Kerry Properties Ltd. (HKSE:00683, Financial), a 13 billion Hong Kong dollars ($1.66 billion) real estate company, provided its annual report in April and is expected to provide its interim report in the last week of August. The Hong Kong-based, 39-year-old company reported a 25% increase in its revenue in fiscal year 2016 to HK$13 billion and 18% rise in profits to HK$6.5 billion (50% margin compared to 53% in 2015).
As observed, profits attributable to non-controlling interests nearly doubled from the prior year to HK$1.2 billion, therefore lowering the shareholder profit margin in 2016 in comparison.
Valuations
Kerry Properties is markedly undervalued compared to peers. According to Reuers data, the company has a trailing price-earnings (P/E) ratio of six times versus the industry figure of 23.5 times, a price-book (P/B) ratio of 0.48 times versus 2.65 times and a price-sales (P/S) ratio of three times versus 2.7 times.
The company also has a trailing dividend yield of 4% with a 24.3% payout ratio.
Average 2017 revenue and earnings per share estimates indicated forward multiples of 1.2 times and 7.3 times.
Total returns
Despite being undervalued, Kerry Properties outperformed the broader iShares MSCI Hong Kong ETF (EWH, Financial) so far this year with 33.7% total gains versus the index’s 26.2% (Morningstar).
Kerry Properties
According to filings, Kerry Properties is a world-class property company with significant investments in Asia. The company is known for its property development activities in China and Hong Kong.
As of December, Kerry Properties had 59% of its non-current assets in China, 38% in Hong Kong and the rest in other countries.
The company’s business can be dissected into three main parts: Property rental and others, property sales and hotel operations.
Property rental and others
In 2016, revenue in the property rental and others segment rose 3.4% to $4.05 billion (31% of revenue) and generated gross margins of 79% (most profitable of the three divisions), compared to 78% the prior year.
Property sales
In 2016, revenue from property sales grew 17% year over year to $7.2 billion (55.5% of sales) and delivered gross margins of 34% compared to 24% in 2015.
Hotel operations
In 2016, revenue in hotel operations grew 6.6% year over year to $1.73 billion (13% of sales) and generated margins of 10% (same as in 2015).
Sales and profits
In the past three years, Kerry Properties recorded average revenue decline of -2.4%, average profit decline of -20.8% and an average profit margin of 50% (Morningstar).
Cash, debt and book value
As of December, Kerry Properties had HK$16.3 billion in cash and cash equivalents and HK$45.3 billion in debt with a debt-equity ratio 0.55 times versus 0.46 times in the same period last year. Overall equity rose HK$1.4 billion year over year while debt climbed by HK$8.3 billion.
Goodwill and intangible assets were negligible in the company's HK$172.6 billion in assets while book value rose 1.1% year over year to $95.2 billion.
Cash flow
In 2016, cash flow from operations actually declined contrary to Kerry Properties strong profits in the period by -28.7% to HK$2.16 billion. As observed, the company experienced higher cash flow in its investment properties, disposal of listed securities, available-for-sale investments and subsidiaries.
Capital expenditures were HK$1.07 billion, leaving Kerry Properties with HK$1.1 billion in free cash flow compared to HK$571 million in 2015. The company allocated 1.2 times its free cash flow in dividends and raised HK$8.53 billion in debt (net repayments and other financing activities).
The cash flow summary
In the past three years, Kerry Properties allocated HK$7.5 billion to capital expenditures, raised HK$10.3 billion in debt (net repayments and other financing activities), generated an accumulated free cash flow of HK$3.17 billion and provided HK$3.8 billion in shareholder dividends on an average free cash flow payout ratio 141%.
Conclusion
Kerry Properties exhibited strong business growth in its operations, while gross margins did indicate the company has sustained consistency in its real estate business in both China and Hong Kong. The balance sheet does seem to have an acceptable leveraged condition at 0.55 times, while the company has been generous to its shareholders and non-controlling interests in recent years.
Eighteen analysts have a median target price of  HK$29.3 a share vs. HK$27.35 a share at the time of writing. Meanwhile, there could be a 93% upside should Kerry Properties trade at 0.8 times its book value at HK$53 a share—compared to its three-year average of 0.4 times.
Although it could be hard to understand why the company has been continuously undervalued, Kerry Properties remains a hold with a HK$29 a share target.
Disclosure: I do not have shares in any of the companies mentioned.
