Sun Hung Kai Properties (SHKP): Poised for Recovery Amid Lower Interest Rates and Strategic Developments

Sun Hung Kai Properties (SHKP): Poised for Recovery Amid Lower Interest Rates and Strategic Developments

Overview:

Sun Hung Kai Properties (SHKP) is one of the largest real estate developers in Hong Kong, specializing in the development of high-quality residential and commercial properties. SHKP also has a significant presence in property investment, telecommunications, transport infrastructure, and logistics, making it a diversified conglomerate. Despite headwinds caused by higher interest rates and a challenging property market, SHKP is expected to see a recovery in its core earnings as interest rates decline and property sentiment improves.

Recommendation and Target Price:

• Recommendation: BUY
• Target Price: HKD 93.10
• Current Price: HKD 77.05
• Potential Upside: +21%
• Broker: OCBC Investment Research
• Date of Recommendation: September 10, 2024

Key Investment Highlights:

1. Core Earnings Likely Bottomed Out

For the fiscal year 2024 (ending June 30, 2024), SHKP’s core profit after tax and minority interests (PATMI) declined by 9.0% YoY to HKD 21.7 billion. Despite a slight revenue increase of 0.4% YoY to HKD 71.5 billion, the gross profit declined by 6.5% YoY to HKD 32.2 billion due to a margin compression of 3.3 percentage points, driven by weaker performance in its property development businesses in Hong Kong and China. Reported PATMI dropped by 20.3% YoY to HKD 19.0 billion, weighed down by higher finance costs and fair value losses on investment properties.

2. Positive Outlook for FY25 with Lower Interest Rates

With lower interest rates expected in Hong Kong as the Federal Reserve begins a rate cut cycle, SHKP is projected to see a recovery in core earnings in FY25. A decline in borrowing costs will support sentiment for the property market, particularly for homebuyers, and improve profitability for SHKP’s property development business.

• FY25 Core PATMI Forecast: Core PATMI is projected to grow by 3.7% to HKD 22.6 billion, supported by new residential project launches and improved property sales in Hong Kong and China.

3. Dividends Expected to Rebound in FY25

SHKP declared a final dividend per share (DPS) of HKD 2.80 for FY24, bringing the total DPS for the year to HKD 3.75, which represents a 24.2% YoY decline. However, as earnings recover in FY25, the DPS is expected to rebound to HKD 3.90.

4. Continued Focus on Recurring Rental Income

SHKP has an extensive portfolio of high-quality investment properties that generate steady rental income. In FY24, gross rental income rose by 1.2% YoY to HKD 17.9 billion in Hong Kong and 7.9% YoY to HKD 6.3 billion in China, despite a slowdown in the office segment. The company is focusing on growing its recurring rental income, especially as demand for retail and commercial properties rebounds in key markets.

5. Strong Property Development Pipeline

SHKP has approximately HKD 24.9 billion in contracted sales from its Hong Kong property development business, of which HKD 19.6 billion is expected to be recognized in FY25. The company also plans to launch six new residential projects in Hong Kong over the next nine months, covering a total gross floor area (GFA) of 2.28 million square feet. In Mainland China, CNY 8.0 billion of contracted sales is expected to be recognized in FY25.

Valuation and Financial Performance:

Financial Summary (FY24-FY26E):

• Revenue:
  • FY24: HKD 71.5 billion
  • FY25E: HKD 73.7 billion
  • FY26E: HKD 75.9 billion
• Core PATMI:
  • FY24: HKD 21.7 billion
  • FY25E: HKD 22.6 billion
  • FY26E: HKD 23.6 billion
• Dividend per Share (DPS):
  • FY24: HKD 3.75
  • FY25E: HKD 3.90
  • FY26E: HKD 4.05

Key Ratios:

• Price-to-Earnings (P/E):
  • FY24: 10.3x
  • FY25E: 9.9x
  • FY26E: 9.5x
• Price-to-Book (P/B): 0.4x (consistent over FY24-FY26)
• Dividend Yield:
  • FY24: 4.9%
  • FY25E: 5.1%
  • FY26E: 5.3%
• Return on Equity (ROE):
  • FY24: 3.2%
  • FY25E: 3.7%
  • FY26E: 3.8%

Balance Sheet and Gearing:

SHKP maintains a healthy balance sheet with a net gearing ratio of 18.3% as of June 2024, down from 21.2% in December 2023. While interest coverage fell from 6.8x in 1H24 to 4.6x in 2H24 due to rising finance costs, SHKP’s debt profile remains manageable, with 46% of its debt either on fixed rates or denominated in CNY floating rates, allowing the company to benefit from lower interest rates in the coming years.

Investment Thesis and Potential Catalysts:

1. Property Market Easing and Sentiment Recovery

Lower interest rates are expected to provide a sentiment boost for homebuyers in Hong Kong, supporting a recovery in property sales. Additionally, any potential easing measures by the government to stimulate the housing market could further boost sales.

2. Recurring Income Growth

SHKP’s focus on growing its recurring rental income is a strategic move to buffer the company against fluctuations in the property sales cycle. The company’s large portfolio of investment properties ensures stable cash flows even during challenging market conditions.

3. Potential Share Buybacks and Dividend Increases

As core earnings recover and SHKP improves its free cash flow, there is potential for the company to conduct share buybacks or increase dividend payouts, which would enhance shareholder returns.

Risks to Consider:

• Rising Interest Rates: While lower rates are expected to boost the property market, any unexpected rebound in interest rates could dampen homebuyer sentiment and raise borrowing costs for SHKP.
• Weaker-than-Expected Economic Growth: A slower recovery in the global and local economy could impact property sales, rental income, and overall corporate budgets, affecting SHKP’s performance.
• Increased Competition and Regulatory Risks: Changes in the regulatory landscape or heightened competition in the property market could pose challenges for SHKP in maintaining its market leadership.

Conclusion:

Sun Hung Kai Properties is well-positioned for a recovery in FY25, driven by lower interest rates and a strong pipeline of property development projects. With its diversified revenue streams from property development, rental income, and other businesses, SHKP offers a solid balance between growth and stability. The company’s focus on recurring rental income and a healthy balance sheet further reinforces its investment case, making it an attractive buy with a target price of HKD 93.10, implying a potential upside of 21%.

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