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

Good morning, everyone. Welcome to the interim results presentation for Sun Hung Kai & Co. This morning, we will be presenting the first half results for the company and the group. We'll go through a presentation where we speak about each of the different business segments, some of what's happened during the period and our outlook going forward. Joining me today -- sorry, I'm Joseph Fuqua, I am the Director and Head of Investor Relations for the group. Joining me is Mr. Robert Quinlivan, who is the Group Chief Financial Officer; and Ms. Elsy Li, who is the Group Treasurer and Head of Corporate Development. I will hand it off to Mr. Robert Quinlivan to start the presentation.

Thanks, Joe. Good morning all. In what's been a challenging year, we believe our business model has held up well. That, combined with our ethos of endure, adapt and excel, fits very well, we feel, with the current situation. So our approach of combining our relationships and access with expertise and innovation, capital and governance on our strategically balanced business has continued to develop and lead to asset growth, relatively stable returns and distributions for shareholders. If we look back at our history, which is more than 50 years now, our heritage goes back to 1969 with the start of the brokerage business. More recently, from 2015 onwards, we started building our asset management business to complement our finance business. And we continue that growth and development in this year. A quick snapshot of our business. It's well balanced between our financing and investing arms. Our lending business provides stable returns and strong cash flows while our investment business seeks new and diverse income streams and incremental returns. Looking forward, we will continue to develop our core lending business and we'll be proceeding with launching a fund management business to complement our existing Investment Management business. So let's turn to the results for this period. In obviously a challenging period, our attributable profit was down 32% to HKD 695.2 million. Similarly, our basic EPS was down by 32%. However, we've made no change to our interim dividend, which remains at HKD 0.12 per share. So these are comparisons against a very strong first half in 2019. Importantly, all our businesses remain profitable through the COVID pandemic and we believe the solid results that we've achieved. Further out, our strong liquidity positions us well to take advantage of future opportunities. Let's have a quick look back now at our track record of performance, which goes back several years, as we've highlighted from 2017, and the performance in our distributions back to 2007. Importantly, we've focused on sustainable growth through a range of market conditions. And obviously, in the current challenging market conditions, we've continued to generate a profit and continue to declare a consistent dividend. Over HKD 12 billion has been returned to shareholders since 2007, and we believe that we will continue to generate good returns for our shareholders going forward. We combine this with capital efficiency and disciplined risk management. In terms of the segments, it's really important to note that we've been profitable across our 5 key business segments, at financing and investment businesses, all profitable for the first half. While the results have been down compared to a strong first half last year, we believe the results and the consistency of profit positions us well going forward in the current situation. Our business is balanced, as mentioned before and overall well positioned. Importantly, we remain -- we retain strong liquidity reserves. I'll now hand over to Elsy to talk more about our balance sheet.

Thank you, Rob. Over the period, our balance sheet remained very strong and conservative. As of June 30, 2020, with a total asset $42.9 billion, and our total cash remains very high at $7.5 billion level. Our total loans is $13.9 billion and is funded by $16.7 billion of long-term and short-term facilities. We then turn to the next page about our capital structure. Our total gearing ratio has further improved from 54.1% to 44.6% in the first half, and our interest coverage has been impacted a little bit due to the reducing income in the first half but still stand at 3.2% (sic) [ 3.2x ]. Overall, we have utilized conservative capital structure and funding to ensure that we are prudent in our cash position and also well positioned for future opportunities. I'll pass to Rob for the business review.

Thank you, Elsy. So we'll start with UA. You can see on the slide that the net loan book size has come down slightly during the period in view of the current coronavirus situation on the back of reduced origination. Overall revenue has declined by 4%, and our pretax contribution has declined by 20% on the back of increasing impairment losses. It's important to note that the Hong Kong business remains resilient and we continue to optimize our Mainland China business with more business shifting online. We continue to explore online business collaborations in Mainland China and see what opportunities there are in that space. Overall, our percentage of business is 81% in Hong Kong and 19% in Mainland China. So we can dive into those results a little bit further. And you'll see from the slide that the increased weight in Hong Kong business has led to a lower return on overall loans, but also lower net impairment losses in the Hong Kong business compared to China. We've had improved cost-to-income ratios in Mainland China through cost control and further branch consolidation. Our finance costs are slightly up as a result of higher borrowings to support the business. As mentioned, we've had an increase in net impairment losses due to COVID-19 and also the delayed impact from the social unrest in Hong Kong in 2019. As you can see, our aging analysis, overall, this has increased in terms of the percentage overdue from 8.3% to 10.2%, and that's obviously something that management continues to focus on in these challenging conditions. Diving to the Hong Kong business. The Hong Kong business has remained resilient and maintained its operational scale and market-leading position. As mentioned, impairment losses have increased as a result of COVID-19 and the delayed impact of Hong Kong social unrest. Importantly, the business has continued to develop and innovate with new products. Yes UA mobile app with more features and One-Click-to-Loan services, also improving drawdown times with Faster Payment Systems. The number of branches has reduced by 1 and the gross loan balance has reduced slightly. As mentioned, originations have declined in the year-on-year period. But overall, we believe, as mentioned, that this Hong Kong business remains resilient and positioned well to benefit from an improvement in the environment. In terms of the Mainland business, the business has experienced further branch consolidations that we maintain our presence in 15 cities. The business has moved more online, as mentioned, with up to around 55% of loans by volume now being approved online. We are exploring business cooperations with other online partners to increase exposure to mass market customers. The business was affected by COVID-19, particularly in the first quarter, as many businesses and cities were locked down. Performance improved in the second quarter as business returned to normal, though, overall, the impairment ratio has increased. It hasn't shown improving trends in the second quarter, but it's still higher year-on-year. Accordingly, we are adopting a cautious approach to new originations, but we do continue to originate new loans and look forward to an improvement in business conditions. Overall, we believe the business remains positioned well to benefit from further improvement in market conditions. Moving on to our specialty finance business. So this is a tailor-made funding business for corporates, investment funds and high net worth individuals focused on Greater China. As you can see, the pretax contribution was down by 63% compared to the prior period with -- mainly on the back of increased impairment losses. We've taken conservative provisions on some of our underlying loans in view of the impact of business from COVID-19. Also, we've seen a reduction in loan balances primarily on the back of loans being repaid, and we have not yet originated new loans to replace them, partly, this is in view of our cautious positioning in terms of credit. So we'll continue to look at opportunities for new loans, but we have been cautious so far. Overall, we believe that this business is still well positioned as banks withdraw from specialty lending and we'll be in a position to capitalize on new opportunities. Moving on to our mortgage loan business. This is our Sun Hung Kai Credit business. Overall, net loan balances have reduced slightly, although revenue is up compared to the prior period. Overall, our pretax contribution has declined slightly, but this business has remained very, very strong given the environment. Our conservative underwriting with less than 65% loan-to-valuation ratios on our loans and 94% first mortgages has positioned the business well in the current credit environment. We had increased impairment losses in view of the environment, but it's important to note that we haven't experienced any actual credit losses in this business in -- since it's been operated. We'll continue to invest in infrastructure and people and believe the business remains well positioned. So now I'll hand over to Joe, who will talk through the Investment Management business.

Thanks, Rob. So the Investment Management division leverages the group's expertise, network, strong financial position to seek out attractive risk-adjusted returns across different asset classes. Currently, the Investment Management segment comprises public markets, alternatives and real assets. In aggregate, this -- the Investment Management division had 4.4% return for the first half of 2020, which given the difficulties in the markets, the volatility that was created and the disruptions that were created by COVID-19, is a fairly solid turn. This generated HKD 365.9 million in pretax profit for the division, which is a drop from the first half of 2019, which was a very strong time. In general -- in total, the portfolio has HKD 14.058 billion in segment assets. The private equity portfolio returned record high distributions during the period, and the rebalanced hedge fund portfolio also had strong returns. Real asset portfolio had a slight markdown based on the values of the properties in Hong Kong. And key thing for the investment management is that moving forward, we will continue to proceed with the launch of our Funds Management division under the leadership of Lindsay Wright. So if we look on the next page, the investment assets and return, we can see the breakdown across the 3 components of investment management. So during the period, the public markets segment did have a 7% drop while alternatives increased 11.8% and real assets, as I mentioned, had 1.1% drop as a result of the markdown of the value of the properties. Moving on to the public markets segment. In total, this was about HKD 3.8 billion in value and is 27% of investment management overall. The segment had a 7% loss for the first half of 2020. Though, if we look at the equity segment, which is based on our actively managed APAC long/short portfolio, this actually generated a 3.5% return for the period. Given the tumultuous ride that markets had during the time, we're happy with that return. And the portfolio performed well after the lows of March. Because of its cash position, it was able to invest during that time and during the recovery was able to see consistent returns. The credit portfolio also suffered during the drop in the first quarter, but also had a strong rebound. It's only down 10 basis points through the first half of the year and has moved into positive territory after the end of period. The Corporate Holdings and cash, this did -- is a segment that we use for hedging corporate holdings and managing some of the positions that are in the private equity portfolio. This did suffer in the volatility of the market, which created the loss for the public markets segment. Going forward, we intend to transition the APAC long/short credit funds into -- under the funds management platform and prepare to take third-party capital. And we are also continuing with the active management in the credit strategy. And we are evaluating where best to hold the Corporate Holdings and cash segment to make sure that we produce the most clear returns for the investment management. If we move to the next page, we have a little bit more detail on the equity and the credit strategies. So as mentioned, equity is the APAC-focused long/short portfolio. There were some impacts in the first quarter, but a strong rebound. In particular, the long positions, which focus on high-quality companies with strong earnings leadership, fared better than the market; and the short positions did add alpha as expected during the downturn. So in aggregate, it outperformed the MSCI Asia Pacific Index. And the significant cash position should provide liquidity to take advantage of opportunities that arise. If we look at the portfolio breakdown, there is a strong basis in Greater China and with some diversity across other major global markets and fairly good diversification by sector. The credit strategy is actively managed long-biased global portfolio. This also had similar impacts during the COVID pandemic and have also had a strong recovery. The portfolio here is more balanced geographically, definitely has a strong bias towards financials in terms of sector. Currently, in credit, after the strong recovery, we're in a risk-off mentality and we expect that there's going to be continuous uncertainty. So we've decided to take profits and wait for opportunities to arise. Moving on to the alternatives segment, which is the largest by total value at HKD 7.8 billion, 56% overall of Investment Management and had strong returns through the first half of the year of 11.8%. So this consists of 3 major segments: externally managed private equity funds, externally managed hedge funds and direct and coinvestment deals through the private equity side. The external hedge funds represent 18% of the portfolio and had 11.2% return. External private equity funds were 31% of the portfolio and were flat through the first half of the year. And then direct and coinvestments were 51% of the portfolio and had a 19.1% return. In total, we received almost $1.3 billion in distributions for the private equity, direct and coinvestment portfolio through the first half, which is a record high not only for half of the year, but even for a whole year since we started the investment management program. And even with new commitments and capital costs from existing managers of HKD 868 million through the first half, we still had a net return of $425 million to the portfolio. This shows the mature nature of the portfolio, and we're starting to see realizations on investment activities that we had taken previously. So the hedge fund portfolio was rebalanced during the period and as a result, we have seen strong performance through the first half. Going forward, we continue -- we intend to continue with our program to invest in high-quality managers that we source through our networks. Moving to the next page, looking at the returns and portfolio construction. So we can see that the segment in total gained HKD 862 million for 11.8% return. And when we look at the portfolio of private equity funds, we can see strong diversification globally, both in terms of geography and sector. And for the hedge funds, there is a strong bias towards global funds and then also long/short strategies, which we believe has had a strong performance through the first half of the year. Moving quickly to touch on the real assets portfolio. This is just under HKD 2.5 billion in value, 17% of the Investment Management portfolio and did have a 1.1% drop in value during the period, though that was -- those are mark-to-market revaluations on the properties based on the difficulties that we're having in the office and hotel sector. So this is commercial and hospitality properties that we hold in Hong Kong, U.K. and Europe. And we believe that real estate is one of the core strengths of the group. So these holdings while they're fairly concentrated in 3 geographies and in a couple of sectors, mostly hotel and office, we plan to continue to use the group's resources to build out a real estate direct lending fund that we'll have in the Funds Management platform that is in advanced -- that's fairly advanced in this process, and we expect to launch that before the end of the year. So now we'll talk about strategic investments. I'll pass it back to Rob.

Thanks, Joe. I'll just touch on strategic investments before we go into the fund management initiative. But as you know, we hold a 30% stake in Everbright Sun Hung Kai, and we hold a 40% stake in LSS leasing. So our returns in relation to Everbright Sun Hung Kai stake are broadly determined by the agreement we entered into in 2015 and the change in profit that you can see here are largely timing differences compared to the prior period. You'll obviously be aware that we have an option to sell our 30% share of this business at a predetermined price. We are currently discussing with Everbright how best to achieve this outcome and intend to conclude these discussions during the 6-month period. In terms of LSS, this business has continued to be challenged by market conditions. It does, however, continue to develop and improve the business and has strengthened its partnership with Lalamove and worked on cooperating with other online hiring and logistic partners. I'll hand back to Joe for the Funds Management initiative discussion.

Thanks, Rob. So to give a little more detail on the funds management initiative, this is something that we had started at the beginning of the year. And the goal here is to take our expertise that we've developed through investment management and working both with our internal managed strategies and our external managers and to leverage the group's expertise and also our balance sheet so that we can increase the returns that we're seeing by being a fund manager and taking positions -- a broad position in seeding funds and having an economic participation. Our target here is to launch multiple funds by the end of 2020. We are focused on, first, transitioning out internal capabilities. The immediate focus is the APAC long/short equity strategy, which we've been operating internally for over 3 years. One of the steps -- the first step we want to take is to spin that out into an independent company in which we have a participation. And that allows third-party investors to be comfortable with the independence of the firm, but also allows us a strong economic incentive in seeing how it succeeds. Secondly, we're focused on, as I mentioned, the real estate direct lending strategy. So taking, again, the expertise that we already have internally and putting this into a structure -- in a -- to a fund structure that allows third-party investors to participate in the deals that we're doing. Both of these, we believe, will add additional revenue streams through the fees that the third-party investors will pay, but also through the increased returns that we'll see from having a larger capital base in the funds. Our subsequent focus is to identify and partner with strong teams or existing asset managers who are looking for additional capital or building additional strategies. We believe that this multi-boutique approach will allow us to increase the returns that we're seeing on the balance sheet capital that's deployed and to also diversify our revenue streams across different strategies and different geographies. So we're in advanced discussions with several different teams and managers. And we hope to have at least one of those strategies launched on the platform by the end of the year. So we'll talk about risk management next. I'll pass it back to Rob.

Thanks, Joe. I guess as we move towards extending our business into third-party asset management, we would like to just reemphasize our focus on risk management. As we've mentioned in the past, the group adopts a comprehensive risk management framework. And risk management framework, policies and procedures are regularly reviewed and updated by our Board of Directors in order to react to changes in markets and the group's business strategy. The group's Risk Management Committee, which is a standard committee of the Board, oversees our risk management throughout the firm and monitors our internal control systems. We see risk management compliance as a key part of every member of the firm's role and expect everyone to take ownership of the process. Obviously, during this recent coronavirus and last year during the ongoing social unrest, we needed to adapt our risk management processes and approach to deal with the situation. We continue to operate throughout the rapid closures related to coronavirus, and we believe we'll continue to focus on risk management as we go forward. So finally, we'll touch on our view on the business outlook. Obviously, the environment continues to be challenging and the outlook is uncertain. As a company overall, we are cautious and we believe prudently positioned. We are carrying some additional liquidity and funding in view of this situation, which we believe to be prudent given the current circumstances. This is a slight drag on our balance sheet -- in our performance, the balance sheet obviously having additional liquidity. But we do believe it's prudent in the circumstances. For our financing business, obviously, operations have been impacted, but the business is resilient. There is residual credit risk as a result of delayed impact from social unrest, COVID-19 and ongoing, say, U.S. tensions. Our mortgage business is stable and we're maintaining cautious underwriting and careful credit standards. For our investing business, it's obviously experienced unprecedented market volatility in Q1, but we've adapted and adjusted our approach in this continually changing environment. As Joe has mentioned, we plan to move our business into third-party asset management in the latter part of this year and next year. And we'll continue to assess the market for opportunities using our network. Overall, on the corporate side, as mentioned, we maintain funding to fund our operations and maintain liquidity, strong governance and risk control, and we've been spending the time and effort to make sure our systems have been and work safely and appropriately throughout the crisis. So overall, we believe we're positioned appropriately in view of the current situation. So thank you for listening to the presentation, and I'll now hand back to Joe to moderate the Q&A.

Thanks, Rob. So we've concluded our formal presentation. We are available for last Q&A. If we have anyone who is on now. So please submit your questions through the webcast system. And if there are any to come in, we can answer them. So no questions so far. So I think we can conclude the webcast here. If you do have any questions that you want to ask, the contact information for Investor Relations is on the last slide of the presentation. You can either send an e-mail or give us a call, and we will do our best to answer whatever questions you have. Thank you very much for joining us for the webcast on the first half results, and we look forward to hearing from you.