Interim Results Analysis: Dampened by upsurge in cash finance cost
- 1HFY24 distributable income declined 18% y-o-y, c.7% below our estimate, mainly due to a provision of HK$6.3m in credit losses for debt securities.
- Balanced portfolio to underpin rental earnings resilience
- No refinancing need until mid-2025
- Correction overdone; BUY despite a lower DDM-based TP of HK$2.67
Interim result missed expectations due to provision for credit losses on debt securities. Sunlight REIT’s 1HFY24 distributable income declined 18.1% y-o-y to HK$162.3m, as higher rental earnings were more than offset by increased cash finance cost. The result was c.7% below our estimate, mainly due to a HK$6.3m provision made for credit losses on debt securities. With a slightly higher payout ratio of 94.4% (1HFY23: 93.7%), distribution income was 17.5% lower at HK$153.2m. Interim DPU fell 18.2% y-o-y to HK$0.09.
New contributions from West 9 Zone Kids (W9ZK) more than offset by increased cash finance cost. Total rental and car park income increased 5.7% to HK$343.7m, primarily reflecting the full period contribution from W9ZK acquired in Apr-23. Stripping out the contribution from W9ZK, total rental and car park income would have been broadly stable at c.HK$325m, as the shortfall in office income was compensated by the improvement from the retail portfolio. Including a rental related income of HK$75.5m (1HFY23: HK$63.4m), total revenue rose 7.9% y-o-y to HK$419.2m. Property operating expenses were 18.6% higher – or 10.4% if excluding operating costs relating to W9ZK – led by higher rental commission and lower pandemic-related fiscal concessions. With cost-to-income ratio higher at 22.9% (1HFY23: 20.8%), net property income grew by smaller 5.1% to HK$323.2m. However, this was more than offset by a 90% surge in cash finance cost to HK$111.3m due to HIBOR hikes and additional borrowings for financing the acquisition of W9Z.
Office portfolio delivers mixed performance. Office rental income dropped 3% to HK$155.8m. While rental growth of 3.3% was achieved on renewing leases, mainly for service trade tenants at Grade B offices, average passing rent dropped 0.9% h-o-h to HK$34.3psf in Dec-23, dragged by lower rents upon reletting. Overall office portfolio occupancy was stable at 93.1% as of Dec-23. Increased leasing activities for relocation or expansions has driven the occupancy at its rental flagship, Dah Sing Financial Centre (DSFC), slightly higher at 91.9% in Dec-23, from Jun-23’s 90.4%. Occupancies at Righteous Centre and The Harvest stood firm at 97.5% and 100% respectively, underpinned by solid demand from service trade tenants. On the other hand, dampened by cautious sentiment of SME tenants, occupancies at Strand 50 and 135 Bonham Strand Trade Centre softened to 90.5% and 94.5% in Dec-23 from Jun-23’s 94.4% and 100% respectively. In 2HFY24, 24% of leases at DSFC are scheduled for renewal. Given the prevailing challenges in the Grade A office market, rental reversions should stay negative, thus weighing on overall office income.
Retail portfolio on the road to recovery. Excluding W9ZK, rental and car park income from the retail portfolio improved c.3.2% y-o-y, led by the gradual recovery from Sheung Shui Centre Shopping Arcade (SSC) and Metro City Phase I (MCPI) which recorded respective reversionary growths of 4.8% and 4.1%. Average passing rent for the retail portfolio climbed 1.1% h-o-h to HK$66.3psf in Dec-23. Were it not for negative reversionary growth from property agency tenants, retail portfolio would have seen stronger income growth. As of Dec-23, overall retail portfolio was 93.2% let. (Jun-23: 93.5%) Occupancy at SSC moderated 6.9ppt to 90.7% in Dec-23 due to the departure of a kindergarten tenant. On the other hand, following the completion to the phase 1 asset enhancement work, MCPI saw its occupancy improving to 94.7% in Dec-23 from Jun-23’s 92.2%.
No refinancing need until mid-2025. Total borrowings stood at HK$5.01bn as of Dec-23 (Jun-23: HK$5.02bn). This represented 26.3% of its total asset (Jun-23: 26.1%). Sunlight REIT has no refinancing need until mid-2025. With the expiry of interest rate swaps (IRS), interest hedging ratio reduced to 32% as of Dec-23 from Jun-23’s 42%. However, the ratio has increased to c.42% upon the execution of IRS with an aggregate notional amount of HK$500m since Jan-24.
Negatives priced in; BUY with TP of HK$2.67. In the past six months, Sunlight REIT’s unit price plummeted 32%, underperforming the broad market as well as most of its peers. Meanwhile, Sunlight REIT is trading at an annualized distribution yield of 10.3% for FY24 and 11.4% for FY25. This translates into yield spread of 6.0-7.1%, c.2SD above its 10-year average of 3.9%. We believe concerns over its earnings outlook should be priced in following the heavy sell-down. Improving contribution from its retail portfolio should help offset weaker office income, and hence, pointing to rental earnings resilience. Potential resumption of the multiple-entry visa for Shenzhen residents should be positive for earnings prospects of SSC, which contributed c.20% of the REIT’s NPI. Any interest rate pivot should improve sentiments towards the counter. Maintain BUY, despite lower DDM-based TP of HK$2.67.