Far East Consortium’s International Real Estate At 83% NAV Discount Will Benefit From China Re-Opening

Far East Consortium (HKEX:35) is a Hong Kong based company with a global hotel and residential property development portfolio focused on middle class Asian consumers. Despite COVID disruptions FEC remained profitable over the past two years due to delivery of residential projects and non-cyclical businesses (e.g. car parks). FEC’s hotels, including 9 in Hong Kong, will benefit greatly from a resumption of Chinese outbound travel. FEC’s Chairman has continually added to his holdings and the company pays a substantial dividend.

The health benefit of China’s international travel restrictions has disappeared and relaxation of border controls now seems likely in early 2023. Recoveries in Chinese tourism departures and Hong Kong visitor arrivals are nearly certain, however share prices of Hong Kong hotel owners and operators including FEC are 47% lower than 2018, the last normal year in the territory.

Topics:

• Hong Kong Valuations
• FEC Profile
• FEC Financials & Segment Performance
• Investment Considerations

FEC’s semiannual investor presentations provide an excellent introduction to the company.

Hong Kong Valuations

Most of the major HK real estate companies are well run and have built substantial value for shareholders over time. Obviously they all trade at large discounts to NAV, however the surprisingly large dispersion of returns does not get enough attention.

Reasons for extremely low current valuations:

• Pessimism about Hong Kong – The territory suffered from disruptive civil unrest in 2019. High property prices are a burden on residents and businesses. COVID controls including quarantine on arrival isolated the city. It’s uncertain whether Hong Kong will retain its position as a major global financial center and the business hub of Southeast Asia. The territory’s new Chief Executive recognizes the urgency of the situation and has launched many initiatives to support flows of people and capital. Five years ago it seemed that free trade zones in Shanghai and Shenzhen might undermine Hong Kong’s role as a gateway to China, but deregulation has not progressed. A multinational firm could use Singapore as a center for ASEAN business, but Hong Kong’s unique advantage as a center for Greater China investment will be hard to overcome.

• Pessimism about China – Investors have become disillusioned by political developments and treat the country as uninvestable. Evaluation of company financials, markets, and outlook is overwhelmed by concerns about regulatory changes, international tension, and COVID controls. China’s large well-educated hard working population, good public infrastructure, and innovative companies provide potential for strong economic growth, but it may not be achieved if private enterprise is suppressed. If China’s government shifts towards more pragmatic policies over the next year then a strong rebound in the economy and financial markets is likely. China is the only major economy with stimulative fiscal and monetary policy. Chinese individuals have accumulated significant savings over the past two years of COVID disruptions and have pent-up desire for consumption.

• Pessimism about interest rates, cap rates, and real estate valuations – The Hong Kong Dollar peg means that Hong Kong interest rates follow US Federal Reserve policy. Stimulus after the 2008-09 financial crisis combined with Hong Kong’s scarce land and desirability of investment drove property prices to very high levels. Prime commercial real estate was appraised at cap rates of 3-4% and some high profile transactions occurred at even lower rates. Investors are cautious about NAV’s calculated with historical property prices that might not have been updated sufficiently to reflect rapidly changing markets.

• Insider Control – Public investors have limited influence at these companies and change of control is nearly impossible. They each have great assets, but sometimes that has not flowed through to great shareholder returns. Investors should study whether a company has a record of building value because valuation multiples may remain depressed.

• Flows follow returns – These stocks were bargains five years ago and they are cheaper now. Fund managers who owned them are losers and clients withdrew capital. Buyers will return after the stocks rally.

FEC Background

Far East Consortium was founded by Dennis Chiu (father of current CEO David Chiu) in 1950 and listed on the HKEX in 1972. Over time the company operated a variety of businesses including movie theatres and a TV station. After developing a large middle class housing project in Malaysia in the 1990s, David Chiu returned to Hong Kong searching for a niche in a real estate market dominated by large firms including Cheung Kong (now CK Hutch) and Sun Hung Kai. He observed that most hotels were 5 star properties geared for Western and Japanese visitors, but there seemed to be a scarcity of 3-4 star properties. A depressed local real estate market enabled FEC to acquire 11 Hong Kong hotels by 2003 when Chinese middle class tourism began to grow rapidly.

FEC has now grown its hotel business to 32 locations with another 10 under development. The company’s Dorsett Hotels (English site and Chinese site) are designed with a “Chinese wallet” (later broadened to “Asian wallet”) strategy of providing conveniences for Chinese travelers such as direct marketing via Wechat, having Chinese speaking staff available, affordable pricing, Chinese restaurants on-site, and accepting Chinese payment networks such as Alipay where possible. David Chiu’s 2017 shareholder letter explained:

FEC has also built a large residential property development business in markets appealing to Chinese buyers including Australia, UK, and Singapore. The company particularly likes large mixed use projects where partnerships with local governments reduce upfront land acquisition costs. Governments benefit from FEC’s sensitivity to public interests and willingness to make long-term commitments. David Chiu explained: “Getting land from local governments will continue to be our priority, as it is less risky and the cost is much cheaper”. Significant examples:

• Manchester – FEC signed an agreement with the Manchester City Council covering redevelopment of 390 acres of blighted districts north of the city centre now designated Victoria North. FEC envisions total investment of GBP4Bn over 20 years that will bring 15000 homes (including affordable housing), schools, transport links, healthcare facilities, and green space. David Chiu described the appeal of Manchester development in his 2018 shareholder letter:

• Consort Place (Canary Wharf) – FEC received City of London approval in 2016 for this GBP500mm project with 25% affordable housing and civic benefits including a new school, health centre, public square, and preservation of a 160 year old pub.
• Brisbane – In 2015 Far East was part of winning proposal for redevelopment of the 26 hectare Queens Wharf site on the Brisbane riverfront. The partnership includes FEC (25%) with its hotel and apartment development experience, jeweler Chow Tai Fook (25%) with its extensive database of wealthy Asian customers, and Star Entertainment (50%) an Australian casino operator. Their plan provides over 800 hotel rooms, 2000 apartments, a new casino, a sky deck and other tourist attractions. Public benefits include preservation and restoration of 9 heritage buildings, extensive public waterfront park space, and new local infrastructure. The A$3.6Bn project is the largest development in the state of Queensland. FEC Director Chris Hoong explained the appeal of Brisbane: “The Australian government has put in great efforts to promote Brisbane as an international city, including the expansion of the city’s airport. Brisbane is also competing to host the 2032 Olympics, and this is expected to elevate the city to a new level“. The casino is expected to open by the end of 2023. Two residential towers are under construction and have been 95% sold, and another is under planning. Unfortunately Star Entertainment has been in trouble with Australian regulators over the past year for failure to monitor transactions at risk of money-laundering. If Star fails to demonstrate to regulators that it has improved its controls then permit to open the Queens Wharf casino could be delayed or the facility might need to find a new operator.

FEC has been an opportunistic buyer during downturns, including the recent COVID recession. Significant examples:

• Melbourne – In November 2008 FEC agreed to acquire a downtown plot for the bargain price of A$33mm where it subsequently built 4 high rise towers of the “Upper West Side” project with 1mm square feet of residential space.
• Kai Tak hotel – In August 2019 FEC purchased a plot on the Kai Tak airport redevelopment site for HK$2.45Bn via public auction. Bidding competition was depressed at the time by civil unrest in Hong Kong and FEC’s winning entry was below market expectations. In 2021 FEC sold the office portion of the site for HK$3.4Bn and recognized a gain of HK$0.9Bn. The remainder of the site adjacent to a planned stadium that will host sporting events and concerts was retained for construction of a flagship Dorsett hotel.
• Kai Tak residential – In November 2021 FEC partnered with New World Development to purchase a plot on the Kai Tak airport redevelopment site for HK$7.9Bn from Kaisa Group, a Chinese property developer in financial distress. Kaisa had purchased the land in 2020 from Goldin Financial, another distressed developer. Goldin originally acquired it at public auction in 2018 for HK$8.9Bn.
• Car Parks – In May 2009 FEC entered the Car Park business in order to add a real estate business with recurring cash flow.

FEC launched a mortgage business in 2016 called BC Invest in order to offer financing to international homebuyers. Traditional lenders ignored this market due to lack of expertise in verifying credit quality, but FEC is more familiar with the customer base and minimizes risk by lending at a low LTV averaging about 60% for residential property. The business has grown rapidly beyond its initial scope of just financing purchases at FEC developments. FEC currently owns 53% with the remainder held by PAG ($50Bn alternative asset manager) and Metrics ($10Bn credit manager). It remains complimentary to the property business, but FEC has suggested that it could be spun off. FEC has used the foundation provided by its Chinese customer base to build a broader residential development business in Australia and the UK. The mortgage business is now undergoing similar expansion with the 2021 acquisition of Mortgageport Management, a domestic non-bank lender in Australia.

FEC Financials & Segment Performance

Operating results in recent years have been heavily affected by extraordinary challenges from Hong Kong civil unrest in 2019 to COVID in 2020-2022, but FEC remained profitable:

“Diversification Yields Resilience” was the title of FEC’s 2022 Annual Report. Hotel Profits fell due to COVID, but development earnings remained strong. Large projects are built in phases with construction beginning after risk is reduced through presales. Profits from individual projects are recognized all at once upon delivery to buyers, but the company’s diverse pipeline is intended to generate fairly steady earnings and cash flow. Hotels remained marginally profitable during COVID by adapting rooms for local quarantine requirements and for essential service workers, but earnings should jump as travel recovers.

The company had HK$55Bn in projects under development and planning at 9/30/22. Within this, projects under construction with expected completion in 2023-2025 accounted for HK$23Bn against which the company has recorded HK$16Bn of presales. The UK and Australia represent 64% of future project values. FEC currently has no projects under development in China. The company’s share price does not fairly reflect the shift in its business mix towards exceptional projects in low risk jurisdictions.

Net Asset Value – In accordance with Hong Kong Financial Reporting Standards FEC reports its “Investment Property” at fair market value, however the company’s hotels are considered operating assets valued at their historical cost of HK$26.5Bn. For the benefit of investors the company has obtained external appraisals of its hotel properties since 2009 in order to calculate a non-GAAP “Net Asset Value”. As of 9/30/22 the valuation surplus was HK$18.8Bn. Net Asset Value declined in the recently reported 6 months ended 9/30/22 due to the foreign exchange impact of converting UK and Australian asset values to the HK$ reporting currency.

Capital Management: The company’s gearing ratio at 9/30/22 was 68% which is not high by international standards, but above the company’s past practice and higher than some Hong Kong real estate peers. FEC actively manages its assets in order to provide capital for its ambitious growth plans.

The company has identified HK$4.8-6.0Bn of assets for sale including completed apartments and some non-core hotels and car parks. For the hotels, FEC expects to hold new hotels developed for the Dorsett brand, but can sell hotels that it launches under other brands such as Ritz Carlton.

Investment Considerations

Hong Kong is the only major market where high quality real estate companies currently trade at extremely large discounts to NAV. Legitimate smaller companies are even available at discounts of 90% or more. A recovery in the Hong Kong economy and investor sentiment would result in very large gains across the board so investors could avoid company-specific risks by investing in a major index ETF. FEC shares seem to trade at a Hong Kong discount even though a majority of its assets are outside the territory and a majority of its development pipeline is in the UK and Australia.

While the Hong Kong business sector and office demand may prove more resilient than current bearish investor expectations, I believe a recovery in the hospitality sector is closer to a sure thing based on the city’s beauty, character, and rich culture. This list of The Best 100 Hong Kong Movies includes classics of world cinema. The city inspires people. The same source could only find 40 Best Singapore films and I’ve never heard of any of them. Hong Kong might not be the more comfortable place to live, but it’s a great place to visit.

These companies with significant exposure to the Hong Kong hotel sector are trading at an average price 47% lower than their close at 12/31/18, the end of the last normal year. This list includes companies with variety of business models including non-hotel and non-HK assets.

For comparison US hotel REITs are currently trading at an average price 19% lower than their close at 12/31/19, the end of the last normal year.

A comparable recovery in HK Hotel owners following a resumption in Chinese outbound travel would result in 53% share price appreciation.

Privatization – In recent years several prominent Hong Kong companies (e.g. Wheelock, Hopewell, and Li&Fung) have been privatized by controlling shareholders at premiums to trailing share prices, but substantial discounts to NAV. I don’t think FEC privatization is likely in the near-term because the Chiu family holding is well below the 75% HKSE cap so they can still buy shares cheaply in the public market, the company supported its shareholders with a substantial dividend even while profits were reduced by COVID, and the company’s public profile is probably a benefit in negotiating development partnerships in foreign countries.

UK Risk – FEC has a substantial long-term commitment to its Manchester Victoria North project. The company uses local currency project finance but still has equity exposure to currency movements. While the pound has fallen due to Brexit, FEC believes the value has made it more attractive for tourists and property investment.

Family Control means that FEC is managed on a dynastic time horizon. Chairman David Chiu has four children and his eldest daughter Winnie Chiu has the most senior executive position, the highest public profile, and seems destined to inherit the top spot. Some interviews with her:

• China Daily July 2018 describes Dorsett hotels market position and the Chiu family business history
• Bloomberg July 2021 discusses Dorsett Hotels response to COVID
• Hotel Journal August 2022 discusses the new Dao by Dorsett brand of long-stay accommodations

From 2019-2022 David Chiu purchased 159mm shares of FEC at prices from HK$1.73 to HK$3.79 and increased his stake from 47.2% to 51.6%

The Group’s target payout ratio is 30-40% of net profit. This should ensure that shareholders directly benefit from the growing value of the business and growing earnings.

Succession Risk. FEC has thrived under the management of CEO David Chiu (68), Managing director Chris Hoong (53 – a former investment banker who has been with the company since 2008 and I believe has no Chiu family relation), and Executive Director Winnie Chiu (42) who has worked at the company since 2005 and has managed the Dorsett Hotels business since 2010. The company has strong veteran local management in each country where it operates (UK and Australia). FEC appears to have a robust management group that is not overly reliant on any individual. The key current employees could remain involved for 20+ years.

Conglomerate Discount. Investors are unwilling to attribute full value to a diversified business and FEC has traded at a persistent discount to net asset value. Chris Hoong suggested that over time each of FEC’s operating businesses could be spun out as an independent entity:

In 2019 FEC was in advanced planning for a HKEX listing of stabilized income generating hotel properties in Australia, Singapore, Malaysia, and the UK. It would have been appealing to income seeking investors wary of Hong Kong exposure. COVID upended those plans, but the company is still seeking a way to achieve the same goal and most recently indicated that it is studying a combination of its Australian hotel assets with those of Star Entertainment (its Brisbane JV partner)

Target Price? – FEC’s share price is not far above its lowest level in 10 years and is at 83% discount to Net Asset Value. A discount to NAV target would be arbitrary and not especially meaningful because investors have not heeded such a guideline as a basis for buying shares. So this article has primarily focused on qualitative factors – is this a business that an investor can be comfortable owning? Is management building long-term value in areas where the company has competitive strengths? Does management and the controlling Chiu family deliver value to shareholders? Is the business poised to enjoy a cyclical upturn from the resumption of Chinese outbound travel? If an investor is comfortable with these issues then FEC shares may be attractive. A number … in 2018 shares traded between HK$3-4 … NAV is about the same, hotel occupancy and income will soon return to 2018 levels and there will be growth from new openings, and the quality of the residential development pipeline has never been better. So a share price return to HK$3-4 is my minimum expectation. If FEC is committed to corporate actions that will reduce the discount then investors have potential for greater capital appreciation.

Disclosures & Notes

At the time of publication the author held shares of Far East Consortium. The author does not make any recommendation regarding any investment in any company mentioned in this article.  Investors are encouraged to check all of the key facts cited here from HKEX filings and other sources prior to making any investment decisions. The author believes all information in in the article is accurate as of the date of publication. Any factual errors in the article will be correctly as promptly as possible. The author does not expect to provide any sort of ongoing coverage or commentary about Far East Consortium.

At the time of publication the author also held shares of K Wah International which was described in this 2017 Koneko article. Since that time K Wah’s NAV is +40.2% and its share price is -37.7%. K Wah’s residential property development business performed well during COVID. The value of the company’s strategic investment in Galaxy Entertainment was protected during the COVID travel collapse by that company’s large cash reserve. Relaxation of Chinese travel restrictions will lead to renewed buying interest in K Wah’s Hong Kong residential property developments and visitation to Galaxy’s Macau casinos.

Additional information about Manchester is available in this documentary

Calculation of long-term total returns for different stocks will vary due to assumptions about dividend reinvestment and treatment of rights offerings and equity dividends. The table in this article used data from the free public site of well-known Hong Kong investor David Webb who provides a very detailed explanation of his methodology. Looking at 5 HK Property companies with the highest 2003-2022 returns should give a sense that if you picked a different starting date then you could get a different relative ranking, but companies with high long-term returns and low current valuations are appealing candidates for study.

Far East Consortium is not related to Singapore-listed Far East Hospitality or its manager Far East Organization. Perhaps FEC will change its name at some point. The “Far East” name is out of sync with the increasingly domestic nature of the UK and Australian businesses. It’s also anachronistic, almost like “Oriental”.