Upgrade to Overweight on attractive valuation: Fortune REIT is now trading at a 68% discount to its net book value of HK$7.5, where its investment portfolio is already valued at 2005 levels. With its sound capital structure and early acquired assets (assets acquired in 2003/2005), we see limited risk of it breaching debt covenants and doing dilutive fund-raising exercises in the near term. A major downside risk is its low stock liquidity, but we believe investors will be well compensated by a high dividend yield of 15.1% for FY09E.

Poor economic outlook and slower retail sales already appear to be priced in: We are cautious about the Hong Kong economic outlook, and believe retail rents will fall by 10-15% in FY09. However, even if we factor in a 15% decline in spot rents for Fortune REIT’s shopping malls in FY09, and another 10% in FY10, we estimate it would still be able achieve a DPU of HK$0.366 in FY09 and HK$0.31 in FY10, implying a 15.1% and 12.8% yield, respectively. Share prices have corrected 54% in the past 12 months; we believe this has more than priced in the downside risks from an economic slowdown.

New Dec-09 PT HK$2.7, on par with NPV: Our DDM-based NPV is now HK$2.7 per share, using a conservative 10.3% discount rate and -0.1% long-term growth rate, which takes into account the lower stock liquidity (average daily trading volume of US$0.32 million) and also potential dilution from unit issuance for REIT managers’ base fees. Risks to our price target include a worse-than-expected slowdown in Hong Kong retail sales, and hence retail rents, and significant asset writedowns in Fortune REIT’s portfolio.