Result analysis: FY21 payout ratio lowered to 90%
- FY21 distributable income fell 3.3% primarily due to lower rental earnings, in line with our estimate
- Payout ratio lowered to 90% in FY21 from FY20’s 95%
- Negative rental reversion is working its way through the portfolio
Champion REIT’s FY21 distributable income fell 3.3% to HK$1.5bn, dragged by reduced rental earnings, partly offset by lower cash finance cost. The results were broadly in line with our estimates. In view of the uncertain business outlook, Champion REIT has lowered the payout ratio to 90% from FY20’s 95% to increase its capital reserve for planned renovation at Three Garden Road and prepare for challenges ahead. This resulted in distribution income falling by a larger 8.4% to HK$1.35bn. Full-year DPU was HK$0.2279, representing 8.7% decline y-o-y.
Total rental income decreased 5.2% to HK$2.5bn mainly dragged by weaker performance at Langham Place Mall and Three Garden Road. Rental income from Three Garden Road shrank 3.8% to HK$1.46bn led by the impact of negative reversionary growth and lower average occupancy. Negative rental reversion has worked its way through this Grade A office property. Average passing rent fell 2.5% h-o-h to HK$108.3psf in Dec-21. Meanwhile, thanks to in-house expansion from existing tenants and new lettings from legal firms, occupancy at Three Garden Road rebounded to 89% in Dec-21 from Jun-21’s 85%. As of Dec-21, banking is the largest among the property’s tenant profile, accounting for 33% of the property’s rental area. This was followed by asset management firms, corporates, and legal firms. Flexible workspace took up 5% of the property’s total rental area.
In 2022, 11.4% of leases are scheduled for renewal with an additional 9.5% up for rent review. With expiring rents for 2022 standing at >HK$120psf and the current spot rent of c.$90psf, rental reversion is expected to turn more negative in 2022. Upcoming office supply in Central may also pose a threat to the property’s occupancy. Against this backdrop, Champion REIT has turned more flexible on leasing strategy for Three Garden Road to retain tenants.
Rental receipts from Langham Place Office declined 3.4% to HK$365m due to negative rental reversions. Passing rents dropped 1% h-o-h to HK$47.1psf in Dec-21. While the property saw downsizing and departures of certain traditional office tenants, expansion and new letting demand from beauty and healthcare tenants drove its occupancy up to 96.3% in Dec-21 from Jun-21’s 91%. This brought the portion of lifestyle tenants to c.70% of the property’s total rental area, up from Jun-21’s c.65%.
In FY21, turnover rent at Langham Place Mall doubled to HK$38m along with the revival of consumer sentiment. However, due to the departure of Beauty Avenue and absence of tourist spending, tenant sales recovery at the mall fell short of the Hong Kong retail market which exhibited 8.1% retail sales growth in 2021. Meanwhile, base rent portion decreased 14.3% to HK$575m, mainly due to negative rental reversions and short- term rent void led by the departure of Beauty Avenue. Overall, total rental income of the mall was 9.1% lower at HK$670m. With stabilizing retail scene, more tenants are willing to commit to the base rent in 2H21. The proportion of tenants paying turnover rent only fell to 12% in Dec-21 from Jun-21’s 14.3%. The mall was fully occupied as of Dec-21.
Property operating expense was largely flat at HK$572m. Higher rental commissions and maintenance fees were partly offset by lower government rent and rates and promotion expenses. With net expense ratio higher at 11.9% (FY20: 10.9%), net property income fell by a larger 6.4% to HK$2.2bn. Cash finance cost reduced 10% to HK$401m thanks to lower average HIBOR and a decrease in the fixed rate debt portion. Total debt stood at HK$15.4bn as of Dec-21 (Jun-21: HK$16bn). This represented 22.9% of the REIT’s total gross asset value (Jun-21: 23.2%). Around 64.6% of interest costs for total debt are on fixed rate basis (Jun-21: 62.1%). All the REIT’s borrowings were unsecured in nature as of Dec-21. The REIT has no major refinancing needs in FY22.
Champion REIT is trading at distribution yield of 5.6-5.4% for FY22-23. The spread of Omicron variant has delayed border re-opening with China and thus the earnings recovery of Langham Place Mall. Businesses for lifestyle tenants at Langham Place Office has been disrupted by retightening of social distancing measures since Jan-22. New round of rental concessions should be inevitable. Three Garden Road should continue to suffer from negative rental reversions and face challenges over upcoming office supply in Central. Hence, we maintain HOLD with a lower DDM-based TP of HK$4.15.