Keck Seng,

a fundamental analysis!

Keck Seng,

a fundamental analysis!

May 30, 2019

TICKER: 0184

ISIN: HK0184000948

SHARE PRICE: $5,12 HKD

MARKET CAP: $1,74M HKD

May 30, 2019
TICKER: 0184
ISIN: HK0184000948
SHARE PRICE: $5,12 HKD
MARKET CAP: $1,74B HKD

1. INTRODUCTION

I’ve been putting off this analysis for quite some time now but I’ve finally decided to grab the bull by the horns.

On the Facebook group there has been some talk about the relevance of book-value and I wanted to use this company as a great example of the limitations of such a metric.  

I’ve found Keck Seng through True Value and Horos, a couple of value oriented Spanish funds. After hearing what these guys had to say, I’ve read a couple more write-ups about the company and the bottom line is always the same: The inability of certain accounting rules to accurately state the current value of an asset on the balance sheet:

This short and inconspicuous sentence is the culprit of a major market inefficiency.  If an investor were to look at Keck Seng’s balance sheet alone, he would find out that the company has assets worth HK$6.6B and liabilities worth HK$2.2B leading to a book-value of around  HK$4.4B, but its assets are worth way more than that.

This happens because the properties are stated at cost less accumulated depreciation. So if the company had bought a hotel in San Francisco in 2009 in the middle of the financial crisis for cents on the dollar – which it did – and had been depreciating it for the past 10 years, it would be reasonable to say that the current book-value doesn’t reflect reality, right?

That is why investors should look under the hood and, in this case, calculate the Net-Asset-Value (NAV) instead. Not only is this company trading at a third of its book-value, it is also trading at a super cheap valuation compared to its NAV. This has been the bull thesis for years. Investors expect that somewhere down the line, this gap will close (or at least narrow). 

2. BUSINESS OVERVIEW

2.1. BUSINESS DESCRIPTION

Keck Seng is a family-owned real estate holding company from Hong Kong that owns prime properties around the world.

I know, I know, most of the investors out there are immediately thrown off when someone speaks about Asian stocks. I get it. But at the minimum you lose about 10 minutes reading this and at the most you might find a good investment idea.

As I was saying, Keck Seng is a real estate company that owns hotels, casinos and buildings around the world. Here’s some of the most important ones:

Hotel Sofitel, New York 

Hotel W, San Francisco 

Hotel Sheraton, Saigon, Vietnam

Caravelle Hotel, Saigon, Vietnam 

Apartment Towers, Taipa, Macau

As we can see, these are not shady hotels that no one has ever heard about…

2.2. LARGEST SHAREHOLDERS

…nor are the major shareholders.
Keck Seng was founded by Mr. Ho Yeow Koon, a chinese citizen that immigrated to Singapore in 1937. Here’s his story. Today the family is one of the richest in the country and there are three generations of Ho’s in charge of the operations.

The Hong Kong Stock Exchange Listing Rules say that in order to keep a company public, the free-float must correspond to at least 25% of its shares outstanding. This means that the Ho family – who already owns 75% of the company – can’t buy any more shares and neither can the company repurchase them.

Keck seng stock analysis Float
Keck seng stock analysis shareholders

I can count at least 5 value oriented funds among the major shareholders.

2.3. MANAGEMENT TEAM

Not only does the Ho family own the majority of the company as there are three generations of Ho’s on the management team or the board of directors.

They have considerable skin in the game but I wonder if it isn’t too much skin in the game this time. Smaller shareholders won’t be able to influence this company’s future even if they wanted to. 

Regarding the management compensation – a crucial topic in such companies – we can take the total compensation for Kian Guan Ho, the executive chairman as an example of cost containment. He earns the equivalent to US$235.000 or 0.09% of the total revenue.

Keck seng stock analysis management

3. HISTORICAL CONTEXT

3.1. LONG TERM CHART

Keck Seng has had its ups and downs through time as Mr. Market ignored the company for long periods of time until he could no longer do it because the fundamentals were so compelling (i.e. the cash in the bank was almost the same as the market cap in 2013). The stock is now trading at HK$5,12…

Keck seng stock analysis stock price1

3.2. MARKET CAP AND SHARES OUTSTANDING

 …which means the whole company is valued at HK$1,74B or about USD$230M. A rather small company.

The number of shares outstanding has remained stable for more than 10 years. One of the benefits of an owner-operated company is that the management team doesn’t want its stake diluted anymore than the rest of the shareholders do.

Keck seng stock analysis Market cap2

Note: All currency in HKD unless stated otherwise.

3.3. SALES - OPERATING INCOME - OPERATING MARGIN

As a hotel business, the revenue is “kind of” recurring. From 2015 onwards, it has stayed around the $2B mark with an operating margin of around 20% (17% in 2018).

Keck seng stock analysis sales

3.4. SALES BY GEOGRAPHY

The two main sources of revenue are the company’s hotels in Vietnam and the U.S.A.

We can clearly see when the company bought the W hotel in San Francisco (its first hotel in the US – red bars) back in 2009 in the middle of the financial crisis from a debt laden Starwood.

Keck seng stock analysis sales by go

3.5. SALES BY SEGMENT

Most of Keck Seng’s revenue comes from its hotel businesses. Let me remind you that this revenue includes rooms, food and beverage, slot machines (from the Vietnamese hotels) and other.

Keck seng stock analysis sales by segment

In fact, let’s check how the vietnamese revenues breakdown. 

Keck seng stock analysis vietnam2

Yep, most of the revenue from the Vietnamese hotels is coming from the slot machines. In a communist country where the state is a co-owner. Oh, the irony!!! 

For those of you who think Vietnam is a very far and forgotten place, I’ve had the chance to visit the country recently and I can tell you that I had never seen a country grow as quickly as Vietnam (never been to China). The level of real estate investment and the feeling on the streets is just amazing, not to mention that it is one of the fastest growing economies in the world.

3.6. NET INCOME

Given the high depreciation charges, one should be looking at the cash flow instead of the net income but let me put it up here for the record.

Keck seng stock analysis net income1

3.7. CASH FLOWS

Looking at the next chart makes me think that the management team knows what they’re doing. 

In the middle of the biggest crisis in almost a century, they were buying hotels for next to nothing. Those big red bars in 2009/2010/2011 are actually good. This is what we should be looking for when trying to find companies in the hands of master capital allocators.

3.8. PROFITABILITY RATIOS

The profitability ratios have been declining since 2012. As these are computed taking the net income as a starting point, they are obviously depressed.

Keck seng stock analysis ROE

3.9. FINANCIAL RATIOS

And this is where an investor understands that we’re not looking at a regular real estate company filled with debt. The current ratio is 3,7, showing a high liquidity level and the debt-to-equity is at 0,4 which is also understated because the book-value is understated due to the high accumulated depreciation.

Keck seng stock analysis current

In fact, the company has more cash than debt, making it effectively debt free, which is VERY uncommon for a real-estate company.

Although the book-value is understated, I think we can at least look at its historical trend. The company has been able to compound it at a 7% CAGR for the past 11 years.

3.10. PRICE RATIOS

All this being said, the price ratio we should be looking at here is the EV/FCF. This has been so depressed along the years that it has even gotten negative in 2008 and 2009. In any part of the world, an EV/FCF of 4 is reserved only to those companies who are in serious trouble.

Keck seng stock analysis EV FCF

4. GAINING PERSPECTIVE

As we arrive to this part, a logical conclusion of what we’ve been able to figure out so far could be:

We are looking at a real estate company without growth, low returns on equity, decreasing net income (although this is led by the depreciation charges and we should look at the FCF instead), in a business with major threats like Airbnb and on top of that Mr. Market values the company at such a low multiple that we better go with Mr. Market and leave Keck Seng alone because there must be something we’re not seeing.

But that would be a very quick and lazy way to look at it, wouldn’t it? Let’s dig in:

4.1. INDUSTRY AND STRATEGY

The whole thesis around Keck Seng is that a sum-of-the-parts valuation leads to a much higher NAV (Net-Asset-Value) than the current market cap. Let’s take a look at the company’s assets.

There are a few ways to value hotels but the most common one is the “Income Capitalization Method”. This is a very simple method, you calculate the Net-Operating-Income (NOI), find out the cap-rate (Yield) for similar hotels and divide the NOI by the cap-rate to get to the final valuation. Confused? Don’t be. 

It works more or less like this. You know a hotel is making “X” amount a year in net-operating-income and you would like to buy it and get a 5% yield out of it. 

How much would you have to pay? How do you define the yield you should be looking for in a specific hotel? You just go and find similar hotels that have been bought recently and see for how much they were bought in relation to their NOI. Don’t forget, the lower the cap-rate, the more expensive the hotel.

Let’s look at Keck Seng’s hotels and make a quick valuation of each one:

Sofitel New York

NOI: $44M
Cap-Rate: 6,9%
Ownership: 100%
Valuation Keck Seng: $640M

*The company acquired the hotel in 2013 at a 5,1% cap rate.

W Hotel San Francisco

NOI: $81M
Cap-Rate: 6,9%
Ownership: 100%
Valuation Keck Seng:$1.170M

*The company acquired the hotel in 2009 at a 15,1% cap rate.

Let’s pause for a minute here just to acknowledge that these two hotels alone are worth more than the total market capitalization of the company so whatever the company has besides these two, is free of charge.

Caravelle Hotel, Saigon, Vietnam

NOI: $70M
Cap-Rate: 10%
Valuation: $700M
Ownership: 25%
Valuation Keck Seng: $175M

Hotel Sheraton, Saigon, Vietnam

NOI: $170M
Cap-Rate: 10%
Valuation: $1700M
Ownership: 64%
Valuation Keck Seng: $1.087M

Hotel Sheraton, Ottawa, Canada

NOI: $11,2M
Cap-Rate: 8%
Valuation: $140M
Ownership: 50%
Valuation Keck Seng: $70M

Delta Hotel, Toronto, Canada

NOI: $14M
Cap-Rate: 8%
Valuation: $175M
Ownership: 25%
Valuation Keck Seng: $44M

Holiday Inn Wuhan Riverside

NOI: $22M
Cap-Rate: 10%
Valuation: $223M
Ownership: 41%
Valuation Keck Seng: $91M

Best Western Fino Osaka

NOI: $21M
Cap-Rate: 8%
Ownership: 100%
Valuation Keck Seng: $257M

So far we’ve got assets worth $3,5B, about 2 times the current market cap….but there’s more. The following image show the investment properties the company has.

Which unlike the other properties, are independently valued using the income capitalization method. These properties are valued by the company at $835M and I will take it at face value. 

But there is still more. Let’s go to the pièce de résistance, the catalyst everyone has been waiting for:

This is Taipa, the waterfront Macau high-end neighborhood. Beautiful right? Not so much.

Keck Seng has a lot of apartments and car parkings in the Taipa neighborhood. They were selling these several years ago but after the new bridge connecting Macau to Hong Kong was announced, the company put a halt to the selling and decided to wait until the bridge was finally built, hoping that the housing prices would go up.

Investors have been waiting for this catalyst to reveal the hidden value of these apartments for years. But now that the bridge is finally built, this is what the company has to say: “The directors had decided to defer sale of the properties classified under Properties Held for Sale to a later time with a view to capturing the full benefits to be accrued with integration in the Greater Bay Area, and will therefore continue to lease out vacant units in order to maximise income for the Group.”.

This means that investor need to be patient. In the meantime let’s check out how much these apartments and car parks can be sold for.

These are the buildings where most of the apartments held for sale are located at:

I did a quick check for housing prices in this neighborhood and found out that they are selling for at least $7.000/square feet.

 and the parking spaces at $1,3M or more.

And here’s the official historical evolution for the housing prices in this neighborhood coming from the Macau government itself.

Keck seng stock analysis preços casas1
Data from www.dsec.gov.mo - The author considered the usable area to be 75% of the gross area

The company stopped selling the apartments back in 2012 and we can now say it was a good decision because the prices have gonne up at a 16% CAGR.

So if we keep on the conservative side, let’s value the apartments at $6.000 per square feet and the parking spaces at $1M per unit. 

All of these combined lead to a valuation of $2,3B (just for the properties held for sale – mostly in Macau).

Keck seng stock analysis valuation macau

If we add all of these assets and subtract the total liabilities, we get to a NAV of …

…HK$14.4 per share while the current share price is HK$5,12. This is a tremendous discount. 

But there it is, we don’t know what the company will do with the cash once they sell the Macau properties. They can use it wisely or not. They’ve recently bought the remaining share of their Japanese Hotel for a lot of money and they’ve also bought a small stake in the newly created AccorInvest Group in order to diversify and get exposure to the European market. If this was a good move or not is yet to be seen. 

The whole thesis to Keck Seng is that the minority shareholder will sometime in the future see the disconnect between the private market value and the market price close the gap. 

Given the fact that shareholders activism isn’t common in Asia, there isn’t much an investor can do besides sitting and waiting for the management team to reward him.

4.2. SEASONALITY

There is no major seasonality to Keck Seng’s revenue.

4.3. TYPE OF PLAY

Keck Seng is a hidden assets play.

4.4. RISKS AND COMPETITION

As a hotel and residential real estate owner there are several risks that must be taken into consideration:

  •  The one risk in everyone’s minds: Airbnb. Airbnb is here to stay and no doubt it took market-share from a lot of hotels but I would say that both hotels and private accommodations can easily co-exist.

     

  • High dependency on Vietnam: Keck Seng’s partner in Vietnam is the government itself and the property in Vietnam doesn’t ever belong to the “owner”. It is just leased from the government for a looong time. I’m sure that they have the best relationship between them but there is always the risk something might change.
  • Competition: The hotel business is a very competitive one and although the company’s hotels are great assets in prime locations, this is still a major risk.
  •  Foreign exchange risk.

  • Risk of a China bubble. If there is really a China bubble, it would likely be an asian bubble and Keck Seng would no doubt suffer.

5. OVERVIEW AND CONCLUSION

5.1. OVERVIEW

All of this to say that I don’t expect the gap between the NAV and the share price to close but I’m comfortable in knowing that the NAV gives investors downside protection. 

If you do some research online you will find that companies trading at a steep discount to NAV in Hong Kong are a dime a dozen and most of them don’t ever get a full valuation. These companies usually have no debt, have a controlling shareholder – in this case, a family – and are usually very illiquid. Check, check, check.

As Mr. Market doesn’t care about a sum-of-the-parts valuation (yes, I’m actually considering Mr. Market’s opinion here), let’s draw 2 scenarios: 1. Cash generation; 2. Sale of assets in Macau.

1. Cash Generation:

The company is generating HK$300M in FCF every year. 40% of it goes to the non-controlling interests leaving HK$180M for the company. In five years time, the net cash will be HK$1.1B which means the company would be trading today at a EV/FCF2023 of 2!!! Of course, this kind of market inefficiency can’t go on and the only way for the price to go is up.

Another way to look at it would be if the company traded at 6x FCF in five years time, the Market cap would be HK$1,8M, plus the net cash generated until then, we would get to a $3B valuation representing a CAGR of 11%. 

2. Sale of Assets:

Let’s imagine that the company sells all its assets in Macau for HK$2,3B in five years from now. At a market cap of HK$1,8M plus the HK$2,3B plus the HK$1.1,  the company would be worth HK$5,3B representing a CAGR of 25%. Pretty good, hein?

Having said that, I must also state that this is not my typical stock. I usually prefer to participate in the growth of a company, but on the other hand, there is such a downside protection with such a great potential upside that I might dip my toe in it.

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5.2. CONCLUSION

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