More room to run

• Results above street estimates
• Stability emerging – 2H09 should turn stronger
• Upgrade to BUY, TP S$0.99, offering total return of 22%.

Results higher than street. ART reported a commendable set of results, beating market expectations but in line with our estimates. 2Q09 distribution income came in 17% lower yoy to $11m (DPU 1.79cts). This was achieved on the back of a 7% dip in revenue to $43m and an 11% drop in gross profit (GP) to $23.4m. Signs of stabilization are emerging with topline, GP and distribution income recording single digit growth on a qoq basis. The group wrote down value of its assets by $61m or 4% of total portfolio value, largely from its Japanese and Chinese assets. Thus, book NAV declined to $1.36/unit. Consequently, gearing rose to 41%.

Stability emerging. Operating condition was challenging in 2Q09 with RevPAU dipping to $119, hindered by Singapore and China segments. Weaker business demand and competition from new supply in Beijing and Shanghai were a drag on RevPAU. The slide was partially offset by better contributions from Australia, Philippines and Vietnam. Looking ahead, there are nascent signs of demand leveling out, particularly in Spore (15% of revenue) with more take up from project groups. Australia, Vietnam and Philippines are expected to remain fairly stable. Management indicated that the present gearing of 41% and ICR of 3.4x are still within their optimal target of 45% and
ICR of 3x, and is unlikely to tap capital markets in the near term.

Upgrade to BUY. We are raising our FY09 and FY10 DPU estimates by 0.7% and 6% respectively to 7.2cts and 7.4cts, on the back of an improving operating environment. We have also adjusted our TP to S$0.99, assuming a slightly higher terminal growth of 2%, which is not excessive, given that half of its portfolio is in emerging markets. ART is one of the key beneficiaries of the global economic recovery, given its focus on corporate medium term accommodation demand and diversified tenant base. Expectations of positive GDP growth in the Asia Pacific region as well as event driven catalysts, such as completion of the 2 IRs in Singapore next year, should likely have a positive impact on the longer stay market.

Less depressed expectations for 2010

• Guidance for 2Q09. ART guides that its 2Q09 earnings are likely to remain weak, but with a slower rate of decline compared with 1Q09. ART’s top four contributors (73% of revenue) are Vietnam, China, the Philippines and Singapore, in order of contribution. REVPAU in Vietnam and Singapore is stable, supported by a long-stay segment and improved occupancy, while the Philippines has recovered strongly and earnings are likely to supersede 2008’s. China’s REVPAU continues to decline due to a supply overhang in Beijing. We continue to expect a 13% decline in overall REVPAU for this year.

• Reviewing estimates. Although the outlook for global business travel still lacks clarity, concerted global efforts to ease the financial crisis have improved liquidity conditions, resulting in a general revival of confidence. We believe this will translate into stable global business travel in due time. As such, we revise our FY10-11 REVPAU assumptions to reflect 0-5% growth, vs. 0-15% decline previously.

• Higher DDM-derived target price of S$0.79 (from S$0.56). Our DPU forecasts for FY10-11 increase by 14-17% following changes to our assumptions. We now use a lower discount rate of 10.3% from 10.5% on a reduced risk-free rate of 4.8% which is applied across our REIT universe. Current P/BV appears attractive at 0.5x vs. SREITs’ 0.6x. Price catalysts look limited in the short term. However, due to the volatile nature of the hospitality industry, the impact of increased REVPAU on revenue when the economy turns would be felt in a much shorter span of time.

Hard to diversify from global slump

Rating downgraded to 3 from 2

Time for a little patience

Lower credit ‘tail risk’ has boosted unit price. Since we re-initiated coverage in April 2009, Ascott Residence Trust (ART) has seen a 41% increase in its unit price on the back of, we believe, lower risk of a systemic credit breakdown. World governments have 1) committed to maintaining the viability of credit institutions and 2) also introduced fiscal stimulus packages. According to The Economist, fiscal packages in Asia are much larger than elsewhere (relative to GDP). China, Japan, Singapore, South Korea, Taiwan and Malaysia have all announced fiscal packages of more than 4% of GDP. Fiscal spending in the US, in contrast, is equivalent to about 2% of GDP.

Private sector keeps wallet shut. This economic stimulus has yet to translate into private spending. In China for instance, foreign direct investment fell for the eighth month in a row from a year ago. Investment fell 17.8% YoY in May to US$6.4b after falling 22.5% in April. FDI data is a reasonable proxy for the extended stay business. The green shoots getting heavy media coverage have yet to translate into ‘real’ business decisions in our view. Companies are still wary about committing to aggressive growth expansions. We think this is especially true of the
financial sector, which has traditionally paid top-dollar for extended-stay accommodations.

Don’t expect a 2Q miracle. In line with this view, we expect 2Q results to be largely unchanged versus 1Q09. We estimate that 2Q distributable income would fall 10-20% YoY but marginally improve on a QoQ basis. We understand that Singapore occupancies have stabilized but rates have come down – this could imply further RevPAU weakness in 2Q09. Performance in other major markets is stable to slightly negative.

Time for a little patience. As such, the jury is still out on corporate spending and travel. We do not believe there is enough justification to upgrade earnings forecasts. Our investment thesis stands: we see nearterm yield volatility but believe ART’s long-term prospects are sound. ART is only trading at 0.44x book but we do not think current levels provide the best entry point for investors, in view of the near-term fluctuations in yield and RevPAU. We advocate patience for now and downgrade our rating for ART to HOLD. Our S$0.82 SOTP value incorporates our assumption of an equity issue of S$160m at the S$0.55 price level (up from S$0.45). Our fair value estimate for ART is S$0.61 (S$0.57 previously), at a 25% discount to our SOTP value.