ESR Group: High Interest-Rate Environment and Weak China Market to Drag 2023 Earnings Lower

We cut ESR Group’s fair value estimate to HKD 17.80 from HKD 19.50 after factoring in the challenging market environment due to high interest rates and a weak Chinese economy. We think narrow-moat ESR Group remains undervalued, but we believe near-term share price performance will be capped by low market sentiment. According to data from PitchBook, real estate fundraising fell 63% year on year in 2023 as higher interest rates dampened fundraising and deal activities. While we had previously expected the group’s assets under management to grow by 8% and 10% in fiscal 2023 and fiscal 2024, respectively, we have now moderated our assumptions to 5% in fiscal 2023 and 8% in fiscal 2024. Aside from Japan, which is still seeing positive yield spreads, we expect the group to continue facing headwinds in raising real estate funds in other regions. The group may also find it difficult to deploy the capital it has raised due to higher hurdle rates. In addition, we forecast a lower contribution from the group’s investment properties in China, judging from the poorer performances of other listed peers with industrial properties in China. We expect rental reversions in China to be under pressure on the back of weaker demand for industrial and logistics spaces as business sentiment remains poor. We believe the group may see some pressure on the fiscal end-2023 valuation of its properties with cap rates rising in Australia and South Korea. This also hits our capital recycling assumption as the value that could be unlocked and redeployed will be lower. Overall, we lower our EPS estimates for 2023, 2024, and 2025 by 24%, 13%, and 6% respectively.