Hong Kong Property:Macro risks materialize,what’s next?

Event

The US FOMC announced an increase in the short-term interest rate by25bps, in-line with our expectation. Our US economist David Doyle expectsthe rate hike cycle to be gradual (25bps/quarter until 2% is reached in mid-17). (For our note, please see Hong Kong Property - Expecting dovish andlukewarm US rate hike.) We expect a negative knee-jerk reaction from HKproperty share prices. Looking ahead, we expect investors to re-focus oncompany fundamentals post materialization of the interest rate hike, the keymacro concerns of HK property. We see more upside than downside forselective developers in 2016. Our picks are Sun Hung Kai and CK Property.

Impact

3 key highlights on rate hike – more dovish, more gradual. 1) Thestatement indicated that FOMC participants expect economic conditions willevolve in a manner that will warrant only gradual increases in the federalfunds rate; 2) Fed-Funds rate projections moved lower across all periods. Atend-16, for example, the median projection held steady at 1.375%, while theaverage projection declined to 1.29% (1.48% in September); and 3) a lowerlong-run Fed Funds rate is becoming increasingly the consensus on thecommittee. (Please refer to FOMC = Dovish hike - RIP Zero rates: Dec-08 toDec-15, written by David Doyle.)

What should we expect? We expect a negative knee-jerk reaction in shareprices. However, HK banks may not necessarily follow the mortgage rate hike.

In coming months, a rebound of monthly transaction volume would be a keysign of market stabilization. It could indicate a willingness of buyers returningand the ease of buyers in digesting this interest rate hike event.

Game plan for 2016 – focus on company fundamentals. We believeinvestors should refocus on company fundamentals post the interest rate hike.

We expect this interest rate hike cycle to be similar to that of 2004. Webelieve the valuations of HK developers are largely reflecting negativesincluding the rate hike, presenting selective buying opportunities. Currentconditions look attractive and comparable to the trough level in 2003 and2008, presenting buying opportunities for selective stocks. Companies withgood fundamentals, resilient earnings growth, attractive valuations andexposure skewing towards mass market should outperform in the toughphysical market. Our picks are Sun Hung Kai and CK Property§ Views on HK property: We prefer Hong Kong developers to HK landlords/REITs in 2016. We see more upside than downside for selective developers.

Key supports include: 1) policy stance changing from tightening to neutral; 2)2) primary sales capturing market share; 3) attractive valuations and4) accumulated unmet demand (262k households) over the past 10 years.

Outlook

Valuations of HK developers look attractive to us and comparable to thetrough levels in 2003 and 2008, presenting buying opportunities for selectivestocks. We expect property prices to correct 5% in 4Q15, followed by flat pricegrowth in 2016E and 2017E, which is not a material market correction. Thesector trades at a 0.54x PB, 9.5x 2016E PE and a 48% discount to NAV.