Hospitality: Recovery Is Delayed But Not Derailed

Existing VTLs have been kept open although capacity will be scaled down by half starting 21 Jan 22. Singapore has to weather a new wave of Omicron variant infections in 1Q22. We expect the reopening of borders with expansion of capacity for existing VTLs and introduction of new VTLs to resume in 2H22. BUY ART (Target: S$1.29), CDREIT (Target: S$1.42) and FEHT (Target: S$0.74), which trade at discounts to NAV of 11%, 7% and 24% respectively. Maintain OVERWEIGHT.

WHAT’S NEW

Omicron variant less lethal than previously thought. Several studies have concluded that the Omicron variant is less likely to cause severe illnesses. A study in England published by UK’s Health Security Agency shows that a person infected with the Omicron variant is 50- 70% less likely to be hospitalised compared with those who caught the Delta variant. A study in Scotland published by University of Edinburgh shows that a person infected with the Omicron variant is two-thirds less likely to be hospitalised. The majority of those who succumbed to breakthrough infections or reinfections experienced mild symptoms.

Singapore’s borders remain open. The Singapore government has established quarantine-free vaccinated travel lanes (VTL) with 24 countries/regions, which accounted for 56% of visitor arrivals pre-COVID-19 during 2019. The existing VTLs by air and land remain quarantine-free and have been kept open, although capacity will be scaled down by half starting 21 Jan 22. Besides the pre-departure and on-arrival polymerase chain reaction (PCR) tests, the government has also imposed daily antigen rapid tests (ART) for seven consecutive days (unsupervised ARTs on the 2nd, 4th, 5th and 6th days and supervised ARTs at Quick Test Centres on the 3rd and 7th days) to prevent imported cases of Omicron variant infections.

The Causeway remains open. The border between Singapore and Malaysia remains open although the government has instituted a supervised on-arrival ART and the same sevenday enhanced ART protocol.

Enhancing immunity through booster shots. Booster shots are currently the best protection against the highly transmissible Omicron variant. Singapore has commenced its booster programme since Sep 21. Singaporeans will be able to receive their booster dose of the mRNA vaccine five months after completing their primary series vaccination regime. The Pfizer-BioNTech COVID-19 vaccine (paediatric doses) was approved for children aged 5 to 11 years and vaccination for children has commenced in Dec 21.

Singapore has one of the highest vaccination rates. Singaporeans overcame vaccine hesitancy and are well adapted to living with COVID-19 as an endemic. As of 3 Jan 22, 87% of the total population has completed their full regimen and received at least two doses of COVID-19 vaccines, of which 42% have received their booster shots.

Pharmaceutical companies working on updated COVID-19 vaccines. Pharmaceutical companies are racing to develop new vaccines and booster shots specifically designed to combat the new Omicron variant. Pfizer-BioNTech has said it will be able to adapt its mRNA vaccine within six weeks and ship initial batches within 100 days. Moderna expects a reformulated vaccine to be ready by Mar 22.

ACTION

Maintain OVERWEIGHT. Singapore has to weather a new wave of Omicron variant infections in 1Q22. We expect the reopening of borders with expansion of capacity for existing VTLs and introduction of new VTLs to resume in 2H22. The anticipated recovery in the hospitality industry has been delayed and postponed to 2H22.

Bumpy transition on the path towards reopening. Self-isolation and recovery at home has become the default arrangement, including those infected with the Omicron variant and their close contacts. Thus, the government might terminate the contracts for some of the dedicated isolation facilities. The affected hotels have to switch to serving transient corporate and leisure travellers and staycation demand. Nevertheless, there is downside protection for hotels under master leases.

Ascott Residence Trust (ART SP/BUY/Target: S$1.29)

Further expansion in student accommodation. ART has completed the acquisition of four student accommodation assets in the US with a total of 1,651 beds for US$213.0m (S$291.2m) in Dec 21. The Link University City is located in Pennsylvania, while Latitude on Hillsborough and Uncommon Wilmington are in North Carolina, and Latitude at Kent is in Ohio. They serve five reputable universities in three states with strong athletics programmes. They were newly completed between 2019 and 2020 and have a weighted average occupancy rate of 94% for academic year 2021.

• The four assets are expected to provide EBITDA yield of 4.9%. The acquisition is estimated to increase pro forma 2020 DPU by 3.0%. The acquisition will be 92% funded by debt and 8% funded by the remaining proceeds from private placement completed in Sep 21. ART’s gearing remains healthy 37.8% post-acquisition.

Scaling up in student accommodation. ART has acquired a diversified portfolio of eight student accommodation assets with 4,400 beds within a year. They are strategically located in Sunbelt states, Ivy League and ‘Power 5’ athletics conference markets. They serve over 250,000 students in six states. Student accommodation and rental housing properties now make up 16% of total portfolio value.

Re-iterate BUY. We raised our 2022 and 2023 DPU forecast by 2.4% and 4.2% respectively due to the four newly acquired student accommodation assets. We roll forward our valuation to 2022. We raised our target price from S$1.20 to S$1.29 based on DDM (cost of equity: 6.5% and terminal growth of 1.8%).

CDL Hospitality Trusts (CDREIT SP/BUY/Target: S$1.42)

Contribution from W Hotel boosted by staycation demand. W Hotel benefits from buoyant staycation demand as Sentosa Island provides Singaporeans with the closest semblance to an overseas holiday. W Hotel is a popular destination for staycations due to its expansive view of the marina and seafront. We estimate that W Hotel’s RevPAR has rebounded 28% qoq to S$221 in 3Q21. We expect further upside with RevPAR increasing 27% qoq to S$280 in 4Q21.

Grand Millennium Auckland has served as a managed isolation facility since 2Q20. The government contract is expected to continue into 1Q22. The hotel, which is the largest in Auckland and centrally located within the CBD and in close proximity to Auckland Conventions, contributed a sizeable 29.6% of NPI in 3Q21.

The UK: Anticipating a rapid recovery after weathering the Omicron variant wave. The UK was hit by a tidal wave of Omicron variant infections, which overtook Delta as the dominant coronavirus variant in mid-December. The British government has ramped up its booster programme. While new cases have skyrocketed, deaths have trended lower. We expect confidence to be gradually restored after Europe weathers the new wave of Omicron variant infections in 1Q22. Recovery should resume in 2Q22, driven by domestic and intra-regional corporate and leisure travel.

Maintain BUY. Our target price of S$1.42 is based on DDM (cost of equity: 6.5% and terminal growth of 1.8%).

Far East Hospitality Trust (FEHT SP/BUY/Target: S$0.74)

Judicious divestment of Central Square. FEHT has entered into a put-and-call option agreement with wholly-owned subsidiary of City Developments to divest Central Square for S$313.2m. Central Square is located at 20 Havelock Road and comprises a serviced residence and commercial spaces including offices and retail units. The divestment consideration represents a 57.9% premium on the independent valuation of S$198.3m as of Dec 20 and a 70.8% premium on the original purchase price of S$183.3m in Aug 12.

• FEHT (owner of Central Square) and City Developments (owner of the adjacent Central Mall) have received an outline advice from the Urban Redevelopment Authority (URA) to redevelop Central Square and Central Mall under the strategic development incentive scheme. The maximum permissible GFA has increased 78% to 341,840sf. Knight Frank was appointed as the marketing agent to carry out a tender exercise and City Developments has emerged as the highest bidder.

• The divestment proceeds will be used to pare down debt to strengthen FEHT’s balance sheet. Aggregate leverage is expected to decrease from 41.3% to 33.5%.

Downside protection from high fixed rent component. FEHT is the most defensive hospitality REIT in Singapore. FEHT nine hotels and three serviced residences are under master lease agreements with subsidiaries within sponsor Far East Organisation (FEO). The fixed rent component from its master leases totalled S$67m per year, which is equivalent to 72% of total gross revenue from its hotels and SRs in 2019 (pre-COVID-19). These fixed rents formed about 81% of 1H21’s gross revenue. These 20-year master
leases run till 2032.

Maintain BUY. We cut our 2022 DPU forecast by 29% due to weakness caused by the Omicron variant in 1H22. We trimmed our 2023 DPU forecast by 2.5% due to divestment of Central Square, offset by lower interest expense. We roll forward our valuation to 2022. We raised our target price from S$0.71 to S$0.74 based on DDM (cost of equity: 6.75% (previous: 7.0%), terminal growth: 1.8%).

SECTOR CATALYSTS

• Reopening of borders in Singapore through the expansion of capacity for existing VTLs and introduction of new VTLs in 2H22 after the country weathers the Omicron variant wave.

• Current share prices for hospitality REITs represent an average discount of 17% to NAV. The correction has brought P/NAV to 0.89x for ART and 0.76x for FEHT.

ASSUMPTION CHANGES

• As mentioned above.

RISKS

• A broader second wave of COVID-19 infections which results in many countries tightening safe distancing measures and even imposing lockdowns.