1. Business overview
New World Development (NDVLY;NDVLF) is a Chinese conglomerate and its headquarter is located in Hongkong. NWD operates in the property and infrastructure business and it also builds and sells department stores and hotels. The company profited from the Chinese economic growth over the last two decades and consequently, it will also benefit from future infrastructre projects and urbanization in China and Hongkong. For the last 13 years, NWD never lost money and the ROE averaged 6%. The diversification is a strong advantage in downturns which helped the company to earn money in 2009, the year of the Financial Crisis. A growing demand for hotels and property in Chinese megacities, the rising wealth of Asian people and increasing infrastructre projects will help the company to grow earnings and dividends.
2. Valuation, balance sheet and investments
NWD currently (11/01/2018) trades at HK$ 10.1 with 10.21 bn shares outstanding which results in a market capitalization of 103 bn HK$ (13.14 bn $, large cap).
|Price (HK$)||EPS 2018 (HK$)||P/E||CAPE|| |
per share (HK$)
The stock appears to be significantly undervalued, especially if we compare today's share price with the earnings average of the last ten years (NYSEARCA:CAPE). The company's earnings fluctuate over time due to the nature of the business, so it is not sure whether NWD will show HK$ 2.34 per share next year or not. Hence, it is important to look at the earnings history which shows the investor that the stock is cheap compared to the average EPS of the last ten years.
Furthermore, the balance sheet is in a healthy state. As of July 2018, NWD had total liabilities of 226 bn HK$ and equity of 255 bn HK$ (equity ratio= 53%). The short-term liabilities of 94.7 bn HK$ were covered by current assets of nearly 170 bn HK$. The company had 63.4 bn HK$ cash (= HK$ 6.21 cash per share) and 42.3 bn HK$ property for sale.
NWD has investment properties with a total value of nearly 150 bn HK$. The property investments atrributed over 3 bn HK$ to NWD's total revenues (+29 % YTD; AR 2018, p. 117). Rental income increased as a result of "satisfactory occupancy". Hotel property revenue was flat with 1.48 bn HK$. The fair value of the investment properties increased over 15 bn HK$, a result which will not occur every year. The major part of revenues was generated by selling property. Hence, the revenues and earnings of New World Development are dependent on the property demand and rental development in Hongkong and Mainland China (Shenzhen, Wuhan, Guangzhou, Ningbo, Peking, Langfang and Shenyang). Nevertheless, the other major part of revenues came from the service business (25.9 bn HK$ = 42.7 % of the group's total revenue). The NWS Holding Limited, a 61% subsidiary of NWD, increased its revenues 24.9%. NWD's investments in the transportation and healthcare business are a very important diversification and generate additional revenue and income. The service business will stabilize the group's business if the property market deteriorates.
The following section focuses on the past performance of the company which illustrates the impressive growth of the past decades.
3. Growth of the past: Earnings, dividend and share count history
|EPS||Total Earnings (bn HK$)||Equity (bn HK$)||ROE||Share capital||total dividend amount (bn HK$)||share count (bn)|
First, let's look at total earnings. NWD increased earnings from 2.71 bn HK$ in 2005 to over 23.34 bn $ in 2018 or to 13.7 bn HK$ (average from 2014-2018; CAGR= 12.27 %). We compare the earnings of 2005 with the earnings of the last five years because of fluctuations. Earnings per share (CAGR= 5.3 %) and the dividend (CAGR= 3.7 %) did not grow that fast. But why? Because the share count nearly tripled in the same period. There are three main reasons for the rising share count:
1. Scrip dividend program: existing shareholders received a part of their dividend in the form of new shares.
2. Special dividends: in 2014 and in 2011, shareholders received special dividends in form of new shares.
3. preferential offers: for a specific numbers of shares held, shareholders of other companies received a certain number of NWD shares.
The rising share count hurt existing shareholders not that much because rising earnings and dividends compensated them for the dilution. Since 2009, NWD kept the dividend at the same level or raised the dividend. The total dividend amount is well covered by earnings and for this reason, dividend increases over the next years are likely. The stock performance was quite satisfying, as shareholders saw a stock price appreciation of 4.2% per annum plus dividends since 2005. The total compound annual return was 7.6 % p.a. which is slightly better than the performance of the DOW (+7.3% p.a.) and the HangSeng (+5.0% p.a.).
4. Future scenarios, upside potential and risks
1. Pessimistic scenario: The Chinese economy will go through a recession and will see a decline of 10% over the next decade till 2030.
In this scenario, we assume that NWD's earnings will decrease 30% by 2030 from today's earnings level (or 2.7 % p.a.) because ...
our costs may not decrease in tandem with a reduction in turnover to be derived from properties, as most of the expenses associated with owning and maintaining the Group’s properties are fairly fixed. AR 2018, p. 245
The average income of the last 5 years was 13.7 bn HK$, so by 2030, NWD will just earn 9.6 bn HK$ p.a. (HK$ 0.94 per share). The P/E ratio would rise to 10.75 which is not expensive. If the dividend grows 3.7% p.a., NWD will pay HK$ 0.74 per share, so the dividend will still be covered by earnings even if the Chinese economy won't grow anymore. Shareholders of NWD still can expect an annual return of at least nearly 5.9 % (which is the today's dividend yield on cost), because the stock's downside risk is low due to its low valuation. More importantly, NWD can become a dividend aristocrat even in a pessimistic scenario. However, this scenario is not very likely for the reason that the region Asia-Pacific and the countries China and Hongkong will grow in in the next twelve years, yet slowlier than before.
2. optimistic and more realistic scenario: The Chinese economy will grow at 4 % p.a. till 2030.
In this case, the earnings of NWD won't grow 12% p.a. or more (which was the growth rate for the last 5 years). We assume that NWD can grow 6 % p.a., above the economic average, because of the accelerating urbanization. The average earnings will increase to 27.5 bn HK$ or HK$ 2.7 per share and the P/E ratio will fall to 3.7. The dividend payout ratio (assumption: HK$ 0.74 per share) will be just 27%, therefore the company has the option to pay higher dividends. In this scenario, NWD deserves a fair value of 10x earnings and 1.2x book value (= HK$ 30 per share). The upside potential for the stock would be 200% and investors can expect an annual return of 15.5 % (9.6 % price appreciation p.a. + 6.0 % average dividend yield on cost) minus the effect of share dilution which was 2% p.a. on average. All in all, NWD shareholders can expect an annual return of 13.6 % p.a. over the next twelve years in an optimistic scenario.
NWD offers great value for investors who want to invest in China, the most populous country in the world. The company will probably continue to raise its dividends and will become an Asian dividend aristocrat for earnings will sufficiently cover future dividends. In consequence of a broad diversification, the stock has more upside potential than downside risks and will offer a safe dividend even in a recession.
Disclosure: I am/we are long NDVLF.
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.
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