Investment Summary

- Tenants in the shopping malls engage mainly in the consumer staples industry, providing stability to the rental income

- High and stable dividend yield , and dividend is expected to grow at a mild rate

Business Overview

1H2017 result is in line with our expectation: In 1H2017, Fortune REIT's revenue had a YoY increase of 2.5% to HK$1,003.3Mn and net property income had a YoY increase of 3.0% to HK$727.0Mn. The differential between the two is caused by the lower YoY increase of property operating expenses due to effective cost control by the Trust. In fact, the cost to revenue ratio decreased from 25.7% in 1H2016 to 25.3% in 1H2017, contributing to a higher increase in net property income. Income available for distribution increased 3.7% and is mainly caused by the decrease in borrowing cost, which decreased significantly in 1H2017 and had a 5.2% decrease, a result of the Trust refinancing its debt at a lower cost. In 1H2017, the Trust raised its dividend per unit by 3.0% and declared an interim dividend of HK$0.2553 per unit.

Effective cost management promotes growth of net property income: In 1H2017, the Trust achieved a 25.3% cost to revenue ratio. This cost to revenue ratio is the lowest ever since FY2010. The decrease in the operating expenses is mainly caused by the decrease in energy consumption and the receipt of the one off rebate for energy charges, resulting in a decrease in utility charges. However, the cost to revenue ratio for the FY2017 full year is expected to be higher than that of the 1H2017 because in 1H2017 there was a one off energy charge rebate. Due to the non-existence of one off rebate of energy charges, we expect the net property income margin to follow the past years trend and narrow. The following tables list the cost to revenue ratio as well as the property operating expenses incurred by the Trust's properties between FY2010 and FY2017, with FY2010 having the lowest cost to revenue ratio across a decade.

Balance sheet continues to be well-managed: In April 2017, Fortune REIT completed refinancing its loan maturing in FY2018. The new HK$1,200Mn loan will mature in FY2022, maintaining the weighted average maturity of the Trust's debts at around 3.6 years as at 30/6/2017, which is a slight decrease in the term in comparison with the 3.7 years as at 31/12/2016. The effective borrowing cost maintains at around 2.41% in 1H2017, a 2 basis point increase in comparison with FY2016. In particular, 60% of the debt has been hedged via interest rate swaps and caps, allowing the company to lower the interest rate risk due to the possible rate hike. Gearing ratio maintains at a healthy level of 28.4% on 30/6/2017, with only 5 investment properties used to secure for the loans and debts. Since the Trust has a stable stream of cash flow in the form of rental income, effective cost management and large number of unsecured investment properties, the capital structure is considered to be healthy and we believe the Trust is able to finance its asset enhancement initiative with ease.

High and stable dividend yield but growth will be mild only: The REIT has a good dividend yield and dividend is steadily rising across years. The tenants of the properties owned by the REIT are highly diversified, with about 60.8% of the gross rental income being generated by the daily necessity industry, such as food and beverages, education, supermarkets and wet markets, thus enabling the Trust to be less affected by shocks in the economy.

The Trust is expected to have no major capital expenditure other than the asset enhancement work on Fortune Kingswood. Moreover, the properties of the Trust has an average occupancy rate of 96.6% throughout the reporting period. Therefore, future growth will likely be fueled by the increase in rent. The Trust can also benefit from the increase in rent collected from the consumer discretionary sector, which contributes to the remaining 39.2% of the rental income, during good time in the economy. Therefore, we expect in the foreseeable future, the growth of the Trust will grow, but at a relatively slower rate.

Investment Thesis, Valuation and Risk

Our valuation model suggests a target price of HK$9.50: Fortune REIT receives a stable stream of income from its investment properties, whose tenants largely engage in the consumer staples sector, allowing the Trust to be less affected by the turbulent economic environment. The Trust also has effective cost management and financial management strategies, as evident by the low cost to revenue ratio and the healthy capital structure. Therefore, a target price of HK$9.50, corresponding to a 30% discount to NAV, and a `Neutral` rating, have been assigned. (Closing price as at 3 Aug 2017)

Financials

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