• Ascott Residence Trust’s 1H20 DPU came in below our forecast. Market conditions appear soft at least in the near term given the challenges Ascott Residence Trust faces in securing fixed-rent terms for its expiring master leases. Management expects the worst to be over with q-o-q improvements beginning 3Q20.
• Ascott Residence Trust’s strong liquidity and diversified presence should tide it through this uneven recovery, as countries differ in their pace of re-opening.
• Downgrade to HOLD with a lower target price of S$0.98 (previously S$1.16) given the limited upside.
• Entry price: S$0.89.

Results Below Expectations; Downgrade to HOLD

• Ascott Residence Trust (SGX:HMN)'s results below expectations; downgrade to HOLD with target price of S$0.98, based on DDM (required rate of return: 7.5%, terminal growth: 1.8%).
• Ascott Residence Trust posted 1H20 DPU of 1.05 S cents (-69% y-o-y) representing 29% of our forecasts. 1H20 DPU mix comprised 1Q/2Q DPU (80%/20%). Ascott Residence Trust retained 15% (S$5m) of income available for distributions due to potential rental deferment/waiver amid ongoing negotiations, but also topped up distributions with S$5m from past divestment gains (ie S$115m balance in past-divestment reserves).
• Ascott Residence Trust's 1H20 revenue and gross profit were down 16% y-o-y and 28% y-o-y, due to absence of contributions from divested Ascott Raffles Place SG and Somerset West Lake Hanoi, as well as lower contributions from existing portfolio. These were partially offset by fresh contributions from Ascendas Hospitality Trust combination (completed in Dec 19) and newly acquired Quest Macquarie Park Sydney (Feb 20) and Citadines Connect Sydney (May 19).

Overall RevPAU Declined to S$70 (-52% Yoy)

• Ascott Residence Trust's portfolio occupancy declined 30ppt y-o-y to 50% in 1H20 (2Q20: 30%), which is still above breakeven levels, while ADR weakened by a lesser extent. 1H20 gross profit was supported by Master Leases (59% of gross profit) and management contracts with minimum guaranteed income (7% of gross profit), while management contracts (34% of gross profit) saw weaker demand for accommodation offset by additional contributions from six Ascendas Hospitality Trust properties in Australia.

Portfolio Weakness Across Markets, Although the Worst May be Over

• In local currency terms for 1H20, Ascott Residence Trust saw y-o-y declines in Australia RevPAU (-56%) from travel restrictions, China RevPAU (-34%) from weak demand, Japan (-68%) from absence of leisure/transient guests amid nationwide emergency, SG RevPAU (-25%) from lower ADR and occupancies, UK RevPAU (-92%) due to the lockdown, USA RevPAU (-59%) from absence of leisure/transient travellers, and Vietnam RevPAU (-38%) from weak corporate demand.
• Of the 21 properties temporarily closed at one point in 1H20, 12 have reopened and seven are scheduled to reopen in 3Q20.

Bright Spots in SG, China and Vietnam

• Despite SG revenue declining 19%, gross profit rose 17% y-o-y due to refund of maintenance and sinking funds, property tax rebates, lower staff costs from government wage support. SG performance will continue to ride on alternative business sources, including block-bookings by the government (eg Somerset LC, PHCQ, Citadines Mt. Sophia) for most of 3Q20, Stay-Home-Notice (eg Ascott Orchard), and Malaysians affected by business closures.
• Its China portfolio is expected to see resilience from long-stays and as domestic travel picks-up; management also noted hotel industry-wide occupancy in China has returned to 70th percentile of last year’s levels. Vietnam portfolio is expected to see resilience from its long-stay base.

Capital-cycling at Pre-COVID Prices

• Ascott Residence Trust is divesting Ascott Guangzhou and Citadines Didot Montparnasse Paris for Rmb780m (S$155m) in 1Q21 and EUR23.6m (S$36.4m) in 4Q20 respectively, which are 52% and 69% above their respective book values, providing a total of S$23.2m in net gains. Divesting Ascott Guangzhou would also have allowed Rmb85m in capex avoidance for a property which has been in operations for 12 years.

Renewal of Master Leases

• According to management, Ascott Residence Trust has one more master lease for a property in France that will be due in Dec 20 (ie not affecting 2020 performance) and another three master leases in 2021.
• During 1H20, the four expired French master leases could only be extended on variable rent terms for one year with effect from 25 Mar 20, while the three expired UK Management Contract Min. Guaranteed Income (MCMGI) was converted to management contracts for one year with effect from 1 May 20. This occurred contrary to management’s preference to put them on fixed leases depending on prevailing market conditions at time of renewal.

War Chest for Uncertain Times and Opportunities

• Management guided that it has sufficient liquidity reserves to cover two years of fixed costs. Ascott Residence Trust’s net gearing of 36.1% (+2.5ppt h-o-h) provides S$2b debt headroom, before breaching 50% leverage limits. Management believes there may be opportunities to acquire distressed assets in 2H20, and has seen more transactions coming from Europe and the US.

Outlook: Recovery Led by Domestic, Leisure, and Free Independent (FIT) Segments

• Management is encouraged that lockdowns are being lifted and saw a pick-up in wow travel data around end-June/early-July, suggesting the worst may be over for hoteliers. They expect a q-o-q recovery in 3Q/4Q20, and possibly one year for travel to return to pre-COVID-19 levels barring the resurgence of a second wave.
• Management also cited UNWTO statistics showing 97% y-o-y decline in April for international arrivals, and a 58- 78% y-o-y decline for FY20. Ascott Residence Trust’s geographically diversified presence places it in a good position to ride the uneven recovery, amid different re-opening schedules by countries.

Ascott Residence Trust - Valuation & Recommendation

Earnings trimmed for 2020-22.

• We reduce our existing 2020/21/22 DPUs by 24%/36%/14%, factoring in steeper 2020 RevPAR declines of between 21% to 68% (vs 43% previously), and 2021/22 recovery of 50%.
• Downgrade Ascott Residence Trust to HOLD given the limited upside with a lower target price of S$0.98 (previously: S$1.16). Our valuation is based on DDM (required return: 7.5% and terminal growth of 1.8%).
• Share price catalyst: positive newsflow on hotel room rates and occupancy, and tourist arrivals.

Source: UOB Kay Hian Research - 29 Jul 2020