A seasonally weaker first quarter

1Q14 DPU formed 20% of our and 22% of consensus full-year forecast, slightly below from a seasonally-weak quarter. We note rising staff cost and slightly lower operating margins, but expect higher contributions from recent acquisitions in the coming quarters. ART’s strategy of stability through the extended-stay model and growth through AEI and acquisitions remains unchanged. However, its gearing of 35.9% is the highest among its hospitality peers, while FY14-15 dividend yields are slightly below peers. We reduce our FY14-16 DPU by 3-5% to adjust for slightly higher operating costs and our DDM-based target price (discount rate: 8.5%) falls accordingly. We maintain our Hold rating.

Operational highlights

Same-store revenue per available unit (RevPAU) rose yoy for most countries with management contracts as its properties recovered from a weak 2013. The bright spots were Japan, UK, and Belgium, which saw RevPAU in local currencies rising by 18%, 13% and 11%, respectively on stronger demand from corporate and leisure travellers. Philippines, accounting for 9% of revenue and 6% of gross profit in 1Q14, remained weak due to lower corporate accommodation budgets, higher staff cost and property tax. Foreign exchange risk is mitigated as ART has hedged c.60-70% of the distribution income derived in €, £ and ¥.

Growth from AEI and potential acquisitions

S$26m of asset enhancement initiatives (AEI) was completed in 1Q14 for selected properties, lifting renovated room rates by 17-25%. Further growth is expected from the S$29.3m of ongoing AEIs that are expected to complete in 2014 and 2015. To date, the Dalian and Japan acquisitions after the rights issue have utilised 77.7% of the S$253.7m that was raised last December. Additional yield-accretive acquisitions, possibly in China, Japan, Malaysia, Australia and Europe can provide further inorganic growth for ART.

Maintain Hold

While valuations appears attractive at 0.9x P/BV, we maintain our Hold rating as ART’s gearing is higher than most hospitality peers and FY14-15 dividend yields are slightly lower.

Good but not great

ART recently announced its acquisition of Infini Garden in Fukuoka, Japan for JPY6.3bn (c.S$78.4m). With an expected yield of 6.6%, we view this acquisition positively. However, given the limited impact on earnings from this acquisition, we maintain our Hold rating on the stock with a slightly higher DDM-based (discount rate: 8.5%) target price of S$1.23 as we await more acquisitions.

What Happened

Ascott Residence Trust (ART) recently announced an acquisition of a rental housing property in Fukuoka, named Infini Garden, for JPY6.3bn (c.S$78.4m) from The Ascott Limited and ArcResidential Japan Investments Limited. Theproperty, ART’s second asset in Fukuoka, is a freehold property with 389 apartments, 5 retail units and 389 carpark lots with a NLA of 33,520sqm. Infini Garden is centrally located in Island City, which has become an increasingly popular area after it underwent a major infrastructure development in recent years. The property is located near the upcoming Fukuoka Children’s hospital and a 25 minute drive to the central business district, offering 2, 3 and 4 bedroom apartments.

What We Think

At a 6.6% yield and fully-funded by debt costing c.1.8%, we expect the acquisition to be yield-accretive and raise FY14-16 EPS by 0.7-1.5%. We estimate currency occupancy to be over 80%, but the master lease due to expire in June 2018 is expected to provide income stability. Post the acquisition, master lease contribution to overall portfolio gross profit is expected to grow from 32% to 34%. Additionally, exposure to Japan will grow to 14% (+2%), while gearing is expected to grow from 34% to c.36%. Although this acquisition will provide some positive impetus to the share price, its impact is relatively small, in our view. To date, the value of the Dalian and Japan acquisitions post the rights issue form 77.7% of the S$253.7m raised in December, while our FY14-15 DPU estimates remain c.7.7% below our pre-rights issue estimates.

What You Should Do

ART is currently trading at 7.3%/7.6% FY14/FY15 dividend yield, slightly below 7.6%/7.8% of the hospitality REITs sector. As such, we have maintained our Hold rating on ART with a slightly higher target price of S$1.23 while we await more yield-accretive acquisitions going forward.

Acquires rental housing in Fukuoka

• EBITDA yield of 6.6%
  
• 2nd property after Dec rights issue
  
• Maintain BUY
  

Another Japan rental housing property

ART has acquired a rental housing property in Fukuoka named Infini Garden for JPY6.3b (~S$78.4m) and with an EBITDA yield of 6.6%. On a pro forma basis, the accretive acquisition is expected to have increased FY13 DPU by 2.1% from 8.40 S cents to 8.58 S cents. ART acquired the 389-unit Infini Garden from The Ascott Limited (Ascott) and ArcResidential Japan Investments Limited. The master leasee is a third-party and with this acquisition, master lease contribution to total portfolio’s gross profit will grow increase from 32% to 34%. The remaining tenure of master lease is ~4.3 years.

Dalian property agreement announced in Feb

Recall also that in Feb ART entered into a conditional agreement with a third party to acquire its first serviced residence in Dalian for RMB571m (~S$118.6m) with an EBITDA yield of 5.5%. On a pro forma basis, that accretive acquisition was expected to increase FY13 DPU by 1.5% from 8.40 S cents to 8.53 S cents. This was the first acquisition announced after ART’s rights issue in Dec 2013 which raised S$253.7m. The 195-unit international serviced residence, which commenced operations in 2009, has an average occupancy of about 80%. ART will refurbish the property and it will be managed by Ascott as Somerset Grand Central Dalian when the acquisition is completed, which is expected to be by mid-2014.

Anticipate S$153m more in acquisitions

Before the announcements about the Dalian and Fukuoka properties, we had assume that around S$350m worth of property yielding ~5.5% will be acquired at the start of 2Q14; ART’s leverage will go back up to around 40%. We assume that any remaining acquisition or acquisitions to be announced in 1H14 will total S$153m with a 5.5% EBITDA yield.

Maintain BUY

Incorporating the Fukuoka and Dalian acquisitions, we maintain our FV of S$1.33 and BUY rating on ART.

Accretive Dalian acquisition

ART’s plan to acquire a serviced residence in Dalian, China did not come as a surprise to us. The S$118m investment offers an EBITDA yield of 5.5% and will be funded by debt costing 3.3%, making it an accretive investment. We estimate the impact of this deal on our FY14-16 DPU to be 0.6%-1.2%. There should be more acquisitions on the cards given that the amount utilised was only about half of the recent rights issue. We believe any additional

acquisitions should come at higher yields in order to justify the previous fund-raising. We maintain our Hold rating while our DDM-based target price (discounted at 8.5%) rises by 0.8%.

What Happened

ART has entered into a sales and purchase agreement with Winner Sight Investment Ltd, a third-party, to acquire a serviced residence in Dalian, China for a consideration of RMB571m (S$118.6m). The property is located in Jinzhou New District, a key development zone in Dalian, and is the only internationally-branded serviced residence in the region. It will be rebranded as Somerset and operated by Ascott Limited under a management contract.

What We Think

Accretive acquisition. At a 5.5% yield and fully funded by debt costing 3.3%, the acquisition is an accretive one. In operation since 2009, the property is a stabilised asset with ~80% occupancy and more than 80% of customers with length of stay longer than six months. International companies operating in the vicinity offer support to its high occupancy. Rebranding and refurbishment of the common areas can provide some upside to the room rates, albeit a small one, in our view.

More acquisitions should come at higher yields. Gearing remains healthy at 36.3% post the acquisition. Given that the acquisition used up slightly less than half of the rights issue, we expect an additional S$150m-200m worth of acquisitions to come. At our estimated cost of equity of 8.5%, we believe further acquisitions need to come at higher yields in order to justify the previous rights issue.

What You Should Do

Maintain Hold. ART’s FY14 dividend yield of 7.2% is slightly below the peer average of 7.5%.

2013: acquisition-led growth

ART’s results were in line with expectations, with FY13 results forming 97% of our forecast and 95% of consensus’s. We maintain our Hold rating, but raise our DDM-based target price (discount rate unchanged at 8.5%) to S$1.20. Our target price and DPS increases c.4% as we adjust for higher AEIs and ADR growth post their completion.

Acquisition-led growth

Growth in 2013 was largely acquisition-led and we expect the same for 2014. Properties worth a total of S$287m in China and Japan were acquired in 2013 at 5.4% annual EBITDA yield. These properties will make their first full-year contribution in 2014 and should continue to generate revenue growth. Given the rights issue and management’s guidance, we expect 2014 growth to be underpinned by acquisitions as well. The first acquisition should happen in the next three months and is likely to be located in China, Japan, Malaysia and Australia.

Same-store growth remains subdued on refurbishments

ART carried out about S$27m in refurbishments on selected properties in 2013, which contributed to lower gross profits in Australia, Indonesia and China on a same-store basis. Refurbishments for 2014 are likely to be about S$50m, largely targeting Vietnam, China Tianjin and Indonesia. Despite the larger scale of asset enhancement initiatives (AEIs), we expect the disruption to gross profit to be mitigated as properties in Vietnam and China Tianjin have lower occupancies. With several AEIs set to complete in 1Q2014, we expect same-store growth in refurbished properties to improve in 2014.

Maintain Hold

ART has rebounded about 6% since plummeting to a low of S$1.17 after its rights issue in Nov 2013. Given the lack of meaningful catalysts, we suspect this is partly due to speculation on its acquisition. We maintain our Hold rating as the stock is currently trading at 7.0% FY14 dividend yield, below its peer average of 7.4%.