PORTFOLIO EXPOSED TO GROWTH REGIONS

• SG SRs account for 10% of lodging
  
• SG SRs still have room to grow
  
• ART exposed to the LT growth regions
  

SG lodging market: 10% serviced residences, 90% hotels

We indicated on 4 Sep 2012 that the supply of serviced residence (SR) units in Singapore is estimated to grow at 5.1% p.a. for 2012-2014 to approximately 5,765 units. This is faster than the 4.8% p.a. rate at which the hotel room stock in Singapore is expected to grow at. While SRs accounted for 9.1% of the rooms and units available as of end-2011, given that their average occupancies are higher than that of hotels (91.8% versus 86.5% for 2011, STB), we estimate that SRs account for approximately 9.6% of the Singapore lodging market (in terms of nights stayed), with hotels accounting for the rest.

SG SR sector not saturated yet

We estimate that SRs have a 20% share of the HK lodging market. According to one of the largest European serviced apartment companies, The Apartment Service (TAS), SRs account for 30% of the Australian lodging market. Against both markets, we see the potential for more growth for Singapore SRs, particularly versus HK – a close hospitality peer. TAS also indicates that SRs make up 8% of the US lodging market, significantly higher than that of UK’s (2%) and Europe’s (1%). By these figures, we believe that the SR sector in Europe has significant potential for expansion.

ART exposed to the LT growth regions

Through ART’s properties in Europe and developing Asia, which respectively accounted for 38% and 25% of its portfolio by asset value as of 30 Sep, it has good exposure to what we believe will be the longer term growth regions for the global SR industry. ART has emphasized that it continues to explore opportunities in Asia as well as London, Paris and key cities in Germany. We also see Europe’s SR industry as being relatively underdeveloped compared to those of the US, HK and Australia. For instance, according to data from CBRE, the number of SR units per 1,000 annual business travelers is 1.2 in London, versus 1.8 in Singapore, 1.9 in NY, 2.6 in Sydney and 5.3 in HK.

Maintain BUY

We maintain our fair value of S$1.37 and BUY rating on ART. We believe that the FY12F DPU yield of 6.9% is very attractive.

Forex dampener

ART's 3Q earnings growth was decent, but we expected a bigger boost from the London Olympics. UK RevPAU was resilient largely on the back of strong room rates post AEI. Revpau growth was again eroded by forex movements, the worst since 4Q08.

3Q/9M12 DPU met expectations at 25%/77% of our FY12 forecast and 26%/80% of consensus number. We adjust FY12-14 DPUs after factoring in the Hamburg acquisition and raise DDM-based target price for a lower discount rate of 8.2% (previously 8.5%). We remain Neutral given the lack of catalysts.

Decent growth

3Q12 growth of 6% yoy for revenue and 2% for gross profit were decent but fairly unexciting as a stronger 3Q had been expected. Group RevPAU edged up 1.4% yoy, led by the pan-Asian portfolio and the UK, offset by Europe. The euro's depreciation against S$ continued to erode gains in RevPAU and gross profit for the European portfolio (3Q: 43% of gross profit). Rental income will see a future boost from Ascott Raffles Place and Ascott Guangzhou acquisitions (completed in 3Q12) and Madison Hamburg (complete by 4Q12), offset by closure of Somerset Grand Cairnhill.

Smaller London boost

UK was resilient but slightly below expectations, with RevPAU +9% yoy and flat qoq from higher room rates post-refurbishment and close to 90% occupancy during the Olympics. Enhancements of its properties in Brussels, Jakarta and Spain should strengthen room rates in the next few quarters. Ascott's occupancies have proven fairly resilient in London (75%) and European cities (>70%), 5-10% pts below peak levels.

Europe opportunities but forex woes

On a portfolio basis, forex movements worsened for another quarter to -2.8%, bordering on the +/-3% range acceptable to management, led by Europe. We see the hedging of the euro as a possibility going forward. While macro conditions present opportunities for acquisition of higher-yielding assets, exposure to forex risk, a key concern, is also heightened.

RESULTS IN-LINE, UPPING FV TO S$1.37

• 3Q12 results as expected
  
• RevPAU grew by 1%
  
• Can compete with hotels and apartments
  

3Q12 results in-line

Ascott Residence Trust’s (ART) 3Q12 revenue increased by 6% YoY to S$77.4m, chiefly due to the contribution of Citadines Shinjuku and Citadines Kyoto, and better performance in the UK and China. Gross profit rose by 2% YoY to S$40.7m. 3Q12 DPU inched up 0.4% to 2.24 S cents. YTD 2012 DPU of 6.76 S cents is in-line with our expectations, forming 77% of our prior FY12 estimate of 8.8 S cents, which we now raise to 8.9 S cents. The portfolio will be enlarged by the acquisition of Madison Hamburg in 4Q12.

RevPAU inches up

Revenue per available unit (RevPAU) for the serviced residences (SRs) grew by 1% to S$148/day. In the UK, RevPAU grew by 9% YoY to S$228. The refurbished Citadines Prestige Trafalgar Square commanded higher rates. In China, RevPAU grew by 15% YoY to S$125, partly due to better demand for the refurbished apartments of Somerset Olympic Tower. There was weakness in France, Australia and Singapore. Revenue and gross profit in France fell 6% and 7% in S$ terms, however, in EUR terms, they had increased by 6% and 4% respectively. On a same-store basis, Australia saw RevPAU fall 2%. Singapore’s RevPAU dropped 4% arising from the then-impending closure of Somerset Grand Cairnhill on 27 Sep. As of Jul 2012, Somerset Salcedo Property Makati was renamed Salcedo Residences after conversion from a master lease arrangement to a management contract.

Balanced profile for duration of stay

We find it encouraging that significant fractions of YTD apartment rental income are contributed by stays of one week or less (34%), <1 month (18%) and >12 months (15%). This indicates that ART’s properties are able to compete with hotels, which are targeted at short-stay guests, and apartments (excluding SRs), which appeal to long-stay tenants. Average apartment rental income by length of stay is around four months.

Raise FV to S$1.37

We update our discount rate and capitalisation rate assumptions. Raising our fair value from S$1.30 to S$1.37, we maintain our BUY rating on ART.

Global headwinds remain

We returned from a non-deal roadshow more positive on the stock after gaining more clarity on growth potential via asset enhancements and acquisitions. That said, we continue to expect macro headwinds to cap same-store growth and see forex volatility as an overhang.

We revise our assumptions for long-term and AEI-led RevPau growth, and factor in S$100m in acquisitions in 2013/14, adjusting our DPU accordingly. DDM-based target price (8.5% discount rate) also rises. As the stock has done well YTD, we remain Neutral on the lack of strong catalysts.

Allaying investor concerns

Investor concerns were precipitated by the REIT's wide geographic reach. Global outlook was a key concern, with queries targeted at its European portfolio as well as Asia growth opportunities. Concerns were slightly allayed by the nature of the asset class (serviced residence vs. hotels) and structure of leases. Management targets long-staying corporate travellers vs. a more volatile tourist segment. Tourist exposure is limited to 10-20% in Asia and 50% in Europe, with average length of stay at 5-6 months in Asia and <1 month in Europe. Potential earnings volatility in Europe is minimised by master leases and minimum income terms, providing downside protection on >40% of portfolio earnings.

Next phase of growth

With the renovation cycle for serviced residences at 8-10 years, we see AEI potential for older assets. The UK's Citadines Prestige Trafalgar Square, which was recently renovated and rebranded, saw a 30-40% uplift in room rates. Ascott Jakarta is next in line, with expected completion in 1Q13. Management expects a 10-15% average increase in room rates post-AEI. Acquisitions will still focus on Asia (e.g. China, India, Vietnam), through 3rd party and sponsor acquisitions, with the latter seeing S$2bn-2.5bn of assets completing over the next few years. Management will maintain 65:35 Asia/Europe exposure.

Macros still a concern

Macro headwinds are our key concern, as we see growth on 60% of portfolio on management contracts (though limited to Pan Asia exposure) largely capped. Forex volatility is also a worry. We take comfort in recent renewed optimism on ECB action, but remain sceptical on its sustainability. Management caveats it might hedge the Euro depending on conditions.