Singapore REITs are set for a gradual, cautious re-opening in what is left of the year, with travel rebounding only in phases from 2021, says DBS Group Research analyst Derek Tan in an Oct 19 note.
As expected, domestic travel will recover faster compared to international travel, as borders here remain shut. The sector’s gearing is set to increase to about 44% assuming 15% to 20% decline in valuations, with the “worst case scenario” priced in at current levels, says Tan.
In particular, Frasers Hospitality Trust (FHT) will see its upcoming full-year results be impacted by the travel standstill. Two properties – ibis Styles London Gloucester Road and The Westin KL continue to remain closed as at end-September.
“We estimate that these hotels only contributed about 7% of revenues pre-Covid-19. This is already an improvement compared to the quarter ended June, where six UK hotels and The Westin KL were closed,” writes Tan.
See: S-REITs picking up steam again by diversifying income streams: OCBC
The steady reopening of the hotels across the portfolio is positive to cashflows to FHT, albeit current occupancy levels will likely be close to breakeven levels rather than profitable, says Tan. “The exceptions are the Singapore hospitality assets (about 21% of revenues), Novotel Melbourne on Collins (about 23% of revenues), Sofitel Sydney Wentworth (about 9% of revenues), which continue to churn steady returns and occupancy rates as these properties have benefitted from quarantine business (government led) for returning travellers.”
FHT’s income available for distribution is expected to decline by 60% to 70%, with distribution per unit (DPU) to drop by 65 to 75%. Tan writes to expect revaluation losses in the REIT’s upcoming year-end results.
Looking ahead, Tan sees the travel industry rebounding in two broad categories, with the domestic travel market gaining traction faster as Covid-19 spread remains under control within borders while international travel (business and leisure) will lag for now.
“While it appears that some governments are relaxing border controls gradually and introducing safe ‘travel bubbles’ internationally, leisure travel will likely normalise in the medium term, despite acknowledging the strong pent-up demand from holidaymakers,” says Tan.
As such, Tan believes that the likes of Ascott Residence Trust (ART), CDL Hospitality Trust (CDREIT), Frasers Hospitality Trust (FHT) will see a rebound in travel demand first.
Far East Hospitality Trust’s (FEHT) operational performance will be subject to the re-opening of the Singapore travel market, says Tan. “On the other hand, the ongoing government quarantine business in Singapore supports demand for hotels in the interim.”
Cashflow re-evaluations
The significant cashflow disruption will likely result in valuers re-evaluating their cashflow projections to revise valuations and we expect downward pressure possibly to the tune of 10% to 20% come year-end, says Tan.
FHT is expected to report valuations as at FYE September. Tan writes that this will provide investors with a possible yardstick into how valuations for other hotel S-REITs may look like come the respective year-ends in December.
Based on Tan’s estimate of 10% to 20% drop in hotel valuations, most hotel REITs are expected to see an increase in gearing from the current 38% to 44% approximates, with the exception of FEHT where gearing may possibly hit 49% (on the assumption of a 20% drop in valuations).
“We believe the scenario of a 20% drop in valuations is unlikely given (i) tight cap rates for transactions in Singapore (hotels are transacted at < 3% yield), and (ii) cashflows are not as severely impacted given the government business in 2020, while the gradual re-opening of borders will be positive for the local hospitality industry over time,” writes Tan.
With the sector trading at 0.7x Price to Net Asset Value ratio (P/NAV), Tan believes that investors have already priced in a “worst case scenario” of a 20% decline in asset values in terms of current share prices.
“Investors should look forward to a recovery in 2021. Our picks are Ascott Residence Trust and CDL Hospitality Trust,” writes Tan.
Tan is recommending ‘buy’ on ART and CDREIT, with a target price of $1.10 and $1.30 respectively.
As at 11.17am, units in ART are trading at 0.5 cents lower, or 0.56% down, at 88 cents, while units in CDREIT are trading at 1 cent lower, or 0.93% down, at $1.07.
