When Hong Kong citizens took to the streets in March this year, most observers expected a short disruption to life in the city.
After four months, police have fired off more than 2,000 rounds of tear gas and made almost as many arrests. Recently, even the city’s beloved Wednesday night horse races were cancelled. Other than for severe typhoons or the outbreak of influenza, that has never happened before. While races did resume the following week, there are still concerns that any further disruptions will be catastrophic for the local economy. Four percent of Hong Kong’s tax revenues came from horse racing last year.
Hong Kong’s economy is suffering
A bill that would have allowed the extradition of suspected criminals from Hong Kong to China sparked the protests, but its withdrawal has done nothing to end them. The protestors’ demands, including more democratic representation, are things China is unlikely to acquiesce to. It is hard to see a logical solution to the standoff. And, in the meantime, Hong Kong’s economy is suffering.
Tourism, retail and leisure are the worst affected. Tourist arrivals were down 40% in August, sharply deteriorating from the 5% decline in July. Health and beauty retailer Sa Sa (HK:178), the Hong Kong equivalent of Australia’s Priceline, reported that sales dropped by a third in August. Such is the desperation of some hotels that room rates have fallen to the point where it is now cheaper to stay in a hotel than to lease an apartment. The Hong Kong stock market is one of the world’s worst performing markets this year.
Finding opportunity in the turmoil
The Fund has made several ‘bite sized’ investments in Hong Kong in 2019, focusing on companies run by seasoned management teams who have a track record of paying shareholders a growing amount of cash every year.
Oriental Watch (SEHK:0398) is an example of one such company. This 58-year-old luxury watch retailer has endured the Hong Kong handover anxieties of 1997, the Asian and Global Financial Crisis, previous social unrest like the Umbrella Movement of 2014 and the outbreak of various epidemics.
Its resiliency has helped cement its position as a key authorised dealer for Rolex in Asia. The current environment is hurting its sales and management is bracing for more uncertainty. Oriental Watch’s balance sheet should allow the company to ride through this comfortably. It has $200m of net cash and $150m in inventory. It also owns some of its shops, bought decades ago, which could be sold for significantly more than their balance sheet value.
As an indication of how much pessimism there is in the company’s future, the company’s market capitalisation is less than its cash holdings. This is not a typical Hong Kong value trap, though. The company paid more than 100% of earnings as dividends last year, equating to a 16% yield. Its cash balance and retained profits should continue to build (the company is not expanding its store footprint and has no desire to buy other companies). In short, with the track record of returning capital, there is much more value to be unlocked here even before contemplating a ‘recovery’ scenario in Hong Kong.
Logistics provider growing
Kerry Logistics (SEHK:0636) is another recent investment that has a clear intention of returning surplus capital. As an integrated logistics provider and freight forwarder, large companies call Kerry Logistics when they require seamless assistance in the storage and movement of goods. Having entered the business in 1981, Kerry aims to become entrenched with the customer for the long-term. It has strong backing, being a key part of the Kuok empire of companies which are involved in property, hospitality, food, agribusiness and maritime.
Trade tariffs and recent events in Hong Kong have weighed on Kerry’s share price, creating an investment opportunity. The half year report highlighted business resilience and growth, with earnings excluding revaluations up 24%. Strong growth in the rest of Asia offset the weaker regions of Hong Kong and China. Deliveries by Kerry’s Thailand business have grown to more than one million parcels a day, doubling in the last two years. In Taiwan, Kerry is the only certified logistics provider in the pharmaceutical sector.
On the capital management side, Kerry has actively been slimming down its portfolio of valuable but low-yielding warehouse assets. The Fund has already received a special dividend arising from the sale of the first two warehouses. There are seven more to go.
The path to resolution in Hong Kong remains clouded, as the underlying causes of discontent are deep rooted and involve political, cultural and economic considerations. Both of these investments are small for the Forager International Shares Fund. Both management teams, however, have dealt with plenty of turmoil before. We’re backing them to do it again.
This is an excerpt from the September 2019 Quarterly Report – you can read the full report here.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.