EQUITY RESEARCH 23 November 2010INITIATING COVERAGE HONG KONG PROPERTY DEVELOPERS Hong Kong Property Developers 1-POSITIVE Initiation of coverage: Bubble wrap from N/A Positive view on Hong Kong property developers: Although property prices are For a full list of our ratings, price targets and earnings in this report, please see table on already overvalued against long-term fundamentals, we expect them to overshoot; page 2 low supply, a government unwilling to deflate house prices, negative real mortgage rates and high levels of equity are all supportive of higher property prices, in our Hong Kong Property Investors view. While all eight developers should benefit, our 1-Overweight picks – SHKP, Sino Andrew Lawrence Land and Kerry Properties – reflect our preference for shorter-duration land banks +852 290 33319 and the pre-selling of developments: ie, business models that capture the late-cycle @ returns, while managing the risks inherent in Hong Kong’s volatile property prices. Barclays Bank, Hong Kong PropeJonathan Hsu rty price momentum remains: Despite the government’s recent measures, +852 290 34732 negative mortgage rates, a belief in the renewed investment potential of housing and @ strong homebuyer confidence will likely allow property price momentum to run for Barclays Bank, Hong Kong another 18-24 months. We forecast residential prices will increase 10-15% in 2011 and 10-15% in 2012: today’s residential market is more comparable to 1994/95 than the Wendy Luo peak cycle years of 1996/97, in our view. +852 290 34673 @ Look to capture late-cycle returns: While rising property prices are positive for all eight Barclays Bank, Hong Kong developers, our preference is for SHKP, Sino Land and Kerry, companies focused on pre- sales, with shorter-duration land banks and a focus on the cash-rich upper rungs of the housing ladder to capture the returns and manage the inherent risks of this stage of the cycle. Our 3-Underweight rating on Hang Lung Properties (HLP) reflects the high expectations priced into the stock and that investors have largely ignored the potential land appreciation tax (LAT) liabilities of its commercial properties in China. US and China interest-rate risks: In the near term, higher interest rates in China, discouraging investment flows and negatively impacting confidence, remain a key risk. Yet, the largest risk, in our view, remains US interest rates, especially given the increased mortgage borrowing by homebuyers. We believe this interest rate link and investor sentiment will continue to tie developers’ stock prices to US-dollar movements. Figure 1: Hong Kong property developers’ valuation table Price Potential (HK$) Rating Price targetup/downside Sino Land (83 HK) 1-OW 30% SHKP (16 HK) 1-OW 25% Kerry Properties (683 HK) 1-OW 20%Guide to the Barclays Capital rating system Cheung Kong (1 HK) 2-EW 18%Henderson Land Dev. (12 HK) 2-EW 13%Our coverage analysts use a relative rating New World Dev. (17 HK) 3-UW 11%system in which they rate stocks as Hang Lung Group (10 HK) 3-UW -1%1-Overweight, 2-Equal Weight or Hang Lung Properties (101 HK) 3-UW -4%3-Underweight relative to other companies covered by the analyst or a team of Note: Pricing as of 22 November 2010 Source: Barclays Capital estimates analysts that are deemed to be in the same industry sector (the “sector coverage Barclays Capital does and seeks to do business with companies covered in its research reports. As auniverse”). result, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of thIn addition to the stock rating, we provide is report. sector views which rate the outlook for the Investors should consider this report as only a single factor in making their investment decision. sector coverage universe as 1-Positive, This research report has been prepared in whole or in part by research analysts based outside the US 2-Neutral or 3-Negative. who are not registered/qualified as research analysts with FINRA. (For a full explanation of our rating system PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE page 84 of this report.)
Barclays Capital | Hong Kong Property Developers Summary of our Ratings, Price Targets and Earnings Estimates in this Report Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E) OldNew 22-Nov-10OldNew %Chg Old New %ChgOldNew%ChgHong Kong Property DevelopersN/A 1-Pos Cheung Kong (Holdings) Ltd. (1 HK / ) N/ N/- N/A - N/- Hang Lung Group Ltd. (10 HK / ) N/ N/- N/A - N/- Hang Lung Properties Ltd. (101 HK / ) N/ N/- N/A - N/- Henderson Land Development Co., Ltd. (12 HK / ) N/ N/- N/A - N/- Kerry Properties Ltd. (683 HK / ) N/ N/- N/A - N/- New World Development Co., Ltd. (17 HK / ) N/ N/- N/A - N/- Sino Land Co., Ltd. (83 HK / ) N/ N/- N/A - N/- Sun Hung Kai Properties Ltd. (16 HK / ) N/ N/- N/A - N/- Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency. FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital. Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating Suspended Sector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative 23 November 2010 2
Barclays Capital | Hong Kong Property Developers INVESTMENT SUMMARY We initiate coverage of the Hong Kong property developers with a 1-Positive sector view. Strong consumer confidence, negative mortgage rates and the availability of credit will likely encourage demand to chase a constrained stock of available properties over the next 18-24 months. We expect already overvalued property prices to increase further. All eight developers should benefit, but the best risk/returns are likely to come from developers whose business model is focused on faster pre-sales, a shorter-duration land bank and a selective land-acquisition strategy. Our 1-Overweight picks are SHKP, Sino Land and Kerry Properties. Property price momentum remains: Distorted by low interest rates, Hong Kong property prices are already 28% overvalued. Yet, a near-term correction appears unlikely. Today’s residential market is more comparable to 1994/95 than the previous peak cycle years of 1996/97, in our view. However, we believe the longer interest rates remain low and household confidence remains strong, the greater the prospects of a more material overshoot in prices. Negative mortgage rates, a belief in the renewed investment potential of housing and confidence that prices can rise and panic that supply will not be available in a few months’ time will likely allow the current momentum in end-prices to run for another 18-24 months. With forecast private residential completions of only 14,000-units per annum (pa) for the next two years, demand will be chasing a constrained stock of available properties. Government policy is likely to remain focused on slowing price growth as opposed to correcting high prices, hence we see a continued focus on longer-term supply and the introduction of demand measures at the margin, neither of which we think will significantly curtail prices. As a result, we forecast property prices will increase 10-15% in 2011 and 10-15% in 2012: the best performance will likely come from those properties in the more equity-rich, upper rungs of the housing ladder. Look to capture late-cycle returns: While expected property price increases should benefit all eight developers, our preference is for those developers – SHKP, Sino Land and Kerry – whose business model is focused on a faster ‘asset-turn’ sales approach, shorter-duration, prime land banks and likely to employ an selective land-acquisition strategy. We believe this business model offers the best risk/reward trade-off to capture the upside in prices at this stage of the cycle, while managing the risk of a potential future price correction. From a valuation perspective our top picks are SHKP, Sino Land and Kerry, which offer 20-30% potential upside to current prices. We have a 2-Equal Weight rating on Cheung Kong and Henderson Land, which offer 13-18% potential upside to current share prices, and a 3-Underweight on Hang Lung Properties, Hang Lung Group and New World Development. We like HLP’s focus on commercial properties in China, but think price expectations for execution of its strategy are high and that investors are yet to price in the potential LAT liability. US & China interest-rate risks: In the near-term, risks lie with a significant rise in China interest rates that discourage fund flows into Hong Kong and negatively impact investor sentiment. However, we believe the longer-term risks from increasing US interest rates remain the largest and most obvious risk to the market, especially as homeowners, via increased floating rate mortgage borrowing, are becoming more sensitive to potential interest-rate movements. In this regard, we think property developers’ stock prices will remain correlated with US-dollar movements, as a strong US dollar – in its own right – would imply a US economic recovery and rising interest rates. 23 November 2010 3
Barclays Capital | Hong Kong Property Developers CONTENTS RISING PROPERTY PRICES OVER 2010..........................................................................................5 ECONOMIC OUTLOOK.......................................................................................................................9 HOUSING DEMAND MODEL...........................................................................................................12 HOMEBUYER DEMAND...................................................................................................................14 HOUSING SUPPLY.............................................................................................................................23 GOVERNMENT HOUSING POLICY.................................................................................................26 PROPERTY PRICES............................................................................................................................30 IMPLICATIONS FOR DEVELOPERS................................................................................................34 VALUATIONS....................................................................................................................................38 COMPANY SECTION SUN HUNG KAI PROPERTIES (1-OVERWEIGHT; PT HK$; +25%).................................56 SINO LAND (1-OVERWEIGHT; PT HK$20; +30%).......................................................................59 HENDERSON LAND DEVELOPMENT (2-EQUAL WEIGHT; PT HK$; +13%)..................62 CHEUNG KONG (2-EQUAL WEIGHT; PT HK$; +18%)....................................................65 NEW WORLD DEVELOPMENT (3-UNDERWEIGHT; PT HK$; +11%)..............................68 KERRY PROPERTIES (1-OVERWEIGHT; PT HK$; +20%)..................................................71 HANG LUNG PROPERTIES (3-UNDERWEIGHT; PT HK$; -4%)........................................75 HANG LUNG GROUP (3-UNDERWEIGHT; PT HK$; -1%).................................................79 23 November 2010 4
Barclays Capital | Hong Kong Property Developers RISING PROPERTY PRICES OVER 2010 Strong consumer confidence, low mortgage rates and a renewed belief in the investment potential of housing has caused demand to chase a constrained stock of available properties over 2010. Distorted by low interest rates, property prices are 28% overvalued. However, the residential property market appears, for the moment, more comparable to that of 1994/95 than the peak years of 1996/97. Residential prices Figure 2: Home buying sentiment 20%15%Positive sentiment15%10%10%5%5%0%0%-5%-10%-5%-15%Negative sentiment-10%-20%-25%-15%990112334556778990990000000000000001------------------rrrrrrcgcgcgcgcgcgpepepepepepeuuuuuuAAAAAADDDDDDAAAAAABuy/Rent Transactions 3MMA Difference from average (LHS)MoM Price change per Centaline City Leading Index (RHS)Note: Buy/Rent sentiment is the ratio of buy-to-rent transactions undertaken by Midland Realty on a monthly basis Source: Midland, Centaline, Barclays Capital Property prices are up 19%… Residential property prices are up 19% year-to-date (YTD), following an increase of 29% in 2009. Since bottoming in July 2003, Hong Kong’s residential property prices have risen 170%. Strong consumer confidence, high affordability and a belief in the renewed investment potential of housing has caused demand to chase a constrained stock of available properties over 2010. Figure 3: Transaction volumes and prices (Vol)(HK$psf)70,0007,00060,0006,00050,0005,00040,0004,00030,0003,00020,0002,00010,0001,00000Transaction HK$ Source: Midland, Barclays Capital 23 November 2010 5 Sep-84Sep-86Sep-88Sep-90Sep-92Sep-94Sep-96Sep-98Sep-00Sep-02Sep-04Sep-06Sep-08Sep-10
Barclays Capital | Hong Kong Property Developers Housing demand We estimate that 50-60% of 2010’s home buyers were up-graders, 30% were investors and the remainder were first-time buyers. Despite all the political talk about first-time buyers, the widening of prices between rungs of the housing ladder, the greater proportion of households aged 35-44 and limited growth in owner occupation all point to equity-rich up-graders as the main driving force behind rising prices and transactions levels. The increasing dominance of up-graders is evident from the rising percentage of transactions of higher priced properties: 37% of all transactions this year have been for properties over HK$3mn against 29% in 1996, when property prices were last at a similar level. In the highly equity-rich HK$20mn-plus segment of the market there have been 2,628 transactions YTD against 2,240 sales in 1997, the last cycle’s peak. … encouraging first-time buyers First-time buyers were supported by low mortgage rates and improving consumer into the market… confidence. The cost of paying the monthly mortgage has remained relatively low, at just 35% of first-time buyer household income, although affording the 30% deposit to put down on a property has becoming increasingly prohibitive for most first-time buyers. However, rising prices continued to encourage first-time buyers into the market. Figure 4: First-time buyer affordability and house price/earnings ratios 1001490128010706085064030450% lending threshold and long-term 202average price to household income ratio100034679023568912457808888899999990000001-------------------rrrrrrrrrrpppppppppaaaaaaaaaaeeeeeeeeeSSSSSSSSSMMMMMMMMMMAffordabilityHouse prices/earningsSource: Hong Kong government, Barclays Capital Demand from mainland buyers remained a major driver of prices over 2010. Centaline estimates that mainland purchasers accounted for 24% of buyers of flats worth more than HK$12mn in 2010, compared with % in 2009 and % in 2008. In 2007, % of buyers in the luxury residential market were mainlanders. In contrast, only % of the buyers in the mass-market came from the mainland, compared with % in 2009 and % in 2008. …and while confirmor Speculative activity, as detailed by confirmor transactions, were notable by their absence. transactions were largely Although at the lower end of the market it was evident that property trading, as determined absent… by property held for less than 12 months, had increased. Based upon Centaline’s data, we estimate that 9% of the total unit turnover in the first ten months of this year has been of properties traded within 12 months of purchase. However, despite the recent introduction of a holding tax on property, we expect the realisation that increased price volatility, as a result of low supply and abnormally low interest rates, will argue less for short-term speculation and more for medium-term holding of high-quality stock. 23 November 2010 6 % of meidan household income(x) P/E ratio
Barclays Capital | Hong Kong Property Developers Figure 5: Confirmor transactions Figure 6: % of properties sold within one-year of purchase (units)16%2,%14%1,80012%%1,60010%1,%8%1,2001,%6%8004%%6002%%0%%678901234567890999900000000001999900000000000111122222222222 56789012345678909999900000000001M----------------llllllllllllllll0uuuuuuuuuuuuuuuu1JJJJJJJJJJJJJJJJHolding period < 1 year % of total transaction valueTransaction Volume of Confirmor (LHS)Holding period < 1 year % of total transaction volumeProportion of Confirmor in Total Transactions (RHS)Source: Midland, Barclays Capital Source: Centaline, Barclays Capital …investment flows into the Given the low cost and availability of credit, property remains an attractive speculative market increased… vehicle. Mortgage loan growth has risen % in the first nine months of the year, despite the unprecedented repayment of mortgage principle due to low interest rates. Figure 7: Outstanding mortgage loans (HK$ mn)800,000700,000600,000500,000400,000300,000200,000100,00000123567801235678099999999000000001-----------------rrrrnpcnpccrcnpnpaaeeeeaeeaaeeuuuuJJJJSSSSMDMDMDMDMSource: Hong Kong Monetary Authority, Barclays Capital Price growth in the luxury residential market slowed in 2010, with prices up % YTD according to Savills. This is perhaps unsurprising, given that prices rebounded by 45% in 2009 and are now some 29% above their 1997 peak. The luxury housing market remains dominated by high net worth individuals and driven by IPO money raised in Hong Kong, which is partly used to acquire luxury properties rather than being repatriated to the mainland. Despite very high prices, this remains a cash-driven market, with sentiment tied to overall economic confidence and stock market performance. 23 November 2010 7
Barclays Capital | Hong Kong Property Developers Figure 8: Luxury residential prices and the HSI small cap index (index)(index)3,5004003503,0003002,5002502,0002001,5001501,00010050050000123456789000000000001 QQQQQQQQQQQ22222222222Small cap index (LHS)Residential prices (RHS)Source: Savills, Bloomberg, Barclays Capital Bubble talk …as a result, property prices are A hot topic has been how far Hong Kong property prices have deviated from fundamentals 28% above long-term and are forming a ‘bubble’. Based upon our long-run house-price-to-earnings ratios since fundamentals… 1975 for the mass market, excluding the distortions created by abnormally low mortgage rates and inflows of external capital, we estimate that property prices are 28% above their long-term average. It should be noted, however, that such overvaluation can last for extended periods – six years during the early to mid 1990s – and that our price-to-income ratios were 63% higher than their long-term averages at the peak of the market in 1997. …but remain well supported However, for the moment at least, prices remain well supported by low mortgage rates, strong availability of credit and high levels of housing equity built up over the past few years. Today’s residential property market is more comparable to that of 1994/95 than it is to the peak years of 1996/97, in our view. Figure 9: House prices and household incomes Index6005004003002001000579135791357913579777888889999900000999999999999900000111111111111122222Residential pricesMedian household incomeSource: Hong Kong government, Barclays Capital 23 November 2010 8
Barclays Capital | Hong Kong Property Developers ECONOMIC OUTLOOK Hong Kong has benefited from China’s massive fiscal stimulus and the extraordinarily easy monetary measures from the FED. With no change expected in US interest rates and little re-pricing of HIBOR-based mortgages, rising Hong Kong inflation implies increasingly negative real mortgage rates. We expect the US dollar to remain relatively weak over the next 12 months, encouraging foreign inflows and forcing Hong Kong savings to be invested locally. Economic forecasts Hong Kong has benefited from China’s massive fiscal stimulus and the extraordinarily easy monetary measures from the FED. Economic recovery is evident from retail sales, the property market and an improving labour market. The consensus economic forecast for Hong Kong GDP growth is % in 2010 and % in 2011/12. US interest rates are forecast to remain flat for the whole of 2011. Figure 10: Economic forecasts (%) 2006200720082009 2010E2011EGross domestic product Private consumption Gross fixed investment Consumer prices Money supply Unemployment rate 3-month interbank rate Prime lending rate Source: Bloomberg, Barclays Capital estimates Inflation Inflation is forecast at % for Inflation is forecast at % for 2010 and 3% for 2011, which, given that Hong Kong is a 2010 and 3% for 2011… price-taker from China, is largely consistent with the outlook for China’s inflation at % in 2010 and 3% in 2011. Rising inflation in China, however, suggests that the current risk to these forecasts is on the upside for 2011. Given the US-dollar peg, differential inflation/economic growth between Hong Kong and the US has largely determined the impact of US interest-rate policy on Hong Kong asset prices. From 1985 to 1997, higher relative Hong Kong inflation provided negative real mortgage rates and high asset price growth. The opposite was true between 1997 and 2002, causing people to divert more of their savings away from housing and into leisure activities and other investments. 23 November 2010 9
Barclays Capital | Hong Kong Property Developers Figure 11: Real mortgage rates and differential inflation: Hong Kong vs the US 10%-6%-4%8%-2%6%0%4%2%2%4%0%6%-2%8%-4%10%-6%12%-8%14%-10%16%3579135791357988889999900000--------------rrrrrrrrrrrrrraaaaaaaaaaaaaaMMMMMMMMMMMMMMHK/US differential inflationHK real mortgage rates (inverted RHS)Source: Hong Kong government, Bloomberg, Barclays Capital Since 2002, it has not been differential inflation that has driven negative real mortgage rates, but the FED’s highly reflationary interest-rate policy and the re-pricing of mortgages to HIBOR by Hong Kong banks (which has effectively reduced mortgage costs by 100-150bps), which implies that this cycle has been driven more by US weakness than by Hong Kong’s growth. …which, with no interest-rate With no change expected in US interest rates and little re-pricing of HIBOR-based increases, implies % mortgages, rising Hong Kong inflation implies increasingly negative real mortgage rates. negative real mortgage rates… Based upon a HIBOR rate of 25bps, a mortgage spread of 75bps and inflation of 3%, we expect negative real mortgage rates to average % over 2011. By implication, the FED would need to raise interest rates by at least 200-250bps for Hong Kong mortgage rates not to remain highly simulative to asset prices. Figure 12: Property prices and real mortgage rate 80%-15%60%-10%Negative real mortgage rates40%-5%20%0%0%5%-20%10%Positive real mortgage rates-40%15%34679023568912457808888899999990000001-------------------rrrrrrrrrrpppppppppaaaaaaaaaaeeeeeeeeeSSSSSSSSSMMMMMMMMMMYoY Change in property pricesReal mortgage rate (RHS)Source: Hong Kong government, Barclays Capital We suspect that over 2011/12, the symbiotic relationship between property and inflation will likely reassert itself. Higher property prices will encourage higher inflation, which in turn will support higher wage growth and support further property price increases. Negative real mortgage rates and desired exposure to property will likely drive an increased mortgage borrowing over 2011. 23 November 2010 10
Barclays Capital | Hong Kong Property Developers The US dollar …while a weak US dollar should Our forex forecasts are that the US dollar will remain relatively weak over the next 12 also support fund flows into months appreciating by only 5% against the euro and 8% against the yen. A weak US dollar Hong Kong not only encourages foreign inflows, but also forces Hong Kong savings to be invested locally. The weakness of the US dollar, and in particular, the strengthening of the RMB, has clearly been supportive of mainland money flows. The US$/RMB has appreciated from at the start of 2010 to currently. Our forex strategists expect the RMB to appreciate to by end-2011, implying an appreciation of %, and providing further support to money flow into Hong Kong property from mainland buyers. Figure 13: US$/RMB exchange rate (x)------------------------lrlrvtrgvtgcrnbypbypucnnuoapacnnJeaeueoJeapeuuauaaJOJJFSAFOJJSANMADMMNAMUSD:CNY Source: Bloomberg, Barclays Capital China interest rates In terms of China interest rates, Bloomberg consensus forecasts a one-year base lending rate of % by end-2011, which implies that there will not be a significant tightening of liquidity in China over 2011, although lending targets will likely be reduced. Whether this affects money flows into Hong Kong is questionable, the prospect of strong price increases and the desire to place money outside the mainland is likely to offset a rise in deposit rates, in our view. Given the increasing administrative measures in China on second home purchases, Hong Kong continues to remain a relatively easy destination for mainland capital. 23 November 2010 11
Barclays Capital | Hong Kong Property Developers HOUSING DEMAND MODEL Forecasting short-term residential price performance is more dependent upon changes in demand. To determine demand and demand drivers, we use a conceptual model based upon changes in economic and social sentiment. The basis of our model is that Hong Kong’s residential demand is largely investment driven: higher prices induce higher demand, as the positive correlation between turnover and prices demonstrates. Forecasting demand Forecasting short-term residential price performance is more dependent upon changes in demand, in our view. This is not to say that supply is not important, but simply to recognise the greater influence subtle shifts in demand can exert on short-term price-setting over the inelastic supply side of the market. Demand improves when an Determining housing demand is difficult, given that demand embodies a wide variety of external factor leads to a change economic and social factors. In order to attempt to estimate the nature and drivers of in affordability and confidence… housing demand, we use a conceptual model based upon changes in economic and social sentiment. Our model assumes a change in the market occurs when an improvement in external economic factors lead to a change in affordability/liquidity and buyer confidence. The basis of the model is relatively straightforward: in stable periods, end-buyers dominate and demand is largely driven by changes in household composition – births, deaths, marriages, divorces, etc. Turnover is relatively low, and affordability, combined with household confidence with regard to employment prospects and the ability to service the mortgage, are the main drivers to demand, in our view. However, as the economy and household confidence improves, rising house prices are seen as a signal that it is a good time to trade. This encourages more first-time buyers into the private housing market and existing private households to use the equity in their homes to trade-up. As prices continue to rise, the investment motive returns and an increasing number of investors enter the market. This forces turnover up and drives prices higher. Confidence in rising property prices and the availability and affordability of credit become the main drivers of demand. Ultimately, if house price inflation remains persistently high, it encourages a speculative culture, prompting people to pay more for property and encouraging them to hold more than they normally would. The availability of credit dominates and an increasing belief in the ‘greater-fool’ theory – someone will always pay more – drives demand. This, in our view, causes higher turnover levels, drives affordability ratios to unsustainable levels and disguises the real demand for property. …reflecting the investment- As the following graphs show, this model – via changes in turnover, affordability, price-to-driven demand for Hong Kong income ratios and price volatility – reflects well the shifting pattern of marginal demand in property Hong Kong’s housing market, resting on the simple thesis that Hong Kong’s residential demand is largely investment driven: cheaper house prices and improved affordability do not induce higher demand. 23 November 2010 12
Barclays Capital | Hong Kong Property Developers Figure 14: Housing affordability – 1983-2009 Figure 15: Transaction volumes as a % of total private housing stock %%Lower %%%%%%%34679023568912457804679023568912457808888899999990000001888899999990000001-------------------------------------rrrrrrrrrrrrrrrrrrrppppppppppppppppppaaaaaaaaaaaaaaaaaaaeeeeeeeeeeeeeeeeeeSSSSSSSSSSSSSSSSSSMMMMMMMMMMMMMMMMMMMSource: Hong Kong government, Barclays Capital estimates Source: Midland, Barclays Capital estimates Figure: 16: House-price volatility Figure 17: House price-to-household income ratio 100%(x)1480%Speculation & investment1260%Speculation1040%Investment820%60%End usersEnd users4-20%2-40%0-60%945780134679023568945780134679023568888809999999000000088889999999000000------------------------------------rrrrrrrrrrrrrrrrrrppppppppppppppppppaaaaaaaaaaaaaaaaaaeeeeeeeeeeeeeeeeeeSSSSSSSSSSSSSSSSSSMMMMMMMMMMMMMMMMMMSource: Hong Kong government, Barclays Capital estimates Source: Hong Kong government, Barclays Capital estimates 23 November 2010 13 % of median Household Income
Barclays Capital | Hong Kong Property Developers HOMEBUYER DEMAND There has been an evident shift to investment-driven demand and an increasing risk appetite for property among homebuyers. The next stage of the market will likely be driven by the availability of credit and confidence that prices can rise, and panic that supply will not be available in a few months’ time. Despite the appearance of stretched affordability, the overly simulative nature of mortgage rates and the availability of credit will likely encourage households to increase their property exposure, leading to a period of high market turnover and rising prices. Investment-driven demand There has been a shift to Although distorted by abnormally low interest rates, the implication from our model is that investment-driven demand and there has been a shift to investment-driven demand and an increasing risk appetite for an increased risk appetite for property among homebuyers. In our view, this reflects expectations of a continued property… economic recovery and low US interest rates, the expectation of further price increases due to limited supply, cheap mortgage rates and money flow from the mainland, and a government ultimately unwilling to significantly deflate the property market. Having been driven by affordability and the availability of equity, we expect the main demand drivers of the next stage of the market to be the availability of credit, confidence that prices can rise and panic that supply will not be available in a few months’ time. While recent government measures are likely to reduce speculative activity, we view the additional 5% cost of holding property for more than 12 months as inefficient to offset the renewed investment demand for property. First-time buyers and the mass market …declining unemployment and In the mass market, buyer confidence will likely improve on declining unemployment and wage growth will likely drive wage growth. The current monthly cost of a repayment mortgage on a starter unit in the first-time buyer confidence… New Territories accounts for only 35% of the median household income and is comparable to the cost of renting. For monthly mortgage costs to reach 50% of household income (the limit for bank lending) would require mortgage rates to increase 400bps or property prices to increase by 42% from current levels. 23 November 2010 14
Barclays Capital | Hong Kong Property Developers Figure 18: Affordability and property prices (HK$psf)7,000100906,000805,00070604,000503,00040302,000201,000100034679023568912457808888899999990000001-------------------rrrrrrrrrrpppppppppaaaaaaaaaaeeeeeeeeeSSSSSSSSSMMMMMMMMMMProperty priceAffordabilitySource: Hong Kong government, Midland, Barclays Capital …although many first-time While monthly mortgage payments remain affordable, the required 30% deposit on a starter buyers appear to be taking out unit represents the annual household income, making the first-time buyer more 85-90% LTV mortgages… reliant on the ‘bank of mum and dad’ than at any time since 1997. Many first-time buyers are resorting to 85-90% loan-to-value (LTV) mortgages to finance deposit payments, reflecting the significant divide between the accumulated wealth of the ‘baby-boomers’ and those the 1980’s ‘hand-over’ generation. Figure 19: Monthly mortgage rate vs rental payment (HK$)18,00016,00014,00012,00010,0008,0006,0004,0002,0000246802468024680888899999000001---------------rrrrrrrrrrrrrrraaaaaaaaaaaaaaaMMMMMMMMMMMMMMMMortgage paymentRental paymentSource: Hong Kong government, Midland, Barclays Excluding refinancing mortgages, we estimate that the penetration rate for the Hong Kong Mortgage Corporation’s (HKMC) Mortgage Insurance Program (MIP) is 17% YTD and that use of the MIP has increased notably over 2009 and 2010. Approximately 14,500 loans were drawn down in 2009, while to the end of August, 10,467 loans had been drawn down, of which 95% were used for secondary property purchases at an average mortgage size of HK$. 23 November 2010 15
Barclays Capital | Hong Kong Property Developers Figure 20: Ratio of household income to 30% deposit (x) term average ---------------------------rrrrrrrrrrrrrrrrrrrrrrrrrrraaaaaaaaaaaaaaaaaaaaaaaaaaaMMMMMMMMMMMMMMMMMMMMMMMMMMMSource: Hong Kong government, Barclays Capital Figure 21: Mortgage insurance usage rate (HK$ mn)40,00025%35,00020%30,00025,00015%20,00010%15,00010,0005%5,00000%20002001200220032004200520062007200820092010Mortgage loan amount drawn down (LHS)Usage rate (RHS)Source: HKMC, Barclays Capital Despite the increasing use of high LTV mortgages, we suspect that savings levels among first-time buyers are likely to be higher than they were in the 1990s, given that the average age of the first-time buyer has increased due to people waiting longer to get married and have children. In addition, the long tradition of family support for first-time buyers should, to some extent, offset the increasingly prohibitive deposit requirements. …expectations of further price As a result, improving economic confidence, highly affordable monthly mortgage payments increases and help from the and expectations that prices will continue to rise and properties may not be available or ‘bank of mum and dad’ will affordable in a few months, will continue to encourage first-time buyers into the market support further demand over the next 12 months. 23 November 2010 16
Barclays Capital | Hong Kong Property Developers Figure 22: Affordability sensitivity ratios Household income sensitivity table Household income growth rate (annual rate) % % % % % % % % % 3937353432302928 % 41 39 37 35 34 32 31 29 Mortgage % 44 41 39 37 35 34 32 31 rate % 46434139 37 35 34 32 % 48 45 43 % 50474543 41 39 37 36 % 53 50 47 4543413937 Capital value sensitivity Capital value change % % % % % % % % % 2931333436384041 % 30 32 33 35 37 39 41 42 Mortgage % 3133343638404243rate % 31 33 35 37 39 41 43 44 % % 33 35 37 39 41 43 45 47 % 3436384042444648 Mortgage vs Rental Payment Differential Rental yield % % % % % % % % % (208) 0 208 417 625 833 1,042 1,250 % (357) (149) 59 268 476 684 893 1,101 Mortgage % (511) (303) (94) 114 322 531 739 947 rate % (669) (461) (253) (44) 164 372 581 789 % (833) (625) (416) (208) 0 209 417 625 % (1,001) (793) (584) (376) (168) 41 249 457 % (1,174) (966) (757) (549) (341) (132) 76 284 Source: Barclays Capital estimates Upgraders, investors and the mid-market Subtle shifts in demographics have changed the dominant nature of buyers in the housing market; the average age in Hong Kong is 41-years against 32-years in the early 1990s. As a result, the majority of homebuyers are now in the 35-44 age-group, as opposed to the 25-34 first-time buyer cohorts of the 1990s. Upgraders are the dominant Upgraders are typically repeat buyers looking to trade-up into larger, better-quality units buyers of residential property… through the equity built up in their homes and via savings. The 35-44 age-group is most likely to take the final step up the housing ladder: the number of adults living as couples with dependent children peaks in this period, and demand for space is paramount. It also explains why house prices in good school catchment areas have outperformed over the past ten years, as couples are prepared to pay a housing premium to provide their children with better schooling. 23 November 2010 17
Barclays Capital | Hong Kong Property Developers Figure 23: First-times buyers and upgraders as a percentage of the population % of population35%First-time buyers 30%Up-graders25%20%15%197619811986199119962001200620112016202120262031203625-35 year-olds35-45 year-oldsSource: Hong Kong government, Barclays Capital The increased purchasing power of upgraders has been due to employment growth, particularly in the bonus-rich financial sector, low interest rates over the past few years that allowed households to pay down the capital proportion of their repayment mortgages and the 170% rise in home prices since 2003. As a result, price growth has been concentrated in the more equity-rich sectors and the areas of strongest economic growth/or particularly constrained supply. …reflected by widening prices Comparing property prices per sq ft (psf) across different size properties shows that up every rung of the housing psf-prices of larger properties has increased at a faster rate than properties of a smaller size. ladder and across locations… In addition, properties on Hong Kong Island, a more equity-driven market, have risen significantly higher in price since 2003 than the same size units in the New Territories, implying that over this cycle property prices have been driven more by the availability of savings and equity from previous house purchases than by the availability of credit. Figure 24: Housing ladder prices (x)--------------rrrrrrrrrrrrrraaaaaaaaaaaaaaMMMMMMMMMMMMMMClass B/Class AClass C/ Class BClass D/Class CClass E/Class DSource: Hong Kong government, Barclays Capital 23 November 2010 18
Barclays Capital | Hong Kong Property Developers Figure 25: Price per square foot by location (HK$psf)12,00010,0008,0006,0004,0002,000035678012356780123567808888899999999000000001----------------------crcrrrcrnpnpcnpcrnpcnpeaaeeaeeaeeaeeeeauuuuuJJJJJSSSSDSMDMDMDMDMDMHong Kong IslandNew TerritoriesSource: Hong Kong government, Barclays Capital …supported by high levels of The level of equity in domestic property can be seen by comparing purchase prices on 550sf equity… mid-level units in Kowloon, as a proxy for average market prices, with the current unit sales price and the rate of capital repayment on mortgages, given the average level of mortgage rates over the period. This shows that a property purchaser prior to 2005 now has over 66% of the value of his/her property in equity, which could be used as a deposit on a larger property. Figure 26: Equity in home prices AverageOutstanding Equity as a Purchase 30%Mortgage mortgage ratemortgage CurrentEquity % of current30% depositDate price HK$ DepositHK$ since purchasebalance HK$price HK$HK$ home pricebuysJun-97 3,714,480 1,114,344 2,600,136 % 1,193,852 3,656,455 2,462,603 67% 8,208,675 Jun-98 2,607,660 782,298 1,825,362 % 926,545 3,656,455 2,729,910 75% 9,099,699 Jun-99 2,111,450 633,435 1,478,015 % 808,788 3,656,455 2,847,667 78% 9,492,222 Jun-00 1,755,490 526,647 1,228,843 % 721,265 3,656,455 2,935,190 80% 9,783,967 Jun-01 1,626,075 487,823 1,138,253 % 714,060 3,656,455 2,942,395 80% 9,807,982 Jun-02 1,418,890 425,667 993,223 % 669,493 3,656,455 2,986,962 82% 9,956,538 Jun-03 1,127,775 338,333 789,443 % 569,257 3,656,455 3,087,198 84% 10,290,658 Jun-04 1,700,875 510,263 1,190,613 % 913,464 3,656,455 2,742,991 75% 9,143,304 Jun-05 2,173,270 651,981 1,521,289 % 1,234,993 3,656,455 2,421,462 66% 8,071,541 Jun-06 2,138,895 641,669 1,497,227 % 1,270,082 3,656,455 2,386,373 65% 7,954,576 Jun-07 2,317,480 695,244 1,622,236 % 1,431,444 3,656,455 2,225,011 61% 7,416,704 Jun-08 2,942,940 882,882 2,060,058 % 1,900,537 3,656,455 1,755,918 48% 5,853,060 Jun-09 3,004,540 901,362 2,103,178 % 2,019,607 3,656,455 1,636,848 45% 5,456,161 Source: Hong Kong government, Barclays Capital, Barclays Capital 23 November 2010 19
Barclays Capital | Hong Kong Property Developers Using the historical behavioural duration of mortgages in Hong Kong of 5-7 years, assuming a typical property upgrader bought a 550sq ft property six years ago with a 30% deposit, and took out a 20-year repayment mortgage, and now used the equity built up in the property as a deposit on a 750sq ft flat, then the required mortgage would be less than 55% of the purchase price of the new property. These upgrader-required percentages mortgages are typical in the middle rungs of the housing ladder and, in our view, clearly imply that the recent reductions in LTV ratios will likely only have a marginal effect on upgrader demand. Figure 27: LTV requirements of upgraders 160%140%120%100%80%60%40%20%0%3579135791357988889999900000--------------rrrrrrrrrrrrrraaaaaaaaaaaaaaMMMMMMMMMMMMMMMortgage required from Class B to CMortgage required from Class A to BSource: Hong Kong government, Barclays Capital estimates This demand has been further supplemented by the inflow of mainland equity-funded buyers over the past three years; attracted by the relative political stability, wealth diversification, benign tax structure and cache of having a Hong Kong address. While we suspect that the expansion of bank lending in China may have supported some buying interest in Hong Kong, the trend of mainland buyers is likely to remain a feature of the market, especially as developers are now increasingly focused on marketing their projects in the mainland. …supplemented by cash-rich Many of these buyers appear to be cash buyers, explaining why, since 2008, mortgages ex-mainland money flows… refinancing have for the first time fallen below transaction levels. A revaluation of the RMB, especially a large one-off move, would make Hong Kong property more attractive to mainland buyers by giving them an immediate discount on current prices. Figure 28: Housing transactions and the number of mortgages ex-refinancing (vol)20,00018,00016,00014,00012,00010,0008,0006,0004,0002,000034567890345678900000000100000001----------------llllllllnunununununununuJJJJJJJJaaaaaaaaJJJJJJJJTransactionsMortgages ex-refinancingSource: Hong Kong government, Barclays Capital 23 November 2010 20
Barclays Capital | Hong Kong Property Developers …and investment-driven Although difficult to quantify, investment/speculative flows into property continue to demand… remain strong, in our view. Low deposit rates are positively encouraging the cash rich into the property market, as evidenced by mortgage growth outstripping deposit growth and the high level of transaction volumes, while expected RMB appreciation has encouraged some investors to buy ahead of mainland money flows. Housing inflation is persuading people to pay more for property and encouraging them to hold more than they normally would. Figure 29: Deposit and mortgage loan growth %%%%%%%%3456789012345678999999990000000000-----------------ccccccccccccccccceeeeeeeeeeeeeeeeeDDDDDDDDDDDDDDDDDDepositsMortgagesSource: Hong Kong Monetary Authority, Barclays Capital For the mid-market segment, we expect continued strong demand driven by confidence in an economic recovery, a shift in the nature of demand due to changing demographics, increased household equity built up over the past seven years and investment-driven demand due to low cash rates. This price inflation is also likely to mean that demand spills back into lower priced markets, as sellers of larger units spend their equity and less affluent households search for value-for-money in the mass market. The truly equity-rich and the luxury market In the very top end of the market, we expect property prices to remain dominated by the prospects for cash raisings and the performance of the equity markets: this is largely a cash-driven market despite the cost of properties. Although like all small, equity-driven markets, this is the most sensitive to rapid changes in confidence. However, given the relatively positive outlook for capital flows, we would expect demand for luxury properties to remain strong. 23 November 2010 21
Barclays Capital | Hong Kong Property Developers Demand outlook ..should lead o a period of higher As a result, despite the appearance of stretched affordability, the availability of credit and turnover and rising prices confidence that property prices will continue to rise, should drive strong levels of demand across the housing market. Given the overly simulative nature of Hong Kong’s monetary policy and the availability of credit, we would expect households to increase their exposure to property, which, all else being equal, should lead to a period of high market turnover and rising property prices over the next 18-24 months. Figure 30: Secondary market transactions (volume)20,00018,00016,00014,00012,00010,0008,0006,0004,0002,0000678901234567890678901234567890999900000000001999900000000001------------------------------lllllllllllllllnununununununununununununununuJJJJJJJJJJJJJJJaaaaaaaaaaaaaaaJJJJJJJJJJJJJJJSource: Midland, Barclays Capital 23 November 2010 22
Barclays Capital | Hong Kong Property Developers HOUSING SUPPLY Our forecast completions over the next three years are still relatively low: we estimate private developer completions of 14,923 units in 2010, 13,219 units in 2011, 8,828 units in 2012 and 8,542 units in 2013 In location terms, unsold completions over the next three years are concentrated in the New Territories, which accounts for 66% of total supply. Of the developers, Cheung Kong, NWD and SHKP dominate the supply pipeline for the next three years accounting for 55% of supply. Private supply Private residential supply is Our forecast completions over the next three years are still relatively low. This reflects the forecast to remain low over the government’s high land price policy, the developers’ relatively cautious approach to the next two years… market and the longer development period required as developers have moved their product increasingly up the housing quality ladder in response to upgrader demand. At the start of 2009, we estimate that developers held 10,048 completed and unsold units. During the year we estimate that 7,141 units were completed, with the government releasing 1,392 Home Ownership Scheme (HOS) units for sale and the Housing Society selling 579 units. As a result, total primary unit availability for 2009 was 19,160 units, markedly lower than the 45,000 units supply seen in the 2001-04 period. At the start of 2009, we estimate that 1,234 units that were completed in 2009 had been pre-sold under the 20-month pre-sale rule in 2007 and 2008. We estimate that 4,210 units of inventory were sold over the year, and 3,512 units of projects completing in 2009 were sold. We estimate that the government and Housing Society sold all their units put up for sale and developers pre-sold 6,172 units for completion in 2010 and 393 units forecast for completion in 2011. …inventories at the start of 2010 As a result, we estimate that at the end of 2009, developers’ inventories fell to 8,233 units, were 8,233 units… effectively taking inventories back to their lowest level since the mid-1990s, when inventories typically ran around 3,000-6,000 units. Our estimate is largely consistent with the government’s estimate of 8,000 unsold and completed units at the end of 2009. 23 November 2010 23
Barclays Capital | Hong Kong Property Developers Figure 31: Inventory and forecast housing completions 20092010E 2011E 2012E2013E2014EInventory Completed and unsold units at start of year 10,048 8,233 8,828 19,832 27,274 35,816 Completions Major Projects Completed in Current Fiscal Year 7,141 14,923 13,219 8,252 8,542 8,178 Housing Society 579 374 HOS/PSPS (excluding resale) 1,392 4,077 Total Supply (a) 19,160 27,607 22,047 28,084 35,816 43,994 Sales Inventory sales 4,210 2,270 Sales of units completed in the year 3,512 5,886 Presale 1,234 6,172 2,215 810 - - Housing Society 579 374 HOS/PSPS (excluding resale) 1,392 4,077 Total Demand (b) 10,92718,779 2,215 81000 Year end completed but unsold stock (a-b) 8,233 8,828 19,832 27,274 35,816 43,994 Source: Midland, Centaline, Barclays Capital estimates Forecast completions …we forecast completions to We estimate private developer completions of 14,923 units in 2010, 13,219 units in 2011, average 14,000-units pa over 8,828 units in 2012 and 8,542 units in 2013. Our supply numbers for 2010 compare with the next two years… Centaline’s forecast of 15,691 unit completions, Midland’s forecast of 13,300 and the government’s forecast of 14,300 units. Our 2012 forecast is also likely to underestimate completions, as a number of smaller projects are likely to emerge over the next two years, increasing completion numbers. Our 2010 supply numbers include 4,073 HOS units and 374 Housing Society units that have been sold this year. Post these sales, there are no more units held in inventory for sale by either the Housing Authority or the Housing Society. …year-end 2010 inventories are For the year up to the end of October, there have been around 11,634 primary sales of expected to decline to 7,800-units, which we have identified 11,555 on our project-by-project analysis. Of these sales, 2,270 as pre-sales slowed over 2010… units of inventory have been sold, 6,233 units for projects that have or are expected to complete during the year, and 2,632 units have been pre-sold for completion in 2011 and 2012. Currently, this implies an inventory of 8,828 units, but given two more months of sales, we would expect this number to fall by around another 1,000 units and pre-sales for 2011 to increase to around 3,000 units with the expected launch of Festival City. This would imply a further fall in developers’ inventories to around 7,800 units. Combining our 2010 year-end inventory with our unsold completions for 2011 and 2012 (based upon the 20-month pre-sale rules), primary private units available for sale in 2011 could amount to approximately 25,500 units. On the basis of 2010’s annualised primary sales volume of 13,960 units, 2011’s 20-month potential availability equates to only demand, demonstrating the relatively low supply over the next 12-24 months. …against long-term demand Our model of end-demand for housing, based upon population growth, immigration and there will be an 18,484-unit household formation, suggests an average annual demand of around 15,000 private units. supply deficit… Given that this does not take into account investment flows from the mainland, we would 23 November 2010 24
Barclays Capital | Hong Kong Property Developers estimate that the medium-term market equilibrium supply is around 15,000-20,000 primary units pa. This compares with the annual average of unsold units that are completed or completing in the next three years of just 11,338 units, implying a supply deficit (based upon demand of 17,500 units) of some 18,484 units over the next three years, or over a full year’s current supply. Supply by location and developer In location terms, unsold completions over the next three years are concentrated in the New Territories, which accounts for 66% of total supply. The highest concentration is in New Territories West which accounts for 32% of total supply. This concentration reflects that the MTRC and KCRC have been the main source of large development site land sales over the past four years. The low supply on Hong Kong Island continues, with only 10% of total forecast supply, or the equivalent of approximately 5,000 units. …Cheung Kong, SHKP and NWD Of the developers, Cheung Kong, SHKP and NWD dominate the supply pipeline for the next dominate supply over the next four years accounting for 55% of supply. New World Development (NWD) has been four years particularly aggressive in increasing its land bank over the past 12 months. Sino Land accounts for 7% and Henderson Land 6% of total supply. Kerry and Hang Lung Properties have the largest percentage exposure to the urban markets, while Cheung Kong, Henderson Land and SHKP have the largest exposure to the New Territories markets, reflecting their development volumes. Sino Land and NWD’s exposure is more equally weighted between urban and New Territories markets. Figure 32: Unit supply by developer and location (units) CKH SHKP SinoNWDHendHLKerryOthers Total%HK Central - 15 297 371 307 - 398 2,014 3,431 7%HK East - 80 146 516 12 - 290 185 1,229 2%HK South - 59 4 7 6 - 195 - 118 153 0%HK West - - - - - - 103 166 269 1%HK Island - 154 447 894 325 - 986 2,247 5,082 10%KLN Central 136 - 120 1,832 65 - 103 569 2,825 5%KLN East 50 805 336 387 121 2 969 1,065 3,735 7%KLN West 344 1,038 654 6 49 1,526 - 1,966 5,586 11%Kowloon 531 1,843 1,110 2,224 235 1,528 1,072 3,601 12,146 23%NT Central 1,668 283 63 982 2,408 - - 306 5,710 11%NT East 4,455 1,028 1,952 2,864 318 - - 1,449 12,066 23%NT West 2,339 7,137 6 2,247 80 - 59 4,609 16,482 32%Outlying Islands - - 95 - - - - 357 452 1%New Territories 8,462 8,448 2,116 6,093 2,806 - 59 6,721 34,710 67%Total 8,992 10,445 3,672 9,211 3,366 1,528 2,117 12,569 51,938 100%% of total 17% 20% 7%18%6%3%4%24% 100% Source: Midland, Centaline, company data, Barclays Capital Figure 33: Geographic breakdown CKH SHKP SinoNWDHendHLKerry OthersTotalHK Island 0% 1% 12%10%10%0%47% 18%10%Kowloon 6% 18% 30%24%7%100%51% 29%23%New Territories 94% 81% 58%66%83%0%3% 53%67%Total 100% 100% 100%100%100%100%100% 100%100%Source: Midland, Centaline, company data, Barclays Capital 23 November 2010 25
Barclays Capital | Hong Kong Property Developers GOVERNMENT HOUSING POLICY For Donald Tsang, we believe a major correction in residential property prices at a time when his government is already deeply unpopular would likely prove highly damaging. Hence, the most material change in government housing policy over the past 12 months has been the decision to return to a balanced land supply program based upon expected housing demand. We expect government policy to be focused on increasing longer-term supply and the introduction of some demand measures at the margin, neither of which will significantly curtail prices. Housing policy Housing policy is the greatest Government housing policy is the greatest internal threat to a continued rise in property internal threat to property prices, prices, in our view. However, we suspect the overhang of the Tung administration’s 85,000 in our view… unit policy likely continues to weigh heavily on the government’s decision-making process, and therefore, we believe the current administration is unwilling to take the necessary measures to deflate the housing market. For Donald Tsang, a major correction in residential property prices at a time when his government is already deeply unpopular would likely prove highly damaging. This view is reflected in the nature of administrative measures taken over the past 12 months: 1. Given that banks were already lending at around 40-50% LTV on properties over HK$8mn, reducing mortgage lending from 70% to 60% LTV for properties over HK$8mn, simply moved the HKMA’s lending guidance in line with market practice. 2. The temporary suspension of property as a qualifying investment under the Capital Investment Entrant Scheme (CIES) only affected some % of total turnover for properties with a price over HK$5m (reflecting the HK$ threshold of CIES), and ignored the majority of capital inflows that enter the market outside this scheme. 3. The introduction of a rent-to-buy scheme of only 5,000 units supply to be provided from 2014 onwards is insufficient to materially affect the market and is largely a political attempt to appease those calling for a more significant resumption of the HOS. As a result, we expect government policy to remain focused on increasing land supply and the continued use of minor administrative measures to slow the rate of price growth rather than causing a correction in property prices. Land supply …yet, we expect government The most material change in government housing policy over the past 12 months has been policy to be focused on the decision to return to a balanced land supply program based upon expected housing increasing long-term supply… demand. This is a return to a pre-1997 policy under which the government supplies land based upon a longer-term view of housing needs and, in effect, implies the government will move to some form of regular auction programme for land sales in 2011 should developers not trigger sufficient sites off the application list. The government’s proposed target of an annual supply of 20,000 private units appears consistent with our own forecasts. The government had already signalled its intent to increase land supply at the start of 2010, 23 November 2010 26
Barclays Capital | Hong Kong Property Developers through encouraging faster delivery of land by the MTRC and URA, becoming more accommodative in land conversion, easing restrictions on compulsory purchase and moving to regular land auctions. Changes to the building code to reduce developers’ ability to “inflate” the gross floor area (GFA) have, however, held back supply, it is now unlikely the MTRC will tender before the start of 2011. … we see no significant rise in The revised land application list, excluding this year’s land auctions and adding back sites near-term supply… already identified for inclusion, now contains around 9,000 units. The MTRC has the potential to tender out some 18,176 units over the next two years, especially if the government stipulates size requirements for units. The URA has in the region of 2,138 units of land supply it can tender. Together, this implies a land supply potential of 29,314 units over the next two years or an annual average supply of 14,657 units – not much larger than the current year’s forecast completions. From a location basis over 70% of the available land available for sale is in the New Territories market. While understandable, it implies a continued mismatch between the types of property being supplied and the type of property that equity-rich upgraders want. Figure 34: Possible MTRC tenders in 2010/11 Station Location (sqf)(x) (sqf) GFA Size (sqf) units Nam Cheong Sham Shui Po 497,292 3,262,236 3,262,613 750 4,350 Yuen Long Yuen Long 373,507 1,467,883 1,467,787 750 1,957 The Lohas Park Phase 4 Tseung Kwan O 145,202 1,379,419 1,379,421 750 1,839 Tai Wai Station Tai Wai 522,049 2,051,653 2,050,308 750 2,734 Tin Shui Wai Tin Shui Wai 374,584 1,809,241 1,810,000 750 2,413 Tsuen Wan West Station (TW5) Tsuen Wan 602,778 2,429,195 2,430,000 750 3,240 Tsuen Wan West Station (TW6) Tsuen Wan 149,618 691,235 691,500 750 922 Long Ping (North) Yuen Long 120,556 540,091 540,250 750 720 Total 18,176 Source: MTRC, Barclays Capital Figure 35: Possible URA tenders in 2010/11 GFA Residential Commercial G/IC No of Street Location District (sqf) GFA GFA GFA units Hai Tan Street / Kweilin Street and Pei Ho Street Sham Shui Po Kowloon 720,757 590,190 106,887 23,681 984 Yu Lok Lane / Centre Street Western Hong Kong 186,432 183,795 2,637 306 Fuk Tsun Street / Pine Street Tai Kok Tsui Kowloon 51,926 43,271 8,654 72 Sai Yee Street Tai Kok Tsui Kowloon 238,799 150,093 88,706 250 Chi Kiang Street / Ha Heung Road Ma Tau Kok Kowloon 89,901 74,917 14,983 125 Peel Street / Graham Street Central Hong Kong 738,626 240,683 497,943 401 Total 1,282,950 2,138 Source: URA, Barclays Capital We suspect the government will continue to prove accommodative in agreeing lease modifications; there has been an increase in the number of modifications agreed year-to-date. The advantage of this route for the government is that it is less transparent and therefore land transactions can be agreed ‘off-market’. It is also a method of land acquisition preferred by the major developers, who are able to determine the timing of their land acquisition through direct negotiations with the government. 23 November 2010 27
Barclays Capital | Hong Kong Property Developers …as the government takes a Yet, supply is effectively fixed in the short term, and increases in land sales will unlikely have a cautious approach to increasing material impact on the current market, in our view. The government, consistent with its current land supply… desire not to cause a correction in private prices, is clearly taking a cautious approach to expanding the supply side of the market and, therefore, it is likely to take some time to reach its 20,000 units pa target. In addition, given the large size of sites being offered for sale on the application list and via the MTRC/URA, control over supply still remains in the hands of large developers, unless the government is prepared to materially drop its land prices or change the land premium payment system from being up-front to a staged payment system. …although Kai Tak offers the That said however, we are of the view that if price increases continue and house prices are potential for a large-scale multi-up 10-15% by mid-2011, then the government will be compelled to make a more public year supply… demonstration of its commitment to increase housing supply. One potential could be the release of Kai Tak, the old airport site, for a mass residential development of around 30,000 units to be provided via some form of public/private joint venture, the Financial Secretary has already highlighted the potential of Kai Tak to provide long-term supply. Other measures A further risk we see to the property market is that the government bows to political pressure and re-starts the HOS development, with the prospect of a material increase in end-supply. Although, this would still take five years to materialise in the form of completed units, it would likely be disruptive to the private market and confuse the outlook for future supply. We think such a move is unlikely, and the government will continue to stick with its limited buy-to-rent scheme. On the demand side, the government could further reduce LTV ratios for mortgages or further increase its holding tax, but increasingly these measures would start to impact genuine homebuyers and become increasingly politically sensitive, given the government’s stance to ensure property is affordable for first-time buyers. The alternative is to try to limit the hoarding of property and, therefore, mortgage borrowing to a single mortgage per person. However, given the negative nature of Hong Kong’s credit database, the information available to achieve this is limited. As a result, while we would expect small administrative measures aimed at curbing demand at the margin over the next 12 months, policy will largely be concentrated on supply-side measures, in our view. Politics …a new Chief Executive in 2012 We would highlight that the current Hong Kong Chief Executive’s tenure comes to an end in could create some uncertainty mid-2012 and this could lead to some potential change in the political environment. The around housing policy risk is that either the current Chief Executive would like to leave office with a large scale run-off project, such as Kai Tak airport redevelopment, or the in-coming Chief Executive would feel compelled to act on rising property prices. We are reluctant to draw too much parallel with 1997 handover period, but we think investors should expect increased uncertainty around property policy from a change in Chief Executive. For the moment however, we expect government policy to be focused on increasing longer-term supply and the introduction of some policy measures at the margin, neither of which we think will significantly curtail near-term demand. Ironically, we believe the government’s fiscal spending on its ten large infrastructure projects over the next 12-24 months will actually further stimulate the very housing demand its current housing policies are trying to dampen. 23 November 2010 28
Barclays Capital | Hong Kong Property Developers Figure 36: demand and supply Growth & Population Projection 2001 200220032004200520062007200820092010E2011E2012E2013E2014EPopulation 6,714,300 6,744,100 6,730,800 6,783,500 6,813,200 6,857,100 6,916,300 6,975,100 7,034,100 7,094,000 7,153,500 7,213,000 7,273,000 7,332,400 Population growth % %%%%%%%%%%%%% Natural Population Registered Births 53,233 47,151 48,815 46,084 53,966 60,30069,30068,80068,60068,60068,90069,40070,20071,100(%)%%%%%%%%%%%%%%Registered Deaths 32,441 34,177 35,936 36,618 38,726 36,90041,20042,00042,80043,70044,60045,50046,30047,200(%)%%%%%%%%%%%%%%Net Increase 20,792 12,974 12,879 9,466 15,240 23,400 28,100 26,800 25,800 24,900 24,300 23,900 23,900 23,900 % Natural Population Growth % %%%%%%%%%%%%% Migration Foreign population 526,510 529,870 523,880 524,200 517,560 517,300 534,427 551,329 Net Migration 13,310 3,360 (5,990)320 (6,640)(260)17,127 16,902 Immigrants from China 53,655 45,234 53,502 38,072 55,106 59,600 44,700 39,100 HK Residents -38,457 -31,768 -73,691 4,842 -34,006-38,840-30,727-24,002 Net Migration 28,508 16,826 -26,179 43,234 14,460 20,500 31,100 32,000 33,200 35,000 35,200 35,600 36,100 35,500 % Migration Population Growth % %%%%%%%%%%%%% Total Population Increase 49,300 29,800 -13,300 52,700 29,700 43,900 59,200 58,800 59,000 59,900 59,500 59,500 60,000 59,400 % Increase % %%%%%%%%%%%%% No of Domestic Households 2,055,900 2,101,700 2,121,200 2,162,000 2,196,400 2,216,500 2,235,400 2,271,900 2,303,500 2,335,473 2,364,793 2,394,357 2,424,333 2,454,360 Household Sizes % change in size of households % %%%%%%%%%%%%% YoY Household Growth % % %%%%%%%%%%%%% Total No of New Units Required 29,000 45,800 19,500 40,800 34,400 20,100 18,900 36,500 31,600 31,973 29,320 29,563 29,976 30,026 Public rental 49,386 20,154 11,605 20,947 24,691 4,430 4,795 22,759 19,021 1370013,900 14,000 14,400 18,800 Subsidised for sale 22,862 12,810 4,513 320 --2,010 2,200 370 Private housing 23,986 32,746 27,197 26,036 17,321 16,579 10,471 8,776 7,157 14,923 13,219 8,252 8,542 8,178 Total96,23465,71043,31547,30342,01221,00917,27633,73526,54828,62327,11922,25222,94226,978 Balance of supply 67,234 19,91023,8156,5037,612909-1,624-2,765-5,052-3,350-2,201-7,311-7,034-3,048Source: Hong Kong government, HKHA, Barclays estimates 23 November 2010 29
Barclays Capital | Hong Kong Property Developers PROPERTY PRICES We expect property prices to overshoot, with the current momentum running for another 18-24 months. We forecast property prices will increase 10-15% in 2011 and 10-15% in 2012. The best performance will likely come from those properties in more equity-rich sectors of the market: those in the upper rungs of the housing ladder. In the near term, increasing Chinese interest rates could impact the market, but in the longer term, US interest rates increases, given increasing mortgage borrowing, remains the largest and most obvious risk to the market, in our view. Price forecasts We expect property prices to Our thesis is to expect a property price overshoot: Low housing supply, a government overshoot… unwilling to deflate home prices, an overly easy monetary environment, increasing consumer confidence and investment-driven demand all point to this. The current momentum in end-prices could run for another 18-24 months, until we see the impact of an increased supply from developers pre-selling projects, higher mortgage rates on increasingly stretched affordability and higher mortgage debt. This property cycle has been typified by a polarisation in performance between locations, property sizes and between generations. Price growth has been concentrated in the equity-rich sectors and areas of strong income growth and constrained supply. We expect this division between the equity-haves – including mainland buyers and investors/speculators – and the equity have-nots, to continue over the next 18-24 months. Our expectation is that the better-quality properties, in heavily dominated equity-driven markets, will continue to show the strongest growth fuelled by increasing borrowing. …with the best growth In location terms, we expect the urban markets to outperform the New Territories, Hong continuing to come in the equity-Kong to out perform Kowloon, and across the market, we expect larger property prices to rich areas of the market… out perform those of smaller properties. Our expectation is that secondary property price growth will range from 10% at the lower equity-poor end of the market, to 15% at the very top-end of the market over 2011. For 2012, we expect prices to continue to go up with a further 10-15% increase from top to bottom of the market. This however assumes limited increase in interest rates over the 1H12. The longer interest rates remain low and household confidence remains strong, the greater the prospect of a significant misallocation of capital into property and a material overshoot in end prices. …by end 2012, we expect the As we reach 2H12, the prospect of rising interest rates, stretched affordability, a change in market to be highly vulnerable to the political environment with a new Chief Executive and the prospect of potentially interest-rate movements increased supply, there is an increased risk of a price correction. By the end of 2012, assuming no change in mortgage rates and a 3% pa growth in household incomes, affordability will be at a 48% of household income and the price-to-income ratio will be against the 1997 peak of affordability at 87%, and the house price-to-earnings ratio at . At this stage the market would be highly vulnerable to interest rate increases. Our 0% growth for 2013 is interest rate-dependent, but given that Hong Kong property prices are highly volatile, this will likely prove a conservative assumption one way or another. 23 November 2010 30
Barclays Capital | Hong Kong Property Developers Figure 37: Affordability and price-to-household income ratios (%)(x)100141280106086404202004567890123456789012345678901288888899999999990000000000111-----------------------------rrrrrrrrrrrrrrrrrrrrrrrrrrrrraaaaaaaaaaaaaaaaaaaaaaaaaaaaaMMMMMMMMMMMMMMMMMMMMMMMMMMMMMAffordability ratioPrice to Earnings ratioSource: Barclays Capital Figure 38: Summary of affordability forecasts 2011E2012E 1997 peakHousehold income growth %% %Mortgage rates %% %Affordability ratio 43%48% 87%Price-to-income ratio : Barclays Capital estimates Figure 39: Household income sensitivity table to interest rates at end-2012, based upon our forecasts Household Income Growth Rate (Annual Rate) -15% -10% -5% 0% 5% 10% 15% 20% % 51 49 46 44 42 40 38 36 % 54 51 48 46 44 42 40 38 Mortgage % 57 54 51 48 46 44 42 40 rate % 60 56 53 51 48 46 44 42 % 63 59 56 53 51 48 46 44 % 65 62 59 56 53 51 48 46 % 69 65 61 58 55 53 51 49 % 72 68 64 61 58 55 53 51 % 75 71 67 64 61 58 55 53 % 78 74 70 66 63 60 58 55 % 82 77 73 69 66 63 60 58 % 85 80 76 72 69 66 63 60 Source: Barclays Capital estimates 23 November 2010 31
Barclays Capital | Hong Kong Property Developers Risks to our price forecasts The risks to our price forecasts are fourfold: 1. Government policy changes: The government becomes more interventionist in the market, by focusing measures on the demand side of the market and further reducing affordability or access to credit. 2. Significant correction in China’s economic growth: Rising inflation causes the Chinese government to raise interest rates significantly, slowing growth and negatively affecting confidence, causing a pull back in demand and outflow of capital from China. 3. US interest rates rise faster than expected: This could cause a negative impact on market affordability and changing buyer perception with regard to future home price increases. 4. HIBOR spikes: Given the increasing dominance of HIBOR as the reference rate for mortgages, a spike in HIBOR caused by some concern over the US-dollar peg would negatively affect the market, in our view. While most borrowers have also negotiated a cap in terms of a prime-minus-mortgage collar, with banks effectively acting as if they are HIBOR-funded, a material jump in HIBOR would also mean a material jump in prime and a significant rise in mortgage costs. Interest rates remain the biggest Given the political risks associated with a correction in the property market, we think the risk – China in the near term and risk of government intervention is limited to slowing growth, rather than causing a market the US in the longer term correction. Hence, the real risk to the market remains a change in an external factor that affects homebuyers’ affordability and confidence in rising prices, which, for the moment, appears to rest with a significant slow down in China’s economic growth or with increasing US interest rates. The more immediate risk for the market comes from China, in our view. Rising inflation could prelude a significant upward increase in interest rates (not our economists view) to encourage people to save rather than spend. This could affect fund flows, encouraging mainland buyers to remain in a higher yielding and potentially appreciating RMB, rather than allocating capital to Hong Kong property. Second, rising rates could negatively impact equity market returns having a negative affect on investment sentiment and slowing domestic capital flows into property. For the moment, this is not our central view, but we think it remains a concern investors should be mindful of. The longer-term risk for the market, however, continues to rest with US interests. While the rise in mortgage lending over the past three years reflects the increased market turnover and rise in property prices, little equity extraction on refinancing and a significant principle repayment rate on the mortgage book has meant that HK$250-300bn has been lent on property over the past three years, at a time when only 33,000 new homes have been added to the housing stock. Increased mortgage borrowing With investment-driven demand and the availability of credit increasingly dominating the makes US interest rates the market, we would expect borrowing levels to increase over 2011-12. First-time buyers will largest and most obvious risk… likely need to increasingly tap the MIP to fund deposits, upgraders will need further debt top-up to bridge the widening housing ladder and investors will likely gear up on low, available debt encouraged by the prospect of making a profit on the back of someone else’s money. 23 November 2010 32
Barclays Capital | Hong Kong Property Developers Hidden supply This is not to say outside those taking mortgages through the MIP, LTV on mortgages are likely to materially rise over their current 60% average level. However, it does highlight that property buyers will be increasingly debt funded and therefore more sensitive to interest rates the longer this cycle continues. Hence, our biggest concern is that the market will simply become more vulnerable to an interest rate up-cycle and we think by 2H12, this will be the biggest (and most obvious risk) to a potential correction in property prices. …a turn in the cycle will see the With regards to a potential property price correction, we think investors should be mindful release of hidden supply and the of the volatile nature of Hong Kong property prices, which in part reflects the small, equity-removal of rental support driven nature of the market. Given the sensitivity to changes in demand and the desire to hoard property into an investment driven up-cycle, there is always a ‘hidden’ element of off-market supply held by investors, which in this cycle is likely to be exacerbated by low holding costs. In April, the government announced a % vacancy rate for properties over 1,100sq ft, evidence, in our view, of the investment demand in this market. Yet, deflating mortgage costs by capital appreciation shows the incentive for investors to continue to hold properties vacant for the ease of future sale (there is typically a 10% sales price discount for a tenanted property). While we see no reason for this stock to return to the market in the near term, once the cycle turns, supply will likely come back to the market, removing the perception of low supply and rental yield support for prices. Figure 40: Hong Kong rents and prices %50%Correlation = %%40%%30%%20%%10%%0%%-10%%%-20%345678901234567890123456789888888899999999990000000000Prices change YoYRents change YoYSource: Midland Realty, Barclays estimates 23 November 2010 33
Barclays Capital | Hong Kong Property Developers IMPLICATIONS FOR DEVELOPERS From a risk/return perspective investors should focus on those developers who are best placed to benefit from the strength in end-prices and are able to capture the high returns on invested capital. This requires a business model focussed on a faster ‘asset-turn’ sales approach, shorter-duration urban land banks and an opportunistic land-acquisition strategy. We prefer Kerry, SHKP and Sino Land. Development margins The 20% increase in property prices over 2010, the 15-20% increase we forecast for 2011 and the 10-15% we forecast for next year, should mean developers’ benefit from a margin expansion over 2011-12. This can be demonstrated by a simple model of development margins, under which land costs are based upon prevailing prices at the time of land purchase, a HIBOR cost of borrowing, a fixed cost construction contract over an average 30-month build period and a pre-sale of the project six months ahead of completion. Figure 41: Developers’ margins 80%60%40%20%0%-20%-40%-60%Source: Barclays Capital Margins on developments We expect development margins to expand from their mid-30% average in 2009 to close to should continue to expand, 45-50% over the next 12-18 months. As a result of this margin expansion, developers’ return supporting narrow NAV on capital should increase from the 12-15% achieved in 2009, to 22-26% or over twice their discounts… cost of capital in 2010-11, which implies that NAVs for these projects should be around 2x their book cost and that NAV discounts should be narrower than their long-term averages. This will, however, require those developers that bought land this year, who had assumed a 20% GFA increase, to gain building plan approval prior to the 1 April 2011 deadline. Those that do not meet the deadline will be provided with only a 10% increase in GFA, negatively impacting development margins. 23 November 2010 34 3Q941Q953Q951Q963Q961Q973Q971Q983Q981Q993Q991Q003Q001Q013Q011Q023Q021Q033Q031Q043Q041Q053Q051Q063Q061Q073Q071Q083Q081Q093Q091Q103Q101Q113Q11
Barclays Capital | Hong Kong Property Developers Faster sales Given our view of a potential overshoot in prices, followed by the increased risk of a correction, we think from a risk/return perspective that investors should focus on those developers who are best placed to benefit from the near-term strength in end-prices. Among the developers we favour – HLP, Kerry, Sino Land and SHKP – who have a more premium positioning and can appeal to the more equity-rich buyers. …with a focus on developers However, we think investors should look for developers who shift their current sales with a faster asset-turn sales strategy to reflect a faster ‘asset turn’ approach, which would limit developer’s risk to a price model…. correction and allow a faster recycling of capital. Rather than holding inventory back from the market to smooth earnings, investors should look for developers who sell down stock to capture the current excess returns in the market and shift from sales on completion to a faster pre-sale approach. A faster ‘asset-turn’ approach is arguably easier to implement for those developers that have a reasonable level of development completions over the next three years and are therefore less constrained in trying to manage earnings through inventory sales. As evident from our supply analysis, pre-sales slowed this year compared with last year, but that was in part reflection to the government’s changes in the property sales rules. Among the developers those who are more recently pro-active in pre-selling or looking to pre-sell are Cheung Kong, SHKP and Sino Land. Shorter-duration land banks …and shorter- duration land This differentiation in amount of near-term land bank is, in our view, likely to prove to be a banks… key determinant in developers’ ability to ‘ride the cycle’ and should be a focus for investors. In effect, at this stage of the property cycle, with the prospect of an overshoot in prices followed by increasing supply and declining affordability at the margin, we think investors should prefer developers with shorter-duration land banks and, where possible, those with higher urban land banks that will benefit from the stronger equity-rich buying demand. As our supply forecasts demonstrate, developers have over the past 6-years reduced the size of their Hong Kong land banks. A combination of land bank ‘right-sizing’ in response to lower demand, the government’s high land price policy and the alternative use of capital in China has meant developers had little incentive to buy land. Hence, many developers simply ran down their land banks, pushing back completions in order to smooth earnings. Based upon our current estimates, developers have around 34mn sq ft of paid-up and unsold residential land bank in Hong Kong for completion over the next four to five years. The scale of this land bank has increased significantly since 4Q09, as developers have spent HK$97bn on acquiring sq ft GFA of development land. The extent of this recent purchasing is a reflection, in our view, of the extent to which developers had run down their land banks and their desire to ‘ride the cycle’. 23 November 2010 35
Barclays Capital | Hong Kong Property Developers Figure 42: Major land purchases since 4Q09 Date Site Premium (HK$m) Sale GFA Developers Oct-09 Wu Kai Sha 9,600 Land conversion 2,850,000 HL/NWD Dec-09 Tai Tong Road 2,857 Land conversion 1,175,503 NWD Dec-09 Tai Po sites 10,400 Auction 1,441,514 Sino Land/K Wah Jan-10 Yuen Long DD507 2,300 Land Conversion 2,319,000 SHKP Feb-10 Lai Chi Kok Road 1,600 Tender 324,000 Cheung Kong Feb-10 Tseung Kwan O site 3,370 Auction 728,185 SHKP Feb-10 Lok Wo Sha, Ma On Shan 9,596 Land Exchange 2,950,000 HL/NWD Mar-10 Austin Station 11,700 Tender1,280,000NWD/Wheelock/MTRC Mar-10 Castle Peak Road, Yuen Long 7,102 Land Exchange 2,319,000 SHKP Apr-10 Shap Pat Heung, Yuen Long 2,334 Land Exchange 1,301,000 HL/NWD May-10 Area 55B, Tung Cheung 3,420 Auction 26,200 Nam Fung May-10 Area 19 Fanling 1,330 Auction 8,900 HK Ferry Jun-10 Ho Man Tin, Kowloon 10,900 Auction 16,151 SHKP Jul-10 Mount Nicholson Road, The Peak 10,400 Auction 23,312 Nam Fung/Wharf Aug-10 204 Argyle Street, Kowloon 4,100 Auction 7,326 Cheung Kong Aug-10 Hung Hom Bay Reclamation Site D1 3,510 Auction 7,551 Cheung Kong Aug-10 1 Ede Road, Kowloon Tong 1,285 Auction 2,399 Kerry Properties Oct-10 3-5 Ede Road, Kowloon Tong 1,630 Auction 2,808 Chinachem Total 97,434 16,782,849 Source: Barclays Capital Based upon developers’ inventory and unsold completion forecasts, we estimate that developers have 54% of their land bank effectively available for sale in the next two years. However, among the developers there is a wide variance in land bank duration. …a model that favours HLP, HLP, given its inventory of residential urban properties, has the shortest-duration land bank, SHKP, Sino Land and Kerry while Kerry Properties has less than 10% of its land bank for completion beyond 2012, with Properties… a strong urban weighting among its developments. Cheung Kong has 34% of its land bank completing beyond 2012, followed by SHKP at 43% and Sino at 48%. For Henderson (59%) and NWD (86%), much of their land bank is weighted towards completion in 2013-14 and is therefore more exposed to the potential for a correction in end-prices prior to their ability to pre-sell. Hence, we consider these developers as less well placed to ride the cycle at the current time. We disagree with the view to overweight developers with large agricultural land banks on the basis that these developers will enjoy better pricing and access to land that would allow for NAV increases when land is acquired. We view this strategy as more risky, not only due to the likely increased capital commitment to longer duration land banks, but also due to the fact that the majority of land acquisition will be in the higher supplied New Territories market. If the government does stipulate maximum unit sizes in its land sales, then there could be a high supply of units at the bottom end of the market within three years – in a segment of the market less supported by demographics and due to a focus on affordability, more sensitive to interest rate changes. Given our belief that US interest rates are the biggest current risk to end-prices, we view these longer duration land banks as an investment on continued low US rates. Should US rates stay low for longer than we assume, then investors should simply rotate between developers’ stocks as the duration of their land bank falls. Given the choices in the sector, we see no reason for investors to assume longer duration US interest rate risk in their stock holdings at the current time. 23 November 2010 36
Barclays Capital | Hong Kong Property Developers Figure 43: Developers’ land banks Cheung Hang Lung Hang Lung SHKP Sino Land HendersonKongNew WorldProperties GroupKerry (sq ft) 16 HK 83 HK 12 HK1 HK17 HK101 HK 10 HK683 HKGFA in inventory 289,638 173,458 683,954 4,488 135,963 1,506,271 1,506,271 75,711 2010 completion 1,641,181 196,323 353,531 237,530 250,956 - - 384,204 2011 completion 1,770,642 915,057 3,188,487 91,988 - - 1,075,044 2012 completion 2,610,000 744,715 504,196 1,383,573 196,465 - - 253,120 Beyond 2012 completion 4,872,000 1,931,921 2,215,762 2,485,246 4,246,752 86,166 86,166 199,469 Total 11,183,461 3,961,474 3,757,442 7,299,324 4,922,124 1,592,437 1,592,437 1,987,548 % completed by 2012 56% 51% 41%66%14%95% 95%90%Source: Barclays Capital Selective land acquisition …developers should not stop This is not to say that we think developers should stop buying land. The level of supply from the buying land, but be selective in current implied land bank of developers is still relatively low. Based upon a year holding their acquisitions… period, (reflecting construction time plus an element of stock-on-hand), current developers’ land bank amounts to an average sq ft GFA pa or 10,281-units pa assuming 750sq ft per unit, and is still relatively low against our 15-17,500 equilibrium supply expectations. However, we think investors should focus on those developers who are likely to adopt an opportunistic land purchasing strategy focused on risk management. This, in our view, would imply a focus on smaller, prime sites on Hong Kong Island where supply is limited and on MTRC development opportunities, where the JV agreement reflected a balanced level of risk sharing. We would also prefer land auction acquisitions over agricultural land conversions because we think the auction market will re-price land faster under the 10% GFA inflation rule than the government will be prepared to accept in its lease modification negotiations. …MTRC and urban sites are In our view, the downside risk to MTRC projects is likely to be lower, given the supporting preferred… infrastructure and because the construction period is typically shorter, as the enabling works/foundations are already completed, reducing the lead time to pre-selling. If the MTRC, as it has done on recent developments, is prepared to pay half the land premium for a higher development profit share, then the level of risk for developers could be further reduced. Developers are, of course, no longer constrained to the Hong Kong market, with most of the developers having China operations, they increasingly have the option to allocate capital to the mainland if they consider the risk/return trade-off to be more attractive. …we disagree with As a result, developers that are focused on a faster ‘asset-turn’ sales approach, which have accumulating those developers shorter-duration urban land banks, a premium-end product mix and are likely to employ an that are materially extending opportunistic land-acquisition strategy – Hang Lung, Kerry, SHKP and Sino Land – are our their land bank preferred choices. We believe these developers are currently best placed to capture the near-term high returns and manage the risk associated with the volatile nature of the Hong Kong property market. Figure 44: How the developers weigh in on our preferred business model Short duration Premium Urban Active Developer land bank Brand Area pre-selling Cheung Kong YES YES Henderson Land HLP/HLG YES YES YESKerry YES YES YESNWD SHKP YES YESYES Sino Land YES YES YES YES Source: Barclays Capital estimates 23 November 2010 37
Barclays Capital | Hong Kong Property Developers VALUATIONS Our top picks in the sector from a valuation perspective are Kerry Properties, Sino Land and SHKP. Our 3-Underweight rating on HLP reflects the high expectations priced into the stock for its China strategy and that investors have largely ignored its potential LAT liabilities. We would not chase deeper discounted stocks, especially towards the top of the cycle, because we consider that investors are not adequately rewarded for taking on structural risk associated with corporate governance concerns and management’s ability to deliver value. From a trading perspective, we expect stocks to remain correlated with the US dollar, as a reflection of potential higher US interest rates and investor sentiment. Net asset values Hong Kong property developments: In arriving at our NAVs we use a discounted cash flow (DCF) approach, incorporating our forecast residential price increases of 15-20% this year, 10-15% in 2011 and 10-15% in 2012, to value developers’ Hong Kong property developments. For agricultural land, we assume a HK$450 psf value, given the increased potential to convert to residential use. We assume our residential price China property developments: Our values for China property developers are also based forecasts in our NAV estimates… upon a DCF approach and assume average price increase of 8% in 2010, 5% growth in 2011 and 2012. We only include sites in our DCF valuation that commence within the next three years and are clearly detailed by the company. We assume that all other sites are in effect strategic options and value these based upon current land values. Commercial property developments: For commercial property, we base our valuations off spot rents rather than passing rents. Our cap rates are in the range of 4-5% in Hong Kong and -12% in China. We include marketable securities at their last disclosed market value and unlisted securities at book value. We include listed subsidiaries and associates at their marked to market prices. In including listed subsidiaries at market prices, we deduct their cash, debt and marketable securities from the consolidated balance sheet values included in our NAV. 23 November 2010 38
Barclays Capital | Hong Kong Property Developers Figure 45: 2011E NAV breakdown Hang Lung SHKP Sino Land Henderson Cheung Kong New World Properties Hang Lung GroupKerry Ticker 16 HK 83 HK 12 HK 1 HK 17 HK 101 HK 10 HK 683 HK Per share Per share Per share Per share Per share Per share Per share Per share (HK$ mn) (HK$) (HK$ mn)(HK$)(HK$ mn)(HK$)(HK$ mn)(HK$)(HK$ mn) (HK$)(HK$ mn)(HK$)(HK$ mn)(HK$)(HK$ mn)(HK$)Development properties Hong Kong & Overseas 90,504 32, 37, 54, 37,010 20, 10, 27, China 7,939 17, 3, 17, - - 10, 5, 23, Land bank 57,550 - - 28, 24, 2,201 - - - - - - Investment properties Hong Kong & Overseas 225,636 56, 72, 47, 22,100 65, 34, 36, China 30,098 2, - - - - - - 29, 20, 15, Hotel 25,983 5, - - 15, 17,681 - - - - 2, Listed associates/subsidiaries 8,945 - - 52, 191, 38,254 - - - - Other assets 13,739 1, 10, 5,515 - - - - 2, Gross asset value (GAV) 460,395 116, 194, 361, 122,760 125, 70, 108, Net debt -42,676 -8, 3, -19,689 22, 5, -7, Other liabilities - - - - - - - - - - - - - - -1, Net asset value (NAV) 417,719 108, 198, 360, 103,071 148, 75, 100, No. of fully diluted shares (mn) 2,570 5,206 2,579 2,316 3,918 4,499 1, 1,480 NAV per share Source: Barclays Capital estimates 23 November 2010 39
Barclays Capital | Hong Kong Property Developers Land appreciation tax (LAT) in China LAT on commercial properties Compared with mainland residential developers’ build-and-sale business model, Land has been largely ignored… Appreciation Tax (LAT) on commercial property has received little discussion. However, with more Hong Kong companies building commercial portfolios in the mainland it is becoming a more material issue in our view. LAT on commercial properties remains a somewhat confused picture, as in practice, LAT actually paid is negotiable between the transaction parties and local taxation bureau. In theory however, LAT, should be calculated and levied according to the accumulative tax rate based on the amount of capital gain. To date, LAT appears to have been creating a two-tier commercial property market on the mainland. …however, it is creating a two-Part of the problem appears to rest with the way property is transacted. There are two tier investment market in approaches: China… Approach #1: Sell the company that owns the property (often an offshore entity although now a wholly owned foreign entity), as no property transaction is recorded this does not trigger an LAT assessment. However, buyers of these companies assume the whole LAT liability and want to get compensated for taking on this risk. Hence the transacted price tends to be lower than the current market value of the property to reflect the risk. Approach #2: This approach, which is required by the large institutional investors, such as insurance companies, is to buy the physical property itself. This of course triggers an LAT liability for the seller, but in return for setting a new floor for LAT assessment, the buyer is prepared to compensate the seller by paying full market price for the property. Given the way we expect the commercial property market in China to develop, we believe that trading the actual property (approach #2) will become increasingly the approach for good quality properties, while those of secondary quality will typically be traded via a mix of the two approaches depending upon how long China’s State Administration of Taxation (SAT) allows the dual approach to continue. …and SAT is becoming more In this regard, we have seen China’s SAT become more stringent in LAT settlement. On stringent in LAT settlements… 10 December 2009, SAT issued Circular 698 “Strengthening of administration of corporate income tax liability on income of non-resident enterprises from transfer of equity interest” that effectively required off-shore sellers in low-tax jurisdictions to submit all relevant transaction data to the Chinese tax authorities, who, if they deemed, the tax to be an attempt to avoid payment, could render the structure invalid and liable to on-shore tax payment. In May 2010, SAT further released circular 220 to better enforce the settlement of LAT. Currently, there is no disclosure by companies of their potential LAT liabilities on commercial properties, as for example, there is with UK property companies and capital gains tax. For now, any potential LAT liability is captured on the profit and loss account as a corporate tax charge against the revaluation gains/loss of the investment portfolio, but not included in analysts NAV assessments. …we are already seeing However, we have already seen evidence of LAT charges appearing on company accounts, evidence of the impact of LAT in where properties have been transacted. SOHO China, whose recent LAT payments have been developers’ accounts… high, acquired secondary property via a company purchase, and were later charged the full outstanding LAT on the properties. SHKP has a significant HK$990mn provision for LAT in the tax notes to its 2009/10 accounts arising from the sale of 22 floors to HSBC in its Shanghai IFC. 23 November 2010 40
Barclays Capital | Hong Kong Property Developers Given that we include mainland commercial properties in our NAV at full market price, we should evidently be also reflecting the tax liability associated with the gains on those properties. LAT is clearly a liability that will be reflected in either a tax charge or a lower than current assumed value in our NAV. Regardless of whether it is the company’s intention to sell the properties or not, it is a liability that investors should not, in our view, continue to ignore. We calculate LAT as defined in State council circular 138 by the three steps detailed below: Figure 46: LAT calculation Step1 Calculate the appreciation amount Deductible amount = Sum (Land cost, construction cost, interest cost, business tax etc, soft cost (about 5% of land and construction cost), another 20% of land and construction cost) Appreciation amount = Sales proceeds – deductable amount Step2 Calculation appreciation ratio Appreciation ratio = Value added / Deductable amount Step 3 Calculate the LAT Applicable tax rate = Level Tax base Tax rates 1 That part of the appreciation amount not exceeding 50% of the sum of deductible items 30% 2 That part of the appreciation amount exceeding 50%, but not exceeding 100%, of the sum of deductible items 40% 3 That part of the appreciation amount exceeding 100% , but not exceeding 200%, of the sum of deductible items 50% 4 That part of the appreciation amount exceeding 200% of the sum of deductible items 60% LAT= Σ (Part of appreciation ×Applicable rate) Source: State Administration of Taxation, Barclays Capital estimates Across the companies in our coverage universe and based upon our assessment of their book value for LAT purposes, we estimate the following LAT liabilities. They are particularly high for those that acquired property in the early 2000s, due to the rapid price appreciation. The largest impact is on Hang Lung Properties, where we estimate that the LAT liability could account for as much as , or 7% of its end-2011E NAV estimate. Figure 47: LAT impact Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew WorldProperties GroupKerry (HK$ per share) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HK2011E NAV without LAT impact LAT liabilities for Investment properties 2011E NAV with LAT impact Difference % -1% 0%-1%0%-1%-7% -7%-7%Source: State Administration of Taxation, Barclays Capital estimates 23 November 2010 41
Barclays Capital | Hong Kong Property Developers …investors need to bear in mind For the moment, we base our valuations on a pre-LAT liability basis, as this remains industry the inherent LAT liabilities in practice. However, we think investors should bear in mind the potential tax liabilities developers’ NAVs inherent in investing in mainland commercial property. NAV discounts We use three separate approaches to determine the appropriate discounts/premiums to NAV for each of the stocks: 1. Historical NAV discount 2. Sum-of-the-parts (SOTP) NAV discount 3. Forward-looking NAV discount (ROIC-WACC spread approach) Historical NAV discount We consider a property company’s discount to NAV to be partly determined by the rate of growth of its property portfolio. The relationship between the change in the property portfolio value and the NAV discount can be seen by comparing the property developer sector discount against changes in residential property prices, as a proxy for changes in the property portfolio value, over the past 15 years. Figure 48: Sector NAV discount and Hong Kong residential price movements 30%25%20%20%15%10%10%0%5%-10%0%-20%-5%-30%-10%-40%-15%Sector Average Discount = 12%-50%-20%-60%-25%95969798990001020304050607080910Sector discount to NAV (LHS)Property price index 3MMA QoQ (RHS)Source: Centaline, Barclays Capital Developers’ average historical discounts to NAVs are consistent with price increases of 5-10% pa. Given our forecast of 15% average rental growth for the next two years, we would expect developers to be trading at a narrower than historical average NAV discount. As a result, we set our assumed NAV discounts to our one-year forward NAVs at + . to each company’s long-term average discount, except for Sino Land, which is adjusted for its narrowed NAV discount since 2003. Adopting these historical-based NAV discounts implies upside of around 26% for Henderson Land to downside of 7% for Hang Lung Properties. 23 November 2010 42
Barclays Capital | Hong Kong Property Developers Figure 49: Implied fair value using the historical NAV approach Hang Lung Hang Lung SHKP Sino Land HendersonCheung KongNew worldProperties GroupKerry(HK$) 16HK 83HK 12HK1HK17HK101HK 10HK683HK2011ENAV Average+ . discount 0%-7% -3%-6%-25%1% -10%-22%Implied fair value Current price Potential upside/downside 15%16% 26%15%21%-7% 0%20%Note: Sino average discount and 1 standard deviation calculation employs data since 2003 as there was a structural change in the company in 2003; Pricing as of 22 November 2010 Source: Thomson Reuters Data Stream, Barclays Capital estimates Figure 50: SHKP NAV discount Figure 51: Sino Land NAV discount 40%60%30%40%20%20%10%0%0%-10%-20%-20%-40%-30%-40%-60%-50%-80%-60%23456789012345678909999999900000000001-------------------2713485679012546890gggggggggggggggpppp9990009999990000001-eeee--uuuuuuuuuuuuuuu----------------lrlrrgtvSSSSbypcrbnnynAAAAAAAAAAAAAAAauupcneaeapJueoeaJauauJJJJFASOFAMANDMMMDisc to NAVAvg-2STDAvg-1STDDisc to NAVAvg-2STDAvg-1STDAvgAvg+1STDAvg+2STDAvgAvg+1STDAvg+2STDSource: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital Figure 52:Henderson Land NAV discount Figure 53: Cheung Kong NAV discount 60%20%40%10%20%0%0%-10%-20%-20%-40%-30%-60%-40%-80%-50%25814701470369258147014703699990001999000099900019990000---------------------lllllll-------lllllllnunununununununununununununuJJJJJJJaaaaaaaJJJJJJJaaaaaaaJJJJJJJJJJJJJJDisc to NAVAvg-2STDAvg-1STDDisc to NAVAvg-2STDAvg-1STDAvgAvg+1STDAvg+2STDAvgAvg+1STDAvg+2STDSource: Bloomberg, Barclays Capital Source: Bloomberg, Barclays Capital 23 November 2010 43
Barclays Capital | Hong Kong Property Developers Figure 54: NWD NAV discount Figure 55: Hang Lung Properties NAV discount 60%100%80%40%60%20%40%0%20%0%-20%-20%-40%-40%-60%-60%-80%-80%25814701470369667801349922556790889990001999000099990990000000000100----------------------------------llllllllllllrrrrrtttttnunununununununcunnnunpcupcupcpcupJJJJJJJJJJJJaaaaaaaaaaaaJJJJJJJJOJJJAOAOJAOAOADisc to NAVAvg-2STDAvg-1STDDisc to NAVAvg-2STDAvg-1STDAvgAvg+1STDAvg+2STDAvgAvg+1STDAvg+2STDSource: Bloomberg, , Barclays Capital Source: Bloomberg, , Barclays Capital Figure 56:Hang Lung Group NAV discount Figure 57: Kerry NAV discount 60%60%40%40%20%20%0%0%-20%-20%-40%-40%-60%-80%-60%-100%-80%687891240134576780902581470147036999099900000000000011-----9990001--9990000---------------------------gvgvgvgvgvlllllllybybybybybonuaeouaeouaeouaeununununununuaeouJJJJJJJaaaaaaaFFFFFANANANANANJJJJJJJMMMMMDisc to NAVAvg-2STDAvg-1STDDisc to NAVAvg-2STDAvg-1STDAvgAvg+1STDAvg+2STDAvgAvg+1STDAvg+2STDSource: Bloomberg, Barclays Capital Source: Bloomberg, ,Barclays Capital SOTP NAV discount We are cautious of historical Despite being conventional in the valuation of Hong Kong property developers, we remain NAV discounts… cautious about relying solely on historical NAV discounts, which implicitly assume that market cycles are the same, there has been no change in the company’s operations/capital structure and that management has remained constant – none of which really holds for this sector. Alternatively, therefore, we also look at a SOTP NAV discount. We do this by using the market’s pricing of stocks that have largely a single business focus (eg property investor stocks) to determine a property investment portfolio discount. Through this approach we can mark to market the discount for each part of the developer’s business. …we therefore use a SOTP For the property investment portfolios, given we are making the same assumptions in our approach based upon the NAV property investor valuations as we are for the developers, we can determine a market discounts applied to single-focus discount by comparing current share prices with our valuations. We do this on a gross asset businesses… value (GAV) basis as opposed to a NAV basis to remove any distortion in the discount created by each company’s capital structure. 23 November 2010 44
Barclays Capital | Hong Kong Property Developers Based upon current market prices, Hongkong Land is trading at a 18% discount to our GAV and Hysan is trading at a 26% discount. For simplicity we mark all developers’ property investment portfolios to a 20% discount to GAV, in line with the average for these two stocks. Figure 58: Market’s discount to GAV for property investor stocks Hong Kong Land Hysan (US$) (HK$) per share (Net debt per share) asset value price -20% -29%NAV discount price debt per share per share -18% -26%EV discount to GAV Source: Bloomberg, Barclays Capital estimates We assume a 15% holding discount for listed subsidiaries and associates. This is consistent with the long-term holding discount of 12% for Wheelock and 20% for Jardine Matheson. For property development, we apply a discount weighted by the development exposure of the developer between Hong Kong and China. China property development: We apply a 20% discount to GAV. This is based upon a 30% sector average discount to NAV and an average net debt of 50%. Hong Kong property development: We have no clean, listed property development stocks by which to determine current market discount rates. We, therefore, assume that Hong Kong property development trades at par to its GAV. 23 November 2010 45
Barclays Capital | Hong Kong Property Developers Figure 59: Implied fair value using the SOTP NAV discount approach Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew worldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKDevelopment properties Hong Kong & Overseas Discount factor 0% 0%0%0%0%0% 0%0% Implied value per share China Discount factor 20% 20%20%20%20%20% 20%20% Implied value per share Land bank Discount factor 0% 0%0%0%0%0% 0%0%Implied fair value per share Investment properties Hong Kong & Overseas Discount factor 20% 20%20%20%20%20% 20%20% Implied value per share China Discount factor 15% 15%15%15%15%15% 15%15% Implied value per share Hotel Discount factor 15% 15%15%15%15%15% 15%15%Implied fair value per share Listed associates/subsidiaries Discount factor 15% 15%15%15%15%15% 15%15%Implied fair value per share Other assets Implied gross asset value (GAV) Net debt Other liabilities fair value per share Net asset value (NAV) per share NAV discount -14% -15%-12%-12%-12%-13% -15%-15% Current price Potential upside/downside 8% 15%23%17%52%-20% -3%43%Source: Barclays Capital estimates 23 November 2010 46
Barclays Capital | Hong Kong Property Developers Our SOTP approach suggests that the property development sector should trade at a discount of 12-15% to our one-year forward NAVs, implying potential share price upside/downside of between -20% for HLP and 43% for NWD. It can also be assumed that, given the limited potential upside for SHKP, it appears that investors are broadly pricing in a flat NAV discount for developers’ Hong Kong property development values. …the inherent problem with this The 52% potential upside to NWD and the 43% upside to Kerry reflects one of the inherent approach is that it assumes all problems with the SOTP approach, which is that it assumes that all management teams are management teams are created equal, penalizing the better management teams and overestimating the share price value of equal those management teams that are underperforming. Likewise, it tends to penalise teams whose management are consider to be above average, such as SHKP and HLP. In Hong Kong, where the large property companies are all family-run, the ability for shareholders to affect management changes is limited, hence, if management fails to meet shareholder expectations or fails to have regard for their interests, then shareholders have little choice but to sell, buying back only when the discount is wide enough to reflect the inherent risks. Forward-looking NAV discount (ROIC-WACC spread approach) We prefer a forward-looking In our view, appropriate NAV discounts reflect expected changes in the value of the NAV discount model… company’s property portfolio and a discount/premium to reflect management’s ability to add or detract from that value. …comprising a structural From a fundamental perspective, we consider this management discount reflects four key discount that reflects factors: 1) management’s ability to add/detract value from capital allocation; management’s ability to add 2) corporate governance; 3) investment focus; and 4) share trading liquidity. In analyzing value… the NAV discounts for the developers over the past 18 years, we estimate that the management discounts for developers range between 0% and 30%. Our 30% assessed discount for NWD is consistent with our SOTP approach. Given NWD’s similar business model to the other developers, we would expect it to trade at a similar NAV discount with comparable potential upside to the current share price to the other developers under a SOPT approach. The fact that the potential upside to its share price at comparable NAV discounts is some 30% above that of the other companies in the sector, suggests that the market applies a +/-30% structural discount to the stock. Generally, we find these discounts tend to be stable over time, although we have seen changes in discounts where there has been an improvement in management disclosure, corporate governance etc. Our average structural discount for the sector is % and compares with our long-term average historical sector discount of 12%, which is, in effect, a through-the-cycle average discount and a good proxy for the structural discount level. Sino Land, in particular, has seen a narrowing of its structural discount since 2003, a fact we put down to its better disclosure and cleaner business operations, given no more JVs with private family-owned companies. Likewise, we have seen a material improvement in Hang Lung Properties’ structural discount, reflecting its change in strategy from a passive property investment company into a residential developer and, more recently, for its focus on China. Better disclosure and a focus on corporate governance have also supported the narrowing of the structural discount, in our view. 23 November 2010 47
Barclays Capital | Hong Kong Property Developers Figure 60: Structural discount Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew worldProperties GroupKerry Ticker 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKStructural discount 0% -5%-15%-10%-30%0% -15%-30%Source: Barclays Capital estimates Given the recent trading pattern of Henderson Land, we are increasingly of the view that the stock is facing a widening of its structural discount. While trading may be affected by the overhang of its warrant issue, we think 39 Conduit Road sales and its strategy to acquire land aggressively at this stage in the cycle, have raised wider concerns among investors. In particular, we believe succession issues are become a more relevant concern, given that all the other major developers have either moved to second generation management or have a clear heir apparent. We, therefore, assume that Henderson Land’s structural discount moves out from its long-term average of 8% to 15%, to reflect these concerns. …and a cyclical discount that In determining the discount to NAV for changes in the property portfolio value, we compare reflects the total return from the the one-year forward total returns (income and capital appreciation) on invested capital to portfolio the company’s cost of capital. The resulting ROIC-WACC spread tells us how much value will be created or destroyed in the coming year and the appropriate discount to be applied to our forward NAV. Hence, a company whose property portfolio is expected to grow strongly in income and capital appreciation terms will likely show a narrower NAV discount to one whose property growth is weaker. We believe that this approach explicitly reflects what we already know from observed NAV discounts; that higher expected returns are rewarded by investors through narrower discounts. The charts below show the results of back testing our model on 18 years’ history of our NAVs. Figure 61: Fair values and implied NAV discounts Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew worldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HK2011E NAV Fair value Implied premium/ (discount) to forward NAV 0% -4%-19%-11%-36%4% -13%-28%Source: Barclays Capital estimates 23 November 2010 48
Barclays Capital | Hong Kong Property Developers Figure 62: SHKP share price vs fair value Figure 63: Sino Land share price vs fair value (HK$)(HK$)180301602514012020100158060104052000123456789012345678905678901234567890999999999000000000019999900000000001------------------------------------cccccccccccccccccccccccccccccccccccceeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDD1 yr fwd Fair valueShr price1 yr fwd Fair valueShr priceSource: Barclays Capital Source: Barclays Capital Figure 64: Henderson Land share price vs fair value Figure 65: Cheung Kong share price vs fair value 90(HK$)80307025602050(HK$)40153010205100034567890123456789056789012345678909999999000000000019999900000000001----------------------------------ccccccccccccnnnnnnnnnnnnnnnnnncccceeeeeeeeeeeeeeeeuuuuuuuuuuuuuuuuuuJJJJJJJJJJJJJJJJJJDDDDDDDDDDDDDDDD1 yr fwd Fair valueShr price1 yr fwd Fair valueShr priceSource: Barclays Capital Source: Barclays Capital 23 November 2010 49
Barclays Capital | Hong Kong Property Developers Figure 66: New World Development share price vs fair value Figure 67: Hang Lung Properties share price vs fair value (HK$)(HK$)70454060355030402520301520101050023456789012345678906789012345678909999999900000000001999900000000001----------------------------------nnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnnuuuuuuuuuuuuuuuuuuuaaaaaaaaaaaaaaaJJJJJJJJJJJJJJJJJJJJJJJJJJJJJJJJJJ1 yr fwd Fair valueShr price1 yr fwd Fair valueShr priceSource: Barclays Capital Source: Barclays Capital Figure 68: Hang Lung Group share price vs fair value Figure 69: Kerry Properties share price vs fair value (HK$)(HK$)60807050604050304030202010100089012345678906789012345678909900000000001999900000000001----------------------------cccccccccccccgggggggggggggggeeeeeeeeeeeeeuuuuuuuuuuuuuuuDDDDDDDDDDDDDAAAAAAAAAAAAAAA1 yr fwd Fair valueShr price1 yr fwd Fair valueShr priceSource: Barclays Capital Source: Barclays Capital 23 November 2010 50
Barclays Capital | Hong Kong Property Developers Price targets The three NAV discount approaches result in the following fair values. Figure 70: Fair values under our three NAV discount approaches Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew WorldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKHistorical NAV discount approach Sum-of-the-parts approach ROIC-WACC spread approach Source: Barclays Capital estimates SHKP – HK$ SHKP: We believe SHKP is well positioned for this cycle, given its shorter-duration land bank, premium brand and more active pre-sales approach. We believe the SOTP discount over-penalizes the stock, given its management record and the liquidity of its shares. We therefore set our HK$ price target in line with the historical NAV discount and our ROIC-WACC spread approach. Sino Land – HK$20 Sino Land: The spread between approaches for Sino Land is narrow and, given its strong position for this cycle, we set our HK$20 price target in line with our ROIC-WACC. Sino Land’s high exposure to Hong Kong residential property, combined with its shorter-duration land bank, exposure to the upper-end urban market, make it ideally placed to capture the near-term returns from this cycle, in our view. Henderson Land – HK$ Henderson Land: We set our price target at HK$, largely in line with our ROIC-WACC discount approach reflecting our more cautious approach. Given the longer duration of the company’s land bank and that we expect it to commit further capital to increasing its land bank over the next 12 months, we remain concerned about cyclical returns. In addition, we think investor concerns over strategy and succession planning is likely to be reflected by a wider structural discount. Cheung Kong – HK$ Cheung Kong: There appears to be a reasonable consensus among the three discount approaches for Cheung Kong, and we therefore set our price target at HK$ per share. Its shorter-duration land bank and faster asset-turn sales approach are offset by its lower-end development product. However, we think it is well placed to capture high margins on its developments over the next 12-18 months. NWD – HK$ NWD: We set our price target at HK$. Its longer-duration land bank suggests it is less well-placed to capture the returns from this cycle, in our view. Hence, this profile suggests that its cyclical returns will lag those of the overall market and implied by its historical NAV discount range. As a result, we believe the stock should trade on a wider NAV discount. HLP – HK$ Hang Lung Properties: We set our price target at HK$, in line with our ROIC-WACC spread, to reflect the narrowing structural discount we have seen over the past couple of years. However, we are also mindful of the potential LAT liabilities that are not yet assumed within our NAV. HLG – HK$ Hang Lung Group: We set our price target at HK$ for HLG, reflecting our approach to our price target for Hang Lung Properties. Kerry properties – HK$ Kerry Properties: We set out price target at HK$, reflecting the narrow spread between the historical NAV discount and the ROIC-WACC spread approach. Given its short-duration land bank and upper-end, urban focus, we think the company should be well placed to capture the near-term cycle returns. 23 November 2010 51
Barclays Capital | Hong Kong Property Developers A strategy of not chasing deeply discounted stocks: We understand the argument to buy the deepest discounted stocks on the basis that all discounts should narrow in a bull market and the widest discounts should narrow most. However, we think this is a naive way of thinking about NAV discounts. In the first instance, wider NAV discounts are, in part, reflecting the back-end, riskier nature of developers’ land banks and the risk that a market correction could see a significant decline in returns. The strategy to buy the deepest Second, buying the deepest discounted stocks, in the hope that the structural discount will discounted stocks is a strategy compress, is largely a strategy to take on significant risk around issues such as corporate to take greater risk than you are governance, investment track record and lack of investment focus. Experience has shown rewarded for that these are risks that investors are simply not adequately rewarded for taking on unless there is clear evidence of management change. Hence, we prefer to remain weighted towards those stocks that offer the best cyclical returns, where investors are adequately rewarded for the risks they take on and against which they can reasonably hedge themselves. Figure 71: Price targets Hang Lung Hang Lung SHKP Sino Land HendersonCheung KongNew WorldProperties GroupKerry (HK$) 16 HK 83 HK 12 HK1 HK17 HK101 HK 10 HK683 HKPrice targets Current price Potential upside/downside 25% 30% 13%18%11%-4% -1%20%Note: Pricing as of 22 November 2010 Source: Bloomberg, Barclays Capital estimates Conservative PTs: From a trading perspective, we are conscious that, given our view of strong property price performance, developers’ stock prices could overshoot our fundamental valuation price targets and that these may prove conservative in the case of a strong market rally. Stock prices will still be linked to Given the increasing sensitivity to interest rates, then we believe these stocks should be the US dollar – a strong US dollar traded with an increasing view to a US recovery. In this regard, we think the US dollar will on its own account would imply continue to remain correlated with stock price movements of developers. A strong US a US economic recovery and dollar, in its own right as opposed to the result of Euro weakness, would imply a recovery in higher interest rates the US economy, the prospect of rising interest rates and the removal of excess liquidity. Figure 72: Hang Seng Property Index vs US$ HSP indexDXY40,0007035,0007530,0008025,0008520,0009015,00010,000956667777890008888999000000000000000001111--------------------lrlrgvttbycrgvnnpybucnuppcuoeaJeeaauoeJuauJJFOJASFAOANDMMANMHSP (LHS)DXY (RHS) Source: Bloomberg, Barclays Capital 23 November 2010 52
Barclays Capital | Hong Kong Property Developers Bull and bear case For our bull and bear cases for the stocks, we look at their sensitivity to changes in our forecast residential property prices. Bull case: We assume that residential property prices rise 20-25% in 2011 and 20-25% in 2012. Bear case: Alternatively, we assume that property prices fall 10% from our forecast and apply a 0-5% increase for 2011 and 0-5% for 2012. All our bull- and bear-case scenarios have been run on our ROIC-WACC NAV discount models. Figure 73: Summary of forecasts under bull and bear cases 2010E2011E 2012EBase case Luxury residential 20%15% 15%Mass residential 16%10%10% Bull case Luxury residential 30%25%25%Mass residential 26%20% 20% Bear case Luxury residential 10%5%5%Mass residential 6%0% 0%Source: Barclays Capital, Barclays Capital estimates Figure 74: Base case Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew WorldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKNAV Fair value Discount to NAV 0% -4%-19%-11%-36%4% -13%-28%Source: Barclays Capital estimates Figure 75: Bull case Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew WorldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKNAV Fair value Discount to NAV 0% -4%-18%-11%-36%4% -12%-27% % change in FV from base case 3% 5%4%4%7%3% 4%3%Source: Barclays Capital estimates 23 November 2010 53
Barclays Capital | Hong Kong Property Developers Figure 76: Bear case Cheung Hang Lung Hang Lung SHKP Sino LandHendersonKongNew WorldProperties GroupKerry (HK$) 16 HK 83 HK12 HK1 HK17 HK101 HK 10 HK683 HKNAV Fair value Discount to NAV -1% -4%-19%-12%-36%3% -13%-29% % change in FV from base case -2% -5%-3%-4%-6%-3% -4%-3%Source: Barclays Capital estimates 1-Positive view on the Hong Kong property developers On average, our 12-month price targets offer potential upside/downside of 14% to current share prices and reflect our 1-Positive view on the property developer sector. Look to manage the risk/return In our view, one of the key differentiating factors for stock price performance for 20111 will trade-off… likely be between those well placed to ‘ride the cycle’ and those who are not. Given the volatile nature of the Hong Kong property market and the profile of the current cycle, how developers allocate their capital over the next 12 months and the implicit risks assumed is going to be important in how stocks perform, in our view. As we have argued, we believe those with shorter-duration land banks, employing a faster ‘asset-turn’ sales strategy and taking an opportunistic approach to land buying over the next 12 months should outperform. Hence, our preferred 1-Overweight picksin the sector are SHKP, Sino Land and Kerry Properties. 23 November 2010 54
Barclays Capital | Hong Kong Property Developers Figure 77: Summary valuation Potential Discount upside to Fwd Price target(downside)Forward NAVNAVUnderlying P/E (x) P/B (x) Div. Yield Net gearing (HK$) Company Rating Price Dec 2011E(%)Dec 2011E(%)2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E Hong Kong Developers: 1-Positive sector view 83 HK Sino Land (HK$) 1-OW 30% -26% 3%3%13%9%16 HK SHKP (HK$) 1-OW 25% -20% 2%2%14%15%683 HK Kerry (HK$) 1-OW 20% -40% 2%2%18%11%1 HK Cheung Kong (HK$) 2-EW 18% -25% 3%3%0%0%12 HK Henderson (HK$) 2-EW 13% -28% 3%2%-3%-5%17 HK NWD (HK$) 3-UW 11% -42% 5%6%18%17%10 HK HLG (HK$) 3-UW -1% -12% 1%1%-3%-6%101 HK HLP (HK$) 3-UW -4% 8% 2%2%-18%-21%Average 14% -23% 3%3%5%3%Note: Pricing as of 22 November 2010 Source: Bloomberg, Barclays Capital estimates 23 November 2010 55
Barclays Capital | Hong Kong Property Developers SUN HUNG KAI PROPERTIES (1-OVERWEIGHT; PT HK$; +25%) 16 HK / We initiate coverage of SHKP with a 1-Overweight rating and a price target of HK$, offering 25% potential upside to the current share price. We think SHKP is Stock Rating well placed to capture the cyclical growth in Hong Kong property prices. It has secured a 1-OVERWEIGHT good pipeline of residential developments and has already secured sufficient land bank Sector View for the next five years of development. It offers relatively lower risk to access the Hong 1-POSITIVE Kong property market, in our view. Price Target HKD Price (22-Nov-2010) Operational outlook HKD Today, SHKP is less a residential property developer and more a commercial property Potential Upside/Downside investor, in our view. The strong cash flows from its residential business have allowed it to +25% build a material commercial investment portfolio over the past 20 years. We estimate that 56% of the GAV now comes from its property investment portfolio. As a result, SHKP is A landlord and developer… expected to be a major beneficiary of the strong outlook for commercial property rents over the next couple of years. Residential development Its residential development business, for those sites on which it has committed, accounts for % of GAV for development. This value is almost entirely derived from its Hong Kong development portfolio, reflecting the larger capital size of Hong Kong projects, but also the cautious approach adopted towards China expansion. Hong Kong business: For its Hong Kong residential development business we estimate that SHKP will complete sq ft of attributable gross floor area (GFA) in 2010, sq ft in 2011 and sq ft in 2012. With expected completion of sq ft in 2013 and sq ft spread between 2014 and 2015, the company already has secured most of its land bank for the next four to five years. This should mean that it pursues a more selective land acquisition strategy over the next 12-24 months. Of its residential developments, % by GFA is in the Hong Kong urban area, with the remaining % in the New Territories. On a unit basis, 80% of its unit sales will be in the New Territories. However, on a Hong Kong dollar basis, we estimate the current GAV split is approximately 50:50 between urban developments and those in the New Territories. This split should provide SHKP with good exposure to the better-growth upgrader and luxury properties in the urban areas, in our opinion. …limited China exposure… China business: SHKP’s exposure to China remains relatively limited in terms of gross asset value. We estimate that China development accounts for %, with much of this value being tied up in the 63mn sq ft of land bank. The investment portfolio, focused on Beijing and Shanghai, accounts for % of gross asset value. Hence, we estimate that SHKP has a total GAV exposure of % in the mainland. 23 November 2010 56
Barclays Capital | Hong Kong Property Developers Balance sheet The balance sheet continues to remain well funded. As at the end of FY10 net debt to equity was % and interest cover was on EBITDA and using recurrent rental income. The estimated average duration of the debt is years and, given the willingness of Hong Kong banks to lend to the company, it has been able to access the syndicated loan market at very attractive funding costs. …risk of equity raisings… The need for additional equity funding appears limited, but we recognise that Hong Kong developers rarely concern themselves with their balance sheet position in deciding to raise equity. SHKP’s last equity placement was at HK$150 per share, suggesting there may be some risk of a placement should the share price go beyond this level. Our credit analyst, Christina Chiow rates Sun Hung Kai Properties as Underweight, A1 Stb/A Pos, reflecting more compelling value in the BBB-rated universe that offer higher yields against our comfortable stable credit outlook. Current yield on SHKP '20s is about %. (See Asia-Pac Credit Insights: “Re-evaluating the landscape into Q4” published on 1 September 2010.) Valuation Our NAV estimate for the company is HK$ per share for end-2011, reflecting an increase of 10% over our end-2010E NAV per share of HK$. Using a + standard deviation to our long-term average historical NAV discount of 8% for the company, we estimate the stock should trade at a 0% discount to its 2011E NAV. …price target of HK$ Based upon our preferred forward-looking NAV discount (ROIC-WACC spread) method, we set our price target at HK$. This reflects a cyclical return in our ROIC-WACC spread approach and assumes a 0% structural discount for management, which has been the long-term discount for management. The recent family concerns, following the removal of Walter Kwok from holding management positions within the group, have clearly raised corporate governance issues, but we are yet to assume any specific changes to our structural discount, although this could be a future risk to the stock price. Risks The key downside risks to our HK$ price target for SHKP are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Any impact on share ownership from changes in the family trust structure is also a risk. Company profile Sun Hung Kai Properties Limited, through its subsidiaries, develops and invests in properties. The company also operates hotels and manages properties, car parks and transportation infrastructure. In addition, SHKP operates a logistics business, construction, financial services, telecommunications and internet infrastructure businesses and enabling services. 23 November 2010 57
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Jun, HK$mn)2008200920102011E2012E2013ESun Hung Kai Properties (16 HK)VALUATIONUnderlying P/E (x) -OverweightP/B (x) yield 5%2%2%2%2%2%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 61%52%50%48%40%42%HK$$%EV/EBITDA (x) price discount to NAV -56%12%-4%-19%-21%-23%Profitability & GrowthNAVNAV per share (HK$) %30%Property type breakdown25%55%Office19%20%23%25%25%26%20%50%Retail23%23%25%26%24%25%15%Residential35%34%24%26%25%24%45%10%Hotl666665%40%Others17%17%22%17%20%19%0%35%Geographic breakdown-5%Hong Kong87%85%83%79%80%80%30%-10%China13%15%17%21%20%20%2008200920102011E2012E2013EGross margin (LHS)Underlying profit margin (RHS)KEY RATIOSReturn & LeverageSales growth -21%40%-3%39%-12%21%Underlying profit growth11%-6%11%9%26%-2%50%8%EPS growth -11%18%12%7%27%-1%45%7%Gross margin52%48%49%38%54%49%40%6%EBIT margin44%41%42%33%48%44%35%5%30%Underlying net margin43%36%42%32%47%38%25%4%Net gearing 15%15%15%14%15%8%20%3%Net interest cover (x) %2%10%1%INCOME STATEMENT5%Revenue 24,471 34,234 33,211 46,110 40,555 49,0810%0%2008200920102011E2012EGross Profit 12,797 16,373 16,324 17,529 21,892 24,158EBITDA 11,918 15,580 15,446 16,625 20,960 23,199Net gearing (LHS)Underlying ROE (RHS)Depreciation & Amortisation -1,190 -1,597 -1,604 -1,453 -1,526 -1,588EBIT 10,728 13,983 13,842 15,172 19,434 21,611Share price discount to NAVNet interest income / (expense) -705 -508 -639 -1,633 -1,648 -1,843Net other pre-tax income 9,328 549 5,457 2,624 3,132 95940%30%Pre-tax profit 32,747 12,967 36,733 17,616 22,444 22,31420%Income tax -9,913 -4,634 -16,184 -5,436 -7,028 -7,11710%Minority interests -549 -207 -598 -1 -1 -10%Net other post-tax income-10%Net profit, 27,602 10,443 28,043 14,897 18,930 18,755-20%Underlying net profit 10,499 12,370 13,883 14,897 18,930 18,755-30%EPS (as reported, FD, HK$) -40%-50%EPS (underlying, FD, HK$) -60%DPS (HK$) SHEETNet tangible fixed assets 179,976 180,205 200,826 202,288 202,677 202,4762011E NAV breakdown by property type Net intangible assets 37,057 36,907 40,738 43,011 45,653 46,933Net working capital 64,888 68,615 65,170 69,361 77,980 87,990Inventories 65,417 68,347 84,923 80,847 87,481 88,278Others17%OAccounts receivable 11,552 15,611 16,060 16,138 18,250 14,724ffice25%Accounts payable - 13,103 -14,600 -17,667 -16,084 - 10,629 -14,073Net other WC assets 1,022 -743 - 18,146 -11,540 -17,121 -940Hotel6%Invested capital 281,921 285,727 306,734 314,660 326,310 337,399Net other assets 91,371 92,689 94,054 91,684 96,910 80,556Capital employed 190,550 193,038 212,680 222,977 229,399 256,843Net debt / (cash) -33,507 -33,882 -37,184 -34,814 -40,040 -23,686ReRetailsidentialTotal equity 224,057 226,920 249,864 257,790 269,440 280,52926%26%BVPS (HK$) FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 9,918 9,268 7,954 12,744 4,345 26,428Net Capex 66 34 36 36 36 36Free cash flow (FCF) 5,329 5,173 3,494 7,305 -1,130 20,688Divestments / (investments) -23,776 -4,218 -6,994 -2,577 -1,597 -1,077China21%Other investing cash flows 3,430 2,241 2,716 855 979 526Dividends paid -6,564 -6,565 -5,943 -6,972 -7,281 -7,666Share issues / (buybacks) 10,836 -196 -152 - - -Other financing cash flows 5,602 868 2,521 -1,680 -1,672 -1,855Increase / (decrease) in cash -488 1,432 138 2,406 -5,191 16,390FCF per share (HK$) ANALYSISHong Kong79%Underlying net margin 43%36%42%32%47%38%Asset turnover (x) leverage (x) : Company data, , Bloomberg, Barclays Capital estimatesUderyng ROE%5%58%5%72%68% 23 November 2010 58
Barclays Capital | Hong Kong Property Developers SINO LAND (1-OVERWEIGHT; PT HK$20; +30%) 83 HK / We initiate coverage of Sino Land with a 1-Overweight rating and HK$20 price target, offering 30% potential upside to the current share price. We believe Sino Land’s Stock Rating development model, with its faster asset-turn approach to sales, focus on premium urban 1-OVERWEIGHT properties and more near-term development projects, should allow the company to Sector View capture the higher returns from this stage in the cycle, while managing the risks of a 1-POSITIVE potential price correction. Following its recent equity raising in the last month, we believe Price Target the challenge for the company will be to selectively buy land at reasonable prices. HKD Price (22-Nov-2010) HKD Operational outlook Potential Upside/Downside Sino Land has one of the highest exposures in our coverage universe to the upper-end +30% residential market, where we see the strongest growth over the next 12-24 months. On a GFA basis, its current development pipeline is split 50:50 between urban and New Territories locations, and on a Hong Kong dollar basis, we estimate that the value High exposure to upper-end contribution is 65-70% from urban and the remainder from the New Territories market. residential... The company has submitted pre-sale approval for five projects, all of which are located in the urban area. Given the prime location of these developments and Sino Land’s focus over the past few years to move up the quality ladder, we expect these developments to be well received. The desire to pre-sell is positive, in our view, and reflects the company’s faster asset-turn approach that should allow it to capture more of the cycle upside and better manage the risk entailed in longer-duration projects. The current land bank is 4mn sq ft and should provide a sufficient development pipeline for the next four years. As a result, Sino Land has the highest NAV exposure to Hong Kong residential property market among the Hong Kong developers. Over the past five years, the company has doubled the size of its investment portfolio income. This has provided it with a stable income base and will also allow it to benefit from the expected strong growth in rents over the next three years. Balance sheet …strong balance sheet… As at the end of FY10, Sino Land’s balance sheet was 21% geared and interest cover was strong. The opportunistic placement of 305mn shares at a price of HK$ per share on 8 November 2010 has reduced overall gearing to 12%. This should provide the company with ample room to selectively acquire land at auction over the next 12 months. The challenge we believe will be for the company to acquire land at reasonable prices. 23 November 2010 59
Barclays Capital | Hong Kong Property Developers Valuation Our NAV for the company is HK$ per share for end-2011E. Using a + standard deviation to our long-term average historical NAV discount of 17%, we estimate the stock should trade at a 7% discount to its 2011E NAV. …price target of HK$20 Based upon our preferred forward-looking NAV discount method, we set our price target at HK$20. This reflects a cyclical return in our ROIC-WACC spread and assumes a 7% structural discount for management. The structural discount for the stock has narrowed since 2003, when the company stopped funding itself significantly off-balance sheet, joint-venturing with family-run companies, and improved its disclosure. With the discount having stabilised at its current level, we expect little further contraction in the discount from current levels. Risks The key downside risk to our HK$20 price target for Sino Land are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. There is also risk to our forecasts from the company aggressively acquiring land and lengthening its land bank duration. Company profile Sino Land Company Limited, through its subsidiaries, develops and invests in properties, trades and invests in securities, and provides financial services. The company also operates hotels and provides building management services. 23 November 2010 60
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Jun, HK$mn)2008200920102011E2012E2013ESino Land (83 HK)VALUATIONUnderlying P/E (x) -OverweightP/B (x) yield 2%2%2%2%2%2%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 61%50%59%42%38%32%HK$$%EV/EBITDA (x) price discount o NAV 6%-7%-3%-%-9%-3%Profitability & GrowthNAVNAV per share (HK$) %60%Property type breakdown54%50%Office18%19%19%21%22%22%52%40%Retail25%25%22%23%23%23%50%30%Residential40%42%48%46%46%46%48%20%Hotl86555546%10%%8%%%4%4%44%0%Geographic breakdown42%-10%Hong Kong99%88%90%77%77%76%40%-20%China-10%2%2%17%20%21%2008200920102011E2012EOverseas11%10%8%6%3%3%Gross margin (LHS)Underlying profit growth (RHS)KEY RATIOSReturn & LeverageSales growth -17%55%-21%-19%42%24%Underlying profit growth-10%22%-15%50%12%19%50%8%EPS growth %23%-16%41%12%19%45%7%Gross margin53%49%54%53%50%46%40%6%EBIT margin45%%47%43%42%40%35%5%30%Underlying net margin49%40%41%76%61%59%25%4%Net gearing 21%16%21%13%9%2%20%3%Net interest cover (x) %2%10%1%INCOME STATEMENT5%Revenue 6,505 9,809 7,953 6,482 9,088 11,2200%0%2008200920102011E2012EGross profit 3,458 4,811 4,334 3,448 4,502 5,111EBITDA 2,977 4,410 3,766 2,864 3,900 4,491Net gearing (LHS)Underlying ROE (RHS)Depreciation & amortisation -34 -37 -38 -54 -56 -58EBIT 2,943 4,373 3,728 2,810 3,844 4,432Share price discount to NAVNet interest income / (expense) -48 -128 -21 -385 -205 -119Net other pre-tax income 6,241 314 3,697 3,260 2,705 3,19060%Pre-tax profit 9,136 4,559 7,404 5,685 6,344 7,50340%Income tax -2,532 -1,755 -2,183 -748 -807 -93420%Minority interests -91 -48 -109 - - -0%Net other post-tax incomeNet profit, 7,721 3,731 6,094 4,937 5,537 6,569-20%Underlying net profit 3,178 3,880 3,297 4,937 5,537 6,569-40%EPS (as reported, FD, HK$) -60%EPS (underlying, FD, HK$) -80%DPS (HK$) SHEETNet tangible fixed assets 52,864 56,991 66,046 68,361 69,736 71,3862011E NAV breakdown by property type Net intangible assets 18,966 18,480 23,142 24,343 25,351 26,549Net working capital 22,949 18,459 19,844 25,576 27,655 30,492OthersHotelInventories 26,400 21,239 22,756 23,003 25,879 27,2265%5%OfficeAccounts receivable 929 1,481 1,008 2,132 2,308 2,27221%Accounts payable -4,067 -4,554 -3,501 -4,637 - 7,808 -11,355Net other WC assets -313 293 -418 5,077 7,277 12,348Invested capital 94,779 93,930 109,032 118,280 122,743 128,427Net other assets 48,077 43,513 57,399 53,798 52,499 48,569ResidentialCapital employed 46,702 50,417 51,633 64,482 70,244 79,85846%RetailNet debt / (cash) -12,285 -9,881 -14,061 -9,259 -6,951 -1,82423%Total equity 58,987 60,298 65,694 73,741 77,196 81,682BVPS (HK$) FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 76 5,194 -115 469 3,265 5,756Net capex 1,579 301 -7 - - -OveFree cash flow (FCF) -1,074 3,956 -1,116 -765 2,202 4,770rseas6%Divestments / (investments) -2,226 -111 -2,384 -22 -22 -22Other investing cash flows -3,563 -607 -1,007 - - -China17%Dividends paid -335 -1,568 -517 -1,956 -2,082 -2,082Share issues / (buybacks) 3,827 -674 -488 5,066 - -Other financing cash flows 1,005 1,693 1,193 1,245 1,147 1,476Increase / (decrease) in cash 363 4,229 -3,325 4,802 2,308 5,127FCF per share (HK$) KongDUPONT ANALYSIS77%Underlying net margin 49%40%41%76%61%59%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUderyng ROE60%65%52%7%73%83% 23 November 2010 61
Barclays Capital | Hong Kong Property Developers HENDERSON LAND DEVELOPMENT (2-EQUAL WEIGHT; PT HK$; +13%) 12 HK / We initiate coverage of Henderson Land Development with a 2-Equal Weight rating and a price target of HK$, offering 13% potential upside to the current share price. Stock Rating Henderson’s heavily long-duration land bank has, in our view, higher development risk 2-EQUAL WEIGHT versus its peers such as SHKP, Cheung Kong and Sino Land. We believe this longer-Sector View duration development pipeline cannot fully take advantage of the current up-cycle in 1-POSITIVE Hong Kong’s residential market. Price Target HKD Price (22-Nov-2010) Property portfolio HKD Potential Upside/Downside Residential development +13% The Hong Kong property market continues to be positively impacted by low mortgage rates and low supply in the medium term. While we have a positive outlook for the residential market in the next 12-18 months, Henderson Land is less well-placed than its peers, in our A long-duration land bank… opinion, having higher development risk due to its longer-duration land bank that is heavily weighted towards completion in 2013/14. For its residential development business, sites on which it has committed account for 20% of GAV for development. This value is almost entirely derived from its Hong Kong development portfolio, reflecting the higher Hong Kong dollar value of Hong Kong projects and its lack of execution in its China expansion to date. For the Hong Kong residential development business, we estimate that Henderson will complete 420,000 sq ft of attributable GFA in 2010, nil in 2011, 504,000 sq ft in 2012 and sq ft after 2012. This is not including attributable GFA from agricultural land where a land premium has not been paid, redevelopment projects that have not completed lease modifications, or redevelopment projects not fully secured. Of its residential developments, 6% by GFA is in urban areas, with the remaining 94% in the New Territories. However, on a HK$ basis we estimate the current GAV split is approximately 10:90 between urban developments and those in the New Territories. Office portfolio Henderson’s prime office portfolio on Hong Kong Island should benefit from strong rental reversions, as we expect 20% rental growth per year for grade-A offices over 2010-12. In Kowloon East, the Manulife Financial Centre and the AIA Financial Centre have both benefitted from strong take-up on the back of “decentralisation” of office tenants, effectively shifting pricing power back to HLD for this portion of its office portfolio. Retail portfolio Retail portfolio positioned for We expect positive rental reversion to lift rental incomes for Henderson’s prime retail strong rental growth portfolio. A sound economic backdrop, coupled with increasing inflow of mainland tourists, supports our forecast of 20%, 18% and 15% y/y growth in rents for 2010-12E, respectively. With shopping centres located in Central and Fanling, HLD is positioned to directly benefit 1from both overnight visitor spending in the traditional “Golden Triangle” retail areas and same-day visitors focused on retail areas near the border (in the “Golden Corridor”). 1 For more on visitor spending in Hong Kong, please refer to our 12 October 2010 report: “Hong Kong Property Investors – Initiation of coverage: Outer space”. 23 November 2010 62
Barclays Capital | Hong Kong Property Developers Balance sheet Gearing As at the end of FY2010, we forecast net gearing of % and interest cover of . Versus its historical net gearing of 23%, Henderson remains liquid and, in our view, has sufficient funds for its various redevelopment projects and agricultural land conversions. …warrant conversion to provide Before 1 June 2011, shares of warrants are exercisable at HK$58 per share, funding… providing Henderson with an additional HK$25bn in funding. This will effectively bring Henderson to a net cash position of HK$, assuming no additional debt. Henderson Land ’19s trade one of the widest in the high-grade bond universe, at a yield of about %. Our credit analyst, Christina Chiow recommends an overweight on the bonds. (See Asia-Pac Credit Insights: “Re-evaluating the landscape into Q4”, published on 1 September 2010) Valuation Our NAV estimate for Henderson at HK$ per share for end-2010E and HK$ for 2011. We estimate the stock should trade on a 19% discount to our one-year forward NAV, reflecting our expectation for continued growth in property values over 2012. Price target of HK$ We set our price target at HK$, based upon our ROIC-WACC approach, which implies potential upside from the current share price of 13%, and rate the stock 2-Equal Weight. We take a cautious approach in setting our price target, given the longer duration of the company’s land bank and that we expect it to commit further capital to converting its agricultural land bank over the next 12 months, and to extend its land bank duration,. Given our price target is above the warrant strike price, we have assumed conversion of the warrants in our NAV valuation. Risks The key downside risk to our HK$ price target for Henderson Land are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. A risk to our forecasts is that the warrants are not converted by June 2011. Company profile Henderson Land Development Company Limited (HLD), together with its subsidiaries, is engaged in property development, investment and management. It also provides project management, construction and finance services. In addition, HLD operates department stores, hotels and infrastructure businesses. 23 November 2010 63
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Dec, HK$mn)2007200820092010E2011E2012EHenderson Land Development (12 HK)VALUATIONUnderlying P/E (x) - EqualweightP/B (x) yield 2%2%2%2%2%2%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 36%41%36%41%49%41%HK$$%EV/EBITDA (x) price discount o NAV -1%-9%-8%-2%-28%-2%Profitability & GrowthNAVNAV per share (HK$) %80%Property type breakdown50%60%Office34%29%26%23%26%27%40%40%Retail27%22%18%20%20%20%Residential21%35%40%42%41%38%30%20%Hotl57555520%0%Others13%8%11%10%9%10%10%-20%Geographic breakdownHong Kong78%65%70%70%70%69%0%-40%China22%35%30%30%30%31%2007200820092010E2011E2012EGross margin (LHS)Underlying profit growth (RHS)KEY RATIOSReturn & LeverageSales growth 23%61%13%-41%47%14%Underlying profit growth1%-3%69%-21%36%18%50%6%EPS growth -6%-12%3%-13%18%13%40%5%Gross margin44%39%43%52%56%53%EBIT margin39%31%31%38%46%44%30%4%Underlying net margin71%42%39%57%55%54%20%3%Net gearing 9%16%18%17%-3%-5%Net interest cover (x) %2%0%1%INCOME STATEMENTRevenue 8,356 13,492 15,230 9,055 13,338 15,141-10%0%2007200820092010E2011E2012EGross profit 3,669 5,268 6,597 4,740 7,470 8,095EBITDA 3,357 4,395 4,954 3,590 6,262 6,827Net gearing (LHS)ROE (RHS)Depreciation & amortisation -115 -173 -281 -121 -121 -121EBIT 3,242 4,222 4,673 3,470 6,141 6,707Share price discount to NAVNet interest income / (expense) -239 -333 -1,091 -615 -593 -318Net other pre-tax income 11,018 15,023 14,710 2,952 3,087 3,36760%Pre-tax profit 14,021 18,912 18,292 5,807 8,635 9,75640%Income tax -2,048 -2,592 -2,356 -619 -1,317 -1,51720%Minority interests -2,156 -848 -1,780 - - -0%Net other post-tax income - - - - - -Net profit, 9,818 15,472 14,156 5,188 7,318 8,239-20%Underlying net profit 5,907 5,734 5,924 5,188 7,318 8,239-40%EPS (as reported, FD, HK$) -60%EPS (underlying, FD, HK$) -80%DPS (HK$) SHEETNet tangible fixed assets 53,010 60,098 69,320 69,238 69,526 69,4422011E NAV breakdown by property type Net intangible assets 34,937 51,451 56,355 57,831 59,374 61,058Net working capital 34,384 55,224 56,792 53,899 85,841 88,680OthersInventories 29,383 37,624 41,541 41,485 41,526 41,5689%HotelAccounts receivable 3,525 5,072 7,365 4,528 6,669 7,570Office5%25%Accounts payable -4,397 -4,589 -5,359 -3,389 -4,632 -5,573Net other WC assets 8,298 16,483 11,090 13,534 40,549 44,063Invested capital 122,331 166,773 182,467 180,969 214,741 219,180Net other assets 30,270 62,372 70,395 63,787 40,234 35,895Capital employed 92,061 104,401 112,072 117,182 174,507 183,285Net debt / (cash) -8,683 -19,797 -25,438 -23,243 4,296 7,959ResidentialRetail41%Total equity 100,744 124,198 137,510 140,425 170,211 175,32520%BVPS (HK$) FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 614 -493 -4,952 3,646 4,529 5,459Net capex - - - - - -Free cash flow (FCF) -1,071 -2,456 -8,066 1,659 2,543 3,748Divestments / (investments) 6,434 -4,260 -640 -354 -408 -37Other investing cash flows 1,622 2,988 4,473 1,581 1,671 2,086China30%Dividends paid -7,411 -4,825 -3,100 -2,273 -2,434 -3,124Share issues / (buybacks) 5,508 - - - 24,902 -Other financing cash flows -4,921 12,025 -1,009 -720 -720 -720Increase / (decrease) in cash 1,845 5,435 -5,228 1,880 27,539 3,663FCF per share (HK$) Kong70%DUPONT ANALYSISUnderlying net margin 71%42%39%57%55%54%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUderyng ROE5%%4%%42%46% 23 November 2010 64
Barclays Capital | Hong Kong Property Developers CHEUNG KONG (2-EQUAL WEIGHT; PT HK$; +18%) 1 HK / We initiate coverage of Cheung Kong Holdings with a 2-Equal Weight rating a price target of HK$, offering 18% potential. In our view, Cheung Kong, with over 80% of Stock Rating its land bank available for sale in the next 18 months, is well positioned to capture the 2-EQUAL WEIGHT current property up-cycle in Hong Kong relative to peers such as Henderson and New Sector View World Development. We prefer developers who have shorter land bank duration, faster 1-POSITIVE asset-turn approach to inventory and pre-sales and are likely to be opportunistic in their Price Target land acquisition strategy. HKD Price (22-Nov-2010) HKD Property portfolio Potential Upside/Downside +18% Residential development Cheung Kong’s shorter-duration land bank available for sale and fast asset-turn approach to inventory and pre-sales matches the profile of developers that we expect to maximize A shorter-duration land bank… revenue in the current up-cycle in Hong Kong’s residential market. For its residential development business, those sites on which it has committed account for 22% of GAV for development. 76% of this value is derived from its Hong Kong development portfolio, reflecting the higher Hong Kong-dollar size of Hong Kong projects but also the cautious approach adopted towards China expansion. For the Hong Kong residential development business, we estimate that Cheung Kong will complete sq ft of attributable GFA in 2010, sq ft in 2011, sf in 2012 and sq ft after 2012. This is not assuming attributable GFA from agricultural land where land premium has not been paid. Of its residential developments, 4% by GFA is in urban areas, with the remaining 96% in the New Territories. However, on a Hong Kong dollar basis we estimate the current gross asset value split is approximately 10:90 between urban developments and those in the New Territories. Balance sheet Gearing ...strong balance sheet… As at the end of 2010, we forecast net gearing of 4% and interest cover of . vs its historical net gearing of 12%, the company remains liquid. Cheung Kong holds HK$182bn in available-for-sale securities largely in the form of Hutchison Whampoa (13 HK, NR), CK Life Sciences (775 HK, NR) and Fortune REIT (FRT SP and 778 HK, NR). 23 November 2010 65
Barclays Capital | Hong Kong Property Developers Valuation Our NAV estimate for Cheung Kong for end-2010 is HK$ per share and for 2011 is HK$. We estimate the stock should trade on a 11% discount to our one-year forward NAV, reflecting our expectation for continued growth in property values over 2012. …price target of HK$ We set our price target for Cheung Kong at HK$ based upon our historical NAV and ROIC-WACC approach, which implies potential upside of 18% from the current share price, and rate the stock 2-Equal Weight. Given the short duration of the company’s land bank and its ability to pre-sale around 70-80% of units before completion, we believe Cheung Kong is well positioned to capture the current property up-cycle, with over 80% of its land bank available for sale in the next 18 months. Risks The key downside risk to our HK$ price target for Cheung Kong are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Hutchison’s share price is a key risk for our price target, given it accounts for 51% of our NAV for Cheung Kong. Company profile Cheung Kong (Holdings) Limited (CKH), through its subsidiaries, develops and invests in real estate, mainly in Hong Kong and China. The company also provides real estate agency and management services, operates hotels, and invests in securities. 23 November 2010 66
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Dec, HK$mn)2007200820092010E2011E2012ECheung Kong (1 HK)VALUATIONUnderlying P/E (x) - Equal weightP/B (x) yield 2%4%3%3%3%3%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 22%38%41%36%35%34%HK$$%EV/EBITDA (x) price discount to NAV 3%-29%-13%-20%-25%-27%Profitability & GrowthNAVNAV per share (HK$) %80%Property type breakdown60%60%OfficeNA13%12%14%16%17%50%40%RetailNA9%10%11%12%13%40%20%ResidentialNA54%54%48%44%41%30%0%HotelNA11%10%9%10%10%20%OthersNA12%14%17%18%19%-20%Geographic breakdown10%-40%Hong KongNA67%62%59%59%61%0%-60%ChinaNA33%38%41%41%39%2007200820092010E2011E2012EGross margin (LHS)Underlying profit growth (RHS)KEY RATIOSReturn & LeverageSales growth 55%-17%31%75%-11%-21%Underlying profit growth62%-41%2%29%8%12%50%14%EPS growth 62%-41%2%29%8%12%12%40%Gross margin60%41%43%33%35%45%10%EBIT margin58%37%41%32%33%43%30%Underlying net margin46%28%30%26%28%37%8%20%Net gearing 13%16%9%4%0%-1%6%Net interest cover (x) %4%0%2%INCOME STATEMENTRevenue 18,591 15,386 20,232 35,506 31,639 24,891-10%0%2007200820092010E2011E2012EGross profit 11,148 6,327 8,760 11,780 11,102 11,169EBITDA 11,045 6,035 8,563 11,583 10,904 10,971Net gearing (LHS)ROE (RHS)Depreciation & amortisation -257 -274 -338 -317 -330 -343EBIT 10,788 5,761 8,225 11,266 10,574 10,629Share price discount to NAVNet interest income / (expense) -813 -370 -212 -806 -551 -312Net other pre-tax income 19,194 11,187 13,887 10,439 12,333 14,70420%Pre-tax profit 29,169 16,578 21,900 20,899 22,357 25,02110%Income tax -1,197 -859 -1,644 -1,151 -1,103 -1,1350%Minority interests -294 -201 -422 - - --10%Net other post-tax income - - - - - -Net profit, 27,678 15,518 19,834 19,748 21,254 23,886-20%Underlying net profit 25,265 14,917 15,312 19,748 21,254 23,886-30%EPS (as reported, FD, HK$) -40%EPS (underlying, FD, HK$) -50%DPS (HK$) SHEETNet tangible fixed assets 26,057 27,294 30,129 30,087 30,032 29,9652011E NAV breakdown by property type Net intangible assets 180,739 186,170 188,110 194,869 203,522 214,546Net working capital 52,768 56,659 58,455 62,929 68,356 73,638Inventories 59,959 64,273 62,999 56,747 52,990 54,425OthersOffice18%16%Accounts receivable 4,066 3,904 2,799 3,551 3,164 2,489Accounts payable -6,889 -3,878 -4,026 -4,745 -6,161 -4,117Net other WC assets - 4,662 -7,662 -3,400 7,294 18,280 20,758HoRetailtelInvested capital 259,564 270,123 276,694 287,885 301,910 318,14912%10%Net other assets 59,873 71,693 52,356 37,583 26,621 24,127Capital employed 199,691 198,430 224,338 250,302 275,290 294,022Net debt / (cash) -30,918 -37,076 -23,066 -10,293 669 3,163Total equity 230,609 235,506 247,404 260,595 274,620 290,859BVPS (HK$) %CASH FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow -260 -253 15,297 15,341 13,947 5,658Net capex 342 1,067 342 275 275 275Free cash flow (FCF) -1,934 -1,202 14,537 14,146 13,007 4,958Divestments / (investments) 4,271 -6,371 112 -550 -550 -550Other investing cash flows 7,912 5,401 5,607 5,299 5,554 5,733Dividends paid -5,368 -5,852 -5,924 -6,557 -7,229 -7,648Share issues / (buybacks) - - - - - -China41%Other financing cash flows -5,070 7,572 - 11,184 -1,035 -3,035 -975Increase / (decrease) in cash 1,827 1,564 4,250 12,773 8,962 2,494Hong Kong59%FCF per share (HK$) ANALYSISUnderlying net margin 46%28%30%26%28%37%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUnderlying %%%%%% 23 November 2010 67
Barclays Capital | Hong Kong Property Developers NEW WORLD DEVELOPMENT (3-UNDERWEIGHT; PT HK$; +11%) 17 HK / We initiate coverage of New World Development with a 3-Underweight rating and a price target of HK$, offering 11% potential upside to the current share price. In our view, Stock Rating New World Development, with over 70% of its land bank completing after 2012, is not 3-UNDERWEIGHT well-placed to capture the near-term high returns and faces higher development risk from Sector View its longer-duration land bank. We prefer peers such as SHKP, Sino Land and Kerry that are 1-POSITIVE well-positioned for this up-cycle, with a front-end loaded, available-for-sale land bank. Price Target HKD Price (22-Nov-2010) Property portfolio HKD Potential Upside/Downside Residential Development +11% Some 70% of New World Development’s developable land bank, not including agricultural land that has yet converted for residential development, is not scheduled for completion Long duration land bank… until after 2012. In this regard, NWD is relatively less able to maximise revenue from residential development versus its peers such as SHKP, Cheung Kong and Sino Land with a front-end loaded land bank, and is also exposed to more development risk, given the longer duration of its land bank. For its residential development business, those sites on which it has committed account for 16% of GAV for development. This value is almost entirely derived from its Hong Kong development portfolio, reflecting the higher HK$ size of Hong Kong projects but also the cautious approach adopted towards China expansion. For the Hong Kong residential development business we estimate that New World Development will complete 938,000 sq ft in 2011, 196,000 sq ft in 2012 and sq ft after 2012. This is not assuming attributable GFA from agricultural land where land premium has not been paid and the Yau Tong redevelopment project. By GFA, its residential development land bank split is 22% urban, with the remaining 78% in the New Territories. However, on a HK-dollar basis, we estimate the current GAV split is approximately 45:55 between urban developments and the New Territories. Investment properties With investment properties located in Central and TST, New World Development does benefit from rising rents in a tight office market, as well as, rising rents on the back of strong retail spending by mainland tourists. Reduction in rental income due However, contributions from rental income is not material, given the size of its portfolio. to NW Centre redevelopment While New World Development’s new shopping centre, K11, is located in TST, it is not located in the prime shopping area around Canton Road. The on-going renovation of New World Centre removes another portion of possible rental income in a prime shopping district. China business Policy overhang continues to weigh on the company’s development prospects in China, as the government continue to actively enforce and introduce new measures to reign in escalating property prices. New World Development’s China property exposure through New World China Land (NWCL) is about 80% in second-tier cities, with the remaining portion in first-tier cities (Beijing, Shanghai and Guangzhou). While second-tier cities are less targeted by property-specific policies, continued liquidity tightening on a national level will likely affect the overall property market. 23 November 2010 68
Barclays Capital | Hong Kong Property Developers Balance sheet Gearing As at the end of June 2010, New World Development’s net gearing was 24%, a figure that we expect to remain the same, as the company will continue to with its redevelopment projects and agricultural land conversions. Valuation Our NAV estimate for New World Development for end-2010 is HK$ per share and for 2011 is HK$. We estimate the stock should trade on a 36% discount to our one-year forward NAV, reflecting our expectation for continued growth in property values over 2012. Price target of HK$ We set our price target at HK$ based upon our ROIC-WACC approach, which implies potential upside from the current share price of 11%, and rate the stock 3-Underweight. Given the longer duration of the company’s land bank, we believe New World Development is exposed to development risk. Risks The key downside risk to our HK$ price target for New World Development are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Execution on its development projects is the key risk for the company. Company profile New World Development Company Limited, through its subsidiaries, develops and invests in properties, provides contracting services, property management, and transportation services. The company also operates infrastructure business, telecommunication services, department stores, hotels and restaurants, and media and technology business. 23 November 2010 69
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Jun, HK$mn)2008200920102011E2012E2013ENew World Development (17 HK)VALUATIONUnderlying P/E (x) -UnderweightP/BV (x) Yield 3%2%2%5%6%6%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 42%62%23%59%59%59%HK$$%EV/EBITDA (x) price discount to NAV -38%-35%-40%-40%-42%-45%Profitability & GrowthNAVNAV per share (HK$) %150%Property type breakdown35%100%Office7%6%7%10%11%11%30%Retail33%29%27%25%24%24%25%50%Residential28%31%28%25%26%25%20%Hotel24%26%28%31%31%32%0%15%Others9%8%9%9%9%8%10%-50%Geographic breakdown5%Hong Kong80%78%78%79%80%80%0%-100%China20%22%22%21%20%20%2008200920102011E2012E2013EGross margin (LHS)Underlying profit growth (RHS)KEY RATIOSReturn & LeverageSales growth 26%-17%24%4%0%6%Underlying profit growth121%-71%104%-28%10%14%50%12%EPS growth 128%-53%168%7%10%14%45%10%Gross margin18%16%26%31%34%34%40%EBIT margin13%10%21%26%28%29%35%8%30%Underlying net margin33%9%25%18%19%21%25%6%Net gearing 31%37%26%18%17%15%20%Net interest cover (x) %15%10%2%INCOME STATEMENT5%Revenue 29,361 24,415 30,219 31,280 31,166 33,0450%0%2008200920102011E2012EGross profit 5,290 4,012 7,982 9,688 10,570 11,345EBITDA 4,652 3,367 7,364 8,937 9,751 10,466Net gearing (LHS)Underlying ROE (RHS)Depreciation & amortisation -967 -911 -994 -959 -954 -925EBIT 3,685 2,456 6,370 7,979 8,796 9,541Share price discount to NAVNet interest income / (expense) -265 -262 -338 -1,334 -1,259 -1,253Net other pre-tax income 4,023 -1,841 4,766 - - -40%Pre-tax profit 14,174 4,191 17,512 9,971 10,891 11,66920%Income tax -1,444 -439 -2,652 -3,724 -3,058 -3,3270%Minority interests -3,056 -1,668 -3,247 -761 -1,804 -1,469-20%Net other post-tax incomeNet profit, 9,674 2,084 11,613 5,486 6,029 6,873-40%Underlying net profit 9,674 2,084 7,663 5,486 6,029 6,873-60%EPS (as reported, FD, HK$) -80%EPS (underlying, FD, HK$) -100%DPS (HK$) SHEETNet tangible fixed assets 43,670 43,412 52,745 51,352 49,963 48,6032011E NAV breakdown by property type Net intangible assets 49,622 50,348 51,473 54,799 58,152 61,533Net working capital 27,275 31,806 45,842 63,489 66,025 68,626OthersOfficeInventories 24,311 30,830 36,468 36,468 36,468 36,4689%10%Accounts receivable 18,898 20,915 16,815 23,995 25,191 26,176Accounts payable - 20,656 -21,421 -23,961 -20,521 - 20,209 -20,794Net other WC assets 987 - 3,640 14,088 21,115 22,143 24,343Invested capital 120,567 125,566 150,060 169,639 174,139 178,761RetailHotel25%Net other assets 55,161 64,300 67,090 75,254 74,726 72,32331%Capital employed 65,405 61,266 82,970 94,385 99,413 106,438Net debt / (cash) -29,401 -36,218 -28,720 -21,215 -20,687 -18,285Total equity 94,806 97,484 111,690 115,600 120,100 124,722BVPS (HK$) %CASH FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow -2,827 -6,749 5,919 -4,929 4,685 6,941Net capex 6,112 3,421 -8,379 -11,174 -5,120 -7,375Free cash flow (FCF) -8,939 -10,170 14,298 6,245 9,805 14,316Divestments / (investments) -7,152 857 42 16,103 435 435China21%Other investing cash flows 3,868 2,470 2,419 - - -Dividends paid -1,437 -1,722 -2,046 -2,336 -3,333 -3,719Share issues / (buybacks) - - - - - -Other financing cash flows 4,860 6,092 3,156 -1,334 -1,259 -1,253Increase / (decrease) in cash 3,423 4,370 1,110 -3,669 -4,592 -4,972FCF per share (HK$) ANALYSISHong Kong79%Underlying net margin 33%9%25%18%19%21%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUnderlying %%%%%% 23 November 2010 70
Barclays Capital | Hong Kong Property Developers KERRY PROPERTIES (1-OVERWEIGHT; PT HK$; +20%) 683 HK / We initiate coverage of Kerry Properties with a 1-Overweight and a price target of HK$, offering 20% potential upside to the current share price. Kerry’s short-Stock Rating duration, premium urban residential development pipeline in Hong Kong places it as 1-OVERWEIGHT one of the best positioned developers in our coverage universe to capture returns from Sector View the current Hong Kong property up-cycle. 1-POSITIVE Price Target HKD Property portfolio Price (22-Nov-2010) HKD Prefer its Hong Kong short duration premium unban residential pipeline Potential Upside/Downside In our view, Kerry has a balanced property portfolio both by location and by property type. +20% At present, the company has an attributable land bank of GFA62mn sq ft, with 24% or GFA15mn sqft in Hong Kong, and rest mainly scattered in 14 China economically advanced cities, among which Shenyang, Hangzhou, Chengdu, Shanghai are major ones. Short duration, urban and upper By location, we estimate 60% of its 2011E NAV exposure is Hong Kong, 37% China and 3% end land bank tick all the right overseas. By property type, it is 42% residential, 21% retail, 19% office and 18% others. boxes Diversity of its portfolio is one of the company’s strategies. Kerry maintains a proportion of upper-end investment properties so as to strengthen its recurrent income base. We like Kerry’s high-end, urban residential development positioning and consider its near-term development pipeline will allow it to benefit from the demand from the equity-rich sectors of the market chasing the upper rungs of the housing ladder. The company has a sq ft residential attributable land bank under development. Its Wong Tai Sin Project is its major launch for 2011 and we expect the company to price at significant premium to the older surrounding property in the area. The project is forecast to bring in HK$ sales in 2011E/12E. In 2012 Shan Kwong Road Project in Happy valley will be launched and we estimate sales of HK$ for 2011E/12E. In 2012, Wilmer Street project in Sheung Wan, and Yuk Yat Street project in Kowloon are on launch plan. In Aug 2010, Kerry acquired Kowloon Tong land plot at the land cost of HK$, or HK$16,587psq ft. Assuming a 3-4 years development cycle, the launch of new acquisition could be in the next 16-28 months. The risk however, is that the company continues to be aggressive buyers of land, extending the duration of its land bank. We would look for a selective land buying approach over the next 12 months. Kerry has an investment property land bank of GFA12mn sqft in HK, 6% residential, 15% commercial, 7% car parks, and 71% ware houses and logistic centres. We estimate a 2011E GAV (gross asset value) of HK$35bn for Kerry’s investment properties or 32% of total portfolio, employing a cap rate ranging from 4% to 7%. China policy overhang Kerry has about 70% attributable land bank exposed to China, and about one-third is residential development. Two key projects in 2010E are Hangzhou Parkview Residence and Chengdu Arcadia, and in 2011, the company will launch Hangzhou Parkview phase 3 and Changsha project phase. In this round of tightening, Hangzhou is one of the 14 home purchase restriction cities, which we think will slow down Parkview’s selling pace. We estimate Hangzhou Parkview contributes 24%/30% to mainland presale in 2010E/11E. 23 November 2010 71
Barclays Capital | Hong Kong Property Developers …commercial rental recovery… Commercial properties have seen continuous recovery since 2Q2009. In October, Beijing commercial price rose 35% y/y, and Shanghai, Hangzhou, Shenzhen and Chengdu have also seen commercial property price increases. Shanghai Kerry Parkside will launch its retail part in 4Q2010 and the office in 1H2010. The management expects an 8-10% gross yield on historical cost and 5-10% rental growth in 2011E. As of October, Kerry had pre-let 40% of the retail space and 25% of the office space. Shangri-la (0069 HK) facilitates land acquisitions in China The partnership with Shangri-la, the well-known hotel brand, provides Kerry with advantages in acquiring land in China. 5-star hotels are favourable image projects that most local governments would like to have built within their cities. Usually, the developer of a 5-star hotel would receive some preferential treatment terms of in land acquisition and taxation. Hence, we see the Shangri-La brand as an opportunity for Kerry to acquire quality sites in China. Balance sheet By 1H10, its net gearing was at 21%. Management expects HK$4bn core capex on investment properties and other costs. Without new land acquisition, we forecast net gearing of 18% and 11% in 2010-11E, respectively, and interest coverage (gross interest charges before capitalization/EBITDA) of 15x and 13x, respectively. Valuation Price target of HK$ Our NAV for Kerry for end-2010E is HK$ per share and HK$ for 2011E. We estimate the stock should trade on a 28% discount to our one-year forward NAV, narrower than the long-term average 33%, reflecting our expectation for continued growth in property values in the next 18-24 months. We set our price target at HK$ based upon our historical NAV discount and ROIC-WACC approaches, which implies potential upside from the current price of 20%, and rate the stock 1-Overweight. In our view, regardless of whether Kerry intends to sell the properties or not, investors need to take account of the potential LAT liabilities inherent in holding commercial property in China. We estimate the present value of the potential LAT liabilities for Kerry’s China properties could amount to HK$ (HK$ per share), 7% of our 2011E NAV estimate. Risks The key downside risk to our HK$ price target for Kerry Properties are from: a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. The main near-term risk to our forecast is the company’s ability to successfully sell its Wong Tai Sin development. 23 November 2010 72
Barclays Capital | Hong Kong Property Developers Company profile Starting its business in Hong Kong in 1978, Kerry properties has accumulated 32 years’ experience in property investment and development. At present, its main business includes: 1) property investment, development and relevant services; 2) logistics, including warehouses, freight and integrated services; and 3) infrastructure. Kerry has expanded its foot print from Hong Kong to Greater China and Australia and Philippine. Listed in Hong Kong Exchange in Aug 1996, it has grown into one of top property investment and development companies in Hong Kong, focusing on luxury residential, mixed-used commercial developments and warehousing portfolio. Kerry’s overall strategy is to maintain its flexibility and diversity, and continue to invest in China and Hong Kong. Kerry properties Ltd is a subsidiary of Kuok Group. The parent, who holds 53% of Kerry, is one of the largest diversified conglomerates in Asia, covering commodities trading, property development and investment, warehouse and logistics operations, hotel, media, plantations, shipping, financial services and insurance, founded by Malaysia richest man, Mr. Robert Kwok Hock Nien. Under the group, there are over 10 listed companies, such as Kerry properties (683 HK), Shangri-la (69 HK), SCMP (583 HK). 23 November 2010 73
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Dec, HK$mn)2007200820092010E2011E2012EKerry Properties (683 HK)VALUATIONUnderlying P/E (x) - OverweightP/B (x) yield 1%6%2%2%2%2%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 52%46%48%31%31%31%HK$$%EV/EBITDA (x) price discount to NAV 19%-81%-24%-32%-40%-48%Profitability & GrowthNAVNAV per share (HK$) %60%Property type breakdown50%29%OfficeNANA17%18%19%20%40%28%30%RetailNANA18%20%21%22%27%20%ResidentialNANA50%45%42%38%26%10%Hotl6725%0%OthersNANA10%12%12%12%24%-10%Geographic breakdown23%-20%Hong Kong54%49%50%59%59%59%2007200820092010E2011E2012EChina41%47%47%37%37%38%Overseas5%3%3%3%3%3%Gross margin (LHS)Underlying profit growth (RHS)KEY RATIOSReturn & LeverageSales growth 23%5%-1%54%-2%24%Underlying profit growth-12%-14%-4%56%32%9%50%8%EPS growth -17%-18%-4%56%32%9%7%Gross margin27%29%29%25%26%28%40%6%EBIT margin25%28%27%24%25%27%30%5%Underlying net margin21%17%17%17%23%20%20%4%Net gearing 18%23%16%18%11%0%3%Net interest cover (x) %2%0%1%INCOME STATEMENTRevenue 12,496 13,116 12,938 19,884 19,576 24,238-10%0%2007200820092010E2011E2012EGross profit 10,962 11,970 11,540 14,043 14,595 16,796EBITDA 3,336 3,834 3,768 5,044 5,099 6,703Net gearing (LHS)ROE (RHS)Depreciation & amortisation -187 -221 -222 -212 -224 -234EBIT 3,149 3,613 3,546 4,832 4,875 6,469Share price discount to NAVNet interest income / (expense) -179 -182 -1 -115 -132 -9360%Net other pre-tax income 4,926 1,029 3,289 1,088 1,338 63240%Pre-tax profit 7,896 4,459 6,834 5,805 6,081 7,00720%Income tax -1,015 -1,086 -1,918 -2,062 -1,412 -1,601Minority interests -318 -323 -525 -391 -257 -6040%Net other post-tax income - - - - - --20%Net profit, 6,563 3,051 4,391 3,352 4,412 4,802-40%Underlying net profit 2,590 2,229 2,146 3,352 4,412 4,802-60%EPS (as reported, FD, HK$) -80%EPS (underlying, FD, HK$) -100%DPS (HK$) SHEETNet tangible fixed assets 49,530 56,613 52,143 55,932 59,208 61,9732011E NAV breakdown by property type Net intangible assets - - - - - -Net working capital 3,957 6,445 10,275 10,570 8,741 5,333OthersInventories 5,988 6,752 14,978 14,165 13,355 9,68211%OfficeAccounts receivable 2,732 3,903 2,631 4,971 4,894 6,060Hotel19%7%Accounts payable 4,330 3,534 5,937 7,167 8,110 9,009Net other WC assets -432 -676 -1,398 -1,398 -1,398 -1,398Invested capital 53,487 63,058 62,418 66,502 67,949 67,307Net other assets 4,442 1,424 4,417 4,597 5,426 5,279RetailCapital employed 57,930 64,482 66,835 71,099 73,375 72,58621%Net debt / (cash) 8,773 11,939 9,241 10,762 7,364 -155ResidentialTotal equity 49,157 52,544 57,594 60,337 66,011 72,74142%BVPS (HK$) FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 1,104 1,074 5,268 2,571 5,384 8,416Net capex -7,853 -4,604 -2,296 -4,000 -3,500 -3,000Free cash flow (FCF) -6,749 -3,530 2,972 -1,429 1,884 5,416Overseas3%Divestments / (investments) 2,732 2,451 1,955 908 509 779Other investing cash flows - - 1,748 -1,535 - - -Dividends paid -390 -1,345 -999 -1,000 1,005 1,324Share issues / (buybacks) 4,147 - 24 - - -China38%Other financing cash flows 1,832 3,900 50 - - -Increase / (decrease) in cash 1,572 -273 2,467 -1,521 3,398 7,519Hong KongFCF per share (HK$) - - - %DUPONT ANALYSISUnderlying net margin 21%17%17%17%23%20%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUnderlying %%%%%% 23 November 2010 74
Barclays Capital | Hong Kong Property Developers HANG LUNG PROPERTIES (3-UNDERWEIGHT; PT HK$; -4%) 101 HK / We initiate coverage of Hang Lung Properties with a 3-Underweight rating and a price target of HK$, offering 4% potential downside to the current share price. The Stock Rating company’s high-end inventory of urban developments is well placed to sell into the rising 3-UNDERWEIGHT market, in our view. However, we believe too much expectation is priced into the stock Sector View for execution on its China strategy. In addition, we think investors have largely ignored 1-POSITIVE its potential LAT liabilities, which could account for up to 7% of our NAV estimate. Price Target HKD Price (22-Nov-2010) Operational outlook HKD HLP has a total land bank of GFA 39mn sq ft, composed of: 1) China: 7mn sq ft GFA Potential Upside/Downside completed and 22mn GFA under development; 2) Hong Kong investment portfolio: 8mn -4% sq ft GFA and 3) Hong Kong high-end residential development 2mn GFA. Clear focus and solid record in China retail property sector We like the China strategy… In the long term, we believe the company will focus on commercial properties, especially retail, in mainland China. The company has a clear strategy and execution plan to launch five upcoming projects in the pipeline (one each year), of which 90% will be retail – Parc 66 in Jinan, Forum 66 in Shenyang, Center66 in Wuxi, Riverside 66 in Tianjin and Olympia 66 in Dalian. The prototypes of the upcoming projects are Plaza 66 and Grand Gateway in Shanghai, with a solid track record in mainland. We estimate China rental revenue will surpass that of Hong Kong in 2013E, once there are more completed projects in the mainland. Jinan Parc66 is the next launch after Palace 66 in Shenyang. The shopping mall will open in September 2011. The company is asking for a rental rate of HK$25psf/month, net of service charge, a similar level to Palace 66, and its positioning will be similar to the Grand Gateway. Target occupancy by end-2010 is 80%, and 90% by the opening in 3Q2011. However, market expectation on rental too optimistic …however, we think the market We estimate the company’s Hong Kong portfolio and China completed investment is too optimistic on execution… properties will contribute HK$97bn to end-2011E NAV. Stripping out these two parts, current market cap of HLP implies a market value of HK$33bn for China investment properties under development, ie the five projects in the pipeline (mentioned above). Adding the outstanding capex of HK$27bn, investors are paying HK$60bn, or an ASP HK$2,685psf, comparable to current prices for Shanghai retail property. Applying the company’s expected net rental income of HK$13-14 psf for Parc 66 to all the centres under development would imply that at a value of HK$60bn, investors are assuming a -6% cap rate on the new China property developments. This would appear relatively aggressive, in our view, especially as the book value is based upon an 8%, cap rate. Potential NAV enhancement from acquisition immaterial in the near term HLP budgets HK$6bn for land acquisition in the next four years. Assuming it acquires 20mn sq ft GFA at a land cost of HK$300psf, similar to the average of the existing mainland portfolio, the NAV enhancement to current NAV would be HK$ (HK$), or 5% of existing NAV. 23 November 2010 75
Barclays Capital | Hong Kong Property Developers Balance sheet Due to the extreme long cycle necessary to develop commercial properties in China, HLP tends to keep a conservative balance sheet with a target of no more that 15% gearing. The company expects to spend capex of HK$15bn over the next four years, with an expected total construction capex of HK$28bn outstanding to fund completion of the five upcoming projects in the mainland. Besides the construction, HLP has a budget of HK$6bn for land acquisition in the mainland. Funding sources will be the pre-sale of Hong Kong residential developments. Management expects to reap HK$20bn from Happy Valley villa project, and HK$16bn from inventory of the Harbour side, and the Long Beach, adding up to HK$36bn. Adding the net proceeds from the recent placement of HK$, the financial resources amount to HK$47bn, well exceeding the existing capex plan, and hence we expect gearing to remain relatively low. Valuation Our NAV is HK$ share for end-2011E, reflecting an increase of 12% over our end-2010E NAV per share of HK$. Price target of HK$ Using the long-term average + standard deviation approach, we estimate the stock should trade at 1% premium to its 2011E NAV at HK$. We prefer a forward-looking NAV discount (ROIC-WACC) method, and think the stock should trade at a 4% premium to 1-year forward NAV. This reflects a 4% cyclical return in our ROIC-WACC spread approach and assumes 0% structural discount for the management. Based on the forward looking approach, we set our price target at HK$ per share, which implies 5% potential downside from the current price and we rate the stock 3-Underweight. In our view, regardless of whether the company intends to sell the properties or not, investors need to take account of the potential LAT liabilities inherent in holding commercial property in China. We estimate the present value of the potential LAT liabilities for HLP’s China investment properties could amount to HK$ (HK$. per share), 7% of our 2011E NAV estimate. Risks The key upside risk to our HK$ price target for Hang Lung Properties is that it achieves higher-than-expected rents on its China developments and acquires a number of new projects in China which would increase its NAV. 23 November 2010 76
Barclays Capital | Hong Kong Property Developers Company profile Hang Lung Properties is one of the well-known property developers in Hong Kong. The company started its foot print in the mainland from Shanghai in the 1990s. At present, it continues to operate investment properties, and develop high-end residential in Hong Kong, mainly in Hong Kong Island and Kowloon. Also it expended coverage in mainland to six cities, namely Shenyang, Jinan, Wuxi, Tianjin and Dalian. HLP’s strategy is to acquire the best located sites in the city where it entered and employ only the top architectural firms to achieve the highest design quality and develop the best properties. HLP constantly reviews and, where necessary, upgrades the tenant mix, while regularly refurbishing the existing portfolio so as to achieve a maximum return. The company’s long-term vision is to expand in the mainland while continuing to invest in its home market Hong Kong, with the aim of becoming a property developer of the highest quality in both markets. 23 November 2010 77
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Jun, HK$mn)2008200920102011E2012E2013EHang Lung Properties (101 HK)VALUATIONUnderlying P/E (x) - UnderweightP/B (x) yield 5%2%2%2%2%2%Current pricePrice targetPotential upside/(downside)Dividend payout ratio 52%115%42%50%50%50%HK$$-4%EV/EBITDA (x) price discount to NAV -50%24%22%8%-2%-12%Profitability & GrowthNAVNAV per share (HK$) %250%Property type breakdown90%200%80%Office34%28%29%30%30%29%150%70%Retail38%43%42%42%41%41%60%100%Residential26%26%26%27%27%28%50%50%40%Hotl00000030%0%Others2%2%2%2%2%2%20%-50%10%Geographic breakdown0%-100%Hong Kong72%71%68%68%69%69%2008200920102011E2012EChina28%29%32%32%31%31%Gross margin (LHS)Underlying profit growth (RHS)Overseas0%0%0%0%0%0%KEY RATIOSReturn & LeverageSales growth 130%-59%189%-15%6%11%Underlying profit growth209%-55%179%-10%2%13%EPS growth 209%-55%176%-16%2%13%0%9%-5%Gross margin65%83%74%88%90%92%8%-10%7%EBIT margin62%73%71%76%78%79%-15%6%Underlying net margin53%57%55%59%57%58%-20%5%Net gearing -6%-6%-5%-18%-21%-25%-25%4%-30%Net interest cover (x) %-35%2%-40%INCOME STATEMENT1%-45%Revenue 10,080 4,173 12,057 10,219 10,852 12,072-50%0%2008200920102011E2012EGross profit 6,598 3,444 8,982 8,988 9,798 11,046EBITDA 6,244 3,074 8,549 7,827 8,447 9,521Net gearing (LHS)ROE (RHS)Depreciation & amortisation -8 -13 -23 -20 -21 -22EBIT 6,237 3,061 8,526 7,807 8,426 9,499Share price discount to NAVNet interest income / (expense) 131 88 -12 -27 24 42Net other pre-tax income 10,441 3,634 21,388 0 56 77100%Pre-tax profit 16,678 6,695 29,914 7,808 8,483 9,57780%Income tax -2,783 - 1,513 - 6,262 - 1,446 - 1,925 - 2,16360%Minority interests -735 - 1,052 - 1,396 -334 -390 -43040%20%Net other post-tax income - - - - - -0%Net profit, 13,159 4,131 22,256 6,028 6,168 6,984-20%Underlying net profit 5,293 2,389 6,674 6,028 6,168 6,984-40%EPS (as reported, FD, HK$) -60%EPS (underlying, FD, HK$) -80%DPS (HK$) SHEETNet tangible fixed assets 64,844 70,460 96,454 102,985 107,961 112,4992011E NAV breakdown by property type Net intangible assets - - - - - -Net working capital 5,628 4,010 3,141 1,733 1,030 -551Others2%Inventories 6,817 7,683 5,855 4,675 3,634 2,609Accounts receivable 1,366 686 1,494 1,266 1,345 1,496Accounts payable 1,632 1,922 3,076 3,076 2,817 3,524ResidentialOffice27%29%Net other WC assets -923 - 2,437 - 1,132 - 1,132 - 1,132 - 1,132Invested capital 70,472 74,470 99,595 104,718 108,991 111,948Net other assets - 6,087 - 7,124 -11,878 -11,850 -11,819 -11,783Capital employed 64,385 67,347 87,717 92,867 97,173 100,165Net debt / (cash) -4,266 - 3,983 - 4,909 -19,972 -25,136 -32,642Total equity 68,651 71,330 92,626 112,839 122,309 132,806RetailBVPS (HK$) %CASH FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 7,813 2,536 8,923 7,762 7,250 8,981Net capex -1,201 - 2,230 - 3,666 - 6,551 - 4,998 - 4,560Free cash flow (FCF) 6,612 306 5,257 1,212 2,252 4,422OverseasDivestments / (investments) 36 36 36 - - -0%Other investing cash flows 270 833 83 - - -Dividends paid -2,404 - 2,738 - 2,820 2,951 2,912 3,084ChinaShare issues / (buybacks) - - - 10,900 - -32%Other financing cash flows -930 -83 48 - - -Increase / (decrease) in cash 3,584 - 1,646 2,604 15,063 5,164 7,506FCF per share (HK$) Kong68%DUPONT ANALYSISUnderlying net margin 53%57%55%59%57%58%Asset turnover (x) leverage (x) : Company data, Bloomberg, Barclays Capital estimatesUderyng ROE85%4%8%59%5%5% 23 November 2010 78
Barclays Capital | Hong Kong Property Developers HANG LUNG GROUP (3-UNDERWEIGHT; PT HK$; -1%) 10 HK / We initiate coverage of Hang Lung Group with a 3-Underweight rating and a price target of HK$, offering1% potential downside to the current share price. Hang Lung Stock Rating Group is a pure holding company. 3-UNDERWEIGHT Sector View 1-POSITIVE Stub trade Price Target Besides holding a 49% stake in its property arm HLP, the group has a stub asset of HKD investment properties located in Hong Kong and Shanghai. The group may inject the Hong Price (22-Nov-2010) Kong portion into HLP in future, but there is no injection plan for Shanghai Grand Gateway HKD because of the material LAT and as transaction costs may be incurred. Other than the Potential Upside/Downside existing stub assets, the group has no acquisition plans of its own. -1% The stub attributable land bank size amounts to mn sq ft, including six commercial- use investment properties in Hong Kong, Kowloon and the New Territories, and Shanghai Grand Gateway office and serviced apartments.. We estimate end-2011E NAV of the stub at A holding company… HK$, or HK$ per share, 4% of the group’s 2011E NAV. We estimate the end-2011E stub asset GAV at HK$ by subtracting 49% of HLP’s GAV of HK$ from the group’s adjusted GAV of HK$ and assuming a 10% discount. As priced in this report (18 November closing), the enterprise value (EV) of Hang Lung Group ex-HLP is negative. We prefer Hang Lung Group over HLP. Balance sheet The placement diluted the group’s interest in its property arm from 52% to 49%, but as Hang Lung Group will continue to control the financial and operating decision of HLP, the financial results of HLP would still consolidate into those of the group. Based on HLP’s cautious balance sheet management, we expect Hang Lung Group to remain net cash in the next three years with its current capex plan. Valuation Our NAV estimate for Hang Lung Group is HK$ per share for end-2011E, reflecting an increase of 7% over our end-2010E NAV per share of HK$. Price target of HK$ Using the long term average + standard deviation approach, we estimate the stock should trade at a 10% discount to its 2011E NAV . We prefer a forward-looking NAV discount (ROIC-WACC spread) method, and think the stock should trade at 13% discount to 1-year forward NAV. This reflects a 2% cyclical return in our ROIC-WACC spread approach and assumes a 15% structural discount for its holding company nature. Based on the forward-looking approach, we set our price target at HK$, which implies 1% potential downside from the current price, and rate the stock 3-Underweight. In our view, regardless of whether Hang Lung Group intends to sell the properties, LAT is a liability that deserves investors’ attention. We estimate the present value of the potential 23 November 2010 79
Barclays Capital | Hong Kong Property Developers LAT liabilities for Hang Lung Group’s China investment properties would amount to HK$ (HK$ per share), 7% of our 2011E NAV estimate. Risks The key upside risk to our HK$ price target for Hang Lung Group is that it achieves higher-than-expected rents on its China developments and acquires a number of new projects in China which would increase its NAV. Company profile Hang Lung Group is one of the most established listed companies in Hong Kong with 50 years of experience in the property development market. Through its subsidiary, HLP, the Group has built a leading reputation as a top tier property developer in Hong Kong and on the Mainland, with a recognized commitment to quality. By Oct 2010, Chan Family holds 37% of Hang Lung Group. The Group’s businesses in Hong Kong include property development for sale and lease. The substantial portfolio includes well-planned large-scale commercial, office and residential developments in prominent locations. The Group made its first investment on the mainland in the early 1990s as the first step in our future business expansion. Its strategy on the mainland is to develop prime sites in major cities. 23 November 2010 80
Barclays Capital | Hong Kong Property Developers AEJ Equity Property Research(Year end: Jun, HK$mn)2008200920102011E2012E2013EHang Lung Group (10 HK)VALUATIONUnderlying P/E (x) - - UnderweightP/B (x) yield 3%2%1%1%1%1%Current pricePrice targetPotential upside/(downside)Dividend payout ratio -26%65%24%22%22%22%HK$$-1%EV/EBITDA (x) price discount to NAV -56%1%-6%-12%-22%-32%Profitability & GrowthNAVNAV per share (HK$) %200%90%Property type breakdown150%80%Office34%29%29%30%31%31%100%70%50%Retail38%41%41%40%39%39%60%50%0%Residential27%27%27%27%28%28%40%-50%Hotl00000030%-100%Others1%2%2%2%2%2%20%-150%10%Geographic breakdown0%-200%Hong Kong68%66%63%64%64%64%2008200920102011E2012EChina32%34%37%36%36%36%Gross margin (LHS)Underlying profit growth (RHS)Overseas0%0%0%0%0%0%KEY RATIOSReturn & LeverageSales growth 121%-56%168%-14%7%11%Underlying profit growth105%-140%154%16%-22%13%EPS growth 105%-140%152%16%-22%13%50%6%Gross margin67%85%74%89%91%92%40%4%30%EBIT margin63%75%70%76%78%79%2%20%Underlying net margin-35%31%29%40%29%30%0%10%Net gearing -35%31%29%40%29%30%0%-2%Net interest cover (x) -10%-4%-20%INCOME STATEMENT-6%-30%Revenue 10,553 4,696 12,580 10,777 11,514 12,807-40%-8%2008200920102011E2012EGross profit 7,061 3,980 9,352 9,546 10,461 11,781EBITDA 6,611 3,546 8,850 8,251 8,951 10,081Net gearing (LHS)ROE (RHS)Depreciation & amortisation - -15 -24 -22 -23 -24EBIT 6,611 3,531 8,826 8,229 8,928 10,056Share price discount to NAVNet interest income / (expense) -307 -172 -77 -77 -66 -52Net other pre-tax income 11,387 3,825 21,888 2,128 32 3560%Pre-tax profit 17,691 7,184 30,637 10,280 8,894 10,03940%Income tax -3,034 - 1,616 - 6,438 - 1,516 - 2,051 - 2,30320%Minority interests -7,141 - 2,931 -11,795 - 4,473 - 3,492 - 3,9490%Net other post-tax income - - - - - --20%Net profit 7,516 2,638 12,404 4,291 3,350 3,788Underlying net profit -3,648 1,454 3,695 4,291 3,350 3,788-40%EPS (as reported, FD, HK$) -60%EPS (underlying, FD, HK$) -80%DPS (HK$) SHEETNet tangible fixed assets 71,900 77,653 104,129 110,657 115,631 120,1672011E NAV breakdown by property type Net intangible assets 1,064 1,182 1,182 1,182 1,182 1,182Net working capital 5,166 3,637 2,744 1,344 652 -922Others2%Inventories 6,848 7,714 5,886 4,706 3,665 2,640Accounts receivable 1,383 699 1,532 1,312 1,402 1,560Accounts payable 2,184 2,388 3,483 3,483 3,224 3,931ResidentiaOfficelNet other WC assets -882 - 2,389 - 1,191 - 1,191 - 1,191 - 1,19128%30%Invested capital 78,130 82,472 108,055 113,183 117,466 120,426Net other assets - 5,879 - 6,908 -11,784 -11,756 -11,725 -11,689Capital employed 72,251 75,564 96,271 101,427 105,741 108,737Net debt / (cash) 195 622 -894 - 3,485 - 6,954 -12,430Total equity 72,056 74,942 97,165 104,912 112,696 121,167Retail40%BVPS (HK$) FLOW STATEMENT2011E NAV geographical breakdownOperating cash flow 8,012 2,752 9,229 10,159 7,526 9,301Net capex -1,303 - 2,267 - 3,686 - 6,551 - 4,998 - 4,560Free cash flow (FCF) 6,710 485 5,543 3,608 2,528 4,741OverseasDivestments / (investments) 314 190 36 - - -0%Other investing cash flows 84 767 125 - - -Dividends paid -2,017 - 2,247 -976 - 1,017 941 735Share issues / (buybacks) - - - - - -ChinaOther financing cash flows - 1,444 -301 - 2,508 - - -36%Increase / (decrease) in cash 3,647 - 1,106 2,220 2,591 3,470 5,476FCF per share (HK$) Kong64%DUPONT ANALYSISUnderlying net margin -35%31%29%40%29%30%Asset turnover (x) leverage (x) : Company data, Barcalys Capital estimates, BloombergUnderlying %%%%%% 23 November 2010 81
Barclays Capital | Hong Kong Property Developers Valuation Methodology and Risks Hong Kong Property Developers Cheung Kong (Holdings) Ltd. (1 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risk to our price target for Cheung Kong are from: Hutchison’s share price, as it accounts for 51% of our NAV estimate for Cheung Kong; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Hang Lung Group Ltd. (10 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key upside risk to our price target for Hang Lung Group is that it achieves higher-than-expected rents on its China developments and acquires a number of new projects in China which would increase its NAV. Hang Lung Properties Ltd. (101 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key upside risk to our price target for Hang Lung Properties is that it achieves higher-than-expected rents on its China developments and acquires a number of new projects in China which would increase its NAV. Henderson Land Development Co., Ltd. (12 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risk to our price target for Henderson Land are from: risks to our forecasts if the warrants are not converted by June 2011; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Kerry Properties Ltd. (683 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risks to our price target for Kerry Properties are from: in the near term, its ability to successfully sell its Wong Tai Sin development; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. New World Development Co., Ltd. (17 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risk to our price target for New World Development are from: execution on its development projects; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Sino Land Co., Ltd. (83 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. 23 November 2010 82
Barclays Capital | Hong Kong Property Developers Valuation Methodology and Risks <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risks to our price target for Sino Land are from: the company aggressively acquiring land and lengthening its land bank duration; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Sun Hung Kai Properties Ltd. (16 HK / ) <b>Valuation Methodology:</b> Listed property companies are proxies for direct property ownership. Our primary valuation metric is therefore net asset value, where values are determined by reference to a relatively active property market. Our NAVs are then subject to analysis of the discount/premium applied to each company based upon historical trading ranges, a sum-of-the-parts discount approach and an analysis of future returns. Our secondary valuation metric is dividend yield, which is derived from our estimates of earnings per share. <b>Risks which May Impede the Achievement of the Price Target:</b> The key downside risks to our price target for SHKP are: any impact on share ownership from changes in the family trust structure; a rise in US and China interest rates that are not currently assumed in our forecast; a material change in our property price forecasts; changes in government policy that could materially affect the market outlook and the operations of the company; and changes in the economic growth contained within our forecasts. Source: Barclays Capital 23 November 2010 83
Barclays Capital | Hong Kong Property Developers ANALYST(S) CERTIFICATION(S) We, Andrew Lawrence, Jonathan Hsu and Wendy Luo, hereby certify (1) that the views expressed in this research report accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, isor will be directly or indirectly related to the specific recommendations or views expressed in this research report. IMPORTANT DISCLOSURES CONTINUED For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report,please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to or call 1-212-526-1072. The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's totalrevenues, a portion of which is generated by investment banking activities. Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSERule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’s September 20, 2008, Barclays Capital acquired Lehman Brothers' North American investment banking, capital markets, and private investmentmanagement businesses. All ratings and price targets prior to this date relate to coverage under Lehman Brothers Inc. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in othertypes of research products, whether as a result of differing time horizons, methodologies, or otherwise. <b>Primary Stocks (Ticker, Date, Price)</b> Cheung Kong (Holdings) Ltd. (, 22-Nov-2010, HKD ), 2-Equal Weight/1-Positive Hang Lung Group Ltd. (, 22-Nov-2010, HKD ), 3-Underweight/1-Positive Hang Lung Properties Ltd. (, 22-Nov-2010, HKD ), 3-Underweight/1-Positive Henderson Land Development Co., Ltd. (, 22-Nov-2010, HKD ), 2-Equal Weight/1-Positive Kerry Properties Ltd. (, 22-Nov-2010, HKD ), 1-Overweight/1-Positive New World Development Co., Ltd. (, 22-Nov-2010, HKD ), 3-Underweight/1-Positive Sino Land Co., Ltd. (, 22-Nov-2010, HKD ), 1-Overweight/1-Positive Sun Hung Kai Properties Ltd. (, 22-Nov-2010, HKD ), 1-Overweight/1-Positive <b>Guide to the Barclays Capital Fundamental Equity Research Rating System:</b> Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the “sectorcoverage universe”). In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone. <b>Stock Rating</b> <b>1-Overweight</b> - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. <b>2-Equal Weight</b> - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe overa 12-month investment horizon. <b>3-Underweight</b> - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon. <b>RS-Rating Suspended</b> - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting inan advisory capacity in a merger or strategic transaction involving the company. <b>Sector View</b> <b>1-Positive</b> - sector coverage universe fundamentals/valuations are improving. <b>2-Neutral</b> - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating. <b>3-Negative</b> - sector coverage universe fundamentals/valuations are deteriorating. Below is the list of companies that constitute the "sector coverage universe": Hong Kong Property Developers Cheung Kong (Holdings) Ltd. () Hang Lung Group Ltd. () Hang Lung Properties Ltd. () 23 November 2010 84
Barclays Capital | Hong Kong Property Developers IMPORTANT DISCLOSURES CONTINUED Henderson Land Development Co., Ltd. () Kerry Properties Ltd. () New World Development Co., Ltd. () Sino Land Co., Ltd. () Sun Hung Kai Properties Ltd. () <b>Distribution of Ratings:</b> Barclays Capital Inc. Equity Research has 1647 companies under coverage. 43% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 52% ofcompanies with this rating are investment banking clients of the Firm. 43% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 46% ofcompanies with this rating are investment banking clients of the Firm. 12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 37% ofcompanies with this rating are investment banking clients of the Firm. <b>Barclays Capital offices involved in the production of equity research:</b> London Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Capital Japan Limited (BCJL, Tokyo) São Paulo Banco Barclays . (BBSA, São Paulo) Hong Kong Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong) Toronto Barclays Capital Canada Inc. (BCC, Toronto) Johannesburg Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg) 23 November 2010 85
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