Champion Real Estate Investment Trust (2778) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to Champion REIT's Analyst Briefing for 2022 Interim Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speakers today, Ms. Christina Hau, Chief Executive Officer; and Ms. Amy Luk, the Investment and Investor Relations Director. Thank you. Please go ahead.

Hi, everyone. This is Christina. Good afternoon. Thank you all for attending our 2022 interim results analyst briefing. Together with Amy, who is also on the line, we would like to welcome you all, and thank you for all your continued support. The past 6 months remained a challenging period for us in the face of pandemic and volatile market conditions. Nonetheless, we're determined to stand firm and weather the challenges with our stakeholders together. To kickstart, I would like to pass this time to Amy to walk you through the 2022 interim results highlights. And I'll continue with the property portfolio and wrap up with the outlook of Champion REIT. Amy, please?

Hi, everyone. This is Amy. In the first half of 2022, the prolonged and tightened social distancing measures attributed by the fifth wave of COVID-19 pandemic has further dampened the already subdued leasing activity and our properties portfolio performance. Negative brand reversion was recorded for both office and retail properties. Our total rental income dropped 5% to HKD 1.1696 million -- sorry, HKD 1.196 billion. And net property income fell 8.2% to HKD 1.044 billion, and our DPU dropped 11.1% to HKD 0.1064. And despite the improvement in tenant sales and footfall after the relaxation of social distancing measures in April, the 3-month mandatory closure of business centers and building centers has particularly posed a significant impact on our tenant operations for the reporting period. And then on the next page, Page 3. Looking at the rental income breakdown by property, both Three Garden Road and Langham Place Mall recorded a drop, mainly due to negative rental reversion with Three Garden Road falling 6.2% and Langham Place Mall dropping 6%. And for Langham Place Office, the high average occupancy offset the impact of negative rental reversion resulted in an increase of 1.6% in rental income. And the turnover rent portion for the REIT increased to HKD 51 million, mainly due to contribution from Langham building. And for the financial position of Champion REIT, our financial position remains stable on the challenging market conditions. Total property valuation dropped slightly to HKD 64.8 billion, mainly because of the lower rental rate assumptions. There's no change in cap rates for all the properties. And the NAV per unit decreased to HKD 8.50. And the chart on the right-hand side shows the debt maturity profile for the MTN and bank loans maturing next year. Undrawn commercial facilities amounted to HKD 3.7 billion is available for the refinancing. Average interest rate was 2.4% for the first half of 2022. Tax rate debt portion was 67.6% at the end of June 2022. The gearing ratio stayed at a comfortable level of 22.3%. Now Christina will go over the performance breakdown of each of our properties.

Thanks, Amy. So for Three Garden Road, the pandemic has been impacting the leasing momentum of Three Garden Road. Many tenants have switched back to the work-from-home arrangement under the fifth wave of COVID. Our demand from financial industry has weakened, along with the tenant relocation and downsizing resulted in a drop in occupancy to 83.8%. We observed that the footfall at Three Garden Road has gradually improved since late April and getting close to pre-COVID level. Banking and asset management sectors remain a major component of the property. For the central office supply situation, I think most of you might notice upcoming supplies in the district. This has made the leasing market even more challenging together with abundant existing available space in the market. Rental has been under pressure in renewals and the passing rent of the property went down to HKD 103.4 per square foot. And for the lease expiry, there is not a lot to handle in the coming 2 years. The 28.7 in the pink bar represents tenants under rent review where their leases will expire in later years. For leases expiring next year and [indiscernible], the average rent they are paying is higher than the current market rate. For Langham Place Office. Even though the fifth wave of the pandemic forced the medical, beauty and health care tenants to suspend their business, rental income of the property was more resilient than others. Beauty occupiers put their expansion and net start-up decision on hold, but occupancy rate was not significantly affected, moderately lower to 94.5%. Regarding tenant profile. Lifestyle-related tenants still took up the majority part, representing 69% of the property area. Inquiries and site inspection request from beauty and medical segments have improved gradually. The office rentals were under pressure amid the market standstill, causing rents slightly dropped to HKD 64.3 per square foot in June. Only a small percentage of tenants will have their leases expired in the second half of this year. The government's temporary protection measures for business tenants, which came into effect on the 1st of May, allowed some specified tenants to defer their rent. The office rental collection rate has been affected for a short period of time, but we are pleased to see that the situation gradually improved after their businesses resumed in April. And about the performance of Langham Place Mall. We are glad that the mall remained fully occupied despite the challenging retail market. Yes, it's not surprising to see retailers, in general, were staying cost-conscious when they make any decision on needs renewal or business expansion. As the pandemic situation becoming more contained, traffic of the mall rebound, but overall footfall was still 18.8% below that of last year. Retail sales of tenants improved after the relaxation of social distancing measures, yet for the first half, it underperformed in the Hong Kong retail market in the lack of tourist spending. The proportion of tenants paying turnover rent only dropped to 9.9% of the mall area. The average passing rents dropped to HKD 154.5 per square foot. The base rent portion dropped to HKD 253 million, resulting from the dual effect from negative rental reversion and nominal base rent structure of Langham building. The rental structure also contributes to the growth in turnover rent portion to $51 million. Compared with early 2020 when pandemic began, the rent to sales level was more affordable now. So the rental concession and support this time around was immaterial. To maintain the attractiveness of the mall, especially in phase of the [indiscernible], we continue to diversify our tenant portfolio to attract shoppers. Here are some samples of new tenants ranging from [ S&P ], Personal Care, Concessionary Gadgets to fashion sectors. We are pleased to introduce some new concept stores such as combining hair salon with cafe, Hair Corner and a brand-new store of top-quality and nutritious food for children, [indiscernible]. In order to boost some more sales and break footfalls, online and offline marketing promotions were launched. Starting with the e-stock promotion on the top left corner, we partnered with over 30 tenants who provided discount coupons and exclusive offering. The campaign was a success with products being sold out in a short period of time. To capitalize on the government consumption voucher scheme in April, we came up with an attractive 200 sales retailers [indiscernible] to cross over top-up stores featuring one of the hottest boy brand members [indiscernible] and rising character customizations were organized. Both of them drove large crowds and social media [indiscernible] local consumption and traffic. For Langham Beauty, throughout the marketing campaigns were also increased. Beauty brands has invested in dedicated PR event and marketing promotions to [indiscernible] and to cope with the latest round of consumption voucher scheme, they have built the over up to 81 discounts -- 81% discount and exclusive premiums to our shoppers. And we are pleased to share that 2 brands, [indiscernible] and Tokyo Lifestyle joined our Langham Beauty family recently. They have further enhanced the offerings to the customers. For sustainability, while we are making steady progress in achieving our 2030 ESG target, some particular achievements in social and climate resilient aspects were worth mentioning. On the social side, we addressed our stakeholders' need on wellbeing during this period. The monthly flagship Music Life concept came back recently to take all participants to their retrospective music journey at Three Garden Road. Stretching and singing workshops were held earlier to provide an immersed and moving experience for both our staff and tenants at the community level. We donated anti-pandemic gift packs [indiscernible] customers during the fifth wave of pandemic for [indiscernible] immediate assistance. Efforts in governance and carbon reduction initiatives were made to enhance our climate resilience level. Apart from establishing the climate risk and resilience policy, more solar panels and EV charging stations will be installed at our properties to amplify the positive environmental impact. For the outlook, even with the progressive easing of social distancing measures, their geographical, tensions, global inflation, interest rate hike and potential global economic recession make the overall recovery cost of the economic -- economy remain certain. For Three Garden Road, we expect the pressure on rental level and occupancy to continue in view of the available existing office space and upcoming supplies in Central. For Langham Place Office, while interest from beauty and health care segments have improved, traditional office tenants might opt for lower-cost alternatives. It also faces challenges in occupancy and market rent. For retail, though we can observe signs of recovery in tenant sales lately, the far below pre-COVID tourism levels and the conservative approach taken by the tenants in lease renewal for new setups due to the fluctuating pandemic situation would probably keep the rental income in a downward trend. Having said that, we cope with the dynamic market environment. We'll continue to absorb a flexible leasing strategy to maintain our portfolio confidence for retaining our tenants. Overall, the downside on rental income and DPU will remain. About liabilities management, we have undrawn committed credit facilities available for the refinancing needs next year. Under the rising interest rate environment, we will closely monitor the market situation. For M&A, we maintain a prudent approach on reviewing the global investment opportunities under the slow macro environment. We'll end our presentation here, and I'll open the line for Q&A. Thank you.

[Operator Instructions] We have our first question comes from the line of Jeffrey Mak from Morgan Stanley.

I have a question on the Three Garden Road. I'm just wondering how is the inquiry levels recently following the relaxation of social distancing measures and also the quarantine requirements. And also, will there be any change in your leasing strategy given that the occupancy rate has dropped a bit further and also 2 new buildings in Central are coming up in 2023?

Thank you for the questions. Indeed, the ripple effect of the business rates continued, and the overall market is quite quiet recently, not only for Central, but the overall in Q2, there is an overall negative [indiscernible] in the whole Hong Kong market portfolio. And still, we remain at -- the border to China is also still remains closed. So it is a very difficult for new tenants travel to Hong Kong to visit the premises to make their decision. So we do see the situation may continue for a while. And in terms of the leasing strategy, we have been emphasizing that we will be very flexible on the leasing terms and try to retain our existing tenants as far as possible while -- to grab new tenants into Three Garden Road.

[Operator Instructions] Our next question comes from the line of Mark Leung from UBS.

Actually, my question will be regarding on the footfall of Langham Malls. Because I think you mentioned the footfall recovery rate was down by maybe like 19% below 2021 level. Therefore do you -- what was the reason behind it from your perspective? And from a tenant mix reshuffle perspective, do you think we need to further localize the mall to fight for a better recovery for foot traffic? I think that's the first question. And second question is, not sure, can you give us the margin guidance outlook going forward because I think we have a kind of like overall flat to hop-on half margin outlook, but how should we look on the NPI margin in the second half of this year?

Mark, it's Amy here. Maybe I just answer your question about the margin first. So if you are basically looking, say, in the past results margin, usually, the second half is usually a bit more of expenses incurred, and then we expect that comparing to next year because of the operation expense of Langham Building, we expect that, that will be lower than last year.

So on the footfall of the mall, recently we did see very good rebound in July and August. The 90% growth is mainly due to the fifth wave. So Q1 is the worst and then the footfall gradually picked up since April up till now. Regarding the tenant mix of the mall, we do see some of the brands. Indeed, they have some expansion plans for their new brands coming in Hong Kong that will try to grab those good tenants to the mall. So it's a good time, although the rent-to-sales ratio now becoming more reasonable is a good time to capture those opportunities to grab our quality tenants to the mall, which has more potential as the upside. So although this is a downtime for the whole retail market in Hong Kong, we do see there's a good chance to reshuffle and improve our tenant mix overall. So that's why in the first half we have introduced more gadgets like Sony into the mall, and we replaced a McDonald by the Hair Corner, with a successful launch, plus a cafe concept. So we'll continue to refine our retail portfolio.

Our next question comes from the line of Percy Leung from DBS.

I have 2 questions. Could you comment on the recent [indiscernible] in Three Garden Road? And how does it compare to 6 months ago? Secondly, regarding your hedging ratio, is there any expiry in the coming 1 to 2 years? How should we expect the ratio going forward?

Percy. And for the hedging ratio, we are now 67.6%. And therefore, the maturity of that next year, all of it is fixed rate debt. So after that refinancing, maybe there would be a little bit decline in the fixed rate debt ratio. But overall, we monitor the market situation very closely, and we will be looking for opportunities, say, to have a more balanced [indiscernible] rate ratio for the debt profile. And regarding the spot rent of Three Garden Road, Basically, it's pretty much quite similar to like 6 months ago. It has been staying at the 90-level per square foot for a while and overall market has been [indiscernible] management. But on the rental rate that we are achieving has been quite stable at the 90-level.

We'll now take the next question from Will Chu of CIMB.

I have 2 questions. First is regarding your [indiscernible]. It seems that you have slowed a bit [indiscernible] expansion. May I know if there is any change in your preference in the location and the property type and also the size of your ongoing M&A. This is the first question. Second question is about your investment portfolio. I remember that last year you made some impairment provisions on some of your holdings and your -- some Chinese developers malls. And based on your latest numbers, you seem to hold some investment in these mall. So do you think there would be any need to make [indiscernible] provisions on your investment portfolio?

Okay. For the question on the investment portfolio. Basically, last year, we have already made some provisions for the investment in China, probably bonds and this year a little bit more. And right now, majority of the bond portfolio is investment grade. And -- but you're right, we're still holding a little bit of [indiscernible] on investment-grade points. So whether there will be further say allowance for credit loss to be made, it depends on the market situation. And we keep monitoring on the market update in the sector. Regarding the M&A, we did not change our strategy. We're still looking for the prime location, a good project in [indiscernible] cities. So basically, we are still looking. We know the market is quiet, some core key projects -- we're not available for sale at this moment. But we are very open, and we study if opportunities arises.

[Operator Instructions] Our next question comes from the line of Peter Young of Goldman Sachs.

Peter from Goldman. I have 3 questions. So the first is regarding the dividend payout. So could you guide because last year second half we kind of lowered the payout ratio. So could you guide for this year second half? How should we think about the payout? And the second question is regarding the rental relief at the Langham Place Mall, could you share how much you have given in the first half? And whether that's amortized or expense? And finally, for Three Garden Road, could you share when do we expect the rental reversion to turn positive, perhaps maybe next year or 2024? That's all of my questions.

Peter, regarding dividend payout in the interim, we used to pay 90% in cost. And for the second half of the year, for full year dividend or distribution, payout will be like depending on the final decision when it comes with the final results announcement. So I'm sorry that we cannot really give you an answer at this moment. Regarding the rent concession, renting to our tenants for this year, we do see there is improvement in rental sales ratio over the past years. So this year, the amount of rental concession we're giving to our tenants are very, very minimal. It's very low single digits, so it did not affect overall our total rental income. But we do support tenant in other forms, such as marketing, such as payment by installment, for example, the office tenants that were affected by the closure. So we did some arrangement on that. And regarding the Three Garden Road outlook, we do not have a, first of all, it really depends on the market, the overall economic situation in Hong Kong, when the borders will be opened, when people can move around and more investors coming to Hong Kong. And honestly, we don't have this crystal ball. And we do also want to know.

We have next question from the line of Fan Tso from Bank of America.

I just wanted to ask the expiring rent for free guidance next year. Because I remember the spot rent 3 years ago probably as high as HKD 110 to HKD 120 or could be even higher. I just wanted to get a sense if the expiring rent next year is close to that level?

Fan, yes, you are correct. It is signed at relatively high rent comparing to the market rent right now. So for expiring rents in 2023 is about HKD 120.

[Operator Instructions] We have new question from the line of Jeff Yau from DBS.

Question on the office demand. To your understanding, any of your top 5 tenant at Three Garden Road [indiscernible] to have any in-house expansion or already expect the interest to take up more space in the foreseeable future? This is first question. The second question is as government reopen the border for the international travelers, so the foreigner can come to Hong Kong for site inspection, do you expect some release of pent-up demand among the multinational companies or a China-based company?

Since the market has been, the economic -- overall economic outlook is quite uncertain, so our top 5, I would say, the major key tenants apart from the ones that we've done this year, don't have expansion planned in this recent year. Regarding the open border or the relaxation of the quarantine on international travelers, it really depends on the overall because if the MNCs need to expand in Hong Kong, and we need to see how the connection with the Mainland China. Now the Mainland China still closed the borders. And so business travel has been difficult. Therefore, we do see there is a time lag and it needs more time to absorb and attract tenant coming back to Hong Kong. It's not only the localized issue in Hong Kong. It's also a global issue because of the war of the economic slowdown seen everywhere and high inflation rate. All these factors are happening in the Hong Kong office market as well.

We have no further questions on the line. I would like to conclude today's conference call. Thank you for participating. You may now disconnect.

Thank you for joining.

Thank you.