2023-06-13 00:24:18 ET
Summary
- Hongkong Land Limited is a real estate investment company with a diverse portfolio of properties in prime locations, benefiting from China's economic recovery and interest rate reductions.
- The company has a strong balance sheet, with a net debt reduction and a share buyback program, while paying consistent dividends of $0.22 per share for the last five years.
- Despite its value investment potential, HKHGF could be a value trap, but investors can enjoy a dividend yield of 5.14% while waiting for the market to recognize its true value.
Investment Case
As real estate is the core of our investment assets, we need to have a good understanding of the why, what, and where of these investments.
- Why own real estate?
- What type of real estate investments?
- Where are these properties?
One of many investments we own in real estate is Hongkong Land Holdings Limited ( OTCPK:HKHGF ).
A company that we one year ago described as one of " Asia's Best SWAN Shares". You will get a good understanding of what they do, by reading our previous article.
Since a year has gone, we would like to share our view on HKHGF and try to answer the questions raised.
Why own real estate?
We chose to own both physical commercial and residential properties together with shares in companies that own properties.
A piece of land, with or without a building, will always have value. If you own a farm and, on that farm, someone can grow a crop that eventually becomes someone's food, that is not going to go away anytime soon.
Governments worldwide can print as much money as they want, but they cannot print land. Humans will always need buildings for shelter. Whether that is a place to live or a place to work.
When you experience inflation, like we have done now over the last two years, it is going to get more expensive to build a new building. This also drives up the prices of existing buildings.
The biggest "investment" most people own is the home they live in. Some people might tell you that it's better to rent than to own. I disagree. It's better to pay "rent" to yourself than to someone else. That way you build equity.
REITs and investments in companies that invest and lease out space are also attractive. Not everybody has to ability to invest in whole buildings, and even if they do, they may prefer to pay for someone else to manage it for them. There are also tax benefits from owning REITs as opposed to direct ownership of properties.
What type of real estate investments?
You should diversify, as that is the only free lunch you are going to get in investing. You will have to pay the price and learn from your mistakes. If you have put all your eggs in one basket and it was a mistake, it could take a long time to recover from it.
We own REITs that own retail space, offices, hotels, industrial properties, and infrastructures like ports. You can also choose to own other types of properties.
One of the companies we do own, which is not a REIT is HKHGF.
Where are these properties?
Since we talked about diversification, if you own real estate in just one city or country, you are not well diversified.
It is, in our opinion, a good idea to own shares in different companies that own properties in several geographical locations. There are cycles in the property segment, and it can be down all over the world.
However, if you look at the present situation, China is doing the opposite of what the rest of the world is doing. They are reducing their interest rates, and they are coming out of the strictest movement on people during the pandemic. It is quite possible that we will see better development for commercial properties in China than in the rest of the world over the next couple of years.
HKHGF will benefit from this with its presence not only in Hong Kong but also on the mainland of China.
Last but not least, the properties a company owns must be in good locations. We have passed on many opportunities where we do not think the company has properties in the right location.
HKHGF's properties are definitively in prime locations.
Profitability and Value
If you are familiar with investing in properties you will know that we often talk about cap rates .
If a property is bought for $1 million and it produces $50,000 in positive net operating income, after you deduct all costs, then the capitalization rate is 5%. Many prominent office buildings had cap rates of 3-4%.
It is not a "get rich quick" kind of business.
In 2022, HKHGF had a net income of $776 million. That was 20% lower Y-o-Y.
We cannot use a cap rate here, because their business is not only investments in properties. They are also a property developer. That has a higher profit margin than the business of investing and leasing out properties. To give you an idea, the gross margin on properties developed and sold in China had been hovering around 40% but came down to 22% in 2022.
HKHGF's ROCE is only 2.33%.
Here is a breakdown of where their rental income is coming from:
Dividends and Share Buybacks
Who does not like to receive dividends from the companies they own shares in?
Warren Buffett does not think Berkshire Hathaway ( BRK.B ) (BRK.A) should pay their shareholders but he loves getting lots of dividends from where they invest.
The size of the dividend matters. Some companies overpay, in other words, more than what they bring in through their earnings or net free cash flow, and then there are others who pay too little.
Looking at HKHGF, they have been paying $0.22 per share for the last 5 years.
However, there are a couple of factors we need to take into account.
First and foremost, they are investing heavily in new large projects, such as the Bund in Shanghai, which is also described in our previous analyses.
They also have a share buyback program that reduces the share counts, The management understands that when their share is trading at just 29% of its net asset value, this is the best kind of capital allocation they can do.
All the shares they buy back are canceled.
During Q1 of 2023, HKHGF continued to invest in its share buyback program.
As of 30th April 2023, the total amount invested in the buyback program since it was first announced was US$598 million. Their last reported share buyback took place on the 18th of April 2023. At that time their total issued share capital consists of 2,214.7 million ordinary shares.
The total number of ordinary shares outstanding has reduced by 138.1 million since 2017. That is a reduction of 5.87%.
The balance sheet
One reason why we state that it is a SWAN kind of share is that its financial position remains strong. Over the first quarter of this year, they managed to decrease their net debt to US$5.2 billion, from US$5.8 billion at the end of FY 2022.
Their committed liquidity was US$3.6 billion, compared to US$3.1 billion at the end of 2022. 54% of the Group's debt interest is at fixed rates.
However, when we look at their debt Y-o-Y over the last couple of years, their net debt ratio has been going up. This can be explained by the large investments that are done in their big project in Shanghai.
Their leverage is still very low.
Business update from Q1 of 2023
Management of HK Land presented their business update from Q1 of 2023 on 18th May.
Their income from investment properties was marginally above the same period last year, with improved performance from the retail segment, partly offset by lower contributions from the Hong Kong office portfolio.
The Physical vacancy increased to 6.3% at the end of March 2023, compared to 4.9% at the end of 2022.
FH 2023 results will come out at the end of July.
Risks to the Thesis and a conclusion
The risks are the same as what we described in our previous article a year ago.
The share certainly falls into the category of being a "value investment" based on all fundamental metrics.
However, the difference between the NAV per share and the closing share price of 2022 widened from $9.85 in 2021 to $10.31 in 2022.
It could certainly be a value trap.
Time will tell. At least you get paid a dividend yield of 5.14% while you wait to find out.
We continue our Buy stance.
For further details see:
Hongkong Land Is Still Our Asian SWAN