• US lodging REITs have rallied on re-opening optimism and seven consecutive weeks of rising occupancies. ARA US Hospitality Trust's management noted that a swift recovery would be dependent on corporate demand returning by late-summer (Aug 20), which will allow for better pricing optimisation and yielding-up.
• The outlook continues to be challenging as management navigates the full re-opening of the remaining 11 hotels by mid-summer.
• Maintain BUY on valuation grounds with a lower target price of S$0.69.

US Hotel Stocks Have Rallied on Re-opening Optimism

• US hotel stocks have rallied on re-opening optimism, as well as better-than-expected US non-farm payrolls (2.5m jobs addition) and unemployment rate (13.3%) in May 20. Bouncing off Mar 20 lows, several US listed peers have seen gains between +151% to 183% to-date. ARA US Hospitality Trust's share price recovery-to-date (+38%) has lagged, and is significantly behind that of Ryman Hospitality (+183%) and Summit Hotel (+169%).
• As US hoteliers navigate their re-opening plans, we spoke to ARA US Hospitality Trust (SGX:XZL)’s management on their expected recovery trajectory (ie rates, occupancy) and operating strategies (ie cleanliness, social-distancing) in a post-pandemic world.

STR Data Points to Green Shoots

• ARA US Hospitality Trust cited positive STR data points showing a slow, gradual rise in US hotel weekly occupancy after mid-Apr 20. Although Weekly RevPAR remains negative, the y-o-y declines appear to be less steep going into May (-74.4%/ -73.6%/ - 69.9%/ -62.1% y-o-y). We also entered into a seventh consecutive week (24-30 May 20) of higher demand and occupancy.

How US Hotels’ Potential Recovery Could Pan Out

• Management opined that essential workers (eg the National Guard, airlines, construction, cargo crews) continued to provide a base level of business during the pandemic season, making up “10%s” of nationwide occupancy. Any demand pick-up in the recent weeks has been coming from the domestic, transient leisure segment, which can be observed from the demand spike over the weekends at ARA US Hospitality Trust’s portfolio of hotels.
• Management noted that this pent-up demand came from individuals, couples, and families going on mini-road trips and visiting friends, after months of staying at home. By late-summer (Aug 20), management expects transient corporate travel to return, forming a second layer of demand.
• As for group demand, management expects demand to return in the form of corporate travel (albeit with smaller group sizes). Finally, the convention business (100-200 guests) is expected to see the slowest revival, taking more than a year to recover, in their view.

ARA US Hospitality Trust Is Well-positioned to Benefit From Early Days of a Demand Comeback

• ARA US Hospitality Trust is well-positioned to benefit from early days of a demand comeback, due to its transient-guest orientation (c.82% of 2018 occupied room-nights), drive-to locations in secondary markets, and small room inventories (averaging 130 rooms/hotel).
• According to expert opinions on Hotel News Now (affiliate of STR), drive-to leisure is leading the early days of a demand comeback, given the expanding scope of “drive-to” leisure with more people willing to drive further. The reliance on drive-to demand is expected to be the new normal, as switching to the “new version” of air travel may take some time.
• Our channel checks with other industry insiders also suggest a domestic-led recovery in demand, which will benefit secondary markets more than gateway cities (ie which serve a higher proportion of international guests). Although countries are setting up “green lanes” and “travel bubbles“, the challenges would lie in trust - as governments will need to trust other countries before allowing their travelers in (at same time protecting their own citizens).
• Finally, ARA US Hospitality Trust’s smaller hotel room inventories (average of 130rooms/hotel) are also easier to fill, before pricing power comes back.

A Swift RevPAR Recovery Is Dependent on Corporate Demand Returning by Late-summer (Aug 20)

• Management expects their second quarter to be the weakest, but their third quarter to come in stronger than both the first and second. Although transient leisure demand is returning, they foresee a favourable shift in pricing dynamic only when corporate demand returns (estimated sometime in late summer).
• Management sees having multiple demand layers as a means to charge at different price points, and yield up. The third quarter is also seasonally strong (ie with portfolio occupancies in the 80-90s% last year) which can allow for better pricing once available rooms become scarce. Management further explained that once occupancy passes certain thresholds, pricing of remaining rooms will also improve to substantially higher rates.

All 30 Temporarily-closed Hotels to Fully Re-open by Mid-summer (Jul 20)

• To-date, 19 hotels have re-opened. Management targets to open the remaining nine by end-Jun 20, and possibly the last two in Jul 20. The re-opening process remains fluid, with management holding weekly conversations with hotel managers to evaluate on the ground-conditions (eg booking pace, travel patterns, air-traffic, changing regulations).

Hotel Cleanliness: An Emerging Theme, Not Necessarily at a Higher Cost

• Management underlined the importance of hotel cleanliness in a post-pandemic world, which will entail more enhanced cleaning and higher labour costs. However, management is also looking at taking out extra amenities (eg door tags, extra pillows) to reduce the number of touchpoints, and improve efficiency.
• Management has also advocated reduced cleaning frequency for stay-over guests. Some of these offsetting changes make it hard to gauge the underlying impact to bottom-line.

Maintain BUY

• We lower our ARA US Hospitality Trust's 2020F DPU by 35%, factoring in higher fixed expenses.
• Maintain BUY on valuation grounds; with lower target price of S$0.69 (previously S$0.70). Our valuation is based on DDM (required rate of return: 9.5%, terminal growth: 1.0%).
• Share price catalyst: lifting of travel restrictions, and reduction in infection rates of COVID-19 in the US.

Source: UOB Kay Hian Research - 12 Jun 2020