Too much expectation on Murray Road office site?

Morgan Stanley Research-Hong Kong Property

Too much expectation on Murray Road office site?

Office stock valuations imply the Murray Road site is to be sold at HK$45-60K/sq.ft. We prefer HKL over Swire Prop and Champion REIT on better two year forward EPS growth and better Central office outlook.
Over-expectation on Murray Road car park tender: We highlight the downside risk of office stocks if Murray Road office site’s land price is HK$40K/sq.ft or below. Office stocks’ current valuations imply 6% gross cap rate for Central office portfolios,30-70bps lower than the 2014-16 level. This means stocks have factored in the scenario that Murray Road site is to be sold at HK$45-60K/sq.ft or 1.6-2.1% gross yield,versus a 2.4% gross yield for en bloc Central/Wanchai office building transactions during 2014-16. Tenders for this 0.465mn sq.ft site was closed on May 12,2017,and the result could be announced within one week after the tender close.

HKL could outperform Swire Properties in 2017: Since 2013, HKLhas tended to outperform/underperform against Swire Prop when its two-year forward EPS YoY growth is stronger/weaker than that of Swire Prop. We expect HKL’s FY18e EPS to grow 3%YoY on positive rental reversion, while Swire Prop’s FY18e EPS could decline 10%YoY from lacking development profits and rental loss due to Taikoo Place redevelopment.

Growing stock market turnover to drive officestock growth in 2017: Relative performance against the Hang Seng Index tracks well with HK’s main board average daily turnover growth. In 4M17,average daily turnover at HKEx was HK$74.3bn, 11% higher than HK$66.9bn for the full year in 2016.

Central officeto see better outlook than decentralized areas: In 1Q17, Central office spot rents were up 2.0%, outperformed overall market (+0.8%). Central is the only area that see accelerating rental reversion. Central spot rent is 30% higher than that three years ago (a typical office lease cycle). This should drive rental income growth of HKLin FY17/18.

Prefer HKL> Swire Prop > Champion REIT: We continue to prefer HKL over other office landlords for its high exposure to Central office space and also stronger EPS growth from positive rental reversion. Champion REIT is our least preferred play among the office sector having a fair valuation at 4.5% dividend yield 3.1ppt spread over HK 10-year, 0.5SD lower than average since 2005.

What’s changed: We raise PTs of HKLand Swire Properties by 4-6% after rolling over the valuations atunchanged target discount (30-35%). We raise Champion REIT’s PT by 4% by reducing our target yield from 5.1% to 4.9%. We raise HKL’s FY18e EPS by 23% on better China residential sales achieved in FY16 and hence stronger expected profit recognition in FY17/18.