Downgrading to Sell from Hold, lowering target price to HK$27.5
With weakening hiring expectations across different industries, softer HK retail sales growth and already high rental levels, we see limited room for rental growth for Hysan’s office and retail properties. At the same time, given weaker rental growth expectations, strengthening USD and normalizing interest rates, we see rising cap rates for commercial properties in HK (from current historical lows) in the next 12-24 months. Given Hysan’s high NAV sensitivity to cap rates changes, we see meaningful NAV downsides. This report marks the transfer of coverage from Jason Ching to Tony Tsang.
We see limited room for further fast growth in office and retail rents
In the past, decentralized office districts such as Causeway Bay (where Hysan’s portfolio is located) were generally immune from weakness in the financial industry. However, in 4Q13, we saw a sharp turn to negative take-up in the decentralized districts, which coincided with a dip in hiring expectations in the non-financial industries. Also, as the Central office market has fallen more than the other districts, the rental gap between Central and decentralized districts is narrowing, which should cap rental growth in decentralized districts.
Interest rates normalization presents high risks of NAV compression
Historically, there has been a high correlation between HK cap rates and the US 10-year treasury yield in the context that cap rates always mirror treasury yield movements. With the 10-year treasury yield surging by over 100bps in the past 12 months to about 2.7% currently (our house view expects 10-yr bond yield rising to 4% by end-2014), cap rates could see a corresponding rise ahead if historical pattern holds. On our analysis, every 100bps increase in cap rates (from our base case of 4-5% for the retail and office properties of Hysan) would lead to a 20% decrease in our estimated NAV for Hysan.
Our revised target price of HK$27.5 is based on 40% discount to NAV
Our 40% target discount is in line with the historical average NAV discount for the stock. We lower our NAV from HK$61.6 to HK$45.83 mainly as we raise our cap rates assumptions for Hysan’s retail and office properties in HK to 4-5% from 3-5%. With the cut in estimated NAV, we lower our target price for Hysan from HK$36.9 to HK$27.5. Key upside risks include a prolonged low interest rate environment, disposal of key assets at low cap rates and stronger-than-expected leasing performances.