California and New York: Selling Manulife REIT

Manulife REIT is one of my few losing stocks.  I bought before covid and its been a laggard in the recovery.  There's a lot of bad news coming out of California and New York.  Are they in a long term decline, or just a blip from covid?

What We Know

Manulife REIT's exposure to California/NY

2/3rds of Manulife REIT's assets by AUM are in California or New Jersey (NJ could be considered part of NY city):

Source: Manulife REIT Corporate Presentation Sep 2020

Are California/NY in Decline?

The news out of New York and California is bad.  Companies leaving: HP, Oracle, Schwab. People leaving: Elon Musk, Joe Rogan, Kayne West.  Crime, homelessness and tent cities in the city centers. 

The news is emotional and politically slanted, so I need numbers.

U-Haul (a self-moving company), ranks states by net migration.  Their Jan 2021 report has New York and NY and California ranked 48 and 50 out of 50.  They were 44 and 49 in 2019.

The 2020 US Census estimate says:

• New Jersey's and New York's populations have dropped for the last 2 and 5 years respectively.
• California's dropped in 2020.  For the first time in ten years.  Even when it was growing before, it has been growing lower than the national rate since 2016.

So the numbers say that NY/NJ have been dropping for a while.  California has been growing more slowly that the rest of the country from 2016 to 2019, and had its first drop last year.

One counterpoint: Tech firms moving in to rent out NY offices.

Operating leverage

From their 2019 & 2020 results, fixed costs are around 55% of their revenue:

• Property operating expenses (mostly fixed, p155): 37%
• Other Trust Expenses (audits, paperwork): 1-2%
• Finance Expenses: 14-15%

So a 5% decrease in revenue - still assuming full occupancy - leads to a decrease in PBT around 6-9% (depends if property taxes also drop).  A 10% decrease drops PBT by 19-24%.

Financial leverage

Their property values fell by single digit percentages in 2020:

The result is that Manulife REIT now has 41% gearing, approaching MAS' 50% limit.

This small valuation drop does not seem to take into account covid.  In July, the US Bank Tower (near Figueroa) sold off for 34% less than its valuation.

What I Don't Know

Is California's 2020 population drop the start of a trend, or just a covid-19 blip?

Long term, how will WFM affect office space usage?

What I Think

The good things about Manulife US REIT:

• Good properties and tenants.  Grade A or trophy offices, with a high number of 'blue chip' or government tenants.  They have held out through the covid crisis well.
• Good management.  Management is incentivised to increase DPU, not make acquisitions or increase AUM.  They had a plan to grow by acquisition to be included in NAREIT, and they succeeded.

The bad things:

• A 100% payout ratio means they will have to raise capital again if they want to expand.  If property values drop by 20%, they will have to raise capital anyway.  Bad when they are paying an 8% dividend.
• NY and California are declining.  NY/NJ is losing population.  California has declined relative to US as a whole since 2015, and may starting to decline in absolute terms. So if you own property there, you are swimming against the tide.

Where Could I be Wrong?

The bad news may already priced into the stock.  With an 8% yield.

California and New York may decline relatively, but still survive.  As long as their cities do not turn back into crime infested shitholes, even if they stagnate and rents stay the same, the stock would be worth it.

And within these declining states, there may still be areas of growth.

Does all the bad news magically disappear after covid goes away? Or is the decline part of a long term trend?  And even if it is, is it already priced in?

So what happens from here?

• If things recover after covid, rents and valuations rise, the dividend yield goes down to 6%,  the stock may rises 20% and they can raise capital to carry on expanding.  The happy recovery scenario.
• If California and New York are in a long decline, rents slowly decrease after 3-5 year lease expiries, the dividend and stock price slowly drops, so do building valuations, and they have to raise money by issuing very expensive stock.  The bleed-to-death scenario.

Conclusion

Hard to say what will happen.  Both scenarios are plausible.  Its the population growth rate chart that convinced me.  I think the trend of US re-industrialisation will favour Texas/Florida against California/NY, and industrial properties against offices.  And I think its a long term trend, not a cycle.  The problem for investors is to tell how much is priced into the market.

I sold my Manulife USD REIT at USD 72c today.  Loss of ~ USD 9000, which includes dividends received.

SNAM - Italian Gas Transmission

 Italy imports most of its gas:

Which comes through 5 pipelines:

The gas pipelines inside Italy are all owned by SNAM, an ENI spin-off.  They provide infrastructure so Italians can enjoy a stable and diversified supply of gas.  For example, the TAG pipeline (on the right of the map) has just been completed - it was built to address previous problems obtaining transport capacity during peak seasons.

Long term gas usage is expected to decline in the future due to higher energy efficiency and higher renewables.  But they still plan to use gas in 2040:

Source: Italian National Trend Scenario - Jan 20201

In 2019, 76% of SNAM's revenue was from gas transmission, with the remainder from storage.  A negligible amount was from re-gasification.  

The numbers

Predictable revenues and high margins:

The main factor affecting business is regulation.  Regulatory review for gas transportation is every 4 years, the current one ends in 2023.  A real rate-of-return of 5.3% is predicted (p17).  

Their long term growth is expected to be 1% (I lost the reference).

Debt

Debt is 13bn, or just under 6X EBIDTA.  A bit high, but OK considering the debt.  EBIDTA covers interest payments 16 times.

Most of their debts is through bonds.  Maturities are well spread out over the next 15 years.  We can see the effects of the Eurozone crisis on the bonds issued in 2012 and 2013.  Since then, rates have gone down to 1% or lower.  Money for nothing:

Three quarters of their debt is fixed rate.

SNAM has a higher credit rating than Italy.

Risks

This type of company has little business risk.  The risks are 'black swan' events.

Biggest risk is Italy leaving the Eurozone.  Although its fallen off the radar, I think it will return.  The effects would be:

• SNAM's revenues convert to lira, which means a drop of lets say 30%.  Their bonds remain denominated in Euros (no one is receiving sub-1% interest for lira bond - holders will expect it to remain in Euros).
• New debt (bonds being rolled over) in lira cost more.  Maybe 5%.  

If that happened, I estimate they'd still be making 1.3bn in EBITDA a year in 'newly depreciated' Lira -  or 1bn current-day Euros.  After (unchanged) interest, it would be over 850m..  Thats an FFO (before tax) of 0.25 current-day Euros per share.  The stock price would probably drop around 35%.

The second risk is regulatory change.

Growth

Gas deposits in the Mediterranean (eg: Israel's Leviathan) could make Italy a transshipment hub for Gas.  Through TAG.

The gas pipes may be used to transport hydrogen.  They have already tested 5% and 10% hydrogen mix as part of a trial.  Italy may become a hub for hydrogen produced int he hot regions of North Africa.  I don't care about ESG hype, but its interesting that they've done trials in the real world.  And the ESG funds may lap it up.

Valuation

In 2019, 70%of earnings were paid out as dividends.  In 2018 it was 76%.  This is decent, though probably not much room for upside.

Conclusion

Steady, boring company, more like a bond.  It's a nice 5% earner in a yield starved world.    With the Sword of Damocles (Eurozone breakup) constantly hanging over its head (although the fallout from this risk is quantifiable).   If I bought it, I would limit it to 5% of my portfolio.

Or wait till Italy leaves the EU.

What I am doing

Nothing.  I'm 110% invested overall.  Still holding my long term dividend stocks while my trading positions in oil/copper producers have been on fire.  I'm buying on margin when opportunities happen and added a small Alibaba position in Dec.  I think the market continues up in the first half, albeit with the potential for a quick 10% correction.  I'm like a pig with my snout stuck in the trough.

I think the rally ends around June/July.  Look to sell my copper/oil then.  Might be time to buy protection/volatility.  Gold and TAIL.  I expect a small sharp correction like Dec 2018, 

I also need to reconsider my Manulife REIT holdings, it has lot of properties in California and New Jersey.  News from those states is not good.

Other than that, nothing to do.  The market is rising like its on cloud nine.  Lay back and enjoy it.

Fufeng (HK:546)

 An ingredients and animal nutrition producer, Fufeng is the largest and lowest cost monosodium glutamate (MSG) producer in the world.

1H20 breakdown by revenue: 40% from MSG, 30% from animal nutrition (half of that from corn products), and 30% others.

Industry Overview

MSG is a commodity - producers have no pricing power so the lowest cost wins.  It takes 2.4 tons of corn and 2.6 to 3 tons of coal  to produce 1 ton of MSG.  Fufeng's production plants are in the north of China near cheap coal and corn, giving them a cost advantage over their competitors.

Source: CICC Research 2013 (Meihua Holdings)

MSG Demand is not affected by the economic cycle:

My research (the first google result) sees MSG demand rising around 3% per year for the next 5 years.

The MSG industry is concentrated.  Fufeng has an estimated 31% global share of MSG by volume, and is the largest in the world.  It has an estimated 57% volume share in China, with the top three producers having a 90% domestic share.  The industry in China has experienced 3 consolidations and 2 booms in the past 20 years (p5).  The number of companies has dropped from over 200 to the current 3 major players (plus a handful of minor ones).  The last boom was in 2008-2012, followed by a bust in 2013-2018.

Their main cost is raw materials, especially corn.  In 1H20, corn kernels were the company's largest cost (55%), followed by coal (15%).  As well as MSG, half of their animal nutrition business is also from corn based products.  Other costs are depreciation (8%) and Employee Benefits (5%).

So this business takes corn & coal and processes them into bulk food materials, for which there is steady or rising demand.  Profits depend on total industry production vs demand.  Long term profits depend on how much new production capacity is added industry-wide.

The company's production capacity:

Source: Fufeng Group: A Leader in an Oligopolistic Market (July 2019)

Numbers

Profitability:

CFO is usually greater than profits, which is expected due to depreciation:

The wild swings in the difference are caused by changes in working capital.

Inventories and Receivables levels swing wildly, but at least they are not trending upwards:

Debt and Equity

As of 1H20, total debt is equal to roughly the last 3 years PBT.  And 40% of this debt is covered by cash.  They have some USD debt.  Overall, their debt is small enough not to worry about.  

The company issues stock options to staff.  Potential dilution from options issued is less than 1% of existing shares (p85) as of end 2019.  But the company is authorised to issue up to new options for up to 8.4% of existing shares.  Something to watch out for.

They had convertible bonds which were redeemed in 2018.

Risks

First risk is the trade war reducing their exports.  With the effect of increasing supply in the domestic China market.

Second risk is the industry going back to being irrational, with new players coming in and adding more production.  Fufeng and the leading players need to keep adding just enough new capacity to discourage them.  Should be possible with the current industry structure, but in China - where new production capacity is not always driven by economics - it may not.

People may switch from MSG over health concerns.

Rising corn/coal prices.

Any China company can be a fraud.  This one does not fit that profile, generating cash (but not holding too much), paying a dividend, and producing a bulk tangible product.  It would be difficult to fake production of 30% of the world's MSG - many people might notice their food has no taste.

Valuation

At a price of HKD 3:

• Their TTM dividend is HKD 13.8c, giving a yield 4.6% (4.1% after 10% WHT), with a payout ratio under 40%.  I did not see a dividend policy.
• Its trading at a PE of 4.5 to 6, if we use 2018 or 2019 profit numbers (excluding exceptional items).

Conclusion

Worth a bet at current prices.  They produce an essential ingredient in an oligopolistic market.  There may be short term fluctuations due to rising corn prices and its hard to know where we are in the cycle.  But in the long run they should make a good return if the industry remains rational.

Bought this for 2% of my portfolio.  Limit to 2% because its a China stock and I can't follow this industry closely.  Also cause I got no more money.

My Dividend Portfolio

I started building this portfolio 18 months ago.  Its been a wild time!  From an "high-and-dry" market in late 2019, where I'd be desperately scrounging around for something to buy like an animal in the desert, to the liquidity crunch in March, where you would buy something a deep value, get punched in the face by Mr Market dropping it 10% in a few days, then repeat again...to the breathtaking recovery which no one believed.  

I was lucky that covid occured when it did.  If you can't build a portfolio when a once-in-50-year pandemic occurs and the end of the economic cycle, you never will.  My timing wasn't great.  I only bought 10% of my portfolio in March.   You can make a lot of mistakes in this business, but as long as you manage risk and don't buy shit that goes to zero, you'll make more than you lose.

My dividend portfolio is now worth SGD 670K, after the last few weeks market hiccups, and can probably pay me SGD 2.7K per month.  Here it is:

What next?

• Keep grinding away at my day job, plow all my salary back into the market.  Its still fairly valued, I can find things with a 5% yield.  No need to time the market too much.
• The portfolio is weighted heavily towards Singapore REITS.  Try to diversify away from this.
• Reits and Utilities weight it heavily towards companies that benefit from low rates.  At some point of the economic cycle, we start expecting higher rates.  Look to buy dirt-cheap banks to balance this out.  "Neither a borrower nor a lender be."
• Keep learning to trade.  I have a small trading portfolio (~SGD 120K), where I learn to trade by following Hedgeye.  Commodities look like a good bet now.  There may come a time when I can't add to my dividend portfolio (like late 2019), and I may need to learn to trade at different points in the economic cycle.

Bought European Airports

I think we get a covid vaccine in the next 2 weeks (Pfizer & BioNTech) to 2 months (Moderna or Novavax).

It won't mean everything is over.  Pfizer and BioNTech's vaccine requires 2 shots and must be stored at -70 degrees Celsius, making distribution hard.  We can expect most people in the US to be vaccinated by the start of 2023.  Mid-2021 if an easier-to-use vaccine makes it.

News of a vaccine will remove uncertainty and give a timetable for recovery. The stock market hates uncertainty but it can take bad news of a known quantity.  I think this is the turning point for covid plays.  If I'm right on the vaccine timing, its now darkest just before dawn, when uncertainty (when will this virus ever go away?) gives way to bad news (one more year to go).

And even if the all the vaccines somehow fail, I think the virus turns into a normal seasonal flu by the start of 2023.  The 1957 and 1968 pandemics lasted around 2 years.  So 2023 is the last we see of corona chan.

My covid recovery play is airports.  They've made it through the crisis without raising cash so far.

I'm buying European Airports because:

• Regional Airports (Australia/NZ/Thailand) are too expensive, even based on pre-covid earnings.
• MAHB has is changing their regulator model to be more capital intensive.  Its probably good for them, but we can't use historical numbers to value it.
• NYSE-listed Mexican airports have only 28 years concession left
• Booking.com is too expensive, as if covid never happened!  The other OTAs are bring squeezed by google.

My picks are Aeroport de Paris and Aena, from Sven Carlin.   Bought 210 shares of AENA @ 118.8 Euros, and 300 shares of ADP @ 82.45 Euros.

Theres still some risk.  From their results, I can't figure out their opex and capex (ie: cash outflows with zero revenue), and Paris has high borrowings.  If the recovery is delayed till 2023, there's a chance they do end up raising money.

Swire Properties

 Hong Kong's largest office landlord.  They hold (mostly freehold) investment properties which they rent out for a steady income stream, using this to develop more property in HK and China.

I want to look at their Investment Property (rental stream) business first, because its recurring and easy to value.  Like a REIT.  So I exclude their lumpy Property Development and Property Trading for now.  Their past ten year Property Investment income is impressive:

Source: 2019 Annual Report, p10

Theres no depreciation in their "Profit Attributable to Company Shareholders" for Investment Properties.  Properties are valued every year and the gain/loss is added to the P&L (HKAS40 does not require depreciation (p17) for Investment Properties held at fair value).  The company helpfully puts revaluations on separate line.  So these profit numbers are purely for rental and 'cost-of-rental', similar to a REIT's Distribution Statement.

These numbers make me excited.  Can you find any SGX listed REIT or property company that doubled their rental profits in 10 years while reducing debt?  And the number of shares issued in this period is only up 3%.  This shows the power of compounding when a company reinvests some of its income, instead of paying it all out as dividends.

Investment Properties

Geographical Segment breakdown

They rent out office and retail properties in HK, China, with a small business in Miami.  They only give breakdown by Total Revenue (not Investment Properties revenue/profits):

Source: 2020 Interim Results Briefing

HK

I estimate that 70-80% of their Investment Property profits are from HK.    I guess 50-60% of HK profits should be from office, with the rest from retail.  Their Office is mostly Grade-A, and saw positive rental reversions in the first half of the year - so not much to worry about here.  Retail is mixed: they have 2 main malls: 

• The Mall, Pacific Place: an upscale mall surrounded by offices and 4 hotels, next to the High Court and British Council.  It boasts a large number of luxury brands as tenants (p29).  Retail sales fell by 47% here in 1H20 (p11).  Long term, I expect the squeeze to continue even after covid and social unrest are resolved, as luxury brands decrease their HK footprint.

Source: Vogue Business, June 2020, Rethinking Hong Kong's Luxury Future

• The largest regional shopping centre in HK, with MTR access, shopping & dining, cinemas and an ice-skating rink.  Retail sales fell 20% here in 1H20, I expect it to rebound long term, as things recover.
• Other properties, around 15-20% of HK Investment Property GFA (weighted by ownership).

4.5% of their HK retail rentals expire this year, followed by another 23.5% in 2021.  We can expect continued pressure here.  This may already be reflected in 1H20's numbers (gross 1H20 HK retail rent was down 10% - p11), as Swire has already given concessions to luxury tenants, showing they will cut rent to keep occupants.  Both malls remain 100% leased as of June.

How bad can it get?  Back-of-envelope calculation: Lets say that The Mall accounts for 40% of HK Investment Property Retail profits, or 20% of HK Investment Property profits.  Then lets say The Mall's Profits halve (following a further 30% decrease in gross rental to 1H20 results).  So we could see a 10% drop in HK Property Investment income, which is maybe a 5-8% drop in total Investment Property income.

China

28% of their Gross rental is from Mainland China, I guess it accounts for 15-20% of profits.  Most of the China rental is from retail.  Skewed towards luxury (p15): 40% if their rental is from "Fashion and Accessories", and 20% is from "Jewellery and Watches".  They are optimistic: "Footfall and retail sales in the Chinese mainland have recovered strongly since March 2020. Retail sales are expected to continue to improve for the rest of the year, led by sales of watches, jewellery and other luxury brands." 

Tenure

Since I'm valuing based on property rental, I need to know their property tenure.  62% of their completed HK investment properties have leases of 800+ years (by GFA), 23% have leases 30 years of less.  All China properties have 40 year leases.

Future Growth

Their development pipeline calls for a ~10% increase in GFA by 2023:

Spending on this is forecast to range from 2bn to 5bn a year:

Assuming 1H20 is as worse as it gets - Investment Property profits were 4bn in six months - they should have no problem covering this expenditure.

Other Segments

They have a small hotel segment, which usually operates at a loss (pre-covid).  Hotel P&L numbers do include depreciation.

Gearing

Company-wide, net debt (including leases) is around 17bn.  Or 2.1 times annualised 1H20 Investment Property Earnings.  This debt is so low compared to their earnings/assets, its not even worth looking at the debt repayment schedule (p28).

Property Development Segment 

"Property Trading" and "Sales of Investment Properties" have been lumpy over the past ten years:

Instead of analysing the history of property transactions, lets look at where they are now.  It means have some residential properties to dispose of after covid:

My guess is that they write down some Miami condos as the market crashes, but most are already sold anyway.  For Singapore and Indonesia, worst case is they sell at a discount if theres a recession.

Second, they are developing new properties:generally, the residential units will for sale in their "trading portfolio" (p18), and office/retail units will be added to Investment Properties.

Valuation

I'd be happy to buy it at a 5% yield, or HKD 18.  What really gets me excited is that this dividend is only 63% of their Investment Properties profits (1H20 numbers, annualised).

Theoretically - as a comparison to SG Reits - a 100% payout ratio with a 6% yield would give them a target price of HKD 23.

Risks:

This company has a great long term track record, and is conservatively geared.  The risks come from the external environment, principally HK Real Estate, and China.

Hong Kong property prices have boomed for the past 10 years:

Source: Trading Economics

This is a bubble.  There are no signs of it deflating, and even signs the government may continue to blow it up.  It must pop one day - one way or another.  High property prices are one of the causes of unrest, and there's always a political risk the government will enact policies against property developers.  This line of thought is that HK's unrest is a structural problem, and one of the fixes required is lower property prices.

Another risk is the China bubble bursting.  The giant China bubble pops, and it becomes like Japan in 1989.  Or the Soviet Union.  The problem is best summarised here.  

Its a book.

I don't think "Work From Home" is a risk to this company.  I think that most people in Hong Kong will not work from home as their units are too small.

Medium term, I'm not sure where we are in the HK property cycle.  HK office rents have fallen for 6 consecutive quarters.

Misc

While Swire Properties and HKL gave concessions to luxury tenants, Wharf REIC did not, causing LVMH to plan to close its 10,000 sq ft Times Square store.