A Big Hong Kong Turnaround Play

06/14/2012 9:00 am EST

Focus: GLOBAL

Yiannis Mostrous

Editor, The Capitalist Times

Most real estate markets are slowly coming back to life, and in Hong Kong this stock is a prime candidate after a foundation-shaking few years, observes Yiannis Mostrous of Global Investment Strategist.

The shares of Hong Kong-based property developer Sun Hung Kai Properties (Hong Kong: 16) have endured tough slogging since co-chairmen and brothers Thomas and Raymond Kwok were arrested by Hong Kong’s Independent Commission Against Corruption (ICAC) in a bribery probe.

The billionaire brothers took over management of the company in 2008, after ousting their brother Walter Kwok in a bitter boardroom battle. Although Thomas and Raymond are out on bail and haven’t been formally charged, investors remain worried. The stock has plunged more than 20% since their arrests in late March, wiping off more than $7 billion from the company’s market value.

Transparent corporate management has not been Hong Kong’s forte, but Sun Hung Kai Properties always has been viewed as one of the best-run companies in Hong Kong. The body blow suffered by the company’s shares indicates that investors’ trust has been seriously shaken.

The ICAC has not formally charged the Kwok brothers, and the outcome of the investigation remains anyone’s guess. However, even if the brothers and some of their associates go to jail, the company will be left to operate relatively unscathed. That’s because officials have made their point by arresting the brothers, and dealing more serious harm to probably the most envied real estate company in Hong Kong would be counterproductive to the government’s interests

That said, if the authorities decide to take the Kwok brothers to trial, Sun Hung Kai Properties’ stock performance will remain weak during what is bound to be a protracted court process. The stock now offers a good opportunity for bargain hunters with a longer-term orientation.

A Seasoned Management Team
Sun Hung Kai Properties has a reputation for high-quality construction and workmanship. It’s the biggest real estate developer in Asia and the largest developer of premium residential property in Hong Kong. For that reason, the stock has always traded at a premium to the rest of the industry.

Sun Hung Kai Properties’ investment property portfolio holds a gross floor area (GFA) of 34 million square feet, of which 28 million square feet are located in Hong Kong, representing 8% to 9% of Hong Kong’s total square footage.

The company also possesses a solid hotel operating division that has been a big beneficiary of the growth in Hong Kong’s tourism. Almost 42 million tourists visited Hong Kong last year, the highest tourist tally in Asia.

Tourist-related receipts now represent 14% of Hong Kong’s gross domestic product (GDP) and tourist shopping accounts for almost half its retail sales. Consequently, hotel rates and retail space rentals have been rising. Rental income accounts for an average 42% of the company’s total earnings, with the remaining 58% coming from the property development, hotels, infrastructure, and telecom units.

The company owes much of its success to an astute and seasoned management team that has been in place for many years. Even if the Kwok brothers are put behind bars, operations should continue undisturbed.

It still begs the question: What happens if the brothers are dragged through a long court battle and are eventually convicted?

Even if the brothers are cleared, the company’s image already has been diminished. Although an acquittal would boost the stock, it would take time for its valuation to reach previous premium levels.

If they’re convicted, it’s likely that one of the company’s top managers would take the position of managing director and run Sun Hung Kai Properties with the rest of the existing management team. This scenario would represent a good outcome for investors.

Regardless of how this saga ends, Sun Hung Kai Properties’ stock will be affected by sentiment, not operational issues. Buying into solid assets when unwarranted negativity is the prevalent sentiment has traditionally proven a good bet. Offering a 4% dividend yield, Sun Hung Kai Properties is a buy up to HK$100 for patient investors.

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