Deutsche Bank Markets Research Asia Industry Date Hong Kong 15 December 2015 Property Hong Kong Property Property Industry Update Special Tony Tsang Jason Ching, CFA Research Analyst Research Analyst Canton Road losing out to Ginza (+852) 2203 6256 (+852) 2203 6205 Chuo -dori [email protected] [email protected] Downturn in HK retail likely to be more serious than market expects Top picks We have just hosted a property tour of Tokyo, visiting various property CK Property (1113.HK),HKD50.40 Buy projects. A key observation is that the bustling Chinese tourist retail scene and Sino Land Co (0083.HK),HKD11.34 Buy numerous tour buses that used to be present in HK (but are no longer) are now New World Dev (0017.HK),HKD7.54 Buy evident in Tokyo. In our view, in addition to more and better tourist attractions MTR Corp (0066.HK),HKD36.35 Buy (plus better service and attitude toward tourists) in Tokyo vs. HK, the lower JPY Hang Lung Properties Buy FX rate (and inability of HKD to adjust given the linked exchange rate) is a key (0101.HK),HKD17.38 reason for this shift in the pattern of mainland tourism. As prices of consumer Source: Deutsche Bank goods and prime retail rents in Tokyo are significantly lower than in HK, retail rents in HK should fall significantly in the absence of HKD adjustments. Companies Featured CK Property (1113.HK),HKD50.40 Buy We see a multi-phase and multi-year downturn in HK retail sales and rents Sino Land Co (0083.HK),HKD11.34 Buy Looking at over 1,700 retail items in 39 categories of interest to mainland New World Dev (0017.HK),HKD7.54 Buy tourists (such as shoes, watches, rice cookers, toilet seats, hairdryers, MTR Corp (0066.HK),HKD36.35 Buy cameras, handbags and leather goods, fruit, cigarettes, F&Bs, beauty products, Hang Lung Properties Buy fashion, pharmaceuticals, milk powder), we found that 1) over 45% of the (0101.HK),HKD17.38 items in Tokyo are not available in HK; and 2) retail prices in Tokyo are on Hongkong Land Holdings Ltd Hold average 34% lower than in HK (international brands are 15% cheaper and (HKLD.SI),USD6.91 other items 36%). This suggests that Tokyo offers mainland tourists a superior Hysan Development (0014.HK),HKD32.00 Sell range of goods at more attractive prices, reflecting the structural Great Eagle Hldgs (0041.HK),HKD24.60 Sell disadvantages of HK. In the next four years, we expect a multi-leg de-rating of Link REIT (0823.HK),HKD46.00 Hold HK retail, hit by factors such as 1) a continued fall in mainland tourist arrivals SHK Properties Ltd (0016.HK),HKD93.50 Buy (which has already happened); 2) weakening domestic consumption (which Wharf (0004.HK),HKD42.10 Hold has just started); 3) likely further RMB depreciation (given cheaper currencies Source: Deutsche Bank such as JPY, KRW and Euro); and 4) a likely further reduction in luxury goods tax in China (to encourage domestic consumption). Hong Kong also losing out on tourist spots to attract mainland tourists According to the latest studies by the China Institute of City Competitiveness, HK no longer has a place in the top 30 special tourist cities in mainland China, suggesting that HK can no longer compete with most other mainland cities, not to mention overseas tourist destinations. On our analysis, there are only 14 key tourist attractions in HK (and this number has risen by only one in the past 10 years), compared to over 200 attractions in the Greater Tokyo area, over 200 in the Kyoto-Osaka-Kobe area and over 100 in Seoul (and these numbers have continued to rise). In our view, the lack of key tourist attractions in HK suggests that mainland tourists are now less likely to make multiple visits to HK. To regain competitiveness in tourism, HK needs to build more tourist attractions (which is hard given high construction labour costs) and/or reduce retail prices (as HKD FX rates cannot adjust), which means lower retail rents. HK retail rents likely to fall by up to 58% in the full downturn ahead As shopping is the primary reason for mainland tourists to visit HK, we believe a worst-case scenario would be all mainland tourists diverting to Japan/Korea/ Europe as shopping destinations due to unfavourable currency movements. In this scenario, retail sales would likely fall back to reflect consumption by locals, implying that retail sales could potentially halve from current levels. Looking at previous cycles, once the downturn phase is confirmed, the downward cycle can last for at least 36 months. With the downturn confirmed (HK retail sales have declined for eight consecutive months since March 2015), we expect retail rents to fall by up to 58% in the next three to four years. ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. 15 December 2015 Property Hong Kong Property Special Table Of Contents Tokyo: A new shopping paradise for mainland tourists ...... 3 We remain negative on retail landlords and hotels in HK; Stay defensive for HK property .............................................................................................................. 3 Retail prices in Tokyo are about 40% cheaper than in HK .................................. 3 HK becoming out of favour for mainland tourists ............... 6 Hong Kong no longer an attractive tourist destination for mainland tourists ..... 6 Retail rents likely to fall by up to 58% in the full downturn ahead ................................................................................. 19 Retail sales could potentially halved if Mainland tourists are no longer coming to Hong Kong ................................................................................................... 19 For 2016, we expect retail rents fall by at least 20% ........................................ 25 Details of 2015 DB Tokyo vs. HK retail prices comparison study .................................................................................. 30 We have looked at over 1,700 retail items in 39 categories in Tokyo ............... 30 HK residential property market update ............................. 79 Transacted prices of major housing estates ..................................................... 83 HK commercial property market update ........................... 87 HK macro update .............................................................. 90 HK policy summary ........................................................... 93 Taking a look at valuations .............................................. 100 Page 2 Deutsche Bank AG/Hong Kong 15 December 2015 Property Hong Kong Property Special Tokyo: a new shopping paradise for mainland tourists We remain negative on retail landlords and hotels in HK; stay defensive on HK property We have just hosted a property tour of Tokyo, visiting various property projects. A key observation is that the bustling Chinese tourist retail scene and numerous tour buses that used to be present in Canton Road in HK (but are no longer) are now evident in Tokyo, especially in the Chuo-dori in Ginza. In our view, in addition to more and better tourist attractions (as well as better service and attitude toward tourists) in Tokyo vs. HK, the lower JPY FX rate (and inability of the HKD to adjust given the linked exchange rate) is a key reason for this shift in the pattern of mainland touristm. As the prices of consumer goods and prime retail rents in Tokyo are significantly lower than in HK, retail rents in HK should fall significantly in the absence of any currency adjustments in the HKD. Our top picks are CK Prop (for its relatively low land cost), Sino Land (for its high net cash position and high dividend yield supported by recurrent income), and MTRC and Hang Lung Prop (for their defensive portfolios), as we believe their current share prices already factor in a residential price decline of 30%. We also like NWD for its attractive valuation and improving management track record. We remain concerned about the outlook for HK retail and hotel markets, and retain Sell on Hysan and Great Eagle. Our TPs are based on NAV discounts. Key risks: unexpected economic and political volatility. Retail prices in Tokyo are about 40% cheaper than in HK On our property tour, we looked at over 1,700 retail items in 39 categories in Tokyo in which mainland tourists are interested. These include toys, TV games and games consoles, watches, shoes, electrical and electronic appliances (such as rice cookers, air purifiers, hairdryers, shavers, TVs, refrigerators, kettles, toothbrushes), cameras and lenses, sweets and chocolate, handbags and leather accessories, cigarettes, fast food, fruit, ramen, luxury restaurants, sake and wines, kitchenware, toiletries, beauty products and beauty appliances, body care products, fitness products, computers and accessories, fashion and clothing, household products, pharmaceuticals and general medicines, milk powders, etc. In our analysis, comparing the availability and retail prices of these consumer goods in Tokyo and Hong Kong, we found that: 1) Over 45% of these items are not available in HK; 2) The retail prices of international brands in Tokyo are on average 15% lower