EXCEEDING EXPECTATIONS

•Beating estimates

•Healthy balance sheet

•AEIs provide good returns

Surpassing forecasts

1Q12 results were above our and the street’s forecasts. Net property income of HK$185m was up 15.1% YoY; 9.9ppt came from organic growth, while the other 5.2ppt was from two properties acquired in mid Feb. Retail continues to remain a bright spot in the HK economy. Average passing rent for the original portfolio rose 11% YoY due to good rental reversions in 2011. Net property income margin declined from 73.6% to 71.5% mainly due to one-off costs associated with the acquisition. DPU climbed 14% QoQ to 7.78 HK cents. With the next three quarters seeing full contributions from the two properties, we raise our FY12 DPU forecast from 29.4 HK cents to 31.7 HK cents, up 20.5% YoY from FY11 DPU.

Strong financial position

As of 31 Mar, Fortune’s effective interest cost is at 2.87%, down by 78bps from 31 Dec 2011. Management believes that it can keep interest cost below 3%. It has an interest cover of 5.3x and a comfortable gearing ratio of 26% and debt headroom of HK$2.6b before reaching the 35% gearing limit. The REIT has no refinancing needs till 2015.

AEIs still on track

By the end of 2012, Fortune City One would have completed its HK$100m asset enhancement initiative (AEI) and looks likely to exceed its ROI target of 15%. Fortune defines ROI conservatively, looking at returns quantifiable within only the first year. Fortune will also undertake a HK$12m AEI at Jubilee in 3Q. We view AEI as a good way to generate returns for unitholders.

Maintain BUY; raise fair value

Fortune is trading at a P/B of 0.5x (NAV per unit of HK$7.81) and an estimated FY12 dividend yield of 7.6%. We maintain our BUY rating and raise our fair value estimate from HK$4.88 to HK$5.22.

Fortune Reit DPU jumps 15.6%

FORTUNE Real Estate Investment Trust (Fortune Reit) posted a 15.6 per cent jump in its first quarter distribution per unit (DPU) to 7.78 HK cents for the period ended March 31 2012.

Correspondingly, income available for distribution also grew by 16.9 per cent to HK$131.8 million (US$16.98 million) from HK$112.8 million a year ago.

The Reit, which holds a portfolio of sixteen retail properties in Hong Kong, also saw its revenue climb 18.5 per cent year-on-year to HK$259.2 million during the first three months of the year following contributions from new properties such as Belvedere Square and Provident Square, and higher unit rents achieved across its property portfolio. Notably, passing rents for the period came in around HK$29.90 per square foot (psf) while a rental reversion of 20.8 per cent was garnered from renewed leases during the quarter.

Boosted by a stronger topline and a healthy portfolio occupancy of 97.1 per cent (as at end March), the retail Reit also saw an improvement in net property income which rose 15.1 per cent from the same period a year back to HK$185.3 million.

HK RETAIL RENTS AND PRICE INDEXES AT NEW HIGHS

•Retail rents and prices set new records

•New Territories sees largest rent climb

•Growing influx of Chinese tourists

Retail rents and prices at new highs

The monthly HK property review supplement was released on Tuesday. The Feb private retail rent index reached a new high of 141.1, 2.8% higher than in Jan (137.3) and 0.8% greater than the previous record of 140.0 in Nov 2011. The private retail price index, which could be interpreted as a leading indicator for rents, also set a new record of 347.2, a 1.6% increase from Jan (341.8) or a 1.5% increase from the previous high of 342.2 in Dec 2011.

Largest rent increase for New Territories

14 out of Fortune’s 16 malls, including its top three by valuation, are located in the New Territories, which saw the largest increase in retail rents. Rent in the New Territories grew 15% from Jan to Feb. Hong Kong Island and Kowloon saw increases of 2% and 1% respectively.

Jump in Chinese arrivals

In the first two months of 2012, visitor arrivals to HK increased 15.2% year-on-year, with visitors from the mainland increasing by 19.7%. Mainlanders are driving retail purchases in two key categories: luxury products and safe groceries. Of greater relevance to suburban retail mall owners like Fortune and Link REIT is the mainlander’s desire for safe foodstuffs, with milk powder being the most prominent example. The most recent tainted milk powder scandal in China erupted in Jan.

Dragon baby boom

As this is the Dragon year in the lunar calendar, we note that China and Hong Kong are expecting a 5% and 5-10% increase respectively in the number of babies born in 2012, according to state news agency Xinhua and the HK Hospital Authority. HK retail sales for milk powder and baby products should increase significantly this year.

Maintain BUY

Fortune is trading at a P/B of 0.5x and an est. FY12 dividend yield of 7.2%. We maintain our BUY rating and a HK$4.88 fair value estimate.

Stable Yield Play with Growth

• New acquisition to provide boost

• Retail market robust and growing

• Asset enhancement initiatives

New acquisition of two properties

Two shopping mall properties, Belvedere Garden and Provident Centre, were recently acquired in Feb for HK$1.9b. The yield accretive acquisition was funded by debt. There is much potential for Fortune to improve their monthly passing rents of ~HK$16.5-19.5 psf (versus HK$32.2 psf for the original portfolio). Like the other suburban retail malls in Fortune’s portfolio, the two new properties have sizeable population catchment areas and are easily accessible by public transportation, including train stations.

Expanding retail market

Retail sales in Hong Kong jumped 25% YoY to HK$406b in 2011, reflecting an increase in consumption by locals and foreigners, including 28m tourists from the mainland. With HK and China’s real GDP projected to grow at 3% and 8.5% respectively in 2012 (Bloomberg), and with median household incomes growing, retail sales should continue to do well. Prices of retail spaces have grown significantly faster than average retail rents, and rents will probably continue to catch up. Knight Frank projects that retail rents in noncore areas will increase by 5% this year.

Upgrading existing properties

Management has a comprehensive asset enhancement programme in place and it intends to spend HK$50m-100m per year on asset enhancement initiatives (AEI). Its current portfolio has enough potential for AEI over at least the next three years. With target ROI of at least 15%, we view properly-executed AEI as a cost-effective way to pursue revenue and dividend growth.

Initiate with a BUY

We initiate with a BUY rating and a HK$4.88 fair value estimate based on a Dividend Discount Model (DDM) analysis. Fortune provides stable dividends with opportunity for growth through continued expansion of the retail market, the upgrading of existing properties and its recent acquisition of two new properties. Trading at a P/B of 0.5x, we see reasonable price upside.