• Hongkong Land’s HK office portfolio should remain resilient, in view of limited supply of premium Central office space.
• We think Hongkong Land will look for familiar domestic strategic partners for its mega prime commercial plot acquired in Shanghai last month.
• Reiterate ADD with a lower Target Price of US$6.05 (45% discount to NAV).

Underlying Profit Up 4% in FY19

• Hongkong Land (SGX:H78)'s underlying profit rose 4% y-o-y in FY19, thanks to a higher development property (DP) profit from China. DPS remained unchanged at US$0.22 with a payout ratio of 48%.

Resilient HK Central Office Portfolio

• Despite a challenging operating environment amid China-US trade tensions and social unrest in HK, Hongkong Land managed to achieve positive rental reversions for its Central portfolio with average HK office rent up 4% y-o-y in FY19 to HK$118/sf. Its vacancy of 2.9% at end- 2019 was below those in other regions, such as Causeway Bay and Admiralty (4-5%), according to Knight Frank.
• Although we expect HK office spot rents to soften further in 2020F on the back of HK’s stagnant economic growth, the limited supply of premium Central office space should cushion the downside in Hongkong Land’s office rents.

Limited HK Retail Rental Loss on Temporary Rent Relief

• Hongkong Land’s effective retail rent in HK fell 5% y-o-y to HK$222/sf, as a result of temporary rent relief and a decline in turnover rent. In view of the current Covid-19 outbreak, management has again offered rent relief to retail tenants, which we estimate would lead to 10-15% y-o-y decline in Hongkong Land’s retail rental revenue in FY20F.
• However, we think the negative impact of Hongkong Land’s rental loss will be limited compared to other landlords, such as Wharf REIC (1997 HK, Hold), as it has a relatively small retail portfolio in GFA terms.

To Look for Domestic Strategic Partners for Shanghai Mega Plot

• Last month Hongkong Land acquired a mega prime plot situated in Xuhui District of Shanghai, for a total land cost of Rmb31.1bn (US$4.4bn). The plot will be developed into 1.1m sq m GFA of predominantly office/retail space, to be completed in 2023-2027 in phases.
• Although Hongkong Land has announced not to seek funding from shareholders to pay for the plot, given the scale of the project, we think it will look for domestic strategic partners with sound financial strength. Those which have cooperated with Hongkong Land before, such as Longfor (960 HK, Add) and CIFI (884 HK, Add), are potential candidates, in our view.

Reiterate ADD on Attractive Valuations

• We think Hongkong Land’s low valuation (55% discount to NAV) has reflected key business risks in its portfolio yet its DP contribution should cushion downside in EPS. Although we cut FY20F/21F EPS by 16%/15% in view of lower rental reversions in its HK/overseas portfolios and higher interest expense, we expect only 6% y-o-y decline in FY20F EPS.
• Reiterate ADD with a lower Target Price of US$6.05, based on an unchanged 45% discount to NAV of US$11.0 (US$12.5 previously).
• A key downside risk is a prolonged Covid-19 outbreak.

Source: CGS-CIMB Research - 6 Mar 2020