(The following statement was released by the rating agency)
Dec 12 -
Summary analysis -- Swire Pacific Ltd. ---------------------------- 12-Dec-2012
CREDIT RATING: A-/Stable/-- Country: Hong Kong
Primary SIC: Special Purpose
Mult. CUSIP6: 870794
Credit Rating History:
Local currency Foreign currency
16-Aug-2005 A-/-- A-/--
20-May-2002 BBB+/-- BBB+/--
The rating on Swire Pacific Ltd. reflects the company’s strong and stable rental income from seasoned investment properties in Hong Kong, its diverse businesses that have good profit records, its good liability management, and strong financial flexibility. The rating also reflects the Swire management’s willingness to use the company’s asset base as a source of financial flexibility. The Swire management’s willingness to utilize the company’s asset base to deleverage was shown in 2011 when the group sold its stake in Festival Walk, a shopping mall in Hong Kong. As a result, the company’s credit ratios are comfortably within levels appropriate for the rating.
Swire’s large growth appetite, debt-funded expansion, and the volatile profitability of and dividends from Cathay Pacific Airways Ltd. (45% owned by Swire) moderate these strengths.
Swire’s credit profile benefits from the company’s operating income from a large portfolio of high quality real estate assets and other income from diverse and unrelated business segments. However, we expect property leasing to remain the key driver of Swire’s profitability and cash flows. For the past three years, the property division accounted for about three-quarters of the company’s consolidated total assets and at least two-thirds of its operating profit before affiliates. We therefore evaluate Swire’s financial ratios based on the company’s predictable net rental income, similar to our analysis of real estate investment trusts.
In our view, the listing of Swire Properties Ltd. (A-/Stable/--; cnAA/--) in Hong Kong early this year has had a limited impact on Swire’s credit profile--partly because Swire did not generate any cash proceeds from the listing. Currently the group’s holding in Swire Properties is 82% and the group is likely to maintain its dominant controlling-shareholder status in exercising operational and financial strategies.
We view Swire’s business risk profile as “strong.” The company has a diverse business portfolio, with each business having a good-to-strong market position. These businesses include property development and investment, aviation, marine services, beverages, and trading and industrial. While overexposure to property investments weighs on our business profile assessment, we also consider the low correlation other businesses have with the property business, and Swire’s geographical diversification. With the exception of aviation, each business has a record of generating good profitability across economic cycles.
Swire’s investment property portfolio in Hong Kong underpins its business risk profile. The company’s portfolio of leasing properties is sizable and of high quality. The portfolio, including properties in Hong Kong and China, is valued at Hong Kong dollar (HK$) 199.3 billion as of June 30, 2012, from HK$191.5 billion six months earlier. Gross rental income from the office portfolio improved in the period, reflecting positive rental reversion at Swire’s Pacific Place and Island East properties. Gross rental income for Swire’s retail portfolio declined in the absence of a contribution from Festival Walk. Occupancy in Swire’s Hong Kong properties has been consistently above 95%, and the portfolio could benefit from positive rental reversions due to the limited supply of new commercial buildings in the territory. The outlook for the property sector in Hong Kong for 2013 is somewhat clouded, due to the ongoing slowdown in the global economy. Profitability is good; we expect Swire’s property leasing margins to be above 70%, in line with its Hong Kong peers’.
In China, Swire is making good progress with new developments and has secured satisfactory leasing commitments for new properties. Nevertheless, in our view, compared with Hong Kong, the Chinese market is less mature and more competitive, and poses higher execution risk. It could take several years before tenancy rates in China stabilize and rental income becomes meaningful. The good commercial location of Swire’s properties and joint ownership with local partners partly offset the development and operating risks.
Unpredictable distribution of Cathay’s residual cash flows affects Swire’s cash generation. Cathay contributes significant cash flows to Swire through dividends. Cathay has a good brand and niche position as a premium airline, but its operating and financial performances are volatile. In our view, Cathay’s performance--both in the cargo and passenger lines--is weak in 2012 and is highly uncertain in 2013. This is because of challenging global economic conditions and consistently high fuel costs. Further, airline’s capital expenditure is likely to remain high due to its fleet expansion plan. As a result, we expect lower dividend contribution from Cathay to Swire for year 2012.
We expect Swire’s profitability to improve in 2012 since property trading profits are likely to be materially higher than in 2011, albeit from a low base. We attribute the improvement to expected revenue recognition from Swire’s largely presold high margin development project, Azura. Swire’s profit margin has weakened since 2010 due to: (1) the consolidation of Hong Kong Aircraft Engineering Co. Ltd. (not rated), which operates in a lower margin segment than Swire; (2) higher overhead expenses on new leasing properties; and (3) continued challenging operating conditions for marine services and beverage businesses.
The profit contribution from property trading is uncertain for 2013 because the pre-sale on Swire’s other projects has been limited. Swire’s property trading business could face challenges if the property market weakens quickly in Hong Kong following policy measures. This is because of the company’s high development cost of upcoming residential projects. Nevertheless, the risk is manageable, in our view, because of the generally good location and small scale of Swire’s projects.
Weak performance at a number of Swire’s business segments hit the company’s performance in the six months ended June 30, 2012. Its aviation business faces challenging operating conditions. The marine and beverage division witnessed margin pressure from higher operating costs. The recovery prospect for these business units remains uncertain.