• We expect hotel RevPAR to increase by 11% YoY for Hilton and 22% for Crown Plaza in FY24e. Downside risk protected by the fixed component of the hotel master lease agreement which will support a 6% dividend yield. The Hilton rebranding has boosted RevPAR by 27%. 
• Singapore office and retail are expected to sustain a 10% rental reversion in FY24e and maintain an occupancy rate above 95%. Shanghai will continue to be under pressure.
• OUE REIT is the investment-grade REIT with the largest discount to NAV (0.43x P/NAV) and an attractive yield of 7.8%. We  believe the discount is not warranted. Around 92% of the portfolio is in Singapore with resilient occupancy rates and rental growth. We initiate coverage with a BUY recommendation on OUE REIT and a DDM-based target price of S$0.33.

Company Background
OUE Real Estate Investment Trust (OUE REIT) is one of Singapore's largest diversified REITs, with assets totalling S$6.3bn as of Dec23. The REIT focuses on hospitality, retail, and office properties in major financial and business hubs. In Singapore, OUE REIT owns two hotels and four office-cum-retail assets in the CBD area: Mandarin Gallery on Orchard Road, One Raffles Place, OUE Downtown Office and OUE Bayfront (with a 50% interest). In Shanghai, OUE REIT owns one Grade-A commercial asset, Lippo Plaza, located in a prime CBD location. Singapore assets account for 92.5% of the total portfolio value.

Key Investment Merits
• Upside potential from AEI and repositioning, with downside protected by the master lease. Hilton had its full contribution in FY23 after repositioning from Mandarin Orchard, focusing more on business travelers with a target on US customers, thereby increasing RevPAR by 27% after rebranding. We forecast RevPAR to grow by 11% for Hilton in FY24, given the continued recovery of visitor arrivals and limited new supply. Meanwhile, Crowne Plaza also completed its AEI in Oct23. The master lease agreement ensures a minimum rent of S$67.5mn, support a group yield about 6%.
• High rental reversion to sustain in FY24e. OUE REIT managed to secure high rental reversions of 12.0% for office and 13.7% for retail in FY23. This momentum is expected to continue in FY24e at 10%. We believe the new office supply will not place significant rental pressure, as asking rents are higher than the office properties owned by OUE REIT. While rental reversion for Lippo Shanghai may still be negative, given its small revenue exposure of c.7.7%, we believe the effect on the overall portfolio will be marginal.
• Attractive investment grade dividend yield. OUE obtained investment grade rating by S&P in 2023. Compared to other nine REITs with investment ratings, OUE REIT has a relatively healthy gearing of 38.8%, the largest discount of 0.43x P/NAV, and an attractive yield of 7.8%. Furthermore, the recent green bond issuance is at a more favourable rate of 4.1%, which is lower than the current all in cost of debt (1Q24: 4.5%). We do expect
another year of interest rate headwinds, causing DPU to decline further in FY24e with a recovery in FY25e.

We initiate coverage with a BUY rating and a target price of S$0.33 based on DDM valuation, COE of 10.5%, and terminal growth of 1%. We expect a DPU of 2.0 cents for FY24e and 2.9 cents for FY25e, translating into yields of 7.8% and 11.4%, respectively.

Revenue
Gross revenue
Gross revenue is comprised of master lease rental, retail, and office revenue. OUE REIT reports its revenue breakdown by rental income, service fee income, carpark income, and other income. In 1Q24, rental income contributed 91% to total gross revenue, service fee income accounted for 6%, and carpark income comprised 2%. Hotel revenue is calculated based on the operating period multiplied by the average daily rate and average occupancy rate. Base Rent is the rental income received after accounting for leasing incentives such as rent rebates and rent-free periods. Service Charge refers to contribution paid by tenants to cover the operational and property maintenance expenses of the Properties. Other income includes income such as utilities and annual license fee, which are recognised over time as the service is provided.

Master Lease Structure
Hilton Singapore Orchard is leased to OUE Limited under a master lease agreement with an initial term of 15 years starting from July13, and an option to renew for an additional 15 years. Crowne Plaza Changi Airport is also leased to OUE Airport Hotel Pte. Ltd. under a master lease agreement until May28, with an option to renew for two consecutive five-year terms. The Master Lease Agreements consist of both a Fixed Rent component and a Variable Rent component. Variable rent for Hilton Singapore Orchard comprises a sum of 33.0% of Gross Operating Revenue (GOR) and 27.5% of Gross Operating Profit (GOP), subject to a minimum rent of S$45.0mn. For Crowne Plaza Changi Airport, variable rent comprises the sum of: (i) 4% of hotel F&B revenues, (ii) 33% of hotel rooms and other revenues not related to F&B; (iii) 30% of hotel GOP; and (iv) 80% of gross rental income from leased space, subject to a minimum rent of S$22.5mn.

OUE REIT has been enjoying downside protection since COVID-19, and the variable component just surpassed the minimum level in 2023, reaching S$91.6mn. We believe the 2 hotels will continue performing going forward.

• OUE owns, develops and manages commercial, hospitality, retail and residential assets. It also has interests in the consumer and healthcare sectors.
• It is the sponsor of OUE C-REIT, which divested 50.0% of OUE Bayfront, OUE Tower and OUE Link in March 2021 at a 26.1% premium over purchase consideration.
• Indirect associate acquired a 32% stake in Matahari, the largest departmental store in Indonesia. This brings OUE’s effective stake to 19% and expands its consumer segment which historically contributes 2% to topline.
• When relaunched in 2022, OUE’s Mandarin Orchard Singapore is expected to become Hilton’s flagship hotel in Singapore and the largest Hilton hotel in the Asia Pacific.

Company background

OUE is a diversified owner, developer and operator of real estate in Asia. It manages  landmark assets in the commercial, hospitality, retail and residential sectors. It is also the sponsor of OUE Commercial Real Estate Investment Trust (OUECT SP, Not Rated). In 2017 and 2018, OUE expanded into the healthcare sector with the acquisition of OUE Lippo Healthcare Limited (IHC SP, Not Rated) and First REIT Management Limited (FIRT SP, Not Rated). In 2019, it entered the consumer sector with OUE Restaurants. Singapore is its largest revenue contributor, at 83% of FY20 revenue.

Highlights                                                           

1. 50% divestment of OUE Bayfront, OUE Tower and OUE Link. On 31 March 2021, OUE C-REIT divested 50.0% of OUE Bayfront, OUE Tower and OUE Link to a 50:50 limited liability partnership between OUE C-REIT and Allianz Investor. Main reasons for the divestment were realising capital appreciation and the opportunity to optimise its capital structure and increase its financial flexibility. The deal was transacted at a 26.1% premium to its purchase consideration in 2014. Net proceeds of S$262.6mn were used to redeem convertible perpetual preferred units and pare down debt to optimise OUE C-REIT’s capital structure.

2. Acquisition of Matahari for consumer expansion. On 15 July 2021, OUE’s indirect associate acquired 32% of PT Matahari Department Store Tbk. This brought OUE’s effective stake to 19.2%. Matahari is the largest departmental store in Indonesia. Prior to Covid-19, Matahari enjoyed healthy cash flows. Despite its market leadership with a unique portfolio of assets, its stock underperformed peers on a 5-year basis. With 147 outlets in Indonesia, the acquisition has extended OUE’s consumer division - which historically contributes 2% to its topline - to the growth market of Indonesia.

3. Mandarin Orchard Singapore to become largest Hilton hotel in APAC in 2022. In March 2020, OUE rebranded Mandarin Orchard Singapore into Hilton Singapore Orchard. This is to leverage Hilton’s strong brand recognition, global sales and distribution network, and highly successful guest loyalty programme to pursue a higher-yielding market among corporate and leisure travellers. Upon its relaunch in 2022, Hilton Singapore Orchard will be Hilton’s flagship hotel in Singapore and the largest Hilton hotel in the Asia Pacific. The rebranding is expected to position the hotel for an anticipated sector recovery once travel restrictions are eased.