Investing in conglomerate with deep discount in Hong Kong is a painful and ineffective strategy. The problems come from multiple fronts I just don't see things improve:
1. Anglo conglomerates such as Swire and Jardine succeed before 21th century is because they are first in the party and they have good relations with authority. For a long time Hong Kong is a heaven for oligopoly and they were at right place at the right time. When you have prime locations, license, relations, finances...etc even dummies can run a business well. Their success were not innovation driven, does not improve people's life. A book called "Asian Godfathers" did a good job explaining such phenomenon. It's not a surprise to me they did poorly in recent years when the world faces rapid changes and disruptions because they are not battle tested in the first place.
2. Deep NAV investing does not work in Hong Kong. I have tried with (296 281 635 373 56 266 51) and David Webb have tried with a bunch more. In US where the legal infrastructure is fully in place, financial rewards are lucrative, shareholder rights are taken care of. Not the case in HK.
3. HK is the place with one of the worst corporate governance. Most of the time undervalued stocks will rot, then large shareholders will privatize the company with a low-ball offer and squeeze out little guys. This happens over and over again. A lot of international value funds flat out had enough and left HK, ditto for many pension/sovereign/endowment funds. The exchange and SFC did jack to fix such problems.
4. HK still has a Covid Zero strategy in place. The juicy part is... they quarantine both Mainland and Overseas travelers. It is now in year 3. That is asinine to the nth degree. I don't see how Swire's business(hotels, leasing malls and office, airlines) going to turn around. On top of that many MNCs set up headquarters in Shenzhen and Shanghai. There is a little point to utilize HK as a hub.
5. Swire trades at $9. It traded at that level in Q1 2007. Under performance for over 15 years tells you everything about management's ability in creating value and return value to shareholders. I don't see buybacks now is going to turn around many years of poor performance.
Thanks Andy. I think you have many valid points there...
The truth is, Swire is not a compounder. This obsession with developing and retaining property on the balance sheet at low cap rates suggests that ROEs will stay low for longer.
So the hope is for buybacks, a change in COVID policies and a border reopening.
A bit too early to tell whether COVID policies will change but I think it's possible. Either sparked by effective anti-virals, improved vaccine uptake or political factors that reduce the need for control.
Hi Michael, pardon me for forgetting to thank you for the website and all the quality work. Outstanding job!
I think buyback may not be sustainable. Swire is a hodgepodge of mediocre businesses. Beverages(net margin <5%) and food and industrial(net margin <1%) are low quality, generate little FCF. As for property division, I'd say be very careful with it. Rent from 2019 and onwards have been in decline. The business model itself is bad: bidding/developing/trading properties all require enormous amount of capital and long time to complete. Yet the monetization via selling/leasing is slow and gradual. Part of profit in property division is from revaluation/remeasurement, which can be manipulated to an extent to produce good numbers, but helps little in generating cash. For airlines I think we all agree the prospect of it contribute FCF now is slim.
Most importantly net debt is $HKD 43.8 billion. That tells you the company has little dry powder. Weakening economy in HK and mainland, substantial debt on the balance sheet, substandard combination of businesses, history of little value creation... maybe it is time think it through again.
1-Most of the conglomerates operate globally and are only HK listed. That is not always relevant today.
2- I think NAV investing that translates in cheap PER works. if its just a non producing EPS NAV, it's more difficult.
3-True, but it also just happened to me in Singapore medical group. It happened to me in Paris also (MIPS). The problem is that HK got many mainland frauds.
4-Yes for Swire its a major risk
5-It's 100% due to covid and Cathay Pacific. one has to look at EPS and NAV creation because maybe the stock was overvalued in 2007? Agree that management did not create a lot of value in any case.
Thank you for this report. Quick comment - on page 42 peer group comparison, I believe you used 86Hk, but should instead have used 16HK. They share very similar names, but are very different companies.
Thanks Forsi. Corporate costs are meant to be captured by the 25% NAV discount. That's usually how sell-side calculates their SOTPs. Imprecise but you're playing the probabilities here
Investing in conglomerate with deep discount in Hong Kong is a painful and ineffective strategy. The problems come from multiple fronts I just don't see things improve:
1. Anglo conglomerates such as Swire and Jardine succeed before 21th century is because they are first in the party and they have good relations with authority. For a long time Hong Kong is a heaven for oligopoly and they were at right place at the right time. When you have prime locations, license, relations, finances...etc even dummies can run a business well. Their success were not innovation driven, does not improve people's life. A book called "Asian Godfathers" did a good job explaining such phenomenon. It's not a surprise to me they did poorly in recent years when the world faces rapid changes and disruptions because they are not battle tested in the first place.
2. Deep NAV investing does not work in Hong Kong. I have tried with (296 281 635 373 56 266 51) and David Webb have tried with a bunch more. In US where the legal infrastructure is fully in place, financial rewards are lucrative, shareholder rights are taken care of. Not the case in HK.
3. HK is the place with one of the worst corporate governance. Most of the time undervalued stocks will rot, then large shareholders will privatize the company with a low-ball offer and squeeze out little guys. This happens over and over again. A lot of international value funds flat out had enough and left HK, ditto for many pension/sovereign/endowment funds. The exchange and SFC did jack to fix such problems.
4. HK still has a Covid Zero strategy in place. The juicy part is... they quarantine both Mainland and Overseas travelers. It is now in year 3. That is asinine to the nth degree. I don't see how Swire's business(hotels, leasing malls and office, airlines) going to turn around. On top of that many MNCs set up headquarters in Shenzhen and Shanghai. There is a little point to utilize HK as a hub.
5. Swire trades at $9. It traded at that level in Q1 2007. Under performance for over 15 years tells you everything about management's ability in creating value and return value to shareholders. I don't see buybacks now is going to turn around many years of poor performance.
Thanks Andy. I think you have many valid points there...
The truth is, Swire is not a compounder. This obsession with developing and retaining property on the balance sheet at low cap rates suggests that ROEs will stay low for longer.
So the hope is for buybacks, a change in COVID policies and a border reopening.
A bit too early to tell whether COVID policies will change but I think it's possible. Either sparked by effective anti-virals, improved vaccine uptake or political factors that reduce the need for control.
Hi Michael, pardon me for forgetting to thank you for the website and all the quality work. Outstanding job!
I think buyback may not be sustainable. Swire is a hodgepodge of mediocre businesses. Beverages(net margin <5%) and food and industrial(net margin <1%) are low quality, generate little FCF. As for property division, I'd say be very careful with it. Rent from 2019 and onwards have been in decline. The business model itself is bad: bidding/developing/trading properties all require enormous amount of capital and long time to complete. Yet the monetization via selling/leasing is slow and gradual. Part of profit in property division is from revaluation/remeasurement, which can be manipulated to an extent to produce good numbers, but helps little in generating cash. For airlines I think we all agree the prospect of it contribute FCF now is slim.
Most importantly net debt is $HKD 43.8 billion. That tells you the company has little dry powder. Weakening economy in HK and mainland, substantial debt on the balance sheet, substandard combination of businesses, history of little value creation... maybe it is time think it through again.
Andy
1-Most of the conglomerates operate globally and are only HK listed. That is not always relevant today.
2- I think NAV investing that translates in cheap PER works. if its just a non producing EPS NAV, it's more difficult.
3-True, but it also just happened to me in Singapore medical group. It happened to me in Paris also (MIPS). The problem is that HK got many mainland frauds.
4-Yes for Swire its a major risk
5-It's 100% due to covid and Cathay Pacific. one has to look at EPS and NAV creation because maybe the stock was overvalued in 2007? Agree that management did not create a lot of value in any case.
Thank you for this report. Quick comment - on page 42 peer group comparison, I believe you used 86Hk, but should instead have used 16HK. They share very similar names, but are very different companies.
You're absolutely right Yongbin. I apologise!
Hi Michael, thank you for the good work. Should we not include corporate costs in the SOTP? Thank you
Thanks Forsi. Corporate costs are meant to be captured by the 25% NAV discount. That's usually how sell-side calculates their SOTPs. Imprecise but you're playing the probabilities here