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

Ladies and gentlemen, thank you for joining our 2023 annual results investor presentation. This presentation will be conducted in English. Alternatively, you may switch to the Chinese channel and mute the original audio if you need translation. I'm Shirley Zhang, Investor Relations Vice President of Sun Hung Kai & Co. The senior executives here with me today are Mr. Brendan McGraw, Executive Director and Group CFO; Mr. Tony Edwards, Deputy CEO. Tony joined Sun Hung Kai & Co. as Deputy CEO last year. He oversees the strategic development of the company and bring his demonstrated leadership and extensive expertise to our Funds Management business as well. We firmly believe his skills will elevate our business to a new height of success. In today's meeting, we will talk about the company's business performance in 2023, the outlook for the coming year and our future plans. After the presentation, we will answer questions from participants. If you would like to ask a question, please type your questions into the Q&A box at the bottom of the panel, and please make sure to include your name and affiliation. I will read them out after the presentation. Before we start, we would like to take the opportunity to remind you that today's discussion will contain forward-looking statements, which are based on assumptions and factors that are beyond the control of the group and are not necessarily indicative of the group's future performance nor are the guarantees of future performance. Now I'd like to pass to Brendan to start the presentation. Brendan, please.

Thank you. Good morning, everybody. Our core business is built around three pillars: Credit, Investment Management and Funds Management. Credit business was referenced as financing business previously. In 2023, we renamed this segment to better reflect its products and services. The Credit business, mainly conducted through UAF and Sun Hung Kai Credit, provides us with recurring and resilient cash flow. Our Investment Management business leverages the group's expertise and global network to seek attractive risk-adjusted returns across diversified asset classes, sectors and geographies. Our Funds Management business is fully licensed to manage external capital through Funds Partnerships, SHK Capital Partners Funds as well as Family Office Solutions, aiming to diversify our strategies and add new revenue streams to the group. I would like to share how we will foster the growth of our business and enhance shareholder value. Our Consumer Finance business has made great progress in tapping into new customer segments and diversifying revenue streams by introducing new products, SIM credit cards, in Hong Kong. In the Mainland, we have been strategically derisking by shifting our focus from unsecured loans to secured lending in response to the slower-than-expected economic recovery. For our mortgage business, we have prioritized capital preservation and operating efficiency during a market downturn. For Investment Management, we harness the group's expertise and global network to generate attractive risk-adjusted returns. Amidst market volatility, we proactively manage our investment portfolio, focusing on increasing liquidity and derisking measures. To capitalize on opportunities arising from financial dislocations, we have focused on special situations. In addition, our investment capabilities can be further enhanced through collaboration with our Funds Management platform to lead the Group's transformation. We continue to build out the Funds Management platform to drive our transformation towards a leading alternative investment platform. In 2023, our Funds Partnership, ActusRayPartners, which employs a differentiated investment process and generates returns uncorrelated to the broader market, launched their second fund with our continued support. We also continue to build out our family -- multifamily office platform, FOS, to expand our client base to high-net-worth individuals and family offices, providing them with bespoke investment solutions. With our efforts in expanding the wholesale network, the three business lines of funds management strive for growing third-party capital and AUM. We prioritize long-term sustainable growth and proactive capital management, supported by strong liquidity and low gearing, which provide the staying power for our future growth. Our commitment to consistent dividend policy and continued share buyback demonstrates our dedication to delivering value to shareholders. Since 2007, we have returned a total of HKD 13.9 billion to shareholders through dividends and share buybacks. Next, I would like to take you through our 2023 annual results. During 2023, our bottom line improved significantly compared to 2022. However, several factors continue to exert pressure on us. This includes the persistence of high interest rates and the resulting volatility across different asset classes, a slower-than-expected regional economic recovery as well as the impact of geopolitical tensions and weak market sentiment in China. Facing a challenging backdrop, we have navigated by maintaining a robust balance sheet and ample liquidity. We focused on increasing liquidity across all business segments and optimizing capital efficiency and operational efficiency. We continue to streamline our business processes and upgrade our technology backbone. The group's revenue for 2023 was HKD 3.9 billion, down 3.4% year-on-year. The decline was mainly due to our strategic shift from unsecured loans to secured lending in the Mainland market, which resulted in a decrease in interest income. Pretax contribution turned to a profit of HKD 76.6 million from a loss of HKD 892.3 million for 2022. This was after a onetime write-down of HKD 158.9 million related to our interest in a joint venture in Mainland China. The year-on-year improvement was primarily due to the decreased unrealized loss on our investment assets as valuations stabilized in overseas markets. After taxation and non-controlling interest, attributable loss was HKD 471.4 million, which narrowed by 69.3% year-on-year. As we continue to derisk amid market volatility and uncertain economic environment, our book value per share was down by 5.3% to HKD 10.8. Our net gearing ratio decreased by 510 basis points to 38.6% year-on-year. Cost-to-income ratio improved by 110 basis points, reflecting our efforts in improving operating efficiency. We remain committed to returning value to our shareholders. The Board declared a second interim dividend of HKD 0.14 per share. Together with the interim dividend of HKD 0.12, total dividend for 2023 is HKD 0.26 per share, consistent with the prior year's payout. We also purchased -- repurchased 2.2 million shares for a total net consideration of HKD 5.9 million during the year. Our balance sheet remained robust with total assets of HKD 40.9 billion at the year-end of 2023. The cash position recorded a substantial increase of 13.7% year-on-year, reaching HKD 6.7 billion. The increase was primarily generated from operating activities and investing activities. Investment assets amounted to HKD 15.4 billion, primarily funded by shareholders' equity. Total loan assets were HKD 13.3 billion, primarily funded by our borrowings. 61% of total borrowings were bank and other borrowings at floating rates and 39% were notes and paper at fixed rates. We continued our proactive approach to optimize capital efficiency. In 2023, we repurchased MTN notes totaling USD 59.5 million, and the net gearing ratio witnessed a decline as net debt reduced from HKD 9.8 billion to HKD 8.2 billion at the end of the year. Now let's take a closer look at the performance of each business segment. The Investment Management segment total assets stood at HKD 16.3 billion at the end of 2023 with Alternatives, Real Estate and Public Markets comprising 71%, 15% and 14%, respectively. The year-on-year decrease was mainly driven by exits and distributions from Alternatives as reflected by the improved cash flow as well as strategic derisking activities. The Alternatives and Real Estate segment substantially narrowed their unrealized loss from HKD 1.9 billion to HKD 134.4 million in 2023, driving the year-on-year improvement in pretax results of the Investment Management segment. Realized loss on Alternatives and Real Estate portfolios was HKD 190 million as we adjusted our hedging strategies and rebalanced certain investments towards more conservative exposure during the year. In the 4 years from 2020 to 2023, the cumulative realized gain on Alternatives and Real Estate amounted to HKD 5.2 billion and the full year total return for the Investment Management segment was 18.6%. The annual return of Investment Management was minus 2% in 2023, improving by 590 basis points year-on-year. For the subsegments, Real Estate recorded a gain of 3.3% while Public Markets and Alternatives was 4.6% and 2.5%, respectively. The Corporate Holdings segment recorded a loss of 5% in 2023, mainly driven by losses from long-term strategic positions with exposure to China as international investors are concerned about the economy's property-related risk and geopolitical tensions, although the portfolio companies' fundamentals remained robust. A portion of the losses stemmed from our hedging positions on the back of U.S. equity markets recovery in 2023, which was partly offset by gains in the underlying investments, particularly in the communication services sector. In addition, our holdings in the energy and shipping sectors as well as consumer sector in the Japanese market also contributed to gains in this segment. The Private Equity segment assets stood at HKD 8.3 billion. A tough financing environment and ongoing decrease in liquidity events during the year continued to pose challenges for the whole market. Our portfolio's diversification helped mitigate risk to some extent and recorded a loss of 2.8% for the year. In the U.S., the stabilization of the Fed funds rate towards the end of 2023, along with the recovery of public markets, benefited our early stage and growth portfolio. Our Financial Services-focused investments continued to record strong growth and contributed gains. We realized some losses on hedging instruments in early 2023, which were implemented to mitigate our private books' exposure to market volatility. The losses were partly offset by gains in our underlying investments. Our exposure to China was impacted by international investors' weak sentiment and ongoing Sino-U.S. tensions, although the underlying fundamentals of our portfolio companies remained resilient. We continue to receive programmatic distributions from our investments and the PE segment recorded a net cash inflow for the year. Special Situations is a new segment that we start to separately report as we are increasingly seeing opportunities emerging from market dislocations. The portfolio mainly includes investments in distressed assets and has further expanded our footprint in Western Europe, North America and Asia, adding geographical diversification to the group. The residual term loan portfolio from Private Credit was also integrated into this segment. During the year, this segment achieved a 19.3% return primarily driven by a strategic investment in the travel sector that we made in early 2022, which has capitalized on the post-COVID rebound in international travel. The Hedge Funds portfolio recorded a return of minus 6.9% and was managed with more conservative exposure to mitigate the market shocks. Setting the terminated funds apart as we continue to rebalance our portfolio, the ongoing funds consist of long-term strategic investments as well as actively managed holdings. The actively managed holdings are dynamically adapted to the investment environment and therefore produced mid-single-digit positive returns in 2023. Entering 2024, our Hedge Funds portfolio with a strong cohort of managers is well positioned to capture the upcoming opportunities ahead. The Real Estate portfolio recorded a gain of 3.3%, primarily driven by the solid performance of our hospitality investments in the European Union, offset by weakness in Hong Kong. We remain cautious when it comes to new investments in the real estate sector. Next, I will hand over to Tony, who will guide you through the development of our Funds Management business.

Thank you, Brendan. Good morning, everyone. Our Funds Management business is structured into three lines -- business lines: Fund Partnership, Sun Hung Kai CP Funds and Investment Solutions as well as Family Office Solutions or FOS. Our Fund Partnerships are mainly established with emerging managers, providing them with seeding or acceleration capital. This is reflected in the partnerships to date: ActusRayPartners, Kernel, E15VC and Point King. SHKCP Funds are launched and managed by ourselves, including: SHK Latitude Alpha, a fund of hedge fund strategy; MCIP, a private credit strategy focusing on the APAC region; and SHK Private Access, which provides specific alternative investment opportunities for clients. We also work with a select group of hedge funds to distribute their funds leveraging our strong local presence and distribution network. The newly established multifamily office platform continues to develop in 2023 as we leverage on their wider relationships with the group to link up with family offices and high-net-worth individuals with a similar investment approach and horizons, capitalizing on our access to a wide range in credit, public and private opportunities. We remained cautious on capital deployment during the year, but we continued to invest in strategies that are best suited for volatile market environment with a proven performance record. In September 2023, with our continued seeding support, ActusRayPartners launched its second fund, which is an Asian market-neutral equity long/short alpha strategy. The second fund is built on the success of its European Alpha Fund. During the year, the quality and diversity of our funds have mitigated the downside impact from volatile markets to some degree. This was particularly evident in the market-neutral strategy of ActusRayPartners, which delivered solid performance, and in MCIP, which has maintained its disciplined approach to underwriting. Our diversified global fund of hedge funds, SHK Latitude Alpha Fund, generated steady returns through volatile equity and fixed income-strapped market. Now let's move our focus on the segment's key operating metrics and financial performance. Despite the challenging fundraising environment, our total AUM at the end of 2023 was USD 964 million, down only 1.1% year-on-year. The decrease was principally a result of the full redemption and closure of GCO and the sale of the revenue rights in East Point while ActusRayPartners recorded strong growth in its AUM, particularly from external investors, offsetting the decrease. Contribution from external capital increased significantly to 62.8% at the end of 2023 from 46.5% a year ago. When it comes to the P&L, total income surged by 52% year-on-year, primarily driven by a 24.3% increase in fee income and the rise in other income, which was attributable to the sale of East Point revenue share rights. Operating expenses decreased by 26.1% year-on-year. Net loss on financial assets, which are the carried interest distribution in kind we received, narrowed by 63.3%, both contributed to a pretax profit of HKD 16.8 million for 2023, a turnaround from 2022. Now I pass to Shirley to talk about our Credit business.

Thank you, Tony. 2023 marked the 30th anniversary of UAF's establishment in Hong Kong. Since 2017, UAF has consistently ranked first among all money lenders in Hong Kong in terms of outstanding balance of unsecured lending. During the year, in response to an uncertain economic environment, we remained prudent in new loan underwriting. In the Mainland market, we shifted our focus from unsecured loans to secured lending to mitigate risks. Therefore, our total gross loan balance decreased by 3.7% year-over-year to HKD 11.2 billion at the end of 2023. Hong Kong and Mainland China accounted for 81% and 19% of the total loan balance, respectively. Revenue for 2023 was HKD 3.2 billion, down by 7.6% year-over-year. Associated with the downsizing of unsecured loans and focus on secured lending in the Mainland, cost-to-income ratio improved by 180 bps year-over-year to 33.3% and net impairment losses decreased by 3.8% year-over-year to HKD 675.7 million. As a substantial portion of our finance costs were HIBOR-based, along with the surge of HIBOR in 2023, our finance costs increased by 45.3% year-over-year. As a result, pretax contribution to the group amounted to HKD 979.5 million, down by 18.2%, while our pretax profit in 2021 was an all-time high in its 30 years' history. In the Hong Kong market, loan originated increased by 3.1% year-over-year, which contributed to a gross loan balance reaching an all-time peak of HKD 9.1 billion in 2023. The growth was primarily attributed to the removal of COVID restrictions, following which inbound tourism and private consumption gradually recovered, which drove the increase in our loan demand. Loan yield in Hong Kong remained stable at 30.4% as the new interest rate cap had a marginal impact on us in 2023. Amid the softer-than-expected post-COVID recovery, we enhanced the credit risk assessment and maintained the charge-off ratio for the year at 6.0%. During the year, we successfully launched the SIM credit card, leveraging our expertise, customer base to drive growth and create synergies with the established personal loan business. We continually shift our marketing and advertising expenditure on various online and offline channels to ensure marketing efficiency amid the fierce market competition. With our continuous efforts in digitizing our service and operations, customer interest generated from our various online platforms has been steadily increasing. This was reflected in the double-digit growth in the number of new accounts created over online platforms. In Mainland China, we gradually scaled down the unsecured loans during the year and the year-end loan balance was HKD 2.1 billion, down by 28.2% year-over-year. The smaller exposure to unsecured loans and the shift to secured lending resulted in a decrease in loan yield to 20.7% as well as a significant reduction in impairment charges for 2023. In addition, the cost rationalization program we implemented in light of subdued business activities helped to streamline the cost structure and enhance profitability. We believe our strategy for the Mainland market will make the segment more resilient and position it to benefit from future economic recovery. Moving on, let's talk about our mortgage business, which is operated by Sun Hung Kai Credit in Hong Kong since 2015. In 2023, we exercised extra prudence in originating new loans to mitigate risks. Return on loans increased by 150 bps year-over-year to 10.1%, reflecting the higher interest rates, which partially offset the impact of rising financing costs. Operating costs decreased by 18.2% year-over-year, leading to a 2.6 percentage point enhancement in the cost-to-income ratio to 20.3%. The net impairment losses were HKD 57.5 million, mainly due to the larger provisions we took in light of the weakening property market in 2023. For the Private Credit segment, as we strategically reallocated the capital to MCIP, an APAC real estate loan fund managed by our Funds Management division, we continue to wind down the term loan portfolio. Consequently, the residual term loans were reclassified to the Special Situations segment within our Investment Management business. To sharpen our breadth of business and to increase our focus, we also decided to fully write down our interest in LSS Leasing, which is a joint venture engaging in auto leasing in Mainland China. It has struggled to recover from the COVID lockdown and the unbalanced post-COVID economic recovery. Next, I will pass to Brendan to give you an update on our risk management, ESG efforts and future plans.

Thank you, Shirley. Looking back at our continued efforts in risk management in 2023. Firstly, we have implemented additional controls such as new controls aligned with NIST frameworks to enhance our cybersecurity protection. We have also strengthened existing controls, resulting in a reduction in overall risk levels. This has enhanced our ability to identify, assess and manage risks, safeguarding our operations and assets. Secondly, we have organized risk training sessions and launched an enterprise risk management quarterly bulletin to increase staff awareness and understanding of risk management and internal controls. Thirdly, we have undertaken a thorough review and fine-tuning of our risk heat map and risk appetite, aiming to optimize the identification, assessment and mitigation of risks for more effective risk management practices. Besides this, we have established and implemented an electronic risk management system. All risks are now recorded and monitored in an electronic risk register, improving the efficiency and effectiveness of our risk management processes. Finally, through regular Risk Committee meetings, we conduct in-depth discussions to address specific risks that we deem of high importance. By proactively assessing and analyzing these risks, we ensure a comprehensive understanding of potential challenges and can implement appropriate risk mitigation strategies. In 2023, we remained committed to the core values of integrity, sustainability and inclusivity. We have elevated the ESG Working Committee to a Board-level ESG Committee, signifying the importance of ESG in our organization. During the year, we conducted mandatory ESG training to promote ESG awareness and knowledge among our staff members at SHK & Co., SHK Credit and UAF. We also actively engaged in various activities and campaigns to contribute to a better community and natural environment. All of our efforts, along with an analysis with follow-up actions, led to an improvement in SHK & Co.'s Sustainalytics ESG Rating from 29.2 in 2022 to 24.5 in 2023. And finally, a look at our business outlook and future plans. Looking into 2024, we anticipate multiple headwinds will persist, including high interest rates and uncertainty in regional economic outlook. We will maintain a cautious approach and prioritize capital efficiency. We will continue to streamline our businesses, diversify our funding sources and maintain a strong liquidity to enable future growth. In the Credit segment, we will remain vigilant to local economic environment and stay agile in managing the loan book to safeguard our capital. Besides, we will continue to enhance our service platforms and innovate product offerings, including the SIM credit card, to drive future business growth. Regarding our Mortgage Loans business, we will focus on generating strong risk-adjusted yields, maintaining rigorous risk management measures and diversifying marketing channels to enhance brand awareness. Our medium-term target in the Credit business is to leverage the SIM credit card to tap into new customer demographics and add revenue streams to our Consumer Finance division. In Investment Management, we will continue to maintain discipline in selecting new investments in deploying capital. We are increasing focus on Special Situations to capitalize on opportunities arising from market dislocations, leveraging our financial strength to create attractive long-term risk-adjusted returns. Our medium-term target is to leverage our global investment insight and proprietary deal-sourcing channels to collaborate with our Funds Management division, leading the way to corporate transformation. In Funds Management, we will continue to source partnership opportunities to create a broader and more diversified platform while remaining selective on significant capital deployment. Additionally, we will continue to build our FOS, enabling us to extend our client reach. Moreover, we will remain focused on expanding our distribution efforts to raise third-party capital, driving growth in AUM. Lastly, we will promote SHKCP Funds and selectively represent third-party alternative managers. Our medium-term target is to expand and diversify our offerings to drive the group's overall transformation. In the future, we are committed to delivering strong shareholder value with sound governance and risk management framework. We will continue to foster collaboration and create synergies among the three business pillars, propelling the group's transformation into a leading alternative investment platform. Thank you.

Thank you, Brendan. We will now proceed to our Q&A session. [Operator Instructions] We have a question from [ Victor Xing ] from [ Preview Capital ]. His question is what kind of exposure do you have to digital assets in your alternative business?

Yes, I'll take that first and then maybe, Tony, you can talk from a Funds Management perspective. Yes, we do have a limited exposure to various platforms through our alternatives. We do look at more the kind of platforms that provide the infrastructure to digital assets, for example, some of our investment in a digital asset bank. That's the kind of investments we try to focus on from the alternative side.

In the Funds Management side, we have a hedge fund partner -- partnership with a group called Kernel. They are running two types of funds. One is a fund which is related to the Bitcoin price. And another is a market-neutral strategy, which looks to arbitrage the various anomalies in the digitized space. And both funds are performing extremely well and the asset growth in that fund partnership has been very strong.

Thank you, Brendan and Tony. Victor has a follow-up question. For your Family Office Solutions business, what is the current AUM? And what do you believe are your competitive advantages are in this relatively new business?

The Family Office Solutions business is performing very well. We are looking to grow and invest in the Family Office Solutions space. We are currently looking for a new leader of the business. I think our strengths rely on our alternative capabilities, both from a private equity, hedge fund and credit perspective. We look to partner with other family offices to enable them to benefit from our scale and investment economics and skills to allow them to reach their investment goals. So it's certainly from the perspective of the future, it's an area which we will continue to invest in and we continue to expect good growth from.

Thank you, Tony. Victor's third question is do you expect the relaxation of property measures in Hong Kong will help revive your mortgage business in 2024? Maybe I will take that question, if you have anything to add. Basically, I think the relaxation of property measures definitely instilled confidence in the market because it accelerated the purchaser's behavior as we can see that the transaction -- the number of transactions have been increased in the past few days since the policy took place. But going forward, we need to closely monitor how the policy will translate into the property price in Hong Kong and because property price is also impacted by other factors, for example, the high interest rate and also economic recovery in Hong Kong. So we are going -- we will closely monitor the situation. But in the first quarter of 2024, we think we will be continue -- we'll continue to be cautious in underwriting new loans. But we will revisit or review our target or plan or strategies to capture the market opportunities but also strike a balance between loan growth and mitigation risks. [Operator Instructions] So the next question comes from Kate from UOB Kay Hian. She has a few questions. The first one is can you elaborate on your strategy for newly reported Special Situations segment and the outlook in 2024 or the longer term? Maybe you can answer that.

Okay, I'll answer that one first. Yes, I mean, I think we've mentioned throughout the presentation that obviously volatile asset markets and higher interest rates have created risks in global markets, but they have also created opportunities. So we do have a dedicated team who are assessing these opportunities globally. We have executed on some, as we've mentioned in the presentation, in European Union and other parts of the world. And so we see this as a good strategy, not just in this particular market but also for the long term. So we will continue to invest in this through 2024.

The second question from Kate is what's your refinancing plan in 2024 -- for 2024 and 2026 in view of the high interest rate environment?

Okay, yes. Obviously, yes, we do continually assess our refinancing plans. You can probably see from our balance sheet, we are fortunately in a strong cash position and liquidity position. But we will obviously be monitoring the market to see when the correct window does open to take opportunity of that or -- so we will make sure that we are maintaining our accesses to multiple sources of financing but going in at the right time. So that will be our strategy.

Thank you, Brendan. I think Kate has a third question, which is also related to the second question. Do you have any target for the net gearing ratio in the coming 3 years?

We generally tend to have kept it between about 40% to 50% in the past. We're quite a conservative organization from that perspective. I think it's dipped down a little bit towards the end of 2023. We're in around about 38%, but I would expect it to be maintained between 40% to 50%.

[Operator Instructions] Victor has a follow-up question. With the expected cut in interest rates, we expect in 2024 impact your Investment Management business?

Repeat that question?

With the expected rate cut in 2024, how the interest cut will impact our Investment Management business?

Okay, yes. Yes, I mean, I think there will be some impact of that. I mean, obviously, valuations are impacted. Our stock market valuations are impacted by the movements in interest rates. So we will expect some impact from that. But of course, you can't expect it to be completely correlated 1:1. It will also depend on the underlying investments themselves, the sectors they're in, the stage of growth, et cetera.

Thank you, Brendan. Next question from Victor is what differentiates your credit cost from those of your peers in Hong Kong, given the stiff competition? Maybe I'll take that question. Yes, like we have shared in our results announcement, our credit card has been commercially launched in the fourth quarter of last year. And although we haven't reported any specific numbers of credit cards, but because it's still in its early stage, but in terms of the customer demographics and also the type of customers and also the number of card issuance, we have recorded a very satisfactory and also better-than-expected results. So to stand out from the competition, I think the UAF has -- we are well positioned to take this market or to launch this product to tap into the credit card market. It's because, first one, we have been in Hong Kong for 30 years. We are the #1 money lenders. And because we have like 48 branches network across the -- like the districts in Hong Kong, we have a big amount of customer base and we can definitely leverage our network, our customer base and also our expertise in the segment to launch the product. So that's our edge. And also in terms of synergies, I would like to separate into cost synergies and also revenue synergies. Because we can basically share all the back-office or mid-office functions with our existing personal loans, and any profit contributed by credit card will be contribution margin. And in terms of revenue synergies, we basically expect that once the new customer segment is growing and then they can generate cross-selling opportunities with our existing personal loans. So basically, I think credit card will be a significant or important driver for our future growth in Hong Kong. Okay. So basically, I think we have no other questions so far. We will now conclude the Q&A session. Thank you for participating in today's earnings conference call. If you have any further questions, please feel free to reach out to me or Christensen. You may disconnect now. Thank you.