Swire Properties: More on the ‘Nurturing Reward’ Q&A on the Progress the Company Has Made in HK/China and the US Over the Past Year

10 April 2015 Swire Properties: more on the ‘nurturing reward’ Q&A on the progress the company has made in HK/China and the US over the past year See important disclosures, including any required research certifications, beginning on page 62. Swire Properties 10 April 2015 Contents How is the unfolding of the ‘nurturing reward’ Q1 1 progressing? Is Greater Pacific Place becoming an increasingly Q2 5 important part of Greater Central? Is Island East an upcoming commercial hub on HK Q3 15 Island? Are Swire Properties’ China investments finally Q4 21 starting to take off? Q5 Is Miami another jewel in the making? 33 Q6 What is the fair value for Swire Properties? 37 Appendix 45 Company section: Swire Properties 55 Please also see: Cheung Kong/Hutch’s Bold Move: Swire Properties: The Hong Kong Property Toolkit: Q&A on the prospect of the group Initiation: a large ‘nurturing reward’ A step-by-step guide to the past, becoming a global play, with a awaits present and future of the Hong Kong valuation to match Property Sector 9 February 2015 22 May 2014 Autumn 2013 Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439 Jonas Kan, CFA (852) 2848 4439 ([email protected]) ([email protected]) ([email protected]) Swire Properties 10 April 2015 Contributing Daiwa Analyst: The ‘nurturing reward’: where are we now? This report follows our 22 May 2014 initiation report on Swire Properties, in which we argued that there was a so-called ‘nurturing reward’ awaiting the group, stemming from its differentiated business model in Hong Kong’s property market. This model has involved multi-decades of meticulous investment in a number of areas in Hong Kong, which is effectively transforming those areas. Jonas Kan, CFA (852) 2848 4439 [email protected] We believe the benefits of such a nurturing award have continued to unfold and that they showed up clearly in the recent 2014 results. Moreover, the various locations that are being transformed by Swire Properties have continued to become stronger and more relevant commercial hubs since our May 2014 report was published, and we discuss our expectations for the future direction of its various divisions in the latter sections of this report. Of particular importance, in our view, is the sustained growth in tenant sales in all of the group’s China malls and what we see as a promising debut for its Daci Temple project in Chengdu, which bodes well for the group’s prospects over the next few years. This report also follows on the heels of our 9 February report on the Cheung Kong Hutchison Group, in which we considered the future direction of Hong Kong family business groups and how they see the valuation discount on their shares. We think this perspective throws an interesting light on Swire Properties, because among the major Hong Kong family business groups, it is probably one of the closest to its major Western counterparts, yet its valuation has not managed to escape “the Hong Kong discount”. As such, we see it as an attractive vehicle through which to play on the theme of any narrowing of “the Hong Kong discount”. Jonas Kan, Head of Hong Kong and China Property Swire Properties 10 April 2015 Swire Properties 10 April 2015 Question 1 How is the unfolding of the ‘nurturing reward’ progressing? - 1 - Swire Properties 10 April 2015 Q1: How is the unfolding of the ‘nurturing reward’ progressing? In our 22 May 2014 initiation report on Swire Properties (A large ‘nurturing reward’ awaits), we argued that there was a large ‘nurturing reward’ awaiting Swire Properties, which stems from it having adopted a special approach to the property business, which involves investing in key locations in order to transform them over a period of decades. Essentially, we think Swire Properties’ business model is about the creation of locations, as it usually starts with securing a large strategic site in a location that is not yet prominent, and it then works on meticulously transforming the area into a stronger and more relevant location for commercial properties. The caveat of this business model is that it requires significant management efforts and commitment in the initial years, but the merits of such an approach continue to improve over time, with the assets it has been nurturing gradually becoming able to generate large and improving free cash flow. Having a large and low-cost income-producing property portfolio in upcoming locations, meanwhile, puts Swire Properties in an advantageous position in terms of participating in the future growth and expansion of that location. We see this type of business model as long-term and back-end loaded in which the largest portion of what we call the ‘nurturing reward’ kicks in most strongly in the last phase. The benefits come from having a large and expanding portfolio in some increasingly strong and relevant locations where it dominates, as the following diagram illustrates. The economics of Swire Properties’ approach to property Source: Daiwa However, once the basic ingredients and structure have been put in place and start driving a continuous upgrading of the property and location, such a ‘nurturing reward’ should start to become evident, resulting in the property asset showing a more resilient performance during down-cycles and its rental and capital values being able to perform better during the upcycles. As and when the portfolio is able to make another major leap forward, then the rental and capital values of the portfolio should have another leap forward. - 2 - Swire Properties 10 April 2015 In our opinion, such a ‘nurturing reward’ has started to unfold for Swire Properties and we think one main feature of its 2014 results was that the rise in its underlying net profit was driven by an across-the-board improvement in all of its key businesses – thus, what we call the ‘nurturing reward’ is emerging. Swire Properties: movement in underlying profit (HKDm) 7,500 +76 +259 7,152 7,000 +346 -29 +152 6,500 6,348 6,000 5,500 Underlying profit Increase in profit Increase in profit Net changes from Increase in profit Increase in profit Underlying profit 2013 from HK prop from PRC prop other prop from trading prop from hotels 2014 investment investment investment Source: Company Below is our take on the position of the 4 key locations (Pacific Place Hong Kong, Island East Hong Kong, China and Miami [US]) that Swire Properties has been nurturing. After more than 10 months since the release of our last report and after reading the various quarterly KPIs provided by Swire Properties since then, our interpretation is that these 4 locations have been making steady progress in terms of becoming stronger and more important commercial property locations, with Pacific Place showing resilience against competition from Citibank Plaza, and Island East seeing continuous positive rental reversions and on track for a new face. Moreover, the group’s Miami project has also been making solid progress with Saks Fifth Avenue having signed up as the anchor tenant in the mall, and some 80% of the units in the first residential tower of the Brickell City Centre having been sold. Swire Properties: industry positioning of various locations on which it focuses . Source: Daiwa - 3 - Swire Properties 10 April 2015 In our opinion, the group’s biggest progress so far has been in China, with its quarterly KPIs showing across-the- board sustained growth in tenant sales in all its China malls. We also think the recent opening of the mall in its Daci Temple project (Taikoo Li Chengdu) is an important development. While we do not have any official sales figures on the performance of this mall at this point, anecdotal evidence suggests this mall has received good feedback. We recently visited the project and our view is that Swire’s Taikoo Li Chengdu project, together with Wharf’s IFS, is having a transformational impact on the Chengdu retail property market. Basically, we see the China retail property market as an ongoing “battle” between shopping malls, department stores and pedestrian areas. Our read is that Chengdu is seeing the first major win for the shopping malls over the department stores. In this light, Swire’s Daci Temple project could have a wider significance for the industry in that it is a new product type for the industry. As such, its successful execution could signal that the group has made considerable progress in the execution of its commercial property projects in China (see the answer to Question 4 for further details). The China Retail property sector Source: Daiwa In what follows, we discuss further the current position and future prospects of the 4 key locations Swire Properties has been nurturing for the past 10-30 years: i) Pacific Place, Hong Kong, ii) Island East, Hong Kong, iii) China, and iv) Miami. Their respective positions in what we see as the development path for the four locations are illustrated in the diagram above. - 4 - Swire Properties 10 April 2015 Question 2 Is Greater Pacific Place becoming an increasingly important part of Greater Central? - 5 - Swire Properties 10 April 2015 Q2: Is Greater Pacific Place becoming an increasingly important part of Greater Central? The position of Pacific Place in Hong Kong’s commercial property sector changed over the years. It started off as an unproven new area on the fringes of Central, and later established itself as a distinct area for commercial properties. Since 2003, Wanchai South has evolved as an extension of Pacific Place, forming what we refer to as Greater Pacific Place, which we believe is becoming a more important commercial hub in Greater Central.

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