20:HK Wheelock & Co

[Packer16]

Has anyone looked at this company/  It is selling for about 60% of NAV and has good record of compounding NAV (20% over the past 5 yrs, 14% over the last 10 yrs).  Whitman owns a good amount.  They are focused on Chinese RE (mainland and HK) and Singapore RE.  They recently purchased an equity and debt stake in a mainland homebuilder.  If you look on their website, they appear to have projects in CBDs of emerging cities in China.  They appear to sell at a larger discount than other HK-based RE operating firms (which are selling at 75% of NAV and higher).  They have good reporting (alot of English material on their website).  I am assuming since Whitman has quoted NAV they are legit.  Any feedback would be appreciated.  TIA.

 

Packer

[ItsAValueTrap]

How exposed are they to the Chinese real estate bubble?

 

(I haven't looked at this stock.)

[twacowfca]

Has anyone looked at this company/  It is selling for about 60% of NAV and has good record of compounding NAV (20% over the past 5 yrs, 14% over the last 10 yrs).  Whitman owns a good amount.  They are focused on Chinese RE (mainland and HK) and Singapore RE.  They recently purchased an equity and debt stake in a mainland homebuilder.  If you look on their website, they appear to have projects in CBDs of emerging cities in China.  They appear to sell at a larger discount than other HK-based RE operating firms (which are selling at 75% of NAV and higher).  They have good reporting (alot of English material on their website).  I am assuming since Whitman has quoted NAV they are legit.  Any feedback would be appreciated.  TIA.

 

Packer

 

Whitman and the other TAF managers have discussed them in past letters to their shareholders.  :)

 

[rishig]

I don't know if anyone cares about this anymore, but I have been looking at all Hong Kong property companies recently. I looked at Wheelock primarily because it is at the widest discount to NAV (0.3x) among all blue-chip property companies in Hong Kong. I was quite puzzled at first, but I think I understand why it is case.

 

Wheelock's primary asset is its 50% ownership of Wharf Holdings (also based in Hong Kong). Wharf Holdings owns the two largest retail malls in Hong Kong - Harbour City and Times Square - that captures over 10% of all retail sales in Hong Kong. The rental rates and occupancy rates have been extremely strong since 2009 (although starting to weaken in 2015). Rental income from these assets have gone up by over 4x. In addition, cap rates have come down since 2009. This has driven IFRS based book value (using fair valuation) to go up by 3x.

 

However, Mr. Market is (fairly in my opinion) assuming that these assets will not be sold at fair values (or at all ever), given that Wharf Holdings and Wheelock are controlled by billionaire families that consider these assets as "trophy" assets that should never be sold. These are unique assets that are irreplaceable (and they are, but at some price you ought at least sell a piece of the assets and release the capital appreciation). Besides, the fair value of these assets are in billions - there aren't buyers for these assets. So, Mr. Market is just pricing them on earnings multiple and ignoring the asset price appreciation over the years. As fair value for these assets went up (2009 onwards), Wharf has been trading below 0.6x.

 

This is a problem that is unique to real estate operating companies that retain quite a bit of their earnings. Unless the mature assets get recycled, the asset price appreciation gets trapped. This is not a problem typically for REITs because REITs pay out most of their earnings. So an earning multiple of 25x (i.e. 4x dividend yield) essentially matches a cap rate based valuation for the assets (4%-6%).

 

Now, Wheelock is a parent company that has 50% ownership in Wharf. So, it has a double discount and have been trading below 0.4x for a while now for the same reason. Mr. Market believes that the price appreciation is trapped and these should be valued using earnings multiple and ignore any price appreciation. It is a fair evaluation in my point of view, unless there is strong evidence that management understands capital allocation. Wheelock's CEO is a 37 year old son of the founder, new to his position. I am not sure if he gets capital allocation.

 

Cheung Kong is another HK based real-estate operating company. And they get capital allocation a lot better than anyone else in my opinion. However, the best one is Brookfield (not based in Hong Kong but a real-estate operating company). They completely get it. Capital recycling is a big part of what they do - buy undervalued assets, use expertise to improve the operations, and sell it in boom markets at low cap rates. For other assets, refinance it using leverage to release the capital appreciation.

[snow pea]

I've been looking at HK based property companies recently as well, including Keck Sang, Shun Ho, Asia Standard, and Hopewell, so I will say that I at least care and am interested.  I hadn't looked at Wheelock/Wharf (or Cheung Kong) yet, so it sounds like you may be further ahead of me in this space, but broadly speaking I believe I'm seeing the characteristics of the HK property cos through a similar lens as you.

 

FWIW, I also agree regarding Brookfield being excellent, and reviewing HK property cos has further highlighted this for me.

[rishig]

I've been looking at HK based property companies recently as well, including Keck Sang, Shun Ho, Asia Standard, and Hopewell, so I will say that I at least care and am interested.  I hadn't looked at Wheelock/Wharf (or Cheung Kong) yet, so it sounds like you may be further ahead of me in this space, but broadly speaking I believe I'm seeing the characteristics of the HK property cos through a similar lens as you.

 

FWIW, I also agree regarding Brookfield being excellent, and reviewing HK property cos has further highlighted this for me.

 

I have looked at the big four - Cheung Kong, Hang Lung, Wheelock/Wharf and Henderson. I own a small position in Cheung Kong and I think the assets that Wharf owns are quite unique and world class. However, I need to figure out what the right price to pay is. My narrative above is qualitative and I am still working on the numbers. I'll update here once I finish my work.

 

Wheelock in 2010 took one of its subs private at 3% discount to NAV and 115% higher than market price. Wharf is much bigger, but they would probably slowly privatize it as well.

[rishig]

I don't know if anyone cares about this anymore, but I have been looking at all Hong Kong property companies recently. I looked at Wheelock primarily because it is at the widest discount to NAV (0.3x) among all blue-chip property companies in Hong Kong. I was quite puzzled at first, but I think I understand why it is case.

 

Wheelock's primary asset is its 50% ownership of Wharf Holdings (also based in Hong Kong). Wharf Holdings owns the two largest retail malls in Hong Kong - Harbour City and Times Square - that captures over 10% of all retail sales in Hong Kong. The rental rates and occupancy rates have been extremely strong since 2009 (although starting to weaken in 2015). Rental income from these assets have gone up by over 4x. In addition, cap rates have come down since 2009. This has driven IFRS based book value (using fair valuation) to go up by 3x.

 

However, Mr. Market is (fairly in my opinion) assuming that these assets will not be sold at fair values (or at all ever), given that Wharf Holdings and Wheelock are controlled by billionaire families that consider these assets as "trophy" assets that should never be sold. These are unique assets that are irreplaceable (and they are, but at some price you ought at least sell a piece of the assets and release the capital appreciation). Besides, the fair value of these assets are in billions - there aren't buyers for these assets. So, Mr. Market is just pricing them on earnings multiple and ignoring the asset price appreciation over the years. As fair value for these assets went up (2009 onwards), Wharf has been trading below 0.6x.

 

This is a problem that is unique to real estate operating companies that retain quite a bit of their earnings. Unless the mature assets get recycled, the asset price appreciation gets trapped. This is not a problem typically for REITs because REITs pay out most of their earnings. So an earning multiple of 25x (i.e. 4x dividend yield) essentially matches a cap rate based valuation for the assets (4%-6%).

 

Now, Wheelock is a parent company that has 50% ownership in Wharf. So, it has a double discount and have been trading below 0.4x for a while now for the same reason. Mr. Market believes that the price appreciation is trapped and these should be valued using earnings multiple and ignore any price appreciation. It is a fair evaluation in my point of view, unless there is strong evidence that management understands capital allocation. Wheelock's CEO is a 37 year old son of the founder, new to his position. I am not sure if he gets capital allocation.

 

Cheung Kong is another HK based real-estate operating company. And they get capital allocation a lot better than anyone else in my opinion. However, the best one is Brookfield (not based in Hong Kong but a real-estate operating company). They completely get it. Capital recycling is a big part of what they do - buy undervalued assets, use expertise to improve the operations, and sell it in boom markets at low cap rates. For other assets, refinance it using leverage to release the capital appreciation.

 

Here is a simple way to think about this:

 

Say you buy a 25,000 sq. ft. Grade-A office building in San Francisco that has stabilized net operating income (NOI) of $1M when it is 95% occupied. Say it is 95% occupied, but it is 2008, and it is being offered for purchase at 8% cap rate. So, you can buy it at $12.5M or at $500 per sq. ft. You pay cash down. That means you purchased your property at 12.5x NOI and your NAV is $12.5M.

 

Now, say once you purchase the property, the economy recovers, rents go up, occupancy goes up and supply tightens. And a result you are able to raise rents by 5% annually for the next 7 years. Thus, your NOI goes up to $1.4M. Interest rates have fallen and private market transactions are now occurring at 4% cap rate. The fair value of your property has gone up to $28M. Let's assume you just let the NOI produced over the interim years build on the balance sheet (as you are waiting for the next big thing to buy). Let's just round that up to $8M. So, my NAV is up to $36M. Now, notice that my unrealized appreciation of $15M is trapped. If this were a public company, and it continued to trade at 12.5x NOI, it would be valued at $17M and the discount to NAV would have widened to 50%!

 

In the case of these HK companies that own these trophy assets, Mr. Market is saying that these assets won't be sold. Hence, the discount to NAV is because of the disconnect between private and public market multiples. Now, Mr. Market could be right if the cycle turns and NOI goes back to previous lows or if the long-term cap rate goes up. But, as an owner operator, who understands capital allocation, it is silly to not capitalize on these appreciated values, when the market is booming.

 

There are two ways of doing this - sell the asset partially or fully. Or, take out a fixed rate long-term low cost loan at a conservative 50% LTV that can be easily serviced using the NOI and pull out the unrealized appreciation when one refinances the property.

 

It is hard for Wharf to do sell the asset, given that majority of its profits come from two malls. So, it is a problem of concentration. And all HK real-estate companies employ very low leverage - so the second is not an option.

[handycap5]

I really like this discussion.

 

One other thing to add, look at the REIT performance charts on this blog post: http://awealthofcommonsense.com/2016/04/mean-reversion-from-the-lost-decade/

 

The punchline is that REITs broadly defined and WW have gone through an unusually buoyant period for the last 15 years. This could reverse, but doesn't have to. But a major tailwind driving up rents and down cap rates is not likely to continue...

 

I will be surprised is BAM, Wheelock, et al do as well over the next many years as their NAV's have in the past. But I welcome comments from those who are betting otherwise - what do I know?

[Packer16]

The question is do you think interest rates mean revert?  I think there is little to no evidence of this & there is evidence that they trend in a major way.  I think inflation and interest rates will remain & even go lower so the tailwind will continue.  The other tailwind in these urban areas is increasing wealth and place to spend that wealth.  My question is what evidence do we have that inflation or interest rates will go up?  What about the decline in wealth in urban areas?

 

Packer

[rishig]

I really like this discussion.

 

One other thing to add, look at the REIT performance charts on this blog post: http://awealthofcommonsense.com/2016/04/mean-reversion-from-the-lost-decade/

 

The punchline is that REITs broadly defined and WW have gone through an unusually buoyant period for the last 15 years. This could reverse, but doesn't have to. But a major tailwind driving up rents and down cap rates is not likely to continue...

 

I will be surprised is BAM, Wheelock, et al do as well over the next many years as their NAV's have in the past. But I welcome comments from those who are betting otherwise - what do I know?

 

I see your macro point of view, but I think in micro terms.

 

What has driven Wharf's rent up is the Hong Kong retail boom over the past 15 years. In 2003, China passed the individual visa scheme allowing individuals from mainland China to travel to Hong Kong on an individual basis. Prior to that, individuals could only travel to Hong Kong on business visits or in a group tour. This started the boom. Visitors from mainland China to Hong Kong increased from 12 million annually in 2003 to 47 million annually in 2014. This is in a city that has 7 million people. As the number of visitors sky rocketed, it became the shopping destination for mainland Chinese visitors, given that the same goods were either not available in mainland China (authentic milk powder) or much more expensive due to tax differences. Harbour City and Times Square - Wharf's two main malls are in the shopping districts.

 

As of 2015, Harbour City has a Gross Floor Area (GFA) of 8.35M sq. ft. with annual footfall of 80M+. It accounts for HK$30B of retail sales and has one of the highest average retail sales for a mall in the world - HK$2,377 per sq. ft. per month. See here: See here: http://fortune.com/2015/01/21/10-highest-rent-shopping-strips-in-the-world/

 

As of 2015, Times Square has a GFA of 2M sq. ft. with annual footfall of 65M+. It acconts for HK$9.1B of retail sales and has retail sales of HK$1,517 per sq.ft. per month. Both these together, account for about 10% of retail sales in Hong Kong.

 

If you are familiar with malls, the numbers for Wharf's mall are absolutely stunning. Wharf understands its position and has thereby increased rents over the years. See below:

 

                2015 2014         2013         2012         2011         2010         2009         2008         2007         2006         2005

Retail

Gross Floor Area (sq. ft.)

Harbour City 2.049 2.049 2.049 2.049 1.948 1.948 1.570 1.948 1.948 1.913 1.913

Times Square 0.936 0.936 0.936 0.936 0.936 0.936 0.936 0.936 0.936 0.936 0.936

 

Occupancy:

Harbour City 99% 98% 98% 98% 97% 96% 95% 95% 100% 96% 99%

Times Square 99% 100% 98% 98% 100% 100% 99% 99% 99% 99% 99%

 

Rent per sq. ft. per month

Harbour City 244 235 204 175 157 130 142 98 76 67 57

Times Square 181 168 136 123 112 96 86 78 70 63 57

 

Revenue:

Harbour City 5,949 5,674 4,909 4,223 3,571 2,928 2,550 2,166 1,775 1,472 1,287

Times Square 2,017 1,883 1,492 1,352 1,258 1,076   956   871   774           706   630

Plaza Hollywood   529   513   475   420   380   353   340   320   302           277   262

Total                 8,495 8,070 6,876 5,995 5,209 4,357 3,846 3,357 2,851 2,455 2,179

 

Operating Profit:

Harbour City 5,312 5,066 4,384 3,700 3,154 2,565 2,199 1,796 1,441 1,160   997

Times Square 1,775 1,701 1,301 1,198 1,121   948   826   739   658   598   531

Total                 7,087 6,767 5,685 4,898 4,275 3,513 3,025 2,535 2,099 1,758 1,528

 

Year-end valuation:

Harbour City 99,639 94,602 80,185 69,644 41,869 34,504 24,311 20,565 19,146 17,022 15,931

Times Square 38,731 37,127 32,070 29,751 25,179 19,549 15,022 13,411 12,689 12,157 10,910

  Total Value    138,370    131,729    112,255 99,395 67,048 54,053 39,333 33,976 31,835 29,179 26,841

 

Implied Pre-tax Cap Rate:

Harbour City 5.3% 5.4% 5.5% 5.3% 7.5% 7.4% 9.0% 8.7% 7.5% 6.8% 6.3%

Times Square 4.6% 4.6% 4.1% 4.0% 4.5% 4.8% 5.5% 5.5% 5.2% 4.9% 4.9%

 

The massive increase in rents meant that local shops had to relocate from the main shopping areas out. Also, the massive increase in visitors put incredible resource constraints on everyday items (think milk powder). In late 2014, China was passing certain regulations that would impact Hong Kong that the locals didn't agree with. Protests broke out and there were several cases of violence against mainland Chinese visitors (search YouTube). Furthermore, USD (and thereby HKD that is pegged to USD) strengthened in 2015. All of these led visitors from mainland China to drop for the first time from 47M to 40M in 2015.

 

Retail sales reported by all luxury brands is down for the first time in Hong Kong. Much of the lost of sales have shown up in places like Europe (as Euro weakened) and the rest of Asia.

 

So, longer term, the question is how viable will Hong Kong be as a tourist destination for mainland Chinese visitors. Harbour City and Times Square's primary competition isn't local competition (1881 Heritage and Central Hong Kong), but the shopping strips of Paris, London, New York.

Also, given these leases are relatively short term in nature, likelihood of rent reversions are quite high. It looks quite likely that rental growth will slow down, if not halt in the next 2-3 years. 

 

Having said all of this, you got to compare apples to apples. Look at where malls in the rest of the world are trading and if at some point, the sentiment becomes extremely negative and the price drops to say 10% cap rate of trough rental revenue, it makes sense to own this. I don't think we are there yet.

 

On Brookfield, I am happy to elaborate. But I think it can continue to do very well, independent of the environment.

 

[handycap5]

The question is do you think interest rates mean revert?  I think there is little to no evidence of this & there is evidence that they trend in a major way.  I think inflation and interest rates will remain & even go lower so the tailwind will continue.  The other tailwind in these urban areas is increasing wealth and place to spend that wealth.  My question is what evidence do we have that inflation or interest rates will go up?  What about the decline in wealth in urban areas?

 

Packer

 

I love the quote about Swiss bankers and interest rates. https://www.quora.com/What-does-this-Warren-Buffett-quote-mean

I have no view.

 

Look at this page and click "chart." http://www.multpl.com/10-year-treasury-rate

Or look at the rates available on Shiller's excel sheet. And eye ball the last 50 years. http://www.econ.yale.edu/~shiller/data.htm

I don't think it takes much insight to see that the last 30 years have had a highly unusual trend, and due to the nature of math and negative numbers, it can't continue. Rates can stay low, but they can't continue to go (much) lower.

 

 

 

[Packer16]

In places where there is negative rates I tend to agree but the US still has a way to go.  Also, I don't see a reason why negative rates cannot exist as the banks are providing a service to its customers and the customers are getting is as part of the interest they receive.  All I see happening is there is a surplus of capital that is growing every day with little or no economic use for the additional capital leading to low demand and thus low interest rates.

 

Packer

[rishig]

The question is do you think interest rates mean revert?  I think there is little to no evidence of this & there is evidence that they trend in a major way.  I think inflation and interest rates will remain & even go lower so the tailwind will continue.  The other tailwind in these urban areas is increasing wealth and place to spend that wealth.  My question is what evidence do we have that inflation or interest rates will go up?  What about the decline in wealth in urban areas?

 

Packer

 

I love the quote about Swiss bankers and interest rates. https://www.quora.com/What-does-this-Warren-Buffett-quote-mean

I have no view.

 

Look at this page and click "chart." http://www.multpl.com/10-year-treasury-rate

Or look at the rates available on Shiller's excel sheet. And eye ball the last 50 years. http://www.econ.yale.edu/~shiller/data.htm

I don't think it takes much insight to see that the last 30 years have had a highly unusual trend, and due to the nature of math and negative numbers, it can't continue. Rates can stay low, but they can't continue to go (much) lower.

 

I have no macro view on REITs in general or interest rates. HKD is pegged to USD, so (private) asset values in HK are tied to US. Mr. Market disagrees and is not willing to give private market value multiples to Wheelock / Wharf. Hence Wheelock is trading at 30% of NAV.

 

Here's the math:

                                  Equity

Wheelock & Co            39,909

Wheelock Singapore    12,610

Wharf Holdings Ltd    182,006

Total                          233,925

Corporate Debt            32,258

Shareholders' Equity  201,667

Shares outstanding        2,031

NAV per share                    99

Share price                        36

 

If I were to peel the layers to look at Wharf (50% owned), here are the numbers:

 

Investment properties

Revenue:

HongKong            12,165

Mainland China      2,305

Total                    14,470

 

Operating Profit:

HongKong          10,516

Mainland China      1,243

Total                  11,759

 

Finance costs:

HongKong          (1,246)

Mainland China          (9)

Total                  (1,255)

 

PBT

HongKong            9,270

Mainland China    1,234

Total                  10,504

 

PAT:

HongKong:          7,740

Mainland China:      987

Total                    8,727

 

Investment Properties Valuation:

HongKong:              251,839

Mainland China:        41,014

Total                        292,853

 

Implied cap rate:

HongKong                    3%

Mainland Chine          2.5%

 

These obviously are ridiculously low. So, let's assume we use the 8% cap rate, given they are Grade A malls that have had 95%+ occupancy for the last 20 years.

 

Investment Properties (using 8% cap rate)

HongKong          96,750

Mainland China    12,337

Total                109,087

 

So, we should mark down Wharf's by 183,766. Or on Wheelock's balance sheet by 50% - 91,833. On a per share basis, that is by 45 HKD. Stated NAV is 99. If one buys at 54, then one is basically getting the underlying investment properties at 8% cap rate. The rest of the balance sheet is at cost (so no need to discount it).

 

One could also argue that these rental incomes are not sustainable and we need to discount it further. Also, one could argue that a holdco discount is justified. All in all, Mr. Market is saying that Wheelock is worth 36.

 

 

 

 

 

 

[rishig]

I really like this discussion.

 

One other thing to add, look at the REIT performance charts on this blog post: http://awealthofcommonsense.com/2016/04/mean-reversion-from-the-lost-decade/

 

The punchline is that REITs broadly defined and WW have gone through an unusually buoyant period for the last 15 years. This could reverse, but doesn't have to. But a major tailwind driving up rents and down cap rates is not likely to continue...

 

I will be surprised is BAM, Wheelock, et al do as well over the next many years as their NAV's have in the past. But I welcome comments from those who are betting otherwise - what do I know?

 

On the topic of interest rate and how it relates to Brookfield, what you said is valid but in my opinion a first level type thinking. One has to know Brookfield well to understand how they operate.

 

One of the cornerstone's of Brookfield's philosophy is recycling of capital in mature real-estate that has low growth prospects. The low cap rates are a benefit to Brookfield, because they are selling this real estate at extremely low cap rates and recycling the funds into development / redevelopment projects that have double digit unlevered ROI. The low cap rates provide them with cheap equity funding. This is in high contrast to REITs that are issuing shares to fund their projects. In addition, Brookfield has relationships with sovereign wealth funds that have a huge appetite for stabilized assets for the yield it generates. Effectively, they are doing a public private market arbitrage, buying cheap in public markets (GGP, Canary Wharf) and selling in private markets. Exactly, what I would expect a value investor to do when they are in the real-estate business.

 

FYI - if you were following Brookfield closely, it would be interesting to note that BPY traded down to $18 recently. This was a massive discount to its NAV of $30, especially for Brookfield because it is doing all the right things for closing the discount.