Ascott Residence Trust (ART SP) - UOB Kay Hian 2017-03-08: Acquisitions Fall Short Of Mitigating Dilutive Rights; Downgrade To HOLD

ASCOTT RESIDENCE TRUST A68U.SI

Ascott Residence Trust (ART SP) - Acquisitions Fall Short Of Mitigating Dilutive Rights; Downgrade To HOLD

We downgrade ART to HOLD (from BUY) with a reduced target of S$1.20 (from S$1.30) on valuation grounds as we factor in the rights issue and acquisitions in Singapore and Germany.
The announcement removes the equity fund-raising overhang on the stock, providing a S$754.4m debt headroom.

Management is in advanced negotiations to divest of non-core assets in Japan to re-constitute their portfolio, with the US likely to see the bulk of the re-deployment.

Ascott Residence Trust (ART) announced a S$442.7m rights issue to acquire Ascott Orchard Singapore (S$405m), Citadines City Centre Frankfurt (S$44.1m) and Citadines Michel Hamburg (S$53.1m).
Existing unitholders will be offered 481.7m rights units at a ratio of 29 units for every 100 units already held.
The rights units will be issued at S$0.919 each, which is at a discount of 21.5% to the closing price of S$1.17 as at 6 Mar 17 and a discount of 17.5% to the theoretical ex-rights price.

The property valuations at an expected EBITDA yield of 4.5% for Ascott Orchard Singapore, 5.4% for Citadines City Centre Frankfurt and 5.4% for Citadines Michel Hamburg are in line with market valuations. However, the transaction will result in a 10.2% dilution after considering the rights issue and contribution from the acquisition.

Gearing will reduce from 39.8% to 37.0% and its debt headroom will increase from S$442.6m to S$754.4m after the rights issue and acquisitions. Management is open to further issuance of perpetual securities given the increased headroom.
Management is also considering capital recycling through potential divestments of non-core assets. The rental housing assets in Japan (six were divested last year) are under advanced negotiations, while underperforming China assets are also being discussed.
To support potential acquisitions, management had previously highlighted the likelihood of footprint expansion in the US.
In Europe, we note that the sponsor Ascott Ltd has been acquiring assets in Germany and Paris, which we reckon could require 6-9 months to see performance stabilise before potential injection of these assets into ART.

Exposure to Germany will increase from 2.6% to 4.4%. ART's asset size will expand to S$5.3b post the transaction. The transaction brings them close to the S$6b target by 2017 they had set earlier.

The lease is structured as a fixed lease rental of S$13.2m p.a. and a variable lease rental at 85% of net operating income for a minimum of 5 years and renewable for another 5 years.
While the expected EBITDA yield from Ascott Orchard on a stabilised basis is 4.5%, management highlighted that the fixed rents, carpark and restaurant rents would alone account for a healthy 4% yield.
Currently, occupancy is around 35-40%, with rents around S$350 per day.

The EOGM will be held only to seek approval for the two German acquisitions with expected EBITDA yield of 5.4%. They have been structured as long-term masterleases (15+5) managed by ART’s parent Ascott.
Citadines City Centre Frankfurt (S$44.1m) will have a fixed rent of €1.7m p.a and Citadines Michel Hamburg (S$53.1m) will have a fixed rent of €2m p.a.

We have reduced our 2017-19 DPU estimates by 5-10% to factor in the dilution from the enlarged unit base, partially offset by income stream from acquisitions.

Downgrade to HOLD with a reduced target price of S$1.20 (from S$1.30) as we factor the 10% DPU dilution from the transaction.
Our valuation is based on the two-stage dividend discount model (required rate of return: 7.7% and terminal growth rate: 1.7%).

Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2017-03-08

UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 1.20 Down 1.300