Good afternoon, everyone. Welcome to the webinar of Wharf REIC final results briefing. I am Angela Ng, Investor Relations Manager. Our management team in the webinar include Mr. Stephen Ng, Chairman and Managing Director, and Mr. Horace Lee, Director. Before the presentation and Q&A session, we will start with an opening remarks by the chairman.
Thank you, Angela. Good afternoon, everyone. First of all, I'd like to take you back to 2019. That was when Hong Kong's economy was running very well in the first half of 2019. You will remember that beginning in the second half of 2019, things started to happen to cause the economy to slow down and eventually slid into reversal in 2020 and 2021. The decline in the economy was rapid. That took a lot of sectors down with it, most immediately the hospitality sector and retail. We, as a landlord, started to suffer at the same time, because of the lease commitments we had with various tenants, there is a time delay factor affecting our rental income.
Eventually, that delay factor played out over 2020 and 2021. At the beginning of this year, when we were looking ahead at 2022, we were hoping that rents would start to stabilize. If everything goes well, maybe start to creep up again. Of course, all of that went down in flames when this fifth wave started in the first week of January. Since then, economy's slowed down, retail has slowed down, people flow has slowed down, everything has slowed down, and it is almost certain that this will carry on into the second quarter of the year. Our interim results, I'm not making any forecasts, but it's almost certain that our interim results for 2021, 2022, sorry, will continue to be affected by this very resilient pandemic.
Back to 2021, because we were still suffering from the lagging effect of rental decline, we reported a lower income from rents compared to 2020. We also invested a little bit more in promoting the malls. As a result, we reported an earnings decline for the second year running. We can go into details a little bit more later on, particularly in the Q&A, but first of all, I will hand back to Angela for her to take you through our presentation. Angela.
Thank you, Chairman. Now, I believe that you will see our PowerPoint presentation on your screen. "Rental income suppressed and marketing dollars double," is the tagline that we use to sum up the 2021 annual results. Against the backdrop of effectively closed borders, the group doubled the marketing budget to capture a bigger share of the competitive local market. This is the investment that we make for today. Although today's rental income performance is under pressure, the group spares no effort to make investment for tomorrow in the form of strategic addition and realignment of brands. Looking back to the market last year, it was full of challenges as tourist spending was missed entirely for over two years. Hong Kong retail sales recover by 8% on a low comparison base and was partly driven by the government's consumption voucher.
Hospitality sector was being tortured, and F&B also suffered because of the strict social distancing measures. Heading into 2022, the city faces even more new challenges as the fifth wave badly hits daily lives and businesses. The border opening timeline is further delayed, and the outlook is even more unclear. In this unprecedented time, the group continued to exercise prudent cash management to navigate the uncertainties. In response to the market challenges, promotion intensity to support more activities is an important investment that we made. We are the first mover of coupon redemption program in the city, and the strategy is proven effective with above market tenant sales reported in Harbour City and Times Square.
To capture opportunities for tomorrow, we proactively invest in strategic brand realignment and addition of brands. Canton Road frontage at Harbour City is fortified with the new flagships of Hermès, Dior, Piaget, Miu Miu, and other international top-tier brands who chose to invest in Harbour City during the time of COVID. Under our continuous efforts, spot rents and occupancies were stabilizing last year, but the lagging impact of negative rental reversion continue to weigh on the performance. We will closely review the promotion scale and constantly fine-tune business strategies to adapt to market change. Taking a closer look at our Hong Kong IP performance. Hong Kong retail revenue drop narrowed to 8%, as the impact of base rent negative reversion was partially offset by higher turnover rents and occupancies. On the other hand, office rent is still soft under weak demand and increasing supply.
Yet vacancy started to see stabilization in the fourth quarter last year. Overall, Hong Kong IP revenue drop narrowed to 8%. Turning to the financial highlights. The group reported a revenue growth of 3% and group profit turned around to HKD 4.4 billion. Underlying net profit of IP decreased by 11% as rent depressed and marketing dollars doubled. Losses for hotels narrowed. IP valuation remains stable, with IP fair value change represents just 1% of total IP asset value. Dividend policy is maintained at 65% of underlying net profit from IP and hotels in Hong Kong, which represents a DPS of HKD 1.31 for the year. The group maintains a strong balance sheet and cash flow. In the following slides, we will walk through the performance of our core assets as well as financial management and outlook.
First, Harbour City, which is our major source of income. Despite the weak market, Harbour City remains the first choice for the top brands. Mall occupancy improved to 93%. Office occupancy improved to 85%. However, loss-making market conditions continued for hotels. As a result, Harbour City's total revenue drop narrowed to 8%. The local-centric experience and stronger recovery of top tenants enable Harbour City to achieve better sales performance. As the most diverse retail landmark in Hong Kong, it houses a balanced mix of over 500 tenants. You can see the breakdown of rental income from the tree map diagram here. The unique critical mass has attracted new flagships of the top-tier brands, together with about 100 of new shops that complement the existing tenant base. Hotels in Harbour City were still bleeding despite improvement in revenue and gross operating profit.
Operating environment became worse this year under the tightened social distancing measures. Prince Hotel seized the opportunity and completed renovation. Next, we will talk about Times Square. Causeway Bay is a highly competitive market for both retail and office. Times Square constantly adds new impetus to entice locals. Retail occupancy rose to 95%. Tenant sales also improved under the effective sales-driven promotion. Office occupancy improved to 89%. Total revenue drop narrowed to 9%. Moving on to our regional mall, Plaza Hollywood. Supported by a relatively stable local demand, Plaza Hollywood deliver resilient performance, and new leasing demand continued despite the pandemic hit. Occupancy was 97%. Our core assets also include the Central portfolio, comprising Wheelock House, Crawford House, and The Murray. Wheelock House and Crawford House maintained high occupancies of 94% and 98% respectively.
For The Murray, thanks to the outstanding asset and service quality, it's achieved gross operating profit turnaround, and also consistently outperformed its competitive set in revenue per available room. Switching to our assets in Singapore. Retail recovery at Wheelock Place and Scotts Square was hit by the pandemic policies. With a prime location in the key Orchard Road intersection, we hope to see a better recovery this year. Let's move on to the next item, financial management. Net Debt reduced by HKD 4.5 billion to HKD 47.5 billion. Total assets around HKD 270 billion, and gearing ratio improved to 22.5%. Average interest cost remained at 1.4%, and the group maintained the Moody's A2 rating with stable outlook. Looking ahead, while a number of factors cloud the macro outlook, local economy in Hong Kong also warrants concern under COVID first.
No early recovery can be assumed without opening of borders. The group will adhere to the proactive business strategies and prudent cash management to navigate the uncertain market outlook. In the last part of the presentation, I will walk through our efforts in sustainability. COVID relief has been the group's key focus and additional round of HKD 5 million donation was made via Wharf Emergency Relief Fund to the Community Chest Rainbow Fund. Also, additional round of HKD 5 million donation was made to students in need in the 82 Project WeCan schools. We also plan to utilize our malls and Star Ferry area to set up city center vaccination posts and advertise the Fight the Virus campaign. In addition, environment protection and youth development remain the pillars of the group's sustainability efforts.
To support the Clean Air Plan for Hong Kong 2035, Star Ferry launched the first low emission green ferry, Silver Star. Youth development is highlighted by the flagship program, Project WeCan, together with other scholarship and internship program. With 10 years of history, Project WeCan benefits more than 80,000 students from 82 schools. In 2021, the group has raised the first sustainability loan of HKD 1.6 billion. The group is also a member of Hang Seng Corporate Sustainability Index and has HSI ESG rating of AA+, being the top 10% ESG performance among peers. Further details of our sustainability efforts can be seen from the data shown in the slide. That concludes my presentation, and now we will come to the Q&A section.
If you have any questions, please press the Raise Hand button on your Zoom control panel. Now we will receive the first question from Ken Yeung, Citi.
Hi, management. This is Ken Yeung from Citi. I would have two questions. The first question I want to ask about, given that this kind of Omicron outbreak or fifth wave is quite sudden, how do you compare this round versus the impact to you versus maybe the initial outbreak in the first half, 2020? For example, in 2020, you have granted HKD 2 billion concession. Sorry. How do you see the rental concession that you will be granted for this round?
Okay. Thank you. Thank you for your question. Now, first of all, it's not for me to say whether this wave is how much more serious this wave is compared to previous waves. There are different indicators. As a start, the number of confirmed infections per day or the number of deaths per day, those are not necessarily directly proportional to business, but they do provide a certain indication about the severity of the current wave. As landlord, what we see immediately is a sharp fall off in footfall. That, of course, would result in a sharp fall off in retail sales. We don't have a lot of retail sales data compiled yet, but I think it's easy to come to that conclusion. We started to offer tenants rent relief.
We're probably one of the first major landlords in Hong Kong to do so for this wave. The size of the relief relative to the size of the monthly bill is comparable to what we provided previously. However, the monthly bill, the monthly rental payable by tenants today, compared to what it was two years ago, you would appreciate, has fallen substantially. Therefore, in dollar terms, the same percentage relief, for instance, would already produce a substantially smaller rental concession. As to how much longer this would continue, I really can't tell. As soon as this fifth wave started, all bets are off. I think that's all I can say. Hong Kong as an economy needs to buckle up. The players in Hong Kong, all of them, including ourselves, need to buckle up to prepare for harder times.
That's all I can say. Now, we're slightly more fortunate than some of the other landlords in that we have a healthy balance sheet. In the course of 2021, what we did was we reduced our net debt by about HKD 4.5 billion. If markets become tougher, and if interest rate were to rise, we would at least be better protected than we would have been 12 months ago. Thank you for your question.
Thank you. We have a couple more questions coming, and the next one is from Bank of America.
Hi, can you hear me?
Yes, we can. Please go ahead.
Hi. Thanks. I have two questions and one quick one. First is, in terms of the rental and the rent enforcement moratorium that was proposed by the government, can you talk a little bit about the expected impact as a result? Second is, trying to have a more of a positive look on things. I mean, there are reports that mainland China may consider an exit from zero-COVID strategy, knowing it could still be a long way away. It's been quite a few years before, you know, we fully opened the borders, yeah, how does that change?
You know, when you talk to your tenants or when you try to, you know, do your leasing strategy, what sort of, you know, eventually longer term, you know, you think the percentage of tourists would come back to Hong Kong longer term if there's any sense that you can give us. Lastly, just a quick one is, if you could give us your percentage floating versus fixed rate debt. Thanks.
Percentage of floating versus fixed rate debt. Okay.
Great.
I'll leave that second question to Horace. Let me deal with the first two. First one first. The rental moratorium, we're really not in a position to answer that question with any degree of precision right now. It's supposed to cover SMEs. How or where is the line drawn between SME and non-SME? If it's drawn higher, then obviously the impact would be greater. If it's drawn lower, then the impact would be smaller. In our case, for Harbour City and Times Square in particular, I would like to think we have a relatively small proportion of SMEs. Most of our tenants would probably not fall into that category as man in the street would define them.
At the end of the day, how SME is defined, it's a matter for government to decide, not for the man in the street. We can't tell. Looking ahead, when would borders reopen? When would tourists come back and everything else? I would rather not hazard any guess. We've been wrong on two or three occasions in the past two years, and I would rather not be wrong again for a third time. Once upon a time, we were hoping, and we were budgeting for tourists to be back by the end of 2021. Sorry, 2020. That was our first attempt at crystal ball gazing. That failed miserably, as you know. When we did our budgets for 2021, we were assuming they'd start to come back around the middle of last year.
Again, that failed miserably. I wouldn't want to make a third attempt, not having any tools available to us, to even make an educated guess. Horace, can you address the third question?
Sure. Yeah. As our ongoing policy, we will swap our fixed rate borrowings to floating. As such, you can assume that if not all of them, that the fairly substantial part of our borrowing are on floating rate at the moment.
Thank you. Thank you for your question.
Thank you. We will have the next question from Mark Leung, UBS.
Yeah. Hi, management. Can you hear me?
Yes, we can. Please go ahead.
Yeah. Yeah, sure. I have two questions. I think the first one is regarding the rent to sales ratio. I think over the past two years, we have seen rent actually has came down, and retail sales in last year actually was reported a pretty good rebound. I just want to check what is the latest rent and sales ratio for the company overall, how do we compare it to the pre-COVID level? I think that's the first questions. The second question is regarding the long-term equity investment, because I saw about a HKD 1.5 billion half on half decline. Could you share with us more details on what drives their valuation losses? Thank you.
Compared to pre-COVID days, if you're referring to occupancy cost, the average occupancy cost for our tenants is still higher than pre-COVID. That's an average because there are actually vast discrepancies between tenants who perform very well and those that struggle. In a way, the average can serve no more than a benchmark, but it's relatively academic. What I can say to you though is, I'm not sure whether it was in the presentation, but it is a fact that the proportion of our rental income in the form of turnover rent has increased compared to a year earlier. Tenants pay turnover rent only when their sales exceed, or rather when, only when their turnover rent exceed the base rent.
An increase in the proportion of turnover rent implies that tenants are trading above the minimum sales level that the base rent is designed to cater to. That's a good sign, but that's coming from some of the tenants, not all of the tenants. Some of the other tenants are probably, or almost certainly, still trading at below this minimum rent threshold. That was 2021. Again, 2022 is an entirely new ballgame. Most people are still in a state of shock, and that includes us and our tenants. We're still trying to figure out how deep this fifth wave is and how long it would last. Was that the only question?
The other question is about the equity portfolio.
Oh, okay.
Mm-hmm.
There was a minor disposal, but otherwise it's been stable. We were not an active trader as far as that portfolio is concerned. It helps to provide stable and quite good yield. Thank you.
Thank you.
Yeah. Thanks a lot.
Thank you. We have the next question from Andy So, Haitong.
Hey. Hi, management. Can you hear me?
Yes, we can. Now we can.
First of all, I would like to ask about the gross margin. The gross margin in FY 2021 seems to be relatively low, which is around 67% and down quite substantially from 72% in FY 2020. Should we expect that the profitability going forward will be even lower in FY 2022 because as we may know, we may need to do more promotion going forward to boost the retail sales this year. Shall we expect that the profitability in FY 2022 will be even lower than that of the FY 2021? This is the first one. The second one that I would like to ask about is our potential expansion plan in Hong Kong or China.
Quite a lot of China-based developers are not doing very well in terms of the contract sales in the past six months, and they need money right now. Do we have any plan to buy their IP investment properties or development properties in mainland China or even Hong Kong here, given the fact that our financial health seems to be relatively good? Thanks.
Okay, thank you. To answer your first question about margin, I think we need to look at the breakdown of both revenue and operating profit, for instance. If I remember correctly, what happened or part of the reason why there may have been a discrepancy between the first half and the second half of last year is because of DP revenue. I believe we booked a good amount of DP revenue in the second half. Almost by definition, the nature of the DP business is such that the margin would be lower than in the IP business. Even the most attractive DP projects would ordinarily not come in close to the margin you would expect from prime IP in Hong Kong.
You really need to dissect it, and you can't just use a global number and say, "Oh, margin dropped." Having said that, there are also other factors affecting margins, particularly between the comparison between first half and second half. They include rent relief and the amortization of rent relief. When these marketing expenditures are accrued, we try to be as fair and as reasonable as possible. But it is possible that between the first half and the second half, it may not be 100%, particularly because at the interim, you would appreciate, while we have done everything we can to present a fair set of accounts, the accounts were not audited at the interim stage.
I think it is fair to say that there was a compression of margin in the second half, partly because of the lagging factor in rental income. Because as spot rent fell, it took a little while for average rent to catch up. Whereas on the expenditure side, it's almost immediate. I think that's probably a reasonable conclusion. Whether or not it would carry into 2022, I think the key factor is the fifth wave. Because if the fifth wave continues to be as severe as it is and for much longer, obviously revenue will be hit hard. For every dollar of revenue that's foregone, it drops directly to the bottom line to affect the operating margin.
As to your second question about any appetite to acquire new assets, I think the answer is, well, we are traditionally already a prudent company. In this investment environment, macroeconomic, geopolitical, and so on and so forth, we have added caution to our general prudence, and we'll be very, very selective about new investment. Particularly when it comes to investment outside of Hong Kong, because we are primarily focused on investing in Hong Kong investment properties. If it's DP or even if it's IP in mainland China, it will have to be a very exceptional opportunity.
Thank you, management.
Thank you.
Thank you. The next question from Simon Cheung, Goldman Sachs.
Hi, Stephen.
Hello.
Horace. Thanks for the presentation, Angela as well. I've just got a couple questions. You mentioned in the presentation slide that you doubled your marketing costs last year. I'm not sure whether that is because you saw, you know, government vouchers and that's the amount allowed you to basically spend a bit more to stimulate, you know, the demand here. But judging from what you are mentioning for this year, how should we think about, you know, that marketing costs? And if you can, I think I saw some number, what HKD 500 million up to HKD 1 billion number. Can you quantify that, you know, marketing expenses if possible? That's the first question.
The second question also, I think on Angela presentation slide, she mentions, you know, that the Causeway Bay district is highly competitive, and that's somewhat reflected in slower sales or rent number for Times Square versus Harbour City. I'm just wondering how you are thinking about your positioning, you know, of Times Square in such a competitive market, you know, vis-a-vis, obviously Harbour City is seemingly in a much better position. How are you gonna be addressing that? And then lastly, more of a small housekeeping questions. I think the property revaluation, if I look at the number correctly, second half is actually quite significantly higher than first half. Wondering there's...
Whether there's any change on cap rates or what's driving that, you know, spike up in the revaluation losses in second half? Thank you.
Okay. Thank you. Marketing dollars. We actually started. You will remember the, if I may say, very popular coupon redemption program that we ran at Harbour City and Times Square last year. We started that way before government's consumption voucher. That proved to be very effective in driving sales. As Angela pointed out in her presentation, we made two kinds of investment in the course of the last two years. One kind was to invest in today. We need to survive today. That was to drive sales to keep tenants trading well. Another kind is preparing for the future. We invested in realigning trade mix and tenant mix and so on.
The first part was, we invested in marketing to drive sales, and most of the marketing dollars were invested in the coupon redemption program. The nice thing about coupon redemption program, compared to, for instance, general advertising and so on and so forth, is that it is very tangible. If there is no sales, there is no coupon redemption, and therefore no marketing cost. In a way, now we continue to be running these coupon programs even now. In a way we wish we would be able to spend more in marketing dollars, because for every dollar we spend on coupon redemption, that means we generate sales. But unfortunately, in the current environment, when shoppers stay away because they're told to stay home, we probably can't spend as much as we were able to last year. It's good news and bad news.
The good news is we'll save on marketing dollars, but the bad news is our tenants do not trade as well as they did last year. It's a necessary investment. We'd rather make the investment than not. We'd rather be able to make the investment than not be able to do so. Times Square, as you rightly pointed out, is in a less favorable position competitively compared to Harbour City. Harbour City has more critical mass, whereas in Causeway Bay, we do have strong direct competitors. We've been doing the tenancy revamp as well in Times Square. For as long as the retail markets are weak, we will not be able to see immediate results. We are a long-term holder. We are a long-term investor. I hope our investment today will start to pay off tomorrow. Housekeeping thing, or was it?
The last question is on the IP valuation.
Oh, okay. It depends on how you look at it. If you look at the revaluation surplus, I just use one example. In 2020, the deficit was something like HKD 11 billion. In 2021 it was HKD 2 billion. If you look at HKD 11 billion and HKD 2 billion, it's easy to conclude that our revaluation deficit improved by 80%. That's not a meaningful view in my way and the way I look at it. It's not a meaningful view. The more meaningful view is that the revaluation deficit in 2021 amounted to HKD 2 billion, which was less than 1% of the total value of the portfolio, implying it was generally a stable market for capital value. It was the view of the valuers, not of ourselves.
Even if the deficit at the mid-year point was wider, it would still have implied not much more than 1% variation compared to the beginning of the year. Obviously, when you compare 1% to 0.5%, you look at a doubling or vice versa, a halving. That is not the relativity which would be meaningful. To answer your direct question about cap rates, as far as we know, cap rates have not changed. Thank you.
Thank you. The next question from Cusson Leung in JP Morgan.
One sec. Hi, management. I have two questions. One is, we know that the fifth wave is making the visibility this year quite difficult, but I think as also highlighted in your review, saying that there has been stabilization of rental before the impact from fifth wave. I just want to see what kind of rental reversion will you be expecting if there was no fifth wave. The second questions is, over the last two years, has there been any restructuring of the leases by moving more normal tenancy from fixed plus variable to more leaning towards higher variable contract?
By that, I guess you mean a reduction in base rent?
Yeah.
Coupled with an increase in turnover rent?
Yeah.
I see. Not any meaningful amount. Possibly a few, but certainly nothing of scale. To answer your first question, we were budgeting for a flattish year. That was before the fifth wave.
Okay. Thank you.
Thank you. If you have any questions, please, press the Raise Hand button. We have the next question from Praveen Morgan Stanley.
Hello, can you hear me?
Yes, we can. Loud and clear.
Thank you. Hi, Stephen. Hi, Horace. Thank you for taking my question. I have two quick question. One, would you be able to tell us the 2/3 of your equity investment seems to be outside Hong Kong, even though majority is in property. Which other country is it in? And the second question was, when you say absent fifth wave, the rental would have been flattish. Did you mean flattish over 2021 or flattish over 2019, three years ago?
Oh. Very bullish. No. Well, first of all, we'd be happy to, so to speak, arrest the rental decline, so it will be flattish against last year, i.e., 2021. That was before the fifth wave. As far as classification of the listed investments is concerned, the classification is based on where the shares are listed, not based on the underlying business. The underlying business is still primarily Hong Kong and Mainland China.
Thank you.
Thank you.
Chairman, I believe that we don't have more questions. Oh, just now Mark Leung has raised his hand again. Hello.
Hi, management. Can you-
Yes, yes. Thank you.
Yeah. Yeah, sure. Thanks for taking my question. I have one additional question regarding on our office portfolio, because I think in the results announcement we highlighted, given the inflated supply going forward, we expect the rents performances will continue to be challenging. Just want to check, will we have any plan to upgrade our offices or obtain any green certificates to maintain the competitive advantages for our office portfolio? Yeah. Thank you.
Thank you. We constantly upgrade our portfolio of IPs both in the retail area and also in the office area. We are embarking on a new round of upgrading the offices in Harbour City anyway. Because they are older buildings, there's only so much we can do about meeting today's standards. We can't pull them down. We're not about to pull them down and rebuild them. If we were to rebuild them from scratch, it may be easier, but that is certainly not something in our current plan. In the absence of redeveloping our current offices, we will invest to upgrade them to meet customer demand, i.e., tenant demand. Thank you.
Yeah. Thank you. Thank you.
Thank you. We have the one last question from Jianping from Credit Suisse.
Hi, this is Jianping Chen. Can you hear me?
Yes, we can. Thank you.
Thank you. I'm asking about like the dividend policy. I understand that you wanna keep the payout ratio at 65%, but if like the leasing activities continue to suffer given like the fifth wave of COVID, do you wanna give investors some of the compensation? Like, can you keep the dividend, the DPS, largely unchanged in absolute value?
I think the answer to that question is, the board has not discussed changing its preset dividend policy. The preset dividend policy was disclosed very clearly at the time we first listed in 2017, and it's been repeated time and again in our various communications with investors. Rather than trying to adjust it from half to half or from year to year on an arbitrary basis, the board is quite happy currently, at least, to stay with the formula. It's almost formulaic. It's very easy. We just calculate what the underlying net profit from Hong Kong investment properties and hotels add up to, and voilà, comes out the DPS. The board has not even started to consider changing it. The board is quite happy with the current policy. Thank you.
Thank you.
Thank you. We will come to the end of our presentation today. The PowerPoint will be uploaded to our corporate website shortly. Thank you for joining us today.
Thank you. Have a good evening.