YTL Hosp REIT upgraded to ''BUY''
Affin Hwang Investment Bank, March 8, 2022
YTL Hosp REIT
BUY
Target Price: RM1.15
Upgrading: a beneficiary of the borders reopening
- Australia reopened its borders to international travellers on 21 February and Malaysia will reopen its borders on 1 April 2022
- The Malaysian and Australian hotels contributed to 98% of YTLREIT’s FY19 net property income; the reopening should drive a recovery in the tourism sector and lift the REIT’s and its lessees’ revenue and profitability
- Reopening of country borders amidst high COVID-19 cases signals a change in the government’s strategy and should mark the start of a sustained recovery in the tourism sector. Upgrading YTLREIT to BUY with a higher TP of RM1.15
Reopening of Australia and Malaysia borders should improve business outlook
After two years of closure, Australia reopened its borders on 21 February 2022, welcoming fully-vaccinated international travellers while Malaysia will open its borders to international travellers from 1 April. The Malaysian and Australian operations contributed, respectively, 50% and 48% of YTLREIT’s FY19 net property income. The reopening should drive a recovery in the countries’ tourism sector and lift YTLREITs and / or its lessees’ FY22-23E revenue and profitability.
Reopening should mark the start of a sustained recovery in the tourism sector
We do not expect the reopening to have a material impact on YTLREIT’s short-term profitability. In Australia, YTLREIT has derived a significant share of its revenue from the government’s isolation group business programme. The reopening should mark a transition from isolation-derived revenue to commercial / tourism-based revenue, which may weaken YTLREIT’s initial revenue / profitability before improving towards 2H2022 on further improvements in tourist arrivals. In Malaysia, YTLREIT has leased its hotels under master-lease agreements – the changes in occupancy have no direct impact to its revenue / profit but help reduce the risks to enter into new rental variation arrangements.
Upgrading to BUY, from HOLD, with a higher TP of RM1.15
We cut our FY22-24E earnings by 7-11% after incorporating lower isolation-derived revenue for the Australian hotels and higher finance costs. Nonetheless, we remain positive on YTLREIT’s FY23-24E earnings outlook. We anticipate its distributable income to exceed FY19 levels driven by the collection of deferred leases, lower finance costs and increase in rents for master leases. We raise our DDM-derived 12-month target price to RM1.15 (from RM0.90) after lowering our cost of equity assumption. At 10% FY23E yield and 0.6x price-to-book, YTLREIT’s valuation looks attractive. Hence, we upgrade to BUY. Downside risks: further deferment in lease payments, sharp rise in interest rate, changes in government’s COVID-19 policies and emergence of new, deadly COVID-19 variants.
Australia reopened in February, Malaysia in April
After two years of closure, Australia has reopened to tourists on 21 February
Australia has had one of the most stringent border controls to protect itself against the COVID-19 pandemic and reported relatively low daily cases for most of 2020-21 (fig 1). For most of the pandemic, Australia pursued a “COVID-zero” policy that included strict snap lockdowns. However, the Government of Australia has abandoned the policy after rolling out vaccines, and the country has been gradually easing its border controls. With a relatively high vaccination rate of c.79.6% and low COVID-19 related mortality (vis-àvis the other nations), the country had on 21 February 2022 reopened the borders to welcome fully-vaccinated international travellers. Fully-vaccinated travellers would not have to self-quarantine when they have a negative post-travel test result.
Malaysia’s borders to reopen on 1 April 2022
Malaysia’s Prime Minister Datuk Seri Ismail Sabri Yaakob said the country will reopen its borders to international travellers starting 1 April 2022, reported The Star. The Prime Minister said visitors, as well as Malaysian returnees, who are fully vaccinated, are not required to undergo quarantine upon arrival. However, they must undergo a RT-PCR test two days before departure and a rapid test (RTK) upon arrival. Datuk Seri Ismail Sabri also said that the country will begin transitioning into the endemic phase starting 1 April, where operation hours for businesses will no longer be limited but face masks will remain mandatory. Social distancing will also no longer be imposed at mosques and places of worship.
Travel momentum builds as restrictions are lifted - IATA
A growing number of countries worldwide are relaxing their border controls in spite of the high daily COVID-19 cases. This is, in our view, attributable to the countries’ high vaccination rates and the decoupling of inflection and serious illness (due to the relatively “milder” Omicron variant and high level of vaccination).
According to a press release by The International Air Transport Association (IATA) dated 17 February 2022, its data shows growing momentum in the recovery of air travel as restrictions are lifted. IATA reported a sharp 11-percentage point increase for international tickets sold in the recent weeks (in proportion to 2019 sales), from 38% during the period around 25 January to 49% in the period around 8 February. IATA said the jump in ticket sales comes as more governments announced a relaxation of COVID-19 border restrictions (ie, Australia, France, the Philippines, UK, Switzerland, and Sweden among them). IATA’s Director General Willie Walsh said “Momentum toward normalizing traffic is growing. Vaccinated travellers have the potential to travel much more extensively with fewer hassles than even a few weeks ago. This is giving growing numbers of travellers the confidence to buy tickets”. Nonetheless, Walsh added that while the recent progress is impressive, the world remains far from 2019 levels of connectivity, as 13 of the top 50 travel markets still do not provide easy access to all vaccinated travellers.
The return of international travelers and relaxation of restrictions should drive a recovery in hotels’ revenue
Malaysian hotels accounted for 47-50% of YTLREIT’s pre-COVID-19 NPI; rental variations are affecting the cash payments between July 2020 and June 2022
YTLREIT owns ten hotels and resorts in Malaysia, all of which are leased to their respective lessees (mainly affiliate companies of YTL Corporation) under master-lease arrangements with fixed rental and a 5% step-up every five years. The master leases for nine of these hotels & resorts are set to expire between 2026-31 while the master lease for JW Marriott Hotel Kuala Lumpur is to expire on 31 December 2023.
The ten Malaysian hotels contributed to RM134m (or 27%) of YTLREIT’s FY19 revenue and RM127m (c.50%) of the REIT’s FY19 net property income (NPI). In 6M FY22, the Malaysian hotel portfolio accounted for 40.6% of YTLREIT’s revenue and 61% of NPI. While the revenue and NPI contributions from the Malaysian portfolio have been stable throughout the pandemic period (fig 3, fig 4), the cash proceeds from these leases are down by half due to rental variations arrangements between YTLREIT and the lessees.
To recap, the lessees had appealed and YTLREIT had agreed to: (i) reduce the lease rentals for 24 months commencing 1 July 2020 until 30 June 2022 (“rental adjustment period”) and (ii) pay the difference between the original rentals and reduced rentals on a staggered basis within 7 years after the rental adjustment period or over the remaining tenures of the existing leases whichever is earlier.
The reopening of Malaysia’s border should support the recovery in the hospitality sector, drive the lessees’ revenue and YTLREIT’s cash collections
The Government of Malaysia had in October 2021 lifted the interstate travel ban. The relaxation in interstate travel restrictions, high vaccination rates, strong pent-up demand and school holidays had driven a strong recovery in domestic tourism and lifted the average occupancy rates for the hotels, especially the resorts at holidays destinations. Based on our observation (fig 5), the hotels at Kuala Lumpur city centre had also shown improvement, though the recovery was relatively muted vis-à-vis the holiday resorts.
Elsewhere, the Prime Minister has just announced the reopening of Malaysia’s borders to international travellers starting 1 April 2022 and the country to begin transitioning into the endemic phase starting on the same date. These announcements mark a transition in the government strategy to prepare the citizens to live with the COVID-19 virus and significantly lowered the risk of reimplementation of blanket, prolonged lockdowns.
The return of international travellers, rise in business travel, corporate and social events and further improvement in domestic tourism (as the public accustomed to “live with the COVID-19 virus”) should drive a recovery in the lessees’ revenue, thereby improving YTLREIT’s cash collections when the rental adjustment period ends on 30 June 2022.
The provision of isolation / quarantine services have supported YTLREIT’s Australian operation during the COVID-19 pandemic period
In Australia, YTLREIT owns 3 hotels, namely Sydney Harbour Marriott (595 rooms), Brisbane Marriott (267 rooms) and Melbourne Marriott (186 rooms). Unlike the Malaysian portfolio, these Australian hotels are operated under management contracts and hence, YTLREIT’s revenue and NPI will fluctuate in tandem with the rise or fall in average occupancy rates and average daily rates. In FY19, the Australian operation contributed RM360m (c. 72%) to YTLREIT’s revenue and RM118m (c.48%) of the REIT’s NPI. The Australian hotels’ revenue and NPI contributions had however declined to RM93m (51%) and RM32m (28%) respectively during 6M FY22 due to lower average occupancy rates and decline in average daily rates. The REIT has seen a substantial decline in travellers’ arrivals during the period, and its business are largely supported by the provision of isolation services under the government isolation group business programme.
Looking ahead, YTLREIT’s Australian operation may see a short-term blip before a sustained recovery in revenue and profitability
As the Australian government reopened the country’s border for vaccinated international travellers and scaled down the isolation / quarantine requirements, we anticipate a transition in YTLREIT’s Australia revenue mix in the coming quarters, from isolation / quarantine-derived revenue to commercial / tourism-based revenue. During the earlier months, we anticipate YTLREIT’s Australian revenue and profitability to see a short-term blip due to lower contributions from the isolation / quarantine business, to be cushioned by a gradual recovery in commercial / tourism demand.
Approximately 9.4m overseas tourists visited Australia during 2019. Of which, the top five inbounding countries accounted for c.48% of the total tourist arrivals. These are China (14%), New Zealand (14%), US (8%), UK (7%) and Japan (5%). Judging from Australia’s previous tourist composition, we anticipate the recovery in its tourist arrivals to be gradual and staggered, as it also hinges on the reopening of the source countries.
Japan has yet to indicate its reopening plan and we see risks for further rental variation for the Japanese hotels
YTLREIT owns two hotels in Japan, namely Hilton Niseko Village and The Green Leaf Niseko Village. Similar to its Malaysian operations, these Japanese hotels are operated under master-lease arrangements and are currently under the rental adjustment period (50% reduction in rental between July 2020-June 2022, to be repaid over a period of 7 years or the remaining tenure of master leases, whichever is earlier). The Japan hotels contributed RM25m (c.5%) of YTLREIT’s FY19 revenue and RM21m (c.8%) of its NPI.
The Japan government had on 1 March 2022 reopened its borders to certain group of foreigners (ie, students, business travellers), but the government remains undecided when tourists will be able to enter the country. Judging from the recent developments in Asia Pacific, where many countries are reopening / considering to reopen after a strict lockdown, we expect Japan to reopen its borders to tourists in 2H22. In our view, the slow reopening poses a risk for further rental variation for YTLREIT’s Japan hotels.
Earnings outlook
We cut our our FY22-24E distributable earnings by 7-11%
We have cut YTLREIT’s FY22-24E distributable earnings forecasts by 7-11% after incorporating: (i) a lower near-term revenue and earnings contributions from the Australian operations in anticipation of lower revenue from the government isolation group business programme. This is to be cushioned by higher revenue from travellers and corporate / social events; and (ii) higher finance costs for its Australia Dollar denominated loans in anticipation of higher interest rate. To recap, the REIT has achieved notable interest savings during FY21 (fig 9) after the expiry of its AU$343m term loans that carried high interest costs of 4.5%; YTLREIT has since refinanced these borrowing at a much lower floating finance costs of 2.1%. As at end-December 2021, c.79.3% of YTLREIT’s borrowings were on floating rates and hence, we expect rising interest rates to lift YTLREIT’s FY23-24E finance costs.
Notwithstanding the cut, we are positive on the REIT’s earnings outlook
Notwithstanding our earnings cut, we remain positive on YTLREIT’s FY23-24E earnings outlook. We forecast YTLREIT’s distributable income to rebound strongly to RM167m in FY23E and RM189m in FY24E, which are higher than the RM134m reported in FY19, driven by a combination of factors including:
(i) Collection of deferred leases under the rental variation arrangements. Based on the current arrangements, YTLREIT is scheduled to receive RM15.6m of the deferred leases during FY23E, RM45.7m in FY24E and RM19.0m in FY25E. The higher lease collections for FY24E was due to a high final payment for JW Marriott Kuala Lumpur Hotel in tandem with the expiry of its master lease agreement on 31 December 2023;
(ii) Lower finance costs relatively to FY18-19A (fig 9) after the refinancing of the AUDdenominated borrowings at a lower interest costs;
(iii) Higher rental for some of the master leases in accordance to the 5% rental step up every 5 years.
Valuation and recommendation
Business recovery in sight, upgrade to BUY with a higher TP of RM1.15
The recent reopening of Australian borders, Malaysia’s plan to reopen to international travellers on 1 April 2022 and the government’s plan to begin transiting the country into the endemic phase amidst the high daily cases are clear indications that the leaders are adopting the “live with COVID-19 virus” strategy. Taking into consideration the leaders’ steadfast will to resume and support all economic activities, the high vaccination rate and a relatively low mortality associated with the Omicron variant, we believe the worst is behind us and we do not expect a reimplementation of strict, blanket lockdowns in Malaysia or Australia.
We turn more positive on the hospitality sector and raised YTLREIT’s DDM-derived 12-month target price to RM1.15 (from RM0.90), after incorporating our earnings revisions, lowering our cost of equity to 10% based on 1.0 beta (from 11.2%) and raising our distribution payout assumptions to 95% (from 90-95%). Taking into consideration Malaysia’s plan to transit into the endemic phase, YTLREIT’s improving medium-term and long-term business outlook, positive earnings recovery trajectory and attractive valuation, we are upgrading the REIT to BUY (from Hold).
At 10.2% FY23E yield and 0.6x price-to-book, valuation looks attractive
At 10.2% FY23E distribution yield, YTLREIT’s valuation looks attractive compared to its peers (fig 13) and against its pre-COVID-19, past-7-year average trailing yield of 7.2% (fig 11). Besides, YTLREIT’s price-to-book ratio of 0.6x is also the most attractive among its peers.
The key risks to our positive view
The key downside risks to our positive view are:
(i) Extension and / or signing of new rental variation arrangements upon the expiry of current arrangements in end-June 2022. While there are risks for rental variations / deferments for certain assets such as the Japan hotels, we do not expect the deferments (if any) to be as material as the prevailing arrangement, given the improving market conditions. We estimate that every 10% deferment to reduce our FY23E distributable earnings by 10%;
(ii) Sharp increase in interest rates. Approximately 79.3% of YTLREIT’s borrowings are on floating rates (as at end-December 2021). A sharper-than-expected, rapid increase in finance cost will negatively affect our earnings forecasts. We estimate a 25bps increase in finance cost to weaken its FY23E earnings by 2.5%; and
(iii) Weaker-than-expected earnings recovery due to weak regional economic growth, or reimplementation of lockdown on emergence of new, deadly COVID-19 variants.
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