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Morningstar | SHKP Full-Year Results in Line; Managing Risk and Waiting for Opportunities in Hong Kong

Sun Hung Kai Properties announced in-line full-year results for fiscal 2018. Underlying profit was HKD 30.4 billion, with underlying EPS of HKD 10.49, both up 17% year on year. The results are in line with our estimate of HKD 30.2 billion. The company declared a final dividend of HKD 3.45 per share, bringing the full-year dividend to HKD 4.65 per share, up 13% year on year. The dividend payout ratio is slightly lower from a year ago at 44%, similar to the historical average. Gearing rose a bit to 12%, compared with high-single-digit at December 2017 and June 2017. Overall, investment properties performed as expected. Lower-than-expected booking of development properties in Hong Kong and China was offset by higher margin achieved during the period. The elevated Hong Kong property market remains an area of risk. The company is managing this risk through quick launch of projects in the pipeline, coupled with prudent land bank replenishment. We maintain our fair value estimate of HKD 153, along with our narrow moat rating.

In Hong Kong, revenue from the property development business, including associates and joint ventures, was HKD 36 billion, down 18% from a year ago. Operating profit was up by 40%, driven by development margin increasing to 39%, up from 33% a year ago. Residential gross floor area completion was 10% lower than a year ago at around 2.6 million square feet. A total of HKD 29 billion was sold but not booked at the end of the period, up from HKD 24 billion a year ago. Contracted sales for the fiscal year remained strong at HKD 41 billion, exceeding a full-year target of HKD 36 billion. Major contributors were Wings at Sea, Cullinan West, and Park Yoho.

Responding to the government’s recent vacancy tax, the company stepped up launches since the fiscal year-end, netting another HKD 26 billion in contract sales. The company exercised restraint in the government land market, with only one residential plot acquired through tender. Of land acquisitions amounting to 6.8 million square feet during the fiscal year, two thirds came by way of farmland conversion. Given the existing large land bank and the stable completion schedule, we expect the company to maintain restraint in land banking activities in the near term.

For the Hong Kong rental portfolio, turnover was HKD 18.5 billion, up 6% year on year on positive rental reversion. The retail segment was strong with 7% growth, the office segment also showed 5% growth. This is with in expectation as the city’s retail sector continued to recover while the office market remained robust. Margin improved a bit from a year ago. The overall results included a top line slightly below our projection due to slower ramp-up of new assets, but better margin offsetting the small shortfall.

In China, revenue from the property development business, including associates and joint ventures, was HKD 6.2 billion, down 25% from a year ago. However, operating profit was HKD 23 billion, up 19% from a year ago, as margin jumped from 24% to 37%. The margin increase was mostly driven by the booked project mix, and we expect the margin to revert to the historical mean. Contracted sales for the fiscal year were CNY 3.6 billion, 50% lower than a year ago. For the China rental portfolio, gross turnover totaled HKD 4.5 billion, up 18% year on year. Excluding currency impact, the increase was 11% in Chinese yuan terms, driven by both rental reversion of mature assets and the ramp-up of ITC in Shanghai. Segment margin remained high at 82%, compared with the historical average of 75%, better than we expected.

The management maintained its strategy of keeping its balance sheet strong to preserve dry powder for potential investment opportunities, especially as the Chinese developers have largely retreated from the Hong Kong land market. Further, the company has large capital expenditure needs related to the construction of investment properties. Hence, the company will maintain the existing dividend payout ratio of 40%-50% and will not embark on share buybacks at this point. Given the company’s track record as a long-term investor, capital recycling through large-scale asset disposal remains unlikely, despite the lofty valuations seen recently in the city.