Confidence in Link REIT and the Hong Kong Market

It was confirmed on May 28 that the Chinese government would start to carry out legislative work for a tailor-made national security law for Hong Kong.  Fear and uncertainty flooded the market. In the weeks that ensued, both the Hong Kong stock and property markets entered a state of flux, and the Hang Seng index witnessed some severe volatility.

During those period of volatility, I bought some more Link REIT shares, doubling my existing position on Link REIT.

I wrote about Link REIT back in February (https://mypecunia2020.home.blog/2020/02/26/2020-feb-my-corona-portfolio-2/).  At that time, Hong Kong was going through a difficult time brought on by the protest movement, the pandemic and the US-China trade war.  Even so, I was confident then of Link REIT being an excellent stock on the account of its first-rate track record and superior growth potential.  And till today, my confidence in Link REIT remains unchanged. It’s still a mighty good stock to accumulate.

Some Quick Facts

1. Link REIT is world’s second-largest retail-focused trust (the first being the US-based Simon Property Group).

2. Its largest shareholders include Blackrock, The Capital Group Companies, State Street, JPMorgan Chase and Stichting Pensioenfonds ABP.

3. Its portfolio Value: HKD196 Billion (129 retail properties, 3 office properties, 57000 car park spaces).

Results and Ratios

In the latest annual report (2020), Link REIT reported the following:

1. Revenue reached HKD10,718 million, an increase of 6.8% year-on-year (2019: HKD10,037).  

2. Net asset value per unit FELL 13.3% to HK$77.61 (vs HK$89.48, Mar 2019).

3. Net property income increased by 6.9.3% year-on-year to HKD8,220 million (2019: HKD7,689). 

4. Distribution per unit was HK287.19 cents, an increase of 5.9% year-on- year (2019: HK271.17 cents.

5. As at 31 March 2020, Link’s total debt increased to HK$34.6 billion (31 March 2019: HK$24.5 billion). 

6. Link’s gearing ratio increased to 16.7% (31 March 2019: 10.7%), partly due to the valuation decline of Link’s investment properties. 

7. As at 31 March 2020, Link’s EBITDA interest coverage stands at 7.8 times (30 September 2019: 8.4 times), which stands favourable against the requirement of more than 3.5 times to 4.0 times set by Moody’s, and against Fitch’s requirement of more than 3.5 times.  With its prudent asset and capital management, Link has maintained a “3A” credit rating from S&P Global, Moody’s and Fitch ratings.  The stable “3A” credit rating will support lower financing costs and potential debt-funded acquisitions.   

8.  As at 31 March 2020, the retail occupancy rate for Link’s HK portfolio and China portfolio remained stable at 96.5% and 97.8% respectively.  The retail reversion rate for Link’s HK portfolio slowed to 12.6%.  The retail reversion rate for Link’s China portfolio remained stable at 29.6% respectively.  The average monthly unit rent for Link’s HK portfolio improved mildly by 3.4% year-on-year to HK$70.3 psf.  The operating landscape for Link in Hong Kong has been challenging since months of social unrest.  The pandemic further weakened business sentiment and deepened Hong Kong’s recession (in Q1, GDP was -8.9% and unemployment rate was 4.2%) and disrupted a wide range of economic activities.   Retail sales and tourist arrivals have fallen drastically.  Even so, Link’s non-discretionary sales (64% of Link’s monthly income comes from food-related tenants) continue to demonstrate high resilience in spite of overall weakened economic situation.  Office leasing demand also took a substantial hit. 

9. Link’s PB Ratio was 0.81 when I made my purchase on June 2nd. The purchase was an attractive value play for me.

10. Based on my purchase price of HKD63, Link’s distribution yield was about 4.5%.

Why did I accumulate more Link REIT?

I mentioned it before, and I reiterate, Link is an excellent stock because of its growth potential and predominant track record.  

It has already added an office property (100 Market Street) in Sydney, Australia to its portfolio.  It is now in negotiations to buy a grade A office property (Morgan Stanley’s European headquarters) in London, in what would be Link’s first acquisition in Europe.  Link is still pursuing its Vision 2025 goal of having Hong Kong represent 70-75% of its portfolio value, China about 20%, and the rest of the world around 10%.

To date, Link has completed 85 asset enhancement projects and has another 19 or more projects in the pipeline.  For a REIT, engaging in AEIs is a viable way to keep its properties up to date with modern designs, reconfigure its properties for expanded commercial use, and increase the value of its properties and hence improve the rentability of its properties.  With its AEIs, Link is able to provide new and attractive shopping experiences for its shoppers.  Link’s goal with its AEIs is to “[create] environments that people want to frequent and enjoy, not just to shop.”

Risks that confront Link REIT

1. Economic Downcycle: The contraction of Hong Kong’s economy has put pressure on retail sales performance.  The social upheaval of 2019 and the pandemic of 2020 have disrupted a wide range of economic activities and plunged the city into a deep recession (GDP growth dropped to around 9%, unemployment rate surged to 4.2% for 1Q 2020 and median household income registered a 4.1% decline).  Tourist arrivals have also fallen drastically due to the pandemic.  

Amid such a lacklustre economic climate, non-discretionary sales at Link’s properties continue to demonstrate high resilience.  Link’s retail tenant mix is non-discretionary and tends to provide better performance in market downturns.  Even so, should the unemployment situation worsen, non-discretionary sales will still get hampered and in turn harm Link’s rental rate.

Leasing demand for Link’s office properties has also taken a hit in this period of economic contraction.  It is hoped that with government support measures and stimuli, economic recovery will come sooner rather than later for Hong Kong.  

2. Political Instability: With the introduction of the security law, protests are now smaller in size and hopefully less frequent.  Will another huge protest erupt some time in the future? Maybe.  Maybe not.  Link’s properties have thus far been quite insulated from the ills caused by social disturbance and political agitation.  Link’s properties are mainly found in neighbourhold areas and are not in the vicinity of major protest sites.  

3. Covid-19: Indeed, social unrest has brought almost every aspect of Hong Kong to a standstill.  The US-China trade war too has brought instability to Hong Kong’s economy.  But these paled in comparison to the Covid-19 pandemic which has already killed millions around the world, shut down cities and countries, and paralysed global economies.  There is no running away from this monster of the century.  Few businesses, except maybe tech-related companies, will emerge from this year unscathed.  

Hong Kong as a whole has done well in dealing with the pandemic, having learnt well from the experience dealing with SARS 20 years ago.  Malls are beginning to see more footfall as social distancing measures are relaxed.  36% of Link’s monthly rent comes from non-food-related tenants.  Barring a very severe resurgence of the virus in the community, mall activities should still pick up across the city and overall retail gross sales psf should improve for Link retail properties.  Link has also set up delivery pick-up points to facilitate shoppers who have placed their grocery and fresh produce purchases on-line.

14 new cases were discovered yesterday (7 July).  The Hong Kong Health authority is saying Hong Kong is now going through the 3rd wave of the pandemic.  Will social distancing measures be tightened soon?  Let’s hope not.

Still confident of the Hong Kong market

I wouldn’t have accumulated more shares of Link REIT just a week from purchasing Ping An Insurance if I weren’t confident of the Hong Kong market.

But don’t you know, Hong Kong is dead? With the introduction of the new security law tailored for Hong Kong, the “one country, two systems” status of Hong Kong is dealt a death knell. Hong Kong, one of the freest places in the world as we know it, has gone the way of the dodos.

Well, wait a minute. Who has been peddling this announcement of the “death of Hong Kong” since the idea of a security act for Hong Kong was mooted more than a month back?

Ah, the western media, led by Chris Patten in Britain and Mike Pompeo of Washington. I really doubt the veracity of their perspectives on Hong Kong, especially that of Mike Pompeo who has been in a senseless crusade against China for years, and who has also been stepping up his attacks on China since the start of the global pandemic.

I’m not wading into the controversial waters of world politics and international relations, but truth be told, the people of Hong Kong, a great majority of them, welcome the new security law (don’t just read SCMP or news from the West only … read local news in Mandarin to get a good grasp of ground sentiments).

The common folks are sick and tired of the weekly mayhem and violent protests. They want the freedom to eat in restaurants without being harassed and inconvenienced. They want the freedom to make a decent living and not be forced “to go on strike” when radicals crippled the transport systems on working days. They want the freedom to open shops without having to worry about their shops being vandalised. They don’t want their children to be misled or pressured into taking part in protest activities.

Security and stability is good for life and business, and this is exactly what Hong Kong needs to survive and thrive. The new security law helps to safeguard the stability and security that Hong Kong so badly needs after a year of social upheaval. The common man in Hong Kong has nothing to fear since the law only targets secession, subversion, terrorism and collusion with foreign and external forces that endanger national security.

But … aren’t expats leaving; international companies relocating; funds exiting; Hong Kongers migrating? Will not Hong Kong sink further because of the mass exodus of foreigners and local brain drain, and outflow of capital? Maybe so, just as it happened in the years leading to the Handover in 1997. Nevertheless, to date, there has not been any palpable outflow of capital or the relocating of international companies. Expats and local Hong Kongers are still staying put in the city.

Did you know that many of those who migrated in the years leading to 1997 returned when Hong Kong’s economy exploded after the Handover? Expats and international companies returned too. Why? Because there was money to be made in Hong Kong! Hong Kong provided them assess to the China market which has grown by leaps and bounds in the last 2 decades. And Hong Kong will continue to provide both expats and the people of Hong Kong opportunities galore to create and keep wealth. 

Interestingly, on the day the new security law was passed (30 June), the Hang Seng Index rose 0.52%, clearly reflecting positive business sentiment about stability.   And in the next few days that followed, the Hong Kong market continued to respond positively to the new security law.  

Richard Frost in his Bloomberg article wrote, “Hong Kong’s rallying stock market is defying predictions of the death of the city in the wake of a new security law. The Hang Seng Index jumped 7.8% in the three days after the law was imposed on July 1, its biggest rally since April 2015, and entered a bull market on Monday.”*

In another Bloomberg article, Richard Frost quoted Raymond Cheng, a property analyst at CSG-CIMB Securities: “Though there were protests yesterday, the number of people that took to the streets was much smaller, and the severity of the clashes was far less than some of the violence we saw last year … That’s reassuring for business.”**

The security law will bolster security and stability, and in my humble opinion, Hong Kong will continue to shine as one of the great financial capitals of the world, especially so when the central government is speeding up the integration of Hong Kong with the rest of the Greater Bay Area.  

The US is canceling Hong Kong’s special customs status but this is nothing more than just a “mosquito bite” for Hong Kong.  Hong Kong products made for export to the US account for only 0.1 per cent of Hong Kong’s overall exports.  The US government is enacting visa restrictions on Chinese officials who are deemed responsible for undermining Hong Kong’s autonomy and freedoms, but this doesn’t hurt Hong Kong at all on an economic level.

What about the US striking against the Hong Kong dollar peg as an option to punish China, which will limit the ability of Hong Kong banks to buy US dollars?  This is quite unlikely to happen.  As Stephen Innes at AxiCorp puts it, “the unthinkable instability that it would trigger in the dollar-based global financial ecosystem could drive a selloff in US equity markets — an outcome abhorrent to the White House ahead of the November presidential election.”***

This new cold war between China and the USA will go on for years to come.  And Hong Kong caught in the middle between the two giants will not come out pretty.  The US will not stop interferring in Hong Kong’s business, and neither will China budge, not after having gone mano a mano with the US in a battle for influence in Hong Kong for years.

What will become of Hong Kong?  Only time will tell.

For now, I choose to bet on a bright future for Hong Kong and her financial market.  Hong Kong is still China’s golden goose, and China will do every thing in her power to keep this golden goose alive and grow her to as big a size as possible. 

制裁香港是“七伤拳”,伤港亦伤己,美国对此不能不认真考虑。在贸易方面,去年美国对香港有260多亿美元贸易顺差,如两地齐加关税,美国损失更大。香港是国际金融中心,也是投资内地的跳板,如美国对港金融设限,不但影响美资金融机构,也打击不少有关服务企业。

《星岛日报》社论

一旦香港独立关税区待遇被取消,直接影响双边贸易。若美国政府强行要求美企和资金撤离香港,将严重损害美企利益。美国评级机构惠誉强调,香港引入国家安全立法也不会带来进一步降级压力,并相信香港在宏观制度上仍能保持高度自治,例如独立运作的货币、财政框架、金融管理体系及商业环境,反映美企跟美国政府未必一条心。

《香港经济日报》社评

* https://www.bloomberg.com/news/articles/2020-07-06/hong-kong-stocks-surge-into-a-bull-market-in-win-for-government

** https://www.bloomberg.com/news/articles/2020-07-02/hong-kong-s-stock-market-reopens-to-a-changed-reality-under-law

*** https://hongkongfp.com/2020/07/08/security-law-white-house-may-target-hong-kong-dollar-peg-as-punitive-response-report/

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.

My Corona Portfolio (2): Link REIT

Hong Kong has been ravaged by protests and riots for months since mid-2019.  The resentments from those tumultuous days continue to linger, right into 2020.  The economy plunged into recession as a result of the social unrest.  As if things could not get any worse, the coronavirus found its way to the Pearl of the Orient, and created further havoc in the weakened Hong Kong economy.  Talk about a double whammy! 

Hong Kong, one of the shopping paradises of the world, depends a lot on tourists. During boom times, Hong Kong’s tourist arrival numbers about 100,000 on a daily average. Today, the daily average has dropped to below 3000. That is a 97% decline in tourist arrival numbers! 

Hong Kong’s tourism and hospitality industries are being decimated. Many hotels are half-filled, with some hotels registering single digit occupancy rate. The coronavirus situation is also dealing a knock-out blow to many restaurants and travel agencies. Popular shopping areas have become quieter, and many high-end stores are reporting muted sales. Tenants are asking for rental discounts or rebates in the wake of poor business. Many landlords, such as Sun Hung Kai Properties and Wharf REIT, have begun slashing rents for their tenants as these retailers struggle in their businesses.

In doing so, these property companies and REITs are hurting their own bottomline. And as a result, share prices of these property companies and REITs began to slide south.

To build up my Corona Portfolio, I began to look into some of these property companies and REITS that pay dividends, and shortlisted some of them.

Here’s my shortlist:

1. Link REIT

2. Champion REIT

3. Sun Hung Kai Properties

4. Henderson Land Development

5. Wharf REIT

6. Swire Properties

7. Wynn Macau

Since it will take a while for me to study each of these companies, I decided to go with the one I’m most familiar with first … Link REIT.  Link REIT has been on my radar for quite a while now, and when the share price dropped to my desired range, I bought some at HKD78.00 and added Link REIT to my Corona Portfolio.

Introduction

Link REIT is the largest listed REIT in Hong Kong.  Link possesses a portfolio that comprises retail facilities, car parks and offices across Hong Kong, Beijing, Shanghai, Guangzhou, and Shenzhen, and Australia.  Its retail properties are located close to public housing estates (heartland malls). 

Highlights (HK properties)

The bulk of Link’s rental income in Hong Kong is derived from tenants selling consumer staples.  It is interesting to note that food-related sales make up 60% of trade at Link’s retail properties.

Therefore, regardless of economic cycles or status, Link’s earnings derived from businesses such as supermarkets, restaurants, and fast food, should remain resilient across economic cycles.  

Results and Ratios

In the latest interim report (2019/2020), Link REIT reported the following:

1. Revenue reached HKD5332 million, an increase of 8.8% year-on-year.  Since most of Link’s properties in Hong Kong are mostly connected to public housing estates, it benefits from having sizeable catchments and good connectivity.

2. Net asset value per unit grew 1.2% to HK$90.58 (vs HK$89.48, Mar 2019).

3. Net property income increased by 8.3% year-on-year to HK$4,071 million. 

4. Distribution per unit was HK141.47 cents, an increase of 8.3% year-on- year.

5. Link boasts an extremely low gearing ratio of 11.9% (relatively low when compared to most REITs listed in the SGX). The low gearing will provide Link with ample flexibility to continue investing in its business. 

6, Link has an interest coverage ratio of 10.65x, meaning to say that it is producing more than enough funds to cover its upcoming payments.

6.  As at 30 September 2019, occupancy rate for Link’s HK portfolio remained stable at 96.9%.

7. Link’s overall portfolio reversion rate stood at a whopping 18.1%. Average monthly unit rent improved to HK$69.6 psf as at 30 September 2019 from HK$68.0 psf as at 31 March 2019. 

8. Because of its excellent management and low gearing, Link will be able to leverage on its strong asset and capital management and asset enhancement capabilities over its diversified portfolio in Hong Kong (and Mainland China).  When it comes to capital management, Link is par excellence, as its history of active portfolio management through acquisition, divestment and development proves.  Link has been able to deliver long-term sustainable return to its unit holders, and have returned capital to unit holders in the form of unit buyback and discretionary distribution. 

9. Link’s PB Ratio was 0.85 when I made my purchase.  That was a bargain. In addition, Link has been growing its NAV at a rapid pace, increasing from HK$56.79 in FY15/16 to now HK$91.92. This makes Link even more attractive as the future PB ratio for shares purchased at the current price will be even lower.

10. Link has a distribution yield of 3.7% which is far better than its yield of around 2.7% at its peak price.  Should Link continue to grow its distribution per unit as it has done in the past, the distribution yield will continue to rise in tandem over time if shares are purchased at its current price.

Why did I buy Link REIT?

All the above provide me ample reasons to buy Link REIT.  To put it succinctly, Link REIT is an excellent stock because of its superior growth potential and first-rate track record.

Going forward, Link has plans to extend its expansion into other areas beyond the shores of Hong Kong and China.  Link intends to opportunistically add investments in Australia, Singapore, Japan and the UK. 

Link has shown its ability to unlock value through asset enhancements. In the past year, 11 AEI projects had been completed. These completed AEI projects had a return on investment of between 13.8% and 35.6%. Link will reap the benefits of these 11 completed projects in future years. In addition, Link has another 4 projects underway that could provide a further boost by this year.  

Following the recent acquisition of 100 Market Street in Sydney Australia, Link fine-tuned its Vision 2025 Goal, with Hong Kong representing 70-75% of its portfolio value, China about 20%, and the rest of the world around 10%.  Link is a company with a well-thought out growth plan, and I want to buy a company that grows its business over time.

Link’s market cap is HKD204 billion, thus making it a large-cap company. Typically, large companies are well-established and highly resourced. That means, while market volatility may impact some short-term strategic decisions, it is unlikely to matter much to such big companies in the long run. Therefore, even during a time when the general market is selling off (like these recent weeks), Link REIT, being a large-cap stock, is a safe bet to buy.

In reality, in the wake of this health crisis, both the Hong Kong and China markets have lost their momentum, and retail consumption and retail rents have been affected. As the saying goes, “this too, shall pass.” I just need the patience and mental fortitude to ride through short to mid-term volatility (and until the coronavirus crisis comes to an end) to await Link’s share price recovery. 

Now one question begs to be asked: has online shopping affected Link in any way?

Not very much.  Link (as well as other commercial REITS in Hong Kong) appears to have dodged this bullet.  Why? Hong Kong people live in tiny apartments with small fridges (I’ve lived in one such small apartment before, and the fridge was really pathetically small … I only used it to keep drinks and fruits cold).  So people tend to shop more regularly and eat outside more often.  Hence, going to the shopping malls is an everyday experience for most Hong Kong people.

Like any other business in Hong Kong, Link does face challenges. The covid-19 crisis, as well as the social unrest, will continue to put pressure on Link’s business.  In addition, any unexpected interest rate hike will also adversely affect Link’s distribution and valuation.

Link REIT is really a gem of a company, and I’m glad to have it in my pocket. 

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.