Performance preview

Net profit to mother is forecast to drop 25% year-on-year in 2023

We expect ESR's net profit (PATMI) to fall 25% year-on-year to US$420 million in 2023, lower than our previous forecast of US$550 million, mainly due to a decrease in fair value income from investment and development in an overseas high interest rate environment. Without considering fair value profit and loss, we believe that the company's business situation in 2023 was generally stable, and the core performance indicators were basically in line with expectations.

Key points of interest

The core business of fund management maintained steady growth. We expect the company's fund management division revenue and EBITDA to achieve high single-digit year-on-year growth in 2023 (mainly due to the increase in 1H23 company's fund management scale). Construction commencement and completion in the second half of the year slowed down due to fluctuations in the macro environment. The annual level may have recorded a slight year-on-year decline, but the total volume is still relatively impressive. Additionally, due to the company's sale of some of its table assets, the 2023 investment segment revenue may have declined year over year.

Increased financing costs and changes in fair value may be the main factors putting pressure on performance. Affected by the high interest rate environment overseas, we expect the company's weighted average financing cost to rise further compared to 1H23 (5.6%) in the second half of 2023, and interest expenses for the whole year will increase year-on-year. Furthermore, there was a marginal rise in the capitalization rate of commercial real estate around the world, leading to adjustments in asset valuations. Although some regions (such as Australia and South Korea) can hedge some of the pressure on asset prices through rising rents, the valuation of the overall asset portfolio is still under pressure.

Buybacks provided some support for stock price performance in 2023. According to our statistics, the company's total repurchase amount in 2023 was HK$1.7 billion (the number of repurchases reached 150 million copies). In 2024, we expect the company to continue to carry out repurchase activities as appropriate.

Potential interest rate cuts in overseas markets may benefit the development of the company's business activities. The rapid rise in interest rates in overseas markets since the second half of 2022 has caused a certain blockage to the real estate industry's business activities, and asset trading activity has declined significantly. In the future, we recommend focusing on potential interest rate cuts in overseas markets in 2024. In principle, interest rate normalization adjustments may also be beneficial to ESR's operating activities and profit recovery statements.

Profit forecasting and valuation

Considering the increase in the company's financing costs and the reduction in fair value earnings, we lowered 2023-24 net profit by 25% and 27% to US$420 million and US$420 million (26% year-on-year decrease and 8% increase), and introduced a net profit forecast of US$50 billion (10% year-on-year increase) for 2025. Maintaining an outperforming industry rating, the target price was lowered by 7.6% to HK$14.6, corresponding to 18.1/16.5 times the 2024-25 core price-earnings ratio. There is 46.3% upside compared to the current stock price, which mainly reflects adjustments in profit forecasts. The company's current stock price is trading at 12.4/11.3 times the 2024-25 core price-earnings ratio and 0.6/0.6 times the 2024-25 net price-earnings ratio.

risks

Real asset prices declined more than expected; financing costs continued to rise; exchange rate fluctuations exceeded expectations.