Far East Hospitality Trust: Initiation Report

Business Model of Far East Hospitality Trust

Far East Hospitality Trust is a Singapore-focused hotel and service residence hospitality trust listed on the SGX. It IPO-ed on 27 August 2012 at 0.93 cents with ticker code of (Q5T.SI). As at 30 October 2018, it has a market capitalisation of SGD$1,132 million. Far East Hospitality Trust is a stapled Trust that consists of both a REIT and a Business Trust. Heartland Boy knows that REIT has a unique set of framework. As REITs are mandated to hold stable assets, Hospitality REITs have to devise creative ways to overcome this regulatory hurdle. Therefore, Heartland Boy has provided some layman notes to Far East Hospitality Trust’s holding structure found in its Annual Report to aid your understanding.

Diagram 1: Chart of Far East Hospitality Trust: Adapted from 2017 Annual Report

• REIT Manager rents out the Hotel and Service Residence portfolio to a Master Lessee
• The Master Lessee enters into a Hotel Management Agreement with a hospitality operator (in this case, it happens to be Far East Orchard, an entity related to Far East Organisation)
• Master Lessee is a passive tenant who simply collects profits (if any) from the assets after paying management fees to the hospitality operator. In turn, Master Lessee pays rent to the Landlord (FEHT) for use of the assets.
• The Business Trust is established with a view to be appointed as master lessee of last resort and has remained dormant so far.

Far East Hospitality Trust’s portfolio of assets is shown in Diagram 2.

Diagram 2: FEHT Portfolio across 3 sectors

It is critical to understand the rental formula under which the REIT is getting its cash flow as it allows unitholders to understand the variability of a hotel REIT’s cashflow. For instance, structuring a high fixed rent with a low variable rent component means lower risk for a hotel REIT. Hotels & Serviced Residences of Far East Hospitality Trust are leased to Master Lessees in accordance to the Master Lease Agreements for a duration of 20 years, with an option for Master Lessees to extend for a further 20 years. Master Lessees will pay rent in the form of Fixed Rent and Variable Rent to Far East Hospitality Trust. The specific breakdown is shown below:

a) Hotels

• Fixed Rent ranging from S$2.5 to S$10 million and
• Variable Rent consisting both 33% of Gross Operating Revenue (‘GOR’) + (23%-37%) of GOP less Fixed Rent in (i)

In 2Q2018, Hotels contributed 70% of Gross Revenue.

b) Serviced Residence

• Fixed Rent ranging from S$1.5 to S$3.5 million and
• Variable Rent consisting both 33% of Gross Operating Revenue (‘GOR’) + (38%-41%) of GOP less Fixed Rent in (i)

In 2Q2018, Serviced Residences contributed 10% of Gross Revenue. For those who are interested to know the specific rental arrangement between the Trust and the respective Master Lessee, please refer to its Prospectus.

c) Commercial Space

Commercial space consists of retail, office and serviced office units. Specifically, Far East Hospitality Trust has approximately 286 units across 9 properties. There is no concept of master lease as the leases are negotiated between the Asset Manager and the various individual end-user tenants at market rates.

In 2Q2018, Commercial Space contributed 20% of Gross Revenue.

Investment Merits of Far East Hospitality Trust

1. Discount To Book

At a stock price of 60.5 cents and a NAV of 0.87, Far East Hospitality Trust currently trades at a Price to Book ratio of 0.7. However, its peers on the SGX are trading at P/B ratio of:

• OUE Hospitality Trust – 0.92
• CDL Hospitality Trust – 1.03
• Frasers Hospitality Trust – 0.85

It is this disparity with its peers that prompted Heartland Boy to conduct further investigation.

2. Growth Drivers

i) Tourists Numbers Are Climbing Up

Demand for Far East Hospitality Trust’s hotels depend greatly on Singapore’s inbound tourist arrivals. In simple economics, if more tourists arrive, there will be greater need for more room nights. Ceteris paribus, the entire hotel industry will sell more room nights. Heartland Boy refers to Singapore Tourism Board to track international visitor arrivals. As shown in Diagram 3, Singapore has done very will in 2018 thus far, recording a YTD 7.5% increase in tourist arrivals.

Diagram 3: Tourists arrival year-on-year comparison by month from Jan-Aug 2018

One-off events such as Trump-Kim Summit and the Crazy Rich Asians movie will increase awareness about Singapore and inevitably spur more tourist arrivals. All these can only bode well for the tourism industry.

ii) Tight Hotel Supply Until 2021

On the supply side, upcoming inventory will be significantly lower than what the industry had experienced for the past decade. From 2008 to 2017, an average of 3,000 rooms per annum had been added to the market. However, only a cumulative total of 2,600 rooms will be added from the period of 2018 to 2020. An absence of Government Land Sale site for the past 5 years has led to a situation of low inventory for the next few years.

Diagram 4: Record-low upcoming inventory from 2018-2020 (Source: Maybank Kim Eng)

A combination of growing demand and tight supply will lead to higher Average Daily Rates (‘ADR’) and Occupancy. As the only Singapore-focused hospitality REIT, the outlook for Far East Hospitality Trust is certainly bright. According to its performance in FY2017, its Hotels & Serviced Residences portfolio earned $81.2 million in gross rent. $60.5 million was from fixed rent while the remaining 25% was variable rent. This suggests that there is significant room for Far East Hospitality Trust to enjoy upside from the favourable micro-economic situation.

iii) Oasia Hotel Downtown To Fully Contribute

Oasia Hotel Downtown is a very new property completed recently in 2016. As a result, its REVPAR underperformed the industry average in 2017 due to a lack of brand awareness. Therefore, there is an opportunity for REVPAR to improve once the property reaches a more mature stage. Given that it was purchased by Far East Hospitality Trust in April 2018, unitholders can look forward to a full year of contribution in 2019.

iv) Sentosa Properties To Complete In 2019

In September 2014, Far East Hospitality Trust entered into a Joint Venture and undertook a 30% equity stake to develop a total of 3 hotels (839 rooms) in Sentosa. They are:

• Village Hotel (606 rooms) which serves the mid-tier market,
• The Outpost Hotel (193-room) which serves the upscale market, and
• The Barracks Hotel (40-room) which serves the luxury market

In its latest announcement update, the properties will progressively open from 1Q2019, furthering driving organic DPU growth.

Investment Risks of Far East Hospitality Trust

1. Unpredictable One-Off Events

In the traditional real estate space, Hospitality is considered the most vulnerable asset class. All it takes is one natural disaster or one pandemic to cause the Hotel’s performance to suffer overnight. Moreover, Hospitality is a perishable product. A room night not sold cannot be returned to the inventory. As these events are often unpredictable in nature, a larger discount is afforded by the market compared to other asset types. Therefore, unitholders of Hospitality assets must be able to stomach this type of risk.

2. Poor Track Record of Manager

The track record of the REIT Manger has been remarkably consistently poor. This assessment is made by observing its dividend history as shown in Diagram 5.

Diagram 5: DPU Track Record of Far East Hospitality Trust

Since its IPO, DPU has declined by a CAGR of -6.9% per year. As a result, unitholders who have held the Trust since IPO would have made an overall loss as the dividends distributed in the past are still insufficient to account for the capital loss. However, Far East Hospitality Trust had demonstrated 3 quarters of outperformance in 2018 thus far. This is a sign to Heartland Boy that a turnaround is in sight for this unloved Hospitality Trust.

3. Under Investigation By CCSS

In the latest news announced in August 2018, The Competition and Consumer Commission of Singapore (CCSS) issued a Proposed Infringement Decision against the owners and operators of three hotels: Capri, Village and Crown Plaza. It is alleged that the operators “entered into agreements or practices to discuss and exchange confidential, customer-specific and sensitive information on the provision of hotel room accommodation in Singapore to corporate customers”.

It is not known at this point if any remedies and financial penalties will be imposed by CCCS. Heartland Boy expects minimal reputational damage to the Trust but any one-off financial penalty will definitely eat into the DPU. Regardless, this is a question that Heartland Boy will definitely be asking the Board of Directors at the AGM.

4. High Gearing

Far East Hospitality Trust has a high gearing ratio of 40% in 3Q2018. As a Trust, it may not face any gearing limits. However, this also implies that any future acquisition from its Sponsor’s pipeline would likely have to be funded via equity. If a private placement is not done, Far East Hospitality Trust could will be calling for a rights offering. Therefore, unitholders, especially those who had purchased FEHT via SRS, would have to bear this in mind.

Review of Far East Hospitality Trust

At a share price of 0.605 cents, Far East Hospitality Trust has a dividend yield of 6.6% and a Price/Book Ratio of 0.7. Heartland Boy thinks that once Far East Hospitality Trust is able to fully arrest the slide in its DPU, the market would start to appreciate it more. The discount it is trading at compared to its peers is simply too large and unwarranted. Heartland Boy expects it to trade nearer to P/B of 0.8 and its DPU to improve to a minimum of 4 cents. Analyst research reports by DBS Vickers and OCBC indicated target prices of 0.74 and 0.69 cents respectively.

Vested at an average price of 0.625 cents since October 2018. Heartland Boy will definitely add more if his thesis of a turnaround in SG Hospitality pans out. He will continue to share his thoughts of Far East Hospitality Trust on forums such as InvestingNote.

This article was published on 4 November 2018.