Okay, good afternoon, and thank you all for coming to Hysan Development's 2017 annual results announcement session. Let me introduce our panel for this afternoon. It is our Chief Operating Officer, Mr. Ricky Lui, and our Chief Financial Officer, Mr. Roger Hao. Apologies from our Chairman, Ms. Irene Lee, who has prior commitments. We will start today's session with a presentation from Roger and Ricky, and we will follow that with time to take some questions from the floor. As we have a live webcast today, we will also be taking questions online. Before that, though, I will invite Roger and Ricky to start. Roger?
Yes. Thank you very much, Mark, and ladies and gentlemen, both here physically with us and for those old friends and new friends online. We do understand you have a lot of news and events that you might need to cover. We will start right away, and then we can go straight into the Q&A sessions. As a quick update, 2017 highlights. Turnover increased by 0.4% against a slight decline in recurring underlying profit of 0.8%. Reported profit increases are reflecting changes in fair value of the investment properties. Retail portfolio occupancy at 97%, office occupancy at 96%. Completion of Lee Garden Three, further building our commitment to lifestyle and community. Overall, we saw a reasonable growth in 2017 global economy.
Hong Kong's economy echoed this positive sentiment, and our local retail sales here saw uptick in growth, especially towards the second half of the year, and office leasing continued to be stable. Up to that point, I will take a break and then maybe I will invite Ricky to share with you some of the operating highlights.
Good afternoon. I think today we will cover some highlights on the market situation, our progress, as well as the way ahead. First, we go for the market changes. For retail, generational shift, products and services are delivered. They really like subscription, so they do not want the whole Who came to settle in Hong Kong over the past 10 - 20 years are mature and sophisticated spenders. So we need to cater tourists, new Hong Kong and old Hong Kong. To do that, landlord has to constantly enhance retail environment and partner closely with both of e-commerce, dominance on mobile technology, prevalence of social media. Brands and retailers, as well as online operators, are making moves to address these issues. Hysan as a landlord, Mall Operator, needs to reinvent and reimagine both strategically and operationally.
First, give support, give shoppers extra special touch to make the shopping experience socially pleasant and interesting. Customers now offer personalized and unique items and service. Hysan starts journey into new retail and will continuously adapt our offerings. In this page, we try to show to you what we are. We take ourselves as communities, and for that communities, it is full of conscious and diversities. It is very unique compared with other developers, other areas, or even other type of retailers. The picture is trying to show you that you can start within our community. In the morning, going to gym, have a run, work hard in the office, take a quick lunch, and then reenergize yourself with a coffee in the afternoon. Then maybe before you go to dinner, read a book in a Eslite.
This is the kind of life that we can offer to our customer, not only retail, but also the office. For office, generational change also happened. Incoming workforce want more fluid and mobile work style, plus work in social setting. Co-working space is growing, and Hysan is increasing its office portfolio co-working space exposure to over 5%. All these changes happened in just the past few months because co-working has been moving so fast. Multinationals opting to relocate to non-central core areas such as Causeway Bay, which really very different from Central, but also offer its own rich offering. For Hysan, also face strong competition from other office area on the island side and also Kowloon. While there is still value for money differentials. Lee Garden Three, then we come to our progress. Lee Garden Three completed in December 2017. First office tenants already moved in.
Other multinationals from a diverse business background moving in. Spaces, a community-based co-working brand, establishing their presence here, too. Retail podium welcome F&B, outlet lifestyle shops, as well as other many offerings, including merchandise like very unique brands of fashions, kitchenwares, all this stuff. So we take Lee Garden Three as a lifestyle extension. Marketing. We are doing a lot of tenants collaboration, which received media attention, extensive footfall, and healthy spending figures. More important, the long-term partnership with all these brands. For example, we rebranded Louis Vuitton shop as this summer program, colorful IT showcases. All this generate sales and brand awareness, as well as promoting the whole area. For loyalty clubs, which is always a very important element or unique elements of Lee Gardens compared with other shopping district. The loyalty clubs show significant percentage growth on membership and number and sales.
For office, we continue to enhance an inclusive office community that fits the needs and demands of modern days users. Diverse office portfolio, which includes sales, banking, finance and insurance, technology, health and wellness, as well as high-end brands, are all in our office portfolio. Three NGOs from different backgrounds moved into Leighton Centre, representing Hysan's continuing commitment to foster innovation and serve our community. Looking ahead, we continue to support brands that offer classic luxuries. At the same time, strengthen our commitment to promote lifestyle through F&B, as well as health and wellness in an environment with a strong sense of community, so that all this customer can enjoy very personalized and unique merchandise and services. This will define the new retail and office, where emerging customers demand quality to be expressed through sustainability, honesty and individuality. Bring new initiative to market with greater speed.
More digitalized and data-driven and technology adopted at customer level. Maintain frequent dialogues with online retail operator and seek opportunities for partnerships. Innovate and curate relevant content for Lee Gardens community. Provide more support for Lee Gardens associations. Trend of global economic expansion is likely to continue in 2018. Hong Kong economy also expected to continue to grow. Lee Garden Three completion confirm our commitment to expand our lifestyle theme and curate the content of Lee Gardens community. All these are the highlights of our performance and our vision of the future.
Thank you, Ricky. In the following few minutes, maybe let me get a little bit into the details of the number, which primarily is those extracted from the announcement. Let me just go through briefly with you as a backdrop for our later discussions. As you all can see, our turnover, we have achieved HKD 3.548 billion, a slight increase of 0.4% year-on-year. On a bottom line basis, as you see the reported profit, we managed to get to HKD 3.6 billion, and thanks largely to the investment property revaluation, which a lot of the minority interest give us about HKD 1.1 billion. So if you take out that HKD 1.1 billion from the HKD 3.6 billion, that arrives at our underlying profit of around HKD 2.5 billion as compared to HKD 2.36 billion last year, about 5% increase on our underlying profit.
As you probably are aware, we had a one-off early surrender compensation from one of the early termination of our retail tenant in Lee Garden Two. The gross amount is about HKD 260 million, and this 142 is net of tax and the minority shares. So if you take away that one-off numbers, then that will arrive at our recurring underlying profits of HKD 2.349 billion, a slight decrease of 0.8% year-on-year. The shareholders' fund, which basically reflects the investment property valuation change, had an increase of 4% to HKD 69.953 billion. Going into our portfolio turnover, all of that HKD 3.548 billion in 2017, about slightly more than half is coming from our retail portfolio, which give us HKD 1.9 billion, about 2% drop year-on-year.
Office is HKD 1.359 billion, which account for about 40% of our income and a 5% growth year-on-year. Finally, residential is HKD 260 million, about 4% drop from prior year. Going into individual portfolio, for retail, our occupancy is 97% at the end of 2017. The portfolio is going through a process of tenants mix adjustment. In general, new lettings are renewable and review saw a mild positive rent reversion over FET. Remember, at the interim stage, we shared with you the portfolio is experiencing a negative mid-teens reversions. Basically, debt positions are all of that negative 15%. At that point in time, around three-quarters of the space actually secure a positive rental reversions, while the remaining 25% is part of that tenant mix change.
Now with the second half of the year coming in, as you all know, the second half basically covers the LG2 of Ralph Lauren space, because we managed to let those space to restaurant. We are going to talk a little bit more later, but because that happens in the second half of the year, so the rental reversions was recorded in the second half of the year. Overall, all in all, in 2017, the overall rental reversion is around negative 21% - 22%. The increase from the mid-teens in interim is largely because of the Ralph Lauren space. Total foot traffic decreased by around 5%, mainly due to a few key renovation and fit-out works for new tenants. The estimated tenant sales for 2017 saw a high single-digit percentage increase when compared to 2016. Here you can see a list of names of new tenants.
In particular, in early 2018, we welcome Ten Shanghai and Sushi Ta-ke, that are the two high-end restaurant, taking up about two-third of the space from the Ralph Lauren space. In terms of the work focus, we try to create show-stopping events in Hysan portfolio. In Hong Kong, most international sporting event, including Hong Kong Sevens, Fan Walk, attract overseas fans and local visitors. In particular, the Fan Walk's dining and shopping promotions brought customers and sales to Hysan's restaurant and shops. In addition, summer program in cooperation with athlete and winter's Christmas Market both provide interesting content and entertainment for shoppers. We also see a strong support for us in the PARKnSHOP and Library, which has called Lee Gardens home since 2013. Going to office, occupancy at the end of the year is 96%, same as 2016 year end.
We continue to see overall positive rental reversion in renewals with re-new lettings. As you may recall, mid-year, we had around a mid-teen of positive rental reversions. For the whole year, we saw a high teens of positive rental reversions from office portfolio. Again, as I talk about the turnover mix, it contribute around 40% of our turnover and accounting for slightly more than half of our space. Again, we continue to see that Causeway Bay being one of the most sought-after areas for MNC and local corporations. Lee Garden Three pre-leasing momentum slowed down somewhat in the second half of 2017. But close to 55% office space committed for rental. So that percentage is actually, as of the day we prepared this slide, I am happy to share with you that as of now it is now close to 60 something percentage for office space.
We continue to see a balanced tenant mix showing the portfolio's diversity. Professional consulting, banking, finance, insurance, as well as semi-retail, with all of them, the four categories account for around half of the office lettable for area. No particular single category took up more than 20% of the area. We see that co-working is also a strong up-and-coming category. Residential portfolio. The overall turnovers decrease by 3% to HKD 264 million. We seek positive rental reversions. Occupancy is 75% at the end of 2017, which is largely due to a number of renovation and changes in demand by expatriates. Lee Garden Three project completed in December 2017. We promote environmental friendliness and work-life balance in that building. We have a rooftop garden and a sky garden with a 100m long running track there.
In terms of our Tai Po project, we had seen good progress in design development and statutory submissions is ongoing. Site formation and foundation work will start in Q2, so in about a month's time. Again, for your reference, these are the cap rates adopted by our valuer, Knight Frank, when they do the valuation of our investment properties portfolio, and there is no change in the cap rate as from those used in 2016. Finally, the financial position. We continue to maintain a low gearing with a net debt-to-equity of 5%. Interest coverage 17 times. Maintain investment-grade credit rating with about three-quarters of our debt at fixed rate. Average maturity above 4.3 years. And average cost of finance is 3.4%. Thank you very much. I hope we gave you a very brief snapshot of the results. Now let's go into the Q&A session.
Sure. Yeah. Thanks, Roger. It's definitely time for questions from the floor and we'd appreciate if you can let us know who you are and which company you represent. If possible, please use the microphone when asking questions as they're going out live online. Now hand back over to Ricky and Roger to start.
karl.
Hi, Karl Choi from Merrill Lynch. A couple questions. One Roger, you mentioned that retail tenant sales were up around high single digit for the year. Can you give us a little bit more breakdown by the different three hubs and also any category color that will be helpful? Can you also give us a little bit more color on what your outlook for rental reversions in 2018, both for office and retail?
Right. Maybe on the retail side first. In terms of tenant sales, overall we saw a high single-digit growth in overall Hysan portfolio. If you look at individual area or groups of buildings, Hysan Place, we saw around a 12% increase year over year. In Lee Garden, we see an increase in the same magnitude. In Lee Theatre, I think we saw around a 2% increase. All in all you see that the two major hubs are accounting for most of the area, Hysan Place and Lee Gardens area, around 10%-11%. We basically make up the most of the 9% increase.
That excludes the electronic store.
Yes. In terms of reversions, I would say that the 2017 number is well within our expectations. Going forward, on the retail side based on the current negotiation and status, we believe that a majority of the lease renewal will have a positive rental reversion situation. By majority I mean in terms of areas around 80% and plus. Of course, that final position we need to observe depending on how our negotiation went. That is the retail situation. For the other part, the around 20% space is actually part of the things related to our tenant mix change and for that obviously we will need to see how it goes. Maybe Ricky can also share with you some of the characteristics or what the things we are going to do with the tenant mix refinement.
I think let's take the two restaurants that took up the restaurant space as an example. With that one, we created very positive response from all the brands as well as you can see the recent pickup of the LG3 lifestyle extension. Having update in this booklet is that for our LG3 retail is almost now close to 70% committed for the retail, which play quite a significant part of the positive impact by the two restaurants that put in Rafal Lauren space. Now when we talk to those brands, they really think we as Hysan is really committed to really build communities.
They saw all the strategic location that we put in the lifestyle elements and haven't touched in the detail in the booklet is about, for example, in our LG3 lifestyle, you will get a very exclusive Starbucks Reserve, Sub-Zero, Bowl Concept, and many other good restaurants that will put into the area. Because of that, as a strategy, we really want to put more this kind of we call it category killer into our portfolio and also enhance to put in the right mix of elements for our so-called communities. That community is a much broader sense of inclusiveness. Having get not only for the retail, is only this retail plus office and even maybe to the surrounding for people not belong to that work or do business in our communities, in our properties.
For some of the category killers, you know, the rental level may be different and also the rental higher turnover. That will come to when you talk about the rental reversion. Sometimes you will see a kind of figure seems to be much lower, but because of the nature of the change of structure of the rent structure, that may distort a little bit.
In 2018, in terms of area, we had around 35% of the retail space. All in all, we see that in terms of the rental revenue, probably we will see a relatively flattish outlook comparing to 2017 with these changes.
Office.
For Office, again, I just mentioned that 2017 we had good rental reversions about high teens and coming to 2018 that is around 10%-15% higher than those expired in 2017. Assuming the spot rent remained at the same level, you will see that, or we expect to see that the positive rental reversion will narrow. At this moment, we are still monitoring the situations and still targeting an overall positive rental reversion for office.
Hi, Sarah.
Hi, Sarah Cooper. I think you got some new approvals for Bamboo Grove before Christmas. Can you talk about your intentions there?
Yeah. Thanks, Sarah. Ricky, you want to-
Yeah. Okay. For Bamboo Grove, I think the market has got aware of the submission of building plans, which got approved. For us, for the Hong Kong system, we try to reserve all the potential of our land by putting in a building plan for approval. Once they approve, this is mainly for reserving our potentials. We've got no solid plan to develop in the near future.
And any change in your expectations on?
The people working there is moving out. But our show is coming. But whether this is this year, next year, or the year after, this quite depends on the government. But no matter how, the positive message is about the government putting in the government office into it, the costs. They put in some costs and other associate office into that site. That help to guarantee certain high-quality customer will be add to this area. Anyone else here? If not, shall we take one from our friends online? There is one from Justin Kwok from Goldman Sachs. You mentioned in the announcement to be more proactive in facing the generational shift and introduce both co-working and co-living businesses to the portfolio. Please discuss more.
I think, as we've mentioned, generation change. I also mentioned about subscriptions. For them, I think subscription, flexibility, personalized, all these are key stuff in the modern economy, particular for the new customers. So, having this element into our portfolio, for example, for co-working will help to provide facility not only to the one who really would need an office. HSBC has taken a seat in co-works in Tower 535. They put in different task force into that space. They keep changing to put in different app department or task force into it for several purpose. For people who for use like, you don't know how long, whether this is permanent, or some contractual base task.
They also put in some cultural element into this one co-working so that they can have some more synergy or cultural change, happy change, effect to their own team. So these are the elements that we think co-working will help the overall office portfolio of Hysan. Even for co-living, these are associate part for that co-working. In future, there may be some more co-living elements in the area that can also help to facilitate the community in a sense that more suitable for these new generations.
Hello, Alvin from CLSA. A few questions. The first would be, can you get us your cash flow forecast for 2018? The second would be, as Lee Garden Three is completed and will contribute this year, how will you spend the net cash inflow? On the land acquisition or share buyback. When the net gearing will probably fall if you don't spend money, will you review the net gearing ratio and resume the share buyback? Thank you.
All right. Thank you very much. In terms of the overall cash positions, first of all, obviously, the largest probably have seen in the announcement. We had spent about HKD 1.1 billion, and we had around, I would say, around HKD 500 million yet to be paid after the completion, part of the retention money. That is one of the key usage of the cash. The other is consideration, obviously, is the operating performance. Because of the negative rental reversions we've seen in 2017, it does have some carry over impact to the operating cash flow. All in all, we would expect to see a kind of like a fetish situation in terms of the cash coming in. What are we going to do with that?
Obviously, we continue to look for investment opportunities as we mentioned and explained in the past few scenario, I mean, occasions to you. We are not stopping that review. That is one of the thing. One of the key criteria for that is, we try to find some assets and opportunities that will bring a long-term sustainable benefit to the portfolio. We are balancing between the long-term value and versus the, obviously, the near-term cash needs and cash distributions. One of the other thing is, maybe let me talk a little bit about the one-off early surrender compensations. Ideally, especially from a financial management point of view, we would like that to be recorded throughout the next few years, as the lease continue.
We got a cash, one lump sum, and we had negative rental reversion for that space, kind of like part of our drive to refine the trade mix. We see that money to help us to support the tenant mix change, to finance part of it. At the same time, we want to create a stable and progressive development path. I guess that is all the considerations behind about the usage of cash. Again, we'll see in six months' time how is the leasing turn out in terms of the overall market situations.
David.
Thank you. It is David M. from Macquarie. Just a question, maybe a little bit too technical, but on the compensation income from the Ralph Lauren. If I remember correctly, the departure was in Q3 2017. So before Q3 2017, they were still kind of accruing the normal rent that they would have been paying to you. The drop-off of their contribution to the rental actually was just one quarter, in 2017. But in 2018, we are talking about then the entire four quarters we will see that impact. For the penalty, it is a one-off in 2017 without further whatever amortization in 2018. That is kind of my first question, and then I have some other question about reversion.
Okay. On that particular tenant situation, let me make a very quick recap. The operation actually stopped before the end of 2016, and we got the cash basically at the end of 2016. If you go back to the notes, you can see that, I mean, notes to the accounts, for the year end of 2016, we do have a payable there. Meaning the cash received. The operation stopped, but the lease is still ongoing, because the tenant will still need to do a reinstatement and all that. So, in effect, the lease continued throughout 2017 up till the end of August. So we had an eight month of income, per se. We receive a cash, and then part of it is actually for the continued recording of the rental. So we record and amortize those part of the cash throughout as rental income for that eight months.
Excluding that part of the cash, we still have the HKD 260 million, which is the lease rental compensation according to contract. The lease finally terminated by end of August. In October, we signed two new leases for the two restaurants. That is why we have the new rent and the old rent, which we can then compute the reversions. So you are absolutely correct that in terms of the contributions, for 2017, we had eight months of full rental reflected in the turnover line. Whereas in 2018, we had the whole four quarter without that level of rental contributions from Ralph Lauren.
For 2018, there won't be any kind of residual or unamortized penalty from this.
No, I think for that particular transaction, it is done.
Another question on the negative reversion. At the interim, we were talking about mid-teens. That basically mid-teen has nothing to do with Ralph Lauren. That basically the remaining retail portfolio sitting around mid-teens.
Right.
When we go to the end of this year, we are talking about - 21, -22. Could you maybe just give a little bit more color, if we take out the Polo or the part of Ralph Lauren, did the negative reversion actually still deteriorate a little bit into the last quarter, like beyond the mid-teens?
Right. I think overall, in 2017, what we see is, apart from the overall weighted average number, two things. One is in terms of the number of tenants and the tenants that they are doing the trade. I think we see a consistent trend like mid-year, around 75% of the space that we renew is neutral to slightly positive. Whereas the 25% remaining is part of the trade mix refinement exercise that we have been doing in connection with the structural change in the market. That distribution or that mix basically continues because when we saw each other back in August 2017, we already anticipated the annual number will be increased because of the convention that we calculate and report the reversions. The second half basically is driven by our Ralph Lauren space because it is relatively large differences between a high brand and a restaurant.
The final question is, I do not know whether I wrote it down correctly. I think last time you also mentioned there is another kind of large group of tenant, I think it was in LG2, that you guys were thinking of changing. Anything happening to that one or should we expect something like what happened to Ralph Lauren to also happen in 2018, like a major tenant being changed into something else?
I guess that ties to what Ricky mentioned earlier about the category leader or category killer, because that is also something that as part of our cooperation working with tenants, that is something we want to do. Maybe, Ricky, if you can
Personally, I think for that, changes that may happen related to something that will help our [KISS elements]. Although the area is big, but it does not cost too much on the rental disruption.
LG2.
For LG2.
Right.
We are still in negotiations with the potential tenants.
Karl.
A few follow-up questions. One, can you remind us where the occupancy cost to sales was for the full year? Also, any color on margin outlook? Presumably, some of the leasing costs will continue in 2018 for LG3. Lastly, now that LG3 is coming on stream, what do you think about the redevelopment potential for the rest of the portfolio? Is it an intention that we may have to wait a little bit for LG3 to stabilize before we go into another redevelopment, or it can be relatively sooner rather than later? Thanks.
Right. Karl, first is our occupancy cost, and the last one is the timing of some redevelopment opportunities. What is the second? Margin. Oh, sorry. Yeah. Maybe let me talk a little bit about the first two. In terms of occupancy costs, overall for 2017, we see that it is now below 20% with the continued improvement in the tenant sales. It is about high teens for Hysan as a whole. Among the portfolios, Hysan Place we see is around 21%, whereas Lee Garden is 15% and Lee Theatre is about 20% with the concentration of those F&B tenants. In terms of margin, again, you will see that in the second half we have increased our property expenses. That is largely due to the opening of Lee Garden Three with the preparation where all the related cleaning costs and all those, with some agency fee as well.
We do not expect that trend will We do expect the cost related to the opening and the first round of leases agency expenses will come in in 2018. Like the case we saw in Hysan Place, in terms of the margin, will be reduced a little bit. Going to 2019, we would expect we should be able to come back to the normal average that we have seen in the last few years. Oh, okay. Sorry, I keep on forgetting your questions.