Hong Kong Ping Pong:Can retail rebound after hitting a wall

　　Chinese inbound flows into Hong Kong and retail sales areshowing signs of improvement after 2 years of deterioration

　　While a rebound is unlikely in our view over the short term, thesecond derivative of growth is clearly going in the right direction

　　Beware of selling names in luxury, retail, and retail landlordsthat have a high exposure to the cityIt’s the Chinese, of courseAs highlighted recently by our economist (Hong Kong (Retail Sales, April) Stillchallenging, 31 May 2016), Hong Kong’s April retail sales saw another sharp decline,although headline numbers were slightly above our expectations. Hong Kong retail salesstarted to decline in February 2014 and, with very few flattish months, have beendeclining ever since. Inbound tourism flows both from the mainland and globally started todecline in June 2015 and have remained negative ever since. We believe, however, thatthings are about to change with both retail sales and inbound flows halting their slide aswe enter the 2H of the year. Why? Mostly because the Chinese may start to return!Where does this optimism come from?Our view is not based on wishful thinking but rather on our recent conversations withretailers and brand managers as well as our recent projections of mainland Chinaoutbound travel (see our recent Luxury Postcard The travelling Panda: the signpost pointsto Seoul, rather than Tokyo, 19 May 2016). For two years now we have been hearingsome investors say “Hong Kong cannot compound -20% on -20% for ever” and thosehopes were ill-founded. It could well be that finally retail sales will find a level. Why? First,Chinese travellers fearful of threats to travel in Europe are staying closer to home.

　　Second, following the surge in the JPY, Japan is losing out to Korea and Hong Kong asprice arbitrage favours them. Third, shopping in Hong Kong may start to benefit fromgreater brand diversity and an improvement in transport as well as cultural infrastructure.

　　April inbound tourism flows have shown a substantial sequential improvement and,importantly for luxury, growth in “overnight visitors” who move the needle for the space.

　　Too late to be negative on retail and real estateDon’t get us wrong, we are not bullish on Hong Kong and the city could well continue tobe a market share loser in terms of luxury and premium goods to other cities. But theimprovement in the second derivative of growth is probably a good reason to be waryabout too much negativity on consumer and retail stocks that are very much skewed toHong Kong. In luxury, think Richemont (CFR VX, CHF58.55, Buy, TP: CHF81) and HongKong jewellers such as Chow Sang Sang (116 HK, HKD13.60, Buy, TP: HKD15.90) orLuk Fook (590 HK, HKD18.96, Hold, TP: HKD16.30). Among landlords, think Hysan(14 HK, HKD33.90, Hold, TP: HKD35.50) and The Wharf (4 HK, HKD43.30, Hold, TP:HKD44.00).