The Hongkong & Shanghai Hotels (45 HK)

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The Hongkong & Shanghai Hotels (45 HK — US$1.3 billion) is a family-controlled hospitality company with a rich history.

Today, the company owns and operates hotels under the “The Peninsula” brand name. They’re widely seen as some of the best in the world. For example, check out the following reviews from Booking.com:

“This is HK's most famous hotel and deserves its reputation. We have stayed in many hotels and this is in a class of its own.” – The Peninsula, Hong Kong

“The best hotel ever I stayed. Every thing was exceptionally very good from the staff to cleanliness to location, the service was excellent.” - The Peninsula Istanbul

“The best hotel in London, not cheap but worth every penny! Superb facilities and staff... outstanding.” – The Peninsula, London

The stock trades at 0.28x book value. Which begs the questions: is the book value real, and can value be unlocked?

The company has three main segments:

• Hospitality: 10 luxury hotels around the world, with typically full ownership of the underlying property. The flagship hotel, The Peninsula Hong Kong, is legendary, but there are several other hotels of almost equal caliber, including the new The Peninsula London.
• Investment properties: The company also owns investment properties such as the Peak Tower, an office building in Hong Kong, and another commercial property in Paris. Most importantly, it owns 484 apartments in the Repulse Bay residential development on the southern side of Hong Kong Island, which it rents out to wealthy individuals.
• Clubs and services: Hongkong & Shanghai Hotels operates the Peak Tram, which takes tourists from Admiralty to The Peak on Hong Kong Island. It also owns and operates a golf course in California and the Peninsula membership club.

Regarding the gross asset value split, roughly half comes from its hotel properties and approximately 40% from the owned apartments at The Repulse Bay development.

The company is controlled by the Kadoorie family. The predecessor of the Hongkong & Shanghai Hotels was founded in 1866 by a group of Scotsmen. It was later taken over by businessman Elly Kadoorie in a series of events documented in the book The Last Kings of Shanghai.

Today, Elly’s 83-year-old grandson, Michael Kadoorie decides on the strategic direction of the growth. But cracks in the facade are starting to show. Under Michael’s leadership, the company's financials have started to deteriorate, with a falling return on equity, rising debt levels, and overspending on new hotel properties. The company’s annual reports emphasize “capital appreciation” and growth in the company’s total asset value. Earnings seem to be a secondary concern.

However, the leadership is currently undergoing a transformation. Gareth Roberts has just taken over as COO. Michael’s 32-year-old son, Philip Kadoorie, will become Deputy Chairman in January 2025. And ex-Cartier, Richemont, and DFS Group professional Benjamin Vuchot will take over as CEO in March 2025.

It’s too early to tell whether these leadership changes will improve capital allocation. Philip seems like a trustworthy individual, but he lacks real-world experience. Right now, his passion seems to be motorsports rather than running a hospitality group.

What the company should do is sell minority stakes in its trophy hotels, use them to pay down debt and eventually buy back shares. The company has now signalled an intention to pay down the debt, but share buybacks are not on the agenda.

The near-term outlook is positive. The company recently completed two high-profile hotels in Istanbul and London, and it is ramping up as we speak. From what I can tell, they are fantastic properties that are just as much trophy assets as Peninsula Hong Kong.

I believe the company’s EBITDA margins will eventually revert to at least 2019 levels. However, due to high interest expenses and depreciation for the London property, my earnings per share estimate will only reach HK$0.31, putting the stock at a 19.8x P/E ratio and 13.7x EV/EBITDA.

What about a sum-of-the-parts valuation? I’ve tried to put together a sum-of-the-parts valuation myself, heavily inspired by the excellent work of Andrew Brown at East72 Dynasty Trust here. I think their valuation numbers broadly make sense. I get to an NAV/share of HK$24, a slight premium to the book value per share of HK$22. That compares to the current share price of HK$6.1.

You could question the book value assumptions, including using three-handle cap rates for residential properties. But even if you make the appropriate adjustments, the liquidation value is undoubtedly far higher than the current share price.

So to summarize, the near-term outlook is excellent with The Peninsula London and The Peninsula Istanbul ramping up this year through the next. But don’t expect the P/E to come down to single-digit levels anytime soon.

There is hope that the ongoing leadership change will cause a shift to a return-on-capital mindset. But until we see more evidence of Philip Kadoorie’s intentions, the base case has to be: “more of the same, for now”.

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