Wharf Real Estate Investment Company Limited (1997) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the webinar of Wharf REIC Final Results Briefing. I am Angela Ng, Investor Relations Manager. Our management team in the webinar include Mr. Stephen Ng, Chairman and Managing Director; and Mr. Horace Lee, Director. Before the presentation and Q&A session, we will start with an opening remarks by the Chairman.

Thank you, Angela. Good afternoon, everyone. First of all, I'd like to take you back to 2019 that was when Hong Kong's economy was running very well in the first half of 2019. You will remember that beginning in the second half of 2019, things started to happen to cause the economy to slow down and eventually slip into reversal in 2020 and 2021. The decline in the economy was rapid. And that took a lot of sectors down with it. Most immediately, the hospitality sector and retail. We, as a landlord, started to suffer at the same time, but because of the lease commitments we had with various tenants, there is a time delay factor affecting our rental income. Eventually, that delay factor played out over 2020 and 2021. And at the beginning of this year, when we were looking ahead at 2022, we were hoping that rents would start to stabilize. And if everything goes well, maybe start to creep up again. But of course, all of that went into -- went down in flames when this fifth wave started in the first week of January. Since then, economies slowed down, retail has slowed down, people flow has slowed down. Everything has slowed down. And it is almost certain that this will carry on into the second quarter of the year. So our interim results, I'm not making any forecasts, but it's almost certain that our interim results for 2021 -- 2022, sorry, will continue to be affected by this very resilient pandemic. But back to 2021 because we were still suffering from the lagging effect of rental decline. We reported a lower income from rents compared to 2020. And we also invested a little bit more in promoting the malls. So as a result, we reported an earnings decline for the second year running. We can go into the details a little bit more later on, particularly in the Q&A. But first of all, I will hand back to Angela for her to take you through our presentation. Angela?

Thank you, Chairman. Now I believe that you will see our PowerPoint presentation on your screen. Rental Income Suppressed and Marketing Dollars Doubled is the tag line that we used to sum up the 2021 annual results. Against the backdrop of effectively close orders, the group doubled the marketing budget to capture a bigger share of the competitive local market. This is the investment that we make for today. Although, today's rental income performance is under pressure, the group spares no effort to make investment for tomorrow in the form of strategic addition and realignment of rents. Looking back to the market last year, it was full of challenges as tourist spending was missed entirely for over 2 years. Hong Kong retail sales recovered by 8% on a low comparison base and was partly driven by the government's consumption voucher. Hospitality sector was being tortured and F&B also suffered because of the strict social distancing measures. Heading into 2022, the city faces even more new challenges as the 5th wave badly hits daily lives and businesses. The border opening time line is further delayed and the outlook is even more unclear. In this unprecedented time, the group continued to exercise prudent cash management to navigate the uncertainties. In response to the market challenges promotion intensity to support more activities is an important investment that we made. We are the first mover of coupon redemption program in the city and the strategy has proven effective with above-market tenant sales reported in Harbour City and Times Square. Also to capture opportunities for tomorrow, we proactively invest in strategic brand realignment and addition of brands. Canton Road frontage at Harbour City is fortified with the new flagships of Hermès, Dior, Piaget, Miu Miu and other international top-tier brands who chose to invest in Harbour City during the time of COVID. Under our continuous effort, spot rents and occupancies were stabilizing last year but the lagging impact of negative rental reversion continue to weigh on the performance. We will closely review the promotion scale and constantly fine-tune business strategies to adapt to market change. Taking a closer look at our Hong Kong IP performance. Hong Kong retail revenue drop narrowed to 8% as the impact of base rent negative reversion was partially offset by higher turnover rents and occupancies. On the other hand, office rent is still soft under weak demand and increasing supply. Yet, vacancy started to see stabilization in the fourth quarter last year. Overall, Hong Kong IP revenue drop narrowed to 8%. Turning to the financial highlights. The group reported a revenue growth of 3% and group profit turnaround to HKD 4.4 billion. Underlying net profit of IP decreased by 11% as rents depressed and marketing dollars doubled. Losses for hotels narrowed, IP valuation remained stable with IP fair value change represents just 1% of total IP asset value. Dividend policy is maintained at 65% of underlying net profit from IP and hotels in Hong Kong, which represents a DPS of HKD 1.31 for the year. The group maintains a strong balance sheet and cash flow. In the following slides, we will walk through the performance of our core assets as well as financial management and outlook. First, Harbour City, which is our major source of income. Despite the weak market, Harbour City remains the first choice for the top brands. Mall occupancy improved to 93%. Office occupancy improved to 85%. However, loss-making market conditions continued for hotels. As a result, Harbour City's total revenue drop narrowed to 8%. The local-centric experience and stronger recovery of top tenants enable Harbour City to achieve better sales performance. As the most diverse retail landmark in Hong Kong, it houses a balanced mix of over 500 tenants. You can see the breakdown of rental income from the treemap diagram here. The unique critical mass has attracted new flagships of the top-tier brands together with about hundreds of new shops that complement the existing tenant base. Hotels in Harbour City were still bleeding despite improvement in revenue and gross operating profit. Operating environment became worse this year under the tightened social distancing measures. Prince Hotel seized the opportunity and completed renovation. Next, we will talk about Times Square. Causeway Bay is a highly competitive market for both retail and office. Times Square constantly adds new impetus to entice locals. Retail occupancy rose to 95%. Tenant sales also improved under the effective sales-driven promotion. Office occupancy improved to 89%. Total revenue drop narrowed to 9%. Moving on to our regional mall, Plaza Hollywood. Supported by a relatively stable local demand, Plaza Hollywood delivered resilient performance, and new leasing demand continued despite the pandemic hit. Occupancy was 97%. Our core assets also include the Central Portfolio comprising Wheelock House, Crawford House and The Murray. Wheelock House and Crawford House maintained high occupancies of 94% and 98%, respectively. For The Murray, thanks to the outstanding assets and service quality, it's achieved gross operating profit turnaround and also consistently outperformed its competitive set in revenue per available room. Switching to our assets in Singapore. Retail recovery at Wheelock Place and Scotts Square was hit by the pandemic policies. With the prime location in the Key Orchard Road intersection, we hope to see a better recovery this year. Let's move on to the next item, financial management. Net debt reduced by HKD 4.5 billion to HKD 47.5 billion. Total asset was around HKD 270 billion (sic) [ HKD 272 billion ] and gearing ratio improved to 22.5%. Average interest cost remained at 1.4%, and the group maintained the Moody's A2 rating with stable outlook. Looking ahead, while a number of factors cloud the macro outlook, local economy in Hong Kong also warrants concern under COVID burst. No early recovery can be assumed without opening of borders. The group will adhere to the proactive business strategies and prudent cash management to navigate the uncertainty market -- the uncertain market outlook. In the last part of the presentation, I will walk through our efforts in sustainability. COVID relief has been the group's key focus and additional round of HKD 5 million donation was made by Wharf Emergency Relief Fund to The Community Chest Rainbow Fund. Also, additional round of HKD 5 million donation was made to students in need in the 82 Project WeCan Schools. We also plan to utilize our Malls and Star Ferry area to set up City-Center vaccination posts and advertise the Fight the Virus campaign. In addition, environment protection and youth development remained the pillars of the group's sustainability efforts. To support the Clean Air Plan for Hong Kong 2035, Star Ferry launched the third low-emission Green Ferry, Silver Star. Youth development is highlighted by the flagship program, Project WeCan together with other scholarship and internship program. With 10 years of history, Project WeCan benefits more than 80,000 students from 82 schools. In 2021, the group has raised the First Sustainability-linked loan of HKD 1.6 billion. The group is also a member of Hang Seng Corporate Sustainability Index and has HSI ESG rating of AA+ being the top 10% ESG performers among peers. Further details of our sustainability efforts can be seen from the data shown in the slide. So that concludes my presentation. And now we will come to the Q&A session.

[Operator Instructions] Now we will receive the first question from Ken Yeung, Citi.

This is Ken from Citi. I will have 2 questions. The first question I want to ask about, given that this kind of Omicron outbreak of 5th wave is quite sudden, how do you compare this round versus the impact to you versus maybe the initial outbreak in the first half 2020. And for example, in 2020, you have granted [ a HKD 2 billion ] concession. How do you see the rental concession that you will be granted for this round?

Okay. Thank you for your question. First of all, it's not for me to say whether this wave is -- how much more serious this wave is compared to previous waves. There are different indicators as a start, the number of confirmed infections per day or the number of tests per day. Those are not necessarily directly proportional to business but they do provide a certain indication about the severity of the current rate. As landlord what we see immediately is a sharp falloff in -- footfall and that, of course, would result in a sharp falloff in retail sales. We don't have a lot of retail sales data compiled yet. But I think it's easy to come to that conclusion. We started to offer tenants rent relief. We're probably one of the first major landlords in Hong Kong to do so for this wave. The size of the relief relative to the size of the monthly bill is comparable to what we provided previously. However, the monthly bill, the monthly rental payable by tenants today compared to what it was 2 years ago, you would appreciate it has fallen substantially. And therefore, in dollar terms, the same percentage relief, for instance, would already produce a substantially smaller rental concession. As to how much longer this would continue, I really can't tell. As soon as this 5th wave started, all bets are off. I think that's all I can say. Hong Kong as an economy needs to buckle up and the players in Hong Kong, all of them, including ourselves, need to buckle up to prepare for harder times. And that's all I can say. Now we're slightly more fortunate than some of the other landlords in that we have a healthy balance sheet and in the course of 2021, what we did was we reduced our net debt by about HKD 4.5 billion. So if markets become tougher and if interest rates were to rise, we would at least be better protected than we would have been 12 months ago. Thank you for your question.

Thank you. We have a couple more questions coming. And the next one is Karl Choi from Bank of America.

Can you hear me?

Yes, we can. Please go ahead.

I have 2 questions and 1 quick one. First is in terms of the rental and -- the rent enforcement moratorium that was proposed by the government. Can you talk a little bit about the expected impact as a result? And second is, trying to have more of a positive look on things. I mean there is -- there are reports that Mainland China may consider an exit from zero COVID strategy, knowing it could still be a long way away from -- it's been quite a few years before we fully opened the borders, [ have this unchanged ]. And when you talk to your tenants or when you try to do your leasing strategy, what sort of eventually longer term, do you think the percentage of tourists would come back to Hong Kong longer term. If there's any sense that you can give us? And lastly, just a quick one is, if you could give us your percentage of floating versus fixed rate debt?

Percentage of floating versus fixed rate debt, okay. I'll leave that third question to Horace. But let me deal with the first two. First one first, the rental moratoriums, we're really not in a position to answer that question with any degree of precision right now. It is supposed to cover SMEs. But how or where is the line drawn between SME and non-SME. If it's drawn higher, then obviously, the impact would be greater. If it is drawn lower then the impact would be smaller. In our case, for Harbour City and Times Square, in particular, I would like to think we have a relatively small proportion of SMEs. Most of our tenants would probably not fall into that category as a man in the street would define them, no. But at the end of the day, how SME is defined, it's a matter for government to decide, not for the man in the street. So we can't tell. Looking ahead, when would borders reopen and when would tourists come back and everything else, I would rather not hazard any guess. We've been wrong on 2 or 3 occasions in the past 2 years, and I would rather not be wrong again for a third time. Once upon a time, we were hoping and we were budgeting for tourists to be back by the end of 2021 -- sorry, 2020, that was the first -- our first attempt at crystal ball gazing, that failed miserably, as you know. And then when we did our budgets for 2021, we were assuming they'd start to come back around the middle of last year. Again, that failed miserably. So I wouldn't want to make a third attempt, not having any tools available to us to even make an educated guess. Horace, can you address the third question?

Sure. Yes. As our ongoing policy, we will swap our fixed rate borrowings to floating. So as such, you can assume that it's not often that the -- a fair substantial part of our borrowing are on floating rate at the moment.

Thank you. Thank you for your question.

Thank you. So we will have the next question from Mark Leung, UBS.

Yes. Management, can you hear me?

Yes, we can. Please go ahead.

Yes. Yes, sure. I have 2 questions. I think the first one is regarding on the rent to sales ratio. So I think over the past 2 years, we have seen rent actually has come down, retail sales in last year actually was reported a pretty good rebound. I just wanted to check what is the latest rent to sales ratio for the company overall. How do we compare it to the pre-COVID level? I think that's the first question. And the second question is regarding on the long-term equity investment because I saw about a HKD 1 billion half-on-half decline. So could you share with us more details on what drives the [ valuation losses? ]

Okay. Compared to pre-COVID days, if you're referring to occupancy costs, the average occupancy cost for our tenants is still higher than pre-COVID. But that's on average because there are actually vast discrepancies between tenants who perform very well, and those that struggle. In a way, the average can serve no more than a benchmark, but it's relatively academic. What I can say to you, though, is you will or I don't know, I'm not sure whether it was in the presentation, but it is a fact that the proportion of our rental income in the form of turnover rent has increased compared to a year earlier. And tenants pay turnover rent only when the sales exceed or rather when -- only when the turnover rental exceed the base rent. So an increase in the proportion of turnover rent implies that tenants are trading above the minimum sales level that the base rent is designed to cater to. So that's a good time, but that's coming from some of the tenants, not all of the tenants. Some of the other tenants are probably -- almost certainly still trading at below this minimum rent threshold. But that was 2021. Again, 2022 is an entirely new ball game. Most people are still in the state of shock and that includes us and our tenants. We're still trying to figure out how deep this fifth wave is and how long it would last. Was that the only question?

The other question is about the equity portfolio.

Oh, okay. There was a minor disposal. But otherwise, it's been stable. And we were not an active trader as far as that portfolio is concerned. And it helps us to -- it helps to provide stable and quite good yield. Thank you.

Thank you. So we have the next question from Andy So, Haitong.

Management, can you hear me?

Yes, we can, loud and clear.

Yes, yes. First of all, I would like to ask about the gross margin. The gross margin in FY '21 seems to be relatively low, which is around 67% and down quite substantially from 72% in FY '20. So should we expect that that -- the profitability going forward would be even lower in FY '22 because as we may know, we may need to do more promotion going forward to boost the retail sales this year. So shall we expect that the profitability in FY '22 will be even lower than that of the FY '21. So this is the first one. The second one that I would like to ask about is our potential expansion plan in Hong Kong or China. Quite a lot of our China-based developers are not doing very well in terms of the contract sales in the past 6 months and they need money right now. Do we have any plan to buy the investment properties or development properties in Mainland China or even Hong Kong here, given the fact that our financial health seems to be relatively good.

Okay. Thank you. To answer your first question about margin, I think we need to look at the breakdown of both revenue and operating profit, for instance. If I remember correctly, what happened or part of the reason why there may have been a discrepancy between the first half and the second half of last year is because of DP revenue. I believe we booked a good amount of DP revenue in the second half. And almost by definition, the nature of the DP business is such that the margin will be lower than in the IP business. Even the most attractive DP projects would ordinarily not come in close to the margin you would expect from prime IP in Hong Kong. So you really need to dissect it and you can't just use a global number and say, "oh, margin dropped." Having said that, there are also other factors affecting margins, particularly between -- a comparison between first half and second half. And then include rent relief and the amortization of rent relief. And when these marketing expenditures are accrued, we try to be as fair and as reasonable as possible. But it is possible that between the first half and the second half, it may not be 100% particularly because at the interim, you would appreciate, while we have done everything we can to present a fair set of accounts, the accounts were not audited at the interim stage. So I think it is fair to say that there was a compression of margin in the second half, partly because of the lagging factor in rental income. Because as spot rent fell, it took a little while for average rent to catch up. Whereas on the expenditure side, it's almost immediate. So I think that's probably a reasonable conclusion. Whether or not it would will carry into 2022, I think the key factor is the fifth wave. Because if the fifth wave continues to be as severe as it is and for much longer, obviously, revenue would be hit hard. And for every dollar of revenue that's forgone, it drops directly to the bottom line to affect the operating margin. As to your second question about any appetite to acquire new assets, I think the answer is we are traditionally already a prudent company. And in this investment environment, macroeconomic, geopolitical and so on and so forth, we have added caution to general prudence, and we'll be very, very selective about new investments. Particularly when it comes to investment outside of Hong Kong because we are primarily focused on investing in Hong Kong investment properties. So if it's DP or even if it's IP in Mainland China, it will have to be a very exceptional opportunity.

Thank you. And then the next question from Simon Cheung, Goldman Sachs.

Just I've got a couple of questions. You mentioned in the presentation slide that you [indiscernible] your marketing costs last year. I'm not sure whether that's because you saw government vouchers and that's -- the environment allowed you to basically spend a bit more to stimulate the demand here. But judging from what you're mentioning for this year, how should we think about that marketing costs. And if you can -- I think I saw some number of HKD 500 million up to HKD 1 billion number. Can you quantify that marketing expenses, if possible? That's the first question. The second question also, I think on Angela presentation slide, she mentions that the Causeway Bay district is highly competitive, and that's somewhat reflected in slower sales or rent number for Times Square versus Harbour City. I was just wondering how you are thinking about your positioning of Times Square in such a competitive market, vis-a-vis, obviously Harbour City is seemingly in a much better position, how are you going to be adjusting that? And then lastly, more of a small housekeeping question. I think the property devaluation, if I look at the number correctly in the second half, it's actually quite significantly higher than first half. Wondering whether there's any change on cap rates or what's driving that spike up in the revaluation losses in second half?

Okay. Thank you. Marketing dollars. We actually started -- you will remember the, if I may say, very popular coupon redemption program that we ran at Harbour City and Times Square last year. And we started that way before government's consumption voucher. And that proved to be very effective in driving sales. As Angela pointed out in her presentation, we made 2 kinds of investment in the course of the last 2 years. One kind was to invest in today, we need to survive today and that was to drive sales to keep tenants trading well. And the other kind is preparing for the future we invested in realigning trade mix and tenant mix and so on. So the first half was we invested in marketing to drive sales, and most of the marketing dollars were invested in the coupon redemption program. The nice thing about coupon redemption program compared to, for instance, general advertising and so on and so forth, is that it is very tangible. If there is no sales, there's no coupon redemption and therefore, no marketing cost. In a way -- we continue to be running these coupon programs even now. In a way, we wish we would be able to spend more in marketing dollars because for every dollar we spend on coupon redemption, that means we generate sales. But unfortunately, in the current environment, when shoppers stay away because they were told to stay home, we probably can't spend as much as we were able to last year. So it's good news and bad news. The good news is we'll save on marketing dollars. But the bad news is our tenants do not trade as well as they did last year. So it's a necessary investment, and we've got to make the investment than not. We'd rather be able to make the investment than not be able to do so. Time Square, as you rightly pointed out, is in a less favorable position competitively compared to Harbour City. Harbour City has more critical mass, whereas in Causeway Bay, we do have strong direct competitors. We've been doing the tenancy revamp as well in Times Square. But for as long as the retail markets are weak, we will not be able to see immediate results. But we are a long-term holder, we are long-term investor. So I hope our investment today will start to pay off tomorrow. Housekeeping, what was it?

The last question is on the [indiscernible] evaluation.

Oh, okay. It depends on how you look at it. If you look at the revaluation surplus, I'd just use one example. In 2020, the deficit was something like HKD 11 billion; and in 2021, it was HKD 2 billion. Okay, if you look at HKD 11 billion and HKD 2 billion, it's easy to conclude that our revaluation deficit improved by 80%. But that's not a meaningful view in my way and the way I look at it. It's not a meaningful view. The more meaningful view is that the revaluation deficit in 2021 amounted to HKD 2 billion, which was less than 1% of the total value of the portfolio, implying it was generally a stable market for capital [ bank ], so was the view of the valuers, not of our ourselves. So even if the deficit at the midyear point was wider, it was still an implied not much more than 1% variation compared to the beginning of the year. But obviously, when you compare 1% to 0.5%, you look at a doubling or vice versa, a halving. But that is not the relativity, which would be meaningful. And to answer your direct question about cap rates, as far as we know, cap rates have not changed.

The next question from Cusson Leung, JPMorgan.

Management, I have 2 questions. One is we know that the fifth wave is making the visibility this year, it's quite difficult. But I think as also highlighted in your review saying that there has been stabilization of rental before the impact from fifth wave. So I just want to see what kind of rental reversion will you be expecting if there was no fifth wave? And also the second question is, over the last 2 years, has there been any restructuring of the leases by moving more normal tendency from fixed path variable to more leaning towards higher variable contract?

By that, I guess you mean a reduction in base rates coupled with an increase in turnover rate?

Yes.

I see. Not any meaningful amount, possibly a few, but certainly nothing of scale. And to answer your first question, we were budgeting for a flattish year but that was before the fifth wave.

[Operator Instructions] So we have the next question from Praveen, Morgan Stanley.

Can you hear me?

Yes, we can, loud and clear.

Two quick questions. One, would you be able to tell us that 2/3 of your equity investment seems to be outside Hong Kong, even though majority is in property, which other country is it in? And the second question was, when you say absent fifth wave, the rental would have been flattish. Did you mean flattish over '21 or flattish over 2019, 3 years ago?

Very bullish. No. Well, first of all, we'd be happy to, so to speak, arrest the rental decline. So it would be flattish against the last year, i.e., 2021. But again, that was before the fifth wave. And as far as the classification of the listed investments is concerned, the classification is based on where the shares are listed, not based on the underlying business. The underlying business is still primarily Hong Kong and Mainland China.

Chairman, I believe that we don't have more questions. Just now, Mark Leung has raised his hand again.

So, I have one additional question, it's regarding on our office portfolio because I think in the results announcement, we highlighted given the inflated supply going forward, we expect the rent performances still continue to be challenging. So I just wanted to check how -- will we have any plan to upgrade our offices or obtain any green certificates to maintain the competitive advantages for our office portfolio.

Thank you. We constantly upgrade our portfolio of IPs, both in the retail area and also in the office area. We are embarking on a new round of upgrading the offices in Harbour City anyway. But because they are older buildings, there's only so much we can do about meeting today's standards. We can't pull them down -- we're not about to pull them down and rebuild them. If we were to rebuild them from scratch, it maybe easier, but that is certainly not something in our current plan. So in the absence of redeveloping our current offices, we will invest to upgrade them to meet customer demand, i.e., tenant demand. Thank you.

Thank you. We have one last question from Jianping from Credit Suisse.

This is Jianping. Can you hear me?

Yes, we can.

I'm asking about like the dividend policy. I understand that you want to keep the payout ratio at 65%. But if like the leasing activities continue to suffer given like the fifth COVID, do you want to -- like -- to give investors some -- like the compensation, like keep the dividend, the DPS likely unchanged in the current value?

I think the answer to that question is the Board has not discussed changing its preset dividend policy. The preset dividend policy was disclosed very clearly at the time we first missed it in 2017 and it has been repeated time and again in our various communications with investors. Rather than trying to adjust it from half to half or from year-to-year on an arbitrary basis, the Board is quite happy currently, at least, to stay with the formula. It's almost formulaic. It's very easy, we just calculate what the underlying net profit from Hong Kong investment properties and hotels add up to and voila comes out the DPS. The Board has not even started to consider changing it. The Board is quite happy with the current policy. Thank you.

Thank you. So we will come to the end of our presentation today. The PowerPoint will be uploaded to our corporate website shortly. Thank you for joining us today.

Thank you, and good evening.

Bye-bye.