SINGAPORE (July 3): Mandarin Oriental International has seen its shares rocket over the past month after the company said on June 5 that it was undertaking a review of its long-term strategic options with regard to The Excelsior, Hong Kong. But some analysts warn that any gain from the monetisation of the property might already be reflected in its stock price.

Mandarin Oriental is 77.37%-owned by Jardine Strategic Holdings. It operates 29 hotels and eight residences in 19 countries. Of these, the hotelier either owns or partly owns 16 hotels, with 13 hotels operated under management contracts. All the hotels are five-star properties with the exception of The Excelsior, Hong Kong, which has a four-star rating. “As part of this review, and in the light of the current strong commercial property valuations in Hong Kong, the company has decided to test market interest in the possible sale of the property, which has approval for the development of a commercial building with a gross floor area [GFA] of some 63,500 sq m [683,260 sq ft] on the site,” the company said on June 5.

Mandarin Oriental uses historical cost accounting for its assets. That means the hotels it owns are held at cost less depreciation. This implies that the company’s net asset value of US$1.17 billion ($1.62 billion), or 93 US cents a share, does not reflect the steep appreciation of comparable real estate assets in Hong Kong over the years. According to the company, if its property assets were carried at current market valuations, its “enhanced” NAV would be US$3.10 a share.

Since the beginning of June, shares in Mandarin Oriental have jumped 38%. They are now trading at 1.17 times its NAV, but only 0.65 times its “enhanced” NAV. Will the stock climb higher? Or, is it too late for investors to get in now?

It is worth keeping in mind that Mandarin Oriental is operating in a challenging sector. For FY2016, the company reported a 1.6% decline in revenue to US$897.4 million and a 38% drop in profit after tax to US$54.4 million. Revenue per available room fell 3%. In particular, the company’s flagship property, Mandarin Oriental Hong Kong, was affected by a decline in visitor arrivals to the city as well as softening demand from the corporate sector. As a result, RevPAR for the company’s Hong Kong properties was down 7%. Some 37% of the company’s revenue and 53% of its earnings before interest, taxes, depreciation and amortisation (Ebitda) is from Hong Kong.

Meanwhile, The Excelsior Hong Kong’s occupancy was just 75%, down four percentage points y-o-y. The Excelsior is worth a lot more as commercial real estate than as a hotel. In its most recent annual report, the company pointed out that The Excelsior Hong Kong was affected “by the citywide decline in leisure demand, particularly from mainland China, combined with an oversupply in its competitive set”.

According to an interim management statement on May 3, conditions remained tough in the first quarter of this year. “Earnings for the period under review were lower than in 2016, primarily because of the partial closure of the London hotel for renovation. Going forward, the group’s results will continue to be affected by the renovation in London, which is scheduled to be completed in the second quarter of 2018,” the company said.

Lofty benchmarks being set Against this backdrop, the whole idea of monetising and redeveloping The Excelsior Hong Kong makes a lot of sense from the viewpoint of shareholders. And, excitement in the market was stoked by an auction in May of a hotly contested car park on Murray Road in Hong Kong, won by Henderson Land Development. The car park is located between Cheung Kong Centre and Hutchison House. Henderson Land paid HK$23.3 billion ($4.14 billion), or more than HK$50,000 psf, for the 465,000 sq ft site, a record price for Hong Kong.

Some analysts warn, however, that the lofty benchmark set by Henderson Land is unlikely to be matched by a transaction involving The Excelsior Hong Kong. While the hotel sits on a 999-year leasehold site that expires in 2842, it simply is not as well located as the small Murray Road car park. “We don’t think Murray Road is a good comparable to The Excelsior, as it is smaller site in a much superior location,” states a Citi report.

Instead, a more appropriate benchmark for The Excelsior Hong Kong would be Times Square, which is owned by The Wharf Holdings. Times Square comprises 1.7 million sq ft of GFA, of which more than 933 sq ft is retail space and 1.03 million sq ft, office space. It was valued at HK$54.5 billion, or HK$27,700 psf of GFA, last year. Some analysts see The Excelsior Hong Kong being sold for as much as HK$20 billion, or HK$30,000 psf.

Citi’s base line valuation for The Excelsior Hong Kong following a redevelopment is only HK$15,000 psf, though. This would add 82 US cents to Mandarin Oriental’s estimated NAV of US$1.03 a share. On this basis, shares in Mandarin Oriental, now trading at US$2.55 billion, would be fully valued. Citi’s assumptions are that 90% of the redeveloped property consists of offices and the remaining 10% retail space. However, if the property were to be valued at HK$30,000 psf in a deal, Mandarin Oriental’s estimated NAV would be boosted by US$1.86 a share. And, if the hotel were to fetch HK$50,000 psf, some US$3.25 a share would be added to the company’s NAV.

“We are opening a positive 90-day Catalyst Watch call on the potential sale of The Excelsior, as we believe the market will continue to respond enthusiastically to this potential catalyst, particularly after the recent government commercial land sale on Murray Road at HK$50,064 psf. Though we think [the] current share price has factored in some of the upside, we think an actual announcement, especially if at a high price, could spark further near-term upside,” Citi states in a June 6 report.

Analysts cautious Yet, Citi has retained its “sell” call on Mandarin Oriental. “While we believe a sale of The Excelsior, if it materialises, could be a game changer for the group, we maintain our long-term ‘sell’ rating, as the outcome of the management review is still uncertain. Also, if the group continues to operate the asset as a hotel, there will be no enhancement to NAV,” Citi says.

Nomura has upgraded Mandarin Oriental to a “hold”. Although the company could unlock as much as HK$20 billion in value, based on a psf price of HK$12,900, Nomura figures that the “option value” of this happening would be just 67 US cents a share. Nomura estimates that Mandarin Oriental’s Ebitda will fall by US$21 million after The Excelsior’s closure for the property to be redeveloped. It has a price target of US$1.73 for Mandarin Oriental, which reflects a forecast EV/Ebitda ratio of 13.5 times. EV, or enterprise value, is a company’s market capitalisation plus debt and less cash.

In the meantime, Mandarin Oriental is pursuing plans to grow its hotel business. It has 11 hotels under development that are expected to open in the next five years. All are management contracts with no equity interest. In April last year, Mandarin Oriental completed the acquisition of Mandarin Oriental, Boston for US$140 million. The company has managed this hotel since 2008. In May 2015, the company bought a 50% stake in Hotel Ritz, Madrid for €65 million ($102.3 million). The hotel will undergo renovation and Mandarin Oriental’s share of the capital expenditure will be €45 million.

Shangri-La Asia may climb more on new management, improving outlook in China SINGAPORE (July 3): Shangri-La Asia benefited from a spillover of enthusiasm for hotel stocks in early June, fuelled by the big run in Mandarin Oriental International. But Shangri-La Asia had already rallied strongly in the preceding months on growing optimism in the market that a new management team, led by a former top executive from the CapitaLand group, would soon set it on a path to stronger profitability. Some analysts see the stock climbing even higher in the months ahead.

Shangri-La Asia is 50.02%-owned by billionaire Robert Kuok’s Kerry Group. It owns and operates 76 hotels across Asia-Pacific and manages a further three that it does not own. It also owns investment properties in China, Singapore and Malaysia. In January, it appointed Lim Beng Chee as its CEO. Lim was CEO of CapitaLand Mall Asia, the retail property arm of CapitaLand. At the beginning of the year, shares in Shangri-La  Asia were trading at just HK$8.31, which was equivalent to 0.59 times the company’s book value of almost US$1.80 ($2.49) a share. Since then, it has jumped almost 60% to HK$13.28.

Like Mandarin Oriental, Shangri-La Asia carries its hotel properties on its books at cost less depreciation. According to analysts, if the company’s assets were revalued, its net asset value would be well in excess of HK$30 a share. Thus, even after their strong run, shares in Shangri-La Asia are still trading well below its revalued NAV (RNAV), which many analysts say is unwarranted in the light of the more aggressive management that is now in place. “Shangri-La Asia’s new management team boosts our confidence in the company. It may finally achieve higher efficiency and its stock price may narrow the deep discount to its NAV,” says Deutsche Bank in a June 2 note, just as Shangri-La Asia’s shares punched higher together with Mandarin Oriental.

Improvement in China Analysts are also growing more confident of a rebound in profitability at Shangri-La Asia’s hotels in China. “Chinese hotels, from the luxury to economy segments, have all seen strong RevPAR [revenue per available room] in 1Q2017,” observes Deutsche Bank. In 1Q2017, RevPAR for five-star hotels in Beijing increased 10% y-o-y, and in Shanghai 7% y-o-y. “For Shangri-La, China Tier-1 cities should start to see room rate hikes as occupancy rates are approaching the mid-70s. Tier-2 cities are seeing demand recovery pushing occupancy rates towards the mid-60s,” Deutsche Bank adds.

This is not evident from Shangri-La Asia’s headline numbers. For FY2016, the company reported a 63% decline in earnings to US$62 million on a 3.1% fall in revenue to US$2.055 billion. However, the company reported a 33% rise in “segment profits” (akin to operating profits) to US$264 million. Rental income from its investment properties contributed US$131.6 million, down 5% versus the previous year. The company’s hotel business contributed US$79 million, up 108% versus the previous year, driven by a reduction in losses at its hotels in mainland China.

In April, Shangri-La Asia also opened a fully-owned five-star Kerry Hotel in Hong Kong, its first new property in the city since 2006. The new hotel has 546 rooms, with weekend room rates starting from US$250 a night. Land cost was US$300 million and total cost was US$600 million. The new Kerry Hotel is likely to break even on an Ebitda, or earnings before interest, taxes, depreciation and amortisation, level this year, but will remain a drag on net profit because of depreciation changes.

Analysts expect higher ROE Deutsche Bank is expecting the new management team at Shangri-La Asia to adopt an “asset-light” growth model that could boost the company’s cash flow and return on equity. With reduced capital expenditure, the company should turn free cash-flow-positive by 2018, according to Deutsche Bank.

Goldman Sachs says in a June 1 report that Shangri-La Asia’s gearing is likely to fall from 2018 as free cash flow turns positive with a lower risk of equity fundraising. “In addition to building financial capacity for debt reduction, we also expect positive direction for future dividend payment,” it adds.

In a report on June 2, Deutsche Bank puts Shangri-La Asia’s RNAV at HK$37 a share. The research house has a “buy” rating on the stock, with a price target of HK$14, a 62% discount to its RNAV estimate. Goldman Sachs is similarly bullish on Shangri-La Asia, and puts its RNAV at HK$31.24 a share. “We see the potential for the company to unlock value in their real estate assets as an option,” it says in a report. “Any actions on this front would likely be value-enhancing, in our view,” it adds.

Will a sale of The Excelsior drive shares in Mandarin Oriental much higher?

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