Wing On builds on solid foundations

PUBLISHED : Sunday, 14 May, 2006, 12:00am
UPDATED : Sunday, 14 May, 2006, 12:00am

In business and investing it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult. So says Warren Buffett, the greatest investor of the twentieth century.

His reasoning applies to Wing On Company, a Hong Kong and Australian office property investment company with a minor but profitable exposure to department stores. Buying Wing On Company at $2.50 in 1998 and hanging on to it would have earned an appreciation of 460 per cent by now, at $14, and that does not include 8 years of fat dividends.

The 2005 results for Wing On were excellent. Revenue gained 5 per cent year on year to $1.53 billion on better department store sales and higher rental income. Excluding exceptional items, recurring operating profit was $348 million, up 13 per cent.

Share of profit, after tax, on the American auto dealership associate was $62.6 million, up 19 per cent (but share of profit before tax dropped 9 per cent). After an interest charge of $54 million, down 5 per cent, this amounted to a recurring profit before tax of $357 million, up 18 per cent.

Major exceptional gains included a $33 million one-off compensation by a tenant on rental-lease termination, and a net gain of $23 million, consisting mainly of equity securities and foreign-exchange gains. There was also a huge non-cash investment property revaluation of $730 million, up 7 per cent, and a gain on disposal of investment properties of $9.2 million, up 198 per cent. All in all, net profit came to $997 million, up 14 per cent, ballooned by the non-cash revaluation. Excluding all exceptionals, recurring net profit was $309 million, up 20 per cent or $1.05 per share. Dividend per share was 70 cents, up 27 per cent year on year.

Analysing by business segment, property leasing captured rental income of $263 million, up 7 per cent, and earned recurring segment profit (excluding the $33 million compensation) of $224 million, up 4.7 per cent. That included Hong Kong rental income of $101 million, up 8.6 per cent. Occupancy of Hong Kong offices was as high as 95 per cent, gaining 5 percentage points on robust demand.

Wing On also charged higher rents on renewal of leases. Recurring rental income from Australian commercial properties was $120 million, up 6 per cent. Occupancy stayed at 95 per cent.

Department stores captured sales of $1.27 billion, up 5 per cent, segment profit was $84 million, up an admirable 40 per cent due to higher efficiency and better marketing.

As at end of 2005, Wing On had equity of $5.89 billion or $20 per share. The current share price of $14.30 implies a deep discount of 29 per cent to book value, and dividend yield could be as high as 4.9 per cent even if dividends remain the same.

Prospects for Wing On are bright. Hong Kong grade-A office properties are in under-supply this year. New supply will be the tiny 120,000 square foot York House, only 25 per cent of average annual supply in past years. Whether Wing On office properties are grade-A might be arguable, but the shortage will probably spill over to grade-B offices as non-finance tenants opt for lower rentals. And the good news is unlikely to be a new supply of grade-A offices until 2008.

Given the shortage, grade-A rentals could rocket this year so rental yield will exceed the prevailing 4.4 per cent for grade-A offices. Considering the prospect of interest-rate rises peaking later this year, investors might go after the high yield and bid up valuations of grade-A offices. So Wing On properties should be revalued upward again and book value per share is likely to exceed $20 per share.

Major risks could be a slump in the Hong Kong equity market, a sharp fall in the Australian dollar if commodity prices slump, and a downturn in the Hong Kong and Australian office property markets.

At market close on Friday, my simulated $10 million portfolio earned a return of 34 per cent, excluding dividends, since inception in January 2005, and outperformed the Hang Seng Index by a wide margin of 9.5 percentage points. Dividends alone amounted to an additional return of 6 per cent, very desirable for investors who need income.

Including dividends, the simulated portfolio returned 40 per cent. This performance, already comparable to the top 10 Hong Kong equity MPF funds, is a result of simple business sense which everyone is able to develop.

Henry Chan is the head of research at Quam (IA) Limited. He owns shares in Wing On Company