Shooting for the stars
Encouraged by the positive operating leverage observed for ARAHT; likely to sustain. We note a better flow-through on the incremental dollar as ARAHT hotels ramp up to cater to the stronger travel demand as a result of pent-up demand momentum. In 1H22, a 54% y-o-y growth in gross revenue translated to a 95% y-o-y growth in gross operating profit and 131% y-o-y growth in net property income. We expect the outsized bottom-line growth relative to top-line growth to continue as we enter 3Q22, which is typically the best performing quarter on the back of the peak summer season.
Labour costs kept in check. As ARAHT operates in the select service space, only lean staffing is needed, as additional amenities such as F&B options are limited. The ARAHT hotels are also generally smaller, with 120-150 rooms, which ensures that housekeepers can keep pace with the higher demand. Without a unionised labour force, ARAHT is able to adjust its labour force to cater to the incoming demand instead of bringing back all of its employees full time. This is positive for ARAHT, given that labour costs have increased significantly in the US due to a tight job market.
Room rates repricing an upside in inflationary environment. We continue to like hotels in this inflationary environment, as the daily repricing of room rates according to demand and supply acts as a natural inflation hedge, compared to monthly or annual lease structures that are less dynamic. This also allows for revenue growth to outpace expense growth; in 1H22, we see that ARAHT’s revenue increased 54% y-o-y while operating expenses rose only 39% y-o-y.
Divestments. The sale of Hyatt Place Chicago Itasca was completed on 8 July 2022, and the sale of the four Hyatt Place hotels is estimated to be completed in 3Q22. We understand that the manager is looking to redeploy the proceeds into better performing assets or acquire new properties in time. We believe ARAHT will continue to optimise its portfolio and divest more of its non-core assets that have been underperforming. These are some of the potential divestment targets, in our view:
Cost of debt. We note that the 81% of debt hedged to fixed rates mostly run till 2024. Hence, there will likely be no significant increase in interest rates in the next year or two. While there may be impact from rising rates on the unhedged portion of the company’s debt, the impact is substantially mitigated. There are no refinancing requirements for the remainder of FY22 and FY23.
Biggest deterrent to travel.
We believe that the biggest headwind to travel demand is the feeling of fear, which could stem from physical, economic, etc. risks. Travel demand plunged during the Global Financial Crisis (GFC) in 2007-2009 on fears of a recession and job losses, and during the COVID-19 pandemic on fears of contracting the virus. Hence, we use the VIX Index, which is an estimate of the expected volatility of the S&P 500 Index, or more commonly known as Wall Street’s “fear gauge”, as a proxy. Observing a strong negative correlation of 0.60 between the VIX Index and ARAHT’s share price, we see that one of the worst dislocations for the hospitality industry is the fear factor. With the VIX Index currently hovering at much lower levels compared to 2008 levels, we believe that travel demand going forward will not be curtailed on recessionary fears, given a healthier macroeconomy with lower unemployment rates and higher savings levels.
Lower FY22F/23F NPI slightly to US$46.9m/US$56.1m to factor in the divestment of the five Hyatt Place hotels that had been underperforming.
Cut FY22F distributable income estimate to US$19.3m (prev: US$26.7m) to factor in higher capital expenditure. We note that capex for the hospitality industry is perpetual due to the nature of the business, and we understand from the manager that the higher capex amount in FY22 was due to a deferment from the COVID-19 period. Nonetheless, we still expect a yield of 7.1% for FY22F and jumping to 12.1% in FY23F at current share price.
Maintain BUY and unchanged TP of US$0.70. We remain optimistic about the recovery trajectory on the back of travel demand momentum and positive operating leverage, and we expect 2H22 performance to be better than in 1H22.