Far East Consortium: Negatives Priced In (OTCMKTS:FRTCF)

Elevator Pitch

I maintain my Bullish rating on Hong Kong-listed Far East Consortium International (OTC:FRTCF) [35:HK], a diversified property conglomerate with business interests in property development, hotel operations & management, car park operations & facilities management, gaming operations, and property investment

This is an update of my prior article on Far East Consortium published on December 11, 2019. Far East Consortium’s share price has declined by -35% from HK$3.84 as of December 9, 2019 to HK$2.46 as of July 9, 2020 since my last update. Far East Consortium trades at 0.52 times P/B, and 0.21 times revalued net asset value per share or RNAV, adjusting for the market value of the company’s hotel portfolio. The stock also offers a consensus forward FY2021 (YE March) dividend yield of 7.7%.

Far East Consortium’s adjusted core cash profit decreased by -38.2% YoY to HK$807 million in FY2020, which was a poor set of results that was expected. The weak performance of the company’s hotel operations & management business was the main contributing factor for Far East Consortium’s poor financial results. This was no surprise, given social unrest in Hong Kong and social unrest in Hong Kong and international travel restrictions imposed as a result of the coronavirus pandemic.

Market consensus is still expecting positive revenue and earnings growth for Far East Consortium in FY2021, given the company’s significant amount of property development pre-sales, which is equivalent to 2.5 years of its FY2020 property development revenue. Furthermore, the worst is likely to be over for Far East Consortium’s hotel operation & management business, with more countries in Asia and around the world gradually easing lock-down measures.

Negatives associated with Covid-19 have been priced in for Far East Consortium at current valuations, which justifies a Bullish rating on the stock.

Readers have the option of trading in Far East Consortium shares listed either on the Over-The-Counter Bulletin Board (OTCBB) as ADRs with the ticker FRTCF or on the Hong Kong Stock Exchange with the ticker 35:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $400,000, and market capitalization is above $750 million, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors which own Far East Consortium shares listed in Hong Kong include Value Partners Group (OTCPK:VPGLF), Dimensional Fund Advisors, The Vanguard Group, Norges Bank Investment Management, and Skagen Funds, among others. Investors can invest in key Asian stock markets either using US brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

FY2020 Results Were Poor As Expected

Far East Consortium announced its FY2020 financial results on June 30, 2020, and it was no surprise that results were poor, considering the negative impact of social unrest in Hong Kong and international travel restrictions imposed due to the Covid-19 outbreak.

The company’s headline net profit attributable to shareholders fell -78.7% YoY from HK$1,714 million in FY2019 to HK$366 million in FY2020. Adjusting for one-off or non-cash items, Far East Consortium’s adjusted core cash profit was HK$807 million, representing a much narrower decline of -38.2% YoY. Key non-cash or non-recurring items included gains or losses relating to investment property revaluation in both FY2019 and FY2020, and one-off gains related to the partial divestment of an equity interest in BC Group Holdings Limited (a provider of residential mortgages) and the bargain purchase of Trans World Corporation or TWC (owner of hotels in Europe) in FY2019.

Far East Consortium’s overall gross profit decreased by -13.4% YoY from HK$2,610 million in FY2019 to HK$2,259 million in FY2020. The company’s hotel operations & management business segment was the main culprit, as the segment saw a -49% YoY drop in gross profit (after depreciation) from HK$791 million in FY2019 to HK$402 million in FY2020. Far East Consortium’s Hong Kong hotel portfolio witnessed a -46.5% YoY decrease in RevPAR (Revenue Per Available Room) in FY2020, due to a -24.5 percentage points decline in occupancy rate to 70.8% and a -27.9% fall in average room rate to HK$578.

In contrast, Far East Consortium’s other business segments performed considerably better in FY2020, as compared to its hotel operations & management business. The company’s core property development business segment saw its segment gross profit increase +4% YoY to HK$1,404 million in FY2020. Far East Consortium’s gaming operations business segment saw flattish gross profit at HK$146 million in the most recent fiscal year, while gross profit for its car park operations & facilities management was HK$101 million in FY2020 which represented a -13% YoY decline.

Positive FY2021 Outlook Supported By Property Development Pre-Sales

Notwithstanding the weak financial performance in FY2020, market consensus expects Far East Consortium’s revenue and core earnings to grow by +14% and +29% to HK$8,502 million and HK$1,040 million, respectively in FY2021.

The greatest uncertainty for Far East Consortium lies with its hotel operations & management business, which is dependent on the lifting of international travel restrictions. Nevertheless, the company’s hotel operations & management business could have already seen its worst performance in FY2020, with an increasing number of countries easing lock-down measures. At the company’s FY2020 earnings call on July 2, 2020, Far East Consortium emphasized that “the worst is over” and “we are in reopening stage, which is looking at really recovery.” But the company also acknowledged at the call that “I can’t really comment on whether or not what the impact on 2021 revenue will be on the hotel side.”

Easing Of Lock-down Measures In Various Countries Globally

Source: CBRE’s June 2020 Asia Pacific Hotels Industry Research Report

Travel Restrictions Put In Place In Various Asian Markets

Source: CBRE’s June 2020 Asia Pacific Hotels Industry Research Report

More importantly, Far East Consortium has property development pre-sales of HK$12.2 billion (2.5 times FY2020 property development revenue) as of March 31, 2020. The company is expected to recognize the pre-sales as revenue over time (as the property projects are being built and subsequently completed), which should support its revenue and earnings growth in FY2021 and the next few years.

On one hand, economic weakness brought about Covid-19 could dampen property buying sentiment. On the other hand, the current low interest environment implies that property remains an attractive asset class in terms of yield and ease of financing. Going forward, Far East Consortium plans to launch property projects in Australia, UK, Singapore and Hong Kong with a total attributable gross development value of HK$8.9 billion in FY2021. Notably, Far East Consortium highlighted at the company’s FY2020 earnings call on July 2, 2020 that recent new property project launches have “performed better than what we expected” including those in Hong Kong.

Seeking Listed Platform To Unlock Value Of Hospitality Assets

In November 2019, Far East Consortium disclosed that it had plans to spin-off and list a number of its overseas hotel properties located in Australia, UK, Malaysia and Singapore, as a stapled trust group comprising a business trust and a REIT. The company has “slowed down the execution of that work stream” relating to the planned spin-off and IPO, as per its comments at the recent FY2020 earnings call.

Nevertheless, Far East Consortium continues to seek a listed platform to unlock the value of its current hospitality assets. In June 2020, it was reported in The Business Times that Far East Consortium is in exclusive talks to acquire a 70% controlling stake in Singapore-listed Eagle Hospitality Trust’s REIT manager and trustee-manager. At the company’s FY2020 earnings call on July 2, 2020, Far East Consortium mentioned that Eagle Hospitality Trust, which owns 18 hospitality properties in the US, is “a platform that we could use as we always think about creating new revenues” and the US is “a market that we think is interesting.”

There is no certainty that either the hospitality trust IPO or the acquisition of Eagle Hospitality Trust’s REIT manager and trustee-manager will be successful. But it is reassuring to know that Far East Consortium is seeking opportunities to unlock the value of its assets, which should bring about a positive re-rating of the stock’s valuations in due course.

Valuation, Dividends And Share Buybacks

Far East Consortium trades at 0.52 times P/B based on its net asset value of HK$4.69 per share as of March 31, 2020, and its share price of HK$2.46 as of July 9, 2020. As a comparison, the stock’s historical three-year and five-year mean P/B multiples were 0.71 times and 0.68 times, respectively.

Far East Consortium’s revalued net asset value per share or RNAV is HK$11.59, if one adjusts for the market value of its hotel portfolio (recorded at historical cost on the company’s books) to include HK$16.3 billion in hotel revaluation surplus. In other words, Far East Consortium is trading at 0.21 P/RNAV, versus a headline P/B ratio of 0.52 times.

Far East Consortium offers consensus forward FY2021 (YE March) and FY2022 dividend yields of 7.7% and 8.9% respectively. The company proposed a final dividend of HK$0.15 per share for 2HFY2020, which brought full-year FY2020 dividends per share to HK$0.19. This represents a dividend payout ratio in excess of 100% (based on headline FY2020 earnings per share of HK$0.155), and a -13% YoY decline in absolute terms.

In the company’s FY2020 financial results announcement published on June 30, 2020, Far East Consortium noted that it is “committed to maintaining a progressive dividend policy in the long term.” Market consensus expects Far East Consortium to maintain its dividends per share at HK$0.19 for FY2021, prior to raising dividends per share to HK$0.22 in FY2022.

Notably, Far East Consortium also bought back approximately 50 million of the company’s own shares in FY2020 at an average price of HK$3.40 in FY2020, which is 38% above the company’s current share price. With Far East Consortium consistently valued by the market at below 0.7 times P/B for the whole of FY2020, Far East Consortium was justified in making significant share buybacks in the most recent fiscal year. Looking ahead, it is possible that Far East Consortium could engage in share buybacks again in FY2021, which could provide downside support for the company’s share price.

Far East Consortium’s financial position remains reasonably strong, which should support future dividends and share buybacks. The company’s net debt-to-equity (book value of equity adjusted for hotel revaluation surplus) was a manageable 56.7% as of March 31, 2020. It also has limited liquidity issues, with HK$6.0 billion in un-drawn banking facilities, and seven hotels that are unencumbered with a total asset value of HK$4 billion.

Risk Factors

The key risk factors for Far East Consortium include a larger-than-expected negative impact of Covid-19 on the company’s businesses assuming the coronavirus pandemic takes a longer time to be contained, a delay in the company’s plans to find a listed platform to unlock the value of its hospitality assets, and lower-than-expected dividends going forward.

Note that readers who choose to trade in Far East Consortium shares listed as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I am/we are long Far East Consortium International [35:HK]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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