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

Good afternoon, everyone. Welcome to Wharf REIC Interim Results Presentation. I am Angela from the IR team. You can download the PowerPoint presentation from the QR code on this LED wall. Our management presenting today includes Mr. Stephen Ng, Chairman and Managing Director; Mr. Horace Lee, Director. We will first go through the PowerPoint presentation and then open the floor to the analysts for a Q&A session with the management. The theme for the presentation is 42% dividend increase on dividend payout revision, which I hope will give you a positive surprise. Now I will share some key highlights from the reporting period. With deleveraging as a key strategic priority since listing in 2017, we have consistently reduced our debt and gearing to new lows, resulting in stronger balance sheet and lower borrowing costs. Helped by the lower borrowing costs, group underlying net profit increased by 6%, while net cash inflow before financing increased by 41% or HKD 1.4 billion. Considering the current earnings base and the debt profile, the Board has decided to increase the distribution payout ratio from 65% to 90% of recurrent core earnings from 2026 onwards, while keeping the policy under regular review. This implies a 38% increase in base dividends. Reflecting the revised 90% payout ratio, our interim DPS increased by 42% to HKD 0.94. Subsequent to the period end, the group has agreed to dispose of Wheelock Place in Singapore at 12% premium to book value. On the completion of the transaction later this month, our gearing is expected to fall from 16% to around 11% by end of this year, further enhancing our strength and flexibility of balance sheet. Now let's take a closer look at our financial management, which is a core strength that enabled the group to navigate different market cycles effectively. Net debt and gearing ratio were reduced to record lows. And as at the end of June, 89% of borrowings were on floating rate and our average interest cost further improved to 3.5%. Our financial health is affirmed by Moody's A2 rating and our interest cover remains strong at 8.2x. The benefit of our deleveraging strategy is clearly visible. Since 2020, net debt has fallen by a cumulative HKD 22.8 billion, as shown on the chart in the left. This proactive deleveraging strategy helped cushion the impact of rate hike cycle and support earnings resilience. With low net debt in the first half, our borrowing cost declined by 26% or around HKD 200 million. As reflected in the chart on the right, our group UNP and DPS remained resilient throughout the rate hike cycle in the past few years. And this year, our interim DPS continued to grow following a mid-single-digit growth in 2025. And then the financial highlights. Group loss narrow with the lower IP revaluation deficit, which is noncash and unrealized. Cap rates remain unchanged. Our recurring core UNP increased by 3%, supported by lower borrowing costs. As mentioned before, DPS increased by 42% to HKD 0.94, representing 90% of recurrent core UNP. Upon completion of Wheelock Place disposal, we expect a gain of approximately HKD 1 billion and net sale proceeds of approximately HKD 6.7 billion will be used to support our deleveraging strategy. Regarding our core earnings performance, underpinned by 6 premium quality properties in Hong Kong, the group's core revenue from Hong Kong IP and hotels were resilient at HKD 5.9 billion. Retail remains the dominant earnings contributor, accounting for nearly 60% of Hong Kong IP and hotel revenue. Office accounts for 26% and the remaining comes from service apartment and hotels. As one of the most productive retail assets in Hong Kong, Harbour City generates over 80% of our Hong Kong retail revenue. With Harbour City delivering mild revenue growth and a 4% increase in UNP, this key earnings pillar accounts for nearly 80% of the group's core revenue and 86% of recurrent core UNP, supported by rising tourist arrivals and stronger discretionary spending. This landmark destination achieved double-digit retail sales growth, outperforming the overall Hong Kong market. In the following slides, I will walk through the performance of our Hong Kong IP and hotels. First of all, let's take a look at the market condition. Driven by discretionary spending, Hong Kong retail sales grew 9.6% to HKD 200 billion despite a moderation in second quarter. Visitor arrivals grew 13% to nearly 27 million. Same-day visitors predominantly from the Mainland, account for more than half of the total, highlighting continued reliance on day trippers. In contrast, overnight visitors only grew by 2% during the period. For non-Mainland visitors, which comprised 23% of total, the top 5 markets represent nearly half of this segment, of which 4 were short-haul markets. And at the same time, for local outbound travel, it climbed to 62 million in the first half, taking up around 70% of total cross-border passenger traffic. Nearly 90% of outbound travel was by land with land departures growing 10%, while air departures remain flat. This reflects the continuing trend of northbound travel, which remains a headwind to local consumption market, particularly in nondiscretionary categories. Against this backdrop, our premium retail portfolio outperformed. As mentioned earlier, Harbour City delivered tenant sales growth well ahead of the overall Hong Kong market, and Times Square also recorded positive sales growth. While retailers are still cautious on major leasing commitments, our malls continue to attract leading brands, including some regional debuts and flagships. At Harbour City, Toys "R" Us has been transformed into first world-class flagship store, while the luxury cluster continues to be strengthened through new openings such as ZEGNA and other brand expansions. At Times Square, FIFA Museum made its Asia debut and SKIMS, a globally popular brand, will open its first Asia flagship store at Times Square. The group also stepped up marketing initiatives to drive footfall across different customer segments. Highlights include the Toy Story 5 and the Minions events in this summer, alongside a lineup of experiential campaigns. Turning to our office portfolio. The office market is showing signs of cautious stabilization, but rental pressure remains. We maintain flexible leasing strategies while accelerating asset upgrades to strengthen competitiveness. As a result, our overall office occupancy increased to 93% at period end, outperforming market average. Then we will switch to our hotel portfolio in Hong Kong. Benefiting from the prime location, the 3 Marco Polo Hotels on Canton Road outperformed the district in occupancy, while The Murray in Central achieved strong double-digit occupancy growth. Our effective pricing strategies also drove double-digit growth in revenue per available room across the hotel portfolio. While performance remains solid, growth momentum moderated towards the end of the period as visitor arrivals begin to slow. Moving on to the overall market outlook. Hong Kong continues to benefit from safe haven capital flows, a weaker Hong Kong dollar and rising visitor arrivals, although the recovery may remain gradual and uneven across sectors due to a complex and uncertain external environment. Despite these uncertainties, the group remains well positioned to navigate evolving marketing -- evolving market conditions underpinned by our premium asset portfolio, strong balance sheet and disciplined financial management. In the last part of the presentation, we will go through our efforts and performance in sustainability. Last year, the group's near-term science-based targets were approved by SBTi, which marked an important milestone for our sustainability journey. Our efforts have also earned a strong ESG ratings. And this year, Harbour City becomes one of the largest LEED Platinum mixed-use developments in Hong Kong, covering approximately 6.5 million square feet of certified floor area. As of June this year, sustainable financing made up over half of our financing. More details about our sustainability efforts could be found in the PowerPoint presentation. So that concludes my presentation. We will now proceed to the Q&A.

A quick housekeeping note for the analysts before we begin. [Operator Instructions] Now may I invite Mr. Ng and Mr. Lee to come to the stage, please. So we will have the first question from the lady, Cindy from Citi.

This is Cindy from Citi. So 2 questions from me. First, obviously, is on the dividend payout ratio. Wanting to better understand your consideration behind this 90% payout ratio, I mean, why wasn't it 95%? Why wasn't it 80%? And did the Wheelock Place divestment actually moving the needle for you to making this decision? And any possibility of future upside or what could drive future upside? And also, how do you see buyback versus dividend payout in future capital allocation? This is the first question. Second question, wanting to dig a little bit more into your Singapore portfolio. So I think Scotts Square is your only portfolio in Singapore for now. So are you actively reviewing a potential divestment option for that? And should that divestment complete, how would the proceeds be allocated beyond further deleveraging, which apparently is maybe not the top priority for now? And will you pursue any, say, potential acquisitions to boost the utilization of your balance sheet?

Thank you. First question, revising the dividend policy from a 65% ratio to 90% ratio. The simple answer is you asked for it. I've been getting that question and suggestion many times. And typically, I would flatly deny it in order not to create any speculation, a little bit like the Hong Kong dollar peg. Any time you ask, I say no. But in fact, we've been thinking about it. Let me go back to when we started -- when we first listed in late 2017. That was when the property market, the economy and so on were very hot in Hong Kong. And we decided to be more prudent, and we decided on the dividend policy of 65%, because we figured that the downside was probably bigger than the upside when the market was hot. 9 years later, it looks like things have stabilized post COVID. And we look at it again, and it looks like the downside is no longer as threatening as it could have been back in 2018 -- '17, '18. And -- why 90%? Because that's a REIT distribution. If REITs can do it and it's well accepted by the market, we'll do the same. It doesn't mean there will be the end of any expansion or development opportunity for ourselves. Because if you look at some of the REITs, Link in particular, they've been paying 90% or more, and it doesn't stop them from building assets or building the asset base. So the fact that we're distributing or we revised the distribution policy to 90% would not prevent us from growing the company at all. And in simple arithmetic, the additional distribution we would be carrying on an annual basis is roughly about HKD 1.5 billion. It's not small money, but it -- compared to the rate at which we've been able to reduce our overall debt, it's manageable. And -- so we have not stopped the deleveraging direction. And what we're doing is we're trying to do both at the same time. Now what we could have done, as you probably suggested, is to do share buyback. But the difference between share buyback and paying a higher dividend, revising the dividend policy upwards is that the share buyback would benefit those investors, those shareholders who are considering or who may be prepared to consider selling. They are also holders, holders for now, holders for longer term, holders until next year, holders until 3 years or 5 years later. And whereas the increase in distribution would benefit all shareholders, whatever your investment thesis is. So I hope that answers the first question in a very, very long way. In Singapore, we currently have 2 assets. We have contracted to sell the bigger one of them at a price which we -- the directors consider attractive, it's a 12% premium to book. And we also benefit from a favorable FX factor. The Sing dollar has appreciated in the past 8, 9 years, which enables us to book a profit of about HKD 1 billion. The other asset we will probably sell as well. You may remember, we actually put the Scotts Square asset on the market publicly 2 years ago. We didn't sell at that time. So we do get reverse inquiries all the time, and we're dealing with them. So hopefully, we'll be able to do a deal, so to speak, before the end of the year.

Okay. The next question from Karl Chan, JPMorgan.

This is Karl Chan from JPMorgan. I have 2 questions. The first question is still on the dividend because now the dividend payout is so generous, should investors expect that for the upcoming few years, there may not be too much CapEx? Because it seems like last year, we started to talk about the redevelopment or renovation of Marco Polo Hotel, which may involve a lot of money, right? So just curious if that is the implication from a higher dividend payout ratio. And speaking of Marco Polo, just curious any update on what's our latest plan? That's the first question. And the second question is back to basics -- sorry, the Hong Kong tenant sales. So you said that for the first half, Harbour City outperformed the Hong Kong average. But just curious what's the trend for the past -- just for the past 2 to 3 months? Because if you look at the latest commentaries from the luxury brands, they said that the sentiment has been slowing down. We also saw that in Mainland China. And then for Hong Kong tourist arrival, we also saw a slowdown in July. So just curious, just for the past few months, do you see a slowdown in tenant sales in Harbour City as well? So that would be my second question.

Good. Thank you. First of all, I need to clarify that Marco Polo Hongkong Hotel is an asset owned by our listed subsidiary, Harbour Centre Development Limited. It's got its independent balance sheet, funding and so forth. And in fact, it is a separate credit entity. Its debts are not guaranteed by Wharf REIC. And our distribution increasing the dividend payout ratio would have no direct impact on Harbour Centre's ability to fund a redevelopment or otherwise. In fact, because of market and performance reasons, Harbour Centre has not been paying a dividend for 6 years, all right? So we've had 0 dividend from that listed subsidiary. And if -- even if it continues not paying any dividend, it will not be a factor. It's a neutral factor. We're reviewing -- continuing to review schemes to redevelop the hotel, at the same time as renovation is a possibility. The schemes of renovation are relatively limited because you're confined by the structure. Whereas for redevelopment, there are many, many possibilities as to how much of what? How much retail, how much office, how much hotel and so on. And we haven't found the optimal scheme yet. In the meantime, we're running the hotel. It's performing relatively well this year compared to last year. While on this point, I should point out that the other hotel owned by the group, again, under Harbour Centre Development Limited, i.e., this hotel, The Murray, did exceptionally well in the first half of this year. So it's encouraging. It's rewarding. So there is no hurry as such, particularly because they are doing better. As for your second question, yes, we did see a slowdown in retail sales in June, particularly in June. In fact, across the different businesses within our group, June was the slowest month in the year -- in the first half, in the first half. If we combine January and February together, given the timing of CNY. Retail sales growth was slowest, hotel performance was slowest and even Star Ferry patronage was slowest. In fact, it dropped, Star Ferry patronage in the month of June. And there may be any number of reasons, weather, World Cup and so on. We can't put our fingers on precisely one single factor. But the truth is June was the slowest month in the first half. And I think that's borne out by government statistics to retail sales. July, we don't have full numbers yet, but July seems to be a little bit better. August, obviously, we don't, 6 -- being the 6th of August. Overall, we're still optimistic about the second half. But the base is a little higher because retail sales started to rise again in May of last year. Having said that, I'm optimistic we will still beat it -- beat last year.

And the next question from Karl Choi, Bank of America.

Two questions. First, just want to continue on the retail theme. Could you talk a little bit about the rental reversion performance in the first half and outlook for the second half and maybe into next year, given what you have seen? And related to that, Times Square had a pretty difficult first half. Could you sort of talk a bit more about the reasons behind? And do you think the rental income has -- is bottoming at this current level? And second is, on the slide you also mentioned the uncertain impact from the new offshore investment rules by China and then now you have the potential taxing of insurance policies held by Mainlanders. How do you think that could impact your Wharf REIC, whether it's on the retail side or on the office side, especially in regards to insurance companies because they're pretty big occupants of Harbour City office.

Right. Okay. First of all, retail sales -- rental reversion. Getting old. Rental reversion on the retail side, it varies. I think we have mentioned in our announcement or maybe in the presentation that tenants are still cautious about making major commitments. So that's why for large space -- large spaces, I think the market is still not strong enough. We actually, within the group have a couple of large spaces, which became vacant. And they are today still vacant for different reasons. One of them, for instance, is the cinema. It's a very large space. And because the renovation and/or redevelopment plan is not finalized yet, we're not ourselves in a hurry to commit a tenant. They are the large spaces. And when it comes to large space, the CapEx required to set it up and the operating commitment is a lot more serious. And that's where we are not seeing a good deal of reversion upside yet. But for smaller places, particularly the attractive locations, we've seen the corner having been turned. But because it's so different throughout the portfolio, I don't think it's useful to say overall, the rate is plus 2% or minus 5%. Generally, it's stabilizing. But because of the new vacancies, overall rental income on the retail side, I don't see that increasing too rapidly in the near term because of the large space vacancies. So that's what we need to try and fill up. Second question?

Times Square rental trend.

Times Square rental trend is stable. And also the turnover rent is also stable. So hopefully, we'll be able to report better results very soon. We've put a lot of effort into enhancing the competitiveness of that property, marketing and also CapEx. And I think they're beginning to pay off. So hopefully, in 6 months' time, I'll be able to tell you something better. Oh yes, yes. China, I can't answer that question. It's too soon. We ourselves are not directly exposed or very marginally directly exposed, but some of our tenants may be. So what we need to find out is to talk to our key tenants, which may be affected, find out how they see it and find out whether or not they've got their own way of dealing with these issues. Oftentimes, there are ways. So it's a little bit early for me to answer the question.

Okay. And then we will have the next question from Mark, UBS.

This is Mark from UBS. Sorry, I may have a little bit more in-depth question regarding on the payout hike. I think the first question is why we have decided to change the payout policy now? Because when I look on our guidance or what you mentioned about the outlook, it seems you are quite cautious, right? So isn't it better to retain the cash to further deleverage maybe to net cash? Why we decided to turn more caring about the shareholder return as of today? I think that's the question, why now? I think the second question is more regarding if we are focusing on shareholder return, do we have any more ongoing activity we are planning on, for example, focusing on asset disposal, recycling, buyback, any total share return target? I think that's my second question. And I think the third question is -- my takeaway is you mentioned about the payout ratio was set in 2017, right? Now we raised to 90%. Does it -- you mean that in Hong Kong we cannot find much as excited M&A opportunity as of in 2017? i.e., the short question is, were we never able to get back in 2017? So the first question is why now? Second question is TSR target. Number three is about are we able to go back to 2017? Because seems what your guidance or comment is we won't go back to the golden age.

I thought I answered most of those questions, but I'll try again. In 2017, the property market and the economy, both of them were quite hot. This was late '17, leading into '18. And at that time and even now, we never thought that good things will go on forever. So we considered the downside being bigger than the upside, and we wanted to be more cautious, particularly when at that time, we had HKD 42 billion of net debt. Today, we're projecting about HKD 20 billion of net debt by the end of this year. So our net debt will have halved. Although because of the turmoil in the market -- in the trading market, our cash flow has also decreased -- annual cash flow because we -- rents were higher and everything else, profits were better. So in a way, we were right. I'm glad we didn't start with 90% because that would have prevent us from being able to deleverage as quickly from HKD 42 billion to, say, HKD 20 billion very soon. When we look at today's market, we see more stabilization, and therefore, we see the downside and the upside being more balanced. And given that outlook, we decided in the Board meeting this morning that we would increase our dividend payout ratio as a matter of policy. Now we could do buyback, but I thought I just answered that. We considered the distribution being in a way, fairer to all shareholders and not just to those shareholders who decided to sell at the moment. Some shareholders are not prepared to sell yet because they came in at a higher price. So we decided on increasing the distribution. Capital recycling, selling assets, yes, we are dealing with the Singapore assets. And if there are good offers for other assets, yes, we can consider them too. It's part of the capital management. And -- I think I've answered all of your questions.

Okay. And then may we have the next question from Raymond, HSBC.

So there are a lot of questions on dividends. So I would like to pivot the question towards the retail side. So for the first question, actually it is about the tenant sales outperformance on the Harbour City. So like the management mentioned that like there's a rather outperformance of the mall compared to other cities, which went up by like 10% year-over-year in first half. Can management quantify like the outperformance to the investors by, say, by a few percentage points or even double digit or mid- double digit? So -- and more important for this question is, are we expect to see improved turnover rent entering the second half or in 2027? This is the first question. And the second question actually is about the quantum of the consumption spending in your portfolios. From a management perspective, do you see like there are stronger momentum or the spending -- capital spending on the tourist spending or the domestic spenders? So are we going to see the trend to sustain in the second half or going onwards?

Our portfolio as a whole, particularly Harbour City, we were doing mid-teens. So probably 50% better than the market. Playing with numbers. Now -- but that doesn't necessarily mean turnover rent will go up by that kind of numbers because, first of all, some tenants in the past or in the recent past were not selling enough to pay turnover rent, all right? So -- and the fact that they're now trading better would allow them to better afford the base rent. So -- and then the other moving part is, of course, new leases and old leases may not have identical either base rent or balance between base and turnover. So it's always -- rather, I should say, it's often misleading to look at just turnover rent and say, you're doing better or not better. If I push it to an extreme, if we want turnover rent to go up very quickly, I can just abolish base rent. Turnover will go up. We won't, of course. So you've got to look at the package. Who's buying more locals or visitors? We're historically quite dependent on tourist spending to give us the upside. Locals, we like them, but it's stable. And then the other problem with locals -- not problem, the other issue with locals is that -- I think Angela pointed out too, out of every 10 border crossings in the first half of this year, 7 were locals. Locals were leaving more than visitors were arriving. And all of the increase in locals traveling out happened across the land border. And that is a trend which hasn't stopped yet, although it seems to be slowing down a little bit. So we will need to count on visitor spending to continue the momentum. Fortunately, the renminbi is stronger. And with the new Huanggang building opening soon, obviously, it's a 2-edged sword -- double-edged sword. It's easier for Hong Kong people to exit, but it's also easier, hopefully, for mainlanders to arrive. So we'll see.

And then the next question from Jeff, DBS.

I have 2 questions. The first is also the follow-up question on dividend hike. Is the decision to raise the dividend related to the Singapore disposal? Put in the other way, if there wasn't any disposal in Singapore, would the management consider increase the dividend payout ratio for long term? Second question is about the turnover rent. If you look at the Harbour Centre, tenant sales increased by mid-teens. However, if you look at the overall turnover rent, it went up by only 3%. But I recall that in the previous upcycle, usually turnover rent increased faster than tenant sales. So what is the major difference between this upcycle and the previous one? Is this because of the change in the terms of the current lease or the tenant which register better performance, are those -- are not those who paid the turnover rent in the past?