Swire Pacific: Real Estate Plus Diversification At A Discount

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About: Swire Pacific Limited (SWRAF), SWRAY, SWRBF, SWRBY, Includes: CPCAF, CPCAY, SWPFF, SWROY
by: Christoph Liu
Summary

Swire Pacific is a Hong Kong-based conglomerate controlled by the founding family.

The company has five primary business segments including aviation, retail, beverage production and distribution and marine services, yet real estate is by far the most important.

The most significant asset is a 82 percent stake in separately listed Swire Properties.

The worst-performing segment is marine services.

The company trades at a considerable discount to the value of its listed holdings alone.

After introducing readers to Jardine Matheson (OTCPK:JARLF; OTCPK:JMHLY) in a previous article today I would like to present a company that has historically been a rival of the former: Swire Pacific Ltd. (OTCPK:SWRAF;OTCPK:SWRAY;OTCPK:SWRBY;OTCPK:SWRBF). This company too operates in various businesses in the form of wholly owned subsidiaries, joint ventures and significant ownership interests in listed companies. Another similarity between the groups is that Swire Pacific is as well-controlled by the descendants of its founder to thievery day.

However, Swire Pacific is less diversified. The real estate division with a clear focus on Hong Kong is by far the most important business. Given that some of the other divisions' performance trails the real estate operations' performance considerably the question remains whether it might not be the better choice to own a direct stake in it rather than buying the parent.

Please note that wherever necessary I am basing my calculation on exchange rates as of June 9th (1 USD = 7.84 HK$). Valuations are based on share prices as of Friday June 7th.

History and Overview

The company's roots date back to 1816 when John Swire founded an import-export business in Liverpool, UK. In 1866 Swire's sons set up a Chinese branch (first in Shanghai, a Hong Kong office opened four years later) and established the name Taikoo (Chinese: 太古, meaning "Great and Ancient") which remains a brandname of various of the companies products and subsidiaries to the present day. Following the Communists' rise to power in China in 1949 Swire & Butterfield/Taikoo was forced to seize its mainland operations, focussing on Hong Kong instead. The company renamed itself Swire Pacific in 1974.

The founding family still exercises control of the company. Private John Swire & Sons Ltd. is the controlling shareholder controlling 55 percent. Merlin Bingham Swire, deputy chairman of John Swire & Sons, leads Swire Pacific as executive chairman.

There are two share classes: A shares (OTCPK:SWRAF;OTCPK:SWRAY) and B shares (OTCPK:SWRBY;OTCPK:SWRBF). Both share classes are equal in voting right (i.e. one share carries one vote), yet class B shares only account for a fifth of the capital per share. Thereby class B shares effectively offer fife times the voting power per dollar. Class B shares trade at a discount compared to the more liquid class A shares. John Swire & Sons owns about two thirds of its stake in class B shares. This enabled the Swire family to maintain control of Swire Pacific despite not owning an economic majority (John Swire & Sons bought class A shares in recent years so by now it owns an economic majority).

Businesses

Swire Pacific has five areas of business: Aviation, Real Estate, Trading and Industrial, Beverage Production & Distribution and Marine Services.

Aviation

In 2018 the segment accounted for HK$1,781 million ($227 million) in underlying profit.

Cathay Pacific

Swire Pacific is the largest shareholder of Hong Kong flag carrier Cathay Pacific Airways Limited (OTCPK:CPCAF;OTCPK:CPCAY); owning a 45 percent stake. The company currently has a fleet of more than 200 airplanes operating under the Cathay Pacific (mostly intercontinental) and Cathay Dragon (regional) brands. Cathay Pacific returned to profitability in 2018.

Swire Pacific's ownership interest in the company currently has a value of about $2.5 billion based on the company's share price.

Haeco Group

Hong Kong Aircraft Engineering Company offers a broad range of airplane maintenance, retrofit and management services. The company also provides customers with technical training solutions. Besides in Hong Kong, the group also has facilities across mainland China, at four US locations, Singapore and Hamburg, Germany. Haeco has been a full subsidiary of Swire Pacific since last year. It reported a net operating profit of HK$ 500 million ($64 million) in the first six month of 2018 (the last reporting period prior to the full acquisition and delisting).

Real Estate

Swire Pacific's most important business segment is the real estate division which consists of a 82 percent share in separately listed Swire Properties Ltd. (OTCPK:SWPFF;OTCPK:SWROY).

Swire Properties owns a portfolio of currently 26.7 million square feet of investment properties (residential, commercial and hotel buildings), 14.5 million square feet of which in Hong Kong. The majority of the remaining 12.2 million square feet of properties outside Hong Kong in China (9.4 million square feet). It also owns the Eden residential building in Singapore and several objects in Miami, FL. Through Swire Hotels it also manages hotel operations. For 2018 the company reported HK$10,148 million ($1,294 million) underlying profit HK$8,331 million ($1,062 million) of which attributable to Swire Pacific making real estate its most important segment by far.

Based on the current share price, Swire Pacific's stake in Swire Properties has a value of $20.46 billion.

Trading & Industrial

The segment accounted for an underlying profit of HK$2,904 million ($307 million) in 2018.

Swire Ressources

Swire Ressources Ltd. operates own and franchised footwear and apparel stores - both multi brand and flagship- throughout Hong Kong and Macao as well as some in mainland China. It represent as variety of brands in the sports, lifestyle and outdoor segments.

Taikoo Motors Group

Through various subsidiaries Taikoo Motors group operates car dealerships across Hong Kong, Taiwan and Malaysia. It represents passenger car brands such as Volkswagen AG's (OTCPK:VWAGY;OTCPK:VLKAF;OTCPK:VWAPY) eponymous core brand and Daimler AG's (DDAIF) Mercedes Benz as well as truck and bus brands including Volvo (OTCPK:VOLVF;OTCPK:VOLAF). Through Taikoo Motorcycles Ltd. it is also the exclusive importer for Harley-Davidson (HOG) in Taiwan.

Swire Foods

Through various subsidiaries under the Swire Foods group the company retails Taikoo branded food products in China. It furthermore operates bakery chain Qinyuan Bakery with over 650 stores in the south west Chinese cities of Chongqing, Guiyang and Chengdu. Hong Kong based Taikoo Sugar Ltd. it markets branded sugar products in Singapore, the Middle East and Canada and is an exclusive distributor of coffee under the Mövenpick brand in Hong Kong. Taikoo Sugar (China) Ltd. is a leading sugar supplier to the retail and catering sectors and serves many leading hotels, restaurants and fast-food outlets.

Swire Environmental Services

The Environmental Services division mainly consists of Hong Kong based Swire Waste Management Ltd., a joint venture with Waste Management Inc. (WM) in which the partners own 50 percent each. The company has contracts to provide waste management services to seven outlying islands and to the north west New Territories.

The company also groups strategic investments in UK biotechnology company Green Biologics Ltd., specialized in developing renewable chemical and biofuel technology, smart and nano fibre researchers and producers NanoSpun Technologies Ltd. and Avantium NV into this segment.

Beverage Production & Distribution

Through various subsidiaries Swire Pacific is a producer and distributor of 61 beverage brands of The Coca-Cola Company (KO).

Swire-Coca Cola Ltd. holds the exclusive right to manufacture, market and distribute products of The Coca-Cola Company (KO) in 11 provinces and the Shanghai Municipality in Mainland China and in Hong Kong, Taiwan.

Through Swire Coca-Cola, USA the company also operates six US production and bottling facilities. Its franchise territory extends through parts of Washington,Arizona, California and Kansas serving more than 28 million consumers.

The beverage segment accounted for an underlying profit of HK$1,630 million ($208 million) at revenues of HK$41,190 million ($5,252 million) in 2018.

Marine Services

Swire Pacific's Marine Services segment is the "problem child" of the company. It posted a loss of HK$5,033 million ($642 million) in 2018. It has been loss making since 2015 yet generated net cash from operating activities, albeit steadily declining.

Swire Pacific Offshore Group

Swire Pacific Offshore through various subsidiaries and joint ventures provides a range of solutions and services to the offshore energy sector (especially oil and gas and wind). The various subsidiaries' vessels are managed through Singapore based Swire Pacific Ship Management Ltd.. The group's enduring underperformance is the main reason for to the segment's losses.

HUD Group

Hongkong United Dockyards Limited provides various ship repair, towage and salvage services. It also offers engineering and contracting services for industrial projects on land. HUD is a joint venture with CK Hutchinson Holdings Ltd. (OTCPK:CKHUF;OTCPK:CKHUY), in which the partners own 50 percent each.

Discount

Based on its current market capitalization Swire Pacific trades at a 26.44 percent discount to the combined value of its listed assets alone ($22.96 billion). Even assuming that the loss making Marine Services division not only has no value but even was to be negatively valued I think it is not too far fetched to believe that the unlisted assets as a whole still would represent at least some positive value meaning the discount would be even larger.

On the other hand one should also consider that Swire Pacific reports net debt on the group level of HK$62.667 million (about $7.99 billion). This reduces the extra discount (or potentially even neutralizes it, depending on valuation assumptions regarding the different businesses).

Dividend

It is Swire Pacific's explicitly stated dividend policy to pay out approximately half of its underlying profits in ordinary dividend over time. The company strives to deliver sustainable dividend growth. For 2018 it paid full year dividends of HK$3.00 per A share and HK$0.60 per B share. The payments are made in two installments, usually in October and May.

Risks And Downsides

While the group aims at diversification, its success is nonetheless highly dependent on the performance of its real estate segment. Even leaving aside the loss making marine services, Swire Properties still accounts for more than half of the companies underlying profit. Given the performance of the segment this focus does not necessarily have to be a bad thing. However, in an environment of real estate downturns, the overexposure could become a problem for the group.

Among the the biggest downsides of the stock is surely also the performance of its marine services division. The segment has been unprofitable for years. While Swire Pacific cites challenging market environments, the existence of profitable rivals in this field underline that it is at least in part an issue with the group itself.

Lastly, one of the risk factors that I see with Jardine Matheson is just as true (maybe even a bit more given the even higher relative overweight of the Greater China region) in the case of Swire Pacific: The (mainland) Chinese government's willingness to take closer control of Hong Kong including the local economy and businesses. In this context I would like to draw the attention on the new Hong Kong extradition law which would enable Beijing to get a hold of subjects in order to try them in China. Given the fact that China is not a country that has adopted the rule of law to the same extend as western democracies have, that inevitably leads to considerable leverage in the hands of Chinese authorities. While I do not wish to discuss political matters or make any political judgement, I still see this as a risk for a company lead from Hong Kong of coming into a position where political interest might prevail over shareholder interests.

Conclusion

Given the importance of the real estate segment, I believe that Swire Pacific is most interesting as a way to acquire a part of that business at a discount. However the crown jewel of the group, Swire Properties which alone accounts for 86.66 percent of underlying profit is separately listed. Therefore, it might be more attractive to investors to acquire a direct share in that company rather than to buy at a discount yet in a bundle with a host of other businesses - especially given that the marine services but - to a lesser degree - also Cathay Pacific and others have been performing less well than Swire Properties in the more recent past.

Whether or not Swire Pacific is the right investment depends on whether an investor prefers a focused approach or diversification at a discount.

For dividend investors who have a focus on the dividend class B shares are interesting they offer the same dividend per dollar of equity yet trade at a discount to class A shares. However, one should be mindful of the lesser liquidity compared with class A shares.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: Disclaimer: All research contained in this article was done with utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his own due diligence and research.

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.