- Signs of global travel resumption are on the horizon. Easing global travel restrictions in mid-2021 bode well for a rebound in the hospitality sector.
- With exposure to key travel markets, Ascott Residence Trust’s recovery is expected to be strengthened by both domestic and international travel.
- We prefer Ascott’s perpetual bonds, which yield above 3%.
Company background
Ascott Residence Trust (ART) is the largest hospitality trust in the Asia Pacific with assets of S$7.2bn as at 31 December 2020. Its portfolio comprises 86 properties across 38 cities in 15 countries. These include serviced residences, business hotels, rental housing and co-living and student accommodation.
ART’s hotels are mostly operated under its Ascott The Residence, Somerset, Quest and Citadines brands. Third-party operators of its assets include Accor, Marriott and Sotetsu, operating under their established brands such as Pullman, Novotel, Courtyard, Sheraton and The Splaisir. Sponsor, The Ascott Limited, is wholly-owned by CapitaLand. ART is rated investment grade BBB by Fitch and was 41% owned by Temasek as at 1 March 2021.
Investment merits: exposure to global travel recovery
Travel bubbles are starting
In June 2021, major economies began announcing border reopening plans. The EU has lifted travel restrictions for 14 countries, including the US. It plans to roll out digital COVID certificates by July. The US has eased its travel recommendations on 110 countries, including Singapore and Japan. South Korea has expedited talks with Singapore and Taiwan to launch travel bubbles from July. China, Japan and South Korea have also started issuing COVID-19 certificates and vaccine passports. The International Air Transport Association expects personal and leisure travel to return from 2H21, which should revive the hospitality sector.
Exposure to large domestic travel markets
ART’s key markets include Australia (14.5% of assets), the US (12.3%) and China (6.8%). These markets have high domestic leisure travel demand, which is expected to pick up as state border restrictions subside in line with domestic vaccination rates. Australia was 23%, China 43% and US 53% vaccinated with at least one dose administered as at June 2021.
Liquidity can cover three years of operations
As at 31 March 2021, ART had S$1.2bn of available funds. These comprised S$360mn of cash, S$830 of credit facilities and net divestment proceeds pending receipt. They should cover 3 years of operations (FY20 operating expenses, interest and fees: S$250mn) in preparation of a full recovery of tourism sometime in 2023/24. Meanwhile, stable income from master leases – at 60% of FY20 gross profit – and ART’s average long stay of three months for properties under management are positive for its cash flows.
Comments
An easing of global travel restrictions is expected spark a strong rebound for the hospitality sector. A TripAdvisor survey in June 2021 suggests strong pent-up demand, with 77% of travellers expressing their likelihood of travel after vaccination. With exposure to key travel markets, ART’s recovery should be strengthened from both domestic and international travel.
We prefer ART’s perpetual bonds given their higher yields and potential capital gains. The trust’s ARTSP 3.07% perpetual bond will yield investors 8.66% if it gets called on 30 December 2021. Yields will be 3.13% if not called. Redemption on 30 December 2021 is at ART’s discretion. The trust’s ARTSP 3.88% perpetual bond is suitable for longer-term investment, with a 3.85% yield to call.
Indicative pricing for ART’s five outstanding bonds as at 1 July 2021 was:
- ARTSP 3.070% Perpetual Corp (S$) – ask price 97.35; yield to call 8.66%; yield to worst 3.13%; call date 30 December 2021; non-cumulative deferral; dividend stopper
- ARTSP 4.205% 23Nov2022 Corp (S$) – ask price 104.75; yield to maturity 0.75%
- ARTSP 3.523% 09Nov2023 Corp (S$) – ask price 105.15; yield to maturity 1.29%
- ARTSP 4.000% 22Mar2024 Corp (S$) – ask price 107.20; yield to maturity 1.29%
- ARTSP 3.880% Perpetual Corp (S$) – ask price 100.20; yield to call 3.78%; yield to worst 3.85%; call date 4 September 2024; non-cumulative deferral; dividend stopper
Risks
Contracts for isolation use and housing healthcare workers in Australia and the US are expected to end in 2Q21. However, contracts in Singapore will continue past June as they were rebooked by the government from May 2021.
More support for some master leases. ART has guided that it may still need to provide support for some of its master leases. Separately, it has issued a letter of demand to the master lessee of Park Hotel Clarke Quay for S$5.4mn owing and S$3.5mn of rent due as at 31 March 2021. ART has S$6.8mn worth of security deposits to mitigate any losses.
A slower-than-expected recovery in global demand or emergence of fresh waves of the virus may drag out the recovery for ART.
Appendix
Ascott Residence Trust’s business model
Master leases formed 60% of FY20 gross profit. ART has 35 operating properties on master leases: 17 in France, five in Germany, five in Japan, four in Australia, two in South Korea and two in Singapore. Rental income is earned from master lessees until their expiry. ART’s master leases in Germany are subject to annual rental revisions pegged to indices representing construction costs, inflation or commercial rental prices. In Australia, its leases are subject to annual indexation until their next market reviews. Master leases in Asia have fixed and variable rent components. Weighted average remaining tenure of ART’s master leases is about seven years. For master leases which were renewed in FY20, their weighted average lease expiry based on the commencement of the leases is around four years.
Management contracts formed 33%. ART has 45 properties on management contracts without minimum guaranteed income. These are signed with providers of property management services to ART. Unlike properties under master leases, guests lease the units directly from ART. Income is derived from room rates paid by the guests.
Management contracts with minimum guaranteed income of 7%. Four properties under such guaranteed minimum income contracts remain in Belgium, Spain and the UK. Under this type of contract, property operators guarantee a minimum income to ART over the term of their contracts. This helps to stabilise the income stream for ART in the event that the properties fail to generate the minimum income. Weighted average remaining term of these management contracts is around five years.
Properties
56 serviced residences, 18 hotels/business hotels, 11 rental housing and 1 student accommodation
Key markets by total assets are Japan 20.0%, Singapore 16.0%, Australia 14.5%, US 12.3%, France 7.4%, UK 6.8% and China 6.8%.
Customers
Short-stay guests. These comprise travellers staying one week or less to 12 months. They made up 80% of FY20 rental income excluding master leases and properties under development.
Long-stay guests. These include tenants with leases averaging more than one year. Long-stay guests made up 20% of rental income in FY20 excluding master leases and properties under development. Average length of stay for all properties on management contracts in FY20 was three months, the same compared to pre-pandemic times from 2017 to 2019.
Business travellers form a significant group of ART’s guests. They include relocating expatriates, staff on corporate assignments and project groups. Demand for corporate travel is driven by long-term macroeconomic factors such as GDP and FDI growth. Business travel is generally more stable than leisure travel which is more seasonal in nature.
Master lessees. They are undisclosed. Master leases made up 60% of FY20 gross profit.
Divestments
Divestments during pandemic were made at high valuations. ART divested three properties in March and May 2021 at 35%, 69% and 171% above book values. Its investment properties are valued by independent valuers every year or in the event of disposal. In FY20, ART managed to divest properties at 44%, 63% and 52% above book although its portfolio value dropped by 7%. Year 2000 to May 2021, ART had completed S$580mn of divestments. Of this, S$220mn or 38% was net gains. Divestments at significant premiums above book are beneficial not only to ART’s bottom line but also its bondholders as they increase the value and salability of ART’s assets.
1Q21 financials as at 31 March 2021
1Q21 RevPAU declined 47% YoY but rose 10% QoQ. Portfolio occupancy improved from mid-40% in 4Q20 to 50% on the back of stronger domestic leisure demand on weekends and during holidays as well as a gradual pick up in corporate demand in March.
Gearing was 36.1% with S$1.9bn of debt headroom to the MAS limit of 50%. 12-month trailing interest cover was 2.1x. About 71% of its property value was unencumbered. ART had S$1.2bn of total available funds.
