UOA Ltd – it is a bargain or value trap? (Part 2 of 3)

Case Study 03-2:  Continuation of the analysis and valuation of UOA Group. This post focuses on the prospects of the Group and the performance of top management.

Value traps and bargains are opposite sides of the value investing coin.  Which side of the coin you are on depends on the company analysis. 

UOA Ltd is currently trading at AUD 0.63 (as of 30 Jul 2020)  per share compared to its Book Value of AUD 1.06 (based on 31 Dec 2019) per share.

Is this a bargain or a value trap?

This is a property group where the cash, land and buildings accounted for about 88% of the total assets in the books. 

Surely the market is not expecting these assets to be impaired. 

We all know that the property sector is cyclical and we are experiencing a long trough of the cycle. 

But strong property companies like UOA Group can withstand the down period of the cycle. 

Join me in the 3-parts series as I lay out my case on why the market is wrong.  

  • Part 1, published on 2 Aug, showed how the Group got to where it is today. 
  • Part 2 is presented here and will focus on its future and top management. 
  • Part 3 that was published on 30 Aug 2020 covered valuation and risk mitigation. 


I will show you that there is definitely mispricing and hence an investment opportunity.  

Does it mean that you should go and buy – well read my Disclaimer?


Contents

  • Is there a Great Future for the Property Development segment?
  • Is there a Great Future for the Investment Property segment? 
  • How well did Top Management Seize Opportunities?
  • Pulling it all together


When talking about projecting the future, Warren Buffet has this to say:

“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

We should be wary when trying to project the UOA Group’s future.

Yes, the UOA Group performance will also be affected by the country’s economic plans. But these affect all sectors and besides, you know as much about economic forecasting as I do.

Furthermore, I would not want to talk about the property market outlook.   

These tend to be “valid/accurate” over the next 2 to 3 years only. This is generally shorter than the property development cycle. 

For those who want to have a better understanding of the Malaysian property market, go online.   

There is a lot of information - from property surveyors reports to those by property portals. Statistics are also available from the Malaysian Property and Valuation Services Department (JPPH).   

Instead, I will look at a few secular trends that may affect the Group’s property business.

But if you have thoughts about other secular trends that might impact on the Group’s business model, do let me know.


UOA - Value Trap or Bargain ?


Case Notes

1) Monetary values are in Australian Dollars (AUD). For cases where the reported figures were in Malaysian Ringgit (RM), I have converted it to AUD. I used the year-end exchange rate as extracted from Investing.com for the conversion. 

2) The UOA Group comprises of 3 listed entities. In the post
  • UOA Group or the Group refers to all the companies within UOA Ltd. These included those under UOA Development Berhad and UOA REIT. 
  • UOA Dev refers to only those companies within UOA Development Berhad
  • UOA REIT refers to only those companies within UOA Real Estate Investment Trust


Is there a Great Future for the Property Development segment?

UOA - good prospects
The property development process covers from strategy to handing over the completed properties.  This can take from 4 to 8 years. 

In view of this, you need 2 perspectives when covering the Group's future. 
  • An immediate to a mid-term period covering up to the next development cycle.  I would look at what the Group has on hand. This covers projects in the pipeline as well as its landbank. 
  • A mid to longer-term period ie beyond the next development cycle.  I would look at secular trends affecting their current business direction.

Pipeline

In the immediate to mid-term, the Group should be able to maintain its historical performance as
  • It still has a considerable pipeline of unbilled sales, projects under construction and inventory. 
  • Its current land bank has the potential to deliver more than RM 17 billion (AUD 5.8 billion) of GDV over the next 10 years.

The chart below shows the Group’s launches, sales and unbilled sales over the past 5 years

UOA Dev Pipeline
Chart 1: UOA Dev Property Sales Pipeline


You can see the impact of the current property market.  Look at how the launches, sales and unbilled sales have not shown any growth over the past 3 years c/w with 2015/16. 

The unbilled sales at the end of 2019 are still equal to about 85 % of the Group’s average annual revenue.  This will be recognized as revenue over several years and gives a sense of the immediate future. 

There is another way to triangulate the Group's immediate to mid-term prospects.   Look at how the “building blocks” of economic activities have changed over time. 
  • Land for held for development pointing to the potential for long term growth
  • Inventory which can contribute to immediate performance
  • Work-in-progress generally captured under land under development. In the Malaysian “sell then build” approach, this can be a source of immediate revenue. 

A profile of the Group under the above criteria is shown below: 
  • All the components of the building blocks show an uptrend. 
  • There has been a slowdown over the past 2 to 3 years in line with the property condition in the country
  • The increase in inventory reflects the challenging property market

UOA Dev - property dev building blocks
Chart 2: UOA Dev Property Development Building Blocks


I would conclude that the Group has enough “building blocks” in the pipeline.   It can cover the current and even into the next property development cycle.

The above of course is an inward-looking perspective. 

What about the demand. We all have heard about the property overhang in the country.

There is a data-based analysis concluding that:
  • The housing market is expected to remain challenging in the coming years.  
  • It will take some time for the market to absorb the unprecedented large property overhang.  
  • The housing overhang today originated from the excessive supply since 2016
  • It will need 12 years to restore the residential property overhangs back to its lowest level.   Historical data suggests that this is 9,300 units in 2003.  

Conclusion – the next 2 to 3 years will be challenging but eventually the overhang would come down.


Beyond the next property cycle

Residential property development is an evergreen industry. But, demographics can have a large impact on real estate trends for several decades.

The Group's property development is centred on residential properties in the Klang Valley.

Are there any secular trends that support or even disrupt this business direction? The good news is that:
  • Urbanization will continue to an important feature of Malaysia
  • The Klang Valley continues to account for the majority of the population movement
  • The Klang valley population will grow at a much higher rate than the national average
  • There are other urban centres in the country that the Group can expand to if needed.  Examples are Penang, Johore Bahru.  

I will elaborate on these in the following sections.  

Urbanization

From 2008 to 2018, the urban population in Malaysia grew from 69 % of the total country’s population to 76 % in 2018.  If it continues at the same pace, it would reach 83 % in 10 years’ time. 

Malaysia Urban Population
Chart 3: % Malaysia Urban Population


Klang Valley will benefit

Klang Valley has been the major destination.  This is because it is the country's main commercial, educational and government centres 

Klang Valley current population is about 8 million.  This is projected to be 9.8 million in 10 years’ time, growing at a compounded rate of about 2.1 % per annum. 

In contrast, the national population growth rate is 1.4 % in 2018 declining from 3% about 30 years ago.

Klang Valley population
Source: Macrotrends.net.  Chart 4: KL Metro Population

Other Urban areas

Klang Valley is not the only urban centre to benefit from the urbanization trend. 
  • Johore Bahru, next to Singapore, has higher than the national average population growth rate.  
  • Penang in the north has also been among the nation’s top urban areas.  


Malaysia urban centres
Chart 5: Malaysia's Major Urban Centres




The demographics point to a continuous demand for accommodation in urban centres.  This is where the Group has the track record and brand.


Is there a Great Future for the Investment Property segment?

UOA Investment property future - tough
The majority of the Group Investment Properties are also in the Klang Valley.  

As shown in Part 1, the Group’s growth has come from increased rentals and increased in nett lettable areas

In the immediate to mid-term, rental rates and/or occupancy will drive the Group's performance.

In the longer term, growth will be driven by new commercial properties.  This, in turn, is affected by the demand for office space in the Klang Valley.

Oversupply in the immediate to mid-term

The Klang Valley office market remains challenging in the immediate to medium term.  This because about 2.3 million sq m of incoming supply is targeted for completion in the next couple of years.  This is about 15 % of the current stock.  

Occupancy has also come down.  Many real estate consultancies estimating it to be around 75 % currently. 

What are the implications for the Group? I see the following
  • There will not be much rental growth
  • Retaining tenants may be challenging
  • Have to focus on cost control
  • There will not be many opportunities for re-valuation surplus

I would imagine that at best, the Group would only be able to maintain its current performance. But I would not be surprised if there is some drop. 

What will drive long term demand?

Klang Valley Purpose Built Office Space
Chart 6: Klang Valley Purpose Build Office Profile


About 12.0 million sq m of purpose-built office in Klang Valley was occupied in 2019.  

Compare this with 8.6 million sq m in 2008. This is equal to a growth of about 0.3 million sq m per year.

From 2008 to 2019, it increased by 44%. Over the same period, the Malaysian economy grew by 2/3.

This meant that the demand for purpose-built office grew at less than the economic growth rate. 

More critical is at 0.3 m sq m of growth a year, it would take more than 15 years to fill up the current vacant office space. This assumes occupying the incoming supply but assumes no further office construction

This is very challenging. 

Office demand is a derived demand.  Firms rent space as they produce services or goods for businesses and households.

The long-term trend does not look too promising as the days of the 7 % GDP growth is gone.

Would it be doom and gloom?

Positive drivers
  • InvestKL is confident of attracting 100 MNCs to set up regional offices in Malaysia by next year. 
  • Malaysia is still trying to be a developed nation. In 2018, the services sector accounted for 53 % of the GDP, up from 44 % in 2008. At the same rate of growth, it would be 64% in 10 years’ time. As a comparison, the service sector accounts for more than 80% of the UK economy. In the US it is around 70%

Negative drivers
  • A report for REHDA stated that the Klang Valley office stock is the largest in ASEAN.   And that it is dependent on the Oil and Gas and Financial sectors
  • Over the medium and longer-term, companies may want co-working spaces as a back-up plan. In the US it is growing at double digits. 

It would be a very challenging time for the Group's Investment Property segment.   


How well did Top Management Seize Opportunities?

UOA Group management
UOA Ltd has a 5-members Board of Directors one of whom is an alternate to the Managing Director. 

2 of the members are executive directors who are also substantial shareholders.   Together they control about 73% of the company (as of 23 April 2020). As founder directors, they have been associated with the Group since the start.

There are 2 two non-executive directors, one of which is the Chairman who has been with the Group for more than a decade. The other was appointed to the Board in 2008

At the UOA Dev level
  • These 4 principal directors of UOA Ltd are also on the Board of UOA Dev with the same role as in UOA Ltd
  • The two founder directors’ children are alternative directors to their fathers

At the UOA REIT level
  • The Chairman of UOA Ltd is also the Chairman UOA REIT
  • One of the founders’ son is the CEO of UOA REIT

Senior Management
UOA Ltd did not feature any senior management staff.

At the UOA Dev level, there were 10 senior managers profiled in the 2019 Annual Report
  • Of these 5 were family members – the 2 founders and their children
  • One other was an executive director who has been the CFO of UOA Ltd since 1994
  • Of the remaining senior managers, 2 has been with the Group for more than 30 years each.  The other 2 has an average of 7 years of service with the Group

The above board’s and senior management representation effectively meant that the Group is controlled and managed by the founders and/or their family members.

With such large shareholders’ control, how did the Board drive the Group?

I could not find any specific statements and/or discussions about the Group strategy or business direction from the past 12 years Annual Reports.

However, I surmised the following: 
  • Focus on the Klang Valley, Malaysia
  • Have a strong recurring income stream from Investment Properties and Hospitality segments
  • In terms of capital allocation, there appears to be about that same allocation to the Property Development segment and the other recurring income stream segments.
  • For the development of property for sales, the emphasis is on residential properties.  This is reflected in the past few years of performance where 80% or more of the sales were from residential units.

In this context, the Board has achieved the above goals. 

From 2007 (a year before UOA Ltd listing in SGX), 
  • The value of the Group (based on SHF plus dividends assuming it is not distributed) would have grown at a compounded annual rate of 18%.
  • The total capital employed by the Group has increased by AUD 1.68 billion with a very significant amount allocated to the operations.
  • Its dividend payout is about 20% per annum 
  • The reinvestment rate (ie additional working capital, new Capex) average about 60% so the 20% dividend pay-out looks about right

How has the Group performed relative to its peers? For an apple to apple comparisons, I selected the peers as
  • Those Bursa Malaysia companies with property development and investment property activities
  • The capital employed for the investment property activities is 50% or more of the respective TCE

There were 5 such groups of companies.

Among the 5 peers, UOA Group has been among the leaders in terms of revenue growth over the past 8 years.  (Note that in the case of IOI we have only considered the revenue from Malaysia)

UOA Peer Companies Revenue Index
Chart 7:  UOA Peer Companies Revenue

Another metric for top management is whether they have bought back shares “cheaply” ie below the intrinsic value of the company.  

For this analysis, I will use the Asset value as the basis of comparison.

UOA Ltd Share Buyback
Chart 8: UOA Ltd Share Buyback History

The results showed that top management has been prudent when buying back shares. 

Oh, yes. The team has also established the UOA brand so that over the past few years, the UOA brand has been ranked around 50 to 55 positions by Malaysia Brand Finance.

If there was a minor weakness, it is that Annual Reports have not been very transparent. For example
  • The Group has not been too transparent on the individual project GDV. Very often the GDV for several projects is reported together. This made it hard to track the sales performance of individual projects. 
  • A summary of the property launch plan was missing in the 2017 UOA Dev 2017 Annual Report. I suspect that this was because the market was bad.

It would be helpful to present the following for individual property projects - total GDV, sales to-date, unbilled sales, balance unsold and construction status.

Investors can then track the performance of individual projects.  

Conclusion

The results are there.  Top management represented shareholders’ interests.  They were both good operators and capital allocators.

The industry is facing a housing overhang and declining office vacancy.  The track record and long industry history of the top management will make a difference. 

In analysing a business, you generally do not have contacts with management.   Yet you have to judge whether they are capable, honest and act in shareholders’ best interest.

This has been the weakest link in my investment process. 

“I think you judge management by two yardsticks,” Buffett said. “One is how well they run the business, and I think you can learn a lot about that by reading about both what they’ve accomplished and what their competitors have accomplished, and seeing how they have allocated capital over time.”

I hope I have lived up to Buffet’s ideas. Let me know what you think. 


Pulling it all together

In Part 1 I have shown that the Group has a strong track record and is strong financially. 

In Part 2, we can see that there are immediate challenges for the Group for both the Property Development and Property Investment segments.

The Malaysian property sector is cyclical.  It is currently undergoing a trough part of the cycle but there are long term secular trends to suggest a promising future.  The Group's assets, especially land and buildings are not going to be impaired.

So even before we undertake a detailed valuation of the Group in Part 3 of this series, is there sufficient evidence to show that UOA is not a value trap?

I would argue that there is.  

As a property Group, most of UOA assets relate to land and buildings. 
  • It Book Value is AUD 1.06 (based on 31 Dec 2019). 
  • The properties held for investments are stated at market prices ie they are intrinsic values. 
  • Most of the land held for development or under-development have been stated at historical prices. ie these are conservative values.   

The UOA Group's Asset value is a very good proxy of the Group's intrinsic value.

And the market price of AUD 0.63 (as of 30 Jul 2020) per share is significantly below its Book Value of AUD 1.06 (based on 31 Dec 2019) per share. 

It is a bargain and not a value trap.

However, if you want a more definitive conclusion, join me in Part 3





End of Part of 2 of 3

Part 1 was published on Sun 2 Aug 2020

Part 3 was published on Sun 30 Aug 2020



Reading guide
If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 



- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 

How to be an Authoritative Source, Share This Post

Disclaimer
I am not an investment adviser, security analyst or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned in this website may not be suitable to you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

Comments

Popular posts from this blog

How To Mitigate Against Risks When Value Investing

Is Eksons a value trap? (Part 1 of 2)

An Introduction to Value Investing - confronting value traps