Saturday, September 26, 2009

Ascott Residence Trust - Buy by OCBC (25 Sep 09)

Performance lags CDL-HT. Ascott Residence Trust (ART) has re-rated 15% since our July upgrade and has achieved our prior S$0.97 fair value. However, its performance lags closest peer CDL-Hospitality Trusts [CDLHT, NOT RATED]. Using end-June 2007 as a base, both S-REITs saw a roughly 83% decline to trough values. But CDL-HT has recovered 260% from its trough versus ART's 177% recovery. A similar discrepancy plays out in price to book; CDL-HT is trading at 1.08x 2Q09 NAV while ART trades only at 0.71x 2Q09 NAV. There is also a 227 basis point trailing yield differential between the two.

Exploit the gap. Key drivers of this discrepancy, in our view: 1) CDL-HT is an earlier beneficiary of economic stabilization and any nascent recovery (shorter-stay hotels versus extended-stay serviced residences); 2) it is a purer IR play; 3) its balance sheet is stronger, with 19.3% leverage versus ART's 40.7% leverage; which has led to 4) the market pricing in the possibility of a cash call. We believe value can be extracted from the gap between the two hospitality REITs even when those balance sheet risks are quantified.

FDI expected to bottom in 2009. The United Nations trade and development agency UNCTAD expects global FDI inflows to bottom in 2009 at below US$1.2 trillion and slowly recover to US$1.4t in 2010 and US$1.8t in 2011. FDI flows are a fair proxy for corporate spend and travel and consequently, the health of the extended-stay business. We believe Pan-Asian markets, where ART operates, will continue to be attractive FDI destinations. We think ART may shine in the coming months as corporate spend and travel gradually return. At 3Q09 results next month, we will look for evidence of occupancy stabilization - the next challenge will be increasing rates, which requires sustained high occupancy levels.

Attractive, even with cash call assumption. We maintain our earnings estimates but lower our discount rate inputs. Our new SOTP value for ART is S$1.40, and we charge a 15% discount to derive a fair value estimate of S$1.19 (prev: S$0.97). Fresh equity could be utilized to support asset enhancement plans and fund acquisitions, but the manager has the luxury/ inclination to wait for further re-rating, in our opinion. Note that with a hypothetical equity issue raising S$150m, our SOTP value could fall to S$1.28 (S$0.87 issue price, 10% discount to current price) or to S$1.21 (S$0.68, 30% discount). This still covers our S$1.19 fair value. Maintain BUY (30% total return).

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