Company Update: Portfolio occupancy softened slightly with reversionary growth becoming less negative
- Portfolio occupancy softened slightly to c.95% from Jun-23’s 97%
- Reversionary growth in FY23 should become less negative than 1H23’s -2.6%
- Forecast cash finance cost to jump by 34% in FY24 due to higher average HIBOR and lower hedging ratio
- Negatives largely factored in given low valuation, BUY with HK$1.92 TP
longer downtime experienced as a result of slower leasing activities. The Metropolis Tower, Prosperity Millennia Plaza and 9 Chong Yip Street should see marginally lower occupancies in 2H23, while occupancy at Prosperity Place improved slightly from Jun-23’s 93.8% thanks to solid demand from service trades tenants, particularly beauty centres.
Given high expiring rents, office reversionary growth for The Metropolis Tower and Prosperity Millennia Plaza should stay in the negative territory in 2H23. This should be partly offset by positive reversionary growth from service-trade and industrial tenants at other commercial and industrial properties. Overall, the portfolio’s reversionary growth should become less negative in FY23 compared to 1H23’s -2.6%.
In 2024, about 37% of leases, in terms of gross rental income, are scheduled for renewal, with more lease expiries taking place in The Metropolis Tower and Prosperity Millennia Plaza. Given the current leasing sentiment, we expect overall rental reversion to remain slightly negative in FY24.
Facelift at office floors at The Metropolis Tower is progressing well with scheduled completion by end-2024. Rejuvenation work at the lift lobby and corridors at Prosperity Millennia Plaza has just started. Elsewhere, Prosperity REIT plans to replace a chiller plant at The Metropolis Tower in 2024.
Prosperity REIT has no refinancing needs until Nov-25. Hedging ratio should drop from Jun-23’s 55% following the IRS expiry in early 2024. We expect hedging ratio to stay at c.30% in 2024, factoring in the HK$100m IRS that will take effect in Mar-24. Given a lower hedging ratio, we forecast cash finance cost to jump further by 34% to HK$122m in FY24. This leads to our projected 13% decline in distribution income.
Share price of Prosperity REIT has dropped by 19% over the past six months. Despite the distribution income shortfall led by expected higher cash finance costs, Prosperity REIT is trading at a distribution yield of 8.8% for FY24 which should rise further to 9.5% in FY25. This translates into yield spread of 4.8-5.6%, above its 10-year average of 4.1%. Current valuation is attractive with negatives largely factored in. Maintain BUY with a DDM-based TP of HK$1.92. Any interest rate pivot should improve the sentiment towards the counter.
