ARA US Hospitality Trust - UOB Kay Hian 2020-04-16: A Hotelier’s Nightmare, But Stay Invested

ARA US HOSPITALITY TRUST (SGX:XZL)

ARA US Hospitality Trust - A Hotelier’s Nightmare, But Stay Invested

With the escalation of COVID-19 in the US, ARA US Hospitality Trust (SGX:XZL) has seen its occupancy slashed to one-third the level last year. The portfolio is facing significant cancellations and declining new reservations.
Management has tabled plans to trim staff, cut services, and consolidate operations to conserve cash.
Looking beyond 2020, ARA US Hospitality Trust (SGX:XZL) will still offer an attractive 2021 yield of 14%, despite our earnings cut (and 49% ytd price correction).

The US has become the new epicenter of the coronavirus pandemic ever since a national emergency was declared on 13 Mar 20. We spoke with management to gain insights into their operating strategies (ie sales and marketing, cost management and cash preservation) and outlook, amid reduced travel demand.
Due to fluidity of the situation, several US-listed lodging REITs have also withdrawn their prior 2020 guidance.

Along with the entire US hotel industry, ARA US Hospitality Trust has had significant booking cancelations, which drops each month out (eg May, June, July), as travellers are unsure as to how long the situation will last. Group travel (c.16% of 2018 occupied room-nights) was quick in seeing cancellations due to the need for social-distancing. Corporates (transient and group) also started to see cancellations, as companies observe “duty of care” provisions for employees to shield themselves from potential lawsuits and liability.
Overall portfolio occupancy in late-March (eg 20s%) was about one-third the usual level, as compared to that in the same period last year.
Management expects travel to slow substantially, with various federal/state efforts to flatten the curve of COVID-19 cases. Due to the timing of the outbreak, the impact would be felt most acutely in the second and (possibly) third quarters of 2020. These are seasonally strong periods, and made up 27%/26.7% of room-nights sold in 2019 respectively.

Management has been consolidating operations, reallocating labour working-hours and pausing sales-and-marketing campaigns. Discounting ADRs will not be appropriate, as the group has to maintain their positioning vs economy hotels, and strive for RevPAR to at least break even.
Management is making targeted efforts to raise occupancy by attracting other target segments (eg travelling doctors and nurses), which may see improved demand in certain locations.

Assuming acquisition of the three branded Marriot hotels was completed on 31 Dec 19, pro-forma 4Q19 gearing would be 38.2%.
On estimates, ARA US Hospitality Trust's hotel valuations will have to decline at least 15% before equity fund-raising is needed (not to breach 45% MAS leverage limits). A devaluation of such magnitude is unlikely.
So far, our channel checks suggest that most valuers are likely to keep their cap rates unchanged due to the lack of transactions in the current environment. They also take a longer-term view, and are only expecting a one-year 2020 dip in hotel earnings.

ARA US Hospitality Trust’s greatest cost component is labour. Since none of its hotels are unionised, the group has flexibility in reducing labour hours and staffing (eg housekeeping) along with reduced occupancy.
Due to the crisis, management has cut back on many of its typical services (eg complimentary buffet breakfasts, shuttle van services), and reduced daily house-keeping to minimise touchpoints with guests and their belongings. The staffing model has also been trimmed down, and managers are required to take on shifts. At this modified service level, management guided that their breakeven occupancy is closer to the 25-30% level depending on location and the market (vs 45% level during normal times).

In terms of recovery, management opined that transient travel will rebound the sharpest, benefitting select-service segments, while group demand will be the slowest to ramp up. They also expect travel in smaller cities to rebound quicker due to the absence of COVID-19 cases, while gateway cities (eg New York) may take a longer time to regain confidence.

ARA US Hospitality Trust had US$45.2m on hand at end-19, and no scheduled debt maturities in 2020 (with earliest loan maturity in Jan 23). Management is conserving cash by:
1. reducing operating expenses,
2. deferring and extending payments, and
3. allotting reduced capex (ie S$7.1m from listing date to end-Dec 19) to only critical items.
As a precautionary measure, management has also drawn down a revolving credit facility. There are also various federal and state government stimulus programmes which come in the form of debt to provide for working capital.
ARA US Hospitality Trust has so far not announced any changes to its distribution policy, which is to distribute 100% of its distributable income in 2020 (and at least 90% thereafter). However, many of its US lodging peers (eg Apple Hospitality REIT, Pebblebrook Hotel Trust, Park Hotels & Resorts, and Ryman Hospitality Properties) have reduced/suspended their distribution plans to conserve cash.

We slashed our 2020F, 2021F and 2022F DPUs by 65%, 17%, and 17% respectively due to dampened travel demand from:
1. COVID-19 travel restrictions, and
2. weaker real GDP growth outlook.
For 2020F, we expect at least six months of subdued occupancies before a recovery in 4Q20. The UOB Global Economic and Market Research team is also expecting US real GDP growth to contract by 4.1% for 2020.

Our base case assumes occupancies stay subdued (eg 20s%) for at least 2Q-3Q20, before recovering to the 60th/90th percentiles of pre- COVID 2019 trading levels in 4Q20 and 2021 respectively. We also factor in softer room rates with 5%/3.5% y-o-y declines in 2020/21.
Despite the earnings cuts, we can still expect a 2021 DPU yield of 14%.
Maintain BUY on valuation grounds, but lower target price to S$0.70 (from S$1.25).
See ARA US Hospitality Trust Share Price; ARA US Hospitality Trust Target Price; ARA US Hospitality Trust Analyst Reports; ARA US Hospitality Trust Dividend History; ARA US Hospitality Trust Announcements; ARA US Hospitality Trust Latest News.

Peihao LOKE UOB Kay Hian Research | Jonathan KOH CFA UOB Kay Hian | https://research.uobkayhian.com/ 2020-04-16

SGX Stock Analyst Report BUY MAINTAIN BUY 0.70 DOWN 1.250