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Follow up on Eagle Hospitality Trust

June 20, 2019 By KK

It’s almost a month since the IPO of Eagle Hospitality Trust and I thought I’ll take a look at it again given the price performance. Here are some thoughts regarding the 2 main concerns I raised in my IPO review – Trust in management and the Queen Mary.

About trust and alignment of interest

One issue that I think most people have is trust in management and the Sponsor as they are relatively unknown to us. But I think there are some indications based on their behaviour that the IPO is thought out and pro-actively managed to maximise investor upside.

Renovations and RGI

The Sponsor and owners obviously decided to renovate all their hotels prior to IPO so that the REIT will only enjoy the ramp up phase and avoid revenue compression if the hotels need to be renovated soon after IPO. This was the main reason why Revenue Generation Index (RGI) was below 100 in the years prior to the IPO. This shows some thought was placed in preparation for the IPO.

REIT vs Business Trust structure

Another point was on the decision to design a master lease structure that is 66% fixed rent with the remainder based on a percentage of Room Revenue and GOP. Based on my understanding, this is above market standard (about 50%) for SGX listed hospitality REITs. It is at least better than ARA US Hospitality Trust which used a largely Business Trust structure. This gives investors additional stability in DPUs.

Alignment of Interest

Source: Pg 110 of EHT's Prospectus

This is mainly seen in how the Founders of the Sponsor chose to roll their equity into the REIT and that the CEO owns a piece of the deal. This also indicated the Sponsor’s interest be along as investors and not asset managers.

About the Queen Mary

There was a lot of smoke surrounding the Queen Mary and I wanted to know what was relevant and what was noise. The main issue that needed clarity on was who’s responsible for the Queen Mary’s repairs – the REIT or the Sponsor.

On re-review of the prospectus, this part ended up being rather clear cut as it can be directly referenced from the prospectus amid a wall of text.

The Sponsor is responsible for the capital budget and major capital improvements

This is kind of implied from the fact that the lease on the Queen Mary was on a triple-net basis. However, for the avoidance of doubt, it was actually spelt out in a line at the top of Page 377 of the Prospectus.

Source: Pg 377 of EHT's Prospectus
Major capital improvement definition on Pg 375 of EHT's Prospectus

As such, even if the repair costs turn out to be massive, the REIT is not on the hook for the costs.

The Sponsor contributes to a Capital Improvement Fund (CIF) Reserve to fund capex

Additionally, if you are concerned about the Sponsor’s potential inability to fund capex, it is mandated in the Master Lease Agreement that the Sponsor contributes a percentage of each property’s Gross Room Revenue (Gross Operating Revenue for the Queen Mary) to a CIF Reserve quarterly. 

CIF Reserve and contributions (Pg 375 of Prospectus)

The percentage is 2% in 2019 and 3% from 2020 onwards. Based on my experience in the hospitality industry, these contribution rates are mostly consistent with industry standard.

Through this method, capex is largely funded upfront, with additional funding if needed footed by the Sponsor.

Given these facts, I feel the only residual risk associated with it is that in the event that structural damage is so significant and the ship is forced to close, the REIT will not be entitled to any rent.

Source: Pg 374 of EHT Prospectus

I feel that the likelihood of this happening is relatively remote though if what management says is true.

The investment case

Source: Yahoo Finance

EHT has performed rather poorly since IPO, with unit price down roughly 10% from IPO price. I like to think there are no bad investments, only bad prices. As such, here are some valuation calculations I did to see if there is a case to take a punt on the REIT.

Conservative Case assumes no value to the Queen Mary

I felt a good way to think about valuing the REIT was to develop a conservative / disaster valuation by excluding the effects of the Queen Mary from DPU and NAV. Do note that these computations are ball park estimates and do not take into account a whole host of knock on effects. 

Looking at the base case, the REIT is trading at a decent discount to book of about 19% and yielding a juicy 9.1%. As for the conservative case, the REIT is trading at close to book while sporting a decent 7.1% yield.

Based on these valuation metrics, I can see a case for taking a punt at base case valuations. That said, it is certainly not at fire sale valuations if you are concerned about the Queen Mary.

In Closing

Overall, on hindsight, I feel the Queen Mary issue is not that big an issue given the safeguards in place. What holds me back is that it’s too early to tell as we have no track record to rely on. The onus will be on management to prove their abilities in the coming years.

Do you agree with my assessment of the pertinent issues with EHT? Do let me know in the comments.

REIT IPO Articles
Eagle Hospitality Trust IPO Review
ARA US Hospitality Trust IPO Review

Resources
Eagle Hospitality Trust Website

If you missed my previous post
CRCT’s planned acquisition of 3 malls from Capitaland

Happy Hunting,
KK

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Related

Filed Under: Companies I've covered, Invest, REITs Tagged With: Eagle Hospitality Trust


Reader Interactions

Comments

  1. Chan Kit Whye says

    July 1, 2019 at 7:50 am

    Can you factor in the following scenario and its impact to dividend yield and NAV in SGD:

    1). A huge depreciation to the USD vs SGD to the extend that 1 USD = 1.20 SGD; and/or

    2) Madman Trump impose at least 15% withholding tax on distributable income to foreign shareholders.

    Please advise me via email kitwhye@hotmail.com when you have published the above assumptions and its financial impact. Thank you.

    • KK says

      July 1, 2019 at 10:05 am

      Hi Kit Whye,

      I’ll send you my reply via email.

      Regards,
      KK

  2. Jon Wai says

    July 15, 2019 at 2:57 pm

    Hi! Thanks for doing this analysis. I’m also quite curious about forex risk, given the uncertain global outlook and that this issue is unique to USD equities. What is your opinion on the impact on US REITS like Eagle and Prime?

    Thanks and regards.

    • KK says

      July 15, 2019 at 5:22 pm

      Hi Jon Wai,

      Glad you found the analysis useful. Forex risk is a risk that is inherent in investing in any overseas assets, not just USD equities. The impact on US REITs can be good or bad. If USD strengthens, you enjoy capital gains and higher dividends. The reverse is also true.

      Personally, I don’t have a view on currency outlook as it is something hard to predict and linked to many factors. Broadly, USD is currently the world’s reserve currency so there will certainly be demand for USD globally. As such, USD should continue to be a OK currency to hold investments in, at least on a short to medium term.

      Here’s a exchange rate sensitivity computation I did for Kit Whye if you would like to see some quantitative impact:

      SGD NAV: 0.881 x 1.20 = $1.0572
      Div Yield: 9% / 1.35 x 1.2 = 8%

      This implies that NAV will drop about SGD0.13 and yield will drop by 1% if currency falls from 1.35 to 1.2.

      Hope this helps

      • Jon Wai says

        July 15, 2019 at 5:37 pm

        Thanks, KK! Appreciate the time that experienced investors like you take to educate the public 🙂

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