Interim results above expectations
Wharf REIC’s 1H22 underlying earnings rose 3% to HK$3.4bn thanks to improved rental earnings. The result was 10% above our estimate mainly due to higher-than-expected rental margin. Interim DPS was 4.5% higher at HK$0.7, representing 65% of its underlying net profit from investment and hotel properties in Hong Kong.
Gross rental receipts were 2.2% lower at HK$5.35bn. Faced by fierce competition among the precincts, retail income from Times Square sank 22% partly resulting from negative reversionary growth and rental concessions. Average retail passing fell 28% to HK$156psf in 1H22. Retail rental income from Harbour City rose 1% despite negative rental reversions. Income from Plaza Hollywood was flat y-o-y. Following the market correction over the past few years, retail rents are stabilising on the back of retail market recovery. Thus, retail reversionary growth has been less negative.
The gradual easing of social distancing measures and distribution of electronic consumption vouchers has underpinned domestic consumption recovery since Apr22. Footfall and tenants’ sales at Harbour City and Times Square have improved. Despite COVID resurgence in early 2022, turnover rent in 1H22 was largely flat at HK$335m (1H21: HK$329m).
Wharf REIC has granted rental concessions to tenants in view of the fifth wave of the pandemic but the amount this round is much lower compared to 2020.
Taking advantage of softer rents after the correction in the past two years, several international brands have made their Hong Kong debut at Harbour City. These include Casa Loewe, AMANTE, deLaCour and Sound United. Dior, Piaget and Van Cleef & Arpels will open their new flagship stores at Harbour City in 2H22. As of Jun-22, retail occupancy at both Harbour City and Times Square stood firm at 93%.
Despite negative reversionary growth amid market rental pressure, office income from Harbour City rose 3% while that of Times Square was flattish, thanks to improved occupancy. Times Square saw in-house expansion from technology tenants in the period. The property remained 90% let as of Jun-22 (Dec-21: 89%). Meanwhile, office occupancy at Harbour City improved to 87% in Jun-22 from Dec-21’s 85%.
While Wharf REIC continued to offer coupon redemptions to its customers, selling and marketing expenses was 52% lower at HK$250m, partly reflecting tenants’ reduced reliance on supportive measures. This brought the rental margin higher to 82.6% in 1H22 from 1H21’s 78.6%. Hence, despite lower rental income, overall rental earnings rose 2.7% to HK$4.43bn.
Operating loss from hotel division further narrowed to HK$172m in 1H22 from 1H21’s HK$208m as the operating performance in 1H21 was partly dragged by opening expense for Niccolo hotel in Suzhou.
Net debt stood at HK$46.8bn as of Jun-22, down from Dec21’s HK$47.5bn. Led by lower rental assumptions, Wharf REIC recorded HK$5.1bn revaluation deficit on investment property in 1H22 with cap rates broadly stable. This brought the gearing slightly higher at 23.5% in Jun-22, (Dec-21: 23.1%). Interest cost of c.100% of its total borrowings are on floating basis as of Jun-22. Therefore, interest expense is expected to rise noticeably in 2H22 with higher interest rates. As of Jun-22, Wharf REIC’s equity portfolio was valued at HK$12.7bn (Dec-21: HK$13.9bn). It comprises mainly blue-chip property stocks.
YTD, share price of Wharf REIC has retreated by 9%. The stock is trading at 43% discount to NAV. The Hong Kong retail market is on the road to recovery led by the revival of domestic consumption. Distribution of the remaining phase of consumption vouchers in Aug-22 should give an additional boost and should improve sentiment towards the stock. While negative rental reversion continues to work its way through its portfolio, rental margin improvement should add momentum to its earnings recovery. Hence, we maintain BUY with TP of HK$42.