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Initiation: a Large 'Nurturing Reward' Awaits

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Initiation: a Large 'Nurturing Reward' Awaits Financials / Hong Kong 1972 HK Financials / Hong Kong 22 May 2014 Swire Properties Swire Properties Target (HKD): 31.60 Upside: 35.9% 1972 HK 21 May price (HKD): 23.25 Initiation: a large ‘nurturing reward’ awaits 1 Buy (initiation) 2 Outperform • We see Swire Properties benefitting greatly from the final phase 3 Hold of its approach to transforming locations 4 Underperform • Pacific Place and Taikoo Place are starting to enter this phase, 5 Sell while China, Miami and others are progressing towards it • Initiating with a Buy (1) rating and target price of HKD31.60 How do we justify our view? See important disclosures, including any required research certifications, beginning on page 143 Financials / Hong Kong 1972 HK Financials / Hong Kong 22 May 2014 Swire Properties Swire Properties Target (HKD): 31.60 Upside: 35.9% 1972 HK 21 May price (HKD): 23.25 Initiation: a large ‘nurturing reward’ awaits 1 Buy (initiation) 2 Outperform • We see Swire Properties benefitting greatly from the final phase 3 Hold of its approach to transforming locations 4 Underperform • Pacific Place and Taikoo Place are starting to enter this phase, 5 Sell while China, Miami and others are progressing towards it • Initiating with a Buy (1) rating and target price of HKD31.60 How do we justify our view? We forecast almost a doubling of ■ Risks both its annual gross rental income The main risks to our view would be and NAV over the 2013-20 period, to a weakened economic outlook for HKD20bn and HKD85.60/share, Hong Kong and declines in the respectively. Moreover, there could importance of the locations that Jonas Kan, CFA be upside to our forecasts. Swire Properties focuses on. (852) 2848 4439 [email protected] ■ Catalysts The following are potential share- price catalysts for the next 6-12 ■ Investment case months. We initiate coverage of Swire Share price performance 1) An improved outlook for Hong Properties with a Buy (1) rating. (HKD) (%) Kong grade-A office demand and 27 105 We see the company as having a rents: Swire Properties is the 25 96 special approach to the property largest office landlord in the city. 23 88 business, which involves investments 21 79 2) Reduced concerns about the 19 70 in transforming key locations over a outlook for Hong Kong May-13 Aug-13 Nov-13 Feb-14 May-14 period of decades. We believe this is a commercial properties and a Swire Prop (LHS) Relative to HSI (RHS) long-term and backend-loaded growing recognition that Swire business model in which the biggest Properties is a good vehicle to benefits – what we call the “nurturing 12-month range 19.02-26.90 gain exposure to this sector. Market cap (USDbn) 17.54 reward” – kick in mainly in the last 3m avg daily turnover (USDm) 7.22 phase. The benefits come from having 3) Interest by investors globally in Shares outstanding (m) 5,850 a large and expanding portfolio in gaining exposure to a potential Major shareholder Swire Pacific (82.0%) some increasingly strong and relevant narrowing of the “Hong Kong locations where it dominates. discount” on property stocks. Financial summary (HKD) Year to 31 Dec 14E 15E 16E Revenue (m) 14,931 15,551 17,331 Stage is set for company to ■ Valuation Operating profit (m) 8,718 9,571 10,306 realise its ‘nurturing reward’. We have a 6-month target price of Net profit (m) 6,760 7,502 8,352 Swire Properties has made several HKD31.60, based on a 30% discount Core EPS (fully-diluted) 1.156 1.282 1.428 important and strategic investments to our end-2014E NAV of HKD45.10. EPS change (%) 6.3 11.0 11.3 over the past 6 months, which will Daiwa vs Cons. EPS (%) 6.1 9.0 17.0 We believe there are numerous PER (x) 20.1 18.1 16.3 drive a 40% expansion (ie, 8.1m sq ft factors underpinning the structural Dividend yield (%) 2.7 2.9 3.1 on an attributable GFA basis) in the rerating we expect for Swire DPS 0.620 0.680 0.720 size of the company’s completed Properties in the coming years. PBR (x) 0.7 0.7 0.6 portfolio over 2013-20. EV/EBITDA (x) 17.3 16.1 15.0 ROE (%) 3.3 3.6 4.0 Source: FactSet, Daiwa forecasts See important disclosures, including any required research certifications, beginning on page 143 1 Buy (initiation) How do we justify our view? 2 Outperform 3 Hold Growth outlook 4 Underperform Valuation 5 Sell Earnings revisions Swire Properties: gross rental income from key locations Growth outlook Swire Properties has achieved strong growth in gross (HKDm) rental income from its investment properties over the 25,000 past 25 years (a CAGR of 13.3% since it completed the 20,000 development of One Pacific Place in 1988), without raising funds from new equity issuance. 15,000 10,000 Despite a much higher gross rental income base now, we 5,000 forecast gross rental income to rise by a 10.5% CAGR to HKD20bn over 2013-20, driven by plans to complete a 0 further 11.6m sq ft (8.1m sq ft on an attributable GFA 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E basis, ie, 40% of its current portfolio size) of new Greater Pacific Place Island East Festival Walk properties, as well as the continued maturing and Other HK properties China Miami strengthening that we expect for the company’s Source: Company, Daiwa forecasts investments in various locations. Swire Properties: PBR Valuation The stock is trading currently at a 48% discount to our (x ) end-2014E NAV of HKD45.10/share. We believe this 1.0 Average since IPO: 0.7x + 1SD: 0.8x discount does not give much credit to the company’s - 1SD: 0.6x decades of productive investments in various locations, 0.9 Current : 0.7x nor to the greater protection we believe its portfolio 0.8 offers to property industry downcycles compared with those of its peers. 0.7 0.6 We expect these locations (especially Greater Pacific Place in Greater Central and Taikoo Place in Island 0.5 East) to become stronger in the coming years and, along Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 with the company’s portfolio expansion programme, PBR Average +1 sd -1 sd drive up its NAV to HKD85.60/share by 2020. Source: Bloomberg, Daiwa forecasts Swire Properties: consensus EPS-forecast revisions (2014-15) Earnings revisions Our 2014-16 EPS forecasts are 6-17% above the (HKD) Bloomberg consensus ones. We think the consensus has 1.40 over-estimated the impact of competition from Citibank Plaza on Swire Properties’ Pacific Place (less than 5% of 1.30 the latter’s office leases are due to expire in 2014), and under-estimated the room for improvement for Swire 1.20 Properties’ rental income from Island East and China, as well as in its property-sales profit. 1.10 Also, we believe the market may not have appreciated 1.00 fully yet the potential of the company’s portfolio- Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 expansion programme set in motion for 2014-20. 2014E consensus EPS 2015E consensus EPS Source: Bloomberg - 4 - Financials / Hong Kong 1972 HK 22 May 2014 Contents Valuation: world-class property company at ‘Hong Kong discount’ ............................................. 8 Already a world-class property company, but yet to be priced as such ..................................... 8 Five catalysts underpinning a structural rerating ...................................................................... 8 Investment perspectives: a valuable franchise waiting to be monetised and recognised ........ 17 Investment thesis: market uncertainties provide buying opportunity for an unusual franchise ................................................................................................................................................... 28 1. Pacific Place has come a long way and its expansion into Wanchai South should open up new opportunities ..................................................................................................................... 35 2. Island East: set to be the largest office hub outside Central ................................................. 51 3. Location transformation in China finally starting to work .................................................. 62 4. Other upcoming locations poised to become supplementary earnings and NAV drivers ... 79 5. Good vehicle to gain exposure to Hong Kong commercial properties, especially offices .... 88 6. A play on the potential narrowing of the ‘Hong Kong discount’ .......................................... 96 Appendix 1: Swire Properties’ approach to property business ............................................... 107 Appendix 2: Swire Group and Swire Properties ...................................................................... 113 Appendix 3: the Hong Kong office market .............................................................................. 115 Appendix 4: the Hong Kong retail property market ............................................................... 119 Appendix 5: NAV and book value breakdown ......................................................................... 123 Appendix 6: portfolio breakdown ............................................................................................ 132 Appendix 7: earnings and gross rental income breakdown .................................................... 136 Please also see: The Hong Kong Property Toolkit: A step-by-step guide to the past, present and future of the Hong Kong Property Sector Autumn 2013 Jonas Kan, CFA (852) 2848 4439 ([email protected]) - 5 - Financials / Hong Kong 1972 HK 22 May 2014 Financial summary Key assumptions Year
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