The stock price has reflected the current dividend level and has been downgraded to a neutral rating

MTR Corporation (MTR)'s total revenue for FY23 increased 19% year-on-year, recurring business revenue (excluding property development) increased 19% year-on-year, net profit attributable to shareholders decreased by 21% year-on-year, and net profit from core business (including property development, not including changes in fair value) decreased by 40% year-on-year. The final dividend remained at HK$0.89, and the full year dividend was HK$1.31 (same as in FY22), corresponding to a 5% dividend rate (yesterday's closing price). We believe that the current stock price reflects future potential profit growth and has been downgraded to a neutral rating, with a target price of HK$28.60.

Passenger transport services in Hong Kong continue to recover; future capital expenditure will rise

The improvement in revenue and operating profit in FY23 was mainly based on the increase in the contribution of passenger transport services in Hong Kong, in particular the recovery of transit operations in bus service operations, and the recovery of rental income from duty-free shops in the train station business.

Thanks to a 19% increase in the number of local railway passengers to 1.58 billion, the Hong Kong section of the transit and high-speed rail services recovered to 90 million. The total number of passengers has recovered to 93% in 2018. Revenue from MTR train operations in FY23 slightly exceeded pre-pandemic levels and reached a record high. EBITDA, on the other hand, returned to 70% of the 2018 level. Due to large depreciation and amortization, the EBIT in this business was a loss for the fifth year in a row, but it has narrowed. In 2023, the MTR's overall market share in the Hong Kong franchised public transport market increased from 48% to 50%.

Business revenue and EBITDA at Hong Kong Station have recovered to 79% and 77% levels respectively in 2018, and new rents for station stores fell 6.9%. We expect it will take time for rental income to grow.

Hong Kong property development profits recorded only HK$2.3 billion in '23, the lowest level since '17. The reason is that project completion and delivery times have slowed in the past two years along with the volume of real estate transactions in Hong Kong.

We expect that the main projects that can be recorded in 24-25 include the Tianrong Station Project, Ho Man Tin Station Project, Hong Kong Island South Shore Phase 34, and Sunrise Kangcheng Phase 11, but the profit amount will not exceed the peak level in '21 and '22.

Core net profit fell 40% year-on-year in '23 mainly due to increased operating costs of mainland/overseas railways and increased impairment provisions, but property development profit contributions did not increase significantly in that year, so despite rising revenue in '23, core net profit declined.

New railway projects currently under construction in Hong Kong include Kwu Tung Station on the East Rail Line, Tuen Mun South Line, Siu Ho Wan Station, and Tung Chung Line, which will be completed in 2027-32, respectively. Combined with existing railway maintenance and renewal costs, there will be significant capital expenses in the next few years. The company expects capital expenditure of 26.1 billion/ 31.5 billion/ HK$30.3 billion in 2024-26. The net debt-to-equity ratio increased by 3 percentage points to 26.5% in '23. We expect the leverage ratio to increase further.

valuations

We expect FY24-26E revenue to grow 4-5% year over year and core net profit to grow 22%/46%/2% year over year. Based on the updated model, we updated our NAV valuation of net assets per share to HK$40.80/share. Considering a possible increase in the debt ratio, we applied a 30% discount to the target price of HK$28.60, which was lowered to a neutral rating. The target price corresponds to a 4.6% dividend rate for FY24. The MTR said it would maintain a stable dividend policy but no target ratio. Upside risks include recorded profits exceeding expectations; downside risks include fare adjustments, passenger numbers falling short of expectations, development costs, interest costs, and depreciation exceeding our expectations.

Other business performance

Revenue from leasing and management businesses in Hong Kong increased 6.3% year-on-year to HK$5.1 billion in '23. Newly opened shopping malls “Weifang” and “THE SOUTHSIDE” in 2023 contributed to additional rents, but this was diluted by an 8.4% drop in overall newly booked rents. We expect this business revenue to continue to grow at a low number of units during the forecast period.

In mainland China and overseas business, the mainland and Macau railway business, property rental income and management revenue decreased by 16% year-on-year, while overseas railway business revenue increased slightly by 1% year-on-year. The corresponding EBITDA profit margins were 14.5% and 3.3%, respectively.

Recurring business losses for these two businesses were HK$101 million and HK$33 million respectively