Result Analysis: Negatives from the office portion outweigh the uplift from the revival of tourist spending
- FY23 distributable income fell 13.6% y-o-y, in line with our estimate
- Still seeing negative reversionary growth at its office portfolio
- Turnover rent at Langham Place Mall almost doubled, led by a robust 50.5% growth in tenant sales
- Lingering concerns over Three Garden Road; maintain HOLD with lower TP of HK$2.15
FY23 distributable income fell 13.6% y-o-y, in line with our estimate. Champion REIT’s FY23 distributable income dropped 13.6% y-o-y to HK$1.12bn, mainly dragged by lower office rental earnings and higher cash finance cost. The result is in line with our forecast. Final DPU declined 15.3% y-o-y to HK$0.0756. This brought the full year DPU down 13.9% y-o-y to HK$0.1683. Payout ratio was slightly higher at 90.2% (FY22: 90%).
Shortfall in office earnings more than offset the growth from Langham Place Mall. Despite a 13.9% y-o-y growth in rental income from Langham Place Mall, total rental income, excluding building management fee income, dropped 2% to HK$2.31bn. This was mainly dragged by Three Garden Road, which recorded a 9.2% decline in rental income in FY23. Langham Place Office, which contributed c.15% of the REIT’s total rental income in FY23, also registered a mild rental decline of 3.7% in the same period. Due to increases in building management expenses, promotional expenses and rental commission, net property operating expenses jumped 11.5% y-o-y to HK$366m. This brought the net expense ratio 1.9ppts higher at 15.8% (FY22: 13.9%), and hence, net property income fell by a larger 4.2% to HK$1.95bn.
Negative office reversionary growth to continue. Three Garden Road recorded negative rental reversion in FY23 as tenants stayed cautious in expansion amid a sluggish financial market performance. This brought the passing rent down 3.8% h-o-h to HK$91.7psf as of Dec-23. Yet, thanks to in-house expansion of tenants in the financial sector which offset the departures, occupancy at Three Garden Road was maintained at 82.8% in Dec-23 (Jun-23: 82.2%). Subdued demand, coupled with upcoming supply in the neighborhood, should put further rental pressure at Three Garden Road. Spot rents have retreated to HK$70-80psf. With high expiring rent, we expect rental reversions for the 18.9% of leases expiring in FY24 to remain in the negative territory, and thus, drag the property’s rental income in the near term. Langham Place Office delivered a rather steady performance with occupancy and passing rent stable at 93.3% and HK$45.9psf as of Dec-23. However, leasing enquiries and inspection activities, especially from medical and beauty tenants, has slowed as the demand from Mainland tourists was weaker-than-expected. With 32.2% of floor area scheduled for roll over, Langham Office Tower should see mildly negative reversionary growth in FY24.
Langham Place Mall staged robust sales performance, reversionary growth turning positive. Following the full border reopening in early 2023, footfall at Langham Place Mall rebounded 27% y-o-y, recovering to c.90% of 2019’s level. Thanks to a revival of tourist spending, tenant sales at the mall jumped 50.5% y-o-y in 2023, and outperformed the overall Hong Kong retail market’s 16.2% and represented 80-90% of 2018’s level. This was mainly driven by the strong recovery in the beauty segment, where sales soared over two-fold in the period. This has resulted in a 91.9% surge in turnover rent to HK$224m in FY23. Hence, total rental income at Langham Place Mall rose 13.9% y-o-y to HK$740m, despite a c.5% decline in base rent. The mall was 98.6% let as of Dec-23, with less than 1% of tenants paying turnover rent only. With rent-to-sales ratio dropping to a level similar to pre-COVID times, we expect rental reversions to turn positive for FY24, and hence, fueling the rental growth of the mall.
Higher cash finance cost likely to weigh on DPU. Cash finance cost surged 41% y-o-y to HK$590m mainly on higher average HIBOR. Total debt was stable at HK$14.6bn as of Dec-23, translating into a gearing ratio of 22.8% (Jun-23: 22.7%). The portion of fixed rate debt stood at 54.5% as of Dec-23, but is expected to drop significantly to c.35% upon the HK$2.9bn IRS expiry in Jun-24. This should further drive up the cash finance cost of the REIT in FY24, which we forecast to rise by 17%. Hence, this will weigh on its DPU outlook.
Loan refinancing under discussion. Champion REIT is in discussions with banks for refinancing syndicated loans of c.HK$5bn maturing in mid-24. With standby committed facilities of HK$3.6bn which could be used to meet the upcoming refinancing requirement, refinancing risk should not be overly concerned.
Stable portfolio valuation, cap rates unchanged. Total portfolio valuation dropped by 0.3% h-o-h, mainly led by lower rental assumptions at Three Garden Road and Langham Place Office. Cap rates for Three Garden Road, Langham Place Office and Langham Place Mall were unchanged at 3.7%, 4.1% and 4.0% respectively.
Inexpensive valuation, yet office market uncertainties to continue to weigh on unit price performance. In the past six months, unit price of Champion REIT tumbled 28%, underperforming its peers by 1-29%. Following the heavy sell-off, Champion REIT is trading at 8.4-8.0% distribution yields for FY24-25. This translates into a yield spread of 4.1-3.7%, above its 10-year average of 3.0%. While current valuation is inexpensive from a historical perspective, uncertainties over Three Garden Road, which contributed c.56% of the REIT’s NPI in FY23, should continue to weigh on the sentiment towards the counter. Hence, we maintain our HOLD call at this stage with a DDM-based TP of HK$2.15.
