Asia Pacific: Conglomerates

Transcription

1 Equity Research Stock picks by themes, stress test on valuation and results preview Top ideas: Buy Hutch, Wharf and COSCO Pacific; Sell Jardine Market sell-down on macro concerns has given back much of the price gain in 1Q, with HK/China conglomerates trading sideways or down ytd. While their valuations look attractive, our stress test suggests an average downside of 18% if macro deteriorates and the stocks de-rate to onestandard deviation below mid-cycle valuation. This said, risk-reward looks favorable for selective stocks, e.g., COSCO, HPHT and Shanghai Industrial, in our view. We also see buying opportunities for those that benefit from sector themes and offer potential surprises in upcoming results. Investment themes and rating changes (1) Prefer exposure to Bohai region, and container over bulk ports - Given the fragility of macro recovery and retailers cautious stance as reflected by their lean inventory levels, shorter restocking cycles would translate to more volatile trading data in coming months, in our view. We prefer ports in Bohai Rim which are more leveraged to fast-growing domestic and intra- Asia trades. We also prefer container over bulk ports for their better demand and supply outlook. We downgrade Dalian Port from Buy to Neutral, as we believe slower-than-expected oil throughput growth ytd could present downside risk to its earnings. We recommend investors switch to COSCO. (2) HK rental upcycle to continue and appreciation in capital value We expect the cap rate to remain low, as (1) its spread over long-term rates has been 2-3%, inline with historical avg; (2) our ECS team believes the US will not raise the Fed rate until at least end In the meantime, hiring expectations, though moderate slightly, remain strong. Coupled with a lack of new supply, we expect HK s rental upcycle to continue and forecast 25% office and 10-15% retail rental growth in We downgrade MTRC from Buy to Neutral on concerns over policy risk, and upgrade Wharf from Neutral to Buy, as the stock has underperformed MSCI HK Index by 4%ytd despite robust rental growth. We expect market to react positively if Wharf confirms its 2011 property sale target at its interim results in August, and see significant upside risk to consensus estimates in SUMMARY OF RATING AND TP CHANGES 12-m NAV Implied Price Ratings based TP +/-% CCY 25-Jul New Old New Old Hong Kong Hutchison Whampoa HKD 88.7 Buy Buy % Swire Pacific (A) HKD Buy Buy % Wharf Holdings HKD 56.2 Buy Neutral % HPH Trust USD 0.8 Buy Buy % MTRC HKD 27.0 Neutral Buy % Cheung Kong Hldgs HKD Neutral Neutral % CKI HKD 42.0 Neutral Neutral % Wheelock & Co. HKD 32.6 Neutral Neutral % Jardine Matheson USD 58.0 Sell Sell % China COSCO Pacific HKD 13.1 Buy* Buy* % Shanghai Industrial HKD 27.9 Buy Buy % CITIC Pacific HKD 17.0 Neutral Neutral % China Merchants Hldgs HKD 28.1 Neutral Neutral % Dalian Port HKD 2.5 Neutral Buy % China Resources Ent. HKD 33.9 Neutral Neutral % Fosun International HKD 6.2 Neutral Neutral % Tianjin Port Development HKD 1.5 Neutral Neutral % SIPG CNY 3.9 Neutral Neutral % Xiamen Port HKD 1.4 Sell Sell % *On our Asia Pacific Conviction Buy list Source: Company data, Goldman Sachs Research estimates. UPSIDE/DOWNSIDE IMPLIED BY TARGET PRICES IN BASE AND BEAR CASE SCENARIO 40.0% 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% -40.0% HPH Trust COSCO Pacific Shanghai Ind. Swire Pacific CITIC Pacific SIPG Wharf Dalian Port HWL CM Hldgs Tianjin Port Dev Cheung Kong MTRC Fosun Intl Wheelock & Co. CRE Xiamen Port Jardine Matheson Source: Bloomberg, Goldman Sachs Research estimates. RELATED RESEARCH Base case Current Bear case : Key takeaways from Conglomerate and Gaming Corporate Day, July 12, 2011 (3) Acquisition opportunities for cash-rich conglomerates Less revenue from land sales as developers turn more cautious on their replenishment plans would prompt local government to seek other ways to reduce their debt burden, which may create acquisition opportunities for cash-rich companies, e.g. Shanghai Industrial or CRE. Simon Cheung, CFA simon.cheung@gs.com Goldman Sachs (Asia) L.L.C. Frank He frank.he@gs.com Goldman Sachs (Asia) L.L.C. Janet Lu janet.lu@gs.com Goldman Sachs (Asia) L.L.C. Alan Tang alan.lk.tang@gs.com Goldman Sachs (Asia) L.L.C. Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC see the end of the text. For other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-us affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research

2 Table of Contents Summary of our latest sector view and rating changes 3 Sector themes, stress-test our assumptions and earnings preview 3 (1) Prefer container over bulk ports, and exposure to Bohai Rim 7 (2) Capital value appreciation in HK rental properties 14 (3) Acquisition opportunities for cash-rich conglomerates 20 Downside scenario - stress-test our key assumptions 23 Conclusion: earnings impact and valuation implication 26 Potential surprises and trading ideas around the results season 29 Stock implications and investment views 32 Stocks with rating changes 32 Other Buy rated stocks 37 Sell-rated stocks 45 Goldman Sachs Global Investment Research 2

3 Summary of our latest sector view and rating changes Sector themes, stress-test our assumptions and earnings preview Similar to what we had experienced last year, the Hong Kong and Chinese conglomerate stocks staged a sharp rally along with the broader market in the early part of this year on expectation of a sustainable macro recovery, especially for those more leveraged to the export-driven sectors (e.g., port, commodity). Given a firmer US outlook and greater inflation/policy tightening concerns in Asia, our strategist also recommended DM (developed market) over EM (emerging market) trades. But toward the end of 1Q, weaker macro data in the US and debt crisis concern in Europe started to weigh on market sentiment. Coupled with the higher-than-expected inflation data released from China and other emerging economies, these had triggered a sell-down across the Hong Kong and China markets in recent weeks. As shown in Exhibit 3, share prices of the HK/China conglomerates with exposure to the more cyclical industries, such as CITIC Pacific and China Merchants, have corrected by 20-30% over the past three months. On the other hand, those that focus more on consumer sectors (i.e., CRE, Jardine Matheson) or benefit from company-specific reasons (i.e., Hutch for HPHT IPO, CKI for EDF acquisition, Fosun for the privatization of Forte Land and proposed listing of Hainan Mining) have outperformed ytd. Looking into 2H2011, as most of the stocks have traded either sideways or fallen ytd, we generally find the sector valuation attractive. In a bear case where we stress-test our key assumptions based on a downside scenario by our ECS team (i.e., 3.4% global, 1.5% US, 1.0% Europe, 7% China and 0.4% Hong Kong GDP growth forecasts in 2012) and value the stocks at one-standard deviation below their mid-cycle valuation, there could be 9%-37% or an average of 18% potential downside from the share prices of stocks in our coverage universe. That said, risk-reward looks favorable for selective stocks, such as COSCO Pacific (on Conviction List), HPHT and Shanghai Industrial, both rated Buy. We also see investment opportunities for those which benefit from the several sector themes we identify below: Prefer port operators with exposure to the Bohai Rim region, and container over bulk ports. Further capital value appreciation of Hong Kong rental properties on favorable demand-supply outlook and our expectation that the cap rate is unlikely to widen for a period of time. Acquisition opportunities for cash-rich conglomerates with strong local relationship with local governments, given mounting pressure for them to lower their debt burden. We upgrade Wharf from Neutral to Buy, and downgrade MTRC from Buy to Neutral. After trading sideways ytd in spite of the strong fundamentals of Hong Kong s retail rental market, Wharf shares trade at a 35% discount to NAV, below the mid-cycle valuation. We see a buying opportunity at this level. If the group continues to execute well on its China investment, we expect a step-up in its property sale profit and see significant upside risk to consensus estimates in E. Confirmation of its full-year property sale target by management is likely to be taken positively by the market. For MTRC, several developments in recent months led us to turn more cautious on its business outlook, i.e., a substantial capex increase which raises concerns about further cost overruns and the return of its new rail projects. MTRC agreed to offer an additional HK$100mn fare promotion, wiping off close to 40% of the revenue increase from previous fare hikes, in response to Hong Kong locals protest against the fare increase. With HK CPI Goldman Sachs Global Investment Research 3

4 rising to 5.6% in June, the magnitude of the fare hike will likely be even higher. MTRC may face more of a challenge then. In addition, there may be a risk that the existing Fare Adjustment Mechanism (FAM) formula may be revised when it is reviewed in 1H We also downgrade Dalian Port from Buy to Neutral and prefer COSCO Pacific. We see downside risk on consensus earnings estimates on weaker-than-expected crude oil throughput growth ytd and potential dilution after the completion of the China-Russia pipeline. The recent fire accident at PetroChina s Dalian Petrochemical plan may also delay the launch of PetroChina s 4.2mn oil storage facility. Our top buys are COSCO Pacific, Hutch and Wharf. Our top Sell is Jardine Matheson. Exhibit 1: Summary of rating, target price and net asset value changes Price Rating 2011E NAV / share Target disc. Target price Implied Valuation Ticker Ccy 25-Jul New Old New Old Chg New Old New Old % +/-% methodology Comments Hong Kong Hutchison Whampoa 0013.HK HKD 88.7 Buy Buy % -10% -10% % 22% NAV-based Swire Pacific (A) 0019.HK HKD Buy Buy % -20% -20% % 28% NAV-based Wharf Holdings 0004.HK HKD 56.2 Buy Neutral % -20% -25% % 23% NAV-based Narrower discount on solid China property execution HPH Trust HPHT.SI USD 0.8 Buy Buy % 0% 0% % 34% DCF-based MTRC 0066.HK HKD 27.0 Neutral Buy % -10% 0% % 17% NAV-based Wider discount on concern over the new projects' return and its ability to raise fare Cheung Kong Hldgs 0001.HK HKD Neutral Neutral % -20% -15% % 19% NAV-based Wider discount on de-rating of property developers and HK property policy risks CKI 1038.HK HKD 42.0 Neutral Neutral % 0% 0% % 8% NAV-based Wheelock & Co HK HKD 32.6 Neutral Neutral % -35% -30% % 13% NAV-based Wider discount on HK/Singapore property policy risks Jardine Matheson JARD.SI USD 58.0 Sell Sell % -30% -30% % -9% NAV-based China COSCO Pacific 1199.HK HKD 13.1 Buy* Buy* % 0% 0% % 34% NAV-based Shanghai Industrial 0363.HK HKD 27.9 Buy Buy % -25% -25% % 30% NAV-based CITIC Pacific 0267.HK HKD 17.0 Neutral Neutral % -15% -15% % 26% NAV-based China Merchants Hldgs 0144.HK HKD 28.1 Neutral Neutral % 0% 0% % 21% NAV-based Dalian Port 2880.HK HKD 2.5 Neutral Buy % 0% 0% % 23% DCF-based SOTP China Resources Ent HK HKD 33.9 Neutral Neutral % 0% 0% % 4% NAV-based Fosun International 0656.HK HKD 6.2 Neutral Neutral % -30% -30% % 15% NAV-based Tianjin Port Development 3382.HK HKD 1.5 Neutral Neutral % 0% 0% % 19% DCF-based SOTP SIPG SS CNY 3.9 Neutral Neutral % 0% 0% % 24% DCF-based SOTP Xiamen Port 3378.HK HKD 1.4 Sell Sell % 0% 0% % -2% DCF-based SOTP * On Conviction List. Source: Company data, Goldman Sachs Research estimates. Exhibit 2: Summary of core net profit estimate revisions Comment Ticker Ccy New Old Chg New Old Chg New Old Chg Hong Kong Hutchison Whampoa 0013.HK HKD 20,694 23,086-10% 27,049 29,906-10% 31,489 33,137-5% Factor in deferral of proeprty profit booking and higher earnings at Husk Swire Pacific (A) 0019.HK HKD 10,225 10,941-7% 12,536 13,325-6% 13,592 14,083-3% Factor in lastest GS estimates of Cathay Pacific and HAECO Wharf Holdings 0004.HK HKD 8,493 8,482 0% 10,456 10,293 2% 13,198 10,659 24% Factor in higher HK retail rental growth & China property sales assumpt HPH Trust HPHT.SI HKD 2,314 2,314 0% 2,514 2,514 0% 2,834 2,834 0% n.a. MTRC 0066.HK HKD 9,599 9,818-2% 9,382 10,795-13% 11,127 11,795-6% Factor in lower margin for its rail business and deferral of profit booking at Lohas Park Phase 3 from 2012 to 2013 Cheung Kong Hldgs 0001.HK HKD 42,393 39,255 8% 21,027 28,854-27% 27,582 31,863-13% Factor in Hutch's latest estimates and latest proeprty schedule CKI 1038.HK HKD 7,458 7,458 0% 7,695 7,695 0% 7,957 7,957 0% n.a. Wheelock & Co HK HKD 6,726 6,588 2% 6,250 6,060 3% 9,181 6,764 36% Factor in Wharf's latest estimates Jardine Matheson JARD.SI USD 1,470 1,406 5% 1,598 1,538 4% 1,859 1,751 6% Factor in latest GS estimates for HK Land, JCNC and Astra China COSCO Pacific 1199.HK USD % % % n.a. Shanghai Industrial 0363.HK HKD 3,727 2,774 34% 4,162 3,288 27% 3,700 3,862-4% Reclassify the Qingpu landbank sales as recurrent earnings CITIC Pacific 0267.HK HKD 5,493 5,493 0% 7,662 7,662 0% 11,561 11,561 0% n.a. China Merchants Hldgs 0144.HK HKD 4,373 4,422-1% 4,661 4,827-3% 5,130 5,476-6% Factor in lower container throughput growth in PRD Dalian Port 2880.HK CNY % 960 1,096-12% 1,068 1,227-13% Slower throughput growth in oil handling division China Resources Ent HK HKD 2,379 2,387 0% 2,861 2,822 1% 3,487 3,404 2% Factor in higher sales growth for retail business in Fosun International 0656.HK CNY 2,101 2,116-1% 2,675 2,706-1% 3,332 3,360-1% Factor in higher interest expenses Tianjin Port Development 3382.HK HKD % % % Factor in higher coal and container throughput growth assumptions SIPG SS CNY 5,032 5,094-1% 5,486 5,695-4% 6,169 6,567-6% Factor in lower container throughput and tariff forecast Xiamen Port 3378.HK CNY % % % Lower container throughput and tariff forecast **Core net profit excluding exceptional items except for Cheung Kong Recurring net profits (mn)** 2011E 2012E 2013E Source: Company data, Goldman Sachs Research estimates. Goldman Sachs Global Investment Research 4

5 Exhibit 3: Share prices of companies with exposure to more cyclical industries have corrected by 20-30% over the past three months while those focusing more on consumer sectors or benefiting from company-specific reasons have outperformed ytd HK/China conglomerates share price performance Market 52-week Share price performance Absolute share price Share price cap CCY share price relative to local MSCI Index (%) performance (%) Jul-25 Company (US$bn) high low 1-wk 1-mo 3-mos YTD 1-wk 1-mo 3-mos YTD Hong Kong Hutchison Whampoa 48.6 HKD (1) 11 MTR Corporation 19.9 HKD (2) (4) (2) (3) 1 (2) (6) (5) Swire Pacific 'A' 21.0 HKD (1) (2) (2) (12) 1 (6) (14) HPH Trust 6.9 USD (3) (3) (15) NA (1) (17) NA Wharf Holdings 21.8 HKD (2) 4 7 (1) (4) Cheung Kong Hldgs 34.2 HKD (4) (2) 3 4 (8) (4) Cheung Kong Infra HKD (6) (4) Wheelock & Co. 8.6 HKD Jardine Matheson 37.8 USD China CITIC Pacific 8.0 HKD (1) (7) (21) (14) (6) (27) (16) COSCO Pacific 4.6 HKD (6) (15) (2) 3 (6) (22) (3) China Merchants 8.8 HKD (1) (4) (16) (8) (4) (23) (9) China Resources 10.4 HKD Shanghai Int'l Port Gp 13.6 CNY (2) (7) 1 Shanghai Industrial 3.9 HKD (6) (16) 2 4 (13) (17) Beijing Enterprises 5.6 HKD (1) (3) (20) (3) (8) (21) Fosun International 5.2 HKD (3) (2) Dalian Port (PDA) (H) 2.3 HKD (5) (10) (11) (20) (4) (10) (18) (22) Xiamen Int'l Port 0.5 HKD (8) (6) 2 1 (16) (8) Tianjin Port Dev (H) 1.2 HKD (1) (2) (10) (17) (1) (17) (18) Source: Bloomberg. Exhibit 4: HK/China conglomerates valuation summary Prem/ GS Share Fwd (disc) to P/E (X) P/B (X) 2011E Company Ticker Rating ccy price NAV NAV (%) 2011E 2012E 2011E 2012E yld (%) Hong Kong Hutchison Whampoa 0013.HK Buy HKD (26.0) Swire Pacific 'A' 0019.HK Buy HKD (37.5) Wharf Holdings 0004.HK Buy HKD (34.5) HPH Trust HPHT.SI Buy USD (25.2) MTR Corporation 0066.HK Neutral HKD (23.4) Cheung Kong Hldgs 0001.HK Neutral HKD (32.6) Cheung Kong Infra HK Neutral HKD (7.0) Wheelock & Co HK Neutral HKD (42.3) Jardine Matheson JARD.SI Sell USD (23.4) China COSCO Pacific 1199.HK Buy* HKD (25.1) Shanghai Industrial 0363.HK Buy HKD (42.2) CITIC Pacific 0267.HK Neutral HKD (32.5) Dalian Port (PDA) (H) 2880.HK Neutral HKD (18.4) China Merchants 0144.HK Neutral HKD (17.3) China Resources 0291.HK Neutral HKD (3.7) Fosun International 0656.HK Neutral HKD (39.5) Tianjin Port Dev (H) 3382.HK Neutral HKD (16.1) Shanghai Int'l Port Gp SS Neutral CNY (19.1) Xiamen Int'l Port 3378.HK Sell HKD Source: Bloomberg, Company data, Goldman Sachs Research estimates. Goldman Sachs Global Investment Research 5

6 Exhibit 5: Summary of key assumptions YoY growth 2011E 2012E HK primary property market price +15% +5% Hong Kong retail rental % % Hong Kong office rental +25% % China property development Flat +5% Hong Kong container port throughput +3% +4% China container port throughput +9% +10% Source: Goldman Sachs Research estimates. Goldman Sachs Global Investment Research 6

7 Key investment and sector themes As in the past, we have identified the following sector themes which the conglomerates in our coverage universe would be able to leverage. Exhibit 6: Conglomerates 2011E EV breakdown (%) by industry Company name HK Dev prop HK Inv prop Property China Dev prop China Inv prop Others Retail / consumer Ports Utility Commodities Transport Others Other businesses of Companies Hong Kong Hutchison Whampoa Hutchison's telecom business in Europe and Australia Wharf Holdings Wharf T&T, i-cable Cheung Kong Holding CK Life Sciences, REITs investments HPH Trust 100 Jardine Matheson Jardine Lloyd Thompson, Jardine Motors Group, JCNC (Astra) MTRC Cheung Kong Infra Swire Pacific Offshore oil exploration support Wheelock & Co Wharf's stake in Wharf T&T, i-cable China COSCO Pacific Container leasing, container manufacturing (CIMC) China Merchants 92 8 Container manufacturing (CIMC) CITIC Pacific Dah Chong Hong, Citic 1616 and other investment holdings Shanghai Industrial Fosun International Fosun Pharmaceutical, Sinopharm, Focus Media, ClubMed China Resources Holdings in Fortune Ng Fung Food and Hunan New Wellfull Dalian Port (PDA) (H) 100 Tianjin Port 100 Xiamen Intl Port 100 SIPG 100 Source: Company data, Goldman Sachs Research estimates. (1) Prefer container to bulk ports, and exposure to Bohai Rim One of the sector themes we identified last year was the market s over-pessimism on global trade. Since then, port stocks have traded up, driven by strong throughput data over the past six months. With renewed concern over the debt crisis in Europe and gloomy macro data released from the US, market sentiment has started to deteriorate since late- April. Based on our recent channel checks with factories and the macro leading indicators (e.g., Europe ISM, China PMI and industrial power production), we believe China s port throughput growth in the coming peak season may not be as robust as seen last year, i.e. up 18% yoy in 3Q10. Looking ahead, given the fragility of macro recovery and retailers cautious stance as reflected by their lean inventory levels (Exhibit 9), we expect shorter restocking cycles would translate into more volatile global trade and port throughput trends in coming months. On the positive side, gasoline and commodity prices have come down; US home prices have shown sign of stabilization. There has also been discussion about a potential extension of the 2% reduction on payroll tax until end In Europe, the approval of more foreign financial aid to Greece should ease near-term concerns over insolvency risk. There is also growing evidence that Japan disruptions are easing and the global industrial cycle may pick up in 2H2011. On the negative side, the disappointing payroll data in June sheds doubt on the pace of the job market recovery in the US. Discussion on the debt ceiling and future fiscal policy stance impose uncertainty and may derail the growth outlook for next year. In Europe, the market remains concerned that Portugal, Ireland and Greece s debt issues may spread to the other bigger sovereigns, e.g., Italy and Spain. Overall, our ECS team forecasts global GDP growth of 4.3% and 4.7% in 2011 and 2012 respectively, a modest downward revision from 4.8% and 5.0% previously, but in line with the 4-5% growth in Goldman Sachs Global Investment Research 7

8 Exhibit 7 lays out our China port throughput growth forecasts. We now project 9.4%, 9.7% and 8.2% growth in 2011, 2012 and 2013 respectively, assuming China s share of global trade would rise from 26.7% in 2010 to 27.7% in Our 7.7% and 8.5% global container port throughput forecasts for are based on the same 1.8x multiplier over our global GDP growth forecasts. We prefer container over bulk ports for better demand outlook and less addition of new capacity in the medium term. We will discuss these in greater detail in a later section. Exhibit 7: We forecast 9.4%, 9.7% and 8.2% China container port throughput growth in respectively Global and China throughput growth estimates E 2012E 2013E 2014E 10-14E CAGR Global real GDP growth 4.4% 5.0% 4.9% 2.9% -0.6% 5.1% 4.3% 4.7% 3.9% 3.6% Global consumption growth 3.2% 3.6% 4.5% 3.0% 0.9% 4.0% NA NA NA NA Global port throughput (000' TEU) 398, , , , , , , , , , % %yoy 11.1% 10.6% 12.7% 5.6% -9.1% 13.4% 7.7% 8.5% 7.0% 6.5% Global port throughput vs GDP China throughput (000' TEU) 75,640 93, , , , , , , , , % %yoy 22.8% 23.8% 21.8% 12.3% -4.7% 18.3% 9.4% 9.7% 8.2% 7.6% China % of global throughput 19.0% 21.3% 23.0% 24.4% 25.6% 26.7% 27.1% 27.4% 27.7% 28.0% Hong Kong total throughput 22,602 23,539 23,998 24,494 21,040 23,532 24,198 25,272 26,230 27, % %yoy 2.8% 4.1% 1.9% 2.1% -14.1% 11.8% 2.8% 4.4% 3.8% 3.9% Kwai Chung throughput 14,284 16,048 17,322 17,724 15,159 17,098 17,654 18,514 19,294 20, % %yoy 6.4% 12.3% 7.9% 2.3% -14.5% 12.8% 3.3% 4.9% 4.2% 4.3% Source: Drewry, China Ministry of Transport, Goldman Sachs Research estimates. Exhibit 8: Our ECS team forecasts global GDP growth of 4.3% and 4.7% in 2011 and 2012 respectively GS economic indicator forecasts Exhibit 9: Lean inventory level of US retailers reflects their cautious stance US retail sales vs. retail inventory to sales ratio E 2012E 15.0% 1.8 Real GDP growth (yoy) World -0.6% 5.1% 4.3% 4.7% 10.0% 1.7 Europe -3.9% 1.8% 2.2% 2.1% US -2.6% 2.9% 2.3% 3.0% 5.0% 1.6 Asia ex-japan 6.5% 9.2% 7.8% 7.9% Japan -6.3% 4.0% -0.8% 3.0% 0.0% 1.5 China 9.2% 10.3% 9.4% 9.2% Consumer expenditure growth (yoy) -5.0% 1.4 World 0.9% 3.5% 3.6% 4.0% Europe -1.3% 1.0% 1.1% 1.7% -10.0% 1.3 US -1.2% 1.7% 2.3% 2.6% Asia ex-japan 6.6% 6.2% 6.4% 6.9% Japan -1.9% 1.8% -1.1% 0.9% China 9.0% 5.9% 6.8% 7.5% -15.0% Jan-00 Jul-00 Feb-01 Sep-01 Apr-02 Nov-02 Jun-03 Dec-03 Jul-04 US retail sales %YoY Feb-05 Sep-05 Apr-06 Nov-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10 Retail Inventory to Sales ratio (RHS) Oct-10 May Source: GS Global ECS Research estimates. Source: CEIC. Goldman Sachs Global Investment Research 8

9 Exhibit 10: Bohai Rim is more leveraged to more stable, fast-growing domestic and intra-asia trades Container throughput by domestic and international trade Exhibit 11: We expect stronger growth in container vs bulk ports in E China container and bulk throughput yoy growth % of throughput contributed by domestic trade H11 Shanghai 7% 7% 9% 9% 10% Ningbo 6% 6% 7% 7% 7% Shenzhen 4% 4% 6% 4% 4% Dalian 13% 22% 19% 20% 19% Tianjin 24% 32% 38% 42% 45% Qingdao 14% 14% 14% 15% 21% Xiamen 9% 10% 13% 12% 13% Guangzhou 73% 71% 71% 72% 72% China top eight ports 14% 15% 18% 18% 19% By region - PRD 21% 22% 27% 25% 27% - YRD 7% 7% 9% 9% 9% - Bohai Rim 18% 22% 24% 26% 29% 30% 25% 20% 15% 10% 5% 0% -5% 23% 24% 22% 12% -5% 18% 18% 3% 9% 10% 7% 8% -10% E 2012E Container yoy Bulk yoy Source: Chineseport.cn. Source: China Ministry of Transport. Still prefer the Bohai Rim exposure in the longer run As shown in Exhibit 12, container ports in the three key coastal regions have shown divergent performance ytd, with port volume up only 4% yoy in the Pearl River Delta (PRD) (including HK), well behind 11% in the Yangtze River Delta (YRD) and 17% in Bohai Rim region. We expect this trend to continue and forecast 6%, 9% and 11% port throughput CAGR in PRD, YRD and Bohai Rim in (Exhibit 16). Power shortage and credit tightening as widely reported in the media, a power shortage in Dongguan has affected factory productivity, which is likely to be temporary. SMEs also find it more difficult to borrow money in light of the credit tightening in China. Capacity expansion by factories in inland provinces In the medium term, labor and other cost inflation should continue to put pressure on manufacturers profit margins. To take advantage of the lower salaries and more stable labor supply in inland provinces (e.g., Chongqing, Sichuan), some manufacturers are considering relocating or expanding new capacity to these areas. Over time, this could result in a diversion of cargo volume from PRD to YRD the latter is better connected by rivers that facilitate cargo transportation by less expensive barges, vs trucks in PRD. The YRD ports are also better positioned to benefit from the growth potential of the larger hinterland economies in the inland provinces. Bohai more leveraged to domestic and intra-asia trades Factories in PRD produce mostly furniture, electronic appliance, toys, apparels and other consumer goods, the majority of which are exported to Europe and the US. This explains why PRD ports recorded strong throughput growth last year on restocking in light of the US/Europe recovery, but much weaker growth ytd due to softened consumer demand in those countries. The goods produced in the Bohai Rim are different, mostly electronics, machinery and auto parts. Some Japanese and Korea companies, such as Sanyo, Canon and Mitsubishi, have set up factories there and ship back the semi-finished products to be assembled in their home countries. As such, the ports in the Bohai Rim are more leveraged to the stronger domestic and intra-asia trades. Indeed, as shown in Exhibit 10, domestic cargos account for 29% of port throughput in the Bohai Rim (vs. 27% in PRD and 9% YRD) in 1H11, and its contribution has been rising over the past few years. Goldman Sachs Global Investment Research 9

10 Of the port operators we cover, COSCO Pacific, Dalian Port and Tianjin Port have more exposure to the fast-growing Bohai Rim region, although the latter two are more leveraged to bulk cycles, where we are cautious (Exhibit 14). Exhibit 12: Container ports in the three key coastal regions have shown divergent performance ytd China monthly throughput YoY growth China ports throughput YoY% growth July Aug Sept 2010 Oct Nov Full year Shanghai 20% 20% 14% 9% 19% 7% 17% 20% 4% 11% 11% 10% 6% 10% Shenzhen 42% 24% 18% 12% 16% 3% 23% 16% -12% 1% 7% -4% 2% 2% Qingdao 23% 23% 22% 24% 24% 24% 18% 21% 14% 18% 18% 15% 9% 16% Ningbo 28% 23% 8% 14% 26% 22% 26% 35% 0% 28% 17% 4% 4% 14% Guangzhou 5% 4% 2% 11% 11% -7% 10% -6% -2% 15% 12% 10% 18% 8% Tianjin 12% 29% 22% 14% 13% 17% 15% 22% 22% 22% 21% 12% 12% 18% Xiamen 30% 24% 17% 12% 20% 6% 23% 17% -9% 5% 5% 5% 5% 5% Dalian 7% 10% 14% 28% 12% 11% 15% 13% 4% 20% 19% 25% 24% 18% China's top eight ports 23% 20% 14% 13% 18% 13% 19% 17% 2% 13% 13% 7% 8% 10% Other coastal ports 12% 17% 15% 18% 33% NA NA 22% 26% 17% 25% 22% 27% 23% Total coastal ports 21% 20% 14% 14% 20% NA NA 18% 5% 14% 15% 10% 11% 12% River ports 13% 17% 14% 21% 15% NA NA 14% 38% 4% 18% 24% 23% 19% China total throughput 20% 19% 14% 15% 19% 3% 18% 18% 8% 13% 15% 11% 12% 13% Accumulated throughput 22% 22% 21% 20% 20% 18% NM 18% 13% 13% 14% 13% 13% NM Hong Kong (Kwai Tsing) 9% 8% 7% 9% 15% 8% 13% 6% -2% 6% 7% 3% -3% 3% YoY% Yangtze River Delta 22% 22% 12% 10% 23% 9% 21% 25% 3% 15% 13% 7% 5% 11% Bohai 15% 23% 20% 20% 19% 19% 16% 19% 15% 20% 19% 16% 14% 17% Pearl River Delta, excluding HK 27% 20% 15% 11% 14% -6% 32% 7% -9% 6% 9% 4% 7% 5% Pearl River Delta, including HK 21% 15% 12% 10% 14% -1% 29% 7% -7% 6% 8% 4% 4% 4% Dec Jan Feb 2011 Mar Apr May Jun Ytd Source: China Ministry of Transport. Exhibit 13: Port throughput from domestic trade in Bohai Rim has shown faster growth Container port throughput yoy growth by domestic and international trade ('000 TEU) Throughput from domestic trade Throughput from international trade H H11 Shanghai 2,054 2,275 2,695 1,394 25,527 22,452 26,014 13,264 Ningbo ,983 9,427 11,778 6,201 Shenzhen 924 1, ,001 16,564 20,235 9,535 Dalian ,193 3,576 4,066 2,233 Tianjin 2,455 3,321 4,003 2,208 5,149 5,364 5,436 2,696 Qingdao 1,406 1,415 1,802 1,366 8,409 8,692 10,046 5,196 Xiamen ,104 3,611 4,490 2,193 Guangzhou 5,167 6,036 6,651 3,498 2,100 2,451 2,554 1,331 China top eight ports 13,722 16,164 18,558 10,209 77,468 72,136 84,620 42,650 By region - PRD 6,091 7,065 7,584 3,918 22,101 19,015 22,789 10,866 - YRD 2,695 2,977 3,542 1,866 35,511 31,879 37,792 19,465 - Bohai Rim 4,493 5,559 6,801 4,109 15,752 17,632 19,548 10,126 YoY growth Throughput from domestic trade Throughput from international trade H H11 Shanghai 9% 11% 18% 5% 8% -12% 16% 7% Ningbo 7% 10% 21% 19% 14% -6% 25% 8% Shenzhen 1% 11% -9% -19% 2% -17% 22% 2% Dalian 93% 30% 21% 11% -3% 63% 14% 18% Tianjin 41% 35% 21% 21% -4% 4% 1% 2% Qingdao 6% 1% 27% 64% 6% 3% 16% 9% Xiamen 23% 27% 12% 1% 12% -12% 24% 6% Guangzhou 9% 17% 10% 8% 21% 17% 4% 9% China top eight ports 15% 18% 15% 14% 6% -7% 17% 6% By region - PRD 8% 16% 7% 5% 3% -14% 20% 3% - YRD 8% 10% 19% 8% 10% -10% 19% 7% - Bohai Rim 32% 24% 22% 31% 1% 12% 11% 9% Source: Chineseport.cn, Goldman Sachs Research. Goldman Sachs Global Investment Research 10

11 Exhibit 14: COSCO Pacific, Dalian Port and Tianjin Port have more exposure to the fast-growing Bohai Rim region, although the latter two are more leveraged to bulk cycles where we are cautious 2010 attributable throughput breakdown by port operators % breakdown Container Bulk Bohai Rim YRD PRD Others Total Iron ore Oil and related Coal Others Total COSCO Pacific 33% 18% 26% 23% 100% n.a. n.a. n.a. n.a. 100% China Merchants 4% 44% 49% 2% 100% n.a. n.a. n.a. n.a. 100% SIPG 0% 100% 0% 0% 100% 36% 13% 43% 8% 100% HPH Trust 0% 0% 100% 0% 100% 0% 0% 0% 0% 0% Dalian Port 100% 0% 0% 0% 100% 24% 45% 24% 7% 100% Tianjin Port Dev 100% 0% 0% 0% 100% 36% 6% 38% 20% 100% Xiamen Int'l Port 0% 0% 0% 100% 100% n.a. n.a. n.a. n.a. 100% Container (000' TEU) Bulk ('000 tons) Bohai Rim YRD PRD Others Total Iron ore Oil and related Coal Others Total COSCO Pacific 4,217 2,268 3,380 2,952 12,817 n.a. n.a. n.a. n.a. 16,111 China Merchants 820 8,416 9, ,988 n.a. n.a. n.a. n.a. 281,000 SIPG - 22, ,667 66,710 23,240 79,190 13, ,060 HPH Trust ,637-15, Dalian Port 2, ,325 21,969 40,927 21,425 5,957 90,278 Tianjin Port Dev 7, ,432 75,341 12,731 79,158 42, ,530 Xiamen Int'l Port ,050 3,050 n.a. n.a. n.a. n.a. 3,331 Note: (1) PRD includes HK, excludes Xiamen; (2) Others for container ports include Xiamen and overseas; (3) Bulk throughput breakdown for SIPG is calculated based on 2009 total throughput and those for Tianjin Port Dev and China Merchants are calculated based on 2010 total throughput. Source: Company data, Goldman Sachs Research estimates. Drastic tariff cut unlikely. Medium-term demand-supply outlook still favorable Having frozen their tariffs for two years, port operators announced a different magnitude of rate hikes in different regions which took effect at the beginning of this year. Our discussions with shipping and port companies suggest that most of the tariff hikes have already been passed through. Coupled with the delivery of new vessels and the rise in fuel charges, shipping companies profitability has deteriorated in 1H11. This raises concerns that port operators may need to cut their tariffs in 2H11. We believe the situation is not as bleak as some investors think, for several reasons: Visibility to mid-2012 on 1-2 year-term contracts - Container handling charges (CHC) are negotiated on a case-by-case basis with individual shipping lines and usually last for one to two years, which should provide some visibility until mid In addition, hub ports in better locations should have stronger pricing power, in our view. Recovery of shipping companies profitability on slower vessel deliveries - Our shipping analyst, Tom Kim, believes supply growth had peaked in 2Q11 at a time when demand should pick up seasonally, lifting freight rates from 3Q10. He also expects vessel deliveries to continue decelerating over the next 18 months, which should help underpin margin recovery and ease the pressure for port operators to cut their tariffs. Medium-term demand and supply dynamics remains favorable We remain positive on the demand and supply outlook for China container ports in a 2-3 year view. Since the onset of economic downturn in 2008, most port construction and upgrades have been put on hold. As the central government has shifted its emphasis more towards driving economic growth through local consumption rather than export, we expect fewer resources to be allocated to the expansion of ports. By our estimate, 23mn TEU of new port capacity will come on stream in , translating to 4% supply growth per year vs. our China port throughput forecast of 9% CAGR. Pricing power for oligopolistic market structure - The oligopolistic market structure also strengthens port operators bargaining power against shipping companies. In PRD, for example, Hutch and China Merchants/MTL are the dominant operators and price leaders. In YRD, Shanghai and Ningbo ports are controlled by the listed arm of Port Goldman Sachs Global Investment Research 11

12 Authorities, namely SIPG and Ningbo Port. Shanghai s pricing strategy is indicative of the trend and Ningbo is usually a price follower. As shown in Exhibit 15, even during the financial crisis, average tariffs for most ports, except for Tianjin Port, only dropped by single-digit percentage points yoy, taking into account the higher empty, domestic box mix and pricing discount. In our model, we assume 0-2% CHC growth for HK/China ports, depending on their location and demandsupply dynamics. Each 1% change in average CHC and throughput assumptions would translate into % and % changes to our 2011E earnings estimates for the port operators in our coverage universe. Exhibit 15: Even during the financial crisis, average tariffs for most container ports only dropped by single digit % yoy, taking into account higher empty, domestic box mix and pricing discount Average revenue per TEU comparison by operator (HKD/TEU) China Merchants HPH Trust - Yantian n.a. n.a. n.a SIPG Tianjin Port Dev Xiamen Int'l Port yoy China Merchants n.a. 10% 6% 19% 4% -4% HPH Trust - Yantian n.a. n.a. n.a. n.a. -6% -2% SIPG -3% -2% 28% -3% -5% -1% Tianjin Port Dev -2% -3% 9% -1% -14% 10% Xiamen Int'l Port -3% -5% -9% -7% -9% -6% Source: Company data, Goldman Sachs Research estimates. Exhibit 16: We expect stronger growth in Bohai Rim to continue and forecast 11% container port throughput CAGR in , vs. 6% for PRD and 9% in YRD China port throughput and capacity growth forecasts by region By Region E 2012E 2013E 2014E 10-14CAGR Yangtze River Delta Throughput 23,290 28,860 35,580 38,855 35,506 42,403 46,763 51,577 55,786 60, % Capacity 35,340 35,340 41,300 42,100 52,130 55,330 55,330 56,130 56,930 61, % Utilization Rate 66% 82% 86% 92% 68% 77% 85% 92% 98% 98% Throughput yoy% 25% 24% 23% 9% -9% 19% 10% 10% 8% 8% Capacity yoy% 38% 0% 17% 2% 24% 6% 0% 1% 1% 7% Pearl River Delta (incl. HK Kwai Chung) Throughput 35,164 41,178 47,682 49,471 44,609 51,865 54,333 57,760 61,288 64, % Capacity 51,320 56,320 61,020 66,820 68,420 72,620 73,620 73,620 75,620 77, % Utilization Rate 69% 73% 78% 74% 65% 71% 74% 78% 81% 84% Throughput yoy% 16% 17% 16% 4% -10% 16% 5% 6% 6% 6% Capacity yoy% 11% 10% 8% 10% 2% 6% 1% 0% 3% 3% Bohai Rim Throughput 13,800 16,860 20,370 23,011 23,542 27,366 31,197 35,078 38,586 42, % Capacity 22,805 24,405 30,405 33,305 33,305 34,805 36,605 38,105 41,005 43, % Utilization Rate 61% 69% 67% 69% 71% 79% 85% 92% 94% 96% Throughput yoy% 24% 22% 21% 13% 2% 16% 14% 12% 10% 9% Capacity yoy% 26% 7% 25% 10% 0% 5% 5% 4% 8% 7% Source: China Ministry of Transport, Goldman Sachs Research estimates. Goldman Sachs Global Investment Research 12

13 Near-term slowdown of throughput growth in bulk ports China s fast-growing economy has underpinned the robust demand for commodities over the past decade, which had grown 11% CAGR since As a result, China s shares of global iron ore, coal and oil demand reached 62%, 48% and 11% last year, up from 19%, 18% and 6% a decade ago. We believe the bulk ports will benefit from continued growth of commodity demand in China over the long run. In near term, however, we share our shipping analyst, Tom Kim s cautious view, as several demand drivers are decelerating. Iron ore throughput only grew 3% yoy to May 2011, as the heightened iron ore price encourages domestic production (+15% ytd), leaving less need for imports from overseas. As shown in Exhibit 18, iron ore inventories at ports are now at their highest levels since 2005, as traders are stocking up inventories in anticipation of a further rise in price. In light of the tightening measures imposed by the Chinese government to cool inflation, our commodity team forecasts weaker steel production growth of 4% and 3% in 2011 and 2012 (vs. 10% in 2010). Ongoing tightening policies also weigh on the demand outlook for industrial materials and coal consumption. Crude oil is another driver for a bulk port s throughput growth. 45% of Dalian Port s throughput is attributed to oil and related products, for example. Our Asia energy team expects China s crude oil demand growth to decelerate from 13% yoy in 2010 to 8.5% and 5% in 2011 and After the sharp rise in oil price last year, China s oil refiners also turn more cautious on their production plans in view of the higher input cost. In addition, the completion of the China-Russia crude oil pipeline since Jan-2011 should transmit 15mn tonnes each year (representing 6% of China s annual import) and dilute some of the seaborne crude oil throughput. Overall, we forecast 7% and 8% China s bulk port throughput growth in 2011 and 2012, slower than our container port throughput growth forecasts of 9% and 10%. On the other hand, we expect more supply in bulk vs. container ports. China Communication Construction Company Ltd (CCCC), one of the leading port construction companies in China, indicates that its order book for bulk port construction is up 10% yoy, vs. flat yoy for container ports, suggesting more new supply of bulk ports in coming years. Exhibit 17: High iron ore price encourages domestic production leaving less need for imports from overseas China monthly iron ore import volume and price Exhibit 18: Iron ore inventories at ports now at their highest levels since 2005 China iron ore inventory at ports (mn tonnes) (US$/tonne) (mn tonnes) Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Monthly iron ore import volume (LHS) Iron ore import price (RHS) Iron ore inventory at ports Source: CEIC. Source: CEIC. Goldman Sachs Global Investment Research 13

14 Exhibit 19: We forecast 7% and 8% China s bulk port throughput growth in 2011 and 2012, slower than our container port throughput growth forecasts of 9% and 10% China bulk port throughput growth breakdown by commodities Throughput (mn tonnes) E 2012E 2013E 2014E Crude oil n.a. n.a. n.a. n.a. n.a. n.a. n.a Iron ore ,137 1,168 1,238 1,324 1,425 1,508 Coal ,063 1,170 1,323 1,405 1,486 1,582 1,661 1,744 Grain n.a. n.a. n.a. n.a. n.a. n.a. n.a Others n.a. n.a. n.a. n.a. n.a. n.a. n.a. 3,416 4,041 4,014 4,336 4,682 5,057 5,461 Total n.a. n.a. n.a. n.a. n.a. n.a. n.a. 5,891 6,972 7,156 7,672 8,252 8,847 9,454 Throughput yoy Crude oil n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 15% 17% 12% 11% 7% 6% Iron ore n.a. 20% 28% 41% 33% 17% 17% 15% 26% 3% 6% 7% 8% 6% Coal n.a. 11% 15% 25% 12% 12% 17% 10% 13% 6% 6% 6% 5% 5% Grain n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 23% 29% 0% 3% 4% 4% Others n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 18% -1% 8% 8% 8% 8% Total n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 18% 3% 7% 8% 7% 7% Source: Company data, Goldman Sachs Research estimates. (2) Capital value appreciation in HK rental properties Although Hong Kong s office and retail rents continue their uptrend, conglomerates with heavy exposure (e.g., Swire, Wharf) have generally underperformed the market index ytd. Aside from policy concerns which have affected sentiment for Hong Kong s property stocks, investors also worry about potential expansion of cap rate. Given our ECS team s view that the US government will not raise the Fed funds rate until end-2013, we believe the cap rate will stay at its current low level for a period of time. In the meantime, we remain positive on the fundamental outlook of Hong Kong s rental market on favorable demand-supply dynamics and weakening currencies locally vs other regional countries. We see a buying opportunity for conglomerates with rental property exposure which trade at deep discount to its asset value. At current share prices, if we strip out their non-property assets, the implied rental yields of Wharf and Swire are 6.9% and 6.1% in 2011E respectively, higher than Hysan s 5.4% and HK Land s 4.7% (Exhibit 20). Exhibit 20: At current share prices, if we strip out their non-property assets, the implied rental yields of Wharf and Swire are 6.9% and 6.1% in 2011E respectively Market price implied net passing rental yield for Swire, Wharf, Hysan and HK Land (In mn, except for per share data) Swire Wharf Hysan HK Land Currency HKD HKD HKD USD Share price as of Jul Shares outstanding 1,505 3,029 1,054 2,249 Mkt cap 165, ,078 38,471 15,048 Net debt (2010) 38,352 29,784 2,594 2,358 Company's enterprise value 203, ,862 41,065 17,406 Non-HK rental property NAV (107,386) (102,584) (10,759) (5,565) Implied EV from HK rental properties 96,366 97,278 30,306 11, E EBIT from HK rental property 5,900 6,729 1, E EBIT from HK rental property 6,843 7,874 1, Implied 2011E net passing rental yield 6.1% 6.9% 5.4% 4.7% Implied 2012E net passing rental yield 7.1% 8.1% 6.4% 5.1% Source: Bloomberg, Company data, Goldman Sachs Research estimates. Rental yield at historical low, but gap with long-term interest rate is still wide By definition, the cap rate reflects market expectation of the long-term rental growth, perceived risk premium (or liquidity) and risk-free rate (as proxied by 10-year US Treasury Goldman Sachs Global Investment Research 14

15 rate) of owning the property. As shown in Exhibits 21 and 22, the sharp fall of the rental yield in Hong Kong since the financial crisis has largely been driven by the decline in the risk-free rate. Its spread over the 10-year US Treasury rate has been around 2-3%, in line with its historical average. In other words, despite the strong trend seen in last two years, market expectations of Hong Kong s rental growth have not changed much. As our ECS team expects the current benign interest rate environment will last for a while, we do not see any imminent risk that the cap rate will rise in the near future. In fact, for selective properties which benefit from structural trend (i.e., Wharf s Harbour City has become one of the key shopping destinations for mainland visitors), there is room for further cap rate compression and hence capital value appreciation, in our view. Exhibit 21: The gap between HK office rental yield and US long-term rate is 2-3% in line with historical average... HK Grade-A office rental yield spreads against 10-year US Treasury Exhibit 22: so is the gap between HK retail rental yield and US long-term rate Retail rental yield spreads against 10-year US Treasury 15% 8% 15% 8% 7% 7% 10% 6% 5% 10% 6% 5% 4% 4% 5% 3% 2% 5% 3% 2% 1% 1% 0% 0% 0% 0% -1% -1% -5% -2% -3% -5% -2% -3% Yield spread (RHS) -4% Yield spread (RHS) -4% -10% Grade A office rental yield (LHS) US 10yr Treasury (LHS) -5% -6% -7% -10% Retail rental yield (LHS) US 10yr Treasury (LHS) -5% -6% -7% -15% -8% -15% -8% 1Q90 1Q91 1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q90 1Q91 1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 Source: Jones Lang LaSalle, Colliers, DTZ, Goldman Sachs Research. Source: Jones Lang LaSalle, Colliers, DTZ, Goldman Sachs Research. Market turns more positive on retail vs. office rental growth After reaching its trough in 1Q09, the capital value of Hong Kong s grade-a office has risen 95% over the past two years, driven by 32% rental recovery and 2.5% cap rate compression from 8.1% in 1Q09 to 5.6% in 1Q11. Similarly, the capital value of the retail space has doubled, though on slower rental growth of 19% which implies a sharper cap rate compression from 8.7% to 5.3% during the same period. This suggests that the market has turned more optimistic on the long-term outlook of retail properties relative to office, as the former more directly benefits from continued growth of mainland tourist arrivals, as we discuss later. Hiring appetite cools down, but office rents set to surpass its last peak in 3Q08 One of the key themes we identified last year is the continuation of strong office upcycle and the spillover effect to decentralized districts. As shown in Exhibit 25, after the 30% increase last year, office rent in Central is up another 16% ytd. Rental growth in the decentralized districts, such as Island East, Causeway Bay and Tsim Sha Tsui, have accelerated to 9-17% ytd, running ahead of our full-year forecasts of +20% for Central and +25% for other districts. According to the latest survey by the human resources consultant, Hudson, hiring appetite has cooled down slightly after eight consecutive quarters of improvement since 2Q09, which suggests to us a potential deceleration of office rental growth in 2H11 (Exhibit 24). But as hiring expectation remains strong in absolute terms similar to levels in (Exhibit 23), coupled with limited new supply until 2013, we expect the upcycle to continue and expect Hong Kong s office rent to surpass its last peak in 3Q08. After a 20-25% increase this year, we forecast office rents to grow another 10-15% Goldman Sachs Global Investment Research 15