&lsquo Undervalued&rsquo Hongkong Land scores higher target prices from CGSI, Morningstar after HK$6.3 bil divestment news

The combination of Hongkong Land' s new share buyback programme and a partial disposal of One Exchange Square (OES) in Hong Kong - both announced last week - is accretive to both net asset value (NAV) and earnings per share (EPS), say CGS International Research analysts Will Chu, Raymond Cheng and Steven Mak.

Despite the " slightly positive impact" , the CGSI analysts are keeping " hold" on Hongkong Land with a higher target price of US$4.91 ($6.46) from US$4.82 previously. While they welcome the " value-unlocking activity" , they think the continued decline in office rents in Hong Kong " hinders its re-rating in the next 12 months" .

In an April 25 note, the CGSI analysts call it an opportunistic disposal Hongkong Land' s management has stated that the market " should not expect similar disposals of Hong Kong assets in the near future" .

The company, which has a secondary listing in Singapore,  announced on April 24  that it would sell 147,025 sq ft of OES to Hong Kong Exchanges and Clearing (HKEX) for HK$6.3 billion ($1.07 billion). It includes the top nine floors, which is currently HKEX' s permanent headquarters, and a retail space on levels one and two.

The property represents 3.2% of the total value of Hongkong Land' s Central portfolio. Management emphasised in an analyst call that Hong Kong Central remains core to its portfolio, along with West Bund in Shanghai and Marina Bay in Singapore.

In addition, management says it remains committed to its US$400 million asset enhancement initiative for its retail asset in Central, which was announced last year.

The average selling price (ASP) for this transaction is 85% above the average ASP of comparable Grade A office transactions in Central in the past 12 months and translates into a 3.1% rental yield, based on CGSI' s calculations. " The ASP difference primarily reflects the passing rent differences between OES and [a] nearby Grade A office tower," say the analysts.

Hongkong Land intends to use up to 6.3% of the gross sale proceeds to provide enhancements to the property and use the remaining proceeds in two ways: 80% for the reduction of net debt, and 20% for a new US$200 million share buyback programme, effective until end-2025.

" Since the sale occurs at market value of OES as at end-2024, we expect minimal impact on Hongkong Land' s book value from the disposal alone," says CGSI. " However, on the back of its new buyback programme and considering the huge discount... we expect the buyback to be NAV-accretive. Moreover, as we expect interest expense savings from debt reduction to be slightly higher than loss of passing rent after disposal, we expect mild EPS accretion in FY2025-2027."

' Undervalued' Hongkong Land

Similarly, Morningstar Equity Research analyst Xavier Lee has raised his fair value estimate on " narrow moat" Hongkong Land by 7% to US$4.88 per share, with a three-star rating against Morningstar' s five-tier scale.

" We think the shares are undervalued, trading at a 14% discount to our valuation," says Lee in an April 25 note.

In addition to the nine floors of office space and two retail floors, HKEX is also signing a new long-term lease for the 63,000 sq ft it occupies in Two Exchange Square, " indicating a modest expansion of its footprint in Exchange Square" , says Lee.

Lee expects " minimal impact" on Hongkong Land' s revenue. " Any revenue decline should be offset by lower financing costs, as 80% of the net proceeds - after deducting Hongkong Land' s contribution to enhancement works on the assets being sold of up to HK$400 million - will be used to reduce debts. Consequently, we raise our net income forecast by 2% from 2026 onward."

Lee says he is " positive" about the deal as it allows the company to " crystallise portfolio value" . The sale price implies a passing yield of 2.9%, which compares " favourably" with the average Grade A office rental yield of 3.4%, according to Rating and Valuation Department data as of January.

In addition, Lee says the sale price is in line with the independent valuation as of end-2024, which exceeded expectations. " Previously, the market had expressed concerns about the valuer' s low capitalisation rate assumption, deeming it potentially unrealistic amid a high interest-rate environment and challenging market conditions. This sentiment is reflected in Hongkong Land' s current low price/book ratio of 0.3 times."

Together with the capital recycling proceeds from other asset sales, Hongkong Land has achieved 30% of its target to recycle at least US$4 billion by 2027.

Management reiterated that its near-term focus, as part of the strategic vision 2035, is to continue capital recycling and build investment capacity to drive mid-single-digit annual earnings growth as opportunities for higher-yielding assets arise, notes Lee.

" We believe this could be positive to our valuation, but its success would largely depend on the execution details," he adds. " Regarding the remaining capital recycling program, we think further divestment of the Central portfolio is unlikely, as Hong Kong, along with Singapore and Shanghai, remains one of the company' s key markets."

As at 11.20am, shares in Hongkong Land are trading 3 US cents lower, or 0.65% down, at US$4.61.