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Elevator Pitch
Wharf Real Estate Investment Company Limited (OTCPK:WRFRF) [1997:HK] or Wharf REIC is rated as a Buy.
Wharf REIC calls itself “one of the largest real estate companies in Hong Kong” with “flagship properties” like “Harbour City” on its corporate website. Harbour City, Hong Kong’s biggest retail mall, accounted for 73% of the company’s revenue last year as indicated in its FY 2023 earnings presentation slides.
I previously analyzed Wharf REIC’s 2020 interim results in my August 14, 2020 write-up. This latest article details the company’s financial prospects for the current year.
My decision is to raise my rating for Wharf REIC from a Hold previously to a Buy now. I take the view that Wharf REIC’s 2024 financial results are likely to be better than that for 2023, considering the potential increase in Mainland Chinese visitors for Hong Kong and the expected reduction in interest expense. The favorable 2024 outlook for the stock isn’t factored into its valuations to a large extent, which explains why I have upgraded Wharf REIC’s rating to a Buy.
Readers can buy or sell Wharf REIC’s shares on the Over-The-Counter market and the Hong Kong Stock Exchange. The trading liquidity of the company’s OTC shares is limited, but the three-month mean daily trading value for its Hong Kong-listed shares was pretty high at approximately $12 million (source: S&P Capital IQ). Interactive Brokers is one of the US stock brokerages offering trading services for Hong Kong-listed equities.
Increase In Mainland Chinese Visitors Will Be Key Revenue Driver For 2024
Wharf REIC’s major property or asset is its shopping center Harbour City, which contributed close to three-quarters of FY 2023 its top line, as mentioned earlier in this article.
The company’s revenue grew by +7% to HK$13,306 million in the prior year as disclosed in its FY 2023 results announcement. Wharf REIC’s FY 2023 top line met the market’s expectations, as the consensus revenue estimate was marginally (less than 1%) higher at HK$13,425 million as per S&P Capital IQ data.
The key factor that contributed to Wharf REIC’s good 2023 top line performance was the +10% increase in revenue derived from Harbour City last year. As indicated in its earnings presentation slides, Harbour City’s retail occupancy rate rose from 94% as of December 31, 2022 and 96% as of end-1H 2023 to 97% at the end of the previous year.
At its FY 2023 results briefing in early-March, the company shared that “luxury (retail) is doing well in Harbour City” as evidenced by the fact that “certain luxury brands (with retail stores in Harbour City) have already achieved high double-digit sales growth versus pre-COVID” levels.
Looking ahead, the performance of Harbour City and Wharf REIC in 2024 should be supported by resilient luxury retail demand.
Consulting firm Bain noted in its January 24, 2024 press release that the proportion of luxury retail spending by Chinese consumers in overseas markets outside Mainland China (e.g. Hong Kong) has increased from below 10% during COVID-19 to 30% last year.
Wharf REIC specifically highlighted “the ability of the Harbour City Mall to draw a good number of Mainland (Chinese) visitors” at its latest fiscal 2023 earnings call. It is realistic to think that Wharf REIC’s Harbour City retail mall will perform even better in 2024, as more Chinese consumers travel outside of Mainland China to shop for luxury items in overseas markets, including Hong Kong.
On March 5, 2024, Hong Kong media publication The Standard reported that “the Individual Visit Scheme allowing Chinese tourists to visit Hong Kong without a guided tour will be expanded to cover (additional Chinese cities) Qingdao and Xi’an.” This takes the number of Mainland Chinese cities that fall under the Individual Visit Scheme to 49. With China having hundreds of cities, there is room for a further expansion of the Individual Visit Scheme in the later part of the year.
In the company’s FY 2023 earnings presentation slides, Wharf REIC noted that Hong Kong’s visitor arrivals and retail sales have only recovered to 52% and 84% of their respective levels in 2018 prior to the pandemic. Therefore, there is a good chance that Wharf REIC’s top line continues to grow at a fast pace this year, as the number of Mainland Chinese consumers and luxury shoppers visiting Hong Kong (and the Harbour City mall) increases.
Expected Decline In Interest Costs Will Boost Current Year Earnings
In contrast with its in-line FY 2023 revenue, Wharf REIC’s actual net income attributable to shareholders amounting to HK$4,766 million last year fell short of the market’s consensus bottom line estimate by a substantial -22% (source: S&P Capital IQ). This was largely attributable to a higher interest cost. The company’s interest expense (excluding fair value changes on interest rate swaps) rose sharply by +90% from HK$1,228 million for FY 2022 to HK$2,333 million in FY 2023 as indicated in its results announcement.
There are two favorable factors which suggest that Wharf REIC’s interest expenses is likely to be significantly lower in the current year.
One factor is an expected decrease in the Hong Kong benchmark interest rate or HIBOR (Hong Kong Interbank Offered Rate). Approximately 94% (source: FY 2023 earnings call disclosures) of Wharf REIC’s borrowings as of end-2023 was floating-rate debt. Overseas Chinese Banking Corporation’s economists see the one-month HIBOR decreasing from around 4.8% now to 4.0% at the end of this year. In other words, Wharf REIC should most probably benefit from lower interest costs associated with its floating debt this year thanks to a decline in HIBOR.
Another factor is that Wharf REIC is expected to pay down part of its debt in FY 2024 with funds generated by asset divestitures. The company revealed at its FY 2023 earnings briefing that it has plans to sell one of its retail malls in Singapore known as the Scotts Square in the current year, which might potentially generate sales proceeds in the HK$2-3 billion range.
The sell side is currently forecasting a -19% drop (source: S&P Capital IQ) in Wharf REIC’s finance costs for FY 2024, which seems realistic taking into consideration the factors mentioned above.
Key Risks
My bullish view of Wharf REIC is based on the assumption that the company will deliver a good set of results for fiscal 2024, but there are risks that are worthy of attention.
A key risk is that the actual number of Mainland Chinese visiting Hong Kong in 2024 turns out to be lower than what the company is hoping for. If the Chinese economy weakens or the relaxation of outbound travel restrictions for Mainland Chinese (e.g., expansion of the Individual Visit Scheme highlighted above to more cities) is limited, Wharf REIC’s actual FY 2024 revenue could possibly miss expectations.
Another risk factor is that Wharf REIC’s interest cost remains elevated this year. This might be due to a smaller-than-expected decline in HIBOR or the failure to divest assets that can finance debt repayment.
Closing Thoughts
Wharf REIC currently trades at a hefty 60% discount to book value and offers an appealing dividend yield of 5.7% as per S&P Capital IQ data. The stock’s undemanding valuations suggest that positive expectations of a better 2024 for Wharf REIC haven’t been priced in. As such, I choose to rate the stock as a Buy.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
