Quality asset acquisition

• Buying quality property within Shinjuku, Tokyo but minimal impact on overall earnings

• Perceived high gearing vs peers and weaker business travel outlook to weigh on performance

• Yields attractive at 8.6-8.8%; but worsening European outlook could mean potential downside, Downgrade to HOLD, TP cut to $1.13.

Acquiring quality asset in downtown Shinjuku, Tokyo. Ascott REIT has entered into a conditional sale and purchase agreement to acquire a 60% interest in 160-unit Citadines Shinjuku Tokyo from Mitsubishi Estate Co Ltd (MEC). A quality serviced residence with good patronage from corporate/leisure travelers since opening owing to its good location and excellent accessibility to regional subway lines. Purchase consideration amounts to JPY 2.6bn (S$45.7m), implying an initial yield of 4.5%yield. While this is lower compared against our estimated WACC of 7.3% for the REIT, as the acquisition will be fully funded by debt, it should be accretive to earnings. Post acquisition ART’s gearing level is expected to head slightly upwards to 42% (vs 41% previously).

Gearing to head up 42%; declining business travel market likely to continue to weigh on share price performance. The impact of the acquisition on ART’s earnings/assets is minimal. Looking ahead, we believe that the following factors will weigh on share price performance: (i) ART’s higher than average gearing level of 42% vs peers, which we believe is justified given its multi-country exposure. The manager has taken higher debt levels overseas, which act as natural hedges against currency fluctuations and for tax efficiency purposes. We also note that other financial metrics (debt maturity profile, interest coverage ratio) remain healthy. (ii) Expected declining business travel especially in/from Europe, which is likely to limit opportunities to raise rates. However, close to 45% of its earnings are contributed by master leases (to Ascott Limited)/minimum income guarantee structures, which offer downside protection. We reduce our RevPAU expectations slightly to reflect our more moderate outlook, resulting in a 3-4% reduction in our FY12-13F DPU estimates.

Downgrade to HOLD, TP revised to S$1.13. While stock offers a relatively attractive yield of 8.6, there exists potential downside risk in the event of a worsening European crisis, given that 42% of its assets are in Europe. Our TP has been revised to S$1.13 due to lower DPU estimates and higher WACC assumptions for its European exposure.

Defensive master leases

3Q results in line. Ascott Residence Trust (ART) announced a 3Q11 distribution of S$25.3m, up 112% YoY. The distribution per unit amounted to 2.23 S-cents. This came in broadly in line with our expectations as 3Q11 distribution income made up 26.3% of our FY11 forecast. 3Q11 topline of S$72.9m, up 57% YoY, was also in line and constituted 25.7% of our annual estimates. We saw revenue improve YoY mainly due to an additional S$31.7m contribution from 28 properties acquired in Oct 10, partially offset by the divestments of Ascott Beijing and Country Woods. We continue to see YoY expansion in gross margin to 55% in 3Q11 from 45% in 2Q11 on the back of higher margins for master leases and higher rental rates.

Portfolio performance buffered by master leases. The 28 properties on master leases and management contracts with minimum-guaranteed income (out of 64 portfolio properties) contributed 46% of 3Q11 gross profit. We continue to believe that the longer weighted average tenure of these leases (~7 years) will inject stability into earnings and buffer ART against potential macro volatilities in the UK and France where the bulk of exposure is. For properties on management contracts, we continued to see pressure on a YoY same-store basis in China, Indonesia and Vietnam. As a result, 3Q11 revenues on a same-store basis decreased 1.2% YoY to S$41.3m. Group 3Q11 REVPAU increased 11% YoY, however, fueled by improved performances in Singapore and the UK.

S$393m to be refinanced in FY12. As of end 3Q11, ART’s gearing was stable at 41.4% with a relatively well spread-out maturity profile. We expect about 35% (S$393.1m) and 11% (S$123.2m) of ART’s debt to be rolled over in FY12 and FY13, respectively. The bulk of the group’s debt is denominated in Euros (48%) and Japanese Yen (25%) and evenly distributed between floating (54%) and fixed debt (46%), which puts ART in a relatively neutral position in terms of currency and interest rate exposure.

Maintain BUY at revised S$1.13 fair value. We continue to see value in ART given defensive earnings from master leases and management contracts with minimum-guaranteed income. In addition, its portfolio is diversified across geographically which would buffer earnings somewhat against region-specific weaknesses. We also expect redevelopment details for the Somerset Grand Cairnhill Singapore to be a potential upside catalyst. Given heightened macro uncertainty, however, we lower our REVPAU assumptions for management contracts and update our country-specific discount rates to reflect increased macro-risks. Hence we revise our fair value estimate to S$1.13 from S$1.35 previously but maintain BUY.

Still going strong

At a Glance

• 3Q DPU of 2.23 Scts in line (YTD 3Q 77% of estimates)

• 4Q11 performance could moderate sequentially from a seasonally weaker quarter in Europe

• BUY Call maintained, TP S$1.34 based on DCF

Comment on Results

3Q11 DPU of 2.23 Scts in line. Revenues and gross profits grew by 57% and 89% to S$73.0m and S$40.0m respectively, largely fueled by revenues from 28 serviced residences acquired in Oct’10 which offset the loss of income arising from divestments. On a same store basis, topline was S$0.5m (or 1% lower) due to weaker Japan & Vietnam, offset by strong Singapore operations. Portfolio wide RevPAU increased 11% yoy to S$146/night. NPI margins improved to 55% (vs 45% a year ago) mainly due to the inclusion higher-margin master leases and an improvement in RevPAU portfolio wide. Distributable income came in 112% higher yoy at S$26.3m lifted by interest savings from refinancing activities. DPU grew by only 21% to 2.33 S cts on a larger unit base.

4Q11 to moderate sequentially. Portfolio performance has remained fairly consistent and strong since the beginning of 2011 with Singapore and London continuing to enjoy the after effect of the group’s refurbishment works supported by strong underlying demand for rooms. Both markets saw RevPAU hikes in excess of 11% and other markets remained relatively stable. Its Japan’s operations also came off its low with 23% qoq improvement in RevPAU. Looking ahead, we understand demand for rooms will continue to remain strong, but performance will moderate slightly in 4Q on a sequential basis as Europe moves into a seasonally weaker quarter (where guests profile mix is largely lower-yielding leisure guests).

Un-locking value at Somerset Grand Cairnhill
could be re-rating catalyst, BUY TP S$1.34. We believe a divestment of Somerset Grand Cairnhill Singapore is likely if it is to be redeveloped. This transaction will unlock value for ART, empower the REIT with firepower to make opportunistic acquisitions. ART trades at an attractive 0.8x P/BV and offers FY11-13F yields of >8.5%.

Ascott Trust posts 21% jump in Q3 DPU

Distributable income more than doubles, thanks to last year’s acquisitions

ASCOTT Residence Trust (ART) saw a more than one-fifth jump in third-quarter distribution per unit (DPU), with the 28 serviced residence properties added to its portfolio last year acting as a booster.

DPU for the three months ended September came to 2.23 cents, 21 per cent higher than the 1.85 cents per unit it paid out a year ago. The payout is also 10 per cent higher than ART had forecast.

Lim Jit Poh, chairman of ART’s manager Ascott Residence Trust Management Ltd (ARTML), said: ‘This is mainly attributable to the yield-accretive acquisition of the 28 serviced residences and the divestment of Ascott Beijing.’

Overall, distributable income for the July-September period more than doubled to $25.3 million, from $12.0 million the previous year.

ART completed the acquisition of the 28 properties in Singapore, Vietnam and Europe from its sponsor, The Ascott Ltd, for $969.6 million, and divested Ascott Beijing to Ascott last year. It later completed the divestment of Country Woods Jakarta, Indonesia.

These properties helped ART achieve a 57 per cent increase in revenue to $73.0 million, from $46.5 million the previous year.

Chong Kee Hiong, ARTML’s chief executive, said: ‘Ascott Reit’s revenue per available unit (RevPAU) achieved an 11 per cent increase this quarter as compared to 3Q2010, mainly attributable to the strong performance of the Singapore and United Kingdom serviced residences. RevPAU this quarter also outperformed the forecast by 6 per cent.’

ART added that it is evaluating the redevelopment options for Somerset Grand Cairnhill Singapore, although there is as yet no certainty of any proposed redevelopment materialising.

Mr Chong concluded: ‘For 2011, we expect to achieve better operating results as compared to 2010 and to deliver the forecast 2011 distribution of 7.74 cents.’

As at Sept 30, Ascott Reit’s international portfolio comprised 64 properties in 12 countries across the Asia-Pacific and Europe. ART’s units closed up half a cent at $1.01 yesterday.

Singapore/London power ahead

• 2Q11 DPU of 2.33 Scts above street and our estimates

• Singapore and London continue to perform, lower than expected interest costs lifts net margin

• BUY, TP revised to S$1.42 and offers 24% total return

2Q11 DPU of 2.33 Scts above estimates. Revenues and gross profits were higher by 65% and 98% respectively to S$73.1m and S$41.2m. This was largely due to the contribution from its acquisition of 28 serviced residences in Oct’10, which more than offset the divestment of Ascott Beijing and Country Woods Jakarta. Singapore operations came in stronger than expected with portfolio wide RevPAU increased 7% y-o-y to S$147/night. Distributable income was 127% higher at S$26.3m due to interest savings from refinancing activities (3.2% vs 3.5% forecast), translating to a DPU of 2.33 Scts. The group also wrote up its book value by S$82.8m, resulting in a 4% hike in NAV /share to S$1.33.

Singapore and London power on while Japan was weak from Earthquake aftermath effects. The group’s refurbishment works is bearing fruit- judging by the performance of its Singapore properties, which saw RevPAU

hikes in excess of 30% for its refurbished units in Cairnhill and Liang Court. Its London operations also posted a 15% increase in RevPAU benefiting from renovation works and should continue to perform well after the completion of its refurbishment of Trafalgar Square property. Looking ahead, Japan is expected to remain weak post the Earthquake but their rental-housing portfolio, which has proven to remain resilient, should limit the impact.

BUY, TP upped to S$1.42/share. Our forward DPU estimates are raised c6.0% from (i) higher RevPAU assumptions in London and Singapore; and (ii) lower than expected interest costs achieved. Trading at an attractive forward yield of 7.2-7.3%, >100bps above the S-REIT sector peers. Re-rating catalysts will hinge on higher than expected operational performance and/or acquisitions.