Company update: Rental income under pressure
Office occupancy has softened from Dec-21’s 94%, partly due to the departure of Prudential Assurance at Lee Gardens Two. In 2022, about 32% of the floor area is scheduled for roll over. Office rents in Causeway Bay have remained under pressure. Rental decline on renewals or new lettings has widened to c.15% currently from 8-9% in late 2021. Negative reversionary growth as well as lower occupancy should exert downward pressure on office rental income.
In 4M22, tenants’ sales of Hysan Development’s retail portfolio fell slightly more than the broad market which registered 3% decline in retail sales value amid the COVID resurgence. Rental concessions were granted to affected tenants, especially in the F&B sector which was hard hit by the social distancing measures. However, the magnitude should be significantly lower than in 2020. After easing of social distancing protocols in late Apr, tenants’ sales staged a strong recovery. Coupled with the distribution of consumption vouchers, the company’s retail sales should gradually regain the lost ground. Despite the fifth wave of COVID outbreak, retail occupancy should remain largely stable. (Dec-21: 99%). Retail reversionary growth has been turning less negative at around 11-12%. Overall, retail income should remain on a downward trajectory. In addition, residential reversionary growth remained negative at >10% due to weak demand from expatriates.
Pre-leasing of office portion of newly acquired Lee Garden Shanghai has commenced. We expect this Grade A commercial building to make maiden contribution in late 2022.
Hysan Development plans to launch Villa Lucca in Tai Po soon. This residential development provides 262 units including 41 houses with 0.5msf GFA. Hysan Development has a 60% stake in this project with the balance held by HKR International. The consortium acquired the two sites where Villa Lucca is built on via government tender for HK$3.39bn in total in Nov-16. Adding construction and financing costs, we estimate total development costs at HK$15,700psf on saleable area basis. We forecast that Villa Lucca, if fully sold, should generate attributable pre-tax profit of c.HK$1.5bn to Hysan Development.
In Feb-22, Hysan Development acquired a 25% stake in the URA’s Bailey Street/Wing Kwong Street project in To Kwa Wan for c.HK$2bn. The redevelopment is an 8–10-minute walk from both To Kwa Wan MTR Station and Ho Man Tin MTR Station. It will provide total GFA of 0.72msf including 0.6msf for residential use and 0.12msf for retail purpose. About 1,150 units will be built. If sales proceeds exceed HK$14.8bn, URA will share 20-50% of the excess revenue. The retail arcade will be held for rental for 10 years after project completion. Hysan Development could leverage on its experience in retail leasing when managing the retail arcade.
Overall, such residential investments can serve to diversify Hysan Development’s earnings profile, adding spice to its profit growth.
Since Feb-22, Hysan Development has repurchased 5.4m shares for HK$124.3m or HK$23.03/sh on average. The share buyback not only enhances the stock’s NAV but also lends solid support to its share price.
The stock is trading at 65% discount to our appraised current NAV and offers dividend yield of 6.1% for FY22. Valuation is undemanding from a historical viewpoint. While office and residential leasing remains challenging, retail portfolio should be on the road to recovery. The upcoming launch of Villa Lucca, if greeted with favourable response, could improve sentiment towards the counter. Moreover, ongoing share buybacks should cushion downside on share price. We therefore recommend BUY on Hysan with HK$30.25 TP. This is premised on a 55% discount to our Jun-2023 NAV estimate.