Keck Seng Investments (HK:0184) is a investment holdings company listed in the Hong Kong stock exchange.
Before you close this tab thinking that it is another one of those Hong Kong property plays taking advantage of the unrest and decreasing property prices, well, it it not.
Keck Seng Investments owns and operates hotel properties in several countries (USA, Vietnam, Japan, Canada, China etc) as well as residential properties in Macau and Singapore. Yup, no Hong Kong at all.
To cut through all the BS, here are the 3 points that attracted me to this company.
- Large discount to NAV (P/B 0.43, assets priced at cost less depreciation)
- Management has track record of being good capital allocators ( Book Value per share 10 year CAGR of 6.5%
- Upcoming catalyst to unlock value (most important!!!)
So all in all, two words to describe this company; hidden assets.
Keck Seng Investments (KSI) is a holding company that owns and operates quality property assets in several countries. Majority of the shares are owned by the Ho family at 74.8%. This might also mean that they will not be able to purchase anymore shares to avoid triggering a mandatory offer.
Good Capital Allocators
Over the years, KSI has been prudent in their investments and have delivered book value per share growth of 6.5% CAGR over the past 10 years.
For example, they purchased their first US hotel , W Hotel San Francisco, in 2009 after the financial crisis. The deal was made at a capitalization rate of 15.1% and it is a steal at that time. FYI, the average cap rate for 2019 is around 6.9%.
Capitalization Rate : Derived by dividing the net operating income(NOI) by the current market value. Inversely, you can find out the current market value by dividing the NOI by the cap rate. (For more info, refer here)
KSI has categorized their properties into Investment Properties, Hotel Properties and Properties Held for Sale. In this article, I will only focus on the more important assets that are relevant for my NAV calculation.
I have tabulated their hotel properties and as you can see, these hotels are well-known hotels in cities and not some shady properties located in some ghost towns. Except for the 2 hotels under renovation, I can say that their occupancy rate is in the healthy 70+% zone. The hotels in US and Vietnam are the main revenue contributors, with 89% of total hotel revenue and 84% of total revenue in 2018.
This is actually where the “hidden assets” are. KSI has listed several held-for-sale properties in Ocean Garden, Taipa Island, Macau. The entire development (of which KSI had a 70.61% interest) was completed in the early 2000s and KSI stopped selling them back in 2012. As of now, they have about 390,000 sqft of gross floor area and 747 car park lots. Why I call them hidden assets is because the properties are recorded at cost value and the property prices has appreciated alot since then (to be elaborated below). These properties are currently rented out at around 2% yield.
At a glance, their revenue has been increasing over the years. The main revenue driver has been their hotel and club operations. Surprisingly, their slot machines in Vietnam contributes 25% (around HKD 500mil) to their revenues.
Profit has been steady at around HKD 300+mil. The profit dip in 2017 was due to an impairment charge taken on their New York Hotel.
All in all, their 5 year performance is nothing out of the ordinary and has been quite consistent. Their current dividend yield is around 3.4%, decent but not very attractive to me.
Referring to their balance sheet, total assets less liabilities are HKD3.78B, or HKD 11.11 per share. Although this already gives us a P/B ratio of 0.40, all of their properties except for their investment properties are stated at cost. Hence, a more accurate way to determine their NAV would be conducting a sum of the parts valuation with my estimated current value of KSI properties.
The easiest way to value a hotel is by the “Income Capitalization Method”. It works by calculating the NOI, find out the yield, or cap rate for similar hotels and divide the NOI by the cap-rate to get to the final valuation.
Allinstocks.com has a very simple analogy for this method and I shall quote them here.
My calculation for NOI is as follows;
Contribution to profit + income tax + share of profits less losses of associates + finance cost + impairments + depreciation
For Capitalization rate, I used the 2018/2019 hotel industry cap rates for high end hotels for each individual countries. With the two values, here are my valuation for KSI’s hotels.
The total value of the hotels is around HKD 12.12. The value of the US hotels alone are worth more than the current share price, let that sink in for a second… now let’s continue. I’m just getting started.
Macau (Held for Sale)
As mentioned earlier, KSI has about 390,000 sqft of gross floor area and 747 car park lots.
In their balance sheet, these assets are held at cost price. The cost stated is the development and maintenance cost. After searching into the properties for sale near the area, I found that the properties are selling around HKD 7,500psf to HKD 8,500 psf. Carpark is priced at HKD 1.5mil each.
For my valuation, I shall be taking the lower end of the range at HKD 7,500 psf for the Ocean Garden properties and HKD 1.5m for carpark.
The value of the properties held for sale in their books is about 0.82 HKD. At per share value of HKD 8.82, the valuation gap between cost and current value is about 10x.
Other than the hotels and Macau properties, KSI has other investment properties accounted at fair value at around HKD 847mil, net liabilities of HKD 510mil (Cash and Deposits – Total Liabilities) and other minority interests.
Why Valuation Gap?
Even though it is so cheap, it is important to understand the reason behind the large valuation gap. For KSI, I believe that these are some of the reasons why;
- No analyst coverage – Could lead to KSI being hidden in the market.
- Limited float – 75% of the shares are owned by the Ho family, leaving about HKD375 mil of free float available.
- High insider ownership – Overly high insider ownership could lead to management not keen in improving stock visibility.
- Poor Investor Relations – KSI does not employ IR professionals or prepare investor presentations, hold conference calls, or conduct roadshows. This may lead to lack of awareness in the investing community.
Being a small cap, KSI could also be hidden among all the huge property development companies in HK. As such, it has such a wide gap between price and its intrinsic value.
Besides the adj P/B ratio, here are KSI’s other per share valuation. PE at 8.72x, P/FCF at 5.5x. In fact, I also suspect that the large discount to intrinsic value is due to its low earnings and FCF. Even if we give a PEx10 or P/FCF 8x, the valuation would only be slightly above the current price.
Catalyst to Unlock Value
Even though I have shown that KSI is severely undervalued. Companies like this can trade at a discount to NAV for very long unless a catalyst comes along which can unlock its property value.
I’m referring to its potential sale of the residential units at Ocean Gardens, Macau.
The management has stated in their annual reports and interim reports that they view the timing wasn’t ripe for them to sell their properties.
After reviewing Macau property market conditions and the state of the economy, the Group has decided to defer sale of the properties currently classified under properties held for sale to a later time in order to capture the benefits to be accrued with the opening of the Hong Kong-Zhuhai-Macau Bridge and the anticipated opening of the Macau light-rail transit system later this year. In the meantime, the Group will continue to lease out vacant units in order to maximize income.Taken from KSI Interim Report 19
Hence comes the million dollar question – when is time to sell?
Many investors were anticipating the completion of the HK-ZH-MC Bridge and its completion date was delayed for about a year from 2017 to 2018.
When things seems to go right, Macau was hit by a double whammy of extra property stamp duties and the political unrest in Hong Kong. Being just 20mins away from HK, Macau’s business was also affected, which led to a drop in home sales (See source here)
The Macau light rail transit is slated to open end of this month. Together with the integration of the Greater Bay Area, I hope that the management could make the decision to divest its held for sale properties soon.
Meanwhile, investors have to remain patient and collect dividends. But don’t worry, the longer the management takes to decide, the higher the discount to its intrinsic value gets. If we look at the chart below, the management has shown its capability to grow its assets value over the years and as time goes on, the recurring business in the hotel and leasing of properties would lead to an even wider valuation gap, making KSI even more undervalued.
Cyclical Hotel Business
The hotel industry is considered an cyclical industry where rising ADRs and RevPAR would lead to an oversupply of rooms and results in a down-cycle, and so on.
We can see that in the US, their hotel business is starting to see an oversupply of rooms and softer demand. This could be the start of a down cycle.
Disruptions to Hotel Business
Unlike Singapore, where short term lease of residential properties are not allowed, other countries are subjected to disruptions in the hotel industry thanks to Airbnb. Although Airbnb are gaining market share, I opined that it will not really have a large impact on the hotels KSI has as they are of the higher tier hotels with MICE facilities and superior guest service. What Airbnb offers is an alternative low cost option.
Vietnam Over concentration
KSI’s Vietnam assets are contributing over 50% to the total profit. This is partly due to the slot machines in the Sheraton Saigon Hotel. Hence, an under performance in this hotel could lead to substantially lower profits overall.
Also, any change in Vietnam gaming laws could also impact their slot machine revenues.
Fluctuation in Macau Property Price
Macro factors like the HK riots and a possible recession could lead to decrease in Macau property prices. In fact, we have seen a correction in prices since the stamp duty kicked in last year and demand waned. If the management did not time the sale right, we could see a much lower price obtained from future sales.
Thesis may not play out
My investment thesis is largely based on the potential sale of the residential properties in Macau and the company would re-rate as a result. As of now, we do not have a clear timeline of when that will happen. Even if it does, there is a risk that a re-rate might not happen and KSI might turn into a value trap.
Currently, KSI trades at HKD 4.41. My SOTP valuation has given KSI an intrinsic value of HKD 22.66, giving a potential 513% upside. Given the low risk high returns, it isn’t just another HK property play.
However, I’m not that optimistic that we will even reach HKD 22.66 in the short or medium term. I do not think KSI is gonna sell the hotels (unless they have an attractive offer) so we can forget about realizing my calculated valuations for now. What I’m banking on is the sale of the residential properties which, based on my valuation, we could potentially see an increase in HKD 8 into their balance sheet (Reminder: current share price is only HKD 4.41). I expect the share price to go up to HKD 10 and higher when that happens.
Although there are risks in this investment, I felt that P/Adj NAV of 0.195 is simply too cheap to ignore. Furthermore, KSI has been FCF positive over the years and they also have a solid balance sheet.
In my opinion, this is a very good “invest and forget” kind of stock with its low risk and high potential reward. Get paid a 3.3% dividend yield while you wait for KSI to realise its potential value.
The Moss Piglet is not vested in KSI at the moment as he has invested in too many companies recently but is very likely to initiate a position in KSI within the month.