The Wharf (Holdings) Limited (4) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the webinar of Wharf Interim Results Briefing. I am Angela Ng, Investor Relations Manager. Our management team in the webinar include Mr. Stephen Ng, Chairman and Managing Director; Mr. Kevin Hui, Director. For today's rundown, we will have the presentation followed by a 4-minute video, bringing you a tour of our flagship IFS in Mainland China. Afterwards, we will come to the Q&A section. Without further ado, let me now pass the time to Chairman for an opening remarks.

Thank you, Angela. Good afternoon, everyone. The year 2021 got off to a reasonable start for our group. The first quarter of this year when compared to the first quarter of last year was, in many ways, more satisfying, partly because the first quarter last year was the height of the pandemic in, particularly in Mainland China. And there, in that market, we saw the economy recovering quickly in the second quarter. And so by the second quarter of this year, in comparison to a relatively stronger second quarter of last year, already, the growth rate was more muted. But overall, the underlying business gave us a pleasant surprise. However, in view of the strict control measures implemented by the Mainland government on real estate, we evaluated our assets and we concluded it would be appropriate to make an impairment provision amounting to a little over RMB 3 billion. So in Hong Kong dollar terms, it's roughly HKD 3.65 billion. That was a large item which we have not anticipated until the end of the period. I can talk a little bit more about that later on. But first of all, I will ask Angela to take you through the PowerPoint presentation.

Thank you, Mr. Ng. Now I believe that you will see our PowerPoint presentation with the theme, welcomed cautious recovery from pandemic. After a devastating year by COVID-19, businesses are generally improving, but the development or potential of each segment varies. In Hong Kong, luxury properties market is emerging, but long-haul project time profile may potentially increase the development risk. Whereas for Mainland development properties, the strict ASP control caps returns and suggest a different risk profile. On the other hand, impairment provisions were made for the slow-moving nonresidential stock. On Mainland investment property side, mall operations benefited from onshore spending repatriation. However, the luxury segment outperformance is spurring a tenancy chase from new malls and intensified the competition. For office, the inflated supply trimmed the upside on occupancy and rent. Moving to the logistics sector. The potential of Hong Kong port business is constrained by the shortage of land. Now looking at the group's performance. With a focus on premium property products, properties account for over 60% of total business assets and nearly 80% of total revenue. Looking at the financial highlights. Group revenue increased by 122% to $12.3 billion. Operating profit increased by 71% to $4.3 billion. Underlying net loss narrowed by 54% after Mainland DP provision of $3.7 billion. Including the IP revaluation gain and other nonrecurring gains, including the disposal of remaining interest in Cable TV Tower, the group's net profit turned around to $1 billion. Basic earnings per share was $0.34 and interim dividend of $0.20 per share was declared. Then we will walk through our different business segments in the order of Hong Kong properties, Mainland DP, Mainland IP, hotel and logistics. A burst of activities in the luxury residential segment on the Peak put the group in the public spotlight. In quick succession, $15.6 billion was invested in 2 prime sites on Mansfield Road, 5 houses and 1 apartment were sold for a total of $3.4 billion, and 2 houses were leased by tender for a monthly rent exceeding $2.2 million. Currently, the group's Peak Portfolio amounted to nearly 600,000 square feet. However, the development profile in this segment is characterized by long holding period and high capital intensity. Including a handful of projects in Kowloon Tong and Kowloon East portfolio, total land bank in Hong Kong amounted to 3 million square feet. Mount Nicholson was acquired in 2010 and for sale in 2016. During the period, 1 apartment was sold for $490 million and 43 parking spaces were sold for $418 million. These transactions will be bought in second half. 12 units remain unsold at the moment. 77/79 Peak Road sold its first 5 houses for a total of $3 billion at up to over $92,100 per square foot. Four houses were booked in the first half. Redevelopment had started in 2012. And for 11 Plantation Road, which comprises 7 houses, those have swung and 3 were leased for monthly rent of over $2.2 million. Moving on to Mainland development properties. Prevailing policies and strict price control in the residential sector increased development risk and rendered some projects no longer profitable. On the other hand, office supply in the nonresidential sectors has been observed in many cities with slow-moving stock piling up. Attributable impairment provision totaled $3.65 billion were made during the period. In the first half of this year, the group recorded contracted sales of RMB 5.7 billion. Our target for this year is RMB 15 billion. And sellable resources totaled 1.1 million square meters. On attributable basis, Mainland DP revenue increased by 64%, while margins significantly suppressed by the strict ASP control. Net order book at the end of June was RMB 27.3 billion or 0.9 million square meters. In the absence of new acquisitions, the group's land bank decreases further to 2.6 million square meters. Moving on to Mainland investment properties. Retail sales is keeping up good momentum driven by the luxury segments. However, due to an oversupply in retail space, many landlords are willing to pay a high price to chase a small number of dominant brands. Underpinned by prime locations, critical mass and premium quality, the group's IP portfolio remains a preferred choice for the celebrated brands and tenants despite the competition. Thanks to the outstanding positioning of the group's IFS series, strong double-digit revenue growth was recorded at IFS malls. On the other side, oversupply in market hindered rent and occupancy upside. Overall, Mainland IP revenue of the group increased by 45% to $2.7 billion. Retail revenue at Changsha IFS increased by 68%. The mall registered a nearly full occupancy. Whereas the Tower 1 office occupancy has climbed to 85%. Chengdu IFS rank regularly among Mainland's top 10 for sales. Retail revenue increased by 57%. And the outstanding market position brought double-digit retail rental reversion. The 3 Grade A office towers continued to rank among the highest rent rates in the city, and occupancy grew notably to 86%. Moving on to hotels. The group manages 17 hotels in Mainland China, Hong Kong and the Philippines under Niccolo brand and Marco Polo brand. Hotel sector in Hong Kong is still suffering, while hotels in Mainland China witnessed business growth. In April this year, Niccolo Suzhou, a sky hotel atop Suzhou IFS celebrated its opening, which is the fifth hotel in the Niccolo Hotels portfolio. For Niccolo Chengdu, Chongqing and Changsha, their revenue-generating indices are consistently at the top of markets. Occupancies pick up quickly after Chinese New Year, achieving record revenue with occupancy of over 90% in Chengdu and Changsha in the second quarter. For Niccolo Suzhou, it ramped up the fastest among the 5 Niccolo Hotels. However, new COVID scare has cast a low outlook in the second half. Turning to our logistic business. Modern Terminal recorded growth in both revenue and operating profit. Throughput in Hong Kong increased by 5%. However, constrained by its natural geographical disadvantage, Kwai Tsing Port mainly competes with other ports in South China for price-sensitive transhipment cargo. Let's move on to the financial management. Net debt was $41.6 billion. Gearing ratio maintained healthy at 24.5%. Average interest cost was low at 1.8%. Interest cover was 9.1x. Looking ahead, as our presentation reiterated, we welcome cautious recovery from pandemic. Indeed, the development or potentials vary from different regions, segments and type of products. For development property business, the characteristics of long project period increases the development risk of the luxury residential in Hong Kong. Whereas for residential projects in Mainland China, the strict price control renders some projects unprofitable. Oversupply is observed in nonresidential market as well. For the investment properties in Mainland China, the chase for top tenants is intensifying competition among landlords. On a broader view, overall outlook is still clouded by macro challenges and the geopolitical risk and pandemic hangover. In the last part of the presentation, I will go through our efforts in sustainability. The group has published 2020 sustainability report following GRI standards and referencing SASB standards. Also, the group is a member of Hang Seng Corporate Sustainability Index and Hang Seng ESG 50 Index. And for green buildings, Changsha IFS and Chengdu IFS were awarded the LEED Platinum certificate. For the new development, the group is devoted in supporting Project WeCan, and our business units are partnering with 5 WeCan schools to provide supports. That concludes my presentation. So now we will come to the Q&A session. [Operator Instructions] Now we will take the first question from Ken Yeung, Citi.

Very impressive review. The first question is on -- I have 3 questions. First question is on your IP, the tenant sales. I think everybody know that last year, the strong pickup was around maybe May time. So probably you already have some data that can share with us versus May, June or, let's say, July versus this year, what kind of the tenant sales growth on already higher basis on your Chengdu and your Changsha IFS mall? So this is the first question. Secondly, I think, overall speaking, there's a quite significant decline in the EBIT margin on your DP portfolio to something like 17%. So can we get an idea for those net order book, $27 billion, is it somewhere that margin is around 17% or any idea what kind of margin is on those projects that already been sold? If we combine this together, does it mean that it is not really profitable for us to continue to do the China DP business? So this is the second question. The last question is on your equity portfolio. I see it keep going up every year. So it's going up to something like $80 billion, quite a mega size, even bigger than some of the fund manager here. So I say, should we be expecting what is the -- should we expect more upside on this $80 billion or do we have any cap for this to give investors some confidence at what kind of level that can be achieved on this equity portfolio on the size?

Okay. Thank you very much. To your first question, tenant sales generally have been in the double-digit area. And that includes the second quarter. But there is a skew among tenants generally towards the luxury end. Whereas mid-market tenants are doing less well. But as Angela pointed out at the luxury end, because the luxury tenants are doing well, they are attracting competitive bids from other landlords, in particular, new malls, start-up malls, which are hungry for anchor tenants. And so that is becoming a new force, a new factor in our Mainland IP business. To your second question, our DP portfolio, I think it's no secret that the central government's policy is to control housing prices. They've been saying that for several years. It's taking a little while for that policy to be turned into effective measures. But after these several years, I think the blunt of it is being felt, which explains partly why our margin has fallen. Because although the market is prepared to pay X, we're not allowed to sell at X. We are only given permission to sell at X minus Y. And I think we have already been alerting investors about that. And as a result of the unfavorable policy towards developers, we have significantly wound down our investment in the Mainland DP segment. For instance, we have not bought a new site for over 2 years. We've made bids from time to time, but we're not aggressive with our bids in order to preserve hopefully our margin if we win. So you're right about the margin coming down for our DP business. And as I said, we are running down our current land bank, and we have not replenished it for over 2 years. Equities, that portfolio, a very good part of the increase in the value of that portfolio comes from organic market value increase. From that point of view, obviously, we'd like to see the increase rather than a decrease. The portfolio is mainly made up of 2 parts. One part is what we describe as CME2, mainly technology and new economy stocks, which we hold for growth. And the second part, mainly property stocks, which we hold for, a, yield; and b, value because property stocks are trading at a significant discount to their underlying NAV. So with this balanced portfolio, we're quite comfortable with the level we are currently investing. And we hope the combined value of the portfolio will continue to rise. But we're not traders so we have not disposed of any significant size. Whatever surplus we see is at the moment paper surplus. Thank you.

Just a quick follow-up on your CME2 investment. Given that currently, I mean, in the recent 1 or 2 month, there are quite a lot of talks regarding the regulations on CME2. Does that affect your long-term investment thesis on your investment in these companies?

No. We don't invest only in China CME stocks. We also invest in the U.S. side, in particular, that aren't unaffected by policy directions from Beijing, at least not directly. And then the China CME stocks are very resilient stocks. And our cost base is also low. So even after the latest round of adjustment, we're still sitting on pretty healthy surpluses. But again, I need to emphasize, these are paper surpluses.

Thank you, Ken. So actually, we have several questions on the queue. The next question from Karl Choi, Bank of America.

Can hear me?

Yes. We can. Please go ahead. Yes. Please go ahead.

Can you hear me now?

Yes.

Yes.

Yes. Can you discuss a bit more the impairment that you took on the DP side related to nonresidential projects? How was the size of the impairment decided? Was it related to the office portion of Changsha IFS? And what's the risk that we will see further impairment going forward? And second is, can you talk a bit about the dividend? How was the interim dividend decided? And how should we think about the full year given the impairment which was a noncash item?

Right. Okay. First of all, about the impairment provision, a good part of it, as you pointed out, relates to Changsha IFS, the office tower. The office demand in Changsha is weak. And it has become weaker following the recent regulatory measures taken by the central government. Some of the growing tenants and not only in Changsha but in other cities have been hit, and they include some of the technology companies, education and so on. And some of them are our tenants. And instead of continuing to commit to additional space, some of them are already asking for early surrender. So it's a weak office market and there is generally oversupply, and oversupply not only in second-tier cities but also in first-tier cities. You look at Shanghai. Shanghai has an oversupply problem as well. So we took a look at the market. And you may know that in Changsha, we have always classified our office stock as DP, not as IP. The IP in Changsha is the mall, not the office. And our intention is indeed to sell the office portion of Changsha IFS. But in view of the weak market and the current prices, we took a view that it would be prudent to write down the carrying cost of the office tower. And that accounts for the main bulk of the impairment provision. Outside of that, we have also provided against other stock, including residential stock. Some of the slow moving or almost nonmoving stock from past projects, we took a look and decided that it is not very likely we'll be able to monetize that without fairly deep discounts in the near future. So that's what we did as well. So it's a combination of the 2. In terms of dividend, the underlying business in the first half was generally better than the first half of last year. And the underlying net profit after the impairment provision was already lower than the underlying net -- sorry, net loss was already lower than the underlying net loss from a year ago. And so in view of that, we're hoping that we'll be able to deliver better results in the second half. But still, we're only 5 weeks, 6 weeks into the second half. So we decided to repeat the same dividend that we paid for the first half of last year. And depending on our performance in the remaining months of the year, we will look again at the final total dividend for the year. Generally, for Wharf (Holdings) Limited, if I may provide a guidance, generally, we are looking to pay about 30% of our underlying net profit annually, but with the first half being probably more conservative depending on the eventual full year performance and obviously subject to audit. Thank you.

And the next question from Shaun Tan, UOB.

Management, can you hear me?

Yes. We can. Please go ahead.

This is Shaun from UOB. I have 3 questions. My first question is on the impairments again. I just wanted to understand what portion of these impairments are related to the office at Changsha IFS versus the residential projects? And also, could we understand how conservative was management in determining such impairments? And is it the end of such impairments? My next question is on the China IP. Management has been warning us of the oversupply situation in China and continues to do so, yet your IP performance has been strong, continues to be strong. So are we expecting the good performance to change in due time and could you share more on the outlook? For instance, it was mentioned that the retail landlords are willing to pay a high price to chase a small number of dominant brands. Could you elaborate more on this? And how does it affect our IFS mall portfolio? And my last question is actually on the IP again. There seems to be a high portion of turnover rent at the malls. For instance, the Chengdu IFS is at 47% turnover rent. Can we understand what is the strategy in terms of the restructuring of leases over time? Yes.

Okay. Thank you. First question, impairment provision. The majority of the total provision relates to Changsha IFS. Bear in mind, we have significant supply in the current tower. And the market is weak not only in terms of price, but in terms of volume. If it takes a long time for the sale to be completed, that factor is also taken into account when we decide what the appropriate impairment provision ought to be. At this moment in time, the Changsha market, office market is not sophisticated enough. The majority of the office users choose price over quality. And that's already quite clear to us after 3 years of leasing the offices. While the offices are intended for eventual sale, we've been leasing the offices to generate income to cover operating expenses and to build traction for the property. And it became quite clear from the leasing activities that the market for Grade A office of our caliber is weak. So that hopefully addresses your first question. Second question, the oversupply in Mainland IP, specifically retail. Fortunately, our 2 flagships, Chengdu and Changsha IFS, are less affected by the oversupply because of their location, because of their critical mass and because of the marketing we've been putting into them. So we haven't been losing, for instance, major tenants from those 2 IFSes that we should not be losing or that we do not mind losing. However, outside of the IFSes, some of our older properties, Time Squares and so on, they're more vulnerable. And new malls would look at the key tenants, and typically they would offer incentives that you would expect: favorable rental, favorable -- rent free and also CapEx subsidy. And these are the main that factors that hungry landlords use to compete for anchor tenants, which they consider to be must-have. And now in our case, we either decide to match the competition, in which case it hits our bottom line directly, or we decide the offer would be so unattractive that we'd rather lose a tenant and get another tenant. But as I said, fortunately, at least in the case of our Chengdu and Changsha IFS, the fact that our tenants have been trading well helps us to retain them. But the -- in doing so, we're having to work with the tenants to keep them. And the final question about turnover rent. Ideally, turnover rent -- well, turnover rent is -- it's a double-edged sword. You want it to be high because it helps to improve your overall yield from the property. And you want it to be reasonably low, not too high, because if you -- if it's too high, that means your base rent is probably not appropriate. So -- and sometimes, it's more an art rather than science. And because the market, particularly for retail sales, has been so strong, base rents that were agreed 3 years ago or 2 years ago are probably no longer relevant. But there are rental cycles. And so when old leases expire and new leases are signed, there is a natural tendency for base rent reversion. But it takes time, and it will probably take 2 or 3 years at least. And we will, of course, not want to see low turnover rent because low turnover rent implies that tenants are not trading as well as we would like them to. So a moderate level of turnover rent would be best for both landlord and tenant. Thank you.

And the next question is from Raymond Liu of HSBC.

This is Raymond. Can you hear me?

Yes, I can. We can.

Yes. Thank you for the good video to remind us of your prime IP portfolio in Mainland China. So I got 2 questions. The first question is about the positioning of the company. So as you mentioned, why the company did not buy any land in Mainland China for 2 years, and together with this like nice rebuild, are you going to like tell us or investor that the focus of Wharf will eventually shift to the commercial property development in Mainland China compared to what you guide us back to 2017? And how should we think about the future positioning of Wharf going forward? That's the first questions. And the second question is about sales stock in Mainland China. So given the current policy environment in Mainland China, do you see any pressure to meet the full year sales target of RMB 15 billion out?

Good. Thank you. I think we probably already indicated a few months ago when we shared our full year results, last year's full year results with you that at the moment, we see good opportunities in Hong Kong to deploy our capital, which explains why we acquired 2 new sites in the Peak half a year ago. Capital is fluid. And at the moment, we don't see a very attractive residential market in the Mainland. And on the commercial side, offices are oversupplied as well. So we're not in a hurry to pour a lot of new capital into new office projects. Retail, possibly, but we have very high standards for retail projects. And so I don't necessarily want to count on encountering new retail projects on the Mainland too soon. In the meantime, there are opportunities in Hong Kong. Apart from the luxury portfolio -- residential portfolio on the Peak in particular, we have a land bank that are hopefully going to start development within the next 12 months or maybe a little longer. And there are 2 projects in particular. One of them is Kowloon Godown. Kowloon Godown is an existing building. We've been running it as a warehouse for a number of years. And we've been in discussion with government authorities about modifying the use of that site either for office use or for residential use. Approvals have been obtained. It's a matter of agreeing a modification premium with the government before the project can start. So if we are able to get a reasonable premium and we can mobilize the redevelopment project at Kowloon Godown -- it's a fairly big site, and so fairly big project. And if that goes ahead, first of all we need to pay a modification premium in the size of the billions of dollars. And then following that, of course, construction costs. Another development project is the Yau Tong Bay joint venture. We have about 15% of that project, but it's a very large project. And when completed, there can be as many as 6,000 units, residential units. It will take years and phases to complete, okay? And it is in modification stage. So if a premium is agreed, then the joint venture will need to put up the capital to pay for the premium and eventually to develop that. So that's where some of our capital, if repatriated from Mainland China, can go rather than into currently unattractive Mainland China projects. Sales target for the current year, we're not optimistic. In fact, we have already missed the half year sales target. And that's part of the reason why we decided it was appropriate to write down our current portfolio. Sales are not up to target mainly because we are having -- I mean, for 2 reasons. A, ASP, the sales price. We're not able to get the sales price that we were hoping. We -- when I say we're not able to get the sales price, I mean, we're not able to get government approval of the sales price that we are hoping. And secondly, even if we're prepared to accept a lower sales price which is mandated by government, they are very slow at handing out approvals. So some of our sales programs have been delayed. And as the clock continues to tick, time will be running out for us to meet our sales target for the current year. So I hope I've answered your 2 questions.

Thank you. So we still have several questions on the on queue. The next one, from Raymond Chin, CIMB.

Okay. Can you hear me?

Yes, we can. Please go ahead.