Company Update: Retail reversionary growth to turn positive
- Retail tenants’ sales continue to recover but yet to return to pre-COVID level due to high base
- Office income under pressure, particular at Times Square
- Valuation is compelling even allowing for slower-than-expected post-pandemic retail sector recovery
- Maintain BUY with HK$30.80 TP
Retail occupancy at Harbour City further improved from Jun-23’s 96% due to the addition of new tenants. Luxury brands staged better post-COVID sales recovery than mid-priced fashion retailers and F&B operators. However, overall tenants’ sales have yet to return to pre-pandemic level due to a high base and a shift in shopping behaviour of Mainland tourists.
In addition to increased turnover rents led by tenants’ sales recovery, amortised rental concession has been gradually declining, thus adding momentum to retail income recovery.
With occupancy cost ratio improving to <20% (better than pre-COVID level), retail reversionary growth should turn positive in 2024.
To boost its competitiveness, Wharf REIC is refining the trade and tenant mix at Times Square which is experiencing slower post-COVID tenants’ sales recovery.
Office occupancy at Harbour City remains broadly stable with increased demand from insurance companies following the border re-opening. Manulife Financials is a case in point. Times Square is impacted by the departure of ByteDance. Overall office income should remain under pressure, dragged by negative reversionary growth and rental void. We project office income of Harbour City and Times Square to fall 10% and 17% in FY23 followed by 3% and 5% decline in FY24.
Marco Hotels in Tsim Sha Tsui staged a decent post-pandemic recovery. However, F&B revenue remains weaker than pre-COVID times.
While the interest rate upcycle is nearing an end, HIBOR is expected to stay high in the near term. With all borrowings mainly on floating rate basis, Wharf REIC should inevitably suffer from the prevailing high interest rates. This would moderate the company’s earnings recovery.
In the past six months, shares of Wharf REIC fell 42%, underperforming the broad market by 14ppts, mainly due to slower-than-expected tourist spending recovery. Meanwhile, the stock is trading at 66% discount to our assessed current NAV, against its average discount of 39% since its listing. Estimated dividend yields stand at 5.8% and 6.3% for FY23 and FY24. We believe concerns over retail market recovery should be largely discounted following the share price correction. The current low valuation should cushion further downside risk. Any interest rate pivot could improve its earnings outlook and share price performance. By applying a target discount of 55% (c.1.5SD below its mean since its listing) to our Dec-24 NAV estimate, we set our TP at HK$30.8 and thus our BUY call.
