Hong Kong 29 May 2012 Initiating Coverage BUY Swire Properties A Proxy Hong Kong Landlord Share price: HKD21.25 Target price: HKD26.02 Archetypal HK landlord with strong brand equity. Swire Properties (SP) is a leading developer, owner and operator of mixed-use commercial properties in HK and China with a well-established record Ivan CHEUNG, CFA of creating long-term value through designing, developing and [email protected] managing transformational mixed-use projects in urban areas. Going by (852) 2268 0634 its portfolio of mixed-use investment properties, we expect this major HK landlord to be able to replicate its success in core and affluent cities across China. With a target net gearing of 20% for FY12F, SP guided a payout of 50% of its underlying profit over the economic cycle. Stock Information Three key growth drivers in the medium term. In our view, SP’s Description: Swire Properties, a leading HK landlord, has a portfolio of 25.1m sq ft of investment and development medium-term growth initiatives would centre on (1) increasing GFA properties in HK, China, USA and the UK. through expansion and redevelopment in HK, (2) gaining critical mass via its vast investment portfolio in China, and (3) launching Ticker: 1972 HK Shares Issued (m): 5,850 development projects in a timely manner in HK, China and the US. Market Cap (USDm): 15,999 Short-term catalysts include stronger-than-expected sales of its HK 3-mth Avg Daily Turnover (USDm): 8.5 luxury residential properties and stronger-than-expected rental HSI: 18,801 Free Float (%): 18.0 reversions in its office and retail investment portfolios. Major Shareholders: % Narrower discount for pure-play landlord. We believe that SP should Swire Pacific 82.0 trade at a premium valuation over other HK landlords (average discount John Swire and Sons 8.0 of 32%) given its expertise in property management and tenancy expiry, as well as premium strategy in managing the tenant mix. The continual expansion of Pacific Place and Island East, its two main exposures in Key Indicators HK, ensures sustainable and long-term growth of its quality portfolio. ROE – annualised (%) 3.80 Net debt (HKDm): 31,019 Initiate with BUY and TP of HKD26.02. We value SP using the cap NTA/shr (HKD): 30.7 rate and DCF methodologies for, respectively, its investment and Interest cover (x): 6.1 development properties, and applying a target discount of 20%, being the long-term average of its parent, Swire Pacific. We estimate that SP has a revalued net asset value of HKD190.2b, or HKD32.52 per share. Historical Chart We believe the valuation is justified given SP’s strong brand equity and 31.0 sustainable growth. Our TP of HKD26.02 suggests an upside of 22.4% 29.0 27.0 from current levels. We initiate coverage with a BUY recommendation. 25.0 23.0 Swire Properties Limited – Summary Earnings Table 21.0 FYE Dec (HKDm) 2010A 2011A 2012F 2013F 19.0 Revenue 8,871 9,581 15,051 14,784 17.0 EBITDA 6,741 6,297 8,632 8,366 15.0 Jan 12 Feb 12 Mar 12 Apr 12 May 12 Recurring Net Profit 3,833 4,372 6,766 6,759 Recurring Basic EPS (cents) 67.36 74.74 115.66 115.54 PRICE PRICE REL. TO HANG SENG INDEX Recurring EPS growth (%) 7.43 10.94 54.76 (0.11) Source: Bloomberg DPS (cents) 0.00 18.00 52.05 51.99 PER 31.55 28.43 18.37 18.39 Performance: EV/EBITDA (x) 24.06 24.33 18.09 18.67 52-week High/Low HKD22.45/HKD16.62 Div Yield (%) 0.00 0.85 2.45 2.45 P/BV(x) 0.77 0.71 0.69 0.68 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) (2.1) 9.1 N/A N/A N/A Net Gearing (%) 23.33 15.73 17.25 16.94 ROE (%) 2.66 2.62 3.80 3.72 Relative (%) 7.4 22.1 N/A N/A N/A ROA (%) 2.02 2.06 3.06 2.98 Consensus Net Profit (HKDm) N/A N/A 6,717 6,392 Source: Company data, Kim Eng Securities SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS Swire Properties Limited 37-year performance record Solid development history; listed by way of introduction. SP ventured into the development business in the mid-1970s, turning the former Taikoo Dockyard site into the 10.3m-sq-ft Taikoo Shing, a private residential estate in Quarry Bay, Hong Kong Island. Over the past 30 years, it continued to expand its investment property portfolio, targeting mainly office buildings and commercial complexes. In January this year, SP was listed in HK by way of introduction. The existing shareholders of Swire Pacific (SPA: 19 HK and SPB: 87 HK) were entitled to the distribution in specie of SP at a ratio of seven shares of SP for every 10 shares of SPA (or 50 shares of SPB) owned. After the listing, SPA and SPB collectively own 82% of SP, while public shareholders own 10% and John Swire and Sons (JSS), the major shareholder of Swire Pacific, owns the remaining 8%. Proactive enhancement of investment property value. SP is adept at maximising the earnings and value of its completed properties through active asset management. It will seek to reinforce assets through enhancement, redevelopment and new additions, as well as ensure optimal mix of retail tenants and early renewal negotiations with office tenants. The long-term goal is to maintain consistently high levels of service. By doing so, SP will maximise the occupancy and earnings potential of its investment property portfolio. Sustainable development increases brand loyalty. Increasingly, tenants are scrutinising the green credentials of landlords and buildings. SP aims to be at the forefront of sustainable development by launching energy-efficient buildings through the innovative use of design, materials and new technology. It will continue to design projects that will have the necessary scale, mix of uses and transport links to become key commercial hubs and to transform the areas in which they are located. Figure 1: Property portfolio of Swire Properties Attributable GFA (m sq ft) Office Retail Hotels Residential Total Completed Investment Properties 12.5 4.9 1.4 0.6 19.4 Hong Kong 10.5 2.4 0.7 0.6 14.2 China 2.0 2.5 0.2 0.0 4.7 Overseas 0.0 0.0 0.5 0.0 0.5 Investment Properties Under Development 2.0 2.1 1.3 0.3 5.7 Hong Kong 0.1 0.0 0.0 0.1 0.2 China 0.9 1.6 1.1 0.1 3.7 Overseas 1.0 0.5 0.2 0.1 1.8 Grand Total 14.5 7.0 2.7 0.9 25.1 Source: Company data, Kim Eng Securities HKD18.8b funding from sale of Festival Walk. SP guided a payout ratio of 50% of its core earnings over the economic cycle. Its net gearing stood at 15.7% as at end-2011 and has hovered around 23.3-32.9% over the past five financial years. Net debt at end-2011 was HKD27.7b, down from HKD36.8b a year ago. The decline arose from the repayment of inter-group funding from Swire Pacific, using the proceeds from the sale of Festival Walk and cash from its operations, partially offset by higher debt levels in China. 29 May 2012 Page 2 of 18 Swire Properties Limited Healthy net gearing; equity financing risk is low in medium term. SP’s net gearing decreased by 7.6ppts to 15.7% as at end-2011. Cash and undrawn committed facilities totalled HKD9.2b as at March 2012, versus HKD7.4b as at end-2011. Upon maturity of the inter-group funding provided by Swire Pacific, SP will obtain new funding (as necessary) on a stand-alone basis without recourse to Swire Pacific, according to the company. We believe that SP will maintain a strong balance sheet with a view to investing in and financing its projects in a disciplined and targeted manner. Debt financing will be a key source of fund, and SP reveals that it aims to maintain exposure to a range of debt maturities as well as debt types and lenders. Its current debt profile reflects a mix of revolving and bank term loans, medium term notes and perpetual securities. Lock-up period of 180 days since listing. Note that both Swire Pacific and JSS have a lock-up period on SP of 180 days after listing, and this will expire on 18 July 2012. While we believe that the risk of raising new capital through share issuance, either top-up or otherwise, is minimal in view of SP’s healthy balance sheet, it is possible that JSS may seek to reduce its 8% stake, as the family owns 468m shares estimated to be worth USD1.25b. SP has also gained approval from the HKEx that a lower public float percentage of 10% or more is allowed for the company. Figure 2: RNAV breakdown by property types and location China Properties Overseas Hotels Under Properties 3.5% Development 4.4% 5.9% HK Properties Under Development 5.6% China Investment HK Investment Properties Properties (Completed) (Completed) 9.3% 71.4% Source: Company data, Kim Eng Securities Figure 3: Property portfolio breakdown by geographical location (in GFA terms) Overseas 9.2% Hong kong China 57.4% 33.5% Source: Company data, Kim Eng Securities 29 May 2012 Page 3 of 18 Swire Properties Limited HK investment portfolio - Office An experienced office developer and manager since the 1980s.