Eagle Hospitality Trust - KGI Securities 2019-10-02: Rock Bottom Valuations; Bound To Soar

EAGLE HOSPITALITY TRUST (SGX:LIW) | SGinvestors.io EAGLE HOSPITALITY TRUST (SGX:LIW)

Eagle Hospitality Trust - Rock Bottom Valuations; Bound To Soar

  • Ripe for growth. EAGLE HOSPITALITY TRUST (SGX:LIW)’s IPO portfolio ticks many boxes; well-positioned in prime submarkets, recently refurbished, actively managed, and diversified for revenue resilience.
  • A favourable balance between stability and growth. We like that the 100% master lease arrangement fixes majority (66%) of rents through a revenue floor, while allowing variable upside should assets outperform.
  • Double digit dividend yield play. We initiate coverage on Eagle Hospitality Trust with an Outperform recommendation and 12m target price of 84 US cts.



Eagle Hospitality Trust Overview


US Hospitality REIT with a focus on full-service hotels.

  • Eagle Hospitality Trust is a US-based hospitality REIT listed on the Singapore Stock Exchange with a primary focus on full-service hotels.
  • The REIT manager seeks to capture value and sustainable shareholder returns via a three-pronged approach:
    1. Proactive asset management and asset enhancement strategy
    2. Investments and acquisition growth strategy
    3. Capital management strategy.

Property Portfolio.

  • Eagle Hospitality Trust’s initial IPO portfolio consist of 18 full-service hotel properties located across 8 US states. The portfolio was valued at approximately US$1.27bn, with a total room count of 5,240. Each hotel primarily relies on three key revenue drivers – corporate demand, leisure demand, and airport demand.
  • The initial IPO portfolio was created from the amalgamation of two separate portfolios – the USHI portfolio and the ASAP6 portfolio. The USHI portfolio consist of 12 assets that were directly managed by Eagle Hospitality Trust’s sponsor, Urban Commons, and equally held by the founders of Urban Commons – Howard Wu and Taylor Woods. The ASAP6 Portfolio was acquired from a third party prior to the listing date and comprise of the remaining 6 assets.
  • As a characteristic of full-service hotel assets, Eagle Hospitality Trust derives revenue from services and amenities. Room revenue makes up two-third of Eagle Hospitality Trust’s revenue stream, with the remaining revenue streams being F&B revenue, carpark revenue and events revenue. We understand that bulk of non-room revenue can be traced back to event revenue from Queen Mary Ship and ticketing revenue from the Lagoon Waterpark within Holiday Inn Resort Orlando Suites.
  • Majority (93.6%) of hotel assets are branded by the top 3 global hotel franchisors by number of room keys – IHG (41%), Marriott (29%) and Hilton (24%). These brands share a total of 302 million loyalty members worldwide. Eagle Hospitality Trust can tap on existing loyalty programmes attached to these global hotel franchisors to attract hotel visitors, apart from online travel agencies which usually charge a commission premium.
  • All assets are leased under a master lease agreement with a fixed base and a variable component that is pegged to gross operating revenue and gross operating profit. According to management’s forecast, fixed rent will represent 66% of Eagle Hospitality Trust’s total rent in FY20F. This allows stability and visibility of future rental income stream, while allowing unitholders to gain from the variable component should the assets outperform expectations. Each master lease agreement is set at an initial term of 20 years, with an option to extend for another 14 years (Californian assets) and 20 years (assets located out of California). A third party hotel management company is responsible for day-to-day operations of all assets held by Eagle Hospitality Trust with 2% of annual revenue as remuneration.

Capital Management.

  • All of Eagle Hospitality Trust’s loans are denominated in USD, lowering operational forex risk. The vast majority (93%) of borrowings are on a fixed rate basis, with an average debt maturity of 4.2 years. Eagle Hospitality Trust recently entered into an interest rate swap in 1 July 2019 to mitigate interest rate on c.75% of borrowings, resulting in cost savings of c.US$1.36mn per annum. The cost savings in interest rate will like flow through to the income statement in the coming quarter (3Q19).
  • We note that Eagle Hospitality Trust’s all-in cost of debt (3.9%) reported in the most recent quarter was c.220 bps above the 10-year risk free rate and may pose as a catalyst should Eagle Hospitality Trust be able to refinance before maturity at a lower rate. At the current leverage ratio of 38.0%, Eagle Hospitality Trust has a debt headroom of c. US$170mn pegged to the current regulatory gearing limit of 45%.

Eagle Hospitality Trust's sponsor – Urban Commons

  • The Sponsor of Eagle Hospitality Trust is Urban Commons, LLC, a privately-held real estate investment and development firm based in Los Angeles. Urban Commons was co-founded by Howard Wu and Taylor Woods in 2008, who are the Chairman and Deputy Chairman of the Managers respectively. The Sponsor also currently manages and/or owns numerous properties under various stages of entitlement and development, spanning hospitality, multifamily, retail and assisted living, valued in excess of US$800 million upon completion.


Primarily freehold hotels located in prime submarkets


Primarily freehold status.

  • Eagle Hospitality Trust’s initial IPO portfolio was an amalgamation of two separately held investment portfolios, namely, the USHI portfolio and the ASAP6 portfolio.
  • The USHI portfolio, which consists of 12 hotels, was previously managed by Urban Commons, a privately-held real estate investment and development firm and also, the sponsor of Eagle Hospitality Trust. The ASAP6 portfolio, which consists of the remaining 6 hotels, was previously indirectly held by the co-founders of Urban Commons and directors of Eagle Hospitality Trust, Howard Wu and Taylor Woods in equal equity proportions.
  • The initial IPO portfolio includes 18 hotels with a total valuation of US$1.27bn spread across 5,420 room keys. All hotels are positioned as full-service hotels offering a wide array of services and on-site facilities. All but one of Eagle Hospitality Trust’s 18 assets are freehold, with the only exception being the Queen Mary Long Beach, which has a remaining lease tenure of c.63 years.

Well-positioned in prime submarkets.

  • 11 out of Eagle Hospitality Trust’s 18 assets are located in the top 10 US markets based on Metropolitan statistical areas (MSAs) ranking, with only one asset that is not within the top 30 markets. The MSA ranking lays out the most populated urbanized area within the United States, signifying continuing geographical importance set by high density of human population above national average. Consistent with MSA rankings, 12 out of 18 assets held by Eagle Hospitality Trust are located within the top 10 states within the US by percentage contribution to GDP (2018 ranking). 7 out of 18 assets, representing 34.1% of Eagle Hospitality Trust’s total room count are located within California, the single biggest US state which contributed 14.5% to the total GDP in US last year.


Revenue diversification with in-built stability.


Master lease structure with long residual tenures.

  • All of Eagle Hospitality Trust’s assets are structured as a master lease agreement with a fixed rent floor and a variable rental component that is based on a percentage of gross operating revenue (GOR) and gross operating profit (GOP) above the fixed component. Each master lease agreement is set at an initial term of 20 years, with an option to extend for another 14 years (Californian assets) and 20 years (assets located out of California). All contracts were signed as of listing date this financial year, ensuing long residual lease tenures across Eagle Hospitality Trust’s entire portfolio.
  • The Queen Mary Ship is the only asset held under a 66-year leasehold arrangement, starting from 1 Nov 16. The asset is the only one within the portfolio that is operating on a triple-net lease structure, whereby the tenants will be responsible for all taxes, insurance and maintenance for the daily operations of the asset.

Approximately two-thirds of rent revenue fixed.

  • Based on management’s projections, the fixed portion of the master lease arrangement is expected to contribute 75%, 66% and 65.6% of total room revenue in FY19F, FY20F and FY21F. This is primarily driven by an expected increase in RevPAR across all assets following the intensive asset enhancement initiatives that took place through FY18 to 3M19. RevPAR is expected to grow at a CAGR in the range of -0.2% to 14.0% from FY16 to FY20F across all 18 assets, with the outperformers being the Holiday Inn Orlando Suites (Waterpark) and Hilton Atlanta Northeast.
  • The fixed portion of the master lease agreements set a minimum revenue floor to room rents. Should a black swan event such as a US recession occur, top line risk is shared with the master lessee, as compared to a lease structure that is entirely variable. Only one of Eagle Hospitality Trust’s asset, the Queen Mary Ship has an annual rental escalation of 2% per annum built within its fixed lease structure. According to our sensitivity analysis, a 6% increase in average occupancy will translate to a USD4.7mn rise in total revenue attributable to Eagle Hospitality Trust to US$93.1mn.

Revenue stream diversification.

  • As a characteristic of full-service hotels, Eagle Hospitality Trust derives revenue from services and amenities. Room revenue made up two-third of Eagle Hospitality Trust’s revenue stream in the latest reported 2Q19 results, with the remaining revenue streams derived through F&B revenue, carpark revenue and events revenue. Bulk of non-room revenue can be traced back to two amenity-rich assets – the Queen Mary Ship and Lagoon Waterpark within Holiday Inn Resort Orlando Suites.
  • The Queen Mary ship is a retired British Ocean Liner parked alongside Long Beach, California. The property is one of the key tourist attractions along Long Beach, California and is famous for its rich history and paranormal activities. Eagle Hospitality Trust owns the Queen Mary ship and the land title rights to 45 acres of land parallel to the ship. Eagle Hospitality Trust is entitled to a cut on numerous revenue streams generated by the Queen Mary ship, including carpark fees from 1,600 open-air parking spaces, tourist attraction room rental fees and event fees. Eagle Hospitality Trust secured a contract with Golden voice, one of the largest concert promoters in the world, worth at least US$1.25mn yearly with additional fees payables according to number of events held. Management expects 10 scheduled onshore concerts to be held in 2019, and 15 concerts in 2020, from 9-12 concert events held annually between 2016 and 2018. Eagle Hospitality Trust also leases a dome-structured terminal to Carnival Cruise Line and receive embarking fees from transferring passengers.
  • Holiday Inn Resort Orlando Suites has an on-site Lagoon Waterpark that offers seven slides, a splash zone and family pool areas. Revenue derived from the resort fees to the Lagoon Waterpark slide is levied onto each room night booked and is accounted for under Eagle Hospitality Trust’s miscellaneous revenue stream. The attraction will be launching a Halloween themed event in FY19F that will aim to attract greater traffic to the Lagoon Waterpark. Management expects the variable rent component for the asset to increase from US$3.4mn in FY19F to US$5.0mn in FY20F, assuming an 85% take up rate on resort fees to the waterpark.

Brand diversification.

  • Alongside the REIT manager’s rebranding efforts, 93.6% of Eagle Hospitality Trust’s portfolio rooms are branded after IHG (41%), Marriott (29%) and Hilton (24%). The backing of the three largest global hotel chain franchisors adds assurance of room quality and comfort. The large client base of these top three brands gives Eagle Hospitality Trust a combined client base of 302mn members worldwide, that may give Eagle Hospitality Trust hotels an edge over other hotels that fall out of these loyalty programmes. Commissions payable to the associated brand franchisees, in the range of 5%, are also more competitive if booked directly through the brand website as opposed as third party online travel agencies that may charge 3% more.

Market segment diversification with targeted demand drivers.

  • All assets within the initial portfolio are positioned as upper midscale, upscale or upper upscale full service hotels. The REIT managers believe that full service hotels tend to be less subjected to cyclical downturns as opposed to luxury hotels. Other demand drivers that may be unique to full service hotels include weddings and corporate functions that help to diversify downside risk away from room rental revenues. The midscale to upper upscale hotel segments in which most of Eagle Hospitality Trust’s asset fall under, also enjoy more attractive operating margins at c.32.0% to 39.4% in comparison with luxury hotels at c.30.4%. These segments are relatively more resilient to growing labour costs in the US as opposed to the luxury segment and insulated from price competition and substitutability from market players such as Airbnb and HomeAway.
  • All assets are also targeted at a specific end user group – Corporate (47.5%), Leisure (39.5%) and airport travellers (13.0%). Corporate demand continues to look bullish, riding on strong business sentiments and resilient corporate expenditure. Leisure demand continue to be supported by healthy consumer sentiments. The U.S. leading travel indicator which projects the future direction and pace of travel volume to and within the U.S. in the coming quarters expect domestic
  • travel to rise approximately 2.0% y-o-y through Jan 2020, with leisure contributing slightly more to the expansion than business. It is also comforting to know that Eagle Hospitality Trust’s exposure to international tourists remains low within the single digit range. International travellers make up just 8.1% (based on USHI asset’s guest profile in FY18), with the vast majority originating from Canada and Mexico. Majority of Eagle Hospitality Trust’s guest profiles are domestic travellers (91.9%), and demand remains largely well-shielded from trade war headwinds and outbound China tourism figures.
  • New airline contracts had also been recently secured for two out of the three airport hotels – Holiday Inn Hotel & Suites San Mateo and Four Points by Sheraton San Jose Airport. These airport hotels will benefit through booking priority with airlines for service crew and staff accommodation as well as emergency bookings relating to flight delays. Doubletree Hilton Salt Lake City may see some occupancy uplift through airline contracts in FY20F as the new Salt Lake City airport nears completion. The Phase 1 of the new airport will open in Sep 20 with Phase 2 scheduled for 2024,
  • A study by Expedia Group showed that, on average, travellers with Gen Alpha children take more than three family trips annually—most being domestic trips (68%). Most families place a high value in entertainment and happiness placing activities such as theme parks and attractions, water activities, and high outdoor activities within top consideration factors. Budget is also a primary factor for the majority (79%) of these family trips. Several of Eagle Hospitality Trust’s assets tick both these consideration criteria within the domestic leisure segment of travellers.


Rental upside from refurbishment and rebranding initiatives.

  • Eagle Hospitality Trust’s portfolio hotels are mostly between the ages of 35 to 40 years, with the youngest asset, The Westin Sacramento, completed in 2008. Significant capex of US$174mn was spent on primarily full refurbishments and major renovation works since 2013. This represents 14% of total portfolio valuation at listing date, with the vast majority (c. 59%) of asset enhancements completed in 2018, and another 25% completed in 1Q19.
  • Bulk of the capital expenditure was spent on the following 4 assets:

Holiday Inn Orlando Suites – Waterpark:

  • A US$27.5 million full-scale renovation from early 2015 to Aug 2018 to rebrand the hotel from a Nickelodeon-branded hotel to a Holiday Inn brand franchise; reduced impact of seasonality by broadening the customer base from having predominantly family and leisure segments to include group, tour and business travel segments

The Queen Mary Long Beach:

  • Sponsor collectively negotiated (with two other ground leases) with the City of Long Beach to include the adjacent land and water along the port of Long Beach; ensured early capital expenditure contributions of US$23.5 million from the City of Long Beach, to reopen and repurpose unutilised public and revenue-generating spaces, including restaurants and event venues, as well as perform structural works on the ship

Sheraton Pasadena:

  • A US$15.6 million full renovation of all guestrooms, meeting space, public spaces and the restaurant from May 2017 to Sep 2018; Renovation of exterior front porch was more recently completed in May 2019

Renaissance Denver Stapleton:

  • A US$16.8 million refurbishment programme between May 2017 and Sep 2018 comprising of all guestrooms, meeting space, the hotel lobby and restaurants were fully renovated; this enabled the hotel to secure a new airline contract (urban commons master lessee).
  • We see lower operational disruptions in our forecast period as most major works had been completed by May 2019. Management expects the growth in RevPAR for Forecast Period 2019 to be mainly driven by organic market growth, higher average daily room rates which will see flow through after enhancement initiatives, and contracts entered into with corporate clients and government agencies. Eagle Hospitality Trust’s portfolio average daily room rate is expected to increase from US$141.83 in FY19F to US$148.84 in FY20F, while average RevPAR is expected to increase from US$113.71 to US$116.93.
  • Eagle Hospitality Trust’s portfolio had generally performed well in comparison with the overall occupancy rates within the lodging market which hovered between 65.4% and 66.1% from 2016 – 2018.
  • Management expects a sharp pick up in occupancy from FY18 (74.7%) to FY19F (79.1%) following the completion of major renovation works in FY18.
  • Further AEI initiatives had been scheduled for an additional 6 assets with majority starting in FY19F, amounting to US$12.6mn. Future AEI had been shortlisted for the following 6 assets spread between 2019 and 2022. To ensure minimal operational disruption, the managers will be planning to commence renovations during periods of lower occupancy, which is usually in the last quarter of each calendar year.


Benchmark inclusion within the GPR/APREA Index may lift trading liquidity

  • Eagle Hospitality Trust announced the inclusion within the GPR/APREA Composite Index and the GPR/APREA Composite REIT Index on 5 Sep 2019. The GPR/APREA Composite Index is a free float weighted index based on shares of the leading Asia Pacific property companies and the GPR/APREA Composite REIT Index considers REITs subsector of the broader GPR/APREA Index. The benchmark inclusion will take effect at the start of trading on 23 Sep 2019 and allow the REIT greater visibility amongst global and institutional investors. This may further lift trading liquidity for Eagle Hospitality Trust, which had seen an average daily trading volume (historical 6 months) of S$2.0mn, on par with sector average (hospitality S-REITs).
  • The inclusion criteria includes minimum levels of market capitalization, free float, trading volume, amongst other factors. The GPR/APREA Composite Index has 421 constituents, representing a free float market capitalisation of US$711 billion. The GPR/APREA Composite REIT Index has 164 constituents, representing a free float market capitalisation of US$305 billion.
  • See SGX Market Update: Recent SGX Additions to FTSE EPRA Nareit Global Developed Index


Valuation


Revenues:

  • In line with management’s forecast, we expect total revenue to grow from US$77.6mn in FY19FF to US$88.4mn in FY20F. Fixed rent will make up 75% and 66% of our total room rental revenue forecast. Non-rental income associated with Eagle Hospitality Trust’s service and amenities segment is expected to remain at 8% of total rental income. This assumption remains conservative due to the likelihood of an increase in patronage at Queen Mary Ship in association to an increase number of events and concerts, as well as an upgrading of restaurants prior to 3M19 that would likely translate to more revenue.
  • On the flip side, several additional AEI works will involve renovations within the F&B spaces and public areas that may pose as an operational risk to the affected restaurants.

Operating Statistics:

  • Occupancy, average daily rate and RevPAR are all expected to increase in FY19F following the completion of major and minor enhancement works from FY18 to 3M19. Occupancy is expected to increase from 74.7% in FY18 to 79.1% in FY19F and subsequently stabilise at 77.7% in the following year. Focus would be to increase average daily rate to drive rental income growth as ADR is anticipated to increase from US$133.11 in FY18 to US$141.83/US$148.84 in FY19FF/FY20F.

Income available for distribution:

  • Factoring in a fair value change amounting to US$164mn in FY19F in line with management’s forecast, our income available for distribution at year end is US$37.3mn and US$57.6mn for FY20F.

DPU:

  • We derived a DPU of 4.3 US cts/ 6.5 US cts for FY19F/FY20F based on the forecasted distribution yield of 8.2% and 8.4% at listing date. This translates to FY19FF and FY20F dividend yield of 10.3% (annualised) and 9.6% based on yesterday’s closing price of 67.5 US cts.
  • See Eagle Hospitality Trust Dividend History.

Cost of Equity:

  • We used a cost of equity rate of 9.3% and a conservative terminal growth rate of 1.5%.


Peer Comparison






Geraldine Wong KGI Securities Research | Amirah Yusoff KGI Securities | https://www.kgieworld.sg/ 2019-10-02
SGX Stock Analyst Report OUTPERFORM INITIATE OUTPERFORM 0.84 SAME 0.84



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