DBS Group Research’s Geraldine Wong and Derek Tan have maintained their “buy” call on Ascott Residence Trust (ART) with a raised target price of $1.20 in a Jan 6 note.
The analysts said they see “compelling value” in ART at 0.8x price to net asset value (P/NAV), which is more than -1.5 standard deviation (s.d.) of its historical 10-year mean, with an attractive 6.9% FY2022 dividend yield with upside if travel rebound occurs faster than expected.
Furthermore, a focus on big domestic travel markets and long-stay segment should pay off for ART, as a phased reopening is a positive sign that its portfolio has attained at least a breakeven level of operations, the analysts highlighted.
“With a diversified portfolio deriving about 70% exposure from these ‘domestic markets’, we believe ART can rebound ahead of peers,” say Wong and Tan.
However, the analysts have cut their earnings estimates on ART by 12% to 25% to reflect their revised view of a four-year normalization period for the sector.
They elaborate that this is due to a refreshed rent structure pegged to underlying performance.
ART has announced the extension of master lease agreements for their assets in France, with most assets extended for a period of three years (and four assets which will be extended for a further two years after a one-year extension in March 2020).
Alongside the extension of leases, the lease structure for all leases will be revised to include a variable rent component. The revised rental structure shifts from a fully fixed structure to one that has a mix of fixed (60%) and variable components (40%), pegged to 10.35% of underlying revenues.
As such, the analysts estimate overall rents will drop by 9.4% (ranging +7% to -21% on an asset level) when compared to FY2019 rent levels.
They estimate rental declines of about -4.1% and -5.6% as the revised lease structure takes effect in 1Q and 2Q/3Q in 2021 respectively, and said the full impact of the rent reset will be felt in 4Q2021, when all the properties move over to the new lease structure.
The revised overall rent (based on FY2019 levels) is estimated to be about 26.8% of revenues, which is slightly lower than about 29% of revenues under the previous lease structure.
Tan and Wong said as a result of this new structure, there will be “near term pain for unitholders.”
The pandemic has taken a toll across all of ART’s geographical markets with France standing out as one of the first few markets where master leases were temporarily re-structured to variable rent terms due to the widespread closures.
They called the timing of the master lease renewal “unfortunate”, as COVID-19 cases in France remain high and domestic travel demand is uncertain in the near term due to provincial travel bans within the country. But they believe that the roll-out of the vaccine inoculation this year should help alleviate uncertainty over time.
Tan and Wong also said in the worst case scenario of zero variable rents, rental loss will approximate 8 million euros ($13 million), equivalent to 2.5% of their full year revenue forecast in FY2021 of $527 million , which is “manageable and likely priced in”.
Despite all these, they believe that investors will likely look beyond this near-term hump in earnings, and look forward to the overall rebound in operational metrics with potential upside from acquisitions in the medium term.
As at 11.32am, units in ART are trading 1 cent higher or 0.9% up at $1.08.
