Grim reality sets in for Hong Kong retailers

Mainland tourists at the Peak overlooking Hong Kong. Retailers in the city are feeling the pinch as the number of mainland visitors to the city continues to drop. [Photo/China Daily]

Although relying on the spending power of mainland tourists, Hong Kong has been experiencing a number of cross-border incidents

It was 7:30 on a Sunday night－a time when visitors usually end a day of shopping by exiting the malls and entering restaurants. Yet Causeway Bay, the holy grail of shoppers in Hong Kong, was not as busy as usual－there were shorter queues for fitting rooms, less people under the mega-screens of Russell Street, and even the notorious sidewalk traffic wasn't as bad on the corner in front of Japanese department store SOGO. But while shopping was more pleasant, on the side streets, shops－large and small－have been quietly shutting down. Further testament to trouble in the retail district were the layers of for-lease ads pasted on the rolling doors.

According to the Census and Statistics Department, the value of total retail sales decreased 9.8 percent year-on-year in April to HK$38.8 billion ($5 billion), a much steeper drop than the predicted 4.4 percent decline. Retail sales volume also tumbled 9.5 percent in the same period last year.

It is the third consecutive month that the city had recorded retrenchment in the retail sector－after sales dropped by 1.3 percent year-on-year in March and 2.2 percent in February. It was the worst slump since May 2003, when severe acute respiratory syndrome, or SARS, crippled the city.

Luxury stores have suffered the most. Sales of Swiss watches, Italian handbags and French jewelry dived 39.9 percent year-on-year in April. Separately, sales of mobile phones, tablets and cameras－hot gadgets among mainland tourists－also tumbled 8.3 percent. Even normally busy department stores recorded a 1.3 percent decline during the month.

While blaming last year's gold rush as a high comparison base, Barclays Bank Plc added in a June note that the dwindling number of mainland tourist arrivals has played its part. According to Hong Kong Tourism Board, the number of mainland visitors rose 14.7 percent year-on-year in April－still rising, but at a "much slower" pace compared with the 27 percent rise in March and 20 percent for the first quarter.

Earlier data from Goldman Sachs Group Inc estimated that mainland visitors contributed HK$217 billion, or 37 percent, to overall retail sales in Hong Kong last year.

But today, they are buying less than three years ago, Barclays wrote in another report published on May 30. The wealthy are decamping to far-off locales like Europe and the United States. Even Japan is luring the budget-conscious as an attractive destination with the yen depreciating.

Hong Kong retailers are on a cliff, cautioned Caroline Mak, chairman of the Hong Kong Retail Management Association.

"Last month, customer traffic started to decline," Mak told Hong Kong media. "Some shops targeting mainland visitors have had to offer an average discount of 20 percent or even 30 percent. Many suffered a 10 to 15 percent decline in same-store sales. This is not a sustainable way to do business, especially as costs remain sky-high."

Although official data for May is not yet available, on the first day of the Labor Day holiday－a traditional shopping period from May 1 to 3－the Immigration Department recorded an 11.88 percent drop in mainland visitors from a year earlier.

During the Dragon Boat Festival, from May 31 to June 2, Hong Kong received 2.5 percent fewer tourists from across the border, compared with double-digit growth in the same period for the past four years.

The city is looking for a way to manage the rising number of mainland tourists. Last year, 40.7 million of them visited Hong Kong, a tiny territory with 7.15 million residents. Three in four visitors arriving there are said to be from the mainland.

At a meeting with members of Commission on Strategic Development on May 26, Hong Kong Chief Executive Leung Chun-ying floated the idea of reducing the number of mainland visitors by 20 percent. "It's just an option," he told media the next day. "No decision has been made."

Yet voices rose against it immediately. "The local retail industry is boosted by tourism," the Hong Kong Retail Management Association said in a statement.

"Any slowdown or pause in the growth of tourist numbers would greatly affect the livelihood of 267,000 workers in the sector and damage its long-term outlook. A ripple effect would also hinder domestic consumption and cripple the economy of Hong Kong."

A 20 percent decline in mainland tourists would lead to a "material reduction" in the operating profits of Hong Kong retailers, the Barclays report noted. Companies that rent their operating space would see a big squeeze in margins in the short term, as rents for high street shops are usually fixed for three years.

Apart from retailers, developers also stand on the front lines. The share price of The Wharf (Holdings) Ltd, which operates the Harbor City and Times Square shopping centers, slid 3.5 percent after Leung's speech. So did Hysan Development Co Ltd, the "lord of Causeway Bay" with dozens of malls and street shops in the district. Lifestyle International Holdings Ltd, operator of SOGO, also tumbled 2.6 percent.

"The impact would be huge. Although the plan is to cut 20 percent, the real reduction could be bigger when the negative message gets out," said Joe Lin, executive director of CBRE Retail Services. "In the face of such cuts, rents for prime location shops could fall by 5 percent. On second- and third-tier shopping areas, it could dive 15 percent or deeper."

Marketing for retail leasing was subdued over the first quarter this year, Savills Plc reported in May. For prime street shops, rents fell 0.5 percent after declining 2.2 percent in 2013. Declines were steeper in some secondary locations.

Meanwhile, the gap between landlords' expectations and retailers' realities is widening. As a result, vacancy rates have been driven up in core retail districts as well as in some prime locations, the report said.

"Retailers are getting cautious. People no longer are willing to pay a 20 to 30 percent premium to bid for good locations. Now they only prefer prime streets," said CBRE's Lin. "Players are changing, obviously. Luxury stores used to be aggressive. But now, as mainland tourists shift to mid-range consumption, pharmacies, cosmetics and fast fashion are active."

"A rental adjustment cycle is underway, as slowing take-up, early surrenders and increasing vacancies start to test landlords. Shop rents will continue to drift down over the remainder of 2014," the Savills report said.