Investment Summary

- Possess a leading luxury hotel brand in the hospitality sector

- Future hotel in London and Istanbul will be located at prime tourist attractions

Business Overview

Recorded a drop in net profit in FY2016 result: Hongkong & Shanghai Hotels has a slight drop in revenue of 1.92% in FY2016, mainly contributed by the renovation of The Peninsula Beijing, which part of the hotel was in closure, causing a drop in the revenue. Net profit dropped 33.63% and the drop is contributed by the both the decrease in revenue and the decrease in the revaluation of investment properties owned by the group. Throughout FY2016, the group continued its renovation of The Peninsula Beijing and completed the renovation of The Peninsula Chicago, which allows the group to achieve highest revenue per available room in Chicago.

Long-standing leader in the sector: The group has been one of the leader of the hotel operation sector for a long period of time. The Peninsula Hotel has hotels established in almost every major global gateway cities in the world, such as Hong Kong, New York, Tokyo and Shanghai. Each hotel is regarded as the best hotel in the city in terms of locations, services and facilities, and the target customers are the high income individuals locating at the top end of the spectrum, allowing the company to have a large pricing power without being affected significantly by the price competition caused by the emergence of the large number of online travel agents providing price comparing services, such as Expedia and Trivago. These websites significantly affect the pricing power of hotels because these websites reduce the information asymmetry faced by the consumers. Moreover, the strategic positioning at the most luxurious segment of the hospitality industry allows the company to target at the high income individual, who is less concerned with prices and more concerned with services offered, thus allowing the company to continue its price setting position and high occupancy rate despite the increasingly competitive industry in terms of prices.

All hotels are located at excellent locations: The Peninsula Hotels are located in almost every wealthy countries in the world and the location of the hotels are all carefully chosen so that they can offer the most convenient and the best locations to their customers, further justifying the leading and price setting positions of the hotels. All of the hotels, especially the one in Tokyo, Chicago and Paris, are located next to the most popular tourist spots, and thus are more attractive to customer.

New hotel construction projects are on good track: The group currently has 3 hotel construction projects, namely The Peninsula London, The Peninsula Istanbul and The Peninsula Yangon. In particular, London and Istanbul are two of the most popular tourist attractions in the world especially London. Moreover, Istanbul is popular among the Middle East nations and the Istanbul hotel is expected to primarily attract tourists from those nations.

The Peninsula London project's development cost is estimated to be GBP600Mn, which the cost has included the construction of the hotel and 24 to 28 luxury residential apartments, which will be for sales. Moreover, given that London is the central hub of business and tourism of the world, the residential apartment is expected to face strong demand especially it is located between Hyde Park and Green Park, which are the traditional high end residential district, and thus the apartments are expected to be sold at a high price. The hotel will also be in walkable distance to Harrods, Buckingham Palace and Victoria Station, which provides train service to the southern part of the Great Britain. The sales of the residential apartments is expected to cover a substantial proportion of the development cost and will significantly reduce the payback period.

Moreover, the group has reached an agreement with Grosvenor to change their partnership agreement to a landlord-tenant agreement. The company will therefore be entitled to 100% of the proceeds of the future sales of the residential units as well as the profits from the hotel, benefiting the group in the sense that the group will be able to have full control over the operation and management of the hotel and fully utilize its pricing power in the hospitality industry.

Renovation project benefits by increasing room rates: The Peninsula Chicago renovation was completed in April 2016 and the newly refurbished hotel has the highest room rate in Chicago. The Peninsula Beijing has also started to undergo renovation and the renovation project is expected to be completed in mid-2017. The number of room will reduce from 525 rooms to 230 rooms. However, we expect the benefit from the room rate increase will cover the loss in revenue caused by the reduction in the number of rooms.

Investment Thesis, Valuation and Risk

Our valuation model suggests a target price of HK$10.48: Hongkong & Shanghai Hotels is a leading hotel operation company in the world and has hotels in almost every global gateway cities in the world. The group's expansion to London and Istanbul will produce significant revenue to the group since both cities are cities extremely attractive to tourists. Therefore, we have raised its target price to HK$10.48, corresponding to a P/E and P/B of 21.62x and 0.42x, with an `Accumulate rating assigned. (Closing price as at 8 May 2017)

Financials

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