CDL Hospitality Trust - CIMB Research 2017-06-12: Sir, It’s Time To Check Out

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CDL HOSPITALITY TRUSTS J85.SI

CDL Hospitality Trust - Sir, It’s Time To Check Out

• We review our call and forecasts on CDREIT. However, due to its outperformance, we forecast total returns of 0% and maintain Hold with a higher DDM-based Target Price.
• Our scenario analysis on CDREIT’s Singapore RevPAR performance shows 4-9% downside to current trading price.
• We believe that CDREIT’s 2Q17F Singapore RevPAR performance could be uninspiring, which could break the share price momentum.
• While further acquisitions could provide upside to our estimates, CDREIT’s leverage would limit the accretion, in our view.

Raising DPU forecasts and Target Price, Hold maintained.

• CDREIT is the second best-performing S-REIT in the sector, gaining c.20% YTD. In our view, bottom-up drivers for share price performance were 
  1. low built-in expectations; 
  2. better-than-expected RevPAR performance in 1Q17 which signaled a potential bottoming out in the Singapore hotel sub-segment; and 
  3. DPU-accretive acquisition of The Lowry Hotel (Lowry) in Manchester, UK.
  However, precisely because of its outperformance, we now consider risk-reward to be skewed towards downside. This view is backed by a scenario analysis which we have conducted.
• To also help you shape your thoughts, we have included our narrative on CDREIT’s individual markets’ outlook. For Singapore, we reiterate our view for the market to bottom out by end-17 and recover in 2018. While we have found that the bulk of the supply expected in 2Q17F has been deferred to 2H17F, the large supplies in 2017F and the virtual absence of additions in 2018F would still mean that supply pressures would still be felt this year, in our view.
• In the near term, we believe that CDREIT’s 2Q17F Singapore RevPAR performance could be uninspiring. We expect a mid-single digit decline in CDREIT’s RevPAR in 2Q17F (1Q17: -0.8% yoy), which could serve as a break to its share price momentum. For FY17F, we expect a 2.5% yoy decline in RevPAR (FY16: -8.6% yoy).
• We also believe that there could be upside risks to our estimates should CDREIT execute further DPU-accretive acquisitions. That said, we deem the trust’s relatively high leverage could limit the accretion. We expect its aggregate leverage to be 39.1% post the acquisition of Lowry. Assuming a gearing limit of 40-42%, and that the new assets are fully debt-funded at 2.5% interest costs vs. NPI entry yields of 5-7%, we estimate a 1-5.8% accretion to CDREIT’s FY17F pro-forma DPU. We estimate that a 1% accretion in DPU would translate into a 1% increase in our DDM-based TP. In the best case scenario, an accretive acquisition could bring up CDREIT’s target price to its current trading price.
• Additionally, while CDREIT could utilise perpetual securities to fund acquisitions, we think the trust could experience some negative carry if it is not able to match the issuance size (typically in excess of S$100m) with the acquisition quantum.
• Putting our analysis together, we forecast total returns of 0% on CDREIT and maintain Hold on the stock. We raise our DDM-based TP from S$1.42 to S$1.52 (implied FY18F yield of 7% and 0.98x FY17F P/BV), on the back of a sector-wide decrease in our Singapore discount rate and DPU forecast increases. We raise our FY17-19F DPU by 4.9-5.5% as we factor in 
  1. the accretive acquisition of Lowry; 
  2. better-than-expected 1Q17; and 
  3. actualize our FY16 assumptions.
  With these changes, we are now expecting growth, and no longer expecting a decline in FY17F DPU. 

Risk-reward is skewed towards downside 

• Our scenario analysis on CDREIT’s Singapore RevPAR performance shows that risk-reward is skewed towards the downside. We foresee 4-9% downside to the current trading price.
• Our base case factors in a 2.5% yoy decline in CDREIT’s Singapore RevPAR for FY17F (FY16: -8.6% yoy, 1QFY17: -0.8% yoy) and a 4.2% yoy improvement for FY18F. Essentially, our assumptions express a view for Singapore hospitality market/CDREIT’s Singapore portfolio to bottom out by end-17F and recover in 2018F. Our base-case assumptions lead to a fair DDM-value of S$1.52.
• Our bull case assumes an earlier recovery in the Singapore hospitality market (by 2H17F). Hence, we would expect CDREIT’s Singapore RevPAR performance to turn positive in 2H17F. Our bull case projects a 1.7% yoy improvement in CDREIT’s Singapore RevPAR for FY17F and a 6.2% yoy improvement for FY18F. Ceteris paribus, our bull-case assumptions derive a fair DDM-value of S$1.56.
• Our bear case assumes a pushback in recovery in the Singapore hospitality market till 2018F. Hence, we would expect CDREIT’s Singapore RevPAR performance to bottom out by end-18F and recover in 2019F. Our bear-case projects a 3.5% yoy decline in CDREIT’s Singapore RevPAR for FY17F and a 1.2% yoy improvement in RevPAR for FY18F. Ceteris paribus, our bear-case assumptions lead to a fair DDM-value of S$1.48.

Narrating markets’ outlook 

• To help you shape the various moving parts of CDREIT, we lay out our views for each of CDREIT’s markets. We forecast a 9.9% yoy increase in FY17F NPI, driven by the change in the lease structure in New Zealand and inorganic contribution from The Lowry Hotel. For FY17F, our projected marginal improvements in other markets are mainly due to strengthening currencies vs. S$.
• In the near-term, we believe that CDREIT’s 2Q17F Singapore RevPAR performance could be uninspiring. We expect a mid-single digit decline in CDREIT’s RevPAR in 2Q17F (1Q17: -0.8% yoy), which could serve as a break to its share price momentum, in our view. 
• Overall, 2Q17F could be a mixed bag as sharper qoq weakness in its Singapore hotels and seasonally weaker New Zealand (2Q and 3Q are typically shoulder periods for the Auckland market) would be offset by inorganic contribution from The Lowry Hotel.

Singapore. 

• Due to the strong upcoming supply in 2017 – Horwath estimates 5.8% addition to the stock – we reiterate our view that that the Singapore market would bottom out by end-17F and recover in 2018F. While we are anticipating completion slippages, the expected large supplies in 2017F, coupled with the virtual absence of additions in 2018F, would still mean that supply pressures would still be felt this year, in our view.
• Already, an internet search showed that the bulk of the supply expected in 2Q17F has been deferred to 2H17F. In the extreme case where half the completions are pushed back, we think it would mean that the inflection point of recovery would flatten.
• In terms of demand, visitor arrivals (according to STB) grew by 4% yoy in 1Q17 vs. our full-year estimate of 2% for 2017F. Overall hotels recorded a 0.4% yoy improvement in RevPAR for 1Q17 vs. our full-year forecast of 3% yoy decrease for 2017F. Digging deeper, however, the picture was mixed with luxury hotels recording a 5% yoy improvement in RevPAR while mid-tier hotels booked a 4.1% yoy decline in RevPAR during the period.
• The uneven picture also filtered down to the hotel S-REITs, with CDREIT reporting a 0.8% yoy decline in Singapore RevPAR in 1Q17 while FEHT reported a steeper 4.6% yoy decline for its hotel portfolio. That said, CDREIT provided a stark guidance that it registered an 8.7% yoy decline in RevPAR for the first 24 days of Apr 2017.
• We believe one of the reasons behind the relative outperformance by CDREIT in 1Q17 was the base effect. Specifically, CDREIT’s Grand Copthrone Waterfront benefited from the absence of renovation works in 1Q17. The property’s lobby was being refurbished in 1Q16, which could have affected occupancy.
• As for the apparent acute weakness in RevPAR in Apr, we believe that the absence of Food & Hotel (biannual event which occurs in even years) and the shift in Easter holidays to Apr this year (Easter was in Mar the previous year) were contributing factors. Corporates would normally avoid travelling during the Easter period. However, channel checks with CDREIT’s peers suggest that things in Apr may not be as bad. 
• Further, we highlight that that the last week of Apr has not been accounted for. With lead conversions now very short, things can change very quickly in a space of a week. Additionally, we believe the delay in completions in 2Q17F could help to soften RevPAR declines.
• As such, we expect a mid-single digit decline in CDREIT’s RevPAR in 2Q17F, and a 2.5% yoy decline for FY17F. 
• In terms of NPI, we project a 2.4% yoy increase for FY17F, as moderate weakness in hotels is offset by higher contribution from the Claymore Connect mall. For FY17F, we are modeling in an occupancy of 90% and monthly passing rents of S$8 psf for the property.

Australia. 

• Owing to the defensive master lease structure, fixed rents have typically made up the bulk of Australian contributions. Given that the natural resource sector is expected to remain subdued over the short to medium term, coupled with the increase in new room supply in Perth and Brisbane, we only expect Australia to recognise the base rent of A$13.7m p.a. over the FY17-19F, which is in line with FY16. 
• Our projected 3.3% yoy improvement in FY17F NPI is due to a stronger A$.

New Zealand. 

• We forecast FY17F NPI to jump 46.1% yoy, on the back of a change in the lease structure from a defensive one to one which has a higher variable component. The new lease structure, which took effect in Sep 2016, has benefited CDREIT as the New Zealand market continues to enjoy strong growth. Visitor arrivals grew 11.8% yoy to a record 3.5m in 2016. 
• In YTD Feb 2017, visitor arrivals grew 6.2% yoy to 0.8m. We note that the surge in tourism arrivals has been facilitated by additional commercial flight capacity serving Auckland. The 452-room Grand Millennium Auckland, which has the largest room inventory in the city, has benefited from the increased crew business.
• Consequently, the property’s RevPAR increased 24.9% yoy in 2016 and 27.6% yoy in 1Q17. We have conservatively factored in 10% yoy growth in RevPAR for 2017F. 
• We also point out that 2Q and 3Q are typically shoulder periods for the Auckland market.

Maldives. 

• We believe that the Maldives market could bottom out in 2017F, after sharp declines in 2015 and 2016. Maldives resorts recorded 8.8% yoy decrease in RevPAR in 1Q17 (FY16: -25.1% yoy; 1Q16: -28.7% yoy). 
• To combat the slowdown in Chinese luxury travel and relative strength of the US$ against some of its top source markets, the resorts have been pricing their room rates much more competitively. We have modeled in a flattening of RevPARs and that the Angsana Velavaru would only earn the minimum rent of US$6.5m in FY17F.
• Our projected 8% yoy improvement in FY17F NPI is mainly driven by a stronger US$.

Japan. 

• The Japan market remains firm, with visitor arrivals growing by 13.6% yoy to 6.5m in 1Q17 and 21.8% yoy in 2016 to a record 24m. However, CDREIT’s Japanese hotels have been registering RevPAR declines since 2H16, despite strong occupancies of over 90%. For example, RevPAR declined by 7.2% yoy in 1Q17. The weakness is attributed to the relative strength of the yen and the price sensitivity of the market, which resulted in a pullback in room rates.
• Looking ahead, the secular strength of the Japan market is expected to remain intact, and would be supported by i) the government’s aim for 40m foreign visitors by 2020F; ii) approval of integrated resorts; and iii) recent announcement to further relax visa requirements for Chinese tourists from May 2017. In the near term, we forecast a 2.5% yoy increase in NPI for FY17F, driven by a slight increase in RevPAR and a stronger Yen.

UK. 

• We project UK NPI to expand by 47.1% yoy in FY17F thanks to the acquisition of The Lowry Hotel. We expect contributions from Lowry would stream in from May onwards. While there is uncertainty from Brexit which could affect corporate demand, we think the weaker pound is likely to help tourist arrivals in 2017F. 
• On the balance sheet, we believe there could be NAV erosion risk due to the weakening of the GBP. We also note that the revenue mix of Hilton Cambridge City Centre is skewed towards the corporate segment, while the revenue mix of The Lowry Hotel is skewed towards the leisure segment.
• Healthy demand and rebranding & refurbishment of Hilton Cambridge bolstered RevPAR growth by 17.9% yoy in 1Q17. However, negative currency translation due to a weaker GBP resulted in a marginally lower NPI contribution.
• Notwithstanding Brexit, we deem that both the UK properties are highly stabilised, and we are modeling in steady profile from both assets. The flip-side, however, is that we do not expect growth from the assets as well.
• To manage its forex risks, CDREIT intends to hedge around 50% of its overseas income two quarters forward.

Risk to our call: further acquisition upside 

• We believe there could be upside risks to our estimates should CDREIT execute further DPU-accretive acquisitions. However, the trust’s relatively high leverage could limit the accretion.
• Post the acquisition of The Lowry Hotel, we expect CDREIT’s aggregate leverage to climb from 36.8% (as at 1Q17) to 39.1% in 2Q17F. Assuming a gearing limit of 40-42% – after which investors could start to raise concerns on balance sheet risks – we calculate that CDREIT would have c.S$40m-130m available debt headroom. Effectively, we believe that this dry powder could fund one more all debt-backed overseas acquisition, before the trust has to look at other sources of funding.
• Based on a scenario of CDREIT acquiring S$50m-150m of new assets and assuming 
  1. the new assets are fully debt funded at 2.5% interest costs (which is around the trust’s weighted average cost of debt); and 
  2. NPI entry yields of 5.0- 7.0%, 
  we estimate a 1-5.8% accretion to CDREIT’s FY17F pro-forma DPU.
• For CDREIT, a 1% accretion in DPU would translate into a 1% increase in our DDM-based TP. Hence, in the best case scenario, an accretive acquisition could bring up CDREIT’s target price to its current trading price.
• Aside from debt, we believe that the REIT could look at perpetual securities to fund acquisitions. However, we deem that DPU-accretion from perpetual securities (perps) could be marginal, given the higher cost of funding. In addition, issuance sizes of the perps are typically above S$100m. As such, CDREIT could experience some negative carry if it is not able to match the issuance size with the acquisition quantum. 
• One of the positives from issuing perps is that perps are treated as equity under accounting standards. Hence, the available debt headroom of CDREIT would subsequently be enlarged.

Acquisition targets 

• Given that we do not expect the sponsor’s 293-room boutique hotel, M Social Singapore, to stabilise in the near term, we believe that CDREIT would continue to look at opportunities in Europe (including the UK) and Japan. These are the markets in which the trust sees relative value and secular growth. 
• In addition, the attractive spread between property yield and onshore borrowing costs is another motivation, in our view.

Incorporating the acquisition of The Lowry Hotel 

• We take the opportunity to factor in the acquisition of The Lowry Hotel in Manchester, which was acquired on 04 May 2017 for £52.5m (S$94.1m) or 7.3% NPI yield. The total acquisition costs including stamp duty and fees were £53.8m (S$96.4m). The property is a purpose-built 5-star luxury hotel with 165 rooms (one of the two 5-star hotels in Manchester), and within proximity to many of the city’s key attractions. It has also undergone refurbishment in 2015 and 2016.
• Assuming onshore GBP-interest cost of c.2.5%, the manager estimates a 2.7% accretion to pro-forma FY16 DPU.
• We see several positives from the acquisition. 
  1. First, we like the diversification into Manchester. Greater Manchester is the second-largest economy in the UK after London. Its economy is relatively well-balanced across all sectors, and is less exposed to the financial sector, the industry most likely to be affected by the Brexit, in our view. 
  2. Second, we believe the hotel could be a beneficiary of a number of development and infrastructure projects which are in its vicinity. Examples include the Spinningfields and Victoria Station developments. There are also a number of ongoing large scale developments in the vicinity such as N.O.M.A (an £800m, 20-acre mixed-use development scheme) and the £1bn expansion of MediaCity UK (a 200-acre mixed-used property development with media organisations as principal tenants, such as BBC). 
  3. Third, the property is supported by both corporate and leisure demand. Manchester is home to two world-famous football clubs – Manchester United and Manchester City. The Manchester Arena is also one of the largest concert venues in Europe.
• Consequently, the revenue mix of the hotel is skewed slightly towards leisure vs. corporate. For Lowry, the corporate segment generally has a lower yield vs. leisure. In addition, there is not much observable seasonality through the quarters, though 1Q is typically a slower quarter.
• With the above-mentioned factors, international arrivals into Manchester grew by 20% yoy to 1.4m in 2016. Accordingly, the property recorded 6.9% yoy RevPAR growth in 2016. 
• Nonetheless, new supply over the next two years could be elevated, and cap RevPAR growth. As such, we have modeled in flat RevPAR over the next three years. Post-acquisition, we estimate that the UK operations would contribute 9.3% of the group’s FY18F NPI (FY16: 6.1%).

Valuation and recommendation 

Maintain Hold with a higher TP 

• Putting our analysis together, we forecast total returns of 0% on CDREIT and maintain Hold on the stock. 
• We hike up our DDM-based TP from S$1.42 to S$1.52 (implied FY18F yield of 7% and 0.98x FY17F P/BV), on the back of a sector-wide decrease in our Singapore discount rate and DPU forecast increases. 
• We raise our FY17-19F DPU by 4.9-5.5% as we factor in 
  1. the accretive acquisition of Lowry, 
  2. better-than-expected 1Q17 and 
  3. actualize our FY16 assumptions. 
  With these changes, we are now expecting growth, and no longer expecting a decline in FY17F DPU.
• From a relative valuation perspective, it appears to us that the Singapore hotel recovery story has been priced in, with CDREIT trading around its past 5-year forward dividend yield and P/BV historical means. 
• In addition, we note that the stock is the only hotel S-REIT which is trading above book value.

YEO Zhi Bin CIMB Research | LOCK Mun Yee CIMB Research | http://research.itradecimb.com/ 2017-06-12

CIMB Research SGX Stock Analyst Report HOLD Maintain HOLD 1.52 Up 1.420