Divests an asset in Indonesia

Divesting an Indonesian asset. Ascott Residence Trust (ART) plans to divest one of its Indonesian assets, Country Woods. Located in the heart of South Jakarta, the rental housing property comprises of 36 townhouses, 78 bungalows and 137 apartment units. It occupies a net lettable area of 48,490 square meters and has tenure of 20 years expiring on 22 October 2025. The purchaser is an un-related party, identified through a competitive bidding process. The sale is expected to be completed by in 4Q10.

Net gain of S$5.7m. The property will be sold for US$24.18m or S$33.9m. This is 60% higher than the asset’s 30 Jun appraised value of US$15.1m or S$21.2m. Based on 1H10 EBITDA, the implied exit yield of Country Woods is a strong 2.9%. The buyer could potentially be looking to re-convert the asset for residential use, in our view. After accounting for taxes and transaction-related expenses (including early termination of existing contracts), the estimated net gain from the sale is S$5.7m. Proceeds will be used to pare down ART’s debts or for funding future acquisitions.

A positive move. The sale does not come as a surprise as the manager has been open about its intention to divest properties that have exhausted their yield optimization potential under current usage. Country Woods is an ideal “non-core” asset as it is operated as a rental housing property and does not leverage on the Ascott or Somerset brands. ART also noted that Country Woods would “require significant capital expenditure in order for it to compete with the increased competition in the vicinity”. With ongoing refurbishment activity at other properties, we believe this is likely the first of several portfolio adjustments (acquisitions and divestments) as ART focuses on yield & portfolio optimization.

Positive impact to fair value. The impact of the divestment is minimal on our earnings estimates as Country Woods contributed only about S$0.4m or 1% to ART’s 1H10 gross profit. On a pro forma basis, ART estimates that the divestment would have added 1 S-cent to the REIT’s 30-Jun NAV per unit of S$1.38. It would also have added 0.01 S-cent to 1H10 DPU of 3.53 S-cents. Assuming net proceeds are used to pay down debt, we estimate that leverage would fall from 40.7% as of 30 Jun to roughly 39.6%. On that same assumption, our S$1.32 fair value estimate edges up by roughly S$0.01 to S$1.33. Both the price and the choice of asset are quite favorable, in our view. Maintain BUY.

A better tomorrow

• Improving outlook for 2H10 as Singapore and China operations fuel growth

• Acquisitions if any, likely to be earnings accretive

• Maintain BUY, TP S$1.44 offers total return of 23%

DPU of 1.87 Scts in 2Q10 (+4% yoy, +13% qoq) Revenues and gross profits increased to S$44.4m (+3% yoy, +2% qoq) and S$20.8m (unch yoy, +1% qoq) on the back of higher average occupancies from its properties in Singapore and China. Average portfolio RevPAU increased to S$125/night (+5%yoy, +4%qoq). Distributable income came in at $11.6m (+5% yoy, +12%qoq), translating to a DPU of 1.87 Scts. The group booked revaluation gain of S$32m from higher valuations of its Singapore and Japan properties, raising NAV to S$1.38.

2H10 performance boost by increasing occupancies in Singapore and China. Performance in 2H10 will benefit from (i) completion of its refurbishment program in Singapore in 2Q10. ART is now able in offer its full suite of rooms priced at c15%higher than previous rates, (ii) improving room occupancies from its Beijing and Shanghai properties. Performance of the remaining portfolio will remain relatively resilient with increasing business activities.

Acquisitions for growth are positive catalysts in our view. ART currently trades at implied yields of c6% and we could potentially see accretive acquisition opportunities from either sponsor Ascott or 3rd parties, which are not factored in our numbers. Management guided that a myriad of opportunities including assets in Vietnam, India, Singapore, China and Europe, are under considerations. With net gearing of 40%, we believe future acquisitions will be funded by both debt & equity.

Maintain BUY and TP at S$1.44. With both organic growth and acquisition opportunities, we are positive that ART will continue to deliver steady distributions. FY10-11F DPU yields of 6.2-6.9% remain attractive.

2H catalysts sighted

• 1H10 results broadly in line; maintain Outperform and target price of S$1.35. 2Q10 DPU of 1.87cts was broadly in line with our forecast (23% of our FY10 estimate) and the Street’s (24% of full year). 1H10 DPU of 3.53cts forms 43% of our FY10 forecast (45% of consensus), as Singapore grew slightly less quickly than expected due to ongoing refurbishment. Nonetheless, we are keeping our estimates and DDM-based target price of S$1.35 (discount rate 8.3%), in anticipation that Singapore’s 2H would catch up with refurbished units able to command higher rents. Management is also exploring divestment and acquisition opportunities. We see catalysts form an anticipated strong 2H as well as potential acquisitions.

• Performance up 3% qoq. Gross profit was S$20.8m, up 3% qoq. Positive qoq growth in Singapore (+8%, higher occupancy and rates), Australia (+25%, mainly on strengthening A$ against S$) and China (+32%, higher rates and occupancy with World Expo in Shanghai) was diluted by poor performances in Indonesia (-18%, higher operational expenses due to currency differences), and the Philippines (-9%, higher utility rates), as well as a flat performance in Japan.

• RevPAU up 5%; Singapore to shine in 3Q. Portfolio RevPAU was S$125/day, up 5% from one year ago. Excluding units taken out for refurbishment, Singapore’s occupancy was above 90% in 2Q10. Management expects strong 2H growth of 25-30% hoh in Singapore, moderate growth of about 5% in China and the Philippines; and flat performances in Australia, Indonesia, Japan and Vietnam.

• Exploring divestment and acquisition opportunities. Divestment targets are assets whose rental growth has stagnated but with sharply appreciating asset values. Acquisition targets are likely to come from the parent Ascott which still has more than S$1.2bn worth of assets in the Asia Pacific. Management is comfortable with a 45% long-term gearing, and all potential acquisitions would have to be accretive with a combination of debt and equity funding. ART has debt headroom for S$179, or up to 45% asset leverage.

2Q10 in line; diversification creates both risks and Opportunities

2Q results in line. Ascott Residence Trust (ART) posted S$44.4m in 2Q revenue, up 3.4% YoY and 2.2% QoQ. Overall RevPAU for the quarter was S$125 compared to S$119 in 2Q09 (+5%) and S$120 in 1Q10 (+4.2%). Distributable amount for 2Q was S$11.6m, up 5% YoY and 12.4% QoQ, as payout in 1Q10 was hit by one-off variances in the tax line. This is equivalent to 1.87 S cents DPU, 3.3% above our estimate of 1.81 S cents. Revenue and gross profit were within 3% of our estimates. For the half-year, ART will pay out a total 3.53 S cents, or an annualized yield of 5.7%.

Asset works and acquisitions. Refurbishment of the two Singapore properties has been completed (the timing of the works was accelerated in response to the strong recovery in the local market). ART has now started refurbishment works on selected properties in Vietnam and China. It continues to explore asset divestments and acquisitions. ART is currently leveraged at 40.7% debt-to-assets, and is comfortable going up to 45% debt-to-assets. The manager noted that any acquisition would be financed using a combination of debt and equity; its target markets include Vietnam, India, Singapore and second-tier cities in China. The manager is also open to exploring any opportunities outside the Pan-Asian region created by the sovereign debt crisis in Europe.

Diversification creates both risks and opportunities. Performance continues to be mixed geographically – markets like Singapore and China are performing strongly but the Philippines and Vietnam recorded RevPAU declines on both a QoQ and YoY basis. ART re-iterated its 1Q10 guidance: the pace of recovery of hospitality demand “differs in [its operating] markets”, providing “income stability”. Right now, the stronger markets are propelling ART forwards: for 2H10, we are estimating a payout of 3.97 S cents (+12.5% HoH). This is driven both by seasonality effects and improving performance in Singapore post-asset works. For FY10 as a whole, we expect YoY DPU growth of 2.5% to 7.5 S cents. Nevertheless, a key risk to our investment thesis is that macroeconomic / regional economy risk tilts the balance between ART’s stronger and weaker markets, impacting DPU growth. This is likely to prove to be a near-to-medium term issue: ART noted it “remains confident of the long term growth in its operating markets.”

Valuations compel us to maintain our BUY rating and S$1.32 fair value [unchanged, 12.5% estimated total return].