Ripples in Hong Kong

Hong Kong-based property developer Sun Hung Kai Properties, or SHKP (HK: 16, OTC: SUHJY) was hit hard last week, after co-chairmen and brothers Thomas and Raymond Kwok were arrested by Hong Kong’s Independent Commission Against Corruption (ICAC) in a bribery probe.

Former Hong Kong Chief Secretary Rafael Hui also was arrested on the same suspicions of graft. The arrests shocked the Hong Kong business community and sent shares of SHKP down 13 percent the same day.

Transparent corporate management hasn’t been Hong Kong’s forte, but SHKP always has been viewed as one of the best-run companies in this city-state, which is governed by the Chinese as a special administrative region (SAR). The body blow suffered by the company’s shares indicates that investors’ trust has been seriously shaken, for the time being.

However, investors should keep the arrests in context and remember that the political world of Hong Kong is a murky one.

The Kwok brothers took over management of the company in 2008, after ousting their brother Walter Kwok in a bitter boardroom battle. Previous to the Kwok arrests, the ICAC had arrested Thomas Chan, an Executive Director of SHKP, but he has been released and is back at work with no charges pending against him. Likewise, the Kwon brothers were released the same day of their arrests and are expected to continue running the company while the legal process takes its course. Finally, the ICAC is probing outgoing Chief Executive Donald Tsang for accepting trips on the yachts and planes of tycoons.

Until the dust settles, Hong Kong property stocks in general and SHKP in particular will perform weaker than the broader market. It’s difficult to predict how the imbroglio will play out; it could reach resolution relatively soon or linger for months.

SHKP’s stock will remain under pressure as long as the scandal drags on. However, the good news for long-term investors is that the stock is now clearly undervalued based on its fundamentals. The company remains the premier property developer in Hong Kong, boasting some of the best properties in the SAR and strong cash flows.

SHKP’s investment property portfolio holds a gross floor area (GFA) of 34 million square feet, of which 28 million square feet are located in Hong Kong, representing 8 percent to 9 percent of the SAR’s total square footage. This investment property portfolio generates roughly USD1.3 billion each year in net rental income and is one of the fastest-growing rental portfolios among all of Hong Kong’s property developers.

The company also possesses a solid hotel operating division that has been a big beneficiary of the growth in Hong Kong’s tourism. Almost 42 million tourists visited the SAR last year, the highest tourist tally in Asia and a remarkable achievement for a city-state of seven million people.

Tourist-related receipts now represent 14 percent of Hong Kong’s gross domestic product (GDP) and tourist shopping accounts for almost half its retail sales. Consequently, hotel rates and retail space rentals have been rising. The corruption probe won’t substantively affect any of SHKP’s daily operations, although the uncertainty does affect the stock’s price.

We’ll continue to monitor the situation. If more selling occurs, the downside probably won’t exceed more than 15 percent from current levels. In the meantime, the selloff represents a solid entry opportunity. SHKP remains a buy.

 

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