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Morningstar | Wharf's Full-Year Results a Slight Beat on Flagship Asset's Strong Performance

Wharf Real Estate Investment Co, or WREIC, reported 2018 full-year results slightly ahead of our projection, with underlying profit of HKD 10.1 billion, up 6% year on year. This is 5% higher than our estimate, mostly attributed to better than expected margin for investment properties in Hong Kong. Harbour City performed strongly on the back of a citywide recovery of the retail sector. The investment property portfolio achieved turnover and operating profit of HKD 14.3 billion and HKD 12.7 billion, respectively, both up 7% compared with a year ago, and compared with our projection of HKD 14 billion and HKD 12.1 billion. We made minor adjustments to our model to account for the latest retail sales, passing rent and occupancy. We rolled our model forward and increase our fair value estimate to HKD 60 from HKD 57, and maintain the company’s narrow moat rating.

For the retail portion of Harbour City, the company’s flagship asset, rental revenue, and operating profit were both up 14% year on year, with occupancy rate improving from 96% to 98%. Average passing rent was up 12%, owing to both positive rental reversion and improving turnover rent. Retail sales were up 24% year on year, compared with up 9.1% in 2017 and declining 12% and 10% in prior years. Retail sales for the year was at HKD 37 billion, surpassing the previous peak of HKD 35 billion set in 2014. Occupancy cost fell further to near 18% from near 20% in 2017. Rental reversion improved to 6% for the year. Performance at Time Square remained relatively weak. Rental revenue for the retail portion was down slightly, due to ongoing tenant mix change. Average passing was down slightly. Retail sales growth was decent, up 12% year on year, compared with up 1% in 2017 and down 12% for each of the two years before that. Occupancy cost dropped to 20% from 23% in 2017. In comparison, the city as a whole saw retail sales grow near 9%, compared with up 2.2% in 2017, after declining 4% and 8% in the prior two years.

For the hotel segment, revenue was up 30%, but operating profit down 24% year on year. The decline was attributed to the initial operating loss and depreciation charges related to The Murray. For three Marco Polo Hotels, operating profit was up 32% with high occupancy rate.

The company declared a second interim dividend of HKD 1.05 per share, bringing full-year dividend to HKD 2.10 per share, which is based on the stated dividend policy of 65% of rental core profit from its Hong Kong portfolio and hotels. The company’s net gearing at year-end was 18%, down from 20% a year ago. Given recurrent nature of the bulk of its earnings, the declining gearing and modest dividend payout, the company has the capacity to take on additional projects. Management commented the balance sheet can carry an additional HKD 20 billion in debt. One potential target is the high-speed rail commercial site. However, given the acquisition cost estimated to be from HKD 80 billion to HKD 110 billion, such a project would entail equity raising and/or joint venture partners.