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Improved long-term FFO outlook; Remain OW

Dividends almost fully covered by FFO, increase payout. The recent acquisition of the Lycee Jean Mermoz hiked our 2018-21e rental income estimates by c9%. However, this increase was offset by the recent sukuk issuance, resulting in a potential jump in interest payments (+24% y-o-y in 2018e). Accordingly, our 2018-21e FFO estimates only increased by c4%, implying payout coverage of c95%in 2018e (59% in 2017). We increased the payout ratio to 95% from 90% starting 2019e, raising our 2019-21e DPS estimates by c6%. Consequently, we upgrade our DDM-based TP by c8% to USD1.35/share, implying c31% upside and warranting an unchanged Overweight rating. The stock now trades at a P/NAV of 0.58x, with our TP implying a c23% discount to the current NAV/share.     

Acquisition and sukuk improve visibility on FFO. In May 2018, Emirates REIT announced the acquisition of the Lycee Jean Mermoz, a French school in Dubai, on a 27-year lease, for a total cost of cUSD20.5mn, increasing the REIT’s portfolio value to USD886mn and the educational exposure in the portfolio to USD238mn (27% of portfolio). This took place following the issuance of a USD400mn fixed-rate (5.125%) Islamic bond during December 2017, maturing in 2022, replacing and adding to all of its maturing debt (cUSD300mn). This move came in a bid to lower the risk of an increasing interest rate environment. REIT’s interest payments are expected to increase in 2018e, however, in the long run, the fixed interest payments should minimise the risk stemming from the expected rise in rates.

Slower-than-expected occupancy build-up in Index Tower. As of end-1Q18, occupancy in Index Tower Offices reached 35%, up from 21% in 2016. That said, with fit-outs well underway, we believe that occupancy could reach 50% by year-end. Index Mall is currently 50% pre-leased and expected to be operational this year, potentially improving demand for the available office space.   

Prefer Emirates REIT over Saudi counterparts, in the short-term. This is due to: i) a higher 2018e dividend yield (c8%, vs. an average of c7% for our Saudi REITs coverage), ii) more room for growth from existing properties (through Index Tower), and iii) more catalysts on the horizon, primarily the Index Mall opening. In the long run, we prefer Derayah [Overweight | TP SAR10.1], on: i) an unlevered balance sheet, and ii) more geographical and segmental diversity.