Seeking Alpha

Sun Hung Kai: Growth In ROE And BV Per Share

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About: SUN HUNG KAI & CO LTD (SHGKF), Includes: SUHJY
by: Tudor Invest Holdings
Summary

Sun Hung Kai is a little known Hong Kong financial company, as it is often confused with the much larger Sun Hung Kai Properties company.

It is growing the business through a disciplined approach.

Get paid more than 7% while waiting for value to be discovered.

Background

Those that follow me here on SA may remember that in my last article on HSBC (HSBC), I wrote that I had reduced the stake in the bank in the middle of this summer, as I saw growing risks associated with events taking place both in Hong Kong and the United Kingdom. I still like HSBC, but the stake was too high, and it was time to take some profit off the table.

Over the summer, I have built up a position in another financial company in Hong Kong. It is in Sun Hung Kai & Co. (OTC:SHGKF). The company’s main listing (86:HK) is on the Hong Kong Stock Exchange, with an ADR in the United States.

This company is much less known than Sun Hung Kai Properties (OTCPK:SUHJY), which is one of Asia’s largest real estate companies with a market capitalization of USD 42.8 billion.

Let us dig deeper into how SHGKF makes its money, and why I think it is a good investment.

Financial Services, consisting of:

Stock brokering & Wealth Management

The company was established in 1969 as a stock brokering company. Founding fathers were three of Hong Kong’s most successful businessmen, namely Fung King-hey, Kwok Tak-seng (founder of Sun Hung Kai Properties) and Lee Shau-kei (co-founder of SHK) and now controlling Henderson Land Ltd. This was their main activity for the first 30 years. In 2015, they sold 70% of the stock brokering company to Everbright Securities, which is part of China Everbright International (OTCPK:CHFFF).

Structured Finance

It has a well-established niche business providing specialty funding solutions to corporates, investment funds and high net worth individuals within the Private Credit portfolio of Principal Investments.

LSS Leasing

It is 40% owned by SHGKF. It is located in more than 350 cities in China. It has traditionally been a car leasing company, but this business model is facing some headwind as competition has compressed margins. The company is exploring financing solutions for other transportation models, such as car-sharing companies.

Half-year profit from this division was HKD 102 million, which was roughly in line with the last interim accounting period.

Consumer Finance

In 2006, the company entered the consumer finance business, through the purchase from ORIX Asia, of a majority stake in United Asia Finance Limited. During the last six months, UAE Finance has repurchased another 7.27% from minority shareholders, and now holds 63% of this company. This repurchase is expected to be earnings-accretive for the Group.

The loans it provides are small in size. The average loan, as of June 30, was HKD 60,247 for its operation in Hong Kong, which equates to USD 7,687 and it has more than 100,000 such small loans. Annualized return on these loans is 31.3%, and the annualized charge-off ratio is 4.4%. The numbers are not as good for mainland China. Here the return is slightly higher at 34.7%, but the annualized charge-off ratio is much higher at 16.3%.

78% of the loan book is in Hong Kong, with the balance in mainland China. More on this later.

Half-year profit from this division was HKD 652.2 million, which was up 7% year on year.

Sun Hung Kai Credit

Sun Hung Kai Credit provides customized financing solutions to home buyers and property investors in Hong Kong. Established in 2015, Sun Hung Kai Credit has already established a leading position in the market. Its loan portfolio stood at HKD 3.6 billion. The fact that its associated company Sun Hung Kai Properties is one of Hong Kong’s largest real estate developers helps in sourcing customers, as they together can package attractive deals to home buyers.

Half-year profit from this division was HKD 68.5 million, which was 40% up year on year.

Principal Investment

It makes investments in private and public equity and debt, plus real estate investment.

The private equity portion is the highest of all the portions in its portfolio. It is 35% of its investment. As a comparison, public equity is 22% of the portfolio.

Half-year profit from this division was HKD 580 million, which was down 15% year on year, and the book value of the investment portfolio was HKD 14.3 billion.

Latest Financial Results

Source: Sun Hung Kai & Co. - 2019 Interim Report

From SHGKF’s 2019 Interim report, which came out in September, we can see that EPS was slightly lower than last year. For me, that is less important than the fact that its ROE is going up, and its Net Tangible Book Value per Share is increasing.

Here is a breakdown of the balance sheet, as of the end of June 2019. Figures are in Million HKD.

Buybacks and dividend

SHGKF has been busy buying back its shares. And it should. As we showed in the graph of the track record since 2016, the Net Tangible Book Value is as much as HKD 9.48 per share. That means it can buy back its shares at a discount of 64%.

As of the end of June, it had bought back HKD 20 million worth of its own shares.

What is important to determine, when we look at a company and its dividend yield is whether it has a long history of uninterrupted, and preferably growing, dividend payment. Here is data on SHK dividend history:

Source: Data from Sun Hung Kai & Co. Annual and Interim Reports.

We can, in fact, see that it has paid a dividend each and every year since 2005. Even during the financial crisis of 2008/2009, when many well-respected companies had to either cut or temporarily halt dividend payments to shareholders, SHGKF was in a position to maintain its dividend. This is an important factor to take into account, as we could again be heading for a recession. There is, in my opinion, a good chance that SHGKF would still be able to continue to reward its shareholders even then.

Another important aspect is to ascertain if the dividend is sustainable. One way to do that is to look at the payout ratio.

Source: Quamnet

We can see that EPS is HKD 0.562 and its dividend payment is only HKD 0.26, so its payout ratio is only about 50%.

Potential risks to the investment thesis

Over the last five to six years, SHGKF has successfully transformed the company from being focused on servicing mostly Hong Kong to include mainland China. Opportunities are understandably huge, both with its size, growth of the middle class and opening up of the financial sector.

However, as I pointed out under Consumer Finance, the charge-off ratio in China is four times larger than that of Hong Kong. Therefore, a risk is a potential deterioration in the quality of the loans in China that could lead to an increase in delinquencies and write-offs. This is an area I want to closely monitor going forward. Growth should come only if it is done with prudence.

Source: Sun Hung Kai 2019 Interim Report

As with many of these ADRs, it suffers from a lack of liquidity. However, in Hong Kong, there is plenty of liquidity in the stock. Potential investors need to be well aware of this.

Last, but not least, I want to keep a close eye on fallouts from the social unrest which has been going on in Hong Kong since July. If it leads to higher unemployment, SHGKF does anticipate higher write-offs of personal loans.

Conclusion

Why do I think it’s a good investment?

It started doing stock brokering, but this field has become extremely competitive all over the world. Commissions or even no commission as fellow contributor Joseph L. Shaefer pointed out in his recent article: “Schwab And TD Ameritrade: The New 0% Commission World.” Schaefer goes on to say:

Total income from commissions amounts to no more than 5% of their total revenues. With a quarter trillion dollars of customer assets, Schwab is more bank than broker these days. The float on cash, the ability to hypothecate shares for a fee, and income from their trading desk are more profitable than commissions.

This is the same for SHGKF. Its assets under management is considerably less than that of Schwab (SCHW) and TD Ameritrade (AMTD), but I believe it will continue to grow. In my personal opinion, it did the right thing by teaming up with Everbright and also venturing into providing financing and wealth management not only in Hong Kong but also in China.

Provided the company sticks to its prudent approach based on its business heritage and connections, I am happy to invest alongside it on that journey. Hopefully, all shareholders of SHGKF will continue to benefit from this. So far, its treatment of shareholders has been good.

I do also believe that the real value of this business is more than what the market is pricing it at. Time will tell if I am right – or wrong. While waiting for this to happen, I get paid 7.6% per year.

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Disclosure: I am/we are long HSBC. 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 Sun Hung Kai & Co in Hong Kong