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Hospitality B Property share analysis

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29 Apr 2012. On 14 March 2012 it was announced that RECM, who I admire & follow closely, had invested in Hospitality B (they had increased their exposure to 5%); and more recently one of our readers asked me to do a write-up on the company, so I decided to take a closer look. In March the Hospitality Property Fund published a healthy looking medium-term forecast, but I'm concerned that far less is being projected in their medium term forecast in terms of refurbishment expenditure than has been the average over the last 3.5 years. If average historic refurbishment spend is assumed then suddenly the forecast looks dismal. It could be that the past 3.5 years has seen far higher refurbishment spend than what is required on average to sustain the hotels, but something would need to convince me of that before I invested. And I would need to be more convinced than usual before I invested in Hospitality B, because I already have a lot of exposure to tourism through my stake in South Africa Travel Online.

Hospitality B gets the leftovers

The Hospitality Property Fund is a property loan stock company with a portfolio of 26 hotel & resort properties in South Africa. The Hospitality B units get whatever is left over of the distributions once Hospitality A units have taken their share.

Arabella Hotel in Hermanus near Cape Town

Medium-term forecast

Hospitality listed on 10 Feb 2006. The distribution of the A linked units grew at 5% p.a. for the first 6 years, and then at the lesser of 5% p.a. & inflation. As you can see in the table, the change in B unit distributions is far more volatile. In this table of the distributions, I used Hospitality's own Medium term profit forecast to guestimate the 2012, 2013 & 2014 distributions (of course reality will be different, and whether you want to invest in Hospitality B depends on the extent to which you think their medium-term forecast will pan out).

 

2007

2008

2009

2010

2011

2012

2013

2014

Hopsitality B distribution (R)

1.40

1.66

1.53

0.88

0.59

0.10

0.70

0.87

Adjustment for refurbishment spend

 

 

 

 

 

-

-1.40*

-2.33*

* Refurbishment costs over the last 3.5 years have been R223m p.a., adding inflation at 5% gives R234m in 2013 and R246m in 2014. No figure was given for Radisson Blu capex assumed in the medium-term forecast, so I've assumed it's half the last valuation (which was R151m), i.e. R75m, so capex assumed by management was then R75m+R35m = R110m. So, must adjust for R234m-R110m = R124m in 2013, and R207m in 2014.

What are the main assumptions behind these forecasts?

I've listed the assumptions in order, with those at the top the ones I consider to be the most contentious (my comments in right hand side column):

Other than the budgeted capex on Radisson Blu, no provision for major refurbishments in the forecast period.

Refurbishment expenditure is less than the R223m p.a. spend over the last 3.5 years.

Normal capital expenditure of R35m in FY2012, escalating at CPI in 2013 & 2014

City of Johannesburg R13m amount in dispute has not been expensed.

Adjustment made in valuation

Refinanced term loans totalling R850m to be concluded with banks through a club loan facility at JIBAR + 260bps on conclusion of the rights issue effective 1 June 2012

If banks are trying to get out of this type of debt, there's the risk they wont be able to secure these terms.

Current Absa access facility rate to be lowered from prime + 2% to prime -0.5% on securing term loans from June 2012

Bad debt averages to that over the period 2006 to 2012 (i.e. R1.9m) instead of the 2012 bad debt provision of R4.8m.

I'd prefer to see percentages averaged, but the principle of averaging is ok for a long-run assumption

The terminal occupancy is the theoretical maximum occupancy that each property is likely to trade at during extended periods of high demand. Occupancies are assumed to grow by GDP until terminal occupancy levels are achieved, after which trading volumes are assumed to remain static for 2 years & then decline by 5% for one year (indicating additional supply being brought into the market in response to high demand).

Seems reasonable

Average room rates growth by CPI annually until terminal occupancy levels are achievel, after which ARR is forecast to grow by CPI + GDP.

Seems reasonable

Bridging loan for Absa debt facility of R1.35m, at prime + 2% until 31 May 2012, debt restructure facility fee of R6.75m payable to Absa in May 2012.

Presumably they've got a good idea of these terms.

Electricity costs take account of anticipated Eskom increases as well as savings through efficiency measures that have been implemented.

Seems reasonable

General head office expenditure based on the 2012 forecast, increasing at CPI annually.

Seems reasonable

Hotel payroll expenses increase at CPI + 2%

Seems reasonable

Rights issue of R500m concluded by end May 2012.

My guess is that the rights issue will be succesful

Valuation

The table below shows the valuation of a Hospitality B unit using a 10% discount rate and assuming various distributions going forward (PLS distributions are usually deemed to be interest in an individual's hands, and so different individuals will have different rates of tax payable. I have not correctly taken this into account - as a rough approximation I've assumed changes in net distributions are offset by changes in the discount rate).

 

2007-2014

2013-2014

2012

Average Hospitality B distribution

R0.97

R0.79

R0.10

RAW Valuation

R9.71

R7.85

R1.00

Valluation after City of Johannesburg dispute*

R9.65

R7.79

R0.94

Valuation after increase to refurbishments

R4.49

R0.00

R0.00

* Since management are confident of a good outcome, I've assume a loss of R5m of the R13m, equating to 6c/unit

Obviously there's nothing golden about using a 10% discount rate, and there's tons of assumptions, all of which are probably wrong, going into these valuations!

About Hospitality

The Hospitality Property Fund is a property loan stock company with a portfolio of 26 hotel & resort properties in South Africa. Its most recent acquisition on 13 May 2011 was the Westin Cape Town & Arabella Hotel & Spa.

Fixed lease
F&V lease

Birchwood Hotel & Conference Centre

Arabella Hotel & Spa

Champagne Sports Resort

Crowne Plaza Johannesburg - The Rosebank

Kopanong Hotel & Conference Centre

Holiday Inn Sandton - Rivonia Road

Premier Hotel King David

Inn on the Square

Variable lease

Mount Grace Country House & Spa

Radisson Blu Waterfront

Paulaner Brauhaus

Courtyard Arcadia (jointly owned with City Lodge Hotels)

Protea Hotel Edward

Courtyard Cape Town (jointly owned with City Lodge Hotels)

Protea Hotel Hazyview

Courtyard Eastgate (jointly owned with City Lodge Hotels)

Protea Hotel Hluhluwe & Safaris

Courtyard Rosebank (majority owned through sectional title scheme)

Protea Hotel Imperial

Courtyard Sandton (majority owned through sectional title scheme)

Protea Hotel Marine

 

Protea Hotel Richards Bay

 

Protea Hotel - The Richards

 

Protea Hotel - The Winkler

 

Protea Hotel Victoria Junction

 

The Bayshore Inn

 

Westin Cape Town

The properties are diversified across South Africa, catering to business travel (some 40% of revenue in FY2011), leisure travel (30% of revenue) & conferencing (30% of revenue).

Refurbishments

Over the last 3.5 years a total of R662m was spent on refurbishment (assumed R70m of the 2009 spend on Mount Grace was for refurbishment as opposed to expansion), or R781m with inflation at 5% added, equating to R223m p.a.

6 months to 31 Dec 2011

R55m spent on refurbishment projects (it wasn't explained why the numbers add to more than R55m):

  • Protea hotel Victoria Junction (R41m)
  • Inn on the Square (R35m)
  • Protea Hotel Hazyview (R8m)

Comment in interims: "With the completion of these projects, all F&V lease properties, with the exception of Protea Hotel Hluhluwe & Safaris have been refurbished and will require minimum further capital expenditure in the short term."

2011

During the year a total of R109m was invested:

  • Protea Hotel Marine (R31m total cost)
  • Protea Hotel Edward (R12m)
  • Holiday Inn Sandton (R8m)
  • Champagne Sports Resort (R28m)
  • Protea Hotel Victoria Junction, Inn on the Square & Protea Hotel Hazyview in progress

2010

R41m was invested in refurbishing:

  • Protea Hotel Imperial (R14m)
  • Champagne Sports Resort, Inn on the Square & Protea Hotel Marine in progress

2009

R532m spent on refurbishing & enlarging the Fund's existing portfolio of hotels:

  • The Rosebank (R312m refurbishment & rebranding - redesign of all 318 rooms)
  • The Mount Grace (R145m to refurbish existing 81 units, the construction of 41 additional rooms & a new conference centre)
  • Protea Hotel The Winkler (R28m to refurbish & construct conference centre)
  • 3 properties in Richards Bay (R47m refurbishment)

2008

Info wasn't shared on refurbishment spend

Forecast

Cents per unit distribution

Hospitality A distribution

Hospitality B distribution

% change in B unit values on previous year

2014 GUESTIMATE

R124m

R78m (87c/unit)

23%

2013 GUESTIMATE

R118m

R63m (70c/unit)

700%

2012 GUESTIMATE

R112m

R9m (10c/unit)

-83%

Year to 30 June 2011

R108m (122.11c/unit)

R52m (58.9c/unit)

-33.1% ("In addition to muted demand, there was a significant oversupply of room stock as the number of rooms available on a national basis increased by almost 20% in the 2 years prior to the World Cup. This has led to widespread discounting. Pressure from increasing overhead costs, which are appreciably higher than inflation, further eroded margins.")

Year to 30 June 2010

R73m (116.30c/unit)

R55m (87.98c/unit)

-42.4% ("as some of the 21% of the Fund's earnings are derived from lease income linked to the operational performance of hotel properties, the lower B-linked unit distribution primarily reflected unfavourable trading conditions in the hotel & leisure industry for the period...The positive effect of the World Cup was partly impaired by bad debt write-offs linked to the Queensgate Group, a tenant at 2 of the Fund's properties.)"

Year to 30 June 2009

R68m (110.76c/unit)

R94m (152.65c/unit)

-8.1% (Some "25% of the Fund's earnings are derived from lease income which is linked to the operational performance of the hotel properties. This decline in distribution of the B-linked unit was pimarily as a result of the unfavourable trading conditions.")

Year to 30 June 2008

R65m (105.49c/unit)

R102m (166.16c/unit)

18.3% (Some "one third of the Fund's earnings are derived from lease income which is linked to operational performance of the hotel properties. The high growth in distribution of the B-linked units was primarily as a result of the favourable trading conditions")

Year to 30 Jun 2007

R41m (100.46c/unit)

R58m (140.40c/unit)

16.7% ("28% of the Fund's earnings are from lease income that is linked to the underlying operational performance of hotel properties. The growth in distributions when compared to the listing prospectus were predominantly attributable to this income component having benefited from recent trading conditions").

Year to 30 Jun 2006

Left out as there were only 4.5 months

 

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