Is now a good time to buy the bonds of Hotel Properties Limited?

Acquisitions and portfolio expansion

Last year, HPL made a few property and hotel acquisitions that brought its cash outflows from investing activities to S$61m in 2Q19 and S$150m in 3Q19. The largest investment was likely the 50-storey mixed development in Osaka City (Table 2) with an estimated acquisition consideration of JPY 20.85 billion (~S$257m). Other transactions involved a few hotel properties in Indonesia and a 5-star resort in Sri Lanka.

In hindsight, those acquisitions may have been ill-timed ahead of the virus outbreak that should lead to a global slowdown in tourist traffic. HPL’s investment outlay of S$150m in 3Q19 may had been too aggressive as it exceeded the outlay of S$133m for the entire year of 2017.

Table 2: HPL property acquisitions during 2019  

Travel sector discussion

Rental incomes along Orchard Road this year and, to a larger extent, hotel revenues, are likely to be adversely impacted by setbacks from the COVID-19 virus. HPL’s top-line performance is expected to be weighed down by room cancellations and a drop in tourists.

Many countries including Singapore and the Maldives have placed travel restrictions on Chinese visitors, who are significant contributors to the tourism and hospitality sectors. Singapore raised the Disease Outbreak Response System Condition Alert Level from Yellow to Orange on 7 Feb, and banned anyone with a travel history to China from entering the nation. According to the STB on 11 Feb, the number of tourists visiting the city-state could decline up to 30% this year, representing a greater decline than the 19% drop during the severe acute respiratory syndrome outbreak in 2003.  

The drop in Chinese tourism spending is likely to weigh on HPL’s top line as hotels made up 87% of group revenue during 2018. Geographically, Singapore and the Maldives contributed nearly 73% of total sales. A possible 24% of aggregate revenue from the rest of Asia may also fall due to lingering virus concerns.

The effect from the virus is likely to be seen from 1Q20 onwards. Based on estimates from the World Travel & Tourism Council, the average recovery time for visitor numbers to an affected destination was 19.4 months, although it could be as short as ten months if the right response was adopted. With these projections in mind, we think hospitality revenue may not pick up within a year, especially for harder hit areas such as Hong Kong and Singapore.

Credit profile

HPL’s credit profile weakened in recent periods. HPL’s profitability, denoted by EBITA margin, declined to ~31% in 2018 from ~36% in 2017. However, EBITA margin for TTM 3Q19 (~15%) was comparable to Banyan Tree Holdings Limited (TTM 3Q19: ~17%) but lower than Far East Orchard Limited (TTM 3Q19: ~32%). Like HPL, Far East Orchard and Banyan Tree are Singapore-listed hoteliers with property development business. However, Far East Orchard is broadly focused on Singapore and Australia with ~S$2.2 billion of tangible assets, while Banyan Tree operates mainly in Southeast Asia with a smaller tangible asset base of ~S$1.6 billion.

HPL’s leverage profile, defined as the ratio of debt to tangible assets, was higher than the other two hotel operators. Our measure of debt added to S$1.3 billion, which included the group’s borrowings, lease liabilities, perpetual notes and the recently issued HPLSP 4.400% Perpetual Corp (SGD). HPL’s gearing of ~41% exceeded that of Far East Orchard (~26%) and Banyan Tree (~36%). If we excluded perpetual securities from our measure, the ratio of debt to tangible assets would drop to ~32%.

Parallel to the trend of lower profitability, HPL’s ability to pay interest expenses deteriorated after 2017. After reaching ~8.3x in 2017, EBITA over interest expense decreased to ~2.4x in TTM 3Q19, which was lower than Far East Orchard (~3.4x) but higher than Banyan Tree (~0.9x). We had taken notice of Banyan Tree’s weak credit profile in an earlier report (see “Banyan Tree Holdings: credit update 16 Aug 19”.

Similar to the comparison results of interest coverage ratios, HPL’s adjusted cash flow-to-debt ratio dropped below Far East Orchard but stayed above Banyan Tree. At a level of ~8.4% in TTM 3Q19, HPL’s cash flow coverage ratio was ranked between Far East Orchard (~9.5%) and Banyan Tree (~5.9%). In determining the firm’s cash flow ability to cover debt, we defined the numerator as the difference between profits before working capital changes and paid dividends; the denominator is the company’s net debt or total debt less cash and cash equivalents.

Table 3: Selected financials of HPL and competitors (as at TTM 3Q19)

Bond valuation – fixed term bonds

Ask yields of HPL’s outstanding perpetual notes and bonds ranged between 2.80% and 4.00% on 17 Feb. With regard to HPL’s fixed maturity bonds, we do not think the hotelier will have difficulty paying off the HPLSP 3.880% 08Apr2020 Corp (SGD) and HPLSP 3.900% 23Apr2020 Corp (SGD) — short-term notes maturing in April with an aggregate principal amount of S$100m. Apart from these bonds, we compared the ask yield of HPLSP 3.850% 27May2021 Corp (SGD) against other notes issued by hoteliers and hospitality real estate investment trusts (Figure 1).

Figure 1: Relative valuation of the HPLSP 3.85% ‘21s

With a yield to maturity (“YTM”) of 2.87% as at 17 Feb, the HPLSP 3.85% ‘21s provided the highest ask yield among comparable credits. For this reason we think the HPLSP 3.85% ’21s are attractively priced among other issuers with exposure to the travel industry. As a pricing reference, Wheelock & Co Ltd’s 4.5% ‘21s had an ask YTM of 2.32%, while Wing Tai Properties’ (“WTP”) 4.3% ’21s and 4.1% ’21s also offered lower bond yields (in SGD terms).

Wheelock & Co and WTP are listed companies in Hong Kong that are principally involved in the areas of property development and hospitality management. The lower bond yields are possibly reflective of their respectable credit profiles. Wheelock & Co is a large developer with a net order book of HKD34.9 billion and net gearing ratio of 15.8%, while WTP’s adjusted net debt over equity remained healthy at 14.5%.  

At this juncture, yields of issuers with larger exposures to China are priced higher than those with more diversified revenue streams like ARTSP. The Shangri-La curve for example was noticeably higher than other issuers as China made up 41% of Shangri-La’s hotel properties EBITDA during 2018. Prior to the COVID-19 outbreak, occupancies at the China hotels were already at a low 64%, and RevPAR dropped 7% YoY in 1H19 from 1H18. We expect Shangri-La to write down its asset in Wuhan in the near term, and possibly delay the launch of its work-in-progress projects in Nanchang, Fuzhou, Shenyang, Kunming and Zhengzhou.

Bond valuation – perpetual securities

Perpetual notes, on the other hand, are subordinated to senior bonds and have embedded dividend pusher covenants with a twelve-month look-back period. Both the HPLSP 4.650% Perpetual Corp (SGD) and HPLSP 4.400% Perpetual Corp (SGD) were issued under HPL’s S$1 billion multicurrency debt issuance program dated 3 Mar 17.

HPL’s 4.650% perpetual note is first callable on 5 May 22. If the security is not redeemed on the first call date, the distribution rate would reset to the sum of the prevailing five-year SGD swap offer rate (“SOR”) and the initial spread of 268.5 basis points (“bps”). An additional step-up rate of 100 bps applies if the HPLSP 4.650% Perpetual Corp (SGD) is still outstanding on 5 May 27.

Analogous to the 4.65% perp, the reset rate for the HPLSP 4.400% Perpetual Corp (SGD) (first call/reset date: 22 Oct 24) is equivalent to the sum of the five-year SGD SOR plus the initial spread of 291.5bps. If the issuer does not redeem the perp by 22 Oct 29, the distribution rate steps up by an additional 100bps on top of the benchmark rate and initial spread.

To protect the interest of perpetual holders, a change-of-control (“CoC”) margin of 300bps will be enforced in predetermined situations for both securities. The CoC clause compensates noteholders in the event of a shareholding change. This is particularly pertinent if the controlling shareholder, Mr. Ong Beng Seng, is willing to sell the company to another party. However, this is unlikely to happen at this point in time.

We think that both the HPLSP perpetuals are attractively priced in regard to its yields relative to other comparable SGD securities (Figures 2 and 3), but we recommend investing in the HPLSP 4.65% perp over the HPL 4.4% perp. The ask yields to call (“YTC”) for the 4.65% and 4.40% notes were 3.93% and 3.92% respectively, implying that there is no incentive for investors to purchase the security with the longer term to first call.      

We observed that WTP’s WINGTA 4.350% Perpetual Corp (SGD) (first call date: 24 Aug 20) was priced at a YTC of 4.25% at the ask price of 100. WTP recorded a cash position of HKD2.4 billion that was substantially higher than its HKD1.0 billion of current borrowings at the end of June 2019. In view of the large cash position, we think there is a high likelihood that the issuer will redeem the 4.35% perp in August 2020. Nonetheless, the yield to reset of 4.36%, assuming that redemption will only take place on the reset date of 24 Aug 27, would still provide an attractive valuation (Figure 3).

Figure 2: Relative valuation of perpetual bonds using yields to next call 

Figure 3: Relative valuation of perpetual bonds using yields to reset

Summary

All things considered, we think that HPL’s credit quality could remain weak until we receive more clarity about the COVID-19 development. It remains to be seen if the situation would worsen further. If projections from the World Travel & Tourism Council are correct, then earnings could take up to a year or longer to recover.

However, we have to keep in mind about the potential uplift from stimulus measures that have been implemented by the governments as well as the potential fiscal spending from policymakers in Singapore. Furthermore, we think HPL should be able to refinance its loans and sell assets if needed to meet liquidity requirements. Given our expectation for an increase in visitor arrivals in 2021, we are positive on the bonds of HPL for the long term.

Recommended bonds

HPLSP 3.850% 27May2021 Corp (SGD) and HPLSP 4.650% Perpetual Corp (SGD)

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.