In late March, Henderson Land, Cheung Kong and Wheelock reported financial results 2011. The common stocks of these issuers are the largest Hong Kong positions in the Fund, representing 26% of the Fund’s net assets as of April 30, 2012. As the table below indicates, reported NAV growth in 2011 was impressive, at 8 to 22%.
Henderson reported that underlying profit increased 10% and net asset value per share increased 7%, to $78.23 per share (8% including dividends). The growth was driven by robust commercial real estate results in Hong Kong and China, as leasing income increased 25%. The occupancy rate of the company’s core rental properties in Hong Kong increased to 97%, from 94.5% a year ago, driven by continued strong leasing progress at the Manulife Financial Center in Kowloon (98% occupied, versus 87% a year ago and initially opened in 2008). In China, net rental income growth increased 149%, as the company’s new developments in Beijing and Shanghai continued to experience strong increases in occupancy levels. For example, the World Financial Centre in Beijing, a 2.1 million square floor office building that opened in 2009, was 90% leased at year end, up from 78% a year ago. In Shanghai, the Henderson Metropolitan was 97% leased, following its grand opening in November 2011. This project includes 400,000 square feet of Grade A office space and 400,000 square feet of retail space, including the largest flagship Apple outlet in China. I visited this property during its construction in 2010 along with Jason Wolf, co-manager of the Third Avenue Real Estate Fund, and have since been very impressed with its progress in attracting high quality tenants.
Earnings at Hong Kong and China Gas Co. (a 40%-owned subsidiary) increased 10%, owing primarily to a 63% increase in profits at 66%-owned Towngas China, as the company continues to add new gas customers in China. The volume of gas and appliance sales in Hong Kong increased by 2% and 8%, respectively. As of April 30, 2011, the market value of Henderson’s stake in Hong Kong and China Gas totaled nearly 60% of its market cap.
Henderson’s residential property development business generated improved results in 2011 with pre-tax earnings of HK$2.2 billion, up from a loss of HK$0.2 billion in 2010 that included a HK$0.7 billion loss related to the cancellation of 20 high priced sales at its Conduit Road luxury property development in Hong Kong. Henderson’s residential property results were very much front-end loaded in 2011, as the tightening measures in both Hong Kong and China resulted in minimal sales activity in the second half of the year. While this second half performance was disappointing, the company seems to be poised to generate much improved results starting in 2012. In Hong Kong, the company has a large pipeline of projects totaling about 4,000 units (compared to 325 units sold in 2011), consisting primarily of agricultural land and old building conversion projects. In China, the company has a low cost land bank of about 150 million square feet mainly in residential developments in second and third-tier cities. Based on this large inventory and the recent stabilization in the Hong Kong and, to a lesser degree, China residential property markets, Henderson’s residential property business should perform better in 2012.
Henderson maintained a very strong financial position with a 16.6% net debt to capital ratio, interest coverage of 6 times and an average borrowing rate of 3.1%. As of April 30, Henderson Common was valued at a 44% discount to reported net asset value and nearly a 50% discount if the company’s stake in Hong Kong and China Gas were valued at market. Henderson Common’s current discount from book value is near historically wide levels (5 year average price to book of 0.85). In 2012, Chairman Lee Shau Kee has increased his stake in Henderson Common to more than 62%, purchasing $75 million of stock in the open market.
Cheung Kong (CHEUY)
Cheung Kong reported a 72% increase in 2011 earnings per share and 16% increase in NAV per share to HK$132.20. The company’s results benefitted from gains on timely resource conversions in early 2011 consisting of sales of stakes of ports and commercial real estate assets in separate IPOs. Although many analysts exclude one-time gains like these in valuing a company, they are important in our analysis at Third Avenue as they demonstrate management’s willingness to be opportunistic in not only buying but also selling assets to increase NAV. Additionally, the large gains confirm our belief that many of the company’s assets are worth considerably more than stated book value. Cheung Kong’s underlying profit increased 15%, driven by a 26% increase in contribution from property sales and 13% increase in property leasing income.
The company also benefitted from strong results at 50%-owned subsidiary Hutchison Whampoa, whose common stock is also held in the Fund. Hutchison Whampoa’s revenue and earnings before interest and taxes (“EBIT”) increased 22% and 33%, respectively. The growth was broad based including Ports (revenue up 12%; EBIT up 14%), Retail (revenue up 17%; EBIT up 19%), Property (revenue up 7%; EBIT up 8%), Infrastructure (revenue up 67%; EBIT up 57%) and Energy (revenue up 41%; EBIT up 79%). The company appears to be taking advantage of depressed economic conditions in Europe as it made a significant acquisition its infrastructure business in 2011 (Northumbrian Water group Limited) and announced the acquisition of Orange Australia in 2012 to bolster its telecommunications operations. Cheung Kong maintained a very strong financial position, with HK$20 billion in cash and a net debt to capital ratio of only 7.6%.
Cheung Kong maintained a very strong financial position with HK$20 billion in cash and a net debt to capital ratio of only 7.6%. Cheung Kong Common traded at a 22% discount to reported net asset value at quarter end, compared to an average premium to book value of 1% over the last five years. Chairman Lee Ka-shing spent $14 million during the first four months of 2012 buying Cheung Kong Common in the open market and now owns 43.3% of the outstanding shares.
Wheelock & Co.
Wheelock reported that underlying profit increased 13% and NAV increased 22%, to $60.32 per share. Leasing income increased 16%, as 25% retail sales growth in Hong Kong drove strong demand for shopping center space. Harbour City and Times Square, two shopping malls that are owned by Wheelock’s 50%-owned subsidiary, Wharf Holdings, generated retail sales growth of 34% and 24%, respectively, and accounted for about 9% of total retail sales in Hong Kong. Based on my visit to Harbour City earlier in the year, which was discussed in last quarter’s letter, retail demand continues to be strong in 2012. Additionally, Wharf’s leasing income in China increased by 121%, as its newly developed 1.2 million square foot office building, Shanghai Wheelock Square benefitted from increasing occupancy (more than 80% versus more than 60% a year ago) and rental rates. As described above with the Henderson Metropolitan, I viewed this property during construction in 2010 and have been very impressed with its leasing progress.
Wheelock generated very impressive property development results, as revenue and operating profit increased 109% and 194%, respectively. The company’s consolidated property development operating margin increased to 50%, from 36% in 2010. Property development income from Wheelock’s 76%-owned subsidiary, Wheelock Properties Singapore Limited, nearly tripled owing to robust demand for luxury residential property.
In Hong Kong, property development income increased by more than nine times, and Wharf’s China property development income increased by 84%. While these results are probably not sustainable, the company’s high margins provide considerable cushion if the residential property markets deteriorate further in 2012.
At year end, Wheelock’s financial position was strong with a net debt to capital ratio of 11%, excluding Wharf’s debt, which is non-recourse to Wheelock. The company’s net debt increased modestly (by $HK5 billion) in 2011 as the company purchased two commercial sites in Hong Kong for $7.5 billion and participated in Wharf’s rights offering ($5 billion). Both investments appeared to be sensible given the favorable supply/demand dynamics of the Hong Kong office market and the large discount to NAV of Wharf’s rights offering (HK$36.50 per share subscription price versus a year-end NAV of HK$67.10 per share and a price of HK$46.30 as of quarter end).
As of April 30, 2012, Wheelock Common traded at a 57% discount to reported NAV, a considerably larger discount than its 32% average discount over the last five years. This depressed valuation appears to more than compensate for the risk of the impact of a severe slowdown in China on Wharf’s China property business. Chairman Peter Woo seems to agree, having purchased $12 million in Wheelock stock so far in 2012, increasing his stake to 59.6%.