Hongkong Land: Interim Dividend Maintained Despite Challenging Times

Summary

• Hongkong Land's 1H 2021 financial performance was decent; the company's underlying earnings increased by +12% YoY and it did not cut its interim dividend.
• Concerns about the company's core Hong Kong office property business seem overdone, considering its recent 1H 2021 results, management's remarks at the earnings call, and relevant news flow.
• The market values Hongkong Land at 0.31 times P/B, and the stock boasts a consensus forward FY 2021 dividend yield of 4.9%.
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Elevator Pitch

I maintain a Bullish rating on Hongkong Land Holdings Limited (OTCPK:HKHGF) [HKL:SP].

Hongkong Land's stock price rose by as much as +42% from $3.70 as of August 7, 2020 to a one-year high of $5.26 on March 10, 2021, following my prior update on the company published on August 10, 2020 where I upgraded the stock's rating to Bullish. Hongkong Land's shares have corrected in the past four months, but its last traded price of $4.55 as of August 4, 2021 still represents a decent +23% gain (excluding dividends) in the last one year.

Hongkong Land's 1H 2021 financial performance was decent; the company's underlying earnings increased by +12% YoY and it did not cut its interim dividend despite challenging market conditions brought about COVID-19. Concerns about the company's core Hong Kong office property business seem overdone, considering its recent 1H 2021 results, management's remarks at the earnings call, and relevant news flow.

The market values Hongkong Land at 0.31 times P/B, and the stock boasts a consensus forward FY 2021 dividend yield of 4.9%. Valuations are undemanding, which supports my case for a Bullish rating to be assigned to Hongkong Land.

Hongkong Land's OTC shares have a very low average daily trading value of under $100,000 in the past three months. On the other hand, the three-month average daily trading value of Hongkong Land's shares listed on the Singapore Stock Exchange was more than $8 million. Readers can trade in Hongkong Land's Singapore shares, which are far more liquid, using US brokers like Fidelity or Interactive Brokers.

1H 2021 Results Were Decent

Hongkong Land announced the company's 1H 2021 financial results on July 29, 2021, and its financial performance in the first half of this year was pretty decent. The company's underlying net profit attributable to shareholders, adjusted for fair value changes on investment properties which are non-cash in nature and tend to be volatile between financial periods, grew by +12% YoY from $354 million in 1H 2020 to $394 million in 1H 2021.

As per the chart below, the growth in earnings contribution for the development properties business segment was the key reason for Hongkong Land's bottom line growth in the first half of fiscal 2021. But it is also important to note that profit contribution from the company's investment properties business segment still increased YoY in the first half of the current year. In a nutshell, Hongkong Land's investment properties business segment was more resilient than expected, while the rise in profit contribution from its development properties business segment is an indication of the company's efforts to diversify its earnings mix. I will discuss more about this in greater detail in the subsequent section of this article.

A Breakdown Of The Change In Underlying Net Profit Between 1H 2020 And 1H 2021

Source: Hongkong Land's 1H 2021 Financial Results Presentation Slides

Hongkong Land kept its 1H 2021 interim dividend per share at the same level as last year ($0.06), which gives investors the confidence that the company will maintain its full-year dividend per share of $0.22 in the current fiscal year.

Hongkong Land also stressed at its recent 1H 2021 earnings call that "the group's balance sheet and funding position remain strong", which should help to support the company's future dividend payouts. The company's net debt-to-equity ratio was 13% as of end-1H 2021, and its weighted average debt maturity remained long at 6.4 years as of June 30, 2021. Hongkong Land also has A and A3 credit ratings from S&P (SPGI) and Moody's (MCO), respectively, which means that the company should have little difficulty in borrowing at reasonable rates if needed.

All Eyes On Core Hong Kong Office Property Business

Hongkong Land's valuations remain depressed (details in the final section of this article), despite the fact that its shares have increased by more than +20% in the last one year. This is largely due to two factors. Firstly, investors are concerned that the acceleration of Work-From-Home trends as a result of the coronavirus pandemic will lead to a significant decline in demand for Hong Kong office properties. Secondly, the market is worried that political issues relating to Hong Kong (e.g. introduction of the National Security Law which drew US sanctions) will drive a lot of companies (existing and potential office tenants) to leave the city.

The company's recent 1H 2021 financial performance, management's observations and relevant news flow suggest that such concerns could potentially be overblown to a large extent.

Hongkong Land's operating income for the investment properties business segment was $431.7 million in 1H 2021, which is largely flattish as compared to the company's 1H 2020 investment properties segment's operating profit of $432.2 million. Specifically, Hongkong Land's core Hong Kong office property portfolio saw the vacancy rate rise slightly from 6.3% as of December 31, 2020 to 6.4% as of June 30, 2021, and the average net rent per square foot per month only declined marginally from $119 in 2H 2020 to $118 in 1H 2021.

One key thing to note is that Hongkong Land's expiring rents in 1H 2021 and 2021 are approximately +12%-15% higher than its current average rent, which potentially implies a further decline in rental income for its Hong Kong office properties in the short term. But things are not as bad as feared. Hongkong Land's weighted average lease expiry for the company's Hong Kong office portfolio as of June 30, 2021 is 4.2 years, so a significant collapse in overall occupancy rates and rents in the near term is unlikely.

Hongkong Land's management also made some important observations at the company's 1H 2021 results briefing. Hongkong Land highlighted that demand-supply dynamics in the Central District office market of Hong Kong remain favorable. There is a strong pipeline of IPOs for the Hong Kong stock market, which supports office demand from tenants in the legal, finance and accounting sectors. Management also estimated that new office supply in the Central District in the near term only accounts for approximately 3% of the total Central District office market's current total net leasable area. More importantly, the company also revealed that its 30 largest Hong Kong office tenants have a very long weighted average lease expiry of 6.2 years, which is even longer than the overall Hong Kong office property portfolio's average lease expiry of 4.2 years.

Also, a recent survey of 109 Asian companies conducted by CBRE (CBRE) which was quoted in a July 22, 2021 Bloomberg article suggests that "66% of Asia-based firms expect to add space in the next three years, up from only 28% in October (2020)." This implies that the negative impact of Work-From-Home trends on the Asian office property market might not be as severe as feared.

Separately, it seems that most international companies in the financial sector are staying put in Hong Kong, despite increased political & legal risks associated with doing business in the city after the National Security Law was introduced a year ago. A June 4, 2021 Reuters article noted that "some global banks, funds and other financial services providers" are increasing "hiring in Hong Kong", which could suggest that Hong Kong's "unique position as a financial gateway to China is outweighing concerns about Beijing's tightening grip over it." In other words, the worst-case scenario relating to a mass exodus of companies from Hong Kong due to political risks has not materialized.

More significantly, Hongkong Land has been diversifying its earnings mix to reduce reliance on the Hong Kong market and the office property segment. In my prior August 10, 2020 article on Hongkong Land, I mentioned that "a key component of Hongkong Land's expansion plans in Mainland China in the medium term is the acquisition of a 23.1 hectare land site in the Xuhui District in Shanghai for RMB31.1 billion" which is "planned to be developed into a mixed-use development." At its recent 1H 2021 results briefing, Hongkong Land also emphasized that approximately 70% of its new capital commitments in the last five years has been allocated to investments in Mainland China (mainly development properties), and the company noted that Mainland China is seen as "a better market for us to grow the earnings and position ourselves" for the future.

Looking ahead, it is very probable that the revenue & earnings contribution from Hong Kong office properties will gradually decline going forward with an increase in investments in Mainland China. A more diversified earnings mix could potentially reduce the current valuation discount assigned to the stock for its relatively high exposure to the Hong Kong market and the office property segment. Investment properties in Hong Kong accounted for 82% of Hongkong Land's total property investment income in 1H 2021, while the company earned 61% of its total revenue from investment properties in the first half of this year.

Valuation And Risk Factors

Hongkong Land is valued by the market at a historical trailing P/B multiple of 0.31 times, according to the company's net asset value per share of $14.75 as of June 30, 2021 and its last traded stock price of $4.55 as of August 4, 2021. Assuming that the stock is able to revert to its five-year and 10-year mean P/B multiples of 0.41 times and 0.49 times, respectively, Hongkong Land could potentially offer upside in the +32%-58% range, without even considering potential growth in its net asset value in the future.

The stock also boasts consensus forward dividend yields of 4.9% and 5.0% for the current fiscal year, and the subsequent fiscal year, respectively. Notably, Hongkong Land has maintained a full-year dividend per share of $0.22 for three consecutive years between FY 2018 and FY 2020, which has been a difficult time for the company with adverse events US-China trade tensions, social unrest in Hong Kong, and COVID-19. The sell-side forecasts that Hongkong Land will maintain its dividend per share at $0.220 in FY 2021, prior to increasing its dividend per share to $0.225 in FY 2022, based on S&P Capital IQ's market consensus data.

Hongkong Land's key risks include the Work-From-Home trends persisting for a longer-than-expected period of time, new political events in Hong Kong in the future which makes the city a less attractive place to do business, and unexpected cut in future dividends.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of HONGKONG LAND HOLDINGS LIMITED [HKL:SP] either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.