY08-09 (March) at 7.0 per cent average yield.

With a total return potential of 30.7 per cent (including 5.9 per cent FY08f yield), we initiate coverage of MI-Reit stock with an Overweight (V) rating.

Risks: The manager’s inability to execute on growth strategies, default risks by tenants or subtenants, competition for assets and interest rate risks.

OVERWEIGHT

It has available debt capacity of about $193m to fund acquisitions

MACARTHURCOOK Industrial Reit (MI-Reit) yesterday got a first-time Baa3 investment grade rating from Moody’s, boosting its maximum gearing limit from 35 per cent to 60 per cent of gross assets, which translates to over $75 million of additional debt capacity.

The Reit, which has a portfolio of 12 industrial real estate assets in Singapore and was listed in April this year at an issue price of $1.20 and distribution yield of 6.2 per cent, traded up to a high of $1.35 at yesterday’s close.

‘With the credit rating, MI-Reit has increased gearing capacity, with available debt capacity of approximately $193 million to fund acquisitions,’ said chief executive Chris Calvert.

The trust said it intends to maintain a long-term target gearing of between 40 to 45 per cent, but might on occasion increase this to secure strategic industrial properties around Asia. Debt is an ‘efficient mechanism’ by which to achieve the target of growing the Reit’s assets by at least $500 million in new acquisitions per year, said Mr Calvert.

The trust’s portfolio had a combined value of about $316 million at listing date. It has not announced any acquisitions post-listing.

Analysts have received the stock warmly, with a present total of four ‘buy’ calls on MI-Reit, according to Bloomberg. These include two reports initiating coverage in the last two days – HSBC and UBS each issued calls on MI-Reit with target prices of $1.57 and $2.07 respectively, making much of its relatively low gearing and capacity for further purchases.

MI-Reit’s acquisition target ‘is achievable given the asset-light trend in a fragmented real estate environment’, HSBC said yesterday. ‘This represents more than doubling its asset size within the first year and a CAGR (compounded annual growth rate) of 79 per cent in portfolio size over the next three years to end FY10.’

Only 12 per cent of the 286 million square feet of Singapore’s private industrial space is owned by Reits, though yields have been driven down by stiff competition, it said.

The bank expects MI-Reit to benefit from JTC’s potential divestment of $3 billion worth of industrial assets, as well as from the networks of strategic partner United Engineers, which it said is expanding in the region.

MI-Reit should trade at a lower yield than peer Cambridge Industrial Trust, due to lower gearing and smaller asset base, which implies higher proportionate accretion from the same value of acquisitions, according to HSBC.

Meanwhile, UBS said industrial assets around Asia are ‘typically the highest-yielding of the main Reit asset classes, providing around a 250 basis point spread over cost of capital’. It believes MI-Reit has identified potential purchases valued at around $210 million in Singapore, to be injected over the next 18 months.

However, UBS noted that 10-year bond yields in Singapore – which have fallen to 2.9 per cent – could rise in the medium term to a forecast 3.2 per cent at the end of the year and put pressure on the Singapore Reit sector.

For its part, HSBC noted MI-Reit’s lack of a sponsor pipeline, but said third-party acquisitions are historically more prevalent for industrial Reits. The potential establishment of JTC Reit could also intensify competition, it noted.

MI-Reit said separately it has appointed Matthew Wrigley, currently head of legal and compliance at parent MacarthurCook in Australia, as chief operating officer of the Reit’s manager in Singapore.

Chris Calvert, Chief Executive Officer of the Manager, said, We are very pleased with Moody s corporate rating for MI-REIT, which is a positive reflection of MI-REIT s strategically located properties, quality tenant base, 100% occupancy rate long average lease expiry profile of 6.7 years. The rating is a testament MacarthurCook s proactive investment management style, disciplined property acquisition process and strong capital and risk management strategy.

With the credit rating, MI-REIT has increased gearing capability, with available capacity of approximately S$193 million to fund acquisitions. The higher leverage limit increases our operational flexibility and allows us to move quickly to acquire assets in line with our investment policy, added Mr Calvert.

Under the Property Fund Guidelines issued by the Monetary Authority of Singapore, as amended in October 2005, a REIT may increase its aggregate leverage maximum of 60% of the value of its deposited property, provided it obtains discloses to the public a credit rating from one of the major rating agencies, including Moody’s.

To maintain the appropriate risk profile of MI-REIT, the Manager expects to maintain a long-term target gearing ratio of between 40%-45%.

Mr Calvert continued, On occasion however, we may increase the leverage ratio above 45% in order to secure strategic industrial properties throughout Asia, which will enhance our capital growth and asset quality. We view debt in the current environment as an efficient mechanism to enable us to attain our target of growing MI-REIT by at least S$500 million in new acquisitions per annum.

The Manager has also successfully negotiated with its bank lending syndicate, which comprised of the National Australia Bank Limited and the Commonwealth Bank of Australia Limited, to increase its facility from S$128.8 million to S$220.8 million, which reflects MI-REIT s increased gearing capability.

In a separate press release issued by Moody s, the rating agency acknowledged that MI-REIT s properties are well located, with seasoned operating histories and stable and high occupancy rates. The agency also stated that it expects stable cash flow generation from the portfolio, supported by committed rental revenues, favourable industrial market conditions, low level of development risk exposure and ongoing financial discipline by the trusts management in pursuit of growth.