Hock Lian Seng - trading at 5x Ex-(cash & investments) PE with 4 years of earnings visibility booked in

Our view: 
Currently no TP on it, as liked HLS due to its good dividend yield, and as we hope to ride it as a proxy to the pick up in local construction demand. We believe current valuations are backed by the earnings visibility it has for the next 4 years, dividend yield of 3.6-5%, and strong cash/investments of S$0.29/share. Upside will come from the sale of industrial property dev, and winning new contracts. 

Hock Lian Seng (HLS) is a BCA grade 1 contractor, with over 40 years of experience in the civil engineering and infrastructure projects in Singapore- with projects including MRT depots, bridges, expressways, water infrastructures and other specialised marine works.

Investment merits

A reputable civil engineering co. with over 40 years of experience and an established track record trading at 11.2x forward PE and ex(cash and investment securities) PE of 4.7x.

Strong balance sheet with net cash and investment securities of S$0.29/share (2016 mix: 84% corporate bonds, remaining in AFS equities) 

A near 100% cash company by end of 4 years? We estimate that the current order book if executed smoothly, may help HLS earn NPAT of S$22m/year for the next 4 years, and become a near 100% cash company by the end of the period, as it is trading at 4.7x forward ex(cash and investment securities) PE. (We assume HLS can sell out its industrial property shine@tuas which it is currently holding on its b/s at about S$96m- (believe will still incur more dev cost of about S$10-15m by the time it TOP), which will sort of net out the other liabilities in the balance sheet)

• industrial development Shine@Tuas South doesn’t seem to be selling that well (maybe due to the sector) - is slated for completion by 2Q18. We personally don’t think HLS will make a loss on it (noted that they are also constructing it themselves), but probably won't make a lot too depending on how fast they want to sell it. The location is not too bad, as it is near the tuas mega port which will start opening in phases from 2021 
•  http://www.propnexinternational.com/projects/shine-tuas-south.html/ 
•  http://www.straitstimes.com/singapore/tuas-mega-port-first-phase-of-works-crosses-halfway-mark

Positive industry outlook. (BCA projects the total construction demand to be awarded for 2018 to be between $26b-31b, up from $24.5b 2017E, driven by both private and public-sector projects. Major civil engineering contracts to be awarded include North-South corridor, new MRT works and deep tunnel sewage phase 2 etc)- Link to BCA press release

A dividend yield of 3.6-5%. HLS has proven to be a good pay master in the past, steadily increasing its dividend payment over the years, with at least S$0.01625 DPS since 2010. In 2016, Management declared a total DPS of S$0.125 (S$0.10 special dividend, S$0.025 normal dividend). Assuming it maintains its normal dividend of S$$0.018-0.025, translates to yield of 3.6-5% (which is well supported by its strong balance sheet and good cash flow generation)

Risks

Costs overrun, margins not as high as expected, inability to win contracts etc

Also noted that while historically the capex for HLS is quite low at S$1-3m/year, in 2016-2017, there is a huge rise in CAPEX as it purchase more PPE and build warehouse (mentioned for its ongoing projects)- not sure how much more it will still incur, which may reduce its cash pile abit, but if we view it positively, hopefully they are expanding their fleet too so they can bid for their other projects given the pick up in local construction demand and not just be tied down to the Changi airport projects. 

___________________________________________________________________

What we think HLS's earnings will be in the next 4 years?

Changi airport JV project with SCI only started contributing significantly in 3Q17. In its 3Q17 comments, HLS mentioned that the main rise in revenue (qoq and yoy) was due to the revenue contribution from the Changi airport JV project with SCI (where its 60% owned JV won a $1.1b contract from Changi airport which will run through 2022). In its 2Q17 commentary, contribution from this Changi airport JV is not yet significant, so 3Q17 was the first real quarter where revenue contribution from the project really kicked in (even though it was awarded only in Aug 16)

YE 31 Dec	1Q16	2Q16	3Q16	4Q16	1Q17	2Q17	3Q17
Revenue	23.6	31.6	29.6	33.3	28.0	23.2	49.5
cost of sales	(22.2)	(30.1)	(23.0)	(12.6)	(25.6)	(22.0)	(42.0)
GP	1.4	1.6	6.6	20.6	2.4	1.2	7.4
Adjusted GP margin	6.1%	5.0%	22.3%**	17.0%**	8.6%	5.2%	15.0%

**Adjusted GPM for 3Q16 were higher due to finalization of accounts for a few completed construction projects at end of defect liability period, such as Ark@Gambas, Ark@KB. 4Q16 GP was also helped by a $15m writeback of maintenance cost provision for completed projects (which we have already excluded in our adjusted GP calculation) 

If we have a look at the quarterly results, prior to 3Q17, sales were about S$23-30m, which we believe should be from projects such as Maxwell station, stabling yard at Gali batu etc.  Noted that this is a huge step up in sales and gross profit from 1Q and 2Q17. In its 3Q17 commentary, HLS attributed the rise in revenue mainly due to the contribution from the Changi Airport JV project. Hence, our 2 cents view is, it is reasonable to believe that the Changi Airport JV project has a much higher GPM than the other existing projects that HLS is currently working on.

Back of the envelope calculation

Assuming 1Q17 and 2Q17 revenue were derived mainly from projects such as Maxwell station etc (minimal contribution from Changi airport JV project), and these projects continue to contribute to HLS in 3Q17, we estimate the revenue and gross profit contribution from the new Changi JV project in 3Q17 to be about S$24m sales and S$5.6m in gross profit, implying a GPM for the project of about 23.6%. 

	sales	GP	GP margin
Assumed average of 1Q17 and 2Q17 sales and gross profit (from other projects)	25.6	1.8	7.0%
Assumed revenue contribution from new changi JV	23.9	5.6	23.6%
3Q17 results	49.5	7.4	15.0%

Based on the current order book of S$830m, we assume the mix of the order book is currently 

Order book	S$830m	Blended GP margin mix: 19.8%
Changi JV	S$640m	23.6%	We less off the assume revenue contribution from the project in 3Q17
Others (eg. Maxwell station)	S$190m	7.0%

Based on the back of the envelope calculation, we assume the following

• S$50m of sales per quarter (this will last them about 16 quarters or 4 years based on current order book of S$830m)
• Assume GPM margin of about 18% (vs assumed order book mix blended GP margin mix of 19.8%)
• Other costs (distribution, admin, other operating costs etc) per quarter of about S$2m. (From 1Q16 to 3Q17, other costs excluding change in fair value has been about S$1m-1.8m)
•  Other income of S$0.75m/quarter (HLS recorded interest income from loans, investment securities of S$3.5-4.5m/year for 2015-2016)

Based on quarterly sales of S$50m, we estimate, HLS can recognised net profit of S$5.7m/quarter or S$23m/year. And the order book of S$830m, can last/provide earnings visibility HLS for another 4.2 years (assuming S$50m sales recognised per quarter)

				Remarks
	Orderbook	830
	no. of quarters it can be recognised	16.8
	no. of years	4.2
		S$m
	Sales/quarter	49.5
	GP/quarter	8.9		Assume GPM of 18%
	Other costs/quarter	-2
		6.9
	Increase in depreciation	-0.8		PPE increased by S$16m in 9M17 due to acq of office units for own use, construction of warehouse, purchase of PPE to meet requirement of ongoing projects- We depreciate it over 5 years
	Other income	0.75		interest income about $3-4m/year in 2015-2016
	PBT per quarter	6.85
	Tax (17%)	-1.17
	NPAT per quarter	5.69		11.5% NPM
	Annual NPAT	22.8

GPM : Gross Profit Margin

PBT : Profits Before Tax
NPAT : Net Profit After Tax

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Fundamental BUY call: HongKongLand (H78) Target price $8.30

Hi All, this is our first (official) fundamental stock pick as we seek to create a place with both fundamental and technical ideas for sharing with investors and traders reading our blog. Welcome any feedback and ideas from our readers. 

We will also be including it in our model dummy fundamental portfolio to track the performance of our investment track record (mostly for our own learning purposes). For fun reading and sharing. Happy holidays! :)

Hong Kong Land

About

One of the largest property developer and investment group in Asia, owning and managing almost 800,000 sqm of prime office and retail property in key Asian cities. Hong Kong and Singapore made up bulk of the portfolio with 452,000 sqm (56%) and 165,000 sqm (20%) respectively. List of properties: http://www.hkland.com/en/properties/list.html FY16 Operating income by segment: Commercial property: 77.8% (should be mostly investment property rental income) Residential property: 22.2% (should be mostly property dev profits)
Source: HKL

My View: 

• While this is just an over simplistic way of looking at the stock, I see HKL as a good proxy to the property market in HK, with its Grade A office assets in Central HK, that may benefit from the booming Chinese economy. Valuations are also backed by its grade A prime office and retail properties such as (Exchange Square, Forum, Jardine House etc in HK, and 33% owned One raffles Quay and MBFC in Singapore).
• With P/B near a multi year low (0.5x), and potential for rise in dividend in the near term (given the dividend history and potential increase in rental income from contributions from new assets, and also multi year low net gearing), think HKL may be a good addition to my medium to long term portfolio at $7.22.
• While waiting, I get a dividend yield of 2.6 % (based on current DPS of $0.19- same as CPF – might as well)

Investment merits:

Trading At 0.5x P/B (with most of its assets at prime locations in cities such as Hong Kong and Singapore), which is near a multi year low and -1SD of its 10 year range. Also attractive when vs its peers like CK asset, Swire properties and Champion REIT who are trading at 0.6-0.9x P/B.

P/B is near a multi-year low and -1SD of its 10 year range.

Source: Bloomberg

Leasing momentum slowed, but overall rental growth still positive in HK. The vacancy rate for prime office space in HK Central rose to 2.4% in 3Q from 1.7% in 2Q, according to Colliers International. According to Colliers, Rents in Central/ Admiralty increased 0.4% QOQ, supported by sustainable renewal and new demand irrespective of the rising relocation trend. Hong Kong’s office area forms 48% of HKL’s total investment portfolio (by floor area).

• ·   For 1H18, HKL’s HK central office portfolio as at 30^th Jun 17 maintained its high occupancy rate with only 1.5% vacancy rates. Average office rent rose to HK$106 psf vs HK$103 in 1H and 2H 16. Its HK central retail portfolio was 99.4% occupied with little change in base rents. There were some mildly negative rental reversions in its Sg office portfolio (S$9.1 psf vs $9.4 psf and $9.2 psf in 1H and 2H16 respectively), but occupancy rate remained strong with vacancy of only 0.2% as at end of Jun 17.

New contribution from Beijing retail mall coming on stream in 4Q?  (84% owned) WF Central (Beijing ) comprising luxury retail complex and 74 room Mandarin Oriental hotel is scheduled for completion in late 2017 and 2018 respectively.

Good free cashflow yield… As a result of its steady rental income from investment properties, HKL typically generates very good free cash flow of more than US$500m in the last 3 years (FY16: US$948m, translating to a free cashflow yield of 5.5%). This has helped it continuously pare down its net gearing to only 5.5%, which will allow HKL to scoop up good assets if investment opportunities arises. 

US$m	FY 2012	FY 2013	FY 2014	FY 2015	FY 2016	Last 12M
12 Months Ending	12/31/2012	12/31/2013	12/31/2014	12/31/2015	12/31/2016	06/30/2017
Cash From Operations	299	908	699	896	1,096	1,202
Capital Expenditures	(515)	(134)	(137)	(152)	(148)	(139)
Free Cash Flow	(216)	774	562	744	948	1,063
Net Debt To Shareholders Equity	12.5%	11.2%	9.6%	8.1%	6.4%	5.5%

Source: Bloomberg

and potential for rising dividends? Noted that dividend/share has been stagnant for 2014-2016 at US$0.19 (dividend yield: 2.6%). If you study the pattern of its dividend payment, DPS remained at US$0.16 from 2009-2011 (3 years) before slowly increasing DPS by US$0.01/year from 2012-2014. If 3 years is a cycle, can we potentially see management raising dividend again this year by at least US$0.01 (or best 1 shot US$0.03). This is considering the potential rise in core investment property rental income (from the potential positive rental reversion in its HK office rentals, new revenue contribution from the new mall in Beijing, WF Central (84% owned) which will be coming up soon in 4Q, and continuously decreasing net D/E which is now at 5.5% (lowest in years)

US$	FY 2008	FY 2009	FY 2010	FY 2011	FY 2012	FY 2013	FY 2014	FY 2015	FY 2016
Dividends per Share	0.13	0.16	0.16	0.16	0.17	0.18	0.19	0.19	0.19
Diluted EPS	(0.05)	0.78	2.02	2.27	0.61	0.51	0.56	0.86	1.42
Dividend Payout Ratio	—	19.8%	7.6%	7.0%	27.8%	35.6%	33.7%	22.2%	13.4%

Source: Bloomberg

Technically, prices have been consolidating between $7.10-7.80, after a strong rally from $5.95 at the start of the year. With prices near the low end of the trading range, and potential near-term catalysts such as the completion of the 84% owned WF Central in Beijing and hopefully higher dividends (my guess- prays), hopefully the stock will be ready to retest $7.80 and breakout soon.

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