HomeFinancial FootprintsWhy I think Link Reit (HKG: 0823) is severely undervalued

Why I think Link Reit (HKG: 0823) is severely undervalued




The protests
hit Hong Kong to usher in a low key traditional new year celebration, with many
locals looking forward to a better 2020. While many are hoping that city will
turn a corner, it’s been unfortunately hit by the Coronavirus. As the virus
began to abate, the protests started gaining momentum again. Since mid-2019,
many mainland tourists and foreigners have largely avoided travelling to HK,
and even travel insurance companies started imposing exclusion for injuries
sustained during the protests (even if you are a victim).

Hong Kong
shares naturally took a beating, including Reits with exposure to Hong Kong. Despite
the doom and gloom, I think there are still some bright spots in the Hong Kong stock
market. One of the Reits which I believe is resilient and has much growth
potential is Link Reit.

Link Reit is
one of the largest Reit by market Capitalization in Asia. Despite a drop from its
peak at HKD 99.8 to current level of HKD 67.1 (price as of 12th June)  it’s market cap is HKD 138 bil
(SGD 24.8 bil).  In Singapore, the
largest market cap Reit is Capitaland Mall Trust, with a market cap of (only) SGD7.3bil.

Some history of
Link Reit

Link Reit’s
properties was formerly own by Hong Kong housing authority, which consisted of
shopping malls, carparks, wet markets and welfare centres. Most of the units are
located near housing estate, serving the poorest, and elderly people with
disabilities. Government then made the move in 2005 to privatize and list in
the stock market. Since it was privatized, it was managed in a ‘business school
fashion’, with the cash generated from housing properties to venture into
commercial properties, and undergoing asset enhancement works and sending
rental price soaring. This drove out cheap family run shops, and less business
opportunity for lower income people who cannot afford the rent.

Hence housing
estates termed Link Reit as a ‘Blood Sucker’, ‘Corporate Monster’ and the ‘ugly
face of Capitalism’. The rental increase has been an increasing concern that
the matter was brought to Carrie Lam to propose capping rental increase in Link

Despite the
unhappiness among residents, Link Reit has done well for shareholders and outperforming Hang Seng Index. Unfortunately, it has given most of
that back since the onset of protests.

However, I felt
that the decline in Link Reit price is overdone and below are some of the
points on why I think it is undervalued.

Here’s why.

Malls located in heartland Areas

Earlier this month,
Link Reit announced its full year results ending Mar 2020. Despite the protests
and Coronavirus lockdown, Link Reit achieved a revenue growth of 7% year on
year and managed to increase its distributable Income by 4.23%  It’s occupancy rate for Hong Kong properties
stands at 96.5% and 97.8% for mainland China property.

Link Reit Malls
are mainly situated in suburban areas close to residential properties, hence
it’s properties are less affected by disruptions or roadblocks caused by the
protesters, as compared to shopping malls in central HK. Even as protests
continues, life will still go for Hong Kongers. Residents will continue with
their daily life shopping for groceries, necessities and ordering food.
Here’s the
breakdown of it’s Trade Mix.

From the chart,
its Food Related Trades: Food & Beverage, Supermarket & Foodstuff and Market/Cooked Food stalls account for 64.1% of the total portfolio as of 31st
March 2020. With the bulk of it’s rent deriving from food and retail, it’s earnings
should remain resilient despite the ongoing economic challenge.  Although Food & Beverage suffered a dip
in rental tenant, its drop of 3.4% in sales growth was caused by social distancing
measures in Hong Kong and China during the lockdown period rather than the HK

In FY2019
ending September, Food & Beverage manage to register a growth of 2.1% Year
on Year in growth in gross sales psf despite the ongoing protests. This shows
that the protests have minimal impact on F&B sector. Management has also
said in the results briefing on 1st June that things are slowly
returning to normal. F&B, especially fast food outlets are experiencing a
positive surge in the takeaway orders. As for retail stores selling
discretionary goods, online orders help to make up for the decrease in
footfall. The same is happening in China as well. 

Hence, should
the economic situations and protests worsens, the overall retail portfolio stays
resilient with trade related tenants accounting for 64.1% of retail portfolio’s

within ‘A’ Rating

Since the start
of the year, many Reits got a credit rating downgrade due Coronavirus,
especially Hospitality and retail sector. This is especially true in Hong Kong.

Whereas for Link Reit, they managed to maintained their credit rating. In general, the better the credit rating,
the lower the costs of debt.

To qualify as a
reit, a company must have a bulk of assets & income related to real estates
distributes 90% of the taxable income to shareholders. Hence Reit tend to hold
lesser cash reserves and dependant on raising of cash in order to fund property
acquisition. Cost of Capital is important is important to Reit, especially it comes
to debt financing. It is the 2nd cheapest option after funding via
retained cashflow. The formula for REIT’s cost of capital is Total Interest
Expense/ Total Debt.

With its sound
financial position, and cash balance of HK$ 7.8b, it’s average costs of debt
stands at 2.94%. Recently, it managed to issue green bonds at an interest of
2.875%, rated A2 and A by Moody & S&P respectively yet purchase HK$2.8bil
investment grade bonds of BBB+ on average, yielding 3.5%, benefitting from
the spread in interest rate. This is done so to manage surplus cash and enhance
returns to shareholders.

Hence under
challenging times, Link Reit is well positioned to acquire more properties with
lower cost of debt. It’s low gearing also gives Link Reit ample room to take on
more debt and acquire properties under distress during market downturn.

Pipeline of
Cashflow generating properties & Good AEIs to come

Link Reit also
seeks to strengthen it’s portfolio through Asset Enhancement Initiatives. Since
IPO till date, it has completed 85 enhancement projects. Generally Retail Reits
tend to benefit from AEI as it unlocks the potential value of the mall by enhancing
the retail environment and strengthen its appeal to shoppers.  

Being one of
the largest Reit has it’s advantages. It has the financial clout to acquire
more properties with better terms and favourable deals. Reits of such size also
has ability to undergo more AEI without impacting its DPU significantly. For
instance, a Reit consisting 10 properties undergoing AEI for two shopping malls will
have greater impact on its overall on its NPI compared to Reit with having 132

Currently it
also has pipeline of 23 AEI projects, with 19 projects under planning which
will improve its DPU once completed. 


Unlike the size
of Champion Reit or Mapletree NAC Trust , Link Reit has a portfolio of 131
properties hence, I am unable to analyse individual properties in depth. I will
be valuing based on 3 stage dividend discount model.
It is interesting to note that the management has been actively conducting share buybacks and cancelled the shares prior to the financial year end, a positive sign to investors which signals that it not only has sufficient funds to acquire properties, but positive outlook on the company’s future prospect. It’s different from the buyback seen in SGX, where management conduct buyback shares but only held as treasury shares and to be issued to management for share vesting purposes or when stock options are exercised.

As management
highlighted that retaining tenants is the key over increase in rental, I will
assume a zero revenue growth from Mar 2020-2022, followed by a growth of 7% growth
for the next 5 years 2022-2027 and terminal growth rate of 2%.

The average YoY drop in unit since 2015 is 2.13%. For units in
issue, I will assume a 1.9% YoY decrease

NPI Margin
Although the
average NPI margin is 74.9%, I am inclined to use NPI margin of 76% throughout
because FY2018 results onwards shown a NPI margin above 76% and it’s improving
year on year. Hence 
NPI Margin= 76%

Ratio of Distributable Income/NPI
Ratio of
Distributable Income/NPI is fairly stable at low 0.70 range. I shall use the
average of 0.73.

Discount Rate
Rate= E(R)= Rf + β (Rm –
Rf )
= 0.543+ 0.6 ( 5.43 – 0.543)

According to CAPM, Link Reit has a low discount rate
attributed by its low beta.

I will be more conservative and assume a discount rate of 5%.

Summing up all present
values = 2.8+2.7+2.8+2.9+3.1+3.2+3.3+116.4= HK$ 137.3
If one holds a pessimistic
view on Hong Kong’s future after 2047, and Chinese government officially takes
away all HK properties and Link Reit cease to exist.

We can find its intrinisic
value by calculating perpetuity cashflow from 2047 onwards and discounting it
to present value.

Hence, intrinic value of
Link Reit= 137.3-64 = HK$ 73.3. It’s still undervalued even with such conservative
Anyway, my belief is that
Chinese government will want to maintain Hong Kong’s ‘One Country, Two
Systems’ framework beyond 2047. I think there are many reasons to do so, one of
which is HK’s status as a gateway for global capital, benefitting Chinese
companies listing in HKSE to raise funds. 
Also most of the
properties owned by Link Reit have a leasehold of 50 years from 2005-2009
onwards, hence, it’s very likely that Link Reit continue to exist beyond 2047.
There are many many more positive points on Link Reit which I did not touch on, as well as other commercial properties and carpark which it owns. As spoken in my previous posts, I would like to maintain the momentum in blogging. The key is to blog consistently and not to break the chain, rather than to blog a very long post.

What are your thoughts on
Link Reit? Do you think current price is undervalued?

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  1. Hi, thanks for the brief yet insightful sharing. I would like to point out that CAPM return should be using expected return and not actual return. With the current uncertainties in the economy, the expected return would be much higher perhaps around 8-9% (http://www.market-risk-premia.com/hk.html). Would it be possible to analyse the sensitivity of the discount rate? Thank you/

  2. Hi Thunderskain,

    Sorry for the delayed response. But with the current low interest rate, a lower discount rate is justifiable too and HK index hasn't been great the past few years, hence that the lower market risk premium. Thanks for the link though.

    Thanks for the feedback, will try to the sesnsitivity analysis on discount rate when I have the time. Will update you!
    Meanwhile stay safe!


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