Asia Standard - Dollar Selling For 4 Cents

| About: Asia Standard (ASASF)
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Summary

Asia Standard International is a small under-followed Hong Kong real estate developer/manager that is currently selling for only 4% of its appraised net assets or at EV/EBITDA=2.

This investment represents a very asymmetrical risk/return possibility. The downside is minimal due to strong asset protection and upside is enormous as investors have potential to make 5-8x their money.

Market price is depressed due to concerns about Hong Kong/China property bubble. The company currently trades at largest P/BV discount historically and potential property declines seem to be already priced-in.

Due to defensive nature of assets (income generating, prime locations and mainly Hong Kong land based) and very low leverage company’s BV seems to be resistant to sharp valuation declines.

There are multiple ways to realize the upside including increase in dividends, sale of development projects, reduction in discount, continued growth in BV and earning power of the assets.

(Editors' Note: Asia Standard International trades on the Hong Kong Exchange under the ticker 0129.HK, with ~1M HKD average daily volume).

Company background

Asia Standard International Group (later ASI) is a 30 years old Hong Kong company that develops, manages and invests in commercial, residential, retail and hotel properties in Hong Kong and first tier cities in China. The company's main income streams are detailed in the chart below and come from (1) development and subsequent sale of real estate, (2) rental income from its investment properties in Hong Kong, (3) hotel operations and (4) returns on investments in listed equities and debt securities.

Source: Investor presentation, June 2013.

ASI is listed in Hong Kong stock exchange (ticker 0129) with a market cap of HK$2.3bn (equivalent to c. $300m) and daily liquidity of c. HK$1m. The company also has an illiquid OTC listing in US (OTCPK:ASASF), but I would recommend trading in Hong Kong market, which all US brokers are offering for quite low fees starting from $2 per trade with Interactive Brokers to c. $30 per trade with the others.

ASI's financial year ends on the 31st of March, thus annual 2013 results are for the period ended March 31st 2013. Annual results for the latest financial year (2013-2014) have not been published yet and are due sometime in June. Thus whenever I refer to the latest financials these will be from the interim results for the half year ended Sept. 2013.

Investment Thesis

ASI Investment thesis is fairly straight forward. As the title suggest the company is trading significantly below its asset value:

  1. The market capitalization stands at HK$2.3bn, whereas book value of equity (based on Sept 2013 results) is HK$13.6bn, meaning that the company is selling at only 17% of its book value;
  2. Moreover, book value is likely to understate the fair valuation as hotel properties have been recorded at cost and depreciated in the financial statements. The net assets have been revalued by independent professional valuers (hired by the company) and indicate equity attributable to ASI shareholders of HK$18.2bn, meaning that the company is selling for only 13% of its fair valuation - an even bigger discount.
  3. And the final sweetener is that out of current market cap of HK$2.3bn, c. HK$1.6bn is covered by net cash at parent level. Thus investors are actually paying only HK$0.7bn for the remaining parts of the business that independent valuers assessed at HK$16.6bn (=18.2-1.6), which would indicate valuation of 4 cents on the dollar.

The table below summarizes this investment thesis. In this table I am comparing market capitalization of the company to both book and assessed values. Additionally, I do a similar comparison with enterprise value. In this calculation I look at valuation differences of real estate assets and for this purpose I have to deduct net cash at parent level from book value and revalued net assets so that basis of comparison to enterprise value (which also excludes net cash) is the same.

In HK$bn

Market Cap

Enterprise Value

Market capitalisation

2.3

adjusted for (parent level):

Cash

0.9

Financial investments

3.7

Debt

3.0

Enterprise value

0.7

Book Value

13.6

12.0

Revalued Net Assets

18.2

16.6

Market and Enterprise value as %:

of Book Value

17%

6%

of Revalued Net Assets

13%

4%

Source: own calculations based on ASI and subsidiaries financial statements

Thus there is a significant asset undervaluation from whichever perspective we look at the company. This undervaluation looks even stranger considering that company has profitable operations, trades at EV/EBITDA=2, pays out 2% dividend, has very low leverage and has grown BV/share at a rate of 20% during the last 5 years.

This investment represents a very asymmetrical risk/return relation. The downside risk in here is minimal as the current market cap is already covered multiple times by the value of ISA's assets. At the same time, the upside is enormous and investors have potential to make 5-8x their money if asset valuations get fully reflected in the market price. Obviously this does not apply to short-term fluctuation in the share price, but long-term investors should fare well.

ASI real estate portfolio

These remaining assets (excluding net cash) that the market is valuing only at HK$0.7bn consist of:

  1. 70% ownership in Asia Standard Hotel Group, which is also a listed company (ticker 0292) with the market cap of HK$1.3bn. Thus deducing this listed equity stake the investors are receiving the remaining property development and rental real estate portfolios completely for free. The hotel group owns 3 hotels in Hong Kong (all 4 star), 1 in Canada (3 star) and also has extension for two of the hotels under development (to be completed in 2016-2017). Hong Kong hotels are in premium locations with occupancy rates of 95%. These have been built in years 1994-2007 and thus BV of hotel subsidiary (HK$3.1bn or HK$2.2bn excluding minority interest) is likely to understate the fair valuation as assets have been recorded at cost and depreciated. Independent revaluation indicates net assets of HK$9.7bn (not-audited) for Asia Standard Hotel Group. This revaluation has been carried out by Vigers Appraisal & Consulting Limited and Grant Thornton Management Consultants in Hong Kong and Canada respectively. Before 2010 ASI used Knight Frank to value Hong Kong investment properties and the gap between book and appraised values has been smaller around HK$1bn. However, this does not indicate that Vigers are overstating the valuation - higher gap between cost basis and market prices of hotels actually seems reasonable in light of sharp property price increases in Hong Kong.
  2. Investment properties - three leased out buildings in Hong Kong, two of which are fully owned and one controlled 33%. These properties are revalued at least annually and should reflect among other things, rental income from current leases and assumptions about rental income from future leases in the light of current market conditions. These Investment properties were revalued by Prudential Surveyors International Limited (seems to be a decent company with long history and blue-chip client portfolio) and as of Sept 2013 had a book value of HK$5.4bn (audited).
  3. Development properties - the Group is at present developing 5 residential projects with an attributable gross floor area (GFA) of 4.0m sq. ft., spanning over Hong Kong, Shanghai, Beijing and Macau. ¾ of GFA is located in Shanghai and Beijing for development of 300 high end villas and apartments (to be completed in 2015) and 50% joint venture for waterfront residential/commercial development (currently in land clearance stage). ASI has a long track record of development and subsequent sale of real estate as indicated in the slide below. I am unable to verify actual investment returns on development of individual properties, but from the book value growth (excluding change in book values of hotel business or investment properties) it seems that reasonable returns on real estate development have been realized. The current book value of development properties is c. HK$4.2bn.

Source: Investor presentation, June 2013.

In total ASI has real estate assets with a book value of HK$12bn (excluding minority interest) that the market is valuing for only for HK$0.7bn. If we deduct listed hotel business (HK$0.9bn) from these amounts, we appear in a situation where investors are attaching negative value for 3 office rental buildings and 4m sq. ft. of development projects. These assets are very unlikely to be worth zero as on the balance sheet they are worth HK$9.6bn. Thus even if the actual values of some of these assets on the books would be 50% lower, it would still leave significant margin of safety at current ASI prices.

Why Asia Standard International is so cheap?

Firstly I should note that ASI is a tiny player ($300m market cap) in the Hong Kong real estate market and thus is unlikely to be interesting for institutional or international investors. Free-float is even smaller as 50% of the company is controlled by single shareholder.

At the same time smaller retail investors might find the company too complicated due to holding structure, financial statement consolidation of parent and subsidiaries as well as mix of revenues from all sources - office leases, hotel room rents, sale of properties, income from financial investments are all recorded as turnover and feed into operating profit. Thus investors have to dig into notes and footnotes to break this company into sum of parts and to grasp its full undervaluation.

As the company remains under-followed by investors, its share price tends to drift together with the rest of the market and undervaluation prevails - the recent 15% decline in a single month without any news is a clear evidence of that.

I will spend the majority of the remaining of the article discussing the other more broad topics of why the market might be undervaluing this company. Below I have identified a number of areas that could be of concern for the market and will elaborate on each of them in detail:

  1. The company has traded at a discount to book value also historically - as I will show this discount has been much smaller historically.
  2. Potential property bubbles in Hong Kong and China real estate markets - as will explain any potential bubble seems to be already priced in and even 50% drop in property prices would still leave the company significantly undervalued. Also I will clarify that due to the defensive nature of the assets (income generating, prime locations and mainly Hong Kong land based) and very low leverage ASI's book value seems to be more resistant to sharp valuation changes.
  3. Minority shareholder expropriation by controlling shareholder - as I will show the largest shareholder continues to invest in the company and at the same time returns part of the generated cash in dividends. Thus it seems unlikely, that the controlling family would engage in any practices that would destroy value for minority shareholders (no evidence of that so far).
  4. Efficiency of capital allocation - as I will show capital allocation does not seem to be the most optimal from minority shareholder perspective, however due to significant undervaluation even the current strategy will result in material upside for shareholders.

Why is it cheap - Historical discount to book

As shown in the chart below ASI has traded at a discount to its book value as well as appraised value for the last ten years (and likely earlier). However, currently the company seems to be trading far below the average historical multiples. It currently trades at similar valuation levels as during the peak of the financial crisis. 10 year average discount indicates P/BV ratio of 28% and P/appraised value ratio of 22%. This would mean a 50%-70% upside even if the company only reverts to historical average valuations.

Chart clarification: the chart compares ASI's 3 months average share price around the annual result announcement to book and appraised values of its net assets per share. Equity dilution, buybacks and splits are taken into account. Information based on company's annual reports.

Why is it cheap - Property bubbles in Hong Kong and China

Hong Kong is well known for some of the most expensive properties in the world. Prices of real estate have doubled since the collapse of Lehman Brothers (see charts below). Authorities have taken steps to cool down the market and recently the house price growth moderated from 17.5% to 5.2% (inflation adjusted). The pace of price increases has not been fully matched by increases in rents and rental yields are currently the lowest in the last 15 years (see chart below).

Source: globalpropertyguide.com

Source: globalpropertyguide.com

On top of high property prices, Hong Kong economy became closely linked with mainland China over the last decade (in fact the recent bubble was likely fueled by mainland Chinese willingness to deposit their savings in Hong Kong real estate) and thus negative economic developments in PRC will likely cause sharp drop in Hong Kong property prices as well.

Overall the market seems to be convinced that current price levels are not sustainable. Some analysts are forecasting double digit drop in property prices and banks are asked to assess stress scenarios of 50% drops in valuations of real estate.

When it comes to Asia Standard International, there are a few points worth noting with regards to potential property bubble:

  • Firstly, the potential bubble seems to be fully priced in. As I have shown above, the market is pricing ASI's real estate at only 4% of its assessed value (HK$0.7bn vs HK$16.6). Thus even a 50% drop in ASI's property market values would still leave the company 10x undervalued.
  • Secondly, investment property (office buildings) valuations are at least partially supported by the income these assets generate. This income is unlikely to be materially affected by the potential property bubble. As clarified above, rental rates in Hong Kong have increased significantly less during the last decade (c. 40%). ASI's cap rate (rental yield) on the leased office buildings stands at historically and internationally low 2.5% (see chart below, for comparison cap rates on office in US are around 4.8%), but seems to be in line with other real estate in Hong Kong. Any decline in property prices is unlikely to sharply reduce demand for the office space in prime locations (albeit softer demand has been documented in couple research reports) as this demand is more driven by ongoing business/economic activity rather than directly linked to real estate market. It is likely, however, that the reduction in property prices will push the cap rates to a more normal 5% level.

Source: CBRE Global Investors also Colliers

  • Hotel assets are also supported by the operating income from the hotel operations. EBITDA yield (excluding any gains from investment operations) stands at 8% of BV (also keep in mind that this BV also includes two ongoing hotel expansions which currently generate no income). This yields seems to fully support the BV of HK$3.1bn, albeit assessed value of HK$9.2bn sounds a bit steep (it is likely based on a similar 2.5% cap rate as for the leased investment properties described above). Hotel income is not very likely to drop due to property bubble implosion as demand is driven by touristic and economic activity.
  • Majority (3/4) of ASI's hotel assets' book value is in the land rather than the buildings. The same is likely to be the case for the leased out office buildings although numbers are not specified in the financial statements. Even if there is a property bubble, lands values in prime island locations are very unlikely to see sharp drops due to permanently constrained supply.
  • With regards to the development portfolio, it is likely that majority of the value in it also currently lies in the land (earliest construction will be finished in 2015 and other projects are in the planning stages). As these land patches are located in proximity of Beijing and Shanghai, sharp and prolonged land value declines are again quite unlikely due to limited supply of land close to multimillion population cities.
  • And lastly the company has very low debt level with net debt ratio (excluding any financial investments) of only 17%. Thus ASI is unlikely to face distress in case of sharp decline in its portfolio value.

The bottom line is that potential bubble is already priced in the market price of ASI and that due to the nature of the assets (income generating, prime locations and mainly land based) book value of company's real estate portfolio seems to be more resistant to sharp valuation changes.

Why is it cheap - Minority shareholder expropriation

The company is 51% owned by Asia Orient Holding (ticker 0214) which is 50.01% controlled CEO Poon Jing (he is also CEO of ASI) and his family. Besides 51% ownership of ASI, the company also has c. HK$0.6bn in net cash (Asia Orient also seems to be similarly undervalued as ASI, thus investors can choose to invest in either of these two companies with a similar upside expectations). It is quite common for controlling shareholders to profit at the expense of minority shareholders, however there is no historical evidence of such behavior within ASI.

I did not manage to find much useful information about ASI's controlling owners, but according to this analyst, his company "engaged Knight Frank, a well-regarded Hong Kong real estate appraisal and services firm to dig around about the family and see if unethical behavior/poor reputation could be the reason for the large discount. The upshot is management has a good reputation, is known for being conservative in how they run their business (which fits with the very low leverage levels), and are considered to be in the upper tier (but not the all-stars) in terms of the most highly regarded property development management teams in Hong Kong."

On a positive side, ASI pays annual dividend (latest yield 2%), which the largest shareholder seems to take in new shares (script program) rather than cash over the last few years. Thus while the controlling family is willing to return part of the money to minority shareholders they continue to increase their own stake in the company. The same applies for Asia Orient Holding, where Poon Jing stake increased from 44.5% in 2010 to 48.5% in the latest report.

Thus the largest shareholder continues to invest in the company and at the same time returns part of the generated cash in dividends. Thus it seems unlikely, that the controlling family would engage in any practices that would destroy value for minority shareholders.

Why is it cheap - Efficiency of capital allocation

With such a huge gap between assessed asset values and market price, it would make most sense to buy back ASI's shares rather than keep HK$3.7bn invested in listed equities and debt securities of the other companies. Management has engaged in buybacks a number of times during the last ten years, but amounts have been rather immaterial. Thus capital allocation does not seem to be the most optimal from minority shareholder perspective. Share-buybacks or other actions (disposal's, spin-offs) to close the gap between intrinsic value and market price are rather uncommon among Asian companies, thus there is nothing surprising about capital allocation decisions of ASI's management.

Actually there might be a business need to safeguard the capital as ASI is due to start or has ongoing major real estate developments in China. There is no clarification provided on how much these new properties are likely to cost for ASI; however, based on square footage the new properties will be twice as big as the current hotel and office rental assets combined. The management has also raised new debt recently which seems to point toward material capital expenditures going forward.

Also it is worth noting that with margin of safety so big (company is trading at 80%-95% discount to its value) the capital allocation does not have to be perfect. Couple of things done right should suffice.

Catalysts

As I noted above, value gap is unlikely to be closed through share buybacks or division/asset disposals. However, a number of other catalysts to realize value are possible:

  1. Increase in dividend payment. ASI has ample of liquidity to pay higher dividends and profitable operating business (see below) to continue generating cash flow. Dividend in 2012 was HK$0.008/share, in 2013 dividend was increased four times to HK$0.036/share. Results for FY2014 (to be announced in June) will be significantly better in terms of earnings from operations and value of company's assets and thus are likely to warrant a further increase in dividend, which is also likely to drive up the share price.
  2. Completion/sale of ongoing projects. The company has HK$1.7bn of real estate properties for sale. Majority of this likely relates to Shanghai development of 300 luxury villas and apartments. Pre-sale of these properties is due to start in mid-2014 and to be fully completed by 2015. Thus I would expect ASI to have converted at least part of this real estate into cash in 2014 interim results (Sept 2014), meaning that enterprise value (market cap less net cash) would inch towards zero or even turn negative. This is unlikely to be left unnoticed by the market.
  3. Reduction of valuation discount towards historical average. ASI currently trades at 17% of BV, whereas 10 year average stands at 28% - indicating 50%-60% upside.
  4. Continued growth in book value per share of the company. Over the last 5 years book value has grown on average by c. 20%. Similar growth is likely to continue going forward keeping in mind new developments and earning power of the assets. The BV itself is a conservative estimate of the assets as amounts are stated at cost after depreciation, not reflecting recent market developments.
  5. Earning power of operations. Hotel assets have earning of c. HK$260m annually and office rents generate another HK$130m. Excluding the minority interest, we get that ASI's annual EBITDA is in the range of HK$350m. At the same time ASI has EV (excluding parent company, cash, debt and financial investments) of HK$700m. Thus company is trading at EV/EBITDA multiple of 2, which is very low by any standards. At this earning rate, ASI will earn equivalent of its enterprise value in just two years. Moreover these earnings will increase further after the two hotel extensions are completed in the upcoming years. Currently this earning power is somewhat hidden in the financial statements, but as these earnings start accumulating, market price should react accordingly.

Conclusion

Asia Standard International is Hong Kong real estate developer/manager that is currently selling for only 4% of its appraised net assets or at EV/EBITDA=2. The market price seems to be depressed due to concerns about Hong Kong/China property bubble. The company currently trades at largest P/BV discount historically and any potential property bubble seems to be already priced in. Due to the defensive nature of the assets (income generating, prime locations and mainly land based) and very low leverage, company's book value seems to be more resistant to sharp valuation changes. Controlling shareholder has been increasing his stake recently and pays 2% dividend yield to minority shareholders. There are multiple ways to realize the upside including higher dividends, sale of properties under development, discount reversion to the mean, continued growth in book value and earning power of the real estate assets.

Disclosure: I am long ASASF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long ASI in Hong Kong market.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.