Final Result Analysis: Portfolio rejuvenation disrupted earnings
- FY23 recurring underlying profit fell 11.2%, mainly on lower rental earnings, broadly in-line with our estimate
- Second interim DPS slashed by 31% y-o-y to HK$0.81, full year DPS down 25% y-o-y
- Newly-renovated retail space contribution to propel near term earnings growth
- Negatives priced in, with long-term rental upside from portfolio rejuvenation; maintain BUY with TP HK$17.16
Recurring earnings down 11.2% y-o-y, second interim dividend slashed by 31%, broadly within expectations. Excluding the one-off exchange gain of HK$66m led by the settlement of the acquisition in Lee Gardens Shanghai in 2022, Hysan Development’s FY23 underlying profit declined 11.2% y-o-y to HK$1.83bn, mainly dragged by lower rental earnings. The result was broadly in line with our estimate. Hysan Development reset its second interim DPS to HK$0.81, down 31% from FY22’s HK$1.17. This brought full year DPS to HK$1.08, down 25% y-o-y. We believe this is a prudent approach for the company to preserve cash under the current challenging market.
Portfolio rejuvenation and negative reversionary growth to dent rental income. Gross rental receipts dropped 7.2% y-o-y to HK$3.21bn, dragged by lower contribution from all office, retail, and residential portfolio. Negative reversionary growth continued to work its way through its office portfolio, where its rental income sank 6.7% y-o-y to HK$1.47bn, accounting for c.46% of the company’s total rental income. Meanwhile, despite a 45% surge in turnover rents to HK$154m, rental contribution from the retail portfolio shrank 6.7% to HK$1.53bn, led by the disruption from the ongoing portfolio rejuvenation, where c.10% of the total retail space were closed for enhancement works during the period. Residential income fell 14.2% y-o-y to HK$205m on lower average occupancy and negative rental reversions. Occupancy at the Bamboo Grove remained low at c.60% as of Dec-23 (Jun-23: 61%). With a 9.5% growth in property expenses led by a significant increase in electricity tariff, rental earnings fell by a larger 10.5% y-o-y to HK$2.59bn. Including administrative expenses, rental margin squeezed by 3ppt to 71% (FY22: 74%). Excluding the negative turnover impact of the Lee Gardens rejuvenation project, rental margin would have been higher at 72.7% on a like-for-like basis.
Office rental income to remain on a downward trend. Flight-to-quality trend remained prevalent under the office market downturn. Hermes and the medical group Adventist & Procare leased new floors in Lee Garden One and Lee Garden Two respectively, while UOB and Chanel expanded their offices in Lee Gardens. This put the office occupancy firm at 89% (Jun-23: 89%) despite sluggish office demand amid global macro uncertainties. Banking, Finance and Wealth Management firms remain the largest tenant group within the portfolio, occupying c.21.4% of the total office area. Meanwhile, the portion of medical and health tenants has increased to 8.2% in Dec-23, from Dec-22’s 6.4%, led by the uptick in business following the border reopening with Mainland China. In FY24, about 20% of leases, in terms of floor area, are scheduled for renewal with expiring rent similar to FY23. Given the prevailing market sentiment, we expect office reversionary growth to remain negative in FY24.
Retail reversionary growth turned predominantly positive, with contribution from the completed portfolio rejuvenation to further propel growth. Since the second quarter of 2023, tenant sales growth at Hysan Development’s retail portfolio has moderated. Overall tenant sales have yet to return to the pre-COVID level in 2018. Sales of luxury brands, representing c.40% of the total portfolio, has exceeded the pre-COVID level while the remaining trades still saw sales lagging behind by 20-30%. Nonetheless, thanks to a healthy occupancy cost ratio of c.15%, rental reversions for the retail portfolio, which was 97% let as of Dec-23 (Jun-23: 98%), was predominantly positive in 2023. Major enhancement works at Lee Garden One were completed with the arcade area reopened in late 2023. A mid-teens rental increment is expected upon the scheduled phased opening of flagship stores by key luxury tenants in 2024 and 2025. This should further reinforce Lee Gardens as a prime shopping destination among tourists and local alike. Coupled with positive reversionary growth, the retail portfolio should see growing rental contribution in the year ahead.
Flexible marketing strategy to move sales in Villa Lucca. In view of the subdued residential market sentiment, Hysan Development, together with its JV partner HKR International, has adopted a flexible pricing strategy to boost sales. The consortium has leased out available units while offering tenants an option to buy. As a result, over 60 houses and apartments were sold or leased in 2023, representing c.23% of the total units. In FY23, a loss of HK$23m was booked from this joint venture project.
Lee Gardens Shanghai seeing progress. Enhancement work at the office tower of Lee Gardens Shanghai was completed in 2023, with tenants starting to move in in 1Q23. Commitment rate reached c.30%, with another 30-40% under negotiation. Renovation work at the retail portion is scheduled to complete in 2024, with the first tenant expected to move in during 1H24.
No significant near-term refinancing needs. Net debt rose mildly to HK$21.7bn as of Dec-23 from Jun-23’s HK$21.2bn, mainly due to capex incurred for the portfolio rejuvenation and Caroline Hill Road project. This represented c.32.3% of its shareholders’ fund (Jun-23: 30.8%). Hysan Development has no significant near-term refinancing need, with only HK$158m debts maturing in 2024. Hedging ratio was maintained at c.62% as of Dec-23 (Jun-23: 61%).
Negatives priced in, uplift from portfolio rejuvenation to bode well for near term earnings outlook. The stock is trading at a 79% discount to our current assessed NAV, >2SD below its 10-year average of 55%. We believe further share price correction is limited given its cheap valuation. Hysan Development should see higher rental earnings led by growing contribution from the retail portfolio, despite negative reversionary growth from the office portfolio. The rejuvenation should solidify its leading position as a prime shopping destination within the precinct, and hence, augur well for its long-term rental growth. Maintain BUY with TP of HK$17.16. This is premised on target discount of 72% (1.5SD below its 10-year average) to our Dec-24 NAV estimate.
