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Edited Transcript of 86.HK earnings conference call or presentation 15-Aug-19 1:30am GMT

Half Year 2019 Sun Hung Kai & Co Ltd Earnings Call

Hong Kong Sep 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Sun Hung Kai & Co Ltd earnings conference call or presentation Thursday, August 15, 2019 at 1:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Benjamin John Falloon

Sun Hung Kai & Co. Limited - MD of Principal Investments

* Nancy Chen

Sun Hung Kai & Co. Limited - Head of IR

* Robert James Quinlivan

Sun Hung Kai & Co. Limited - Group CFO

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Presentation

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Nancy Chen, Sun Hung Kai & Co. Limited - Head of IR [1]

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Hi. Good morning, everyone. Welcome to the 2019 Interim Results Analyst Meeting and Webcast of Sun Hung Kai & Co. Limited. Today, we have a live analyst meeting in Hong Kong, and we are also concurrent webcast. And presenting today are Mr. Robert Quinlivan, Group CFO; Mr. Ben Falloon, Managing Director of Principal Investments; and myself, Nancy Chen, I'm the Head of Investor Relations.

Just some housekeeping issues as we have a webcast on today. After the presentation, we'll first see if there are any questions online and then we'll close off the webcast and turn to the questions in the live meeting. Thank you.

Now Robert, can you present the results, please?

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Robert James Quinlivan, Sun Hung Kai & Co. Limited - Group CFO [2]

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Thank you, Nancy. Good morning, everyone. Well, overall a very strong first half. You can see on Page 4 of the pack that our attributable profit was just over HKD 1 billion, slightly down on the first half of last year but significantly up on the second half of last year. You can see that our EPS increased on the back of share buybacks. Dividend is unchanged at HKD 0.12 per share and a steady increase in our book value per share.

Moving to the next page to give you the breakup of earnings. So you can see that Consumer Finance remains our largest individual contributor with a 7% increase in profitability mainly on the back of lower expenses and lower bad debts.

The Principal Investments achieved a strong result, slightly down on the first half last year, and that's partly a result of a reallocation of some assets and income to -- from Principal Investments to our group management and support center to better reflect those assets. So that's part of that reason and Ben will talk more about that in a minute. But overall, a 12% annualized return from Principal Investments.

The Financial Services business, which is our investment in Everbright Sun Hung Kai and LSS Leasing, steady contributor. And our mortgage business, which has now been going for 4 years, a steady contributor, and profit before tax up 40%. So overall, a strong result.

Moving to the next slide, which shows our track record since 2016. You'll see a steady performance. As mentioned, increase in book value per share, strong return on equity of 10.6% for the first half and EPS of $0.515 per share, just for the first half compared to those annual figures there. So overall, a strong result. We've looked to ways to improve our capital efficiency. We completed a HKD 1 billion share buyback last year. And towards the end of the first half, we completed a repurchase of a block of shares in UA, so looking to improve our capital efficiency.

It's also worth noting that the investment business, and Ben will talk more about this, is entering into a phase of monetization, and despite all the volatility that we're seeing in the markets at the moment, has been a very steady earner.

So if we look on the next page, on Page 7, at our balance sheet, you can see our liquidity position remains very healthy, with our cash funding and our short-term debt and long-term assets funded by long-term debt and equity, and so a very -- a strong balance sheet.

If you look on the next page, on Page 8, to break down a little more into our capital structure and funding, you'll see that assets and leverage remain sort of broadly consistent and gearing, slightly up but partly as a result of the purchase of shares in UA towards the end of the first half, which is about 3% of that figure. So overall, increased interest coverage ratio on the back of strong earnings, and funding structure, as discussed, remains strong.

So I'll now hand back to Nancy to give a review of the Consumer Finance segment.

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Nancy Chen, Sun Hung Kai & Co. Limited - Head of IR [3]

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Thank you, Robert. This slide, it's a snapshot of Consumer Finance business in the first half of 2019. I think overall, we have a solid period, driven by the Hong Kong business which now accounts for increased share of 78% of the loan book. The gross loan balance is HKD 10.7 billion, and the pretax is up 7% to HKD 652 million, mainly driven by the decline in the blended charge-off ratio.

As Robert mentioned, in June, UA -- end of June, UA completed a repurchase of 7.3% share from a minority shareholder, ORIX Asia Capital, which has been a very -- a minority shareholder since the very beginning of UA's base, and the total consideration was JPY 10 billion. And as a result of this, the group's shareholding increased from 68% from 70 -- sorry, 58% to 63%. And this -- because this happened towards the end of the first half, so it is anticipated to be earnings accretive for the group from the second half onwards.

So more details on the pretax profit analysis. The pretax was up 7%. This is mainly from the strength of the Hong Kong business, which the share of the loan book increased from 70% to 78%. And this led to lower revenue because Hong Kong business has lower yield in general but also lower impairment and bad debts and overall better profitability.

Cost to income also improved with a net reduction in operating cost by 6% because of the consolidation in the Mainland China branches. We have an increase in finance costs from higher local borrowing rates and also increased funding for the growth in Hong Kong loan book as well as the repurchase of shares.

Next page is more analysis on our impairment, bad debts and delinquency. During this period, there were no big impacts from the impairment in loan movements. But it's worth noting that the total charge-off ratio and amount declined both half-and-half and year-on-year on a planned basis. This is mainly from the impact of having a high proportion of the business in Hong Kong. Worth noting that our policy for write-off is 90 days, which -- there's a policy alongside with HK IFRS 9, we deducted since last year.

For the Hong Kong business, UA celebrated its 25th anniversary in Hong Kong at the end of last year. And alongside with that, they launched a lot of new ad campaigns and promotions. For example, in the first half, there were new reward programs for new customers and they launched a new product called Renter's Loan. On the back of this, business enjoyed good growth and the loan balance was up 7% year-to-date and reached a new high of $8.3 billion. Charge-off remains very low at 4.4%. I think the biggest driver for charge-off, as we have seen through our 25 years history, is unemployment and that factor is very benign in Hong Kong year-to-date.

During the period, we also stepped up resources for our technology and our fintech team was set up. For example, in February, we were the first money lender to launch FPS for loan disbursements, and UA also reviewed and obtained certification of our IT measures for our online business.

In Mainland China, we continued on a trend to be cautious in credit quality and maintain tight approvals. As a result, the loan book fell a little bit but we see it's a good time to reposition our business. During the period, we continued our restructuring plan and 15 branches were closed. 31 branches are still in operation at the end of June as we move the business further online. I think -- and also we obtained a new official Internet license in our Shenzhen subsidiary which will further facilitate the move online.

At the end of last year, we launched a new automatic credit scoring system, which encompass our in-house credit scoring as well as external data and also big data. So they are -- although the charge-off ratio, you'll see remains still pretty high in terms of percentage, I think this is caused also by the drop in the loan book mathematically. But there are some encouraging early signals we see in the decline in the China delinquency numbers.

I think all in all, it's hard to tell whether the market improved in the short term, but I think our strength is being a properly licensed money lender with a strong capital base and also a much leaner operating structure which will give us the flexibility to gear again in the right conditions. And also whilst we develop our new platform -- our own platform, we are also looking for ways to make use of our idle capital. I think one such example is the cooperation with other online lenders and platforms which will allow us to quickly deploy some of our idle capital.

So now I'll turn to Ben for our Principal Investment business.

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Benjamin John Falloon, Sun Hung Kai & Co. Limited - MD of Principal Investments [4]

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Good morning. For the first half of 2019, the 6-month gross return on average assets was 6% compared to 6.1% for the first half of 2018. Taking into account operating expenses and funding cost allocation, the segment contributed $580.4 million to pretax profit.

Strong credit and equity markets in the first quarter allowed us to generate solid returns in our public business as well as strong capital markets giving a reasonable backdrop to private equity valuations. We proceeded to lock in gains in the first quarter and reduced our overall risk as we entered into the second half of the quarter, and I'll speak a little more about our forward-looking view later.

On the operational side, we maintained our focus on human capital, upgrading systems and infrastructure and improving our efficiency and workflow, in line with the strategy we outlined in our 2018 results. Over the period, we have made progress in executing on those goals as we strengthened the sector-focused analyst team and made significant progress in our operating infrastructure upgrade on the public side.

The second half will see us continue to build out our analytical and investment framework across both public and private businesses with a focus on risk management and control in what we expect to be a volatile environment.

As you can see, we have also stepped up our disclosure for the investment business to present and analyze our performance like an independent manager. One additional disclosure is the nature of our gains with the first 3 lines in the table above or 36% of the gains are realized or received.

Another point to note is that whilst the earnings are driven by valuation change, liquidity is also an important for the business, and we are moving in a very positive direction for our private equity business, which is the largest portfolio. Our total distribution of $145.3 million was received in half 1 and a further HKD 342 million is anticipated in the near term. This, together with our 3-year track record and the investments we have made to the team and the infrastructure, puts us closer to getting the business ready for the possibility of launching funds for external money in the future.

When you turn to Page 16 and look at the sector-based returns, public equity had a strong year -- half year at a 13.2% annualized return. Private equity is annualizing 15.6%. Public credit had a very strong first half, annualizing 25.2%, private credit at 11.2% and the real estate a little bit down at minus 1.4%.

Turn to Page 17. On the public equity side, the internal fund strategy is really focused on 3 things: good fund -- stocks with good fundamentals and yield; a change from activism and quality growth. We overlaid this with a derivative hedge and run a traditional long/short strategy. Given the volatility we see in the external environment, which we saw start to show its head in the second quarter, we reduced our net exposures significantly and feel that we're able to manage the volatility in this market going forward. While we're concerned about the macro backdrop and a number of the issues that are being thrown at us globally, we remain very comfortable with the underlying equity positions we have. And with our ability to hedge out our macro risk through derivatives, we feel we can reduce the overall volatility in this business.

On the public credit side, we entered 2019 with very strong conviction for the credit market. We used the significant rally in emerging markets and European bank capital to take profits on that portfolio and reduce our balance sheet down as the quarter end. We view this as a key part of our business with a very strong team who's able to analyze companies from the bottom up. And with our capital relatively light at this point, we see significant opportunities going forward to be able to add risk into this part of our business.

If we turn to Page 19 on private equity. Private equity business is at a key point in its cycle. We're very focused on portfolio management and monetizations at this stage. Any new investments we are making are alongside our existing partners. We feel that valuations are high that the support of capital markets can help us to monetize our existing investments.

In terms of new investments, we've been looking at 2 funds that we re-upped with this year, we're existing investee partners. With the strong analyst team we have, we continue to look at a number of opportunities across different sectors and geographies but remain extremely conservative in terms of how we look to invest going forward, just given the overall environment.

In private credit, the 5.6% return, taking into account impairment and bad debts of $45 million, almost all loans are secured by collateral or with guarantees. Our loan balance is lower year-to-date from repayments and prudent underwriting. We view this as a very key part of our overall strategy and have a positive outlook as banks look to scale back as credit becomes scarce and as financing opportunities reprice to levels which we think are more appropriate, given the overall risk. We originated our first third-party loan working alongside a large credit institution in Hong Kong, and we continue to see that opportunity to work with our partners and deliver solid business to the balance sheet going forward.

In terms of real estate, a small loss from portfolio mainly from accounting adjustment of 1 co-investment vehicle for the London hotel. We see future opportunity to develop a third-party platform and real estate debt and have got a long way towards that. This will be one of our key focuses is using our capital to launch third party-focused investment vehicles across the real estate space, and that's both on the debt side and on the equity side.

Again, the opportunity we see coming, the repricing of underlying markets, the fact that we can use our own capital with strong third-party partners is a way for us to generate a multiplier effect for our overall business. We've identified 1 specific partner on the debt side. We've identified another partner on the equity side. And we hope through Q2 -- Q1 2020, we'll be able to publicly announce launches of our different products. This is a key focus for us and we think a key area for us to generate value going forward.

Just in terms of the outlook. Markets remain extremely volatile. We don't see any end in sight to the trade negotiations. We're concerned about yield curves and what that means in terms of global macro environment, so we remain very defensive. While we have exposure on the credit side, it's far less than we've had in the past. And our exposure, as I mentioned, on the equity side, remains relatively light as we brought our needs down.

I think our performance as a whole across the public businesses this year has far exceeded many of our peers. We view this business as a modest strategy business, so while we talk about public equity and public credit, we run our risk as a multi-strategy. And with significant enhancements coming in terms of our systems infrastructure and risk architecture, we feel that our ability to generate excess returns over the market is very high. Thank you.

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Robert James Quinlivan, Sun Hung Kai & Co. Limited - Group CFO [5]

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Thank you, Ben. So we'll now move to the mortgage loan business. This is the Sun Hung Kai Credit business, which is now in its fourth full year of operations and is becoming a meaningful contributor to the group. The secured portfolio is complementary to our Consumer Finance business, which focuses on unsecured loans. So you can see that compared to the prior year, the profit before tax was up 40% with good operating leverage and no write-offs during the year.

The loan book size was $3.6 billion, which is down slightly since year-end. And since year-end, we have slowed down the underwriting of lower-margin loans, considering the increased opportunity cost of capital for the group from higher local rates. We're also cognizant of the potential volatility in residential property prices in Hong Kong, so we continue to adopt a prudent underwriting approach.

The overall loan-to-value ratio of the portfolio is below 65%. So you can see we've been investing in infrastructure and focusing on achieving efficiency and margins in this business. And we believe there's potential to grow this business, given the right situations.

So moving to the last component of the business which is Financial Services. So this is our 30% investment in Everbright Sun Hung Kai and LSS Leasing JV. So the Hong Kong market activity was lower during the first half but Everbright Sun Hung Kai performed well with revenue and profit growth. The client AUM was HKD 130 billion. So the business has performed well since its integration into Everbright Securities, and the net accounting gain from our put option was HKD 51 million for the half.

LSS Leasing is a business-to-business and business-to-commerce auto leasing business in Mainland China. The environment was unfavorable with an overall decline in auto sales and production and a rising interest rate environment in China as government continues to deleverage. So this presented challenges to LSS Leasing. But against this backdrop, LSS has started to tap into the ride-hailing and goods delivery companies as a provider of comprehensive financial and management services. As such, partnerships were formed with leading platforms and started to work with various ride-hailing platforms such as DiDi.

Okay. So that's the end of the review of the business in terms of the outlook and Ben has touched on this. So the full year obviously is subject to mark-to-market volatility. As mentioned, we've reduced exposures going into the second half but long term, our strategy is on track. We're seeing increased monetization from our private equity investments, more efficient capital deployment in Mainland China. We continue to seek EPS accretive opportunities. Obviously, the impact of Hong Kong situation and social unrest is difficult to tell, but as mentioned, we remain cautious and well positioned.

So with that, we'll hand it back to Nancy and we'll take questions.

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Questions and Answers

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Nancy Chen, Sun Hung Kai & Co. Limited - Head of IR [1]

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We have a question online about the growth expectations of Consumer Finance business in Hong Kong and China for the remainder of 2019.

Yes. I think in China, first of all, China, in the recent 2 months, we have seen that actually the loan book is steady and actually started to pick up a little bit. And as mentioned, with the official Internet license, we are also to expedite our growth into the online platform. And also we are actively trying to also look for other ways to deploy our capital, including extending loans through other online partners and platforms, which could actually be a pretty good way to deploy our capital quickly. And we are anticipating it to happen in the second half.

For the Hong Kong business, I think it is anticipated to be steady in terms of the loan growth based on our long history in Hong Kong. And -- but I think the key potential risk is what happens with unemployment and whether the social unrest would turn into a slowdown and how bad the employment -- unemployment will be. And historically, this has got a very high correlation with our charge-off ratio and hence the profitability. So we are -- we will be cautious about this factor.

I think at this point, there seems to be no further questions. So we'll close off the webcast, and please feel free to reach out to us if you have any further questions.