Thursday, December 1, 2016

Analysis of Kerry Properties



Please read the disclaimer here:http://greedydragoninvestment.blogspot.com/p/about-greedy-dragon.html. Enjoy the article, bitches!



Hey yo, I hope you’ve been getting what’s yours and making life treat you right. In this article, I will be discussing my investment in Kerry Properties which I made awhile back. Kerry Properties trades on the Hong Kong stock exchange. The group owns investment properties in China and Hong Kong. The group also has a property development arm and a hotel division. I don’t need to tell y’all that I’m all about that sweet, delicious cash flow generated by investment properties in Hong Kong and major cities in China such as Shanghai. The stock closed December 1, 2016 at HKD 21.55, which is slightly lower than the HKD 21.7 I paid per share. The stock traded above my purchase price for a bit, but dropped when Hong Kong raised the stamp duty on residential property transactions. The increased stamp duty could very well have a negative impact on the profitability of Hong Kong developers in the short-term. However, I think that the impact will be limited over the long-term. After all, there’s only one thing that the Chinese love more than gambling, and that’s real estate. Although a case can be made that some Chinese people view real estate investing as simply another way to feed their gambling habits. But I would think that speculating on properties is just a little less exciting than getting your smoke and your game on in some mahjong parlor. And to the SJWs out there, I’m not racist to Chinese people. I’m just trying (and probably failing) to get a chuckle out of some of my readers. In fact, I am Chinese although I like to identify as a dragon from time to time. For real tho, I don’t care about race. What I care about is someone’s character. Anyway, let’s get down to business.

Update on the Greedy Dragon portfolio: I recently purchased 800 shares of Northern Oil & Gas at USD 1.95 per share. I also bought 1,000 shares in Maybank at RM 7.67 per share. I sold 150 shares in Oasis Petroleum at USD 13.4 per share.

If you just look at Kerry Properties’ market cap/equity ratio, it would appear that the stock is undervalued. As at June 30, 2016, the group had equity of HKD 81.982 billion; the group had a market cap of HKD 31.10 billion when the Hong Kong market closed on December 1, 2016 (according to google finance). The group also pays out a healthy dividend, which makes sitting on the stock and waiting for its price to move up closer to intrinsic value a pretty fun proposition. Based on the dividends paid in the past 12 months and the stock’s closing price of HKD 21.55, the stock would have a gross dividend yield of 4.18%. But what I’m really interested in is if the value of the group’s assets on its balance sheet can be backed up by earnings. The rest of this article will detail my process of estimating Kerry Properties’ earnings power. 

Revenue from property rental was 35% of the group’s revenue for the 6 months ended June 30, 2016. But due to the high margin nature of the business, gross profit from property rental was 60% of gross profit. Revenue from property rental was approximately HKD 1.964 billion (73.93% of which were attributable to investment properties in China), up 12% from the same period a year ago. Gross profit from property rental came in at HKD 1.568 billion, up by about 7%. Investment properties in Shanghai, Beijing and Shenzhen made up 90.65% of the group’s gross floor area (GFA) in China. Apartment, office, and commercial made up 15.33%, 56.26% and 28.41% respectively of the group’s GFA in China.

The group had administrative and other operating expenses of HKD 584.197 million for the 6 months ended June 30, 2016. Total finance costs incurred was HKD 672.123 million. The group had interest income of HKD 127.116 million. The group also had dividend income from listed and unlisted investments of HKD 53.947 million. During the 6 months ended June 30, 2016, the group made a HKD 80.682 million provision for impairment loss for hotel property. I would add back the provision for impairment loss when assessing the profitability of the group as I will assume that it’s not an item that will keep recurring. The following table illustrates how I arrived at my estimate of profit before tax:

Figures are in millions of HKD
Gross profit from property rental
1,568
minus

Administrative and other operating expenses
584.197
Total finance costs incurred
672.123
add

Interest income
127.116
Provision for impairment loss for hotel property
80.682
Dividend income from listed and unlisted investments
53.947
Profit before tax
573.425
Profit before tax annualized
1,146.85
   
The group also has other divisions that contribute to its profits. Gross profit from property sales was HKD 949 million for the 6 months ended June 30, 2016. As mentioned earlier, Hong Kong recently raised the stamp duty on residential property transactions which could have a negative impact for Hong Kong property developers. Revenue and profits from property development are also less predictable than rental income. To build in a margin of safety, I will assume that annual gross profit from property sales will fall back to the levels seen in 2015. Gross profit from property sales was HKD 1.21 billion in 2015. The group’s hotel operations generated gross profit of HKD 95 million. While gross profit from the hotel division has improved significantly (up 23% from the same period last year), I’ll be conservative and take last year’s annual gross profit of HKD 153.934 million for the purpose of calculating my estimate of the underlying net profit of the group. The group’s tax expense was HKD 894.802 million for the 6 months ended June 30, 2016. However, that HKD 894.802 million figure includes some HKD 391.07 million in deferred tax expenses which I will not be taking into account when estimating net profit. Some of Kerry Properties’ net profit are shared with non-controlling interests. For the 6 months ended June 30, 2016, profit attributable to non-controlling interests was HKD 476.526 million. The group’s share of results of associates also contributes significantly to its profits. For the 6 months ended June 30, 2016, the group’s share of results of associates was HKD 547.725 million. 

I did not take into account the increase in fair value of investment properties as that’s only relevant, in terms of cash flow, if the group embarks on a strategy to divest its investment properties portfolio. For the 6 months ended June 30, 2016, the group experienced an increase in fair value of investment properties of HKD 919.275 million. The following table illustrates how I arrived at my estimate of net income attributable to shareholders:

Figures are in millions of HKD
Profit before tax annualized from table 1
1146.85
add

2015 annual gross profit from hotel operations
153.934
2015 annual gross profit from property sales
1,210.683
Annualized share of results of associates
1,095.450
minus

Annualized tax expense (excluding deferred tax expenses)
1007.464
Annualized profit attributable to non-controlling interests
953.052
Net profit to shareholders (my estimate)
1,646.401
  
My net profit to shareholders estimate is simply an estimate, and could very well be significantly off from the company’s actual profitability in the future. With that said, the group would have a P/E ratio of 18.88 if we used as inputs my estimate of net profit attributable to shareholders of HKD 1.646 billion and the group’s market cap of HKD 31.10 billion (based on the stock’s closing price on December 1, 2016). While I don’t think that the stock is an awesome gem at this valuation, I don’t mind taking a small position at this price. One of the reasons is that the net profit to shareholders I calculated would significantly underestimate the group’s profitability if its property sales division continues to perform as strongly as it did in the first half of 2016.

The other reason is that  Kerry Properties has a number of major investment properties under development that will add significantly to its GFA once completed. Major mixed use development and other investment properties slated for completion from between the second half of 2016 to 2019 would add slightly over 12 million square feet to the group’s GFA (one of the properties will be completed in phases from 2019). As at June 30, 2016, the group’s investment property portfolio had a GFA of 9,641,000 square feet. Now, I don’t know what the increase in rental income will be as a result of this expansion to the investment property portfolio as that would depend on things like rental per square foot, occupancy rates, and net lettable area. However, such a large planned increase to the group’s GFA is a good indicator that rental income has room to grow (duh!).  The group’s major mixed use development and other investment properties under development are all located in China; major properties under development in Hong Kong are all for sale properties. Please refer to “Kerry Properties, FY2016 Interim Results, Analyst Briefing Presentation” for more details on the cities in which these major properties under development are located.

I think I will end this article here. I hope I didn’t bore too many of you with this rather long analysis. As always, thank you for reading. Take care and stay rational.

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