- By Mark Yu
So far this year, the largest Hong Kong exchange-traded fund--iShares MSCI Hong Kong ETF--outperformed the broader S&P 500 index with 20% returns vs. 8.3% (Morningstar). Nonetheless, country-based Swire Properties appeared to be undervalued.
2016 operations
The 151.8 billion HKD ($19.5 billion in today's exchange) property business reported 2% sales growth to 16.8 billion HKD and 6.9% profit growth to 15 billion HKD--an impressive 89.6% margin compared to 85.6% in 2015.
"Demand for space from Hong Kong retailers dependent on tourism is likely to remain weak in 2017. Demand for space from other retailers is likely to be stable. Retail sales are expected to grow modestly in Guangzhou and Beijing and more briskly in Chengdu. In Shanghai, demand for retail space is expected to remain firm except for space for luxury goods. In the U.S.A., weak retail sales have made some retailers cautious about expansion.
In Hong Kong, notwithstanding the expectation of a gradual increase in interest rates, over demand for residential property remains resilient. Trading profits are expected to be recognised in 2017 from the handover of presold units at ALASSIO and sales of units at WHITESANDS. In Miami, profits are expected to be recognised on the sales of units at the Reach and Rise developments.
Trading conditions for our hotels are expected to remain difficult in 2017.
On behalf of the shareholders and my fellow Directors, I wish to express our appreciation to all our employees, whose commitment and hard work have been central to our continuing success."
John Slosar Chairman Hong Kong, 16th March 2017
Total returns
Swire Properties ADR shares (ticker SWROY) outperformed the broader S&P 500 index so far this year with 22.3% total gains vs. the index's 8.3% (Morningstar).
Valuations
Swire Properties traded at some discount compared to its peers. According to GuruFocus, the company had trailing P/E ratio 10 times vs. industry median 13 times, P/B ratio 0.7 times vs. industry median 1.1 times, and P/S ratio 9 times vs. 2.9 times.
Swire also had trailing dividend yield of 2.85% with 28% payout ratio.
Average 2018 sales and earnings-per-share expectations indicated forward multiples of 8.3 times and 18.3 times.
Swire Properties
According to filings, Swire Properties was founded in Hong Kong in 1972. The company is a leading developer, owner, and operator of mixed-use, principally commercial, properties in Hong Kong and Mainland China, with a record of creating long-term value by transforming urban areas.
In 2016, Swire derived 62.6% of its revenue from Hong Kong, 23% from the United States, and 14% from Mainland China.
Impressively, the company was able to generate a huge amount of business from the U.S. from 26 million HKD in revenues in 2015 to 3.9 billion HKD in 2016. According to filings, 2016's overall revenue was principally due to higher sales revenue from the sale of residential units in Miami, and higher rental income from investment properties.
Swire's business comprises three main elements: property investment, property trading, and hotel investment.
Property investment
In 2016, sales in property investments grew 0.4% to 10.9 billion HKD--65% of total unadjusted Swire sales, and delivered a profit margin of 54.5% (highest margin compared to other segments) vs. 57.4% in 2015.
Property trading
Sales in property trading grew 6.7% to 4.8 billion HKD--28% of total unadjusted company sales, and delivered a margin of 25% compared to 24% in the previous year.
Hotel investment
Sales in hotel investment grew 0.3% to 1.13 billion HKD--6.7% of total unadjusted sales, and had 117 million HKD in losses compared to 303 million HKD in losses in 2015.
Sales, profit growth, and margin averages
For the past three years, Swire had sales growth average of 9%, profit growth average of 6.3%, and profit margin average of 79% (Morningstar).
Cash, debt and book value
As of December, Swire had cash and cash equivalents of 1.68 billion HKD, and 31.9 billion HKD in borrowings with debt-equity ratio of 0.14 times--similar ratio to previous year. As observed, debt climbed one percentage higher than the company's overall equity with 5.5% year over year.
The company had no intangibles nor goodwill stated in its consolidated balance sheet information and had net assets of 227 billion HKD compared to 218 billion HKD the year prior.
Cash flow
In 2016, Swire improved its cash flow from operations by 5.6% to 8.6 billion HKD and 366 million HKD in capital expenditures leaving it with 8.3 billion HKD in free cash flow compared to 7.6 billion HKD in 2015.
In addition, Swire has been allocating a lot of its cash flow in investment properties additions. In 2016, cash allocation to this activity increased by 63% to 5.9 billion HKD. Nonetheless, the real estate specialist still delivered positive cash flow after these heavy cash flow deductions.
Minus the investment properties, Swire allocated 174.8% of what's left of the cash flow to dividends for the recent year. On the past three years, the company allocated an average of 129% of its free cash flow in shareholder payouts including share buybacks it made in 2014.
Swire also had 450 million HKD in debt payments, net any borrowing proceeds.
Conclusion
Swire demonstrated relatively in line overall business growth figures in its recent fiscal year of operations. Having observed specific segments, however, revealed that the company has been able to make a significant change in its operations geographically from a non-existent US operation the prior year and now having generated nearly a quarter of its business in terms of revenue (1).
The company also remained very-very profitable as it also maintained an impressive not so much leveraged balance sheet. In addition, Swire has been overly generous to its shareholders in terms of dividend payouts.
Meanwhile, using a generous 9x P/S multiple and applying a three-year average sales growth figure followed by a 35% margin would indicate a value of 107 billion HKD--30% decline from today's market capitalization of 151.8 billion HKD.
The 107 billion HKD target price, however, indicated a 50% discount to Swire's current assets of 227 billion HKD--which would be more conservative when used for valuation purposes. Therefore, averaging a 25% discount on net assets with the calculated value would indicate a value of 139 billion--indicating a 9.5% upside.
In summary, investors who have appetite for Hong Kong undervalued properties with a little mix of U.S. as well should buy Swire Properties (LOCAL SHARES) with a target price of 23.7 HKD a share (9.5% upside from 25.95 HKD)
In the current currency conversion, Swire ADR shares would indicate a good value at $15 per ADR share (6.3% downside from $16.03--at the time of writing).
Notes
(1) Swire Properties: In March 2016, Swire Properties opened the first of two office towers (Three Brickell City Centre) in the Brickell City Centre development in Miami, U.S.A.
In November 2016, Swire Properties opened its 60.9% owned 500,000 square feet shopping centre in the Brickell City Centre development in Miami, U.S.A.
Disclosure: I do not have shares in any of the companies mentioned.
This article first appeared on GuruFocus.
