Company Update: Recovery momentum sustained
- Retail tenants’ sales in Hong Kong grew 5.8% in 1QFY23, outperforming the overall market
- Mall operations in China clouded by intermittent lockdowns and pandemic-led restrictions
- Concerns over exchange rate volatility should not be overplayed
- Maintain BUY, despite lower TP of HK$70
On the back of domestic consumption recovery, tenant sales at Link REIT’s Hong Kong retail portfolio has recovered to c.95% of pre-COVID level. In 1QFY23, overall tenant sales of the portfolio registered 5.8% growth, outperforming the overall Hong Kong market’s 1%. Boosted by the distribution of consumption vouchers, general retail trades demonstrated stronger-than-average sales growth of 11.9% in 1QFY23. Meanwhile, tenants’ sales from F&B, and supermarket & foodstuff also rose by 0.1% and 5.6% respectively. This resulted in occupancy cost ratio further easing to 12.9% in 1QFY23 from FY22’s 13.1%. Driven by solid reversionary growth from the F&B and supermarket trades, Hong Kong retail rental reversion should further improve from FY22’s 4.8%. As of Jun-22, occupancy of the Hong Kong retail portfolio was high at 97.2% (Mar-22: 97.7%).
To support tenants amid the fifth wave of pandemic, Link REIT earmarked HK$220m for the tenant support scheme in Hong Kong during FY22, of which 70-80% has been utilised. We do not expect further rental reliefs for Hong Kong retail tenants in FY23 with the improving retail scene. Despite the enactment of rental enforcement moratorium, rental collection in the period was at a high level with no significant arrears.
The city lockdowns and pandemic-led restrictions have heavily weighed on Link REIT’s mall operations in Mainland China. As such, rental concessions are budgeted and will be granted to affected tenants. Despite recovering from the trough in 2QCY22, tenants’ sales remain 20-30% below that of pre-pandemic levels. Excluding Happy Valley Shopping Mall in Guangzhou which is undergoing renovation, overall retail occupancy in China softened to 89.2% in Jun-22 from Mar-22’s 92.3% amid the sluggish retail scene. Overall, rental reversion should moderate from FY22’s 8.8%.
Commencing in Sep-22, Ph 1 of asset enhancement work at Happy Valley Shopping Mall is currently well underway. With a budgeted capex of >RMB150m, this phase targets to reconfigure the space previously occupied by a department store. Expected completion for Ph 1 is scheduled by the end of 2023 while Ph 2 is expected to commence in 2024. A low double-digit ROI is expected for the entire enhancement work.
On the office front, occupancy at Link Square in Shanghai was firm at 96.2% as of Jun-22. Nonetheless, rental decline upon renewals should further widen from FY22’s 8.1%. Asset enhancement work at the property, which includes upgrading the reception lobby and public areas, is expected to complete by the end of 2022. Meanwhile, committed occupancy at The Quayside in Kwun Tong edged up slightly to 97.3% in Aug-22 from May-22’s 96.6%.
Acquired in Dec-21, two logistics properties in Dongguan are fully occupied and are delivering steadily growing income with embedded rental escalation.
The five office assets in Sydney and Melbourne acquired in Jun-22 should provide maiden contributions in 1HFY23. Including 100 Market Street in Australia and The Cabot in London, the overall occupancy of overseas office assets stood at 93.4% as of Aug-22, with the aid of “flight to quality” trend. Meanwhile, the three 50%-owned retail assets in Sydney that were acquired in Jul-22 are 95% let. Link REIT has fully hedged its overseas assets with the aid of local currency debt and income hedged at the beginning of the financial year. This should help to safeguard its overseas rental income and NAV from foreign exchange volatility.
We have revised down our FY23 and FY24 DPU forecast by c.5% and c.10% respectively to reflect higher finance cost amid interest rate hikes.
In Aug-22, Link REIT secured a commercial site off Anderson Road in Kwun Tong through government tender. With total estimated development cost of c.HK$1.6bn (including the land premium of HK$766m), the site will be developed into a community commercial facility, which comprises of retail facilities, a fresh market, and carparks, with a maximum GFA of 139,242sf upon scheduled completion in 2027. Link REIT expects an initial yield in the mid-to-high single digit based on cost. The government will offer another commercial site in the neighborhood for tender before end-Mar 2023. Strong synergetic benefits are expected between the two sites if Link REIT wins the tender.
Taking into account the acquisition of a commercial site off Anderson Road in Kwun Tong, Link REIT’s gearing is expected to reach 25.4%. While Link REIT is vying for the Mercatus portfolio in Singapore, it is highly likely for Link REIT to introduce capital partner(s) to diversify its investment risk. This arrangement could enable Link REIT to make a foray into Singapore without overstretching its balance sheet. Fixed-rate debt ratio should remain between 50% and 70%. This should help mitigate the impact from interest rate hikes.
Link REIT is trading at 5.3% distribution yields for FY23-24, which translates into yield spread of 1.8%. P/B is low at 0.73. We remain positive on the recovery momentum of its Hong Kong retail portfolio. Since Jul-22, Link REIT has repurchased 6.1m units for >HK$300m. Continued unit buybacks should cushion downside risk on unit price. We have lowered our DDM-based TP to HK$70 to reflect the higher discount rate and lower DPU but we are maintaining our BUY rating. Any faster-than-expected rate hikes would dampen its earnings and valuation, and remains the key investment risk, amongst others.