Company Update: Strong embedded value
- Cathay Pacific benefitting from international travel re-opening
- Share buyback to support share prices
- Planned property expansion to brighten long-term prospects
- BUY with HK$70.90 TP
The recurring underlying profit of property division fell by a marginal 2% to HK$2.97bn in 1H22. Rental income was broadly stable. Retail revenue from Hong Kong fell 10% as a combined result of COVID resurgence and increased amortised rental concessions. The shortfall more than offset higher income from China malls, due to new contributions from Taikoo Li Qiantian in Shanghai and Taikoo Li Sanlitun West in Beijing, which opened for business in 2H21. Office income from Hong Kong was largely steady. While Pacific Place Office suffered from negative reversionary growth, positive reversion was seen at some of the Taikoo Place properties.
The soon-to-be-completed 1msf Two Taikoo Place in Quarry Bay is > 50% pre-leased. Committed tenants include Julius Baer, BASF, Amundi and Boston Consulting Company. Elsewhere, CITIC Bank is reportedly to be an anchor tenant. Construction works of 46-54 Queen’s Road East is well underway with scheduled completion in 2023. Pre-leasing is expected to commence soon. These should add to the company’s rental earnings growth.
Listed property arm Swire Properties intends to invest over HK$100bn in China, Hong Kong and Southeast Asia in the coming decade to power its long-term outlook. While HK$50bn will be allocated to China with a focus on retail-led mixed-use developments, HK$30bn will be set aside for expanding the Pacific Place and Taikoo Place portfolios in Hong Kong. The balance will be used for exploring residential trading opportunities in Hong Kong/China and growing its footprint in Vietnam, Indonesia, Singapore, and Thailand.
After securing a retail-led mixed use development site in Xi’an in Mar-22, Swire Properties acquired a residential/retail site in Wan Chai in Jul-22 and a site for retail-led development in Sanya in partnership with China Tourism Group Duty Free Corporation in Oct-22. Contributions from these investments should underpin long-term property earnings growth.
Attributable underlying loss from the aviation division narrowed 31% to HK$2.23bn (1H21: HK$3.25bn loss), mainly due to reduced losses at Cathay Pacific. Despite the lingering COVID-19 situation and weaker performance from Air China at the associate level, attributable loss from Cathay Pacific softened to HK$2.25bn from 1H21’s HK$3.4bn, mainly due to the increase in capacity and easing COVID-19 restrictions.
With the Hong Kong government lifting the mandatory quarantine requirement for all inbound travelers, strong pent-up demand for travel is set to be unleashed. Against this backdrop, we envisage Cathay Pacific to return to profitability starting from 2H22.
At HAECO, attributable profit fell by 46% to HK$166m (1H21:HK$310m), principally due to the absence of financial assistance provided by the US government. Excluding this non-recurring item, HAECO’s profit improved, reflecting a recovery in demand for engine overhaul and more airframe base maintenance.
Revenue of beverage division rose slightly by 0.5% in 1H22 despite an 8% sales volume drop, primarily led by price increases in the US. Sales revenue in China and Hong Kong were adversely impacted by pandemic related restrictions. This was partly offset by the strong revenue growth in US (+13%). However, EBITDA margin decreased to 11.1% from 12.4%, reflecting higher raw material costs and operating expenses. Overall, attributable underlying profit softened 22% to HK$1.15bn. With the gradual easing of the negative impact of COVID-19, the business in Asia is expected to recover in 2H22. Revenue from the US should remain strong. But margin pressure should remain, given rising operating expenses.
In Jul-2022, Swire Coca-Cola agreed to acquire Coca-Cola’s bottling businesses in Vietnam and Cambodia from The Coca-Cola Company, representing the company’s first foray into the fast-growing non-alcoholic beverage markets in South East Asia. After the acquisition, franchise population will expand by 15% to 876m people, and three bottling facilities in Vietnam and one bottling facility in Cambodia will be added to the company’s portfolio. The total consideration amounted to US$1,015m, payable in cash, reflecting a valuation of c.28.4x PE for the acquired business. The acquisition is expected to be completed in 4Q22.
Hard hit by COVID-19 related lockdowns in Shanghai and Shenzhen in 2Q22, attributable underlying losses of healthcare more than doubled to HK$103m in 1H22. Swire Pacific has invested HK$1.7bn in the healthcare sector. Currently, the company has exposure to the healthcare sector in the Yangtze River Delta and the Greater Bay Area through its associate investments in Columbia China Healthcare, Shenzhen New Frontier United Family Hospital and HEAL Medical Group, and DeltaHealth. The company plans to invest at least HK$20bn in the growing healthcare sector in Mainland China by 2030.
The disposal of a 100% stake in Swire Pacific Offshore (excluding the stake in Cadeler) was completed in Apr-22. The consideration for the transaction was settled partly in cash and partly in the form of warrants issued by the buyer, Tidewater. Coupled with the sale of HUD in 2021, Swire Pacific has completed its divestment of its marine services business. After the disposal of a 6.7% equity interest in Cadeler in Feb 2022, the company’s shareholding in Cadeler was reduced to 18.13%.
Trading & industrial division slid into red with an attributable underlying loss of HK$311m (1H21: profit of HK$71m). This was mainly dragged down by the impairment of long-term assets and write-off of goodwill for Qinyuan Bakery which totaled HK$424m. Excluding the non-recurring losses, the division record a profit of HK$113m in 1H22.
Swire Pacific’s net debt surged 14% to HK$43.9bn from Dec-21’s HK$38.7bn, mainly due to its active land replenishment and construction expenses for investment properties. This translates into 13.6% of total equity (Dec-21: 11.9%). Even allowing for the share buyback program, the ratio would have risen to 15.1% which remains comfortable. There is room for the company to gear up for new investments on the property, beverage and health care fronts.
Interest cost for 72% (Dec-21: 84%) of total debt has been hedged into fixed rates in Jun-22. This should help mitigate the impact of interest rate hikes.
In Aug-22, Swire Pacific announced its intention to spend up to HK$4bn for share repurchase. This marks its first share buyback program. Since then, Swire Pacific has bought back 32.2m “A” shares and 31.4m “B” shares for HK$1.8bn (or HK$56.3/sh on average) and HK$285m (or HK$9.08/sh on average) respectively. This large-scale share repurchase program not only signals the stock’s strong embedded value but has also boosted its share price.
In 1H22, first DPS rose 15% to HK$1.15 for ‘A’ share ( or HK$0.23 for ‘B’ share). Swire Pacific revised its dividend policy in FY21 to better achieve its goal in delivering sustainable growth in dividends. It targets to pay out not less than half of its recurring underlying profit regardless of its associate Cathay Pacific’s result, but including all dividends received from Cathay Pacific.
Share price of Swire Pacific has appreciated 23% over the past three months led by share repurchase and international border re-opening. Yet, the stock is now trading at 36% to our current estimated NAV, with dividend yield of 5.5%. Swire Pacific is well poised to benefit from international border re-opening through its exposure in Cathay Pacific. Property expansion should underpin the company’s long-term growth. Ongoing share repurchase should continue to lend support to its share price. BUY with HK$70.90, based on 40% discount to our Dec-2023 NAV.