CDL H-Trust – CIMB

Increasing Singapore exposure

Proposes to buy Studio M for S$154m

Maintain Neutral and target price of S$2.14. CDLHT has entered into a conditional sale and purchase agreement with Republic Iconic Hotel (wholly-owned by its sponsor, M&C Hotels) to acquire the 360-room Studio M hotel in Robertson Quay for S$154m or S$428,000/key. The hotel will also be master-leased to the sponsor for 20 years on a fixed plus variable structure, for a guaranteed initial net yield of 6%, above CDLHT’s FY10 dividend yield of 5.2%. We are positive on this long-anticipated accretive deal. We fine-tune our estimates with no material changes to our DPU estimates or DDM target price (discount rate 8.6%). Despite our positive view, expectations have been priced in, we believe, and upside remains limited in the short term. Re-rating catalysts could include announcements of accretive acquisitions and stronger-than-anticipated REVPAR growth in 2011.

REVPAR of S$155. Studio M is a contemporary hotel comprising two wings with 360 rooms. Completed in mid-2010, it is located at 3 Nanson Road, in the Robertson Quay entertainment precinct. The hotel is a short distance from the CBD and close to other portfolio hotels including Grand Waterfront Copthorne and Copthorne Kings in the Havelock Road area, the stronghold of the sponsor. Occupancy is high at 88.9% with average room rates of S$174 in the six months of operation from Jun to Dec 10. This represents REVPAR of S$155/day. Room revenue contributed more than 90% to hotel revenue.

Lease structure improved to capture REVPAR upside. Studio M will come with: 1) a fixed rent component, set at S$5m for the first 10 years and adjusted every 10 years; and 2) a variable component comprising 30% of revenue and 20% of gross operating profit less fixed rent. With more than 90% of hotel revenue from rooms, this lease structure will position CDLHT for capturing REVPAR upside.

Sweetener 1: fixed rent escalation every 10 years; downside protected. The fixed rent of S$5m for 10 years will be adjusted higher every 10 years to an equivalent to 50% of the average annual aggregate fixed rent and variable rent for the five fiscal years preceding the rent revision date. However, if this amount is lower than prevailing fixed rents, the fixed rent for the next 10 years will be unchanged.

Sweetener 2: safety net of guaranteed rent. For the first 12 months of the master lease, CDLHT will receive a minimum rent (net of property taxes and insurance premiums payable by the H-REIT trustee under the master lease agreement) of S$9.24m, which represents a net yield of 6%, based on the purchase consideration of S$154m. The minimum rent was derived out of the actual operational performance of the hotel in the last six months.

Sweetener 3: master lease could be extended up to 70 years. Studio M will be master-leased to the sponsor for 20 years, with a renewal option for two terms of 20 years each, and a third term of 10 years. The total lease thus could extend to 70 years, the longest for any SREIT lease. This represents considerable income stability for CDHLT.

Fully funded by debt; gearing to reach 26.5%. The manager intends to fund the acquisition by drawing down its S$1bn MTN programme. Cost of debt is expected to be about 2%. The manager expects asset leverage to rise to 26.5% from 20.4%. This leverage would still be low against the average SREIT average of 33%. Acquisition fees payable to the manager will be paid in units.

EGM required by end-April. As this is a related-party transaction, unitholders’ approval would be needed in an EGM by end-April. We anticipate deal completion by June.

Valuation and recommendation

Positive on the deal. We estimate FY11 DPU accretion of 4.2%. We believe that average room rates would trend up further over the next three years given that occupancy at 88.9% is already above technically full levels, and room revenue constitutes more than 90% of the hotel’s revenue. With this acquisition, CDLHT’s total fixed rent component will increase 8% to S$66.2m or about 47% of our FY11 revenue forecast. This represents considerable downside protection for a REIT positioned with the biggest upside in this hospitality upcycle. With this acquisition, CDLHT’s exposure to Singapore would increase, with a 15% addition to its Singapore hotel rooms to 2,711.

Maintain Neutral and target price of S$2.14. We earlier expected CDLHT to make an acquisition of S$150m at 6% net yields. We fine-tune our estimates, factoring in the lease structure. Changes to our DPU estimates are not material and our DDM target price remains S$2.14 (discount rate 8.6%). Although the manager has not disappointed us with this acquisition, given the keen competition for hotel assets in the past 12 months, expectations of Studio M have been priced in, we believe, and upside remains limited in the short term. Re-rating catalysts could include announcements of accretive acquisitions and stronger-than-anticipated REVPAR growth in 2011.