Investment Highlights

• We downgrade YTL Hospitality REIT (YTL REIT) to HOLD from BUY with a slightly lower fair value (FV) of RM1.01 (from RM1.05) after changing our valuation method to the dividend discount method (DDM). No changes to our neutral 3-star ESG rating (Exhibit 11).

• We cut our distributable income forecasts by 4% for FY22F, 8% for FY23F and 10% for FY24F after factoring in a slightly lower average daily rate (ADR) and occupancy rate for the group’s Australia assets. In Australia, the guaranteed rental income for YTL REIT’s hotels will cease with the expiry of the government’s Covid-19 isolation programme. Recall that the Australian portfolio has contributed 51% of the group’s total gross revenue in 2QFY22.

• During the pandemic, YTL REIT has entered into a quarantine contract with the respective district governments to provide isolation accommodation to travellers arriving in Australia. Through this agreement, an occupancy rate of 70% has been guaranteed with a slightly higher daily rental rate offered by the Australian government.

• We have changed our valuation method to the DDM from an FY23F target distribution yield of 6.5% (Exhibit 1). In our view, DDM is able to better reflect the medium to long-term prospects of the company which distributes at least 90% of its income to unit holders as dividends.

• YTL REIT’s FY22F earnings will remain weak in FY22 due to reduced rentals to tenants which will end on 30 June 2022. From FY23F onwards, we expect the rental income to increase as tenants will need to repay the deferrals on a staggered basis as shown in Exhibit 2.

• With the reopening of international borders on 1 April 2022 and no further lockdowns, the likelihood of any extension of the rental deferrals to tenants in Malaysia will be low.

• However, we remain cautious on the recovery prospects of the group’s hotel in Japan as leisure tourists are still not allowed entry. Overseas tourist arrivals in Japan in February 2022 accounted for only 0.64% of the pre-Covid level (Exhibit 3).

• Similarly, we are concerned over the performance of the Australian portfolio in the upcoming quarters. This is due to the shift from a guaranteed rental income derived from the quarantine contracts executed with district governments to a tourism-based revenue.

• With the reopening of international borders in Australia, we foresee a gradual recovery in the number of visitors arriving in Australia. Nonetheless, we do not expect a substantial recovery in the near term as yet (Exhibit 3). In 2021, the purpose of the majority of the visitors arriving Australia was mainly for visiting friends/relatives. This amounted to 60.2% of the total short-term tourist arrivals. Meanwhile, only 8.7% of the tourist arrivals were for holidays and 8.5% for business-related trips. The relaxation on quarantine requirements varies from state to state in Australia. We expect leisure tourists to remain cautious entering Australia as: (i) visitors are still required to take Covid-19 rapid antigen test within 24 hours of their arrival; and (ii) the emergence of more contagious Omicron sub-variant, the XE.

• The downside risks to our assumption are: (i) further contraction in yield spread against the 10-year MGS with a faster-than-expected interest rate hike to curb rising inflation; (ii) a slower-than-expected recovery in the travel and tourism industry due to the reintroduction of international border restrictions with the emergence of more contagious Covid-19 variants; and (iii) stagflationary risks which could substantively dampen the company’s revenue and earnings due to lower occupancy rates and average rental per room.

• The spread between YTL Hospitality REIT’s FY22Fdistribution yield of 4.5% is narrowing against the 10-year Malaysian Government Securities (MGS) yield of 4.1% as of 20 April 2022. However, YTL REIT’s distribution yield is still slightly higher than the average DPU yield for REITs under our coverage.

Source: AmInvest Research - 21 Apr 2022