Wharf REIC Earnings: Valuation Slightly Reduced on Higher Finance Costs; Near-Term Headwinds Remain

Narrow-moat-rated Wharf REIC’s 01997 first-half results were slightly below expectations. While we have anticipated the slow recovery in tourism to drag on the operating performance of the company’s malls and hotels, earnings were hit by higher-than-expected finance costs, with the first-half borrowing rate jumping to 4.7% from 2.5% in 2022. As such, first-half underlying net profit declined 9% year on year to HKD 3.1 billion. Consequently, Wharf REIC’s interim dividend of HKD 0.67 per share was 4.2% lower than HKD 0.70 in 2022. We adjusted our model to reflect the near-term impact of higher interest rates given Wharf REIC’s 100% floating debt portfolio. As a result, we lowered our 2023 and 2024 EPS forecast by 8% and 4% to HKD 2.30 and HKD 2.81, respectively, while our fair value estimate was lowered to HKD 48.50 from HKD 49.50.

Share prices plunged 7.7% after the midday results announcement, following management’s bearish take on the company’s outlook. We think the market’s negative reaction presents a great buying opportunity as we view the headwinds faced by the company as temporary, and we continue to like Wharf REIC’s leading retail assets in the key shopping areas of Hong Kong.

Besides labor and flight capacity constraints, management thinks that the strong Hong Kong dollar adds to the uncertainty in tourism recovery as it reduces the relative attractiveness of Hong Kong as a tourism destination. Management also expects the office oversupply situation to linger in the next one to two years and current weakness to persist until corporates regain leasing appetite on the back of global economic recovery. These are within our expectation as we have assumed full recovery of the retail and hotel segments only in 2024, followed by full recovery of office division in 2025. In the near term, we forecast a 2023 full-year revenue growth of 11%, as we expect Wharf REIC to benefit from the gradual easing of labor and air capacity constraints in the second half of 2023.