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Morningstar | Soho China Strategy Unclear, Rental Portfolio Results Lower on Compressed Margin

Soho China reported full-year 2018 results slightly below our expectations. Rental turnover and gross profit were down 1% and 9% year on year, respectively. The margin compression was likely due to slightly lower occupancy and opening expenses. The company declared a final dividend of CNY 0.030 per share.

We maintain our fair value estimate of HKD 3.40 and our no-moat rating. Operationally, the portfolio’s performance was reasonable. However, the company’s strategy seems to be moving back to that of an asset manager. Without better articulation on the performance of Soho 3Q and the company’s long-term plan, investors would likely be disappointed by the low dividend payment and shy away from the shares.

For the rental portfolio, revenue totaled CNY 1.65 billion, down 1% year on year. The decrease was attributed to the asset disposals occurred during both years. On a like-for-like basis, the company reported rental income up 18% year on year, mostly due to the ramp-up of Soho Tianshan since its opening in mid-2017. Gross margin on rental portfolio declined to 74% from 80%. The portfolio occupancy rate was at 96% at the end of the year, down from 97% a year ago. Management did not provide comment on the reason for margin compression. It may be related to the fit-out expenses related to the Soho 3Q business. Margin may continue to be low in 2019 due to the opening costs associated with Gubei Soho and Soho Leeza.

The company did not separately disclose the performance of Soho 3Q, other than that it has expanded to 30,000 seats in 31 centers in seven cities. But this is unchanged from the metrics reported during interim. It is not clear what the breakdown between seats in company-owned space versus those in third party properties. Compared with a year ago, the company had 26,000 seats in 26 centers.

Net gearing was at 43% at year-end, compared with the 51% seen a year ago. The gearing is lower than we expected. The company has capital commitment of CNY 3.8 billion at the end of the year, mostly related to the ongoing construction of Soho Leeza (to be completed in July 2019) and Gubei Soho (completed in January 2019). Most of the company’s cash is placed in structured bank deposits. Foreign currency borrowing now accounted for 4% of total debt at the end of the year. The effective interest rate has been lowered further to 4.6%, compared with near 4.9% in the past.