Equity Research 28 October 2013 Hong Kong Property Not crying wolf Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, 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. This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified as research analysts with FINRA. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 132. Barclays | Hong Kong Property HONG KONG PROPERTY Not crying wolf Asia ex-Japan Real Estate First real downturn since 1998, home prices to fall 30% by end-2015E: We initiate Industry view: NEGATIVE coverage of the Hong Kong property sector with a negative view. We believe the property From Neutral market is about to enter its first real downturn since 1998 and we expect home prices to drop by at least 30% by the end of 2015. While we believe consensus also expects prices to decline, we think the magnitude of the fall is underestimated, as are the potential Paul Louie knock-on effects on commercial property. We expect a synchronised downturn, with +852 2903 4545 office prices falling by 20%, while retail properties escape with just zero growth through [email protected] end-2015E. Among the 14 stocks on which we initiate coverage, we rate eight UW, four Barclays Bank, Hong Kong EW and only two OW. Our UW-rated stocks are: SHKP, NWD, Sino, Kerry, Midland, Wharf, Swire Prop and HKL. Our negative view on Hong Kong causes us to also downgrade our Zita Qin Asia ex-Japan Real Estate industry view to Negative from Neutral. +852 2903 4450 [email protected] Why 30% and why now? Although there have been previous calls for a property market Barclays Bank, Hong Kong correction, the key questions remain: “How much?” and “Why now?” How much? We believe property prices are always set by the marginal buyer. Our analysis of the home price-to-income multiple, the buy-vs-rent cash flow equation and the opportunity costs of holding a property suggest that home prices should correct by at least 30%. With home prices up 111% since end-2008, we believe there is significant scope for owners to take profit on their property holdings. Why now? While the market waits for interest rates to trigger a correction, we see other important catalysts: 1) household income growth is stalling; 2) rents are hitting the income ceiling; 3) supply is exceeding demand; and 4) developers are speeding up presales. As developers and homeowners adjust their opportunity cost expectations from a rising to a falling market, a downward spiral of home prices is likely. Stock selection: First pain, then gain: With property stocks being macro-driven, during the initial home price correction we believe the right strategy is to underweight the sector. As past cycles suggest, property stocks can rebound significantly as physical prices bottom, but we believe this is premature and the time to bargain hunt can wait. Screen for maximum defensiveness: We recommend investors focus on companies with: 1) overseas/non-property exposure; 2) cashed up balance sheets; 3) short-duration/high- margin landbanks; and 4) depressed valuations. After screening for these factors, Cheung Kong and Hang Lung Properties are our only OWs. We expect our eight UW-rated stocks to fall by an average of 16% to our 12-month PTs. Risks to our negative outlook: Key upside risks include: 1) pre-emptive unwinding of the various property cooling measures; 2) additional quantitative easing and stimulus in the US causing 10-year Treasury yields to fall back below 2.0%; and 3) a significant rally in Chinese equities, which could trigger a re-rating for Hong Kong stocks, including property. 28 October 2013 1 Barclays | Hong Kong Property Summary of our Ratings, Price Targets and Earnings Estimates in this Report Company Rating Price Target EPS FY1 (E) EPS FY2 (E) Old New Date Price Old New %Chg Old New %Chg Old New %Chg Asia ex-Japan Real Estate Neu Neg Champion REIT (2778 HK / 2778.HK) N/A EW 23-Oct-2013 3.47 N/A 3.31 - N/A 0.23 - N/A 0.16 - Cheung Kong (Holdings) Ltd. (1 HK / 0001.HK) N/A OW 23-Oct-2013 122.40 N/A 135.00 - N/A 12.08 - N/A 11.81 - Hang Lung Properties Ltd. (101 HK / 0101.HK) N/A OW 23-Oct-2013 25.55 N/A 27.95 - N/A 0.88 - N/A 1.58 - Henderson Land Development Co., Ltd. (12 HK / 0012.HK) N/A EW 23-Oct-2013 46.45 N/A 46.70 - N/A 3.10 - N/A 3.38 - Hongkong Land Holdings Ltd. (HKL SP / HKLD.SI) N/A UW 23-Oct-2013 6.26 N/A 5.59 - N/A 0.40 - N/A 0.39 - Hysan Development Co., Ltd. (14 HK / 0014.HK) N/A EW 23-Oct-2013 35.85 N/A 33.32 - N/A 1.93 - N/A 2.03 - Kerry Properties Ltd. (683 HK / 0683.HK) N/A UW 23-Oct-2013 33.30 N/A 28.06 - N/A 3.02 - N/A 2.31 - Link REIT (823 HK / 0823.HK) N/A EW 23-Oct-2013 38.90 N/A 37.94 - N/A 1.58 - N/A 1.69 - Midland Holdings Ltd. (1200 HK / 1200.HK) N/A UW 23-Oct-2013 3.05 N/A 2.25 - N/A -0.35 - N/A -0.05 - New World Development Co., Ltd. (17 HK / 0017.HK) N/A UW 23-Oct-2013 10.96 N/A 8.52 - N/A 1.17 - N/A 1.12 - Sino Land Co., Ltd. (83 HK / 0083.HK) N/A UW 23-Oct-2013 11.18 N/A 9.69 - N/A 0.91 - N/A 1.08 - Sun Hung Kai Properties Ltd. (16 HK / 0016.HK) N/A UW 23-Oct-2013 101.60 N/A 84.00 - N/A 6.89 - N/A 7.17 - Swire Properties Ltd. (1972 HK / 1972.HK) N/A UW 23-Oct-2013 21.45 N/A 18.65 - N/A 0.97 - N/A 1.13 - Wharf (Holdings) Ltd. (4 HK / 0004.HK) N/A UW 23-Oct-2013 67.65 N/A 59.50 - N/A 3.74 - N/A 3.80 - Source: Barclays Research. Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency. FY1(E): Current fiscal year estimates by Barclays Research. FY2(E): Next fiscal year estimates by Barclays Research. Stock Rating: OW: Overweight; EW: Equal Weight; UW: Underweight; RS: Rating Suspended Industry View: Pos: Positive; Neu: Neutral; Neg: Negative 28 October 2013 2 Barclays | Hong Kong Property CONTENTS INVESTMENT SUMMARY ................................................................................ 4 PHYSICAL MARKET OUTLOOK ...................................................................... 9 IS THE POTENTIAL DROP PRICED IN? TWO COMMON MISCONCEPTIONS .......................................................................................... 22 IS IT PRICED IN? SHARE PRICE PERFORMANCE AND VALUATIONS . 28 STOCK SELECTION: FIRST PAIN, THEN GAIN .......................................... 33 STOCK PICKS: CK AND HLP, MOST DEFENSIVE ...................................... 41 KEY INVESTMENT RISKS ................................................................................ 44 DISCOUNTS TO NAV ...................................................................................... 45 COMPANIES ...................................................................................................... 50 CHEUNG KONG (1 HK; OW; PT HKD135.00; +10%) ............................... 51 HENDERSON LAND (12 HK; EW; PT HKD46.70, +1%) ........................... 56 SUN HUNG KAI PROPERTIES (16 HK; UW; PT HKD84.00; -17%) ........ 61 NEW WORLD DEVELOPMENT (17 HK; UW; PT HKD8.52, -22%) ....... 66 SINO LAND (83 HK; UW; PT HKD9.69; -13%) .......................................... 71 HANG LUNG PROPERTIES (101 HK; OW; PT HKD27.95; +9%) ............ 76 KERRY PROPERTIES (683 HK; UW; PT HKD28.06; -16%) ..................... 81 MIDLAND HOLDINGS (1200 HK; UW; PT HKD2.25; -26%) .................. 86 WHARF HOLDINGS (4 HK; UW; PT HKD59.50; -12%) ........................... 90 HYSAN DEVELOPMENT (14 HK; EW; PT HKD33.32; -7%) .................... 95 SWIRE PROPERTIES (1972 HK; UW; PT HKD18.65; -13%) ................ 100 HONGKONG LAND (HKLD.SI; UW; PT USD5.59; -11%) ..................... 105 LINK REIT (823 HK; EW; PT HKD37.94; -2%) ........................................ 110 CHAMPION REIT (2778 HK; EW; PT HKD3.31; -5%) ........................... 115 APPENDIX ....................................................................................................... 120 28 October 2013 3 Barclays | Hong Kong Property INVESTMENT SUMMARY Not crying wolf We initiate coverage of the Hong Kong property sector with a negative view. We believe the Hong Kong property market is about to enter its first real downturn since 1998 and we expect home prices to drop by at least 30% by the end of 2015. While the market consensus view is also for prices to decline, we believe consensus has underestimated the magnitude of the fall, as well as the potential knock-on effects that a fall in residential prices will have on the commercial property sector. As past cycles have shown, housing, office and retail property prices tend to be highly correlated, and we expect a synchronised downturn. Our forecast is for office prices to fall by 20% and retail prices to escape the worst, with zero growth, by end-2015E. With property stocks being macro-driven, during the initial home price correction we believe the right strategy is to underweight the sector. We recommend investors screen for maximum defensiveness. Among the 14 stocks on which we initiate, we rate eight UW, four EW and only two OW (Cheung Kong and Hang Lung Properties). Given our negative view on Hong Kong property, we also downgrade our Asia ex-Japan Real Estate industry view to Negative from Neutral. Why a 30% decline, and why now? Although there have been previous calls for a property market correction, what has always been important are the answers to “How much?”, “Why now?” and “Is it priced in?” Why would home prices drop 30% and not 15%? We believe property prices are always set by the marginal buyer, in this case, the end-user.