The Wharf has been in business for 130 years, but 2015 was a year to forget for the Hong Kong shopping mall giant.
The company – whose Times Square and Harbour City malls are among the busiest on Earth – has been walloped by a slump in spending by visiting mainland Chinese. The market’s slammed the stock as a result: shares in Wharf ( 4.HK ) are down about a third since the start of last year.
That’s left the stock trading at bargain basement levels. So is it time for investors to go shopping then? It could be - but don’t expect retail spending in Asia’s shopping mecca to make a comeback anytime soon. Even Wharf’s bosses admit as much. The stock’s 4.5% dividend yield is one compelling reason to sit around and wait, though.
Wharf, whose other assets include the world famous Star Ferry, is caught in the storm of China’s slowdown. Spending in Hong Kong’s shopping malls is being crimped by a weaker Chinese yuan and President Xi Jinping’s corruption crackdown north of the border. Even Hong Kongers could be less inclined to shop ‘til they drop: higher interest rates could leave locals with less to spend on goodies like watches, clothes and electronics.
That’s understandably starting to put the screws on Wharf. Core profit – or that from the company’s property businesses – rose 5% during fiscal 2015. That was slightly ahead of the market’s reserved estimates, but stress is showing up elsewhere. Rents from Wharf’s flagship Harbour City and Times Square shopping malls rose 5% and 6%, respectively, but sales at both fell in the double digits. That second point is worrying. Obviously if stores are selling less there’s a higher chance of them closing down and moving out. More importantly, about 15% of Wharf’s leasing agreements with tenants are based on a percentage of their sales. If shoppers stop getting their wallets out, Wharf gets less rent. These so-called ‘turnover rents’ fell off sharply in the second half of the year. Wharf’s shares dipped almost 4% after the announcement. They’re down about 3% year-to-date.
Things could be about to get a lot uglier, too. Wharf’s two biggest malls are more or less fully occupied, but dark clouds are closing in. BOCOM International analyst Alfred Lau points out the number of vacant stores on popular shopping street Canton Road – directly opposite Harbour City – has accelerated in the last couple of months. The stores of jeweler Chow Tai Fook ( 1929.HK ) have been a ubiquitous presence in the area, but the chain has been shuttering outlets of late amid reversing sales.
Wharf chairman and managing director Stephen Ng tells Barron’s Asia he expects weak sentiment in Hong Kong’s retail market to continue for another two years. “What we need to do is to outperform the competition in a weak market,” he says. That’s not happening yet: In January Wharf’s Hong Kong retail sales fell 12% year-on-year, underperforming a city-wide decline of about 6%. Still, Ng says he’s “not particularly worried” about the impact of a weaker yuan and strong U.S. dollar on spending by mainland Chinese. “All currencies move in cycles. It’s just something we need to adjust to.” Wharf says it’s targeting more visitors from markets like the Philippines, South Korea, India and Russia – despite the swings in those countries’ currencies. Vice chairman Doreen Lee adds that Chinese wages and spending power is still rising on average, while Hong Kong’s malls are still a draw for first-time visitors from tier two and three cities. “There’s still room for us to sell ourselves,” Lee insists. This China allure extends to The Wharf’s projects inside the Middle Kingdom proper: these developments could contribute with a quarter of all rental income within five years. Rents from Chinese malls were up 25% last year, but income here is only about one-tenth of that from Wharf’s Hong Kong properties. Positively, Wharf has been paying down debt. Net gearing fell further to 15% in December, compared to about 20% a year earlier.
Investors couldn’t be much more pessimistic on Wharf’s prospects than they are now. On current valuations the stock trades at a 60% discount to its book value – a level last seen during the Global Financial Crisis. But while Wharf may be cheap, analysts are rummaging around for catalysts for a rebound. BOCOM’s Lau says there’s still room for more falls in the stock if Wharf’s malls keep low-balling Hong Kong retail sales overall. BNP Paribas’s Wee Liat Lee is a bit more chipper: he thinks sales of Wharf’s residential properties at Hong Kong’s uber exclusive Victoria Peak could give the shares a boost. If you’re willing to sit on your hands, now could be a reasonable time to buy. “We don’t have a crystal ball” though, admits Wharf’s Ng, when asked about longer-term prospects.
Rival Hong Kong retail operators like Swire Properties ( 1972.HK ) and Hysan Development ( 14.HK ) likewise face headwinds and trade at similarly depressed valuations. Hysan has more exposure to office space, which could give it a cushion as retail spending dwindles. Swire is more deeply involved in Hong Kong’s residential market, which is fighting similar battles to retail in 2016. Barron’s Asia has written positively about Link REIT ( 823.HK ) recently. The trust owns shopping malls across Hong Kong that are more focused on local customers’ everyday needs, meaning they are less exposed to the whims of Chinese tourists. That stock’s down 2% this year, versus a 7% fall in the Hang Seng Index and pays a 4% dividend based on its current share price.