Thursday, December 1, 2016

Analysis of Kerry Properties

Please read the disclaimer here: 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

Administrative and other operating expenses
Total finance costs incurred

Interest income
Provision for impairment loss for hotel property
Dividend income from listed and unlisted investments
Profit before tax
Profit before tax annualized
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

2015 annual gross profit from hotel operations
2015 annual gross profit from property sales
Annualized share of results of associates

Annualized tax expense (excluding deferred tax expenses)
Annualized profit attributable to non-controlling interests
Net profit to shareholders (my estimate)
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.

Sunday, October 23, 2016

Why I held on to Cloudpeak Energy

Please read the disclaimer here: Enjoy the article, bitches!

Whaddup guys, in this article I’ll be discussing an investment I made a long time ago but for some reason didn’t write about. Aight, I’ll be straight with you. The reason I didn’t write about it was because I was a procrastinating asshole at first, and depressed about the investment later when the stock plunged. The stock finally rebounded, and I recently sold about 40% of my investment in Cloudpeak Energy for an approximately 20% return on the dollar-cost averaged purchase price (this return excludes fees and forex gains/losses).

Update on the Greedy Dragon portfolio: Other than selling 300 shares in Cloudpeak Energy, I also bought 90 shares in Skechers after the stock plunged due to missing earnings estimates or something.

The main reasons I held on to Cloudpeak’s stock was because the company had liquidity AND its operations wasn’t hemorrhaging cash. We’ll take a look at the company’s financial position and performance during the 1st quarter of 2016, as that was when the effects of the warm winter could clearly be seen in terms of significantly reduced coal shipments. Cloudpeak had $79.39 million in cash and cash equivalents as at March 31, 2016. The company had a credit facility with a borrowing capacity of $457.1 million, and an accounts receivable securitization program which would have allowed for $21.2 million of borrowing capacity as at March 31, 2016. However, the borrowing capacity under the credit facility is at risk of being reduced if the company’s EBITDA continues to decline. There were no borrowings outstanding under the credit facility and the accounts receivable securitization program as at March 31, 2016.

More important than liquidity, though, is the motherfucking cash flow. I didn’t want my investment in Cloudpeak to do me the same way my horrendous investment in Alpha Natural Resources did me (Alpha declared fucking bankruptcy despite reporting over a billion dollars in cash and short-term investments in the quarter before it filed). For the first quarter of 2016, the company had an adjusted EBITDA of negative $1.3 million. The company’s interest expense was $11.05 million in the first quarter of 2016. There’s no 2 ways about it, the company had a really bad quarter. Management, however, expected coal shipments to increase significantly in the second half of the year. Cloudpeak would barely be out of cash flow positive territory at the low end of 2016 adjusted EBITDA guidance of $75 million, the high end of capex guidance of $35 million, and $41 million in estimated cash interest.

Of course there is a risk that things could be even worse than the guidance. But I don’t think that actual EBITDA will stray far from the guidance range as Cloudpeak has already committed to sell, at fixed prices, approximately 63 million tons of coal in 2016. The company’s guidance for 2016 coal shipments was between 60–65 million tons as at March 31, 2016. Even if customers wanted to reduce their contracted volume, the company would still get some compensation in the form of contract buyouts (as was the case in the second quarter of 2016). As at March 31, 2016, the company has committed to sell 42 million tons of coal in 2017, with 39 million tons being under fixed-price contracts.

So, why didn’t I buy more Cloudpeak when its stock got absolutely destroyed? I mean the fucking stock was trading at barely above a dollar for a bit. I could have set myself up for that illusive “fuck you money” that I’ve been chasing since the time I was watching Lizzie McGuire on the Disney channel way back when. Well, there was too much uncertainty for me at the time. The warm winter in combination with asinine regulations and cheap natural gas had significantly tanked coal demand. I was also overexposed to the natural resource sector. And I got to admit, the losses from my natural resource investments (some paper, some real)  had got me rattled. I had no idea how far coal consumption and the price of coal could fall. Then the hot summer came and the shares of coal companies experienced a nice rebound from their lows. Right now I'm still not sure if the coal industry is finally coming back to life. That’s why I decided to only sell some of my shares in Cloudpeak, and wait on more information before making any more moves.

Another thing I learned from my investment in Cloudpeak is to pay attention to any throughput or transportation agreements that a natural resource company might have. Cloudpeak has significant take-or-pay contracts for rail and terminal capacity which requires it to pay for a minimum quantity of coal to be transported regardless of whether it sells any coal. This could be a problem if the price of coal drops below the cost of producing and transporting the coal, which it did. Cloudpeak has amended its transportation and throughput agreements to mitigate the losses from its logistics segment. Investors analyzing coal companies should also look at whether the company engages in self-bonding. Self-bonding is where a mining company doesn’t need to have any collateral or surety bonds for its reclamation obligations. However, if the company’s self-bonding status is revoked, it may have to turn to the corporate surety market and may have to put up significant collateral to get the surety bonds. I think that Cloudpeak’s management acted prudently by trying to transition the company fully to  third-party surety bonds.

Despite a really shitty start, 2016 appears to be shaping up to be a pretty good year for me. I hope that your investments have been treating you right as well. Anyway, thank you for reading. Take care and stay rational.