Construction & real estate / Hong Kong 11 January 2012 Hysan Development Target price: HK$35.20 Up/downside: +35.1% 14 HK | HYSNY US Share price (9 Jan): HK$26.05 Initiation: ready for take-off • Hysan has one of the best pure retail portfolios in Asia and its potential is just starting to emerge • We believe the company is poised for a take-off in earnings and dividend growth, which could last for several years • It offers both growth and defensive appeal; coverage initiated with a Buy rating How do we justify our view? over 3x more than Hysan’s current Risks. We see the main risk as a share price, in three years’ time. We decline in Mainland visitors to Hong apply a 40% discount to our end- Kong. In addition, we believe good 2012E NAV to derive our six-month execution is required to bring out the target price of HK$35.2, implying 35% full potential of Hysan’s portfolio. Jonas Kan, CFA upside potential. (852) 2848 4439 Share price performance [email protected] Catalysts. The opening of Hysan (HK$) (%) Yannis Kuo Place, scheduled in mid-2012, is a 44 110 (852) 2773 8735 38 100 [email protected] strong potential catalyst, and also one whose significance we believe extends 32 90 Alex Ye beyond driving net-profit growth of 26 80 (852) 2848 4471 21.8% for 2012E and 23% YoY for 20 70 [email protected] Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 2013E. We think Hysan’s retail and Hysan Development (LHS) Relative to HSI (RHS) office portfolio and also Causeway Bay Investment case. We believe as a district for retail and office 12-month range 23.00-39.10 Hysan Development (Hysan) owns properties are entering into a period Market cap (US$bn) 3.54 arguably one of the best pure retail of rising competitiveness. The group’s Average daily turnover (US$m) 4.92 portfolios of the Asia real-estate portfolio looks well-positioned to ride Shares outstanding (m) 1,056 companies. It owns the largest retail on what we see as the formation of a Major shareholder Lee Hysan Estate Company retail triangle in Causeway Bay. We (40.9%) portfolio in Hong Kong’s Causeway Bay, which we see as the most believe Hysan has yet to unlock its full potential. Financial summary (HK$) promising retail district in the world’s Year to 31 Dec 11E 12E 13E emerging shopping Mecca. Given an Revenue (m) 1,857 2,193 2,607 appropriate execution strategy, we Rising visibility on Causeway Bay’s Operating profit (m) 1,499 1,804 2,201 believe Hysan’s share price could appeal as a retail district, and Hysan’s Net profit (m) 1,271 1,548 1,904 double over the next three years and reinvention, should drive increasing Core EPS 1.203 1.466 1.803 initiate coverage with a Buy (1) rating. investor interest in the stock, in our EPS change (%) 10.2 21.8 23.0 view. We expect Hysan’s reinvention Daiwa vs Cons. EPS (%) (1.9) 1.8 6.6 Valuation. We believe Hysan’s to reap rewards for shareholders, as PER (x) 21.7 17.8 14.4 current valuation is attractive relative we believe the company is likely to Dividend yield (%) 3.1 3.8 5.0 to its past-10-year levels, and that it is raise its payout ratio back to closer to DPS 0.800 1.000 1.300 the pre-1996 level exceeding 80% – PBR (x) 0.6 0.6 0.6 heavily undervalued, given its EV/EBITDA (x) 19.6 16.2 12.9 transformation that we expect over we forecast a CAGR in its DPS of 20.6% for 2010-13 and see upside ROE (%) 2.9 3.3 4.0 the next 3-10 years. Our base-case Source: Bloomberg, Daiwa forecasts end-2012E NAV per share is HK$58.6 scope to this forecast. and could potentially rise to HK$87.6, Important disclosures, including any required research certifications, are provided on the last two pages of this report. Construction & real estate / Hong Kong 14 HK | HYSNY US 11 January 2012 Table of contents A gem whose day is in the making ................................................................................................... 6 1. Poised for an earnings take-off ................................................................................................. 8 2. Retail portfolio poised to ride on formation of a retail triangle in Causeway Bay ................. 11 3. Causeway Bay boasts strong potential to emerge as a credible alternative to premier office tenants ......................................................................................................................................... 17 4. Defensive appeal from high-quality non-core assets and other factors ................................ 20 5. Room for a valuation uplift ..................................................................................................... 22 Risk factors ................................................................................................................................. 25 Appendix 1: The development of Hysan .................................................................................... 26 Appendix 2: The Causeway Bay retail property market – on its way to becoming an integrated cluster .......................................................................................................................................... 28 Appendix 3: Challenges and opportunities facing Hysan’s Causeway Bay retail portfolio ....... 32 - 2 - Construction & real estate / Hong Kong 14 HK | HYSNY US 11 January 2012 Hysan: Causeway Bay portfolio and the retail triangle Source: Daiwa - 3 - Construction & real estate / Hong Kong 14 HK | HYSNY US 11 January 2012 Financial summary Key assumptions Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Completed investment properties (m sq.ft) 3.7 3.7 3.7 3.7 3.7 3.7 4.4 4.4 Blended average office rent (on GFA) 21.4 23.7 29.2 30.3 31.3 34.6 36.4 38.4 (HK$/sq.ft.) Blended average retail rent (on GFA) 48.1 49.3 59.2 61.2 66.2 66.0 69.8 76.7 (HK$/sq.ft.) Blended average residential rent (on GFA) 24.5 27.7 30.8 30.1 31.1 32.3 32.9 33.3 (HK$/sq.ft.) Pay-out ratio (%) 70 54 59 64 68 66 68 72 Profit and loss (HK$m) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Property rental - office 509 584 720 747 770 852 953 1,066 Property rental - retail 491 522 626 648 700 699 928 1,225 Others 268 262 292 285 294 306 312 316 Total revenue 1,268 1,368 1,638 1,680 1,764 1,857 2,193 2,607 Other income 147 98 63 38 49 60 61 62 COGS (240) (208) (217) (235) (250) (263) (284) (295) SG&A (111) (106) (134) (133) (140) (147) (159) (165) Other op. expenses (4) (4) (2) (7) (8) (8) (8) (8) Operating profit 1,060 1,148 1,348 1,343 1,415 1,499 1,804 2,201 Net-interest inc./(exp.) (163) (175) (155) (131) (117) (116) (115) (114) Assoc/forex/extraord./others 85 447 326 161 133 187 208 227 Pre-tax profit 982 1,420 1,519 1,373 1,431 1,570 1,897 2,315 Tax (163) (185) (264) (189) (201) (220) (266) (324) Min. int./pref. div./others (64) (77) (54) (71) (82) (80) (84) (87) Net profit (reported) 755 1,158 1,201 1,113 1,148 1,271 1,548 1,904 Net profit (adjusted) 755 1,158 1,201 1,113 1,148 1,271 1,548 1,904 EPS (reported) (HK$) 0.716 1.101 1.156 1.064 1.091 1.203 1.466 1.803 EPS (adjusted) (HK$) 0.716 1.101 1.156 1.064 1.091 1.203 1.466 1.803 EPS (adjusted fully-diluted) (HK$) 0.716 1.101 1.156 1.064 1.091 1.203 1.466 1.803 DPS (HK$) 0.500 0.600 0.680 0.680 0.740 0.800 1.000 1.300 EBIT 1,060 1,148 1,348 1,343 1,415 1,499 1,804 2,201 EBITDA 1,064 1,152 1,350 1,350 1,423 1,507 1,812 2,209 Cash flow (HK$m) Year to 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Profit before tax 982 1,420 1,519 1,373 1,431 1,570 1,897 2,315 Depreciation and amortisation 4 4 2 7 8 8 8 8 Tax paid (61) (140) (183) (469) (161) (181) (198) (239) Change in working capital 51 31 64 24 72 21 64 79 Other operational CF items (58) (271) (223) (55) (51) (76) (93) (113) Cash flow from operations 918 1,044 1,179 880 1,299 1,342 1,678 2,050 Capex 0 0 0 (242) (871) (880) (680) (380) Net (acquisitions)/disposals 168 172 (759) 959 (274) (100) 215 260 Other investing CF items 0 0 0 0 0 0 0 0 Cash flow from investing 168 172 (759) 717 (1,145) (980) (465) (120) Change in debt (1,487) 0 765 179 632 800 0 0 Net share issues/(repurchases) 3 (498) 2 1 1 0 0 0 Dividends paid (482) (497) (641) (642) (733) (790) (853) (1,096) Other financing CF items (144) (162) (140) (127) (109) (153) (135) (130) Cash flow from financing (2,110) (1,157) (14) (589) (209) (143) (988) (1,226) Forex effect/others 0 0 0 0 0 0 0 (2) Change in cash (1,024) 59 406 1,008 (55) 220 225 702 Free cash flow 918 1,044 1,179 638 428 462 998 1,670 Source: Company, Daiwa forecasts - 4 - Construction & real estate / Hong Kong 14 HK | HYSNY US 11 January 2012 Financial summary continued … Balance sheet (HK$m) As at 31 Dec 2006 2007 2008 2009 2010 2011E 2012E 2013E Cash & short-term investment 385 484 1,015 1,984 1,993 2,026 2,056 2,106 Inventory 0 0 0 0 0 0 0 0 Accounts receivable 159 66 94 83 98 102 120 143 Other current assets 644 686 1,331 489 320 320 320 320 Total current assets 1,188 1,236 2,440 2,556 2,411 2,448 2,496 2,569 Fixed assets 192 196 203 396 429 453 483 513 Goodwill & intangibles 0 0 0 0 0 0 0 0 Other non-current assets 34,873 39,458 38,893 41,090 45,714 52,703 53,902 54,111 Total assets 36,253 40,890 41,536 44,042 48,554 55,604 56,881 57,192 Short-term debt 0 0 550 400 650 850 626 424 Accounts payable 253 278 320 314 433 458 541 643 Other current liabilities 694 761 836 499 552 560 593 893 Total current liabilities 947 1,039 1,706 1,213 1,635 1,868 1,760 1,960 Long-term debt 2,821 2,861 3,201 3,491 3,937 4,351 4,381 3,931 Other non-current liabilities 3,577 4,142 3,919 606 665 694 1,471 1,409 Total liabilities 7,345 8,042 8,826 5,310 6,237 6,913 7,612 7,299 Share capital 5,276