Buoyed by a property boom in Macau - the Asian gaming industry equivalent of Las Vegas - and Mainland China's western Pearl River Delta, the company’s portfolio of well-positioned residential, retail and logistics property assets soared in value by an eye-watering $110m to $565m (£340m) last year. In turn, this lifted underlying net asset value per share by a quarter to US$4.95, or 299p at current exchange rates.
It’s hardly a surprise that shares in the company have been making significant headway too. Post results they hit an all-time high of 242p, up 36 per cent in the six months since I initiated coverage at 177p ('Far eastern delight', 6 September 2013). There have been multiple repeat buying opportunities in the interim as I reiterated the advice when the price was 193p (‘Blue sky territory’, 24 September 2013), again at 206p (‘Hot property plays’, 12 November 2013) and in my end of year round up at 210p (‘Seeking income and safety at a reasonable price’, 17 December 2013). Each of these updates was in response to a relentless flow of positive news.
It would be easy to bank profits now, but I strongly believe that would be a mistake. In fact, there are compelling reasons to maintain my buy recommendation. Firstly, there is no overhead resistance to stop the share price from making further gains. The whole point about charting is to identify a trend and follow it until it ends. In this case, there is little to suggest that last week’s high was a major top. The 14-day RSI has a reading in the high sixties so is not too overbought; the share price chart has just signalled a major breakout above 225p; and the 20-day moving average is rising rapidly and at 225p is modestly below the current share price. From my lens, the break-out is the real deal and should be used as a buying opportunity.
Strong economic dynamics driving property values
The positive technical set-up aside, the fundamental case to invest is as strong as it ever has been, driven by Macau's gaming industry.
Last year, Macau’s gaming revenues rose by 19 per cent to $45.2bn (£27.2bn), and that follows on from a 13 per cent rise the year before. To put this figure into some perspective, that is six times greater than the gaming Mecca of Las Vegas. A growing middle class in China, and ongoing urbanisation in the tier one cities in the country, has led to a boom for tourism in Macau, a situation that is highly supportive of the province’s bumper economic growth. Interestingly, China’s target is to increase its urban population from 52 per cent of the total to 70 per cent by 2025, implying 250m people will be moving into the cities in the next 11 years and increasing the target group for Macau’s tourist industry.
Consequently, analysts predict that Macau’s gaming revenues will rise by a further 70 per cent over the next four years to $77bn by 2017. Even that could be conservative because US investment bank Wells Fargo forecast that gaming revenues could hit $107bn by 2018.
Economists also predict that Macau’s GDP growth will be in the region of 12 to14 per cent this year which doesn’t seem unrealistic considering the robust trading in the gaming industry. Moreover, a tight labour market, and unemployment of only 1.8 per cent, means that monthly median earnings of Macau’s residents grew 15 per cent year-on-year to $1,877 in 2013.
In turn, the combination of booming spend by tourists in retail outlets, coupled with rising incomes for Macau’s residents, is sending retail sales surging. Indeed, in the third quarter of 2013, retail sales increased by almost a quarter to $1.95bn on the same period in 2013. In the circumstances, it’s hardly a surprise that these strong drivers have been forcing up property prices and rental values for luxury brands and high-end retailers. It also means that demand for the company's apartments is well underpinned too.
The inflow of gambling mad tourists has also been creating one almighty hotel boom in Macau to service the increasing number of visitors. Currently, there are only 27,773 rooms spread across 97 hotels. By comparison, Las Vegas has 150,000 rooms even though Macau generates six times more revenue from its gaming industry. Even neighbouring Hong Kong has 70,000 rooms. So, with Macau’s hotels boosting an eye-catching 80 per cent occupancy rate, the race is on to build another 20,000 rooms in the next four years to meet demand. This will clearly give a boost to the economy, further underpinning the residential property market servicing Macau’s population of 558,000 residents and second homes for visitors. It’s also good news for Macau Property given that 70 per cent of its portfolio is in residential, 17 per cent in retail and the balance in warehouses.
Risk factors
It’s a fairly compelling story although there are risks worth considering given the heavy reliance on China to drive the double digit growth rates in Macau’s economy. The most obvious one is a slowdown in China’s economic growth as the country moves towards a consumption-led model.
It’s also worth pointing out that there has been a 20 per cent rise in property prices in China’s tier one cities in the past year, increasing the chance of a correction which would have negative implication for tourism in Macau. There are potential threats from overseas too including from new gaming destinations in the Philippines and Japan. But given the immense scale of Macau’s gaming industry and its proximity to China, I feel that it should be able to see off these challenges.
Possibly more threatening is a change in the interest rate cycle in the U.S. as this could lead to a liquidity drain from emerging markets, and the ones that have benefited from hot money flows in the past five years. However, I still expect the fundamental drivers of Macau’s economy to be strong enough to withstand the impact of any modest monetary tightening by the US central bank.
So after taking all these risk factors into consideration, I firmly believe that the balance of risk is skewed to the upside especially since Macau Property Opportunities has an enviable portfolio of properties and an investment strategy that will see shareholders enjoy substantial cash returns in the coming years.
Return of capital
At the end of last month, the company completed on the $64m (£40m) sale of its Zhuhai properties, APAC Logistics Centre and Cove Residence. That price represented a 34 per cent uplift on the valuation at the end of September and means Macau Property made a hefty $29m profit on the deal, all of which will be returned to shareholders shortly through a 21p a share distribution.
In addition, and having consulted shareholders, the board are proposing at a forthcoming EGM that not less than 50 per cent of any future net profits from asset sales will be distributed to shareholders. This virtually guarantees some hefty cash distributions.
The board are also being pretty smart when it comes to buying back its shares to narrow the discount to book value. In August, the company purchased 1.5m of its shares at 168p and acquired a further 5m shares at 202p in December. Since the buy back programme started in May 2011, Macau has bought back 22.26m shares at an average price of 146p to shrink its issued share capital by over a fifth to 82.7m shares.
It's a smart strategy because, by repurchasing shares in this way, the company is immediately enhancing net asset value per share and taking institutional stock off the market. As a result, this stock repurchase mechanism is helping to underpin the steady increase in the company's share price. Furthermore, share repurchases remain a top priority as long as the share price trades on an unwarranted discount to the book value. In other words, it’s only reasonable to expect the share price discount to narrow further as additional repurchases are made.
The board also has the financial flexibility to do so because the $565m portfolio only had a loan-to-value ratio of 21 per cent at the end of last year, and that was before accounting for the outstanding $58m of consideration (less $6.4m held in escrow until August 2014) due from the APACs sale which completed after the period end.
Anomalous valuation
In my opinion, a 20 per cent share price discount to book value is not only an attractive valuation, but an anomalous one considering the growth potential in the company’s residential assets.
For instance, Macau Property has just received formal government consent for the architectural plan for its Senado Square retail development, situated in the heart of Macau’s vibrant shopping district. The 70,000 sq ft development has just been revalued at $100.6m, up from $73m at the end of June, reflecting record rents achieved for properties in the UNESCO-listed heritage centre. The valuation is based on a $55 per sq ft rental value, 10 per cent higher than at the time of the previous valuation. Macau Property acquired the site for $16m and the development cost is $21m, so the company is already sitting on bumper gains. Analysts at brokerage Liberum Capital calculate that once developed Senado could add a further 27p a share to the company’s book value. The plan is to market the development for sale as a prime retail development once the units have been leased out.
We can also expect more valuation upside from The Fountainside, a development of 38 apartments and four villas encompassing an area of 80,000 sq ft and which has been revalued at $73.3m at the end of December, a 13 per cent increase in the latest six month period and up from $42.2m in June 2012. Macau Property is investing $22m in total in The Fountainside and has to date pre-sold 22 apartments. The remaining four villas (accounting for $15m of the property’s value) and 16 apartments are currently being marketed for sale.
It’s well worth considering that the first sales in the scheme (in late 2010) achieved average capital value of HK$4,500 per sq ft (£360 sq ft). However, analysts at brokerage Liberum Capital believe that prices of HK$9,500 per sq ft (£760 sq ft) are achievable on the remaining sales. Assuming half the sales complete at these prices in the second half of this year and first half of 2015, then by my reckoning this could add a further 16p a share to Macau Property’s net asset value.
The good news story doesn’t end there either as Macau Property also owns The Waterside, a 148,000 sq ft development of 59 luxury apartments which has been valued at $268m, up 21 per cent in the second half of 2013. Rents in the residential tower are now at record levels and occupancy rates have hit more than 90 per cent. Average monthly rental rates have risen from HK$22.30 to HK$23.57 (£1.80) on a per-square-foot basis, representing a near six per cent increase in the past six months alone. So, with rental values strong and the development accounting for 47 per cent of the portfolio, then expect further rental increases to feed through to higher valuations.
Upgraded target prices
Needless to say, having seen my 230p target price smashed last week, I am upgrading my target price. Analysts at brokerage Liberum have done the same and raised their own target price from 234p to 286p post the company’s interim results. This is based on Macau Property’s net asset value per share rising to 318p by the end of June, to 336p by December and to 345p in June 2015.
I have a strong feeling they could be right given the anticipated valuation uplifts from the development pipeline I have outlined in my analysis. As a result, I am lifting my fair value target price to the range 275p to 290p to factor in the 21p forthcoming capital return and valuation uplifts in the full-year numbers.
Trading on a bid-offer spread of 238.25p to 239.5p, I rate Macau Property’s shares a buy and have a six month time scale to achieve my target.
Please note that I am currently working my way through a very large number of updates following the release of trading statements and financial results from several of the companies on my watchlist. These include announcements from other 2014 Bargain shares in this year’s portfolio, Barratt Developments (BDEV) and Taylor Wimpey (TW.) and last year's constituent, Heritage Oil (HOIL). I will also be publishing investment updates following announcements from Bovis Homes (BVS), BP March & Partners (BPM) and First Property (FPO).
