Hongkong Land Holdings Limited (SGX: H78) is a giant in real estate, but it is not immune to economic pain.
The Hong Kong based firm owns properties primarily in Hong Kong, Beijing, Singapore, and Jakarta.
Yet, since 2019, the company has been caught in a perfect storm of bad news.
Hongkong Land has experienced setback after setback from unfortunate events such as street protests in Hong Kong, the China-US trade war and mostly recently, the COVID-19 Pandemic.
These episodes have adversely affected the profitability of Hongkong Land.
Its share price has dived 32.2% year to date, from US$5.65 to US$3.83.
Earlier in April this year, we outlined the struggles and future potential of the company.
Today, we provide an update on how Hongkong Land has fared during this pandemic.
Lower underlying profits
Hongkong Land is required to record its investment property fair value gains and losses in its profit and loss statement.
Every six months, the company’s investment properties are revalued by independent valuers.
The resulting unrealised gains and losses from the changes in fair value of the properties lead to large swings in net profit.
Therefore, we look at underlying profits for Hongkong Land, which focuses on the core business income.
With the pandemic’s headwinds, it comes with little surprise that the company reported lower underlying profits for the first half of 2020.
Interestingly, there was positive rental reversion from Hongkong Land’s largest sector – office properties.
However, this was not enough to overcome the other challenges the company had to face.
Firstly, retail properties have been badly affected by the pandemic.
Aside from the rental relief taken directly out of Hongkong Land’s pockets, the poor retail environment has further pushed down turnover rent.
Turnover rent is defined as rental based on tenant sales. The lower the sales, the lower the rent, and vice versa.
These rental schemes hurt the profits of Hongkong Land but serve to protect their tenants
during this tough period.
Additionally, the pandemic has led to construction delays that are hampering the completion of Hongkong Land’s residential development properties.
Sales of development properties scheduled for 2020 have been pushed back, creating a gap in the revenue stream.
Higher debt levels
Hongkong Land reported increased net debt, at US$5.6 billion on 30 June 2020 from US$3.6 billion at the end of 2019.
This jump in debt has increased the company’s net gearing to 16% on 30 June 2020 as compared to 9% at the end of 2019.
Net gearing is a ratio which reflects the proportion of net debt as a percentage of the company’s total equity base.
A higher gearing ratio generally reflects correspondingly higher risk.
While it is worrisome that debt has increased, it is important to analyse the context of the situation.
We look at Hongkong Land’s gearing ratio in comparison with other real estate companies.
For example, MAS recently increased the leverage limit for real estate investment trusts (REITs) to 50% from 45% due to the pandemic.
Most Singapore REITs have a gearing ratio of between 30% to 40%.
From this perspective, Hongkong Land has low debt risk.
Next, we examine the state of Hongkong Land’s debt profile.
Roughly half of the US$2 billion increase in debt came from long-term bank loans, while the other half was from the issuance of medium-term notes.
The medium-term notes have varying tenures stretching from 2020 all the way till 2040.
Aside from the staggered debt maturity, the cost of borrowing is another important factor to consider.
To this end, Hong Kong’s 10-year bond yield is at an all-time low of 0.47%.
Bank and corporate loans follow the government bonds closely, as does the risk-free rate.
Therefore, it is safe to assume that the cost of these borrowings is low.
Lastly, let’s look at the reasons for taking on additional debt.
In its 2020 half yearly report, Hongkong Land explained that the cash from the debt was mainly used for land payments of the West Bund site in Shanghai.
This highly anticipated mixed development will feature the complete range of office, retail, residential, hotel and other spaces.
The project is expected to complete gradually from 2023 to 2027.
Get Smart: Short-term pain, long-term gain
Hongkong Land is undoubtedly impacted by the global pandemic.
The company’s core underlying profits have been hit, while its debt has increased nearly two-fold.
Having said that, the company has good reasons for these poor results.
During this crisis, Hongkong Land has continued to support its tenants and has also continued the construction of its property developments.
The company also maintained its interim dividend pay-out at US$0.06, with trailing 12-month dividend yield at an attractive 5.91%.
As investors, we must be forward-looking and find value where others are not looking.
Hongkong Land might just offer that opportunity.
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Disclosure: Zachary Lim owns shares in Hongkong Land.
