Regal REIT (1881, $1.92) 12M Target $2.20 BUY

Eric Yuen – ericyuen@guoco.com (852) 2218 2865

Event: Regal REIT will benefit from a strong recovery of the hotel industry.

• The outlook for Hong Kong's hotel industry is promising given expectation of renminbi revaluation, increasing disposable income of mainland residents and continuous influx of mainland visitors to Hong Kong.
• According to information of the Hong Kong Tourism Board, the number of overnight visitor arrivals to Hong Kong expanded 1.0% in 2008 but decreased by 2.3% in 2009. Given the total number of hotel rooms in Hong Kong grew continuously by 6.4% in 2008 and 8.5% in 2009, the average hotel occupancy rate declined from 86% in 2007 to 85% in 2008 and 78% in 2009 whilst the average hotel room rate rose 0.6% in 2008 and dropped 16.4% in 2009.
• For the year 2010 and 2011, the Hong Kong Tourism Board forecasts that the supply of hotel rooms in Hong Kong will add 4.6% and 5.6% respectively, slower than the growth rate in 2008 and 2009. This combined with strong growth in visitor arrivals caused a strong recovery of the hotel industry year-to-date.
• In the first half of 2010, the number of overnight visitor arrivals to Hong Kong surged 21.2% yoy whilst the average hotel room rate rose 7.7% yoy. Meanwhile, the average hotel occupancy rate improved to 84% from 74% in the first half of 2009. High tariff B and medium tariff hotels, which target the mainland tourists, performed extremely well in the first half of 2010 with the average room rate growing 13% and 12% yoy respectively.
• Approximately 60% of tourists are mainland residents in 2009. The number of mainland visitors increased by 54.5% yoy in June and 43.5% yoy in the first half of 2010. Per capita spending for overnight mainland visitors soared 16.6% in 2009 and a CAGR of 8.7% from 2004 to 2009. We are confident that the spending of mainland tourists in Hong Kong will continue to trend upward in the coming years.
• In our view, Regal REIT is the key beneficiary of the booming hotel industry in Hong Kong. The company has a total of 3,830 hotel rooms in Hong Kong with a market share of 5.9% by end-2009. In the past three financial years, the company managed to increase DPS from $ 0.1 53 in 2007 to $ 0.1 68 in 2008 and $ 0.1 70 in 2009 on the back of guaranteed income provided by parent company.
• Looking forward, we forecast DPS to reach $0.202 in 2010 and $0.152 in 2011, translating into attractive dividend yield of 10.5% in 2010 and 7.9% in 2011. We have assumed that the remaining guaranteed income of $118.4mn (equivalent to $0.033 per share) provided by parent company will be booked in 2010 leading to exceptionally strong DPS this year. However, DPS in 2011 will rely on the actual operating results of the hotels given the absence of guaranteed income.
• While interest rate will remain low in the foreseeable future, high yield stock could be a safe haven for conservative investors. We maintain our BUY rating Regal REIT with 12-month target price of $2.20 based on dividend yield of 7% for 2011.