“Must-buy” item for value investors

Managed by The Link Management Limited, The Link Real Estate Investment Trust (00823.HK), Hong Kong's first REIT, invests in a portfolio of 180 retail and car park facilities that are on the doorstep to 40% of Hong Kong population. At present, the portfolio consists of about 11mn sq ft2 retail space and 80,000 car park spaces and boasts a large and diverse tenant base, including retailers of varying sizes in a wide array of trades. Some of them are Hong Kong's best-known retail and restaurant brands. Priced at HK$28.3, The Link REIT trades at P/NAV of 1.15x with NAV HK$24.63. Based upon our 5-Period 2-Stage Discount Dividend Model (DDM Model), assuming 6.5% required rate of return and 2.3% sustainable growth rate, we would like to upgrade our 12-month target price from HK$32.02 to HK$35.18. As such, we maintain Buy recommendation for The Link REIT. Key risks: interest rate risk, political risks, and increasing operation costs.

1H12 Results still solid

Revenue was up 10.1% YOY to HK$2,887mn, which was driven by the strong performance of the portfolio. Average monthly rent increased 4.3% YOY to HK$34.2 per sq ft. Contribution from AEI soared to 39.6% and overall occupancy rate improved to 92.1%. Property operating expenses declined slight 1.2% YOY to HK$846mn due to the reversal of an over provision of car park waiver fees accrued in prior period. Reported net profit increased 20.3% YOY to HK$4,692mn. NPI margin expanded to 70.7%. The Link REIT follows the 100% dividend payout policy. The interim distribution per unit (DPU) was up 19.4% YOY to HK$0.6311 (1H11: HK$0.5286). The interim results were solid, we believe.

Regroup of Revenue Categories from 1H12 Results

Investors should bear in mind that the Link REIT regrouped several categories as the income contributions to Total Revenue from these “Cooked Food Stalls”, “Education/Welfare”, “HD office”, “Ancillary”, & “Mall Merchandising” are relatively small (constituting just above 5% of total revenue). For the sake of consistency, we will state both categories in our report.

Strong Operation Statistics

At present, composite reversion rate maintained at 21.5%. Composite reversion rate is the percentage change in per square foot average base rent plus management fee between old and new leases based on like-for-like space. Overall occupancy rate remained at 92.1%. Average monthly unit rent per sq. ft2 rose 4.3% YOY to HK$34.2., retention rate improved to 79.3%.

Solid Financials

During the fiscal period, The Link REIT has focused on extending debt maturity and lowering average interest rate. The Link REIT has about HK$12.55bn interest-bearing liabilities with gearing ratio (debt: total asset) of 16.7%, though effective interest rate was down to 3.5%. The financials still solid, we believe. More importantly, we find there is room for the Link REIT to increase leverage in order to finance its acquisition strategy in the future as the sound credit ratings (S&P) A / (Moody’s) A2.

AEI is still the growth driver

Since listed in 2005, the Link REIT had completed 22 AEI projects, which accounts for 39.6% of revenue and a total IFA of 3mn sq ft. During the fiscal period, the AEI of Choi Yuen Plaza was completed in Sep 2011 with HK$168mn. At present, seven AEI projects with a total investment of HK$753mn are currently under construction, which are expected to be completed within the next two years.

Broaden Tenant Mix

During the fiscal period, new tenants like QuickSilver, Espirit, Agatha, Mama Kid, Goods of Desire have been introduced. The broaden of tenant mix not only conforms to the norms that residents would like to improve their living standards, but also reduces the operation risks of the whole portfolio. More importantly, the introduction of new sort of tenants can improve the rental income growth rate, we think.

Review of Nan Fung Plaza Acquisition

On 8 June 2011, The Link REIT acquired the commercial portion of Nan Fung Plaza from the Nan Fung Group for HK$1,170mn. Nan Fung Plaza is located adjacent to the Hang Hau mass transit railway station in the Tseung Kwan O district in the New Territories. It is connected by footbridges to The Link REIT’s Hau Tak Shopping Centre in Hang Hau. Nan Fung Plaza has been successfully integrated into The Link REIT’s portfolio of assets following completion of the acquisition.

The Future of AEI………

During the interim results presentation, we find many street analysts puzzled about the future of AEI. Some argue that the acquisition of Nan Fung Plaza implies the lack of AEI in the future, which may affect the growth rate. Also, during the analyst meeting, management indicated that some properties already completed AEI will launch a new AEI again, which makes street analysts puzzle about the future of AEI. As such, we conducted an interview with the management about the future of AEI.

Valuations

Priced at HK$28.3, The Link REIT trades at P/NAV of 1.15x with NAV HK$24.63. Based upon our 5-Period 2-Stage Discount Dividend Model (DDM Model), assuming 6.5% required rate of return and 2.3% sustainable growth rate, we would like to upgrade our 12-month target price from HK$32.02 to HK$35.18. Thanks to the Asset Enhancement Initiatives (AEI), change of tenant-mix, and a series of marketing campaigns. We are bullish on the long term perspective of The Link REIT. More importantly, the acquisition of Nan Fung Plaza and AEI of Tai Yuen Market are good pilot tests for sustaining strong growth rate. The 100% dividend payout ratio and stable dividend policy are still our prime favor. As such, we maintain Buy recommendation for The Link REIT. Key risks: interest rate risk, political risks, and increasing operation costs.