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3 Reasons I’m Avoiding Far East Hospitality Trust

Far East Hospitality Trust (SGX: Q5T), or FEHT, is a Singapore-focused hotel and serviced residence REIT. Its portfolio comprises 13 properties totaling 3,143 hotel rooms and serviced residence units that are valued at around S$2.63 billion as of 31 December 2018.

When analysing REITs, I tend to look for attributes that assure me of both the sustainability and consistency of its distribution per unit (DPU) as well as the stability of its portfolio. I also have a tendency to lean towards REITs with bright growth prospects, either by way of rental reversion, asset enhancement initiatives (AEIs), or mergers and acquisitions (M&A). The type of assets in the REIT’s portfolio also determine its risk profile and how badly it may be affected during a downturn.

FEHT recently reported its Q2 2019 earnings, and going by the numbers within the report, here are three clear reasons why I’m avoiding this REIT for now.

1. Decline in DPU

FEHT reported a 2.1% year-on-year decline in gross revenue for the quarter, mainly attributable to softness in corporate travel demand amid global macroeconomic uncertainties. With US-China trade tensions still ongoing, corporations have started being cautious about business travel spending, thus dampening the hospitality industry in Singapore. Furthermore, there was an absence of large-scale events in the same period last year, as these provided a one-off boost to occupancy rates back then.

As it incurred higher finance costs during the quarter (up 10.9% year-on-year), distributable income fell by a larger 7.4% year-on-year, resulting in a 9.9% year-on-year decline in DPU to 0.91 Singapore cents. For H1 2019, the decline in DPU was 6.7% year-on-year to 1.82 Singapore cents. FEHT is offering a dividend yield of around 5.6% based on its last traded price of S$0.66 per unit.

2. Poor operational performance

Operating metrics remained weak during the quarter, with average occupancy falling by 1.7 percentage points (ppt) and 1.6 ppt for hotels and serviced residences, respectively. The average daily rate (ADR) for hotels was down by 2.6% but was offset by an improvement in ADR for serviced residences. Revenue per available room (RevPAR) for hotels softened by 4.5% year-on-year as weaker demand translated to lower overall revenue for each hotel room.

The saving grace here is that serviced residences displayed better operational metrics, reporting higher ADR and RevPar, so this provided some buffer for the REIT. Nevertheless, the poor operational numbers show that the REIT is unable to shield itself from the effects of the challenging environment it is currently facing.

3. High gearing level

Finally, FEHT reported a high gearing level of 39.8%. This leaves hardly any room for M&A as the statutory limit for gearing for REITs stands at 45%. Though it may seem that the REIT still has some headroom for gearing up, most REITs tend not to cross the 40% mark for conservative reasons.

This implies that FEHT has hardly any wiggle room for borrowing more and would have to resort to either a rights issue or a placement of shares in order to reduce its gearing level.

Waiting for an improvement

FEHT seems to be caught between a rock and a hard place. It is a victim of the hospitality industry’s woes and is also unable to extricate itself by acquiring good assets at knock-down prices. The REIT has to hunker down and wait for conditions to get better but it may continue to see revenue and occupancy being affected by weak demand. Unless I see its financial and operating metrics improve, I am staying away from its shares.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Royston Yang does not own shares in any of the companies mentioned.