Morningstar Equity Research analyst Xavier Lee has cut his fair value estimate for ESR Group by 18% following a “disappointing” 1HFY2024 ended June 30 with softer fee income growth.
The real asset manager posted on Aug 21 a loss of US$58 million ($75.84 million) for 1HFY2024, reversing from earnings of US$304 million in 1HFY2023.
In an Aug 22 note, Lee has a four-star rating on the Hong Kong-listed stock against a five-tier scale, which represents that “appreciation beyond a fair risk-adjusted return is likely”. He has trimmed his fair value estimate to HK$13 ($2.18) from HK$15.80 previously.
Loss after tax and minority interest reached US$219 million in 1HFY2024, driven by an absence of promote fee income, non-cash revaluation losses for its mainland China properties and a non-cash write-down of its investment in Cromwell Property Group and in both the ARA US Hospitality Trust XZL 's manager and the trust's units.
Management has shared that promote fee income varies depending on the lifecycle of its managed funds and the real estate cycle.
“Although we expect a pivot in the US Federal Funds rate in September, we think that any positive impact from this event will only help the group from 2025 onward,” says Lee. “Hence, we expect no promote fee income for 2024 and assume a gradual return in 2025-2026.”
See also: ESR Group reports US$58 mil loss in 1HFY2024; 31.4% lower revenue
Lee has also lowered his assets under management, or AUM, growth assumptions and “fine-tuned” his capital recycling projections, as he believes pressure on real estate valuations to persist in the near to medium term.
Lee has lowered his EPS estimate by 34%-50% for FY2025-2026. “Our valuation was lowered by a smaller magnitude as part of the earnings cut was due to lower non-cash fair value gain estimates.”
Lee notes that ESR Group has also decided not to distribute an interim dividend, given the ongoing privatisation proposal.
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“Despite weak results and the absence of interim dividend, we think the share price will continue to be supported by the potential privatisation offer by a consortium of investors comprising Starwood Capital, Sixth Street Partners and SSW Partners,” writes Lee.
ESR Group had paid an interim dividend of HK$12.5 cents per share for 1HFY2023.
Overall, Lee thinks the group is slightly undervalued, trading at a 12.5% discount to our fair value. “Our top pick for alternative asset managers is Keppel, which is trading at a wider 30% discount to our fair value estimate.”
Fundraising environment
Despite the tough fundraising environment that saw the lowest amount of funds raised in private real estate for the first half since 2012, ESR Group still managed to raise US$2.3 billion, surpassing the amount raised in 1HFY2023.
The group’s dry powder currently stands at US$23.7 billion as of June 30. Management thinks this puts it in a good position to scout for acquisition opportunities following interest rate cuts in the US.
Portfolio occupancy slipped to 87% as of the end of June from 91% as of the end of December 2023. The decline was largely driven by Japan and China, which posted occupancies of 86% and 77% at end-June compared with 98% and 82% as at end-December 2023, respectively.
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Management said the decline in Japan was driven by a couple of large completions, and leasing activity for these assets is progressing well. As for China, the oversupply of logistics and industrial properties remains a key headwind as the group prioritises occupancies over rents, leading to a negative 11% rental reversion.
Nevertheless, at the portfolio level, this negative rental reversion was offset by robust rental reversions in its Australia and New Zealand portfolio, as well as its South Korea portfolio, which registered positive rental reversions of 27.9% and 24%, respectively.
As at 11.03am, shares in ESR Group are trading 8 Hong Kong cents lower or 0.68% down, at HK$11.60.
