Weak HK office still a profit drag
- We expect negative rental reversions for HKL’s HK office through FY24F due to falling rent rates and new completions in the HK Central District.
- We also expect a rollover of its share buyback programme by one year, if its buyback pace stays slow due to high floating rate borrowing costs.
- Reiterate Hold with a lower TP of US$4.0 (60% discount to NAV).
We see continued, mild negative rental reversions for its HK offices
As at end-May 2023, HK Central Grade A office vacancy stood at 9-10%, vs. overall HK Grade A office at 12-15%, according to real estate agencies JLL, Savills and CBRE. HKL’s Central office portfolio had a vacancy of 6.3% as at end-Mar 2023 and we expect it to be resilient enough to maintain a vacancy lower than the Central average through FY24F, given its prime location and HKL’s commitment to ESG standards for its investment properties (IP). Nevertheless, we expect the mild negative rental reversions
for HKL’s HK office to continue through FY24F due to falling market rent rates and upcoming new supplies in the HK Central District.
Lower GPM for China DP a new norm
Management expects sales completions of its China development properties (DP) to be higher in FY23F than in FY22 due to the absence of pandemic-related restrictions, but profit booking would be skewed to the second half of FY23F. We believe lower GPM for China DP sales recognition (22% in FY22 vs. 28-44% in FY19-21) will be a new norm for HKL, and is comparable to China’s largest state-owned developers such as COLI and CR Land.
We expect a rollover of share buyback budget by one year
As floating rate borrowing cost for HK$/US$ now stands high at c.6%, we think HKL will continue to keep a slow race in share buyback – even though it still had US$0.4bn budget unused for buyback as at end-Jun 2023. We also believe HKL will extend its buyback programme by one year to 31 Dec 2024 and maintain its buyback budget.
Reiterate Hold; new TP based on a wider discount to NAV
We cut FY23-25F EPS by 5-15% to reflect 1) lower ASP assumptions for its China and Singapore DP sales, 2) new HK$/Rmb assumption of 0.93 (0.91 previously), 3) delay in property sales booking schedule in FY24-25F, 4) weaker-than-expected EPS growth due to slower share buyback. We also cut our NAV for HKL by 3% to US$10.1 accordingly. Our new TP for HKL is US$4.0, now based on a wider 60% discount to NAV (55% previously), as its EPS recovery is taking longer than we expected earlier amidst a high interest rate environment. Reiterate Hold for HKL, as we believe the falling HK office rents and slower-than-expected share buyback reflect a lack of near-term re-rating catalysts. Key downside risks: slower-than-expected recovery of its DP sales in China and weaker-than-expected rental reversions for its HK offices. Lower-than-expected borrowing costs are, on the other hand, a key upside risk.
