Part of a strong franchise. We are re-initiating coverage on Ascott Residence Trust (ART). ART owns a portfolio of serviced residence and rental housing properties in the pan-Asian region. The REIT's properties are managed by The Ascott Group (Ascott), the serviced residence arm of 47.2% stakeholder CapitaLand. Ascott is the world's largest international serviced residence owner-operator and has a 25-year industry track record. Its serviced residence brands enjoy world-wide recognition and strong award-winning reputations. ART's highly diversified portfolio spans 11 cities in seven countries with no country contributing more than 25% of total FY08 revenue. ART trades at one of the highest forward yields within the S-REIT sector. It is also trading at a 68% discount to last reported NAV.

Near-term yield volatility. RevPAU is the key metric driving ART's earnings and distributions performance. 4Q08 RevPAU showed the first impact of global economic events. ART's China properties saw a 43% drop in 4Q RevPAU to S$127, as rates and occupancy fell post-Olympics. ART's Singapore properties saw a 12% decline in 4Q08 RevPAU to S$230. We expect RevPAU to remain volatile (and on a downtrend) with demand for corporate travel impacted by the current macroeconomic turmoil. We are estimating DPU of 6.6 S cents for FY09F (down 24% YoY) and 6.2 S cents for FY10F (down 7% YoY). These figures are roughly 6-7% below consensus.
A viable investment option. While we agree that yields will decline in FY09-10F, ART's current valuation seems to be pricing in a perpetual bearcase. In our view, current share prices reflect a belief that business conditions deteriorate to a certain extent and then stay that way. The investment question then breaks down into two components: 1) A volatile (but still comfortable) yield over the next two years, and 2) A very low "floor" valuation that leaves ample room on the upside. We believe ART is a viable investment option for investors who can accept the near-term yield volatility and judge ART on the basis of its long-term prospects (which we think are sound).

Re-initiating with BUY rating. Our SOTP value of the trust is S$0.76. This incorporates our assumption of an equity issue of S$160m at the S$0.45 price level. Our fair value estimate for ART is S$0.57, at a 25% discount to our SOTP value. Key risks to our estimates include a worse- than-expected deterioration in the economic outlook in ART's operating markets, a larger-than-expected cash call or more-than-expected dilution, and higher debt costs.