Sun Hung Kai & Co. Limited (86) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us today via webcast. So this is the presentation of the 2019 annual results for Sun Hung Kai & Co. Limited. With us today, I am Joseph Fuqua, I'm the Head of Investor Relations for the group. To my right, we have Mr. Robert Quinlivan, who is the Chief Financial Officer. Next, we have Ms. Elsy Li, who is the Group Treasurer and Head of Corporate Development. And on the end, we have Mr. Benjamin Falloon, who is the Managing Director of Investment Management. We will be presenting a number of slides today that discuss the company and our activities over the course of 2019 as well as some of our outlook for 2020. So with that, I'll hand it over to Mr. Robert Quinlivan.

Thank you, Joe. I'm just going to have to take my mask off while I speak. Thank you. Right. Today, we will go through the company overview. Then we will talk through the results in a high level before getting into a detailed analysis of the segments. And then we'll cover our business initiatives at the end and finish with the outlook. So as you know, Sun Hung Kai & Co. has been in operations since 1969 and during that time has gone through -- experienced a number of milestones. And today, we're at a point where our businesses has 2 engines: our financing and investing business. So we believe that with our relationships and access, our expertise and innovation, our capital and governance, we are a strategically balanced business that is well placed to deliver asset growth, stable growing returns and distributions to shareholders. So as mentioned, our heritage goes back to 1969. We started the brokerage business through our listing in 1983 and the acquisition of the majority stake in SHK & Co. by Allied Properties in 1996. We have continued to grow and expand our business in financial services. The establishment of UA Finance business in Hong Kong and eventually in China brought us into the consumer finance sector, as we expanded our own operations in Hong Kong to include wealth management. In 2015, we began the next phase of our evolution by partnering with Everbright in the wealth management business, launching our mortgage business and starting to build out internal investment management capabilities. With each step, we've built on our past successes, and we've leveraged the networks we've built out through our 50-year history. So where are we now? So we have a strategically balanced investing and financing business. We've realigned our business segments into 2 categories: financing and investing. So the philosophy behind this dual-engine model is our core lending business. It provides stable returns and cash flows while investing that seeks new income streams and opportunities for increased returns. This diverse yet complementary business portfolio resulted in 2019 being one of our strongest years ever, and we feel it further validates the strategic transformation we embarked on 5 years ago. Our lending businesses remain our largest in terms of assets and provide steady cash flow and organic growth through consumer finance at UA, mortgage loans and Sun Hung Kai Credit and specialty finance, which is now improved with these finance businesses. Our Investment Management business focuses on strategies across sectors and geographies, and this includes HKD 13 billion of assets in public and capital markets, alternatives and real assets. We group our strategic investments in Everbright Sun Hung Kai and LSS Leasing here as well. Moving forward, we will continue to expand the Investment Management business by launching a fund management platform, which we'll be able to manage external money and bring assets and revenue. As we continue to grow our offerings, we believe the Investment Management business will be a major driver for future growth, and Ben will talk more about this later in the presentation. So on to the results. So as you can see from the slide, 2019 was a very strong year across the business. Our attributable profit was up by 76%. Our basic earnings per share increased by 86%. We've maintained a steady dividend, and our book value per share has increased by 7%. So we'll go into more of the details of those results. And before we do that, we'd just like to touch on our long track record of performance through various market cycles. So let's look back over the last few years. This is the highest level of return on equity at 10.6% and our highest EPS at HKD 1.044. We've continued on the track we set out in the group's strategic transformation 5 years ago, as mentioned, with the beginning of our Investment Management business. We've maintained a consistent dividend payout and steady dividend per share and have also undertaken a number of share buybacks over the years. Also, we've continued to improve capital efficiency and risk management. This year, we reduced the amount of share buybacks, though we did acquire a 7.27% minority stake in UA. Looking at the segments of the business. Overall, the numbers are very good with a total consolidated pretax profit of $2.7 billion, which is up 50% year-on-year. This slide shows how we are grouping the financing and investing businesses together, along with our group management and support, which holds our central capital reserves and services. Consumer Finance, which is the UA business in Hong Kong and China, was the largest in terms of assets and total profit with a 6% year-on-year return increase. Specialty Finance, which has moved into the financing side, saw a drop in profits as loans were paid back, and we increased our level of provisioning at year-end. Our mortgage loan business had a solid year and seemed to have reached the scale and maturity over the 5 years since its launch in 2015. Investment Management had a very strong year, going to over $1 billion gain in 2019, and we'll talk more about that performance. You'll note our significant liquidity reserves, and Elsy will talk more about that shortly. Thank you, Elsy.

Thank you, Ben. For fiscal year 2019, our liquidity position of the group remained very strong. As of the end of 2019, our cash reserve totaled HKD 5.7 billion with an interest coverage of 4.5x plus. And of that, our total loans outstanding is about $15.9 billion, and our total long-term debt is about $10.5 billion, and our total short-term debt is about $6.2 billion. And in November 2019, we conducted a tender offer and new issuance. The tender offer is for a total of USD 270 million, and the new issuance is about USD 350 million. Such exercise substantially lengthened our long-term liability profile from 2.7 years to 3.5 years. Turning to the next page, is our capital structure. As of the end of the year, our total liability is HKD 19 billion, which is a 6% increase from the years before, and our gearing ratio remained very steady at about 54.1%, which is a slight increase from the year before of 52.4%. And in terms of our funding structure, we have a profit debt and notes outstanding of about $8.6 billion. This is a 10% increase, mainly due to the new issuance that we have conducted in 2019. And in terms of total bank facilities as well as borrowings, it's about $8.1 billion, which is 14% increase from the previous year. Given our low gearing and strong cash position, we believe that we have sufficient cushion as well as dry powder to sustain the -- to weather the volatility in the market as well as the potential strategic opportunities as well. I'd like to...

Thank you, Elsy. We'll start now by looking at the detailed business segments, and we'll start with UA, which is the largest of our financing businesses and has seen -- has been a steady contributor of profits to the company. As you may know, UA has been operating for over 25 years. In 2019, we saw organic growth in total business and profits. It was a solid year with steady growth in the Hong Kong business, which accounts for 76% of the loan book. And gross loan balances is now over HKD 11 billion. Overall, we saw a slight drop in impairment ratio to 7.5%, and we'll get into those details as we look at the 2 components of UA. So first of all, let's start with some more details of the overall position and with an analysis of pretax profits. Overall, we've seen an increase in revenue and a decrease in operating costs primarily as a result of further efficiencies from our Mainland China business through branch closures. We've seen a slight drop in impairments overall, as mentioned, and overall, an increase in profit. In the China business, we've seen a reduction in loan returns overall. But overall, a better performance with tighter lending criteria and lower loss ratios. Our higher -- we have a higher impairment loss ratio at year-end -- and at year-end, the lower impairment costs during the year, which was driven by increase in aging at year-end. So let's talk about the Hong Kong business next. So here, we've seen an increase in gross loan book and origination to achieve a new high in our loan book size. Returns have increased, and the charge-off and impairment ratios remain manageable. As mentioned, we increased the impairment provisions at year-end on the back of social unrest in Hong Kong. Business continues to invest in platforms and features while enhancing the security and resilience of our infrastructure. If we look at the -- next at the Mainland China business, where we've seen a reduction -- a further reduction in branches and staff. We've seen increased investment in online business and technology. We're a licensed online lender. We've seen a drop in returns based on policy limits and tightened lending criteria to compensate. We've seen a similar number of loans but for slightly smaller amounts with lower charge-off and impairments. Overall, we see businesses being positioned to take advantage of the restructuring that's taking place, and we believe that the business will have opportunities in the future as a result of ongoing changes in the Mainland Consumer Finance space. Now to Specialty Finance. Specialty Finance is performing -- known as private credit and was included in the investment space. We've realigned this to better reflect the nature of the business. It's the group's structured and specialty finance business which provides tailored funding solutions to corporates, investment funds and high net worth individuals. Almost all the loans were either secured by assets or with guarantees from corporates or high net worth individuals. The gross loan balance dropped as loans were paid back with an overall drop in revenue. We've seen little increased competition in the space, but we did increase impairment allowances at the year-end on the back of the credit environment. Now we move to our mortgage loan business. Sun Hung Kai Credit had a solid year. The business seems to have achieved maturity and scale. The loan balances are slightly lower compared to the prior year. But overall, average loan balances were higher than the previous year. We adopted a conservative underwriting strategy with less than 65% loan to value ratio, and 95% of our mortgages are first mortgages. We have low impairment losses, have improved -- achieved significant cost efficiency over the year by investing in systems and people. And this business, we believe, is well positioned. So I'll now hand over to Ben to talk about the Investment Management business.

Good morning. Going forward, the Principal Investments business, PI, which manages over $13 billion of assets and generated $1.8 billion in gains last year, were rebranded -- will be rebranded as Investment Management, IM, in order to pivot towards managing external investment capital and aligning existing investment businesses. The Investment Management division leverages the group expertise, network and strong financial position to seek attractive risk-adjusted investment opportunities. In 2019, the annual return on average assets for the segment was 12.4% compared to 4.3% in 2018. Even after operating expense and funding cost allocation, the segment contributed $1.0832 billion in pretax, an increase of 1,202% from the $83.2 million achieved in the previous year. 2019 provided good investment opportunities in both equity and the credit markets. We saw over $300 million in realized gains, dividend and rental income. Our alternatives portfolio continued to mature. And while we continue to invest in new funds and co-investments, we saw a net flow impact to IM, $154 million net back to IM over the year. Over the past several years, we've built a strong global network of investment professionals and partners, and we are now ready to expand the Investment Management business by first launching a fund management platform. Our immediate next steps will be the launch of Sun Hung Kai Fund Management, a fully licensed and regulated fund manager under the SFC that will manage third-party capital investments and assets, including public equity, credit and real estate credit. We have received regulatory approval to proceed and have been working to build out the infrastructure to support this new business. As this happens, the IM teams who have managed different fund strategies will move on to this platform with the IM operations team supporting all of them. If you look at the Investment Management return -- assets and returns, we see the public markets and capital market business returned 15%. Alternatives returned 17%, and real assets was minus 3.9% to give a total of 12.4%. If we move to public and capital markets. The public equity portfolio has been reclassified to only include the company's internally managed APAC long and short strategy, direct equity holdings and our internally managed global credit strategy and cash. Overall, these strategies made up 24% of the IM book and returned 15% in 2019, generating HKD 400 million in returns. Equities, which make up 51% of the book, generated 18.5%. Credit at 22% generated 23.5% in what was a particularly good year, and the remaining 3% of direct equity holdings also generated 14.3%. The equity holdings were global with a focus on the companies in Asia Pacific or that is APAC as a significant driver of growth and value. Our team's proprietary research and access to networks across the area and through the company allows us to gain a deep understanding of the companies and markets. The portfolio is focused on certain sectors like financials, health care and consumer goods but maintains good diversification. Our credit portfolio returned solid results in 2019. Our strategy was to identify and invest in credit situations globally which presented attractive risk/reward profiles with near-term upside with a net long bias at the portfolio level. Global markets presented opportunities in European banks and Middle Eastern sovereign debt, which we were able to capitalize on as well as several Asian companies. I go to capital markets. The actively managed credit and equity strategies had very strong years in 2019, and we view the best way to grow them is to allow them to manage third-party capital. Over the past several years, we've built up a strong team of investment professionals and a network of partners, and we are now ready to expand the Investment Management business by first launching a fund management platform. The goal is to bring in any additional assets and revenue as we build our world-class asset management capabilities and grow our offerings. We believe the Investment Management business will be a major driver of future growth. Our immediate next steps will be the launch of Sun Hung Kai Fund Management, a fully licensed and regulated fund manager under the SFC that I already mentioned. We have received regulatory approval, and we're looking to build out the infrastructure to support the business. As this happens, the IM teams who have managed different fund strategies will move on to the platform with the operations supporting them. If I move to the alternatives section. Alternatives, which comprises 57% of Investment Management, had a strong year, achieving a 17.1% return. The alternative investments include private equity funds, hedge funds and direct and co-investments. Over the past several years, we invested the group's capital thoughtfully and built a portfolio of private equity funds, direct investments and co-investments to enhance the returns and diversify our exposure by industry and geography. The portfolio is invested through a combination of direct or co-investments and external managers who are selected based on performance, strategic fit as well as access to markets and sectors. The portfolio benefited from early positioning in growth sectors and companies. Our key direct and co-investments include the Wuxi Pharmaceutical Group of companies and financial and fintech names such as Fairstone Inc., which is a consumer finance business in Canada; and Jefferson Capital Systems, a debt collection business in the U.S.A. With the group's expertise and network in the financial services segment, this will continue to be a core theme of the portfolio. As the portfolio matures, we are in the process of monetizing many of the investments we made in previous years, receiving HKD 74.6 million in distributions. While we continue to make new investments in funds, direct and co-investments in 2019, we received more in distributions than we invested for the first time since we started this program with a net $154.8 million coming back to IM. If I continue on the alternatives section. The external hedge funds generated 9.4%. The external private equity funds generated 14.1%, and the direct and co-investment segment generated 21% to give a total of 17.1%. If you look there, there are splits across the various different sectors based on geography and segment. The PE and direct portfolio has global exposure with a focus on China, Australia and Southeast Asia, where we have strong sourcing networks. Major sector focus, as I mentioned, was in health care, tech, financials and consumer. Hedge funds tended to have a global mandate with the vast majority employing long/short equity strategy. This is a key part of our overall strategy to use our investments to generate strong information flow to allow us to make decisions across our investment management platform. If I look at real assets. The real assets portfolio includes all of the group's real estate holdings and had a valuation of HKD 2.542 billion (sic) [ HKD 2.543 billion ] as of December 31, 2019. This is slightly down from 2018. The portfolio includes the group interests in Hong Kong commercial real estate as well as hotels and commercial investments in global markets. During the year, there was a small loss in the portfolio of $94 million, arising from increased provisions on property valuations. In late 2019, the group acquired 17 Columbus Courtyard located in Canary Wharf in London. This acquisition strengthened and diversified our portfolio in London and showed the value of the team's expertise and sourcing network. Real estate is a core strength of the group, an area we expect to grow our portfolio going forward. In addition to our equity real estate holdings, we plan to launch our first real estate debt fund in 2020. With the group's long track record and strong institutional knowledge of the lending space, we see the private debt in real estate as having attractive risk/reward, particularly in this market environment, and we look forward to offering our expertise in deal flow to outside investors. In terms of strategic investments. During the year, EBSHK delivered a strong performance with a solid increase in turnover of $112 million despite the Hong Kong market's lower average trading volume. Client AUM was $130 billion. The business has performed well since its integration of the Everbright Securities. The overall valuation change on the group's 30% stake in EBSHK was a gain of $131 million. Rob, would you like to finish that?

Sure. For LSS, the business environment continued to be challenging in 2019 with declines in auto sales and production and tight liquidity as the government continued to deleverage the economy. Against this backdrop, LSS Leasing has expanded into the ride-hailing and goods delivery segments, leveraging its network and know-how in auto leasing. In 2019, LSS has formed partnerships with leading platforms such as Lalamove and Deppon to further explore and develop new business initiatives. We'll now go back to Ben just to explain a little bit more about the philosophy behind our move into fund management.

So over the last 5 years, the company has built our investment platform by leveraging our capital, our business expertise and our networks in financial services. During this period, we established the Investment Management business through careful and continuous efforts to build a strong and diversified portfolio. We believe our expertise and the returns generated by IM puts us in a strong position to expand to our next phase, fund management. The company is nearly ready to launch a fully licensed and regulated fund management platform, as I've previously mentioned. Going forward, we expect fund management to be a new driver for sustainable growth in assets under management and revenue. In the first quarter, we have received regulatory approval to proceed and have been working to build out the infrastructure to support the new business. We plan to use the networks and relationships built up over the last 5 years to create a specialized and attractive fund management offerings, which will allow our internal teams to build their investment base, expand their reach and diversify risk. To prepare for this move, we have build out strong teams in investment and management. Three funds will be launched at the start, with each fund ceded by the company and are able to take in third-party capital. The equity and credit funds are the next evolution of the investment program that have been incubated in the public capital markets for the past 3 years and will lead by the same -- will be led by the same portfolio managers, Simon Walsh and Banny Leung. The real estate fund will have a focus on direct lending across Australia, Greater China, U.K. and Ireland and the EU and will be led by Rai Katimansah in Singapore. We have built out an institutional-grade infrastructure to support the funds and have been able to get industry-leading partners like Morgan Stanley to work with us.

Thanks, Ben. So just as we undertake this move into a regulated asset management business, we felt we'd like to explain our risk management focus. So the group adopts a comprehensive risk management strategy. Risk management policies and procedures are reviewed regularly and updated by the Board to react to changes in the market and the group's business strategy. The Risk Management Committee, a standing committee, reports to the Board and acts as -- to oversee the group's risk management and monitors internal control systems. We see risk management and compliance as a responsibility of every member of the firm and expect everyone to take ownership of the process. The Compliance and Risk Committee regularly updates procedures and policies to adapt to emerging risks such as those that we've seen from the coronavirus and the need for more remote work. But overall, risk management has been a very significant focus as we move into our Fund Management business. Right. We'll change topics a little bit and just touch briefly on our community, culture and environment. We value our people and are committed to provide a flexible, diverse, inclusive and open culture to attract and retain talent. In January 2019, we announced an unlimited annual leave policy and over the year, built out systems and processes to allow our employees to work more flexibly and remotely. Outside the office, Sun Hung Kai & Co. has a vision to promote sailing, a sport with a rich legacy in Hong Kong, as we believe that sailing exemplifies endurance, adaptability and excellence. We launched the Sun Hung Kai Foundation, a Scallywag Foundation in May 2019, with the mission of making sailing more accessible for underprivileged youth in Hong Kong. Since its launch, over 100 young sailors have trained under the program. Off the water, we have engaged with the community through the Sun Hung Kai Foundation through our support of eye health initiatives with Orbis, a Harvard University scholarship scheme in the arts in Hong Kong, where we endeavor to enrich the communities that we live in. We know these things are the right thing to do, and we believe that they will contribute to making our company a continued success. So now we'll finish on the business outlook. And obviously, as we speak to you today, the world is dealing with the coronavirus outbreak and its effects, disrupting businesses and markets. We're closely monitoring the situation and the potential impact on all of the group's businesses and investments, and we will continue to update our strategy as the situation develops. The UA business was the most immediately impacted by the coronavirus when it first broke out in China. Branches were closed, and we expect ultimately that credit quality may be impacted. For the Hong Kong business, we remain cautious. The travel ban, social distancing and mandatory business closures likely increased unemployment and are expecting -- and are expected to impact credit quality in due course. We have initial indications that delinquencies are rising and loan origination has slowed, but we're monitoring this space very closely and will respond as appropriate. The Investment Management business has felt the impact of the intense sell-up across markets after a strong 2019. We've been actively managing the investment portfolio through these difficult conditions. Through this, we have maintained our liquidity and are managing our assets carefully. We are ready to launch the Fund Management platform this year. And to reiterate, we are focused on protecting our staff by both staying productive and engaged, actively managing our assets, preserving our cash and managing expenses. We're working with borrowers in line with government initiatives. Our specialty credit and mortgage businesses are working through the volatile markets, and our investment business is actively managing risk. We're also, on the positive side, looking at opportunities in this market where we believe there is significant opportunities as a result of market dislocations. So with that, we come to the end of our formal presentation, and we will now take questions from viewers. Are there any questions? Can you explain how?

Sure. So if anybody has questions, you can submit them through the web interface. And then as they come up here, we can address them as we go.

So we have one question. So what would be the focus now for equity investments as far as geographies and sectors are concerned in the current volatile market scenario?

Yes. I think the focus for us on the equity side continues to be strong companies that we know very well with good balance sheets that can weather the storm that's being -- that the market is facing. As they say, all storms will pass. It's how you weather them that matters. And the companies we invest in tend to be companies that exhibit very strong balance sheets, good cash reserves and the ability to weather through this difficult period and come out the other side even stronger. We see significant opportunity in these markets to add into the areas we like, including financial services, health care and diversified companies. Again, we also see the opportunities in the technology space as well, as the market continues to show strong winners that come out of this environment. And we will continue to look at opportunities in that space going forward.

So we have another question. It says, "I want to ask about the payout ratio dropping from 30% to 25%, and what are the implications of the change?"

I'll take that one. So we've maintained our dividend steady in terms of cents per share. Obviously, our results are up significantly in this financial year, and we've maintained our ratio -- our dividends steady. There's no long-term implications. I guess in view of the current uncertainties, we've elected to remain cautious and keep our dividends steady rather than increase the amount paid out.

So there's another question about Investment Management. So pointing out that much of the Investment Management gains in 2019 were mark-to-market, do you have a view on the size of the mark-to-market impact of the IM business in Q1?

We've managed the business extremely well in Q1. While we won't talk about the actual return so far, I would say, we're in line with the market at this point given the markets that we're focused on. And in some cases, we have definitely outperformed.

So one of the questions is, "Is there a worst-case assumption? And can the company share this with us?"

Well, I think we believe that our business model is well positioned to manage through this difficult situation. As mentioned, we are -- have strong liquidity and balance sheet, and I'll get Elsy to talk a little bit about that in a minute. But our businesses are well positioned, we believe. Obviously, it's a disruptive time, and we're managing through it. But how about, Elsy, on the funding.

I think the company have a combined 20 to 50 years in operation as well, especially with our core business. UA Finance have 25 years of life experience in the market, in the region. I think we have weathered about 3 to 4 storms at least, including the SARS, the Asian financial crisis, the GFC, the liquidity drain in China. Given our capital structure and liquidity management, I think we have sufficient amount of dry powder and mechanisms in place to ensure that our fundamental -- despite the market volatility and the market and the shock in the market, we have sufficient amount of cash as well as liquefiable assets to support the normal operation of our core businesses. So I think the worst case is -- that's definitely a worst-case scenario in this world. I mean we have seen this to a certain degree in the great financial crisis, but we think that we have learned from the experience in the last 25 years. And we continue to improve ourselves.

Yes. Look, I'd add from the Investment Management side, these sorts of markets create enormous opportunity. As I said, the storm will eventually pass. So we're spending a lot of our time looking to identify companies which have been beaten down, which have very strong fundamentals and focusing on investing in those companies over the period. And we expect to generate outside returns from that process.

Okay. So one other question that we have is specifically regarding the U.K. real estate acquisition, which I believe is the 17 Columbus Courtyard. What kind of cap rate was the deal done at? And are there any other details that we can share?

I don't want to share that.

Can we just talk about the acquisition in general, I think?

Yes. I don't think we want to share the actual cap rate of the deal was done at. But we did the deal alongside one of the premier Australian investment banks at a very reasonable rate. It's an interesting deal, and we think there's considerable upside in that investment just given the environment in London. Putting the virus issues aside, we think the long-term opportunity for that space in London is very, very strong. There's considerable demand for this type of real estate in the London market. We feel we bought it at a very reasonable rate, which gives us considerable upside. And we think we're working with very strong partners, which will give us a very strong opportunity for success in this transaction.

All right. I think that about answers most of the questions. If anybody else has any final questions, you can submit them now. And if not, I will say thank you to everyone who tuned in. Thank you to my colleagues for taking the time to present this morning. If anybody has additional questions that weren't answered, the contact information for Investor Relations is on the last slide of the deck. So please do get in touch with us either today or going forward, and we will be happy to -- sorry, there is one final question that came in, a question about are there plans for continued share buybacks in 2020.

So as you will have seen from the presentation, the company has a long history of share buybacks. It is likely that the share buybacks will continue. We don't have an official policy around that, but it's likely that some form of share buybacks will continue. That's, I guess, what we can say at this time.

All right. Thank you very much. Thank you, everyone, for tuning in, giving us time to talk with you. And as I said, if there are any further questions or comments, please direct them to Investor Relations, and we'll be happy to get back to you.