Hong Kong reeling but pockets of potential exist

Amid the Molotov cocktails, the damaged shop fronts, the bullets – both rubber and real – and the recession fears, there is value potential in the protest-scarred streets of Hong Kong.

The city’s real estate landlords may face the risk of weaker earnings, especially if the protests persist, but many of the large real estate companies are well diversified, which should limit the fallout, according to Morningstar.

In a research report released this week, entitled A Better Tomorrow, Morningstar has identified its ten top picks for an end-of-protest recovery in the former British colony, whose sovereignty was handed back to China in 1997.

The list includes seven names from the real estate sector, two from financial services and one industrials name. They are trading at discounts of up to 35 per cent and have posted year-to-date returns of up to 20 per cent.

Morningstar top ten picks for an end-of-protest Hong Kong market recovery

Source: Morningstar. Share prices as of close of 26 September 2019. *Listed on the Singapore exchange (USD), all other names are on the Hong Kong exchange (HKD).

“We do think that the laggards hit by protest concerns will recover once protests end and as such, there are some buying opportunities among these names,” says report author Lorraine Tan.

“Although there are other names that we currently rate as 5 stars that have also been sold down sharply over the same period, such as CK Infrastructure Holdings and China Resources Pharmaceutical Group, these stocks have underperformed for other reasons and may not rebound as quickly if the protests ease and end.”

Protests smash HK stocks

The MSCI Hong Kong has plunged 18 per cent since its April peak as protests increasingly paralyse the city. The tourism industry has been hammered, while the economy is heading toward a recession. Retail sales fell by a record 23 per cent in August from a year earlier.

The protests, which show no sign of abating, pose the biggest challenge to Chinese President Xi Jinping since he came to power in 2012 and are Hong Kong's thorniest political crisis since Britain returned the then Crown colony to China in 1997.

Hong Kong was handed back to China with no framework for what would happen after the year 2047, leaving the city to carve an identity out of two ideologically opposed empires.

What started as opposition to a now-withdrawn extradition bill has grown into a pro-democracy movement against what is seen as Beijing's increasing grip on the city, which protesters say undermines a "one country, two systems" formula promised when Hong Kong returned to Chinese rule.

Hong Kong chief executive Carrie Lam has not ruled Chinese military intervention to quell the protests, in which at least two protesters have been hit with live rounds.

Trigger point may involve fatalities

China is unlikely to intervene directly to quell the protests, in Morningstar’s view, and the government will have to rely on increasingly emergency measures to end the unrest.

“Given the escalating violence, heightened emotions, and uncertainty over whether the original protest leaders can contain the violence, we think that a trigger point will arise soon—which may involve fatalities—and finally end the protests,” Tan says.

What started as opposition to a now-withdrawn extradition bill has grown into a pro-democracy movement against what is seen as Beijing's increasing grip on the city

“The Hong Kong government will then have to act quickly to reinstate confidence. Given that the One Country, Two Systems policies will not change, we think the government should announce improved social welfare policies," Tan says.

“We believe that confidence can return quickly, and a V-shaped recovery is possible given past response.”

Hang Seng tipped to lift once cease

Since the first protest began on 12 June, and subsequently intensified in mid-July, the Hong Kong’s Hang Seng Index has lagged other major indices.

The sell-off has been led by the real estate sector, which has fallen by 11.4 per cent.

But Tan expects a turnaround once the protests end, arguing that tourism and discretionary spending will recover quickly once confidence returns.

“We have seen this in other situations where consumer confidence is impacted by non-economic shocks with the 2003 SARS outbreak being one example,” she says, referring to the respiratory illness that struck the city, killing 299 people.

“The rest of the world is rightly more concerned about the potential economic slowdown driven by trade uncertainty, but stock markets are seeing slight gains with risk appetite returning somewhat since midyear.

Tan suggests the sluggish global economic growth may be a hindrance to a stronger rebound in the Hong Kong market should the protests end.

“Unlike in 2004, after SARS ended, when the world grew 4.4 per cent, Hong Kong posted strong GDP growth of 8.7 per cent and China at 10.1 per cent.

"GDP growth in 2020, assuming the protests end in 2019, is expected to be 3.5 per cent globally, 3.0 per cent in Hong Kong, and 6.1 per cent in China. As such, we expect a more lacklustre rebound compared with what we've seen previously.”

Spotlight on three five-star names on Morningstar’s Hong Kong list

Swire Pacific

Swire Pacific is a Hong Kong-based conglomerate with interests in property, aviation, beverage, marine service, trading, and industrials. The property division, an 82 per cent stake in Swire Properties, contributes more than half of the group's operating profit.

The aviation division consists of Haeco, an aircraft engineering company, and a 45 per cent stake in Cathay Pacific. The beverage division is one of two Coca-Cola bottler in Greater China, and in the mid-west and west of the US. JSS Group, the parent company, holds a 43 per cent stake in Swire Pacific but has 58 per cent of the voting rights through a dual-class share structure.

Wharf REIC

Wharf spun off Wharf Real Estate Investment Co in November 2017. WREIC is now a leading property investor in Hong Kong, with a focus on prime retail assets. Rental income, mostly from two flagship malls, accounts for 95 per cent of the company’s operating profit, while the hotel operation contributes the remaining 5 per cent.

The company holds a few projects in China that it expects to wind down or dispose of over the next few years. Wharf was originally a shipping company, but transformed into a property developer and investor in the 1960s by redeveloping its unused industrial assets, many located in city-centre or waterfront locations

Wharf Holdings

After the demerger in late 2017, Wharf (Holdings) Ltd is now mostly a China-focused property developer. We expect China assets to contribute 70 per cent to 80 per cent of the earnings, splitting between investment properties and development properties.

A small portfolio of Hong Kong assets, consisting of niche luxury residential properties located on the peak, and some industrial and residential assets in Kowloon East, is expected to contribute 15 per cent of the earnings. Incomes from hotel management and logistic businesses account for the rest. The parent company, Wheelock holds a stake of 62 per cent.