Embassy REIT: Is the worst behind us?

29 Mar 2023 , 10:06 AM

Recommendation: Buy

Target Price: Rs 410

EOP has announced the acquisition of ‘Embassy Hub’ in Bangalore (<1% of GAV), which is largely NAV neutral. Leasing demand outlook remains muted. Occupancy improvement will be steady, but gradual. FY24/25 distribution yields are attractive at 6.8/7.5%, although rising interest rates remain a key risk.

Amendments to Finance Bill lower tax impact on distribution

Amendments to the budget announcements allow for repayment of capital being adjusted by the cost of unit issued by REIT. Further, it will also be reduced from the cost of acquisition for calculating capital gains tax. This has effectively replaced the maximum marginal rate of tax in the year of receipt, with the tax now at capital gains rate at the time of units’ sale. EOP has 45-50% of its distribution as repayment to capital, impacting the post-tax yield negatively by >100 basis points. Analysts at IIFL Capital Services believe this was among the best possible outcome for REITs, after the budget announcement on 1^st February 2023.

Acquisition of Embassy Hub NAV-neutral

EOP has announced the acquisition of ‘Embassy Hub’ from the sponsor (Embassy Group), for an EV of Rs3.4 billion (~1% of existing GAV). This asset will be NAV-accretive by 2 basis points and NOI-accretive by 104 basis points, as per management. The acquisition will be funded through debt borrowed at 8.1%. Management estimates 8.25% NOI yield for Phase 1 of the project, and 12% yield to cost of under construction Phase 2. Beyond the 1.4msf being acquired, EOP also stands to benefit from 46acres of ROFO for future phases.

Valuations attractive; demand outlook still cloudy

Occupancy improvement depends on: 1) Improvement in hiring outlook especially in the tech space 2) Clarity on DESH Bill allowing partial de-notification of SEZ buildings. Post recent correction in unit prices, EOP trades at an attractive post-tax yield of 6.8% and 7.5% for FY24/25. However, rising interest rates remain a key risk to distribution growth, even as EOP is targeting double-digit NOI growth in FY24. Analysts at IIFL Capital Services have retained a Buy rating on the stock citing attractive valuations (25% discount to NAV).