STRONG FUNDAMENTALS

• HK sales rebound
  
• No impact from proposed Park’N Shop boycott
  
• Maintain BUY
  

Good HK retail sales

The growth in HK’s retail sales has picked up significantly since 4Q12. Combining the first two months of 2013 to eliminate distortions from the timing of Chinese New Year, retail sales climbed up 15.8% in value and 15.5% in volume. According to a government official, the generally stable labour market conditions and vibrant tourism should continue to lend support to retail business in the near term, although there are still notable headwinds on the external front. Provisional statistics from the HK Tourism Board indicate that the tourism expenditure associated with inbound tourism grew 16.5% YoY in 2012 to HK$306.5b. In contrast, Singapore’ retail sales fell 2.0% YoY in Jan 2013, and tourism receipts grew by only 3% YoY to S$23b in 2012. Robust retail sales will continue to underpin the growth in retail rents throughout HK.

No worries over call for Park’N Shop boycott

The media has reported that a group has called for the boycott of Park’N Shop supermarket chain, which is part of Li Ka-shing’s Hutchison Whampoa Ltd, in support of dock workers who are striking for better work conditions. The workers are employed by Hongkong International Terminals (HIT) either directly or through contractors. HIT is a subsidiary of Hutchison Port Holdings Trust, which is owned by Hutchison Whampoa Ltd. Park’N Shop is FRT’s top tenant, accounting for 8.0% of the REIT’s total gross rental income in Dec 2012. According to FRT management, the incident is not affecting FRT malls. Businesses are running as usual and impact to the sales of the Park’n Shop outlets in FRT’s malls has not been seen.

Another solid year ahead

Overall rental reversion in 2012 was high at 19.8%, partially because of the low base in 2009. Management has indicated that 2013’s rental reversions are likely to be in the mid-teen percentages. It is worthwhile emphasising that FRT has a low gearing of 23.4% and no refinancing needs till 2015.

Maintain FV

We are maintaining our fair value of HK$7.28 and BUY rating on FRT. FRT is trading at a low P/B of 0.78x.

EXCELLENT FY12 RESULTS AS EXPECTED

• Record DPU growth rate
  
• Portfolio valuation up 5%
  
• Maintain BUY
  

Rental reversions likely to be in mid-teens

FRT’s had a solid FY12, with revenue climbing 22.5% YoY to HK$1.11b and NPI rising 22.8% YoY to HK$788.3m. The two properties acquired on 17 Feb 2012 accounted for 12.4% of NPI growth. The remaining 10.4% of NPI growth from the original portfolio of 14 properties was from strong reversion and AEI results. Passing rent for the original portfolio was up 8.3%. Overall rental reversion was high at 19.8%, partially because of the low base in 2009. Management indicates that 2013’s rental reversions are likely to be in the mid-teen percentages. FY12 DPU of 23.35 HK cents was up 23.0% YoY, representing the highest growth trend in the REIT’s 9-years history. The results were in line with ours and consensus.

More AEI opportunities

Portfolio occupancy climbed from 96.1% as of 30 Sep 2012 to 97.7% as of 31 Dec 2012, reflecting good recovery upon AEI completion. Significant portions of GRA for FRT’s three largest assets by valuation, i.e., Fortune City One (FCO), Ma On Shan Plaza (MOSP) and Metro Town, will expire (43.1%, 41.4% and 69.9% respectively) in 2013. For FCO, 2013 will see the first reversion of leases from the AEIs that were completed in 2010. Following the completion of HK$100m AEI in 4Q12 (ROI of over 20%), management is considering a HK$10-20m AEI at FCO to improve the wet market and increase occupancy. At MOSP, FRT will explore getting back some space from the supermarket to bring in some higher yielding trades (e.g. another AEI at HK$10-20m). At Metro Town, there is mark-tomarket upside because of improvement in foot traffic. One of the Feb acquisitions, Belvedere, may see a ~HK$80m AEI starting end 2013.

Solid balance sheet

The portfolio valuation increased by 4.9% to HK$20.2b between Jun to Dec 2012; capitalisation rates stayed the same. The valuation of the original portfolio climbed 5.0% to HK18.0b. FRT has a low gearing of 23.4% and no refinancing needs till 2015.

Maintain FV

We are maintaining our fair value of HK$7.28 and a BUY rating on FRT. FRT is one of our top REIT picks and has an attractive P/B of 0.75x.

9M12 DPU up 23% YoY

• Strong performance in line
  
• Impressive rental reversion
  
• Raise FV to HK$6.63; Maintain BUY
  

Good growth in 3Q12

9M12 DPU grew 23.1% YoY, representing the highest rate of growth in the REIT’s nine-year history. The results are in line with our expectations, with 9M12 DPU of 23.98 HK cents forming 74% of FY12 DPU estimate. 3Q12 revenue climbed by 22.6% YoY to HK$284.7m and NPI rose 22.9% YoY to HK$199.3m. 9M12 revenue increased by 21.1% to HK$822.1m. The 20.7% increase in 9M12 NPI to HK$581.4m can be broken down into an 11.6% increase from the two new properties acquired in mid-Feb and a 9.1% increase from the original portfolio due to strong reversion and AEI.

Strong rental reversion

Despite AEI at Fortune City One and Jubilee Square, portfolio occupancy only declined slightly from 96.5% as of 30 Jun to 96.1% as of 30 Sep. The average rental reversion clocked was impressive at 20.1%, among the highest level in years. The fraction of tenant’s trade mix attributable to non-discretionary retail sector remains constant at about 60%, giving the portfolio resiliency. Management indicates that even tenants who are in discretionary consumption may also renew leases at substantially higher rents, e.g. real estate companies are willing to accept paying double the rents they signed on for in 2010.

Price can appreciate further

We believe that there is room for further appreciation of FRT’s unit price. As we have written about in our report dated 8 Oct 2012, FRT can see further dividend yield compression (from unit price increases). Relative to the average yield for HK physical retail property (currently around 2.7%), FRT’s FY12F yield of 5.4% is above the historical average. At an NAV per unit of HK$8.32, FRT is trading at 0.7x NAV, significantly under the retail S-REITs average of ~1.1x. Gearing remains low at 24.6%.

Raise FV to HK$6.63

Rolling forward our DDM model to FY13, we raise our fair value from HK$6.49 to HK$6.63 and maintain our BUY rating on FRT. We believe that the FY13F DPU yield is attractive at 5.6%.

FURTHER YIELD COMPRESSION COULD TAKE PLACE

• Aug retail sales slightly better than Jul
  
• Landlords have more bargaining power
  
• Raise FV to HK$6.49; Upgrade to BUY
  

Aug sales show slight improvement over Jul

In Aug, the value of HK retail sales climbed 4.5% YoY, a slightly improvement over Jul, which saw sales rise 3.9% YoY (revised figure). We note that these increases are substantially lower than the YoY increases earlier in the year, which ranged between 8.7% and 17.1% for Jan-Jun. However, despite the recent lackluster growth, we believe that landlords have reasonably good bargaining power.

What retailers are thinking…

According to a recent press release by the Hong Kong Retail Management Association, for full year 2012, most sub-sectors sectors expect single-digit to double-digit growth. Given the uncertain economy and high rental and labor costs, the majority of subsectors will consider more automated store operations to reduce manpower costs. Apart from closely monitoring stock control, should inflation continue, they may increase prices. They may also reduce the rate of store expansion and close shops if rental costs are too high. We interpret that rental rates may have more room to climb vis-à-vis the cost of other production factors, specifically wages and inventory costs.

Rental rates keep climbing

In Jul, the HK retail rental index climbed by 2.3% MoM and 14.3% YoY. The HK retail price index climbed by 2.7% MoM and 29.2% YoY. In comparison, for Jun 2012, the nominal wage index for those in the import/export, wholesale and retail trades increased by only 4.3% YoY. Given that FRT’s malls are geared more towards non-discretionary spending, they should have a stronger footing versus high-end malls.

Upgrade to BUY

We lower our discount rate on the premise that interest rates will stay low till at least mid-2015 given QE3. We raise our fair value from HK$5.33 to HK$6.49 and upgrade FRT from Hold to BUY. On a historical basis, the FY12F dividend yield of 5.4% is not low relative to the HK retail market yield of ~2.7% (YTD, based on government’s provisional figures). This suggests further yield compression could take place.

DISAPPOINTING HK RETAIL SALES IN JUL

• Poor HK retail sales in Jul
  
• Easier visa policy for Mainlanders
  
• Maintain HOLD
  

HK Jul retail sales below expectations

In Jul, HK retail sales climbed 3.8% YoY by value, significantly lower than the median 9.0% forecast of five economists surveyed by Dow Jones Newswires and the YoY increases from Jan-Jun, which varied between 8.7% and 17.1%. Jun retail sales had grown 11.0% YoY. A government spokesman attributed Jul’s slow growth to the external economic environment and more cautious local consumer sentiment. Retail sales growth could be more moderate in 2H12 than 1H12 and this will reduce the extent of possible rental increases.

New visa policy could increase PRC visitor numbers…

The Chinese government has announced a change in the Individual Visit Scheme, whereby non-residents living in Beijing, Shanghai, Guangzhou, Shenzhen, Tianjin and Chongqing are able to apply for passports and visas to HK, Macau and Taiwan starting from 1 Sep 2012. Currently, people need to return to the area that issued their residency permit (hukou) to apply. The six cities have substantial nonresident populations. Shenzhen reportedly has a non-resident population of 4.1m, of which many are thought to be migrant workers with mass-market consumption patterns – which suits FRT’s positioning.

…but PRC arrivals account for only 19% of retail sales

For the first seven months of the year, overall visitor arrivals to HK climbed 15.2% YoY to 26.7m. In particular, arrivals by visitors residing in the mainland increased 22.6% YoY to 18.8m. Residents of mainland China spent HK$78,792m on shopping in 2011. Based on this, we estimate that mainlanders accounted for only 19.4% of the HK’s total retail sales in 2011, so additional arrivals due to the visa policy will not necessarily be a panacea. For suburban mall operators like FRT, local consumer sentiment will still be a more important driver for positive rental reversions. We calculate that visitor arrivals as a whole accounted for 24.4% of 2011 retail sales.

Maintain HOLD

We maintain our fair value of HK$5.33 and HOLD rating.