Ascott Residence Trust - DBS Research 2019-07-04: A Whole New World

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ASCOTT RESIDENCE TRUST (SGX:A68U)

Ascott Residence Trust - A Whole New World

• Merger of ASCOTT RESIDENCE TRUST (SGX:A68U) and ASCENDAS HOSPITALITY TRUST (SGX:Q1P) via Ascott Residence Trust offering S$1.0868 for each Ascendas Hospitality Trust unit.
• DPU accretive transaction with greater scale and diversification; benefits to accrue to both sets of unitholders.
• Potential index inclusion post-merger may trigger further re-rating.
• BUY; Target Price lifted to S$1.45 after pricing in recent Sydney hotel acquisition and lower interest rates.

Just the beginning.

• We maintain our BUY call on ASCOTT RESIDENCE TRUST (SGX:A68U) with a revised Target Price of S$1.45.
• In our previous reports (see: Ascott Residence Trust - Delivering Is Believing), we expressed that as management enacts value maximising initiatives, investors will begin to recognise the conservative valuation of Ascott Residence Trust’s portfolio, which would lead to a re-rating of the share price and the stock trading closer to book value. While this has played out, we believe Ascott Residence Trust has yet to fully maximise the value of its portfolio, thus there is still potential for Ascott Residence Trust’s share price to rally further.

Where we differ – Ability to crystallise book value.

• Consensus has a Target Price of S$1.29 which implies a HOLD call. This is largely due to its disappointing historical DPU performance. However, we believe the critical factor that would drive Ascott Residence Trust’s share price is the trust’s more aggressive execution in the past year of selling properties with limited growth potential and recycling the proceeds into better-yielding assets.
• This strategy of “love your assets but loving profits more” has seen Ascott Residence Trust selling its properties above book value, and at the same time reduced its reliance on equity raising to drive growth. This warrants Ascott Residence Trust to trade above its book value as implied in our S$1.45 Target Price.

Transformative merger with Ascendas Hospitality Trust (ASCHT).

• We believe the proposed merger with Ascendas Hospitality Trust creating a top ten S-REIT should result in Ascott Residence Trust being added to major property indexes, triggering a re-rating. The merger will also form a stronger platform to pursue DPU accretive acquisitions which should attract greater investor interest.

WHAT’S NEW - Transformative merger

ART to acquire ASCHT for S$1.0868 per unit

• Ascott Residence Trust and Ascendas Hospitality Trust announced a merger between the two trusts to create the largest hospitality trust in the Asia Pacific and eighth largest globally. The enlarged Ascott Residence Trust will also become the tenth largest S-REIT. Total assets under management for Ascott Residence Trust will increase by a third to S$7.6bn from S$5.7bn.
• By way of a trust scheme of arrangement, Ascott Residence Trust will acquire Ascendas Hospitality Trust’s units for S$1.0868 per unit comprising S$0.0543 in cash and 0.7942 Ascott Residence Trust units at a price of S$1.30. This compares against Ascendas Hospitality Trust’s closing price of S$0.975 before the announcement and NAV per unit of S$1.02. Ascott Residence Trust’s pre-announcement price was S$1.31.
• The consideration is based on a gross exchange ratio of 0.836, based on Ascendas Hospitality Trust and Ascott Residence Trust’s audited NAV per unit which stood at S$1.02 and S$1.22 respectively as at 31 March 2019.
• Based on Ascott Residence Trust’s calculations, they estimate a 2.5% accretion to Ascott Residence Trust’s proforma DPU with a neutral impact on its NAV per unit. For Ascendas Hospitality Trust, the transaction is expected to be 1.8% accretive to its proforma DPU.
• Post-merger, earnings from developed markets is expected to increase to c.82% which should facilitate a potential inclusion of Ascott Residence Trust into the FSTE EPRA NAREIT Developed Index. This may result in greater investor interest, higher trading liquidity and compression in trading yields. Currently, 75% and 100% of Ascott Residence Trust’s and Ascendas Hospitality Trust’s EBITDA are from developed markets. In addition, Ascott Residence Trust’s free float is expected to increase from c.S$1.6bn to S$2.4bn which is above the S$1.7bn threshold for index inclusion.
• Proforma gearing is expected to settle around 36.9%, which provides c.S$1bn of debt headroom assuming 45% gearing. As at 31 March 2019, Ascott Residence Trust’s and Ascendas Hospitality Trust’s gearing stood at 35.7% and 33.2% respectively.
• In terms of timeline, the proposed merger is expected to be completed in December 2019, with Ascott Residence Trust and Ascendas Hospitality Trust’s EGM’s to be held in October 2019.

Our thoughts

• Given the overlap in investment mandates post the merger of Ascott Residence Trust and Ascendas Hospitality Trust’s Sponsor CapitaLand (SGX:C31) and Ascendas-Singbridge, a merger between the two trusts has long been speculated by various market participants and we have previously written about this potential merger. Thus, this announcement is not a surprise, although the timing was earlier than expected.
• Generally, we are positive on the merger between the two entities to build scale and gain greater investor interest via inclusion into the FSTE EPRA NAREIT Developed Index. In our recent S-REIT report (see Singapore REITs - A Premium For Your Assurance), we had highlighted that Ascott Residence Trust was one of the S-REITs on the cusp of index inclusion. Ascott Residence Trust had to potentially increase its free float market cap by another S$130-150m to gain index inclusion.
• However, with close to 50% of Ascendas Hospitality Trust’s earnings derived from Sydney and Melbourne, both of which are facing supply pressures over the next few years, and Ascott Residence Trust increasing exposure to a weak AUD (exposure to Australia increases to 18% from 9%), there may be some push back from some investors on Ascott Residence Trust’s acquisition of Ascendas Hospitality Trust at this point in time.
• Mitigating this risk is increased exposure to Japan (18% versus 13% previously) which is expected to benefit from a structural growth in tourism arrivals. Near term, the Japanese portfolio should benefit from the Rugby World cup this year and the 2020 Tokyo Olympics. Furthermore, for Australian portfolio, there is structural growth in demand from a potential uplift in Chinese visitors. In 2018, Australia only received 1.4m Chinese tourists which is significantly lower than 3.4m, 4.8m and 8.4m Chinese visitors that Singapore, South Korea and Japan receive currently.
• Furthermore, Ascendas Hospitality Trust’s earnings are currently understated as it is yet to complete the acquisition of Aurora Melbourne Central. Ascendas Hospitality Trust had entered into a forward purchase agreement in 2015 to acquire the 252-unit service apartment at the end of 2019 for A$120m.
• Moreover, in the medium term with the majority of hotel management contracts for Ascendas Hospitality Trust’s Australian hotels set to be renewed in 2022, there may be potential for Ascott Residence Trust to renegotiate better terms or initiate AEIs to drive earnings higher.

Raising FY19-20F after incorporating recent acquisition of Sydney hotel, and lower borrowing costs

• In April, Ascott Residence Trust announced the acquisition of Felix Hotel, a prime freehold limited-service business hotel located near Sydney Airport for A$60.6m (S$58.8m). This implies an EBITDA yield of over 6% and A$404,000 per key. The 150-room property is expected to be rebranded into a Citadines Connect Sydney Airport property.
• After incorporating this acquisition and lowering our borrowing costs to better reflect expectations of rate cuts by the US Federal Reserve, we raised our FY19- 21F DPU by 1-5%.
• Furthermore, in an environment of lower interest rates for longer, we now assume 2.5% risk free rate versus 3.0% previously. We also lowered our cost of debt to 2.75%, down from 3.0%. This leads us to raise our DCF-based Target Price to S$1.45 from S$1.35.

Maintain BUY with revised Target Price of S$1.45

• With 13% capital upside and upcoming catalyst of index inclusion post the merger of Ascott Residence Trust and Ascendas Hospitality Trust, we maintain our BUY call on Ascott Residence Trust with a revised Target Price of S$1.45.
• We believe Ascott Residence Trust deserves to trade a premium to book as implied by our Target Price as Ascott Residence Trust enacts its asset recycling strategy of selling lower yielding assets or properties with limited growth prospects above book value and redeploying its proceeds into higher yielding or growth assets. An example of this could be the potential sale of Ascott Residence Trust’s Somerset Liang Court as part of the overall redevelopment of the Liang Court mixed development site.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2019-07-04

SGX Stock Analyst Report BUY MAINTAIN BUY 1.45 UP 1.350