Mid-Year Letter from Ronnie Chan of Hang Lung Group

Hong Kong real estate tycoon Ronnie Chan of Hang Lung Group has a reputation for writing insightful shareholder letters.  His latest is available on pages 2-8 of his company’s 2016 Interim Report.  A bit of background about Hang Lung:

  • Reputation for very long-term outlook.  The company completed its Harbourside luxury apartment tower in Hong Kong in 2004 and held many units off the market until selling them in 2014 and realizing a 78% gross margin due to market appreciation.
  • Early investor in China.  The company completed its first shopping mall and multi-use commercial center in Shanghai (Grand Gateway) in 1999.
  • Heavily exposed to retail leasing.  The company now operates 8 luxury shopping malls in China which face many simultaneous challenges: rise of ecommerce, corruption crackdown, softer economy, and overbuilding in many cities. Hang Lung’s 2 Shanghai properties are market leaders, but current results  at some others are weak (e.g. Shenyang, Wuxi, and Dalian).  The company also has a smaller portfolio of retail space in Hong Kong which has suffered from a fall in Chinese tourist arrivals.
  • Conservative financial management.  The company maintains a strong balance sheet (net debt to equity ratio just 5%) and prides itself on taking advantage of investment opportunities in bear markets

Excerpts from the mid-year letter:

The Chinese economic winter continues and I see little signs of spring.

Economic activities are conducted by mostly feeble men who tend to overreact on the upside and downside. As a result, cycles are inevitable. For businessmen who are coolheaded, cycles present them with money-making opportunities. This phenomenon is particularly severe in industries with high unit prices and long production periods. Real estate is a typical case.

Six months ago I wrote that the Mainland residential market was fairly healthy. Nevertheless, of late we have observed some worrying signs, namely land prices in some places are rising too fast. To be sure, this has only happened in selective cities; as such, it cannot yet be construed as a national phenomenon.

…many developers are running out of land reserves. Those active in better second-tier cities have sold their properties well in the first half of the year, hence the need to replenish raw materials. As a sizeable developer has told me recently, if he does not buy land now at very high prices, he will die immediately, in the sense that he will no longer have flour to make bread. On the other hand, if he buys the “king of land”, in other words pays record-breaking prices, he may die three to five years later as he may then record a loss. Given the two evils, he will choose the latter; at least there is a chance that the market may bail him out.

… taken as a whole, the Chinese residential market is very lowgeared. Most end users and investors have rather low mortgage commitment, and this is why the market is quite healthy. For this reason, I have always maintained that high unit price notwithstanding, China does not have a “housing bubble”. By definition bubbles lack substance and can burst at the lightest touch. But if end users and investors are not highly geared, they are not in danger of having loans being called by banks or other lenders. Consequently, such a market is more like an “iron ball” than a “bubble”. This phenomenon is somewhat unique to China.

In the long term, we are quite sanguine about our business prospects. Over the past 30 years, mainland Chinese have transformed from owning little to owning a lot now. This is especially true in the cities. However, their newly acquired possessions, from apartments, cars, clothing and electrical appliances to daily necessities such as food, for the most part, are of a lower quality. The same is true of the level of service quality. The need for better goods and services is enormous. A key trend in personal consumption for many years to come is continuous upgrade. This will be the story of the 750 million city dwellers.

Moreover, as city dwellers demand better goods and services, their need for basic things will be taken up by new migrants from rural areas. In time, this latter group will also move up the value chain. Such waves of demand are expected to continue in the coming few decades. This is why your Management believes that we cannot be in a better business than the one we are now in.

For a complete collection of Ronnie Chan’s annual shareholder letters: 25 years in Retrospect

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