• Real Estate

Initiation of Hong Kong Land

Business Overview:

Hong Kong Land (HKL) is a subsidiary company of Jardine Matheson Group(JM) which generates a majority (50-60%) of income through leasing out its superprime office and retail portfolio in Central, Hong Kong’s CBD. It also has significant commercial holdings in Singapore and mainland China, and participates in the development of residential properties in mainland China.



Investment Thesis:

HKL’s share price has come under an unprecedented three-pronged assault of increased US-China tensions; Covid-19 related uncertainty and social unrest from the Hong Kong protests. It is now firmly in deep value territory, trading at 0.48 P/B; with a dividend yield of 6% and adjusted P/E of 6.4. The market is pricing in a significant long-term decline in income which has not materialised, and is unlikely to materialise. While nominal profits have seen a 92% decline YoY, this is almost all down to property revaluations, with underlying profits increasing 4% YoY. We view the long-term prospects of Hong Kong as positive to neutral, with its’ competitive advantage of being a gateway to China unlikely to disappear, despite any reputational damage it may have suffered; and HKL’s positioning in the market as being poised to take advantage of this.



Catalysts:

-An end to any of the short-term factors driving down price mentioned above would likely cause multiple expansion.

-The non-realisation of fears related to long-term decline in HKL-owned properties would likely cause multiple expansion (for retail, we view HKL’s extremely high-end luxury positioning as safe from e-commerce; while we view WFH fears over HKL’s office holdings as somewhat exaggerated given the cramped homes present in Hong Kong).



Risks:

Downturn in the Chinese property market: On an average basis, Chinese residential developments account for 20% of HKL’s revenue. By conventional metrics, the Chinese residential market is in a bubble and long overdue for a correction. However, given the lack of alternative investments for Chinese investors and the heavy incentive for the government to prop up the property market, we feel any such crash is unlikely to happen barring the following scenario:

Liberalisation of China’s capital account: The greatest threat to HKL’s long term performance is if China’s tightly regulated capital accounts are liberalised. This will most likely cause a crash in the Chinese residential property market as investors flee to more attractive, Western assets; while Hong Kong’s role as an intermediary between China and the world will also largely become redundant, having a devastating effect on HKL’s property values and rental income. However, given the disastrous attempt in 2012, any attempt is unlikely to happen again in the next few years, and if it does happen there should be a gradual process of liberalisation which will give investors ample opportunity to exit HKL.

Jardine Matheson: Given JM’s majority control of shares and lack of desire to sell, there is no incentive for (JM appointed) management to take measures that would be beneficial to share price and minority investors, from reorganising as a REIT or share buybacks. This is the biggest barrier to price realisation.



Valuation:

In our bear case, we view HKL as a safe income generator that does not see price realisation. A-rated bonds currently yield an average of 1.62%, far below HKL’s 6% yield. Given the low payout ratio (38% of underlying profits); low gearing (16%); and stated commitment to dividend preservation, we feel this is a consevative baseline.

With a DCF analysis, we have an average price target of $7.21 (vs current price $3.77)

The following assumptions were made:

-Operating yields on investment properties/development properties are 2.8%/7%

-Perpetual asset writedowns recorded in 2020 on investment/developments are 5%/25%

-All scenarios assume 15% depressed income and asset valuations for the next 2 years due to Covid-related rent relief.

For scenario analysis, please view our detailed report.


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