Swire Properties

 Hong Kong's largest office landlord.  They hold (mostly freehold) investment properties which they rent out for a steady income stream, using this to develop more property in HK and China.

I want to look at their Investment Property (rental stream) business first, because its recurring and easy to value.  Like a REIT.  So I exclude their lumpy Property Development and Property Trading for now.  Their past ten year Property Investment income is impressive:

Source: 2019 Annual Report, p10

Theres no depreciation in their "Profit Attributable to Company Shareholders" for Investment Properties.  Properties are valued every year and the gain/loss is added to the P&L (HKAS40 does not require depreciation (p17) for Investment Properties held at fair value).  The company helpfully puts revaluations on separate line.  So these profit numbers are purely for rental and 'cost-of-rental', similar to a REIT's Distribution Statement.

These numbers make me excited.  Can you find any SGX listed REIT or property company that doubled their rental profits in 10 years while reducing debt?  And the number of shares issued in this period is only up 3%.  This shows the power of compounding when a company reinvests some of its income, instead of paying it all out as dividends.

Investment Properties

Geographical Segment breakdown

They rent out office and retail properties in HK, China, with a small business in Miami.  They only give breakdown by Total Revenue (not Investment Properties revenue/profits):

Source: 2020 Interim Results Briefing

HK

I estimate that 70-80% of their Investment Property profits are from HK.    I guess 50-60% of HK profits should be from office, with the rest from retail.  Their Office is mostly Grade-A, and saw positive rental reversions in the first half of the year - so not much to worry about here.  Retail is mixed: they have 2 main malls: 

• The Mall, Pacific Place: an upscale mall surrounded by offices and 4 hotels, next to the High Court and British Council.  It boasts a large number of luxury brands as tenants (p29).  Retail sales fell by 47% here in 1H20 (p11).  Long term, I expect the squeeze to continue even after covid and social unrest are resolved, as luxury brands decrease their HK footprint.

Source: Vogue Business, June 2020, Rethinking Hong Kong's Luxury Future

• The largest regional shopping centre in HK, with MTR access, shopping & dining, cinemas and an ice-skating rink.  Retail sales fell 20% here in 1H20, I expect it to rebound long term, as things recover.
• Other properties, around 15-20% of HK Investment Property GFA (weighted by ownership).

4.5% of their HK retail rentals expire this year, followed by another 23.5% in 2021.  We can expect continued pressure here.  This may already be reflected in 1H20's numbers (gross 1H20 HK retail rent was down 10% - p11), as Swire has already given concessions to luxury tenants, showing they will cut rent to keep occupants.  Both malls remain 100% leased as of June.

How bad can it get?  Back-of-envelope calculation: Lets say that The Mall accounts for 40% of HK Investment Property Retail profits, or 20% of HK Investment Property profits.  Then lets say The Mall's Profits halve (following a further 30% decrease in gross rental to 1H20 results).  So we could see a 10% drop in HK Property Investment income, which is maybe a 5-8% drop in total Investment Property income.

China

28% of their Gross rental is from Mainland China, I guess it accounts for 15-20% of profits.  Most of the China rental is from retail.  Skewed towards luxury (p15): 40% if their rental is from "Fashion and Accessories", and 20% is from "Jewellery and Watches".  They are optimistic: "Footfall and retail sales in the Chinese mainland have recovered strongly since March 2020. Retail sales are expected to continue to improve for the rest of the year, led by sales of watches, jewellery and other luxury brands." 

Tenure

Since I'm valuing based on property rental, I need to know their property tenure.  62% of their completed HK investment properties have leases of 800+ years (by GFA), 23% have leases 30 years of less.  All China properties have 40 year leases.

Future Growth

Their development pipeline calls for a ~10% increase in GFA by 2023:

Spending on this is forecast to range from 2bn to 5bn a year:

Assuming 1H20 is as worse as it gets - Investment Property profits were 4bn in six months - they should have no problem covering this expenditure.

Other Segments

They have a small hotel segment, which usually operates at a loss (pre-covid).  Hotel P&L numbers do include depreciation.

Gearing

Company-wide, net debt (including leases) is around 17bn.  Or 2.1 times annualised 1H20 Investment Property Earnings.  This debt is so low compared to their earnings/assets, its not even worth looking at the debt repayment schedule (p28).

Property Development Segment 

"Property Trading" and "Sales of Investment Properties" have been lumpy over the past ten years:

Instead of analysing the history of property transactions, lets look at where they are now.  It means have some residential properties to dispose of after covid:

My guess is that they write down some Miami condos as the market crashes, but most are already sold anyway.  For Singapore and Indonesia, worst case is they sell at a discount if theres a recession.

Second, they are developing new properties:generally, the residential units will for sale in their "trading portfolio" (p18), and office/retail units will be added to Investment Properties.

Valuation

I'd be happy to buy it at a 5% yield, or HKD 18.  What really gets me excited is that this dividend is only 63% of their Investment Properties profits (1H20 numbers, annualised).

Theoretically - as a comparison to SG Reits - a 100% payout ratio with a 6% yield would give them a target price of HKD 23.

Risks:

This company has a great long term track record, and is conservatively geared.  The risks come from the external environment, principally HK Real Estate, and China.

Hong Kong property prices have boomed for the past 10 years:

Source: Trading Economics

This is a bubble.  There are no signs of it deflating, and even signs the government may continue to blow it up.  It must pop one day - one way or another.  High property prices are one of the causes of unrest, and there's always a political risk the government will enact policies against property developers.  This line of thought is that HK's unrest is a structural problem, and one of the fixes required is lower property prices.

Another risk is the China bubble bursting.  The giant China bubble pops, and it becomes like Japan in 1989.  Or the Soviet Union.  The problem is best summarised here.  

Its a book.

I don't think "Work From Home" is a risk to this company.  I think that most people in Hong Kong will not work from home as their units are too small.

Medium term, I'm not sure where we are in the HK property cycle.  HK office rents have fallen for 6 consecutive quarters.

Misc

While Swire Properties and HKL gave concessions to luxury tenants, Wharf REIC did not, causing LVMH to plan to close its 10,000 sq ft Times Square store.