Meeting takeaway: Positive reversionary growth sustainable in FY3/22
Aided by improved pandemic situation and distribution of electronic consumption vouchers, overall tenant sales growth at Link REIT’s Hong Kong retail portfolio accelerated to 10.4% in 3QFY22 from 1HFY22’s 8.9%. This was primarily driven by stronger tenant sales from general retail trades which grew by a larger 14.6% in 3QFY22, compared to 13.4% in 1HFY22. Tenant sales decline for supermarket and foodstuff trades also narrowed to 6% in 3QFY22 from 1HFY22’s 8.6%. Receipts from F&B tenants continued to register robust growth of 25.4% in 3QFY22 (1HFY22: 25.7%). This brought the overall occupancy cost ratio further down to 12.8% in 3QFY22 from 1HFY22’s 13%, lowest since the outbreak of COVID-19.
However, the fast spread of the Omicron variant and tightening of social distancing measures since early 2022 has taken a toll on the retail market recovery. Tenant sales growth in 4QFY22 (or 1Q22) should return to negative territory with F&B sector taking the hardest hit from dine-in restrictions. Sales of general retail trades should be dampened by sluggish consumer sentiment. On the other hand, supermarket sales should resume positive growth as tightened social distancing measures is driving demand for groceries.
Rental reversion of Hong Kong retail portfolio has turned positive at 3.4% in 1HFY22 on the back of domestic consumption recovery. Despite recent disruptions led by the COVID resurgence, we expect Link REIT’s retail rental reversion to remain positive for FY22. If the fifth wave of the pandemic can be brought under control in the near term, reversionary growth could stay slightly positive in FY23 in our view.
Hong Kong retail portfolio occupancy reached a record high of 97.9% as of Dec-21 (Sep-21: 97.5%). Compared to 2020, existing retail tenants have become more experienced in coping with challenges led by the COVID resurgence. Selected tenants that are severely impacted are seeking for lease restructuring and rental concession. Hence, the impact from the proposed new law on rental enforcement moratorium should not be overplayed.
Link REIT has been running a new round of tenant support scheme, amounting to HK$120m, since early Feb. Rental concessions are offered to retail tenants on a case-by-case basis with a priority to those severely impacted by social distancing protocols including fitness centers, beauty salons and Chinese restaurants. In 2020, Link REIT had established a tenant support scheme amounting to HK$600m, with c.HK$500m being utilised ultimately.
Including Happy Valley shopping mall, Link REIT’s China retail portfolio was 92.4% let as of Dec-21 (Sep-21: 91.5%). Link REIT has completed the asset enhancement work at Link CentralWalk in Shenzhen, with grand re-opening in Jan-22. With the number of shops increasing by 20% post renovation, Link CentralWalk provides more diversified retail offering, catering to the shopping need of young shoppers, office workers in the surrounding areas and family-oriented customers.
Link REIT plans to renovate the newly acquired Happy Valley shopping mall in Guangzhou, marking its second AEI in China. Link REIT has completed the planning and design for ex-department store space which will become the new annex of the mall. The renovation works are expected to commence in 3Q22 and last throughout FY23. Despite intense competition in Shanghai office market, occupancy at Link Square remained firm at 95.1% in Dec-21 (Sep-21:96.7%). Link REIT is upgrading major facilities including reception lobby and public areas with target completion in mid-22 to enhance the property’s competitiveness.
Following the proactive acquisition since late 2021, Link REIT’s pro-forma gearing ratio stands at 24.6%. China and overseas assets accounted for 16.5% and 7.6% of Link REIT’s total portfolio valuation, falling short of its management’s guidance of 20-25% and 10-15% respectively. In addition to organic growth, more acquisitions are expected to help the REIT achieve its Vision 2025 strategy, which aims for high single digit CAGR growth in AUM.
In Feb-22, in view of the unsolicited expression of interest towards Stanley Plaza, Link REIT invited interest from the market to purchase the property on a standalone basis. The disposal of Stanley Plaza, if materialized, could free up capital for future acquisitions. If this private tender receives strong market interest, we do not rule out the possibility of Link REIT disposing more mature assets in Hong Kong. This should enable Link REIT to expand and diversify its property portfolio without overstretching its balance sheet.
On the other hand, Link REIT has submitted a tender for the design, construction, and operation of Artist Square Towers project at West Kowloon Cultural District. Comprising three commercial towers, the project sets to offer a total GFA of 0.7msf including 0.67msf for office space and the balance for retail use. We have revised down our FY22 and FY23 DPU forecast by 2-3% respectively to reflect mainly the impact of rental relief and lockdowns in China.
Link REIT is trading at 4.7-4.8% distribution yields for FY22- 23. This translates into yield spread of 2.5%, same as its 10-year average. The government plans to ease social distancing measures starting from Apr-22. This should release pent-up demand for consumption with distribution of consumption vouchers giving an additional boost. Continued asset acquisitions should enhance and diversify its earnings. Any positive news flow on asset disposal should prompt stock price appreciation. Hence, we maintain BUY with a DDM-based TP of HK$82. Any faster-than-expected interest rate hike should be among the key investment risks for Link REIT which is a bond-like investment.