Ascott Residence Trust - Potential value creation (CIMB)

OUTPERFORM Maintained

S$1.23 Target: S$1.37

Mkt.Cap: S$1,384m/US$1,150m

Provisional permission to redevelop Somerset Grand Cairnhill

Potential accretion. ART announced yesterday that URA has granted provisional Outline Planning Permission for the redevelopment of Somerset Grand Cairnhill Singapore, into an integrated hotel and residential project. While we believe that any redevelopment could unlock value for unit-holders (asset appears undervalued against capital values for comparable residential and hospitality properties on the conversion of use), we believe this will have to be weighed against high replacement costs, potentially lower Singapore income contributions and development risks. No change to our DPU estimates or DDM-based target price of S$1.37 (discount rate 8.3%) pending clarity on any potential redevelopment. At a forward yield of 7% and 0.9x P/BV, we believe ART offers more value exposure to strong Asian consumption and travelling. We see catalysts from higher-than-expected room REVPAU.

The news

The URA has granted provisional Outline Planning Permission for the redevelopment of Somerset Grand Cairnhill Singapore, into an integrated hotel and residential project. Approval has been granted on the following terms and conditions:

• Rezoning the site from residential to commercial and residential

• Maximum allowable GFA of about 43,400 sq m; comprising minimum hotel and hotel-related uses and 60% residential use

• Retention of the Al-Falah Mosque in the redevelopment; and

• Payment of development charges, if any, and land/differential premiums.

The existing lease will expire in 2082 and the manager will look into the possibility of an extension. Apart from the above, management’s priorities would be the retention of ART’s presence in the Orchard Road area and yield accretion for unit-holders. Management is evaluating possible options and there is no certainty if it will proceed with plans.

Comments

Potential unlocking of value. Somerset Grand Cairnhill is a 32-storey building with GFA of 33,000 sq m and NLA of 20,048 sq m. It has been valued at S$271.9m (as at end-Jun 11), implying S$765 psf (GFA) and S$1,260 psf (NLA). We believe the unlocking of value could come from:

• A higher maximum allowable GFA: URA’s approval allows for a 31% increase in GFA to 43,000 sq m which should add to saleable/leasable area and the value of the asset.

• Higher efficiency: its low efficiency of 61% (norms of 70-75% for serviced apartments) had always been a downside. Asset redevelopment should allow ART to extract higher efficiencies and value from the asset.

• Higher value for alternative uses: current psf valuations appear low against comparable hotel and residential assets. With nearby 99-year leasehold residential projects selling at ASPs S$2,700 psf and hotels (such as Mandarin Orchard, albeit older with a 99-year lease from Jul 1957) valued at about S$1.1k psf (GFA) or an estimated S$1.6k psf (NLA) as at end-Dec 10, redevelopment of the asset into an integrated hotel and residential project could unlock significant value.

Replacement costs could be high. Somerset Grand Cairnhill is ART’s largest asset locally by value and contributes to nearly half of its local gross rental income. Its redevelopment could reduce income contributions and further dilute its presence locally. With a low acquisition price of S$155m back when ART was listed, the completion of the refurbishment of its apartments recently in 2010 and likely high capital values for local competing assets, the opportunity cost of replacing this income stream could be high.

Structure. As management is still evaluating various options, no details on potential structures have been furnished. As REITs are not allowed to spin off development projects on completion, we believe CapitaLand and other third parties could potentially be involved should there be a residential component to the redevelopment. This could take the form of joint ventures with CapitaLand or a potential spinning off of the asset as an integrated residential and hotel to CapitaLand (before development), in our opinion. CapitaLand could also be potentially involved as a developer to ring-fence development risks for ART.

Too few details to determine net value now. Due to a lack of clarity on the configuration of the final asset (should there be redevelopment) and the mode of structuring the deal, there are too few details for the evaluation of its overall net value. We believe the transaction is likely an opportunistic one. Any action should also be weighed against development risks which ART may have to undertake.

Valuation and recommendation

Potential accretion; maintain Outperform. While we believe that any redevelopment could unlock value for unit-holders, this would have to be weighed against high replacement costs, potentially lower Singapore income contributions and development risks etc. No change to our DPU estimates or DDM-based target price of S$1.37 (discount rate 8.3%) pending clarity on any potential redevelopment. At a forward yield of 7% and 0.9x P/BV, we believe ART offers more value exposure to strong Asian consumption and travelling. We see catalysts from higher-than-expected room REVPAU.