• Fortune REIT (SGX:F25U)’s 1H19 distribution income was flat at HK$505.4m. Interim DPU was 0.8% lower at HK$0.2613.
• Total revenue fell slightly mainly due to income shortfall from transitional vacancies created by the renovation at Fortune Kingswood (commenced in Jun-18) and disposal of Provident Square in Feb-18, and lower average portfolio occupancy. On a like-for-like basis, revenue would have risen 0.7%.
• Retail rental reversions, albeit moderating, remained healthy at 7.8%. Better-than-average reversionary growth came from F&B and education tenants. Retention rates stayed high at 74.8% in 1H19.
• With cost-to-income ratio improving further to 20.8% in 1H19 from 1H18’s 21.1%, net property income (NPI) was flat at HK$748.7m (up 1.1% on a like-for-like basis).
• Portfolio occupancy recovered to 97.4% in Jun-19, from 93.1% in Dec-18, mainly driven by improved occupancies at Fortune Metropolis, Fortune Kingswood, and Ma On Shan Plaza.
• Fortune REIT is carrying out the renovation works at the West Block of Fortune Kingswood. Leasing of enhanced area has been progressing well with the occupancy of the West Block exceeding 90%. The entire renovation is expected to be completed by 3Q19. Total capex is estimated at HK$150m with expected ROI of 10%.
• Despite higher HIBOR, cash interest expense was 3% lower at HK$128m due to interest saving resulting from the HK$1.95bn loan repayments over the course of 2018.

As of Jun-19, total borrowing stood at HK$8.89bn

• Aided by increased property valuations, Fortune REIT’s gearing improved slightly to 20.5% in Jun-19 from 20.9% in Dec-18. In view of certain interest rate hedging contracts expiring in 2019, the REIT entered into additional interest rate swaps in 1H19. As of Jun-19, interest cost for 59% of debt was hedged with the aid of interest rate swaps and caps.
• Assuming that Fortune REIT raises its gearing to the statutory limit of 45%, this would result in HK$19.3bn for new acquisitions. Yet, given the current low market yield, identifying yield-accretive acquisitions remains challenging. Fortune REIT has been exploring acquisitions in southern China but there are no immediate plans for any yet.

• Over 60% of its rental income is derived from tenants selling consumer staples whose businesses are stable across economic cycles. This points to resilient income, and makes it a safe harbour in the current uncertain market.
• Potential interest rate cuts should also benefit the valuation of Fortune REIT.
• We maintain our BUY recommendation with DDM-based Target Price of HK$11.80.