Singapore Hospitality REITs - DBS Research 2020-12-01: Waiting For Lift-Off

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ASCOTT RESIDENCE TRUST (SGX:HMN) FAR EAST HOSPITALITY TRUST (SGX:Q5T) CDL HOSPITALITY TRUSTS (SGX:J85) FRASERS HOSPITALITY TRUST (SGX:ACV)

Singapore Hospitality REITs - Waiting For Lift-Off

• Travel plans back on the cards in 2021; strong pent up demand from leisure to drive a “V-shaped” recovery.
• Some business travel disruption as companies adopt more virtual meetings but we expect most corporate travel should resume.
• Based on a 4-year normalization trend, we project hospitality S-REITs to post 4-year DPU CAGR of 17%-30%.
• Our picks are Ascott Residence Trust (SGX:HMN) and CDL Hospitality Trusts (SGX:J85) for their attractive valuations.

Travel revival on the cards

Travel rebound back on the cards.

• The hospitality sector has borne the brunt of the COVID-19 pandemic and we believe there are green shoots on the horizon. The recent encouraging results in the final trials of vaccine candidates with strong efficacy from Pfizer and Moderna is fueling optimism that travel will return sooner than originally thought. Therefore, while international air travel and hospitality is said to only fully recover in 2024 according to International Air Transport Association (IATA), we believe that the chance of an earlier than anticipated recovery is there and if so, the recovery will most likely be front-end loaded.

Pent-up demand for leisure travel while marginal business travel may be disrupted.

• We believe that the hospitality sector will likely emerge with a new face after the battle with COVID-19. With technology enabling virtual meetings through either Cisco Webex, Zoom and other conferencing platforms, we believe that businesses and employees have adjusted to this “new normal” of having virtual meetings replacing actual meetings to a certain degree.
• We anticipate that business travel of the future will be more focused and less frequent for the typical traveler who may drop selected trips (e.g. 1-2 business meetings) and replace them with virtual meetings due to cost savings. That said, we believe that that the bulk of corporate travel for meetings, incentive-travel, conventions and exhibitions (MICE) will most likely continue given that many aspects of business engagement, networking and interaction cannot be replicated or replaced.

Leisure travel – get me on the next flight out!

• Demand for leisure travel will likely remain robust with pent up demand from would-be holiday makers, as a holiday can never be replaced virtually. The catalyst for a return in leisure travel for the masses will likely hinge on the distribution of a vaccine, and we believe the return of mass travel will likely come in 2H21 onwards. When that happens, we believe it is important to consider how hotels will reposition themselves to capture this upside when it happens.

Where is the growth coming from?

Projecting a steady rebound in operating metrics.

• While we believe that 2021 brings much promise of a recovery for the sector, the growth trajectory will likely differ drastically between markets and hospitality asset types. Given that most governments will likely be more cautious and gradual in their plans to re-open their borders to allow international tourist arrivals post the mass distribution of a vaccine, the focus will be on domestic travel markets in the meantime.
• Countries like China, Japan, Europe, the USA and Australia with strong domestic market demand, should recover first. Destinations with a focus on international travel, like Singapore, while starting to re-open her borders in 4Q20 to selected countries, will most likely see a more lagged pace of recovery.

Domestic markets to lead the rebound.

• The hospitality S-REITs have diversified and invested in global hospitality markets and now have just c.40% of their portfolio exposed to assets from Singapore. In overseas markets, we note that that the S-REITs have c.53% exposure in “domestic markets” which we deem to have strong potential for a travel rebound come early 2021 and the majority of these overseas assets are in UK/Europe (16%), Australia (14%) and Japan (13%). These markets have seen domestic travel and flights restarting and thus, operational metrics (RevPAR, occupancy rates) will likely rebound back to pre-COVID levels earlier than Singapore.
• According to data from OAG, the number of seats on domestic flights in China have already exceeded pre-COVID levels by October, while hospitality players in their recent outlook guidance have also indicated that RevPAR has headed up towards 60%-70% of pre-COVID levels. If we use this as a guide on the potential trajectory in other domestic markets, we believe the outlook for other domestic markets can be equally bright as the pandemic gets under control.
• In this respect, Ascott Residence Trust (SGX:HMN) and Frasers Hospitality Trust (SGX:ACV) have the biggest exposure in these overseas domestic markets at 72% and 59% of asset exposure respectively. This is followed by CDL Hospitality Trusts (SGX:J85) and Far East Hospitality Trust (SGX:Q5T).

Singapore – a cautious relaxation of borders point towards a sustainable recovery

Singapore is re-opening her borders gradually.

• With the sector deriving 40% of assets from Singapore, the health of the Singapore hospitality market is key in driving earnings going forward. While there are many comparisons with the 2003 Severe Acute Respiratory Syndrome (SARS), the COVID-19 pandemic has been far more disruptive, and borders remained substantially closed 7 months after the first incidence of COVID-19 in Singapore.
• The impact of the COVID-19 pandemic on the hospitality industry has been far more protracted with a steep drop in RevPARs as average daily rates (ADRs) fell significantly. In fact, occupancies were supported by the Singapore government mandatory quarantine or stay-home-notice (SHN) at these facilities (including hotels) for returning citizens and workers during the pandemic.

Hospitality S-REITs outperformed market averages.

• Most hospitality S-REITs have managed their occupancies by participating in the quarantine business and also housing those workers who could not return to Malaysia. This has helped to buffer the drop in RevPAR to -25% to -60% during 2Q/3Q2020 despite border restrictions, outperforming the average 70%-80% plunge in the sector.
• With low to zero community cases coupled with single digit imported COVID-19 cases, the government’s quarantine business should be tapering off from 4Q20 onwards for most hotels. In the near term, alternative sources of business that hoteliers can rely on will be locals booking staycations (weekends and upcoming school holidays at end Nov-20 to Dec-20) and potential travelers from an increasing number of travel bubbles. That said, sources of demand in the near term is unlikely to compensate for the drop in the government quarantine business.

Filling up capacities in 2021 is the focus.

• Going forward, we expect the operational performance to further drop in 4Q20- 1Q21 before improving from 2Q21 onwards. The reason for this is excess capacities (supply > demand). On a positive note, this should be quickly absorbed with the potential formation of new travel bubbles with more countries with low COVID-19 cases. The re-opening of travel bubbles to key visitor source markets of China, Indonesia, Australia, India and Malaysia for leisure and business will be key to see a more meaningful rebound in operational metrics.
• With expectations of a mass distribution of a vaccine sometime in 2021, we remain optimistic on the accelerating growth momentum for the Singapore hospitality sector.

Supply growth is manageable.

• Supply of hotel rooms in Singapore is not a key issue in our view as the pandemic has delayed the construction pipeline. According to STB and Horwath HTL (as at end 2019), the supply pipeline over the next 3 years is manageable at less than a compounded annual growth rate (CAGR) of 0.8% up till 2023, while some of this could face further delays.

Key overseas markets.

• Key markets that are noteworthy include the likes of China, the USA, Europe/UK and Australia, which are at different phases of their own recovery from the COVID-19 pandemic. Given the respective countries large domestic travelling base, where flights have restarted, and in the case of China, we have seen a “V-shaped” recovery taking place.
• Selected countries like Japan are encouraging locals to tour their own backyard in the hope of restarting the tourism industry. This will be a near term driver for hotels’ operating metrics in the near term prior to the re-opening of the borders to international travel.

Revision of estimates and valuation for Singapore Hospitality REITs

Accelerating growth path.

• While the road back to pre-COVID levels may be a couple of years away, we are optimistic on the forward growth trajectory in distributions (or distribution per unit (DPU)) which should accelerate upon the mass distribution of a vaccine globally. We conservatively assume a 4-year trajectory to normalcy in our estimates (on front end loaded growth) but acknowledge that the timing remains fluid for now.
• We present three scenarios, with our base case assumptions of a 68%/89%/95%/100% catch up in RevPARs compared to pre-COVID levels in our models for the various hospitality S- REITs. Our assumptions are summarised in the table below.
• Based on our scenario analysis, most hospitality S-REITs would be able to exceed their pre-COVID-19 DPUs between 2023- 2024 (base case) while a stronger than anticipated recovery will see this happening a year earlier (bull case). In our bear case scenario, the hospitality S-REITs will only be able to achieve close to its pre-COVID RevPARs by 2024.

Market to price ahead a recovery.

• While we do not anticipate a quick rebound in DPUs in the immediate term, we believe the market will most likely price the stocks ahead of their recovery, with expectations that the approach towards pre- COVID-19 travel days is likely to be sooner rather than later.
• While share prices of hospitality S-REITs have increased by 15%-20% in the past weeks, the sector is still trading close to -1 to -2 standard deviation of the respective stock’s average historical level, which is attractive.

Close correlation to RevPAR growth.

• Based on historical share price performance for the hospitality sector, we have seen a close correlation between
  1. y-o-y changes in RevPAR and
  2. P/NAV multiples.
• In anticipation of a sustained rebound in RevPAR from 2021 onwards, we believe the sector can continue to re-rate.

Estimates and target price changes.

• We have refreshed our DPU estimates in accordance with our latest base case scenarios and have raised our target prices for
  • Ascott Residence Trust (SGX:HMN) to S$1.25,
  • CDL Hospitality Trusts (SGX:J85) to S$1.40,
  • Far East Hospitality Trust (SGX:Q5T) to S$0.70 and
  • Frasers Hospitality Trust (SGX:ACV) to S$0.70,
• implying total returns ranging 15% - 60%

Deep value play.

• While hospitality S-REITs tend to trade up together in a basket, we prefer Ascott Residence Trust (SGX:HMN) and CDL Hospitality Trusts (SGX:J85) for their global portfolios with varied demand drivers, followed by Far East Hospitality Trust (SGX:Q5T).
• We believe that a near term target should be - 0.5 standard deviation to -1.0 standard deviation of their respective P/NAV mean, which implies upside ranging 10% - 20% among our preferred hospitality S-REITs.

Book valuation risk priced in

Valuation deterioration priced in and unlikely to be as significant as feared.

• The significant cashflow disruptions will likely result in valuers re-evaluating their cashflow projections to support valuations and we expect downward pressure possibly to the tune of 10% come year end 2020.
• Frasers Hospitality Trust (SGX:ACV)’s latest valuation saw a dip of 3.5% in S$ terms (but c.5%-11% in local currency terms, with the biggest drop from Germany) as at Sept 2020. This in our view provides investors with a possible yardstick into how valuations may look like come their respective year ends in Dec 2020.
• Based on our estimated 5%-15% drop in hotel valuations, most hotel REITs are expected to see their gearing levels increase from the current c.39% to c.42%, with the exception of Far East Hospitality Trust (SGX:Q5T), with gearing possibly hitting 46% (on the assumption of a 15% drop in valuations).
• We believe that this scenario of a 20% decline in asset prices is unlikely given
  1. tight cap rates for transactions in Singapore (hotels are transacted at < 3% yield) and
  2. cashflows are not as severely impacted given the government quarantine business in 2020, while the gradual re-opening of borders will be positive for the local hospitality industry over time, and
  3. low interest rates which is supportive for cap rates to not expand significantly.

Derek TAN DBS Group Research | Geraldine WONG DBS Research | https://www.dbsvickers.com/ 2020-12-01

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