David Kuo’s Personal Income Portfolio “Cornerstone Stock” No. 1: Hongkong Land Holdings (SGX: H78)

Fact box

Headquarters: Bermuda
Website: www.hkland.com
Industry: Real estate operating companies
Volatility: Low (5-year beta: 0.79)
Market cap: US$16,734.4
Cash/debt: US$1,622.1 / US$4,170.9
Revenue (TTM): US$1,959.8
Earnings (TTM): US$5,585.4
Recent price: US$7.15
Yield: 2.8%

TTM = Trailing 12 months
Dollar amounts in millions except recent price
Data as of 15 May 2018

Recommendation

What The Company Does: One of the very first stocks David will be purchasing for his Personal Income Portfolio will be Hongkong Land Holdings (SGX: H78), which is a property investor and developer with two aptly-named business segments, namely investment properties, and development properties.

The investment properties segment, which refers to properties that Hongkong Land owns for the long term, is the key part of the company’s business. In 2017, 67.7% of the company’s underlying operating profit of US$1.46 billion (this includes Hongkong Land’s share of results from its associates and joint ventures) came from the investment properties business; the segment also accounted for 90% of Hongkong Land’s gross assets at the end of the year. As the chart below shows, most of the company’s investment properties are in the form of offices, with another big chunk in retail.

Source: Hongkong Land earnings presentation

Hong Kong is Hongkong Land’s key geographical market. The company’s investment properties in Hong Kong contributed 85.3% of the total underlying operating profit of US$988 million for the investment properties segment in 2017. At the end of the same year, Hongkong Land’s investment properties in Hong Kong had a value of US$30.9 billion; for perspective, the company’s had total assets of US$43.0 billion at end-2017.

Singapore is the second-largest market for Hongkong Land’s investment properties segment. The company’s investments in Singapore consist of full and partial stakes in three properties which contributed 11.7% of the underlying operating profit of the investment properties segment in 2017. The three investments are:

  • 100% of One Raffles Link
  • 33% of One Raffles Quay
  • 33% of Marina Bay Financial Centre

Coming to the development properties segment, it is active in seven Asian countries, but focuses on China and Singapore.

Why We Like The Company: Hongkong Land’s assets in Hong Kong are some of the most valuable buildings in the city. The company owns and manages 12 commercial properties in the Central Business District of Hong Kong’s Central region. These are Grade “A” commercial properties located in an area where new supply is expected to be limited over the next few years. Put another way, Hongkong Land’s properties are premium buildings situated in the heart of Hong Kong.

The strong position of Hongkong Land’s properties are aptly demonstrated in the chart below, which plots the growth in the average rental rate of the company’s Central office portfolio over the past decade. You can see that the average rent (on a per square foot per month basis) has increased by 5.5% annually from US$8.52 in 2008 to US$13.82 in 2017. It’s also impressive that Hongkong Land has managed to raise the rent of its Central portfolio in nearly each year for the same period; 2015 was the only year that saw a decline in the average rent. Hongkong Land’s investment properties provide it with a very stable recurring rental income base. This is also one of the key strengths that we see in the company.

Source: Hongkong Land annual report

We think that Hongkong Land has a good ability to maintain or grow its dividends for two reasons: It has a strong stream of free cash flow that covers its payout, and a robust balance sheet. Firstly, Hongkong Land generated US$800.2 million in operating cash flow in 2017, and incurred US$213.7 million in capital expenditures (for major renovations and developments). This gives rise to free cash flow of US$586.5 million, or US$0.25 per share. Meanwhile, the company’s dividend in 2017 was US$0.20 per share. Secondly, at the end of 2017, Hongkong Land had net debt of just US$2.55 billion, and a leverage ratio (total debt to total assets) of only 9.7%.

Another trait about Hongkong Land which really caught our eye is its attractive valuation: At its current stock price, it is valued at merely 0.46 times book value per share of US$15.63 at the end of 2017.

The Risks Involved: Hongkong Land’s investment properties are concentrated in Singapore and Hong Kong, and the majority of its tenants are from the financial, legal, and accounting industries. This means that the company is dependent on the ability of both Hong Kong and Singapore to maintain their status as important financial hubs; it also means that the company is susceptible to downtourns in the three areas.

Another key risk is the trend of tenants moving from Singapore’s CBD (central business district) to cheaper business parks. Hongkong Land’s Hong Kong properties are facing a similar risk of tenants moving away from the CBD to lower cost properties too.

The risk posed by China’s debt load is something to be mindful of too. Estimates put China’s debt as a percentage of its economic output at 283% by 2018, and this could have ramifications for Hongkong Land’s tenants. In the company’s earnings briefing for the first half of 2017, its CEO, Robert Wong, said that around 8% of the company’s Hong Kong office tenants originate from mainland China – the percentage is expected to grow to around 10% this year.