Monday, July 11, 2016

It is frustrating to see this Chinese property agency business so cheap: Hopefluent (733.HK)

Hopefluent (733.HK), Among the largest property agencies in the country

One of the most frustrating value investments in Hong Kong for us has been Hopefluent (733.HK). 
Hopefluent is the dominant property agent in Guangzhou, the largest city in Southern China, with a population of 12 Million residents. To give you an idea of scale, that's more than the population of Belgium.
Like any other property agency business, Hopefluent generates revenue through sales commission. In China however, secondary property market is still nascent and primary market dominates the transactions nationwide. For Hopefluent, primary agency business is three times as large as secondary business. In 2015, primary agency business generated a turnover of HK$1.8bn, from arranging property sales worth HK$215bn. Against this, the country's largest property company, China Overseas Land (688.HK) had primary property sales of HK$135bn in 2015. Hopefluent managed sales for over 900 projects in over 150 cities in China, with over 60% of its primary segment revenue coming from outside Guangzhou.

In addition, the company also has a sizable property management business. Hopefluent managed over 300 properties generating a revenue of HK$350mm in 2015.

It is frustrating to see this Chinese property agent trading so cheap

We own the stock in our portfolio and here are the reasons why we think it is frustratingly cheap. 

1. The company has a net cash of HK$1bn (vs a market cap of HK$1.3bn, or US$175mm, at the stock price of HK$2.03) - net cash forms 77% of the company's current market cap. It has short-term debt of only HK$39mm and no long-term debt. Its 2015 annual report, which will get you this data, can be found here.

2. In 2015, the company earned profits of HK$223bn. Excluding a disposal gain of HK$61mm, the core earnings were HK$177mm. That translates to a trailing core P/E of 7.3x, with trailing 3.9% dividend yield. Do you even want me to talk about ex-cash P/E?

3. The trailing book value is HK$2.23bn, translating to trailing P/B of only 0.6x, at trailing 10% RoE. And again, I'm not even talking about ex-cash P/B.

4. It's not that the stock is going cheap because its earnings are too volatile. Since listing in 2004, company has always been profitable, except one year: 2008. Average profit in the last ten years was HK$131mm; the stock is trading at 10x trailing ten years' average earnings. 

5. Soufun holdings (SFUN.US) acquired about 112mm shares in Hopefluent in 2014 at HK$3.00 per share. The controlling shareholder, Mr. Fu also bought 42mm shares at HK$3.00 per share, since he did not want to get diluted. While the earnings have grown in 2015, stock has languished, trading now at 31% discount to where Soufun and the controlling shareholder bought. 

We are hopeful for Hopefluent

As a small cap value investor, our journey with Hopefluent has been frustrating. The stock price has been virtually flat since 2012. It is down 10% YTD, and 15% since the inception of our fund, when we bought the stock.

Yet, we are hopeful about the company's earnings prospects.

Outlook for 2016 seems rosy. Property sales in China are up. Guangzhou, Hopefluent's key market where property transactions and prices had trailed last year, is seeing revival in transactions as well as pricing this year. The company has made foray into several property related segments late last year, which we believe should start yielding results this year.

The controlling shareholder has been acquiring shares in the open market. Since the beginning of the year, the Chairman Mr. Fu has bought 4.87mm shares in the company, a bit under 1%. Creeping acquisition rules in Hong Kong market allow him to buy 2% per year at most without triggering a general offer. 1H16 results may or may not act as a catalyst, but for a stock that is trading at <2x trailing ex-cash earnings and 0.6x trailing book, we see little downside. As a value investor, we are patiently waiting.

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