2023 results fall short of our expectations

ESR announced 2023 results: Net profit to mother (PATMI) fell 59.8% year on year to US$230 million, lower than our previous forecast of US$420 million. It is mainly due to a decrease in fair value income from the investment and development division, an increase in interest costs, and a decrease in one-time income in the overseas high-interest environment.

The fund management business performed well. By the end of 2023, the management scale of assets related to the company's management fee revenue increased 6.3% year on year to US$81 billion, driving some revenue from the company's fund management in 2023 and EBITDA rising 3% and 2% year over year to US$737 and US$579 million respectively after excluding changes in fair value of financial derivatives.

The fundamentals are solid, and the development process has slowed down. By the end of 2023, the average maturing rent increase rate of the company's asset portfolio was 8.2% (14.3% excluding mainland China), the rental rate of the new economy asset portfolio remained above 91% (98% excluding mainland China), and asset portfolio management remained steady. The scale of new construction started and completed in 2023 reached US$6.3 billion and US$4.2 billion respectively (down 3% and 24% year on year), mainly due to the slow development of the company in mainland China.

The company recently issued two announcements: 1) the March 11 announcement revealed that the company will sell part of the ARA private equity interest (initial price is US$270 million), and we believe the proceeds will help ease the pressure on the company's debt; 2) the March 20 announcement revealed that RIC (an entity controlled by the company's non-executive director Charles Alexander Portes and Mr. Stuart Gibson, a non-executive director and co-chief executive) transferred 10.657% of the company's shares to Starwood Capital Group The holding company, and RWI (also the controlling shareholder of RIC), will be fully repaid all outstanding amounts under existing margin loans, and all financing obligations of RWI under such existing margin loans will be lifted.

Development trends

The balance sheet is expected to be further optimized. According to the disclosure, the company expects to dispose of about US$15-20 billion of in-statement assets within the next 12 months. We believe this measure is expected to reduce the Group's balance ratio and interest costs (30.7% of the company's balance ratio as of the end of 2023, and the weighted average financing cost is 5.3%), and will help increase potential allocations or fund subsequent share repurchases.

Profit forecasting and valuation

Considering the decline in investment segment earnings after the company accelerated asset disposal, we lowered our 2024-25 net profit forecast by 6% and 8% to US$431 million and US$460 million (+87% YoY). Maintaining an outperforming industry rating, the target price was lowered by 17% to HK$12 (corresponding to 15.7/14.7 times the 2024-25 core price-earnings ratio, with 63% upside compared to the current stock price), which mainly reflects adjustments in profit forecasts and potential pressure on asset prices in an overseas high-interest environment. The company currently trades at 9.7/9.0 times the 2024-25 core price-earnings ratio and 0.5/0.5 times the 2024-25 net price-earnings ratio.

risks

Global commercial real estate prices declined more than expected; financing costs rose; and the company's 2024 construction volume fell short of expectations.