Initiate at non-consensus SELL . We initiate coverage of SOHO China with a contrarian SELL and TP of HKD5.61. We forecast FY14-15 earnings to slump by 57% and 26% YoY due to limited saleable resources over the next two years and a change in strategy.
Our negative investment thesis is largely based on four key concerns: 1) unproven leasing capability; 2) doubts over SOHO’s commitment to transform its long-term strategy to being a pure landlord; 3) the sizeable share buyback that supported the stock price in 2013 is unlikely to be repeated in 2014; 4) a likely earnings void in FY14-15F.
Unproven leasing capability and portfolio skewed towards Shanghai. The rate of take up of rental space at SOHO Fuxing Plaza has been slow so far. Based on our checks, only ~20% of the commercial space has been leased so far, while the office portion is still about a year away from completion with pre-leasing expected to be soft. In addition, Fuxing Plaza will face stiff competition from Shui On Land’s adjacent project, Corporate Avenue, where rental rates for Phase 2 have been unsatisfactory.
Furthermore, SOHO’s investment property portfolio is now heavily skewed towards Shanghai (~71% by GFA) where we believe the upcoming supply dynamics are less favourable than in Beijing. Wavering strategy. Media reports that SOHO plans to sell three of its Shanghai projects appear to contradict earlier management announcements to retain these as long-term investments. While a disposal would smooth the potential FY14F earnings void, this would casts doubt on whether it will persevere with its “build-and-hold” long-term transformation strategy.
Another large share buyback unlikely in 2014. The stock has outperformed the China property sector average so far in 2013 and it was helped by the ~287m shares buyback. We believe the buyback attempted largely to neutralize CB conversion dilution and as the counter had even dipped below the HKD5 level at some points. Even if there were a buyback at the HKD6 level next year, a repurchase is unlikely to be as sizeable as the one in 2013.
Unattractive valuation. The counter is trading at 32% discount to NAV, which we see as expensive. Our TP of HKD5.61 represents a 45% discount to NAV vs the current average of 48% for its peers. We believe SOHO’s risk-reward profile is skewed towards the downside. Initiate SELL.