A postcard from Hangzhou
We visited Hangzhou recently and met with a number ofcommercial real estate operators in the city, and while we cameback with more confidence in the strategic merit of Hang LungProperties （HLP）’s site acquisition in early 2018, we think based oncurrent achieved rentals for major mixed-use projects, it may not beeasy to meet management’s initial yield guidance of 4-5%, unlessthey could achieve a substantial rental premium over the peers
Rmb16bn price tag for Hangzhou Xiacheng mixed-use site
As a quick recap, back in May 2018, HLP won a land auction in Hangzhou throughlisting-for-sale, its first mainland purchase in five years. The site’s details include:
The 194k sqm GFA （gross floor area） land site is located in the Xiacheng District ofHangzhou, with retail and office spaces at a split of 45% for retail and 55% foroffice, based on Hang Lung’s initial plans. The bid value was for Rmb10.7 bn,implying a per/sqm value of roughly Rmb55,000. Company expects total capex ofabout Rmb16bn for the project.
The Hangzhou site is Hang Lung Properties’ first land acquisition since 2013, whenthey bought the Wuhan Heartland 66 site for Rmb3.3bn.
Our key takeaways
Retail market: The Hangzhou land site is located in a core commercial area in theXiacheng District with a critical mass of mature projects. We came back with moreconfidence in the strategic merit of the site acquisition given its core location in theWulin Square area of the Xiacheng District, and the sizable single land parcel thatmay offer ample design flexibility. While Hangzhou does not have shopping mallswithin the top 10 nationally by tenant sales, it has two department stores rankedwithin the top 10 — Hangzhou Tower and Wulin Intime — both in the sameneighborhood of HLP’s site.
Office market: Our discussions with the commercial real estate operators in the citysuggest that the overall market continued to improve and absorbed some supply innew districts, where we think higher-spec buildings in the Wulin Square area and theQianjiang New Town area could reach c.Rmb 9-10 per sq m GFA per day and Rmb6-7 per sq m GFA per day, respectively.
Opportunities:
Successful shopping malls remain a relatively new scene in Hangzhou, whichhas traditionally been a market dominated by department stores. Our visit toKerry Properties’ Hangzhou Kerry Centre mall suggested that the mall formathas gained appeal to customers.
Supply of sizable land plots in the core city area remains limited, and we thinkmuch slower growth of land supply in that area is likely going forward, whichshould be viewed as favorable to HLP’s project.
Higher maturity of the office market in the Qianjiang New Town area hasremoved some supply overhang and we think it is likely to support ongoingimprovement in office market fundamentals, and we see limited competitionin the area.
Challenges:
While it could be advantageous to be located in the traditional shopping areain Wulin Square, however, Hang Lung’s properties may need to competeagainst the successful Hangzhou Tower and Wulin Intime, the twolong-established department stores, which have high brand awareness and astrong VIP customer network.
While the Hangzhou land site is located in a core commercial area in theXiacheng District, it has no direct frontage with the main Yan’an Road; thus wethink management would need to focus on improving the accessibility to thesite.
At the moment, from our channel checks with the commercial real estateoperators in the city, we think the higher end of mixed-use projects inHangzhou core areas could fetch a rental of c. Rmb 9-10 per sq m GFA per dayfor offices, and c. Rmb 9+ per sq m LFA （lettable floor area） per day for retail.If we were to factor-in these rentals, we would get to a c.3+% initial rentalyield on the Rmb16bn total cost （land and construction）， versusmanagement’s 4-5% guidance made back in May 2018. While we think the management’s office rental guidance is broadly in line with the market （theylook for c.Rmb10/sqm/day）， we think the key to whether they can achievetheir c.Rmb20-30/sqm/day target for retail is how they can bridge theperformance gap between department stores vs shopping malls in Hangzhou.
A shift from debate on return of capital to deployment of growth capex
While we expect a resumption of DPS hike in 2019E, we think the debate amonginvestors has shifted to deployment of growth capex:
Looking ahead, although near-term positives in the retail market recovery are likelyto continue to be partly offset by ongoing AEIs, as was the case in FY2017, wecontinue to expect HLP to start to see noticeable rental profit growth into 2019when newly completed projects are scheduled to be opened （including Kunming’sSpring City 66 shopping mall/office, Shenyang’s Forum 66 hotel portion, Wuxi’sCenter 66 office tower 2 and Wuhan‘s Heartland 66 shopping mall）， which shouldprovide additional support for a potential dividend hike.
At its 1H2018 results briefing, management guided that amid the Hangzhou siteaddition, it expects a new wave of completions to be scheduled from 2019 to 2024,at an average of 2.8mn sq ft GFA p.a., versus the 2010 to 2017 average of 2.5mn sqft GFA.
Nonetheless, management plans to continue looking for new investmentopportunities in China and is expecting more capex in the years ahead. While mostof the HK real estate names under our coverage have been selling down their Chinaprojects in the past few years, in 2018YTD, in addition to HLP there were also selectcompanies resuming acquisitions onshore, including Kerry Properties （0683.HK,Neutral, Dec 17 closing price HK$28.45）’s Wuhan and Shenzhen acquisitions, NewWorld Development （0017.HK, Neutral, Dec 17 closing price HK$10.82）‘s Guangzhousite additions, Link REIT’s Beijing shopping mall acquisitions, and Hongkong Land’sNanjing site acquisition. On a broader basis, we think investors are less inclined to ascribe any value creation to such aforementioned acquisitions at the current stageamid the uncertain macro and FX environment.
On the capital management front, management explained the current objective fordividends, making reference to the current rental profit trends. We note that whileHLP itself has not been doing share buybacks, its parentco Hang Lung Group（0010.HK, NC） has been raising its stake in HLP through the years, to 57.02% as ofAug 2018, up from 55.69%/55.13% in Dec 2017/2016, respectively.
We revise our FY18-20E EPS by from 1.5% to -3.3% and TP by -1.5% to factor-in （1）updated HK sales progress, （2） assumptions for Hangzhou, （3） FX, with a new12-month NAV-based target price of HK$19.71. While HLP trades at a 59% discountto our FY19E NAV, versus the stock’s historical NAV discount levels of 49% （post-QEaverage） and 57% （-1SD）， we remain Neutral partly on increased macrouncertainties （e.g., RMB FX） and a likely smaller growth trajectory in 2H18 as wemay see negative FX impact from the company’s China rentals.
Risks: NAV-accretive acquisitions or disposals; slower-than-expected recovery inChina luxury retail market.