Hong Kong Financials 25 May 2016 Hong Kong Property Sector It’s time to be more greedy than fearful Challenges abound, but we think the Hong Kong property market is more mature and sophisticated than many observers realise Corporate fundamentals are stronger than industry fundamentals – a distinction that we think deserves more recognition Jonas Kan, CFA Significant investment value could be unlocked if family-owned (852) 2848 4439 property companies continue to modernise; reiterating Positive stance [email protected] See important disclosures, including any required research certifications, beginning on page 175 Hong Kong Property Sector: 25 May 2016 Table of contents 1. The physical market showed restraint and prudency during 2H03-2015 ......... 6 2. Is the physical market showing signs of a potential meltdown? .................... 13 3. Is a meltdown likely? The real situation is more subtle and complex ............ 15 4. Are we seeing a correction or a normalisation? ............................................... 47 5. Can property companies pay more dividends and modernise their capital management? ...................................................................................... 55 Company Section Cheung Kong Property .......................................................................................... 73 Hang Lung Properties .......................................................................................... 119 Henderson Land .................................................................................................. 123 Hongkong Land .................................................................................................... 129 Hysan Development ............................................................................................. 135 Midland ................................................................................................................ 139 MTR Corporation ................................................................................................. 143 SHK Properties .................................................................................................... 149 Sino Land ............................................................................................................. 153 Swire Properties ................................................................................................... 157 Wharf Holdings .................................................................................................... 161 Great Eagle .......................................................................................................... 165 Kerry Properties ................................................................................................... 167 New World Development ..................................................................................... 169 Wheelock & Company ......................................................................................... 171 Hong Kong Financials 25 May 2016 Hong Kong Property Sector It’s time to be more greedy than fearful Challenges abound, but we think the Hong Kong property market is more mature and sophisticated than many observers realise Corporate fundamentals are stronger than industry fundamentals – a distinction that we think deserves more recognition Jonas Kan, CFA Significant investment value could be unlocked if family-owned (852) 2848 4439 property companies continue to modernise; reiterating Positive stance [email protected] What's new: In this report, we look at how the physical property market Key stock calls has responded in the face of widespread pessimism towards Hong Kong New Prev. property in the past few months. We conclude that the sector is not heading Swire Properties (1972 HK) for the kind of meltdown scenario that share prices appear to be pricing in. Rating Buy Buy Target 30.70 30.70 Upside p 54.3% What's the impact: Can the Hong Kong property market avoid a Hongkong Land (HKL SP) meltdown? In our view, the Hong Kong property market is more mature Rating Buy Buy and sophisticated than many observers realise. While other property Target 8.50 8.50 markets facing contradictory forces of a similar scale have succumbed to Upside p 39.8% sustained slumps, the Hong Kong property market has survived – and even Henderson Land (12 HK) thrived – over the past few decades, and does not appear to be heading for Rating Buy Buy a meltdown today. Rather, we believe the current situation could well be Target 60.80 60.80 simply a correction, or a return to normalisation from the unusual Upside p 36.8% circumstances the market has faced since 2H03. Indeed, if market SHK Properties (16 HK) participants respond to today’s challenges in a proactive and sophisticated Rating Buy Buy Target 131.60 131.60 way, it is not inconceivable that these challenges will turn into catalysts, Upside p 51.4% taking the sector to the next level as a metropolitan property market. Cheung Kong Property (1113 HK) Rating Buy The traditional valuation swings in Hong Kong property stocks Target 71.00 provide upside potential for share prices. Historically, Hong Kong Upside p 56.9% property companies’ share prices have recovered strongly, and quickly, Source: Daiwa forecasts when the market has accepted it has over-discounted the downside for the physical market. If the experiences of 2H05, 4Q08 and 2H13 are anything to go by, we could see a 50-150% share-price rebound in a few months. Moreover, we see room for further share-price upside if the family property companies continue to modernise the way they manage their assets and allocate capital. We see improvements in capital management as being key, and note that many of these companies have been growing their DPS for over 10 years, while some have begun to accept share buybacks. What we recommend: We still see considerable value in the sector, and hence maintain our Positive stance. Our top picks among the landlords are Swire Properties (1972 HK, HKD19.90, Buy [1]) and Hongkong Land (HKL SP, USD6.08, Buy [1]), while our top developer picks are Henderson Land (12 HK, HKD44.45, Buy [1]) and SHK Properties (16 HK, HKD86.95, Buy [1]). Also, we initiate coverage of Cheung Kong Property (1113 HK, HKD45.25) with a Buy (1) rating. How we differ: We expect the Hong Kong property market to be more resilient than share prices seem to be pricing in. Moreover, we discern signs of change in these companies’ capital management, and if this trend continues, the hidden investment value of these shares (worth up to USD100bn, on our estimates) could be gradually unlocked. See important disclosures, including any required research certifications, beginning on page 175 Hong Kong Property Sector: 25 May 2016 How do we justify our view? Growth outlook Valuation Earnings revisions Growth outlook Aggregate rental income of 5 major property companies While property sales profits in the residential segment can (HKDm) be volatile, the Hong Kong landlords and developers 70,000 generally delivered respectable YoY rental income growth 60,000 for 2015. Meanwhile, their China earnings have been 50,000 growing consistently, to the point where 7 companies now 40,000 have annual China gross rental incomes exceeding 30,000 HKD2bn – 2 of which are over HKD3bn. 20,000 10,000 The latest results confirm that the Hong Kong property 0 companies’ rental income has been holding up, even for FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 retail properties. This should cushion them against market SHK Properties Henderson Land Swire Properties Wharf Hang Lung Prop headwinds going forward, in our view. Source: Companies Valuation Major Hong Kong property developers: PBR While the share prices of the Hong Kong landlords and (x) Weighted-average PBR of four developers developers have not fallen that much in absolute terms, we 3.0 believe the sustained growth in their book values, NAVs Current PBR: 0.59x 2.5 and recurrent incomes over the past 10 years is not +2 SD: 2.01x 2.0 reflected in their share prices currently. The result: +1 SD: 1.61x 1.5 expanding discounts to both book values and NAVs. Average: 1.21x 1.0 After performing well in 2014 and 1H15, these shares saw -1 SD: 0.81x 0.5 a major sell-off in the broader market correction recently. -2 SD: 0.41x As a result, on PBR and P/NAV, their valuations are now at 0.0 about past-crisis levels (GFC, SARS, Asia financial 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 turmoil), or have breached the lows seen in these crises, Source: Companies, Datastream, Daiwa despite their much-improved corporate fundamentals. Earnings revisions Hong Kong property companies earnings revisions The Bloomberg-consensus earnings and NAV forecasts (Rebased) have been trending down for some time, which we take as 105 evidence that some pessimism is built into share prices. 100 Our take on the latest results is that the rental income and earnings of most Hong Kong property companies were 95 stronger than the market had expected. 90 Meanwhile, large transactions are still going through in the 85 physical market. We expect Mainland capital to continue to Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 support property asset purchases and note a growing FY16E consensus EPS FY17E consensus EPS acceptance among Hong Kong property companies of recycling capital through non-core asset disposal. This Source: Bloomberg, Daiwa suggests to us there is considerable room for the market to