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Equity Bottom-Up

<a target="_blank">Sun Hung Kai &amp; Co. Limited [86_HK; HK$6,900 million/ US$896 million market cap; HK$6.45 million total average daily value traded] has announced that it has completed the remaining 30%&nbsp; sale of Sun Hung Kai Financial Group Limited (SHKFGL) to Everbright Securities Financial Holdings Limited (EB) on 17th November 2020 for a consideration of HK$1.26 billion in cash and HK$1.16 billion of preference shares of SHKFGL. The proceeds per share cumulatively amount to HK$1.20 per share which can be used by the company for the purpose of further expansion in its Investment and Fund Management business.</a>
With this EB has acquired complete ownership in a leading brokerage and wealth management business in Hong Kong. The preference shares will be repurchased in three tranches over the next three years. This transaction is expected to strategically help SHK to focus on their Finance and Investment Management businesses. We expect the investment management business to be a major driver of the company’s future growth and the financing business to be a steady cashflow generator in the long run. (More details below)
Mr. Lee Seng Huang who is the SHK Group Executive Chairman said, "We are very proud of the partnership we have had with Everbright over the past five years and wish them all the best as they take full ownership of the business going forward. We're happy to have been part of this important step in facilitating the further opening of capital markets between Hong Kong and the mainland. The sale allows us to further focus on our lending and investing businesses, especially the upcoming launch of our Funds Management business."&nbsp;
The Transaction Background and Details
On 1st February 2015, SHK and ESFH entered into the Original Sale and Purchase Agreement for the sale and purchase of 70% equity interest in SHKFGL. Completion of the 70% disposal took place on 2nd June 2015. On the same date, SHK and ESFH entered into the Original Shareholders’ Agreement to regulate the management of SHKFGL and their relationship with each other as shareholders. As part of the Original Shareholders’ Agreement, SHK and ESFH agreed that SHK could during the Put Option Period, exercise the Put Right to require ESFH to buy part or all of the shares SHK holds in SHKFGL.&nbsp;
As advised and confirmed by SHK, on 17 November 2020, SHK, ESFH and SHKFGL entered into the Repurchase and Subscription Agreement to exercise the Put Right to require ESFH to buy the remaining 30% shareholding in SHKFGL held by SHK at the Consideration of (i) HK$1,257,106,447 in cash; and (ii) HK$1,156,000,000 in SHKFGL Preference Shares.&nbsp;
SHK has exercised the Put option and has sold 90.36 mn SHKFGL shares which ESFH has purchased, representing 30% of the entire issued share capital of SHKFGL along with all of SHK’s rights, title and interest to the SHKFGL shares, free and clear of all encumbrances for a cash consideration of HK$1.25 bn and an issuance of preference shares by ESFH to SHK which will be repurchased later. ESFH will repurchase 90.36 mn SHKFGL preference shares for a consideration of HK$1.16 bn as remaining part of the transaction over a period of next three years. &nbsp;
Capital Position to Strengthen; Net Proceeds to be Used for Business Expansion
The stake sale transaction has generated a cash inflow to the tune of HK$1.25 bn instantly and will additionally generate HK$1.16 bn after the repurchase of preference shares by EB in three tranches over a period of next three years thereby strengthening the capital position of SHK. SHK intends to use the net proceeds for business expansion in investment management, general working capital purposes and for payment of dividends to its shareholders.
We believe SHK is fundamentally robust and the company is well positioned to leverage its market leadership during times of the pandemic. SHK’s balance sheet remains strong, with shareholders equity comprising 55% of all liabilities.&nbsp; Net gearing is modest at only 44.6%, and the current ratio is 2.6x.&nbsp; Low levels of gearing has resulted in a healthy interest coverage ratio of 4.5x.&nbsp; Additionally, SHK has received a cash of HK$1.25 bn from its stake sale in SHKFGL thereby further improving liquidity. Also, SHK has received preference shares in SHKFGL which will be repurchased by EB in three tranches over a period of three years giving them an additional cash inflow of HK$1.16 bn. This amounts to over HK$2.4 bn in cash which will further consolidate and strengthen the BS of SHK. The total cash has now increased by 53% to HK$8.75 bn since December 2019 after the recent transaction where the prior amount was HK$7.5 bn (31% up from December 2019).The company’s BS and the Investment Management business are consistent with the company’s stated “cautious” and prudent outlook to financial markets and the overall economy. We believe this posture is appropriate, especially in light of the ongoing coronavirus pandemic and EM equity and currency volatility.
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<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/174/240/original/image_63325247721606363949913.jpg?1606363949" width="600" height="235" class="editor-image img-responsive" data-smartkarma-image-id="174240"></figure>
HK$7.90 PT = 127% Upside 
The stock is currently trading at just 0.34x tangible P/B and at 3.1x P/E on our FY2021 earnings estimate.&nbsp; We use a sum of the parts [SOTP] methodology to value SHK.&nbsp; We value the UAF [United Asia Finance] business at 1.1x tangible loan book value taking into account the high net interest margin resulting in higher ROE and strong future growth prospects of the business.&nbsp; This provides us with a value of HK$5.18 bn for SHK’s 63% stake in the business.&nbsp; &nbsp;
We value the non-UAF business including Investment Management and Mortgage Loans at about 1.0x book value.&nbsp; Plus, the company also has a strong balance sheet with substantial amount of net cash and cash equivalents amounting to net cash of HK$1.7 per share at the end of the first half of FY2020. Together, the value of cash and the non-UAF business comes to about HK$11.46 bn. As a result, we arrive at a value of HK$16.64 bn for SHK which equals HK$7.90 per share, an upside of about 127% over the current stock price of HK$3.48. Based on FY2019 reported numbers, our price target implies a Price to Tangible Book of 0.9x and P/E of 7.2x on our FY2021 earnings estimate of HK109 cents.
0.41x P/B; 3.3x P/E
SHK is currently trading at only 0.41x tangible P/B vs. its own 5-year historical average ratio of 1.0x. Similarly, the stock is cheap even on a P/E basis. The company’s current P/E multiple on FY2019 actual reported EPS is 3.3x vs. its 5-year historical average ratio of 7.7x. Based on our FY2021 EPS forecast of HK109 cents, the P/E comes to 3.1x on the current stock price. In our view, the lower valuation is mainly a result of the difficulties faced by the company over the last couple of years, especially in its Mainland China consumer lending business. However, management has undertaken various strategic initiatives such as reducing small business exposure in China, cost rationalization by closing down underperforming branches, exiting the brokerage business, scaling up its investment management business, etc. to revive the company’s growth. We believe that these initiatives will help the company to deliver healthy and sustainable revenue and EPS growth in the next couple of years and reinstate investor confidence in the stock. This could likely result in a re-rating of the stock to its historical average multiples. Applying the historical average P/E multiple of 7.7x to our FY2020 EPS estimate of HK102 cents gives a stock price of HK$7.90, which is about 127% higher than the current stock price.
For further details and financial model, please see our attached Business Update Note.

Sun Hung Kai &amp; Co. Limited [86_HK; HK$6,900 million/ US$896 million market cap; HK$6.45 million total average daily value traded] has announced that it has completed the remaining 30%&nbsp; sale of Sun Hung Kai Financial Group Limited (SHKFGL) to Everbright Securities Financial Holdings Limited (EB) on 17th November 2020 for a consideration of HK$1.26 billion in cash and HK$1.16 billion of preference shares of SHKFGL. The proceeds per share cumulatively amount to HK$1.20 per share which can be used by the company for the purpose of further expansion in its Investment and Fund Management business.
With this EB has acquired complete ownership in a leading brokerage and wealth management business in Hong Kong. The preference shares will be repurchased in three tranches over the next three years. This transaction is expected to strategically help SHK to focus on their Finance and Investment Management businesses. We expect the investment management business to be a major driver of the company’s future growth and the financing business to be a steady cashflow generator in the long run. (More details below)
Mr. Lee Seng Huang who is the SHK Group Executive Chairman said, "We are very proud of the partnership we have had with Everbright over the past five years and wish them all the best as they take full ownership of the business going forward. We're happy to have been part of this important step in facilitating the further opening of capital markets between Hong Kong and the mainland. The sale allows us to further focus on our lending and investing businesses, especially the upcoming launch of our Funds Management business."&nbsp;
The Transaction Background and Details
On 1st February 2015, SHK and ESFH entered into the Original Sale and Purchase Agreement for the sale and purchase of 70% equity interest in SHKFGL. Completion of the 70% disposal took place on 2nd June 2015. On the same date, SHK and ESFH entered into the Original Shareholders’ Agreement to regulate the management of SHKFGL and their relationship with each other as shareholders. As part of the Original Shareholders’ Agreement, SHK and ESFH agreed that SHK could during the Put Option Period, exercise the Put Right to require ESFH to buy part or all of the shares SHK holds in SHKFGL.&nbsp;
As advised and confirmed by SHK, on 17 November 2020, SHK, ESFH and SHKFGL entered into the Repurchase and Subscription Agreement to exercise the Put Right to require ESFH to buy the remaining 30% shareholding in SHKFGL held by SHK at the Consideration of (i) HK$1,257,106,447 in cash; and (ii) HK$1,156,000,000 in SHKFGL Preference Shares.&nbsp;
SHK has exercised the Put option and has sold 90.36 mn SHKFGL shares which ESFH has purchased, representing 30% of the entire issued share capital of SHKFGL along with all of SHK’s rights, title and interest to the SHKFGL shares, free and clear of all encumbrances for a cash consideration of HK$1.25 bn and an issuance of preference shares by ESFH to SHK which will be repurchased later. ESFH will repurchase 90.36 mn SHKFGL preference shares for a consideration of HK$1.16 bn as remaining part of the transaction over a period of next three years. &nbsp;
Capital Position to Strengthen; Net Proceeds to be Used for Business Expansion
The stake sale transaction has generated a cash inflow to the tune of HK$1.25 bn instantly and will additionally generate HK$1.16 bn after the repurchase of preference shares by EB in three tranches over a period of next three years thereby strengthening the capital position of SHK. SHK intends to use the net proceeds for business expansion in investment management, general working capital purposes and for payment of dividends to its shareholders.
We believe SHK is fundamentally robust and the company is well positioned to leverage its market leadership during times of the pandemic. SHK’s balance sheet remains strong, with shareholders equity comprising 55% of all liabilities.&nbsp; Net gearing is modest at only 44.6%, and the current ratio is 2.6x.&nbsp; Low levels of gearing has resulted in a healthy interest coverage ratio of 4.5x.&nbsp; Additionally, SHK has received a cash of HK$1.25 bn from its stake sale in SHKFGL thereby further improving liquidity. Also, SHK has received preference shares in SHKFGL which will be repurchased by EB in three tranches over a period of three years giving them an additional cash inflow of HK$1.16 bn. This amounts to over HK$2.4 bn in cash which will further consolidate and strengthen the BS of SHK. The total cash has now increased by 53% to HK$8.75 bn since December 2019 after the recent transaction where the prior amount was HK$7.5 bn (31% up from December 2019).The company’s BS and the Investment Management business are consistent with the company’s stated “cautious” and prudent outlook to financial markets and the overall economy. We believe this posture is appropriate, especially in light of the ongoing coronavirus pandemic and EM equity and currency volatility.
&nbsp;

HK$7.90 PT = 127% Upside 
The stock is currently trading at just 0.34x tangible P/B and at 3.1x P/E on our FY2021 earnings estimate.&nbsp; We use a sum of the parts [SOTP] methodology to value SHK.&nbsp; We value the UAF [United Asia Finance] business at 1.1x tangible loan book value taking into account the high net interest margin resulting in higher ROE and strong future growth prospects of the business.&nbsp; This provides us with a value of HK$5.18 bn for SHK’s 63% stake in the business.&nbsp; &nbsp;
We value the non-UAF business including Investment Management and Mortgage Loans at about 1.0x book value.&nbsp; Plus, the company also has a strong balance sheet with substantial amount of net cash and cash equivalents amounting to net cash of HK$1.7 per share at the end of the first half of FY2020. Together, the value of cash and the non-UAF business comes to about HK$11.46 bn. As a result, we arrive at a value of HK$16.64 bn for SHK which equals HK$7.90 per share, an upside of about 127% over the current stock price of HK$3.48. Based on FY2019 reported numbers, our price target implies a Price to Tangible Book of 0.9x and P/E of 7.2x on our FY2021 earnings estimate of HK109 cents.
0.41x P/B; 3.3x P/E
SHK is currently trading at only 0.41x tangible P/B vs. its own 5-year historical average ratio of 1.0x. Similarly, the stock is cheap even on a P/E basis. The company’s current P/E multiple on FY2019 actual reported EPS is 3.3x vs. its 5-year historical average ratio of 7.7x. Based on our FY2021 EPS forecast of HK109 cents, the P/E comes to 3.1x on the current stock price. In our view, the lower valuation is mainly a result of the difficulties faced by the company over the last couple of years, especially in its Mainland China consumer lending business. However, management has undertaken various strategic initiatives such as reducing small business exposure in China, cost rationalization by closing down underperforming branches, exiting the brokerage business, scaling up its investment management business, etc. to revive the company’s growth. We believe that these initiatives will help the company to deliver healthy and sustainable revenue and EPS growth in the next couple of years and reinstate investor confidence in the stock. This could likely result in a re-rating of the stock to its historical average multiples. Applying the historical average P/E multiple of 7.7x to our FY2020 EPS estimate of HK102 cents gives a stock price of HK$7.90, which is about 127% higher than the current stock price.
For further details and financial model, please see our attached Business Update Note.

SHK [86_HK]: Stake Sale, 7.5% Div Yield, 0.41x P/B - Business Update