Post-mortem of Metro Holdings Divestment

Investment History

I first initiated a position in Metro Holdings back in 2012, at a price of $0.64 then. The reasons for investing were mostly based on valuations, and the fact that Metro Holdings seem to be misunderstood. (more on this later)

Metro has been great at giving out dividends as well, and even excluding this year’s bumped 7 cent dividend which I did not collect, I still collected a total of 22 cents in dividends since 2012.

Aside from the initial position at $0.64, I added to my position at $0.69, $0.72 and most recently, at $0.88. My average price for 350,000 shares was $0.75.

Since then, I’ve divested 150,000 shares at $1.06 in May 2016 (Portfolio Changes – May 2016), and the remaining 200,000 this week at $1.025-1.03.

This results in a net quantum gain of 38.67% over 4 years, or a profit quantum of  $101,500.

This is excluding dividends (Portfolio performance page says inclusive of dividends but this is not for Metro as the position was built up at different times in different years)

The dividends collected would amount to approximately another $60,000 for an estimated total gain of $161,500 in 4 years.

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Why did I invest in Metro Holdings?

After analyzing in depth, I realised that Metro Holdings could hardly be considered a retail setup. 90% of it’s revenue comes from retail, but that accounts for <10% of it’s net profit. 10% of the revenue comes from property, but that accounts for 90% of the net profit.

Check out the consolidated figures I painstakingly compiled.

The gross profit margin (when I first invested) was a very impressive 32.22%, with equally as impressive margins in the prior years.

But what pops out is the net profit margin.

How often have you seen a company where the NPM is >>> GPM CONSISTENTLY every year?

Not to mention that the NPM is ridiculously high. (97.6%?!)

The reason for this very unusual margin is because of all the one off gains and extraordinary items in the income statement……. except that, they aren’t extraordinary at all.

Every year we see some sort of “extraordinary items” from asset disposals, from joint ventures and from associates results.

Metro doesn’t just earn via the traditional retail and the traditional renting out of property etc.

They behave just like a hedge fund (without the fees). Their main business is actually capital allocation, specifically in the property sector.

There are several “not so extraordinary gains” over the course of the past 4 years since I’ve vested, but off the top of my head I can recall the divestment of the Frontier building, the EC malls, the Tesco lifespace malls (together with Tesco), Gurney Plaza, Metro City Beijing, Metropolis Tower Beijing, together with the reverse negative accounting after consolidating Top Spring International as an associate. (Basically Top Spring has been accounting based on a “completed contracts method” whereas Metro feels it should be a POC method and has recognised a “profit” by changing the method of recognition)

I used to walk into a Metro store, stand around and observe the counter for an hour or so just to have a gauge of how well the sales are doing. Until I realized it’s ridiculous to do so as retail is a very small portion of what Metro does.

It’s their heritage. But not their future. Not even their present.

I’ve previously described this in an earlier post:Metro Holdings – A New, Old CEO

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Why divest now?

In short, as with all capital allocators, inevitably there will be a time when you’ve to divest and reinvest. Metro Holdings is at the stage where they’ve successfully divested and recognized the fruits of their work previously. They’re cash rich (hence the bumper 7 cent dividend), with no debt, and are in the midst of allocating capital again.

I think the new investments will struggle to perform as well as previous investments.

Even if they do eventually show results, unfortunately this is the start of the capital allocation cycle. It’ll be quite some time before the projects eventually show results, IF they do in the 1st place.

Let me dissect the prospects in greater detail. This is a list of where the future growth/earnings may come from:

1. Retail stores
2. 60% owned Metro City and Metro Tower in Shanghai
3. Subsidiary 100% owned GIE Tower in Guangzhou
4. Shui On Land
5. Top Spring International
6. JV with Wingstar and Maxdin (The Crest condo project)
7. JV with Top Spring International (Nanchang Fashion Mark)
8. 30% stake in Shine Rise (Shanghai Shama Century Park)
9. Fairbriar Real Estate Ltd (Scarborough Real Estate Limited) (Milliners Wharf The Hat Box & Middlewood Locks projects in UK)
10. Scarborough DC Limited (Sheffield Digital Campus project)
11. InfraRed NF China Real Estate Fund II
12. Other liquid investments eg. REITSs, dividends, financial instruments

Alright. This is literally everything that Metro Holdings is involved in. I don’t think I missed out anything

Red indicates that I’m pessimistic about the venture/project.

Blue indicates that I think it’ll do fairly well

Grey indicates that the jury is still out on this/neutral

1.   Retail Stores

This is a no brainer. It’s no secret that all of retail is currently undergoing tremendous stress and the outlook is not getting any better. Metro has tried to diversify geographically by going into Indonesia but even then, as a whole, the retail portion has either contributed minimally or even gone into the red.

The latest store, Metro Centrepoint, would have renovations completed by now. Still, I don’t think this business will contribute positively.

It is just a really tough sector to be in right now.

In FY16, Retail contributed a revenue of $146,095,000 out of the total revenue of $154,595,000, and yet accounted for a profit of only $144,000 out of total profit of $122,332,000.

In FY15, Retail segment was loss making.

I’m expecting the retail revenue to rise in FY17, due to the full year operations of Metro Centrepoint (renovations are completed). Still, it is going to be only slightly profitable, or even loss making again.

2.   Metro City and Metro Tower

It is telling that as all of the other assets that Metro owns gets divested, only these 2 are held steadfastly. On top of that, Metro City has been undergoing asset enhancement works to increase it’s retail space. Metro City is a retail mall, while Metro Tower comprises mainly offices.

To have an understanding about how these 2 assets will perform, one would obviously need to have an idea how the general property market in Shanghai would do.

According to the official stats in 2015, retail/commercial property rents continued to rise in Beijing and Shanghai, but dropped/ remained stagnant in the 2nd tier cities.

Vacancy rate in Beijing is the lowest in China at 5.2%, followed by Shenzhen at 6.2%

“Supply in prime areas in the 1st tier cities will remain limited, most of the expansion is in the outskirts/community malls, or in 2nd tier cities. Prime areas will continue to see growth in rents.”

As we can see, the occupancy rates of Metro City and Metro Tower has traditionally been very high. The dip in occupancy rates for Metro City to the high 80s% in FY13, 14, 15 and 16 is due to closure of certain levels for asset enhancement, and subsequent development and increase of more retail space available. Currently, Metro City is undergoing the last 2 levels of asset enhancement, which is why occupancy is only 88.2%

Metro City and Metro Tower enjoy certain competitive edges due to their locality. I think Metro has been wise not to divest them thus far, and instead, worked to improve on the assets.

In fact, one of the potential catalysts for Metro, would be eventual divestment of these crown jewels after the asset enhancement has been completed.

Knowing how Metro Holdings operates, they have traditionally worked to improve on the assets, and enhancing and increasing the yield by increasing occupancy rates, they have not been shy in divesting them.

Both Metro City and Metro Tower recorded an increase in their valuations in FY16, and I am expecting further small increases in FY17, of course, barring any major property market crashes in China.

As Metro City and Metro Tower are not fully owned by Metro Holdings (60% owned), their results are parked under “Share of joint ventures’ results, net of tax”

This share of joint ventures’ results has contributed $63,017,000, $28,555,000 and $68,160,000 in FY 14, 15 and 16 respectively.

In FY16, this “joint venture results” comprises results from:

• Metro City
• Metro Tower
• EC Mall (which has since been divested) (Contributed $41.7mil)
• The Crest

Bearing in mind that this $68.16mil in FY16 includes $41.7mil from the EC divestment, if there are no divestments in FY17, this “joint venture results” will be much much lower than FY16.

The Crest condo project is also not doing well currently. They will have to ramp up marketing or face additional ABSD charges as the deadline is due in Sept 2017. More on this later.

So how did Metro City and Metro Tower fare in FY16?

Nordevo is the holding company for the 50% stake in EC Mall.

Both Metro City and Metro Tower increased their profitability in FY16. Barring any major shocks, it’s safe to expect further slight increases in profitability in FY17.

3.   Subsidiary 100% owned GIE Tower in Guangzhou

Alright, let’s move on to the GIE Tower. At this rate and depth that I’m covering, this post will end up to be way longer than what I intended it to be. (Many outstanding earnings results to analyze)

The results from the GIE Tower will appear within the “Revenue” instead of a separate column, as GIE Tower is 100% owned by Metro Holdings and is thus a subsidiary.

I’ll reproduce the property portfolio chart here again:

As one can see, the occupancy rates has not fared as well as the 2 other properties in Shanghai. That’s in line with my research into how Guangzhou office properties has been doing in recent years.

As we can see from the earlier property valuations chart taken from AR 16, the valuations or GIE Tower has also dipped slightly in FY16, from $108miil to $100mil currently.

The properties that are fully owned by Metro Holdings are marked to market annually. This means that any increase or decrease in the valuations are recorded in the income statement, under “(Deficit)/gain from fair value adjustments on investment properties”

Metro Holdings recorded -$813,000 in deficit for FY16, this comprises the GIE Tower, Lakeville Regency in Shanghai and the Frontier Building in Tokyo (which has since been divested)

Let me digress a bit here. Frontier Building has been divested, and if u read many reports, including the news article about the divestment and the news release by Metro Holdings themselves, this divestment has been held up as being profitable to Metro Holdings, and supposedly “good news”.

I quote: “The Divestment of the Property is expected to result in a gain on disposal of investment property estimated at S$4.0 million on completion. “

But is that true?

Frontier Building was acquired in FY11Q1 for S$ 89.7 million.

Subsequently, Metro proceeded to depreciate the asset over the years, such that at the point of divestment in FY16Q2, it was carried in the books at S$54.8 million.

With the divestment in FY16Q2 for JPY5.22 billion or approximately S$58.7 million, the asset yielded a “gain”

Having tracked the occupany rates, I do think Metro has done it’s best to enhance this asset. It’s hard though as this property has had like 5 or  6 tenants only, and these tenants are mostly government linked institutions and bodies.

Still, the news related to this is highly misleading. If you bought a condo property for $1mil, and every year you “write off” the value of the condo by $100k (or pay down the mortgage) such that at the end of 5 years you tell yourself that this condo is now worth $500k, and in the following year you then proceed to sell this condo for $800k, would you happily trumpet this as a $300k “gain”?

Oh btw, did I mention that this Frontier Building is freehold? In my experience, nobody depreciates a freehold building. But admittedly, perhaps this is common practice for Japanese buildings.

I am not faulting the divestment, just bringing this up as an example of how if one invests by simply reading the news (and doing simple stuff), it is likely that you won’t have an accurate picture of what’s going on.

4.   Shui On Land (SOL)

This seems to be more of a passive investment for Metro Holdings. Metro has not proceeded to do any JVs with Shui On Land, instead preferring to work with Top Spring International.

A bit of history here:

Metro Holdings bought convertible redeemable participating preference shares in Shui On Land in 2004. At that time, SOL was not listed. Metro paid USD 50 million for these preference shares.

These preference shares converted to 3.5% of SOL shares during IPO in 2006, amounting to 139.2 million shares, of which 1.7% was disposed of. (60 million shares disposed at HK$5.35)

Well, Metro must be wishing they’ve divested everything. Since IPO, SOL’s shares has done this:

well, the chart is not a pretty sight obviously.

But let’s work through the math.

Metro invested USD 50million, and sold 60million shares at HK$5.35.

That works out to be HK$321million, which is USD 41.7million.

Metro Holdings management obviously decided to sell out at IPO to recoup the USD 50million that they have invested. Whatever value in SOL currently is considered “profit”

So on the balance of things, SOL has not exactly been a poor investment per say, but I think Metro is making the mistake of forgetting that all investments are time weighted in nature.

Sure, the investment has been profitable if you peer into the dollars and cents of it, but every day that passes where the SOL share price languishes, that weighs on your investment returns. And certainly one has to view SOL as purely an investment, since Metro has not garnered any other advantages or worked with SOL on anything else.

As an investment, Metro is getting paid a paltry miserable dividend, and holding on to the stake while waiting for the price to rise is not wise either. It can languish like that indefinitely. Perhaps Metro regrets not selling out when the price hit HKD10, and cannot bear to sell out at the current price. (There’s some investing bias term for this, I can’t remember the name right now)

Overall, my outlook on this is neutral as all Metro does is to record any rise or fall in the share price as investment gains or losses. The dividend isn’t much to shout about. 

I’ll admit I didn’t spend much time looking into SOL’s financials. A quick look though, and I’m not particularly impressed. I think the share price has hit a bottom, but will likely stay around where it is currently at in the near future.

5.   Top Spring International

They’re really unlucky huh. That pretty summarizes what I feel.

Since Top Spring has a closer working relationship with Metro, and is accounted for as an associate of Metro Holdings, I decided to spend some time analyzing it’s prospects as what I’d have done if it’s a standalone investment by itself.

Top Spring International is currently divesting a HUGE amount of it’s property assets. to Sunac. Here’s the official announcement:

http://www.aastocks.com/en/stocks/news/aafn-news/NOW.735477/1

In another related announcement: “It is estimated that the Group will record an unaudited net loss before taxation of approximately HK$215.4 million from the Disposal”

On 22nd July 2016, the total consideration was reduced from RMB4,394,070,000 to RMB4,225,230,000. What has changed?

Basically Top Spring has a 51% stake in “Sanhe Xue Zhe Zhi Jia”. The remaining 49% stake is held by Beijing Huaxia. If Top Spring wants to divest, Beijing Huaxia has right of first refusal. This is the norm usually in this kinda 49-51 JVs type.

Initially, Top Spring was planning to divest all the other properties, including “Sanhe Xue Zhe Zhi Jia” to Sunac. If they could dispose to Sunac, Top Spring would’ve booked a profit of HK$551mil, resulting in a overall net profit of HK$336mil.

Unfortunately for Top Spring, Beijing Huaxia decided to cough up money to buy up the remaining 51% stake from Top Spring for RMB 446mil, and Top Spring still has to repay intercompany loans of RMB40.52 million.

If Top Spring could package and sold all these properties to Sunac, they’d have recorded a net profit instead of having to record a net loss of approximately HK$215.4 million from this disposal.

In addition, the disposed companies were losing money to the tune of HKD233.8mil in 2015

Aside from this loss making divestment, the financials of Top Spring seem to be improving:

In Q1, Top Spring recorded a quarterly profit of HKD36.38mil, a turnaround from the loss of HKD25.94mil a year ago. However, much of it came from “valuation gains on investment properties”, and we all know how fickle these valuation gains can be.

TBH, I was considering for a long time whether Top Spring should be classified as red or neutral. It’s share price has fallen substantially, and it seems to be forming a bottom.

More importantly, they have sold a chunk of assets and recorded the loss. Property sales has been improving in 2016 too. After much consideration, I decided to still go with red though, as I am overall pessimistic about HK and China property market, and the PE ratio is still rather high for a developer. (yes, even after the sharp fall in share price)

6.   JV with Wingstar and Maxdin (The Crest condo project)

Again, it’s rather obvious that this is not going well.

This is a JV with Wingstar and Maxdin to develop 23,785.4 square metres of 99-year leasehold land parcel located at Prince Charles Crescent, Singapore.

The land was acquired at the price of S$516,298,888. ($960 psf per plot ratio). The est. break even price is $1,450 psf. (I got this from an earlier news report when it first got announced, no other due diligence goes into determining this)

Sales of other condos nearby at the point of land acquisition was good: Echelon ave $1,815 psf, Mon Jervois ave $2,143 psf.

Times have changed though.

The Crest is now struggling to move units.

In Nov 2015: 90 units out of 469 units sold, at ave price of $1,705 psf

In July 2016: 124 out of 469 units sold, at ave price of $1,730 psf

The Crest has an ABSD deadline due in September 2017, failing which they’d have to pay $64.5mil in taxes. From Nov 2015 to July 2016 though, they’ve only moved 34 units. Now, they’ve just over a year to sell the remaining 345 units.

Yes, that’s 345 units that’s unsold.

The fact that they have not cut the psf selling price for The Crest tells me 1 of 3 things:

• They think that there shouldnt be a problem selling at $1,700+ psf, the remaining 345 units, within a year. (IMO, this is a fantasy)
• They plan to maintain the selling price relatively high, in the hopes of having more room to discount the price and do a bulk sale to an investor.
• The breakeven selling price that’s projected is actually much higher and they can’t cut too much or risk incurring losses.

Either way you cut it, The Crest is just not doing that well currently. IMO, the selling price has to come down substantially in order to move the remaining 345 units within the next 12mths or so.

7.    JV with Top Spring International (Nanchang Fashion Mark)

Just so that we’re clear on this, when it’s classified as red, I mean that it’s likely to perform poorly/below expectations GOING FORWARD. It’s not indicative of the entire investment per say.

Nanchang Fashion Mark hasn’t done too poorly thus far. Going forward though, it’s likely to fare much worse and contribute much less than before.

Metro Holdings said so themselves.

“As the majority of our Nanchang Fashion Mark project’s presales of residential and ancillary retail properties of the residential sites have been recognised, going forward, the project’s contributions for the subsequent phases will primarily be from recognition of presales of commercial space. On that front, we are encouraged by the presales of these properties, which largely comprise office and skirt retail space, as almost half of the project’s next phase has been presold. However, the gross margins of the office component, as indicated following the presales, were reduced and will continue to be significantly lower than that of the residential properties.“

How much lower is it going to be? Metro didn’t say.

Fortunately though, I digged around the other partner in this JV, Top Spring’s financials:

In Q1 up to Mar 2016, 12,670sqm of area was sold for $222.3mil HKD. ASP of Nanchang fashion mark is HK$17,545/sqm

For 1H 2016, 27,759 sqm of area was sold for 445.5mil HKD. ASP of HKD16,049/sqm

(ASP = average selling price)

The data pretty much confirms what Metro says: Nanchang Fashion Mark is selling units (they record the amount of sqm of area sold), but the margins are much lower, and have continued to drop.

This is a crucial point to note. Why?

Simply because for FY16, of the total profit before tax of $122.3mil that Metro recorded, $46.7mil comes from Nanchang Fashion Mark.

This is recorded under “Share of associates results”. This share of associate results accounted for $75.66mil in FY16, and is the cumulative results from Nanchang project, Top Spring associate results and the InfraRed NF China Real Estate Fund.

Since Nanchang Fashion Mark accounted for 38% of Metro Holdings PBT, any drop in margins for Nanchang Fashion Mark is going to hit Metro Holding’s margins too.

8.   30% stake in Shine Rise (Shanghai Shama Century Park)

This has been valuted in the AR as one of the gems for FY16. Metro holds a 30% stake in this serviced apartments project, and the occupancy and rental yields has been good in FY16..

This also ties in with my prior research earlier: In the 1st tier chinese cities, location is all that matters. In a good location, the prices are highly resilient. A similar project not far away can have much much lower demand.

Similarly, all the lower tier cities may have tanking property prices, but with the right location in Shanghai (Metro City and Metro Tower), valuations are completely unaffected.

Ave occupany for Shanghai Shama Century Park (FY16Q4) is 78.3%, and the valuation is $368mil. 78.3% doesn’t sound like much , but bear in mind this is a serviced apartment project.

I think Shine Rise will continue to do well for FY17, and contribute positively to Metro Holdings earnings.

In addition, during FY2016, over one-third of the Shanghai Shama Century Park serviced apartments were disposed by Metro Holdings.

Again, this ties in with my earlier comments about Metro Holdings being more like a hedge fund focused on property. Upon realizing that the project is adequately valued, Metro Holdings has traditionally not been shy in recognizing profits, and reinvesting them elsewhere.

9. Fairbriar Real Estate Ltd (Scarborough Real Estate Limited) (Milliners Wharf The Hat Box & Middlewood Locks projects in UK

Metro Holdings has a direct 25% stake in this project, and an indirect stake via Top Spring, which also owns 25%.

The good news: Milliners Wharf The Hat Box is fully sold.

The bad news: The proceeds from any sales will be in pounds. And we all know what Brexit did to the pound.

Middlewood Locks is not fully sold yet, and it is debatable what effect Brexit has. On the one hand, the all time low pound makes this more attractive to foreign investors.I assume it also makes the costs of construction lower (again assuming no locked in/committed costs)

On the other hand, Brexit’s effect on Britain’s economy is well documented. Britain will likely experience a recession in the near term. Any proceeds and profits will also be in weakened pounds. Much of the earlier investment that Metro has sunk into this, is done at an exchange rate that is much higher than what the pound is at right now.

On the balance of things, I’m overall pessimistic about Metro’s foray into the UK market because of this 2 things: the much weaker pound and Britain’s economy in the mid term.

Metro would’ve been fine if Brexit and the subsequent crazy fall in the pound happened way before they ventured into Britain. But unless Metro predicted Brexit, the pound’s drop would’ve been the equivalent of a black swan event for Metro. They certainly have to go back to rework their sums.

I’ll again temper the pessimism here with a word of caution: I’m talking about the extent of contribution the project will have here.

I do not think that Metro will incur losses, just that the investment gains will not be as pretty as prior years. That translates to lower earnings, not an overall loss.

Unfortunately, lower earnings itself translates to an impact on Metro’s share price. It is highly unusual for the share price to rise AFTER reporting lower earnings, regardless of how high this lower earnings actually is.

I know that statement sounds confusing, but what I mean to say is that imagine the company has a EPS of $5, and in the following year it earns $4. Now, $4 may be a great amount to earn based on the equity base, or based on the capital base. The ROIC, ROA and ROE figures may all be astronomically high with $4 in earnings, but the news is going to report that the EPS has dropped by 20% y-o-y. All that translates to a negative impact on the share price.

10.   Scarborough DC Limited (Sheffield Digital Campus project)

My concerns for this would mirror that in 9. The completion of this project is scheduled in late 2017. Metro agreed to acquire a 50% stake in this project for 1 million pounds, and extend a further 18million pounds in working capital loans.

Just to illustrate my concerns above:

In the most recent FY16Q4, Metro transferred SGD 2mil for this JV. This SGD 2mil (=1mil pounds), is at a time before Brexit when the pound – SGD rate is 2+

The good news is that the 18mil pounds in shareholder loans, will likely cost Metro Holdings much less in SGD terms.

Again, as I mentioned earlier, subsequent profits (which will be in pounds) will be  much lower.

Here, I’ll acknowledge that there can be a WIN scenario for Metro. That is during this period of investing, the pound is weak. When the JV is trying to sell units, the pound is weak. Upon conclusion of the entire project, UK and the pound recovers, and Metro nets a nice currency gain on top of profits.

Since I am no currency expert, (I dont think anybody really is tbh), I will have to base my projections on hard, current facts though.

11. & 12.

There hasnt been much movement or news with regard to the InfraRed China Fund. Metro also doesn’t break down it’s investments in REITs so there isn’t much to be said here.

I am, thus fairly neutral regarding these 2 investments. It is hard to comment until we see more activity here.

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Having worked through each of the projects Metro is and will be involved in in the foreseeable future, I think it is not difficult to have a fair idea of how the earnings picture will look like.

The only caveat is asset divestments. I cannot predict when these extraordinary gains can pop up, and Metro does have a long track record of divestments and reinvestments. Metro City and Metro Tower would be obvious targets, but I personally think that Metro management wants to keep these crown jewels for the rent.

On a valuation side, despite divesting at a near term high, the valuations are still quite low.

At the ave $1.04 price that I divested, the price is still only 63% of NAV, with a PER of 7.6

On top of that, shareholders would’ve received a 7 cent dividend. I am glad to have divested before ex-div date though,as the share price has dropped >7 cents upon ex-div status.

The company is also extremely cash rich, with 0 debt. Current cash holdings of $493mil is the one of the highest it has been in the past 7 years, with only FY12 being higher at $543mil.

Finally, I’ll end by sharing a little note that I wrote down in the earlier part of 2016:

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CONCLUSION

While I do not think Metro Holdings is overvalued, my reason for divesting out of this long held stake is because I think most of the undervaluation is gone. The risk:reward ratio is no longer as compelling as before, and I think there are more speed bumps than catalysts in FY17.

True to the nature of this blog, I’m looking out for DEEP VALUE & CONTRARIAN opportunities, and Metro Holdings at $1.04, may be reasonable valued, but is certainly not deep value or contrarian.

I also expect a cut in dividend from the current 7 cents in FY16. FY17 would likely have a much lower dividend.

As with all my divestments, I’ll continue to monitor the company for future attractive entry points as I think my in-depth knowledge of the company built up from years of monitoring the investment, forms a strong competitive edge for me.

As always, I welcome and greatly appreciate comments, counter arguments and opposing thoughts.