Saturday, November 15, 2014

Analysis of Mongolia Growth Group

Please read the disclaimer here: Enjoy the article, bitches!

Greeting and salutations value investors. In this article, I’ll try to explain my rationale for investing in Mongolia Growth Group (MGG). MGG is a property investment and development company in Ulaanbaatar, Mongolia. The stock trades in Canada (stock code: YAK) and in the U.S. (stock code: MNGGF). I’m investing in this stock with the knowledge that I may have to hold it for a long period of time before being able to reap the rewards (if any). Mongolia is also a very young emerging economy, so there might be additional risks associated with investing in stocks with exposure to the country. The stock price can be very volatile, but I’ve eaten a lot of spicy curries in my life so I’m pretty sure that my stomach can handle a little volatility (I don’t consider volatility to be a risk, but a lot of people do. Whatevs..). The stock has declined significantly since I bought it. When I invested in the stock it was trading at Canadian Dollar (CAD) 1.60 per share. It closed Friday at CAD 1.25 per share.

I want to get exposure to Mongolia because there’s potential for Mongolians to get a lot richer as the country has large natural resource reserves. In fact, there are already enough rich Mongolians to attract luxury brands such as Louis Vuitton and Burberry to set up shop in Mongolia. Don’t get me wrong, there are still a lot of poor people in Mongolia. The potential for growth resides in the poor people getting more job opportunities to lift themselves out of poverty; this can only be achieved in a significant way if the government moves towards being a free economy that respects property rights. Central Ulaanbaatar’s retail space is also concentrated in a small area. According to MGG Properties’ Q1 2014 Central Ulaanbaatar Retail Space report, “In central Ulaanbaatar, retail space is concentrated: there are only 5 km of active retail streets.” According to the report, the most valuable street is Fountain Street with market price per square meter of between USD 4,200-4,600. You can read more about the market prices and rental rates of the various retail streets in Central Ulaanbaatar in the report.

For the 6 months ended June 30, 2014, MGG had a net profit of CAD 5.24 million or CAD 0.15 per diluted share. Excluding unrealized gain on fair value adjustment on investment properties and gain on disposal of investment properties, the company experienced a loss before tax of CAD 2.29 million or CAD 0.06404 per diluted share for the 6 months ended June 30, 2014. In terms of the company’s ability to continue as a going concern, the loss isn’t as bad as it seems as there was $0.95 million in share based payment which is a non-cash expense. Management is also trying to reduce costs. According to this press release, “the Company has identified annual expenses of approximately CDN $500,000 that will be reduced or deferred until the Company shows positive cash flow.” Apart from cutting costs, the company can try to reduce its losses by generating more revenue (#basic stuff you can learn from running a lemonade stand #trolling). About 35% of MGG’s investment properties portfolio consists of land and redevelopment assets that should start contributing to rental revenue once redevelopment is complete. Also, according to the Management Discussion & Analysis for the quarter ended June 30, 2014, recent lease renewals have seen sizable increases in lease rates. So, rental revenue could increase if the company is able to renew expiring leases at significantly higher rates. “In terms of our core commercial portfolio rents on a same ‐ property basis on properties owned 12 months or longer, we reported revenue growth of 36.8%, 28.8% and 32.3% in April, May and June compared to 2013’s results in Mongolian Tögrög” (source: Management Discussion & Analysis for the quarter ended June 30, 2014). But because Mongolia has experienced high inflation and a plunge in FDI recently, the Mongolian Tögrög has weakened significantly against the Canadian Dollar. Therefore, the increases in rental in CAD terms are nowhere near as significant as the increases in rental in the local currency. 

Note: I’m well aware that in terms of profitability, share based payment is just as much an expense as any cash expense as it ultimately results in less money for existing shareholders. But as I said, I made this investment for the super long-term and I accept that the company may lose money for some time. 

MGG targets shorter lease durations to reduce its exposure to inflation. As at June 30, 2014, the weighted average remaining lease term was 19.0 months. The company’s commercial property portfolio has healthy occupancy rates of between 93.7-95.2%. At CAD 1.60 per share, the company would be valued at 1.17 times book value based on the balance sheet data as at June 30, 2014 (after taking into account the dilutive effect of stock options). I think that is an alright price to pay for a company that has a lot of potential to grow in the long-term. At the current price of CAD 1.25 per share, MGG would be valued at 0.91 times book value. 79.01% of the company’s CAD 54.96 million in total assets consists of investment properties and 7.86% consists of cash and cash equivalents. The company only had CAD 6.30 million in liabilities.

I like MGG’s goal of eventually establishing property funds that it co-invests in. This will increase the amount of capital the company has access to and hopefully allow it to leverage that additional capital from other investors to earn higher returns for shareholders. The risk that I worry the most about is that the government might expropriate the company’s assets. Political risk is a very real risk in Mongolia. You can read this article here about some of the things that have negatively affected foreign investor confidence in Mongolia. While I think that real estate has less political risk involved than a sector like mining, I accept that there’s a possibility that MGG might get its assets expropriated without adequate compensation. Thank you for reading. Take care and stay rational.

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