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On the cusp of a rebound

The Embassy Office Parks REIT (Embassy REIT) delivered a resilient Q1FY22 performance with rental collections of 99% (similar to FY21) and portfolio occupancy remaining flat QoQ at 88.8%. While possible fresh tenant exits of 1.2msf remain a near-term dampener, we build in a gradual recovery from H2FY22E with a full recovery in FY23E.

We believe that the REIT’s low leverage (net debt/TEV of 0.23x) and marquee tenant profile will enable the REIT to deliver 18% NOI CAGR over FY21-24E. We retain our BUY rating with an unchanged target price of Rs415/unit based on Mar’22 NAV.

With the REIT manager intending to refinance existing zero-coupon bonds of Rs45bn to coupon bearing bonds from Nov’21, this will result in optically lower REIT NDCF distribution of Rs1.5/unit in FY22E and Rs3.3/unit each in FY23E and FY24E. At CMP of Rs356/unit, this implies distribution yields of 6.0% in FY22E, 6.1% in FY23E and 6.8% in FY24E. Key risks are a slower recovery in office leasing and higher portfolio vacancy levels.

* Expiries a near-term concern, expect recovery from Q3FY22: The REIT had total lease expiries of 1.9msf in FY22E of which 0.4msf has been renewed in Q1FY22E. Of the balance 1.4msf of estimated expiries in FY22E, 0.2msf of exits have happened in Q1FY22 and the REIT manager maintains its guidance for balance exits of 1.2msf in FY22E. While this may lead to a further dip of 200-300bps in portfolio occupancy in FY22E, with increased pace of vaccinations and possible return to office from Sep’21 for many occupiers, leasing activity may see an uptick from Q3FY22 with a strong recovery estimated in FY23E.

* Flat FY22 NDCF guidance by REIT manager in line with estimates: Factoring in the second Covid wave impact, the REIT manager has given a mid-range REIT NDCF/unit guidance of Rs21.5/unit in FY22E (same as FY21) factoring in likely incremental tenant exits of 1.2msf in the remainder of FY22E and a 5% same-store YoY NOI decline ex-ETV asset. We currently estimate FY22E SPV to REIT NDCF of Rs24.6bn and REIT NDCF of Rs20.3bn or Rs21.4/unit (final payout to unitholders). This guidance does not build in a possible third Covid wave in India.

* Conversion of ZCBs to coupon bearing debt to optically impact yields: The REIT had issued zero-coupon bonds (ZCBs) of Rs36.5bn in May’19 at an annual coupon of 9.3%. While these ZCBs were due for maturity in Jun’22 and the REIT manager’s earlier intent was to refinance these as a ZCB on maturity (amortized cost of Rs47bn), the REIT manager has now indicated its intent to convert these ZCBs into a coupon bearing debt in Nov’21 at ~7% annual coupon. While our revenue/NOI/SPV NDCF estimates remain unchanged, the conversion of Rs45bn of ZCBs (fully amortized cost) to a coupon bearing bond will result in lower REIT NDCF distribution of Rs1.4bn in FY22E (Rs1.5/unit) and Rs3.2bn each in FY23E and FY24E (Rs3.3/unit).

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