DOWNGRADE TO HOLD

• Jun retail sales could signal turnaround
  
• Resilient non-discretionary purchases
  
• Downgrade to HOLD on valuation Grounds
  

HK Jun retail sales beat expectations

In Jun, the value of HK retail sales climbed 11.0% YoY due to resilient local demand and an increase in the number of tourists. The rise was greater than the comparatively low 8.7% YoY increase seen in May, and was above the 8.2% median forecast from a Dow Jones Newswires poll. Given that the indexes for private retail rents and prices for May were up 2.4% and 3.8% MoM, we are mildly optimistic that there could be further increases in the months ahead.

Non-discretionary purchases

FRT is arguably exposed to one of the more resilient sectors in the HK real estate market – suburban retail. We note that 57.5% of the gross rental income is in the non-discretionary categories (Services & Education, F&B, Supermarkets, Homewares, Wet Markets and Community Services). We have just visited Fortune City One, Ma On Shan Plaza, Fortune Metropolis and Provident Square, which was recently acquired in Feb 2012, and observed that a substantial component of FRT’s tenant sales were resilient in nature, e.g. F&B outlets were quite full during weekday lunch and dinner periods.

Attractive yield compared to The Link

FRT’s closest peer is The Link REIT. FRT is the purer HK retail play since The Link has about a fifth of its revenue from carparks. The Link is offering a consensus FY13 (end Mar 2013) DPU yield of 4.2%. In comparison, FRT’s estimated FY12 yield is reasonably attractive at 5.9%.

Downgrade to HOLD

Fortune is trading at a P/B of 0.66x (NAV per unit of HK$8.34) and an estimated FY12 dividend yield of 5.9%. We last wrote about FRT on 23 Jul following its excellent 2Q12 results. The share price has since jumped 10.2% to HK$5.49. We maintain our fair value of HK$5.33 but downgrade FRT to HOLD on valuation grounds.

HIGHEST DPU GROWTH IN NINE YEARS

•Record-breaking growth

•Strong rental reversions

•Recently acquired malls improving

Impressive growth and strong financial position

FRT achieved a record-breaking 1H12, with revenue and net property income climbing by 20.3% and 19.6% YoY to historic highs of HK$537.4m and HK$382.1m respectively. 1H12 DPU rose by 23.6% YoY, the highest growth in FRT’s nine-year operating history, to 15.82 HK cents, slightly better than our expectations. As of 30 Jun, FRT’s gearing is healthy at 24.5%. The weighted average effective cost of borrowing was brought down to 2.77% for 1H12 versus 4.44% for 1H11.

Good rental reversion and occupancy

FRT’s private housing estate shopping mall portfolio saw rental reversion of 20.6% for the enlarged portfolio, with passing rent for the original portfolio rising 11.5% YoY. Portfolio occupancy was healthy at 96.5% as at 30 June 2012. There are vacancies due to ongoing AEIs at Fortune City One (FCO) and Jubilee Square.

Ongoing AEIs to deliver returns

Over 70% of the planned AEI at FCO is completed and the remaining works are to be completed by end 2012. The capex is expected to total HK$100m and target ROI is 15%. FRT has started AEI at Jubilee Square in 2Q12 to capitalise on the growth in the immediate catchment. Capex is estimated to be HK$15m with a target ROI of 15%. The expected completion is in 1H13.

Newly acquired malls are improving

Since Feb, a few retail shops and a F&B outlet have been introduced at Belvedere Square. With over 30% of its leased area expiring in the rest of 2012, the management seeks to broaden the tenant and trade mix. Provident Square’s occupancy has been significantly boosted to 99.6% as of 30 Jun, versus 92.3% in Sep 2011.

Maintain BUY

Fortune is trading at a P/B of 0.6x (NAV per unit of HK$8.34) and an estimated FY12 dividend yield of 6.5%. We maintain our BUY rating and raise our fair value from HK$5.22 to HK$5.33.

SUBURBAN SHOPPING MALLS ARE MORE DEFENSIVE

•HK retail rents increased in Apr

•HK retail sales grew slower in May

•But supermarket sales beat luxury sales

Retail rents climbed in Apr

The HK private retail rent and price indexes set new records in Apr, the third consecutive highs starting from Feb. Compared to the Mar figures, the rent index and the price index were up 1.4% and 2.9% respectively. New Territories, where the majority of Fortune’s malls are located, saw average private retail rents climb a respectable 15.2% YoY in Apr.

Retail sales grew slower in May

For May, retail sales in HK climbed 8.8% YoY to HK$36.0b. While this is the lowest pace of growth since Sep 2009 (excluding seasonal distortions during Jan and Feb each year due to Chinese New Year), we believe that Fortune will continue to have good positive rental reversions this year. China’s slowdown is manifesting itself in the decline in HK luxury sales – jewellery, watches and clocks, and valuable gifts saw a 2.9% YoY decline in sales volume in May.

Supermarket sales beat luxury sales

In contrast, supermarket sales climbed 9.1% by volume. Last month, two dairy companies in China, Inner Mongolia Yili Industrial Group and Bright Dairy & Food Co., recalled their products from the market due to contamination. As food safety continues to remain a concern, grocery purchases by Mainlanders in HK should continue to be resilient, thus helping to support suburban shopping malls such as those owned by Fortune. Suburban shopping malls also see a lot of non-discretionary purchases by local HK residents.

Maintain BUY

Fortune’s stock price has climbed 17.5% to a one-year high since we initiated coverage on 14 Mar and we think further upside is possible. 2Q12 will be the first quarter to see full contributions from Belvedere Square and Provident Square, which were acquired in mid-Feb. Fortune is trading at a P/B of 0.6x (NAV per unit of HK$7.81) and an estimated FY12 dividend yield of 6.8%. We maintain our BUY rating and our fair value of HK$5.22.

RENTS IN NEW TERRITORIES GROW THE FASTEST

•Mar 12 retail rents at new highs

•Slowing retail sales growth in April

•Mainland tourists shop more

Rents in New Territories grow the fastest

The HK private retail rent and price indexes set new records in Mar, after the previous highs in Feb. The rent index was 0.9% higher than in Feb, while the price index showed a 2.4% MoM improvement. Perhaps more instructive is the rental rates for the different regions. New Territories, where the majority of Fortune’s malls are located, saw average private retail rents climb 31% MoM and 24% YoY, outperforming both HK Island (3% MoM, 0% YoY) and Kowloon (20% MoM, 22% YoY). The continued strength in the New Territories rental market bodes well for positive rental reversions at Fortune’s suburban malls.

Retail sales climb slower

For April, retail sales in HK climbed 11.4% YoY to HK$35.7b. While this is slower than the 17.1% YoY increase for March (revised figure of HK$36.6b), we note that the Chinese government had its first ever nationwide Consumption Promotion Month on the Mainland, which may have temporarily reduced average spending by Mainland tourists in HK. A HK government official expressed cautious optimism, with the still buoyant labour market and inbound tourism continuing to lend support.

Importance of the Chinese tourist

Visitor arrivals to HK continued to be strong in April, with the total number of arrivals growing 14.4% YoY to 3.8m. Arrivals from Mainland China climbed 23.9% to 2.6m. In 2011, the latest period for which data is available, the average overnight tourist spent HK$4,430 per trip on shopping (an overnight tourist is one who stays for at least one night in HK). Overnight Mainlander tourists spent an even greater amount, HK$5,795, on shopping every trip.

Maintain BUY

Fortune is trading at a P/B of 0.6x (NAV per unit of HK$7.81) and an estimated FY12 dividend yield of 7.2%. We maintain our BUY rating and our fair value of HK$5.22.

Fortune Reit to pay additional US$58,000 to acquire Belvedere Garden, Provident Centre

Fortune Reit on Friday said it will pay an additional HK$450,000 (US$58,000) for the acquisition of Belvedere Garden and the Provident Centre properties.

The additional consideration comes after an audit, which brought the final aggregate purchase consideration for the acquisition of the new properties to HK$1,931,779,182.

Fortune Reit had paid the aggregate purchase consideration of HK$1,931,328,352 in cash on February 17.

The further aggregate sum of HK$450,830 is to be paid in cash, on or before June 1, 2012.