jackie chan: “should i give them the money or the stock?”

Jackie Chan:““Should I give Should I give

them the money them the money or the stock?”or the stock?”

Wing Yee Winnie ChanWing Yee Winnie ChanElaine LamElaine LamPatrick NgPatrick Ng

Zhi Ming Vicky WenZhi Ming Vicky WenJessie ZhengJessie Zheng

Background & OverviewBackground & Overview

Real Estate Market in AsiaReal Estate Market in Asia

Company PerformanceCompany Performance

Investment Risk & ConcernInvestment Risk & Concern

Analysis of Stock ValuationAnalysis of Stock Valuation

Recommendation Recommendation

AgendaAgenda

Stock ValuationStock Valuation

Cheung Kong GroupCheung Kong Group• The biggest conglomerate in Hong KongThe biggest conglomerate in Hong Kong• Owned by the richest man in HK: Li Ka ShingOwned by the richest man in HK: Li Ka Shing• Started from $1 in 1972 to $116 in 2000Started from $1 in 1972 to $116 in 2000• Even in economic downturn today, still priced at $44Even in economic downturn today, still priced at $44

Cheung Kong (Holdings), Cheung Kong (Holdings), Ltd.Ltd.

• Company’s long-standing policy is : continuously enhance Company’s long-standing policy is : continuously enhance quality and introduce innovations and initiatives to cater to quality and introduce innovations and initiatives to cater to changing needs and trends in the property market, with the changing needs and trends in the property market, with the aim of brining quality to our customersaim of brining quality to our customers

Economic Overview of ChinaEconomic Overview of China

• External demand affected by Asian External demand affected by Asian financial crisis and global economic financial crisis and global economic slowdown slowdown

• Domestic demand affected by increased Domestic demand affected by increased pace in corporate reform and weak rural pace in corporate reform and weak rural incomeincome

• Government engagement in expansionary Government engagement in expansionary fiscal monetary policyfiscal monetary policy

Continued…Continued…• By August 2001, China regained its By August 2001, China regained its

growth momentumgrowth momentum

• Increase in external demand Increase in external demand

• Property prices in Shanghai rose 30 – Property prices in Shanghai rose 30 – 50% 50%

Economic Overview of Hong Economic Overview of Hong KongKong

• Hong Kong suffered a sharp Hong Kong suffered a sharp slowdown in 2001, with GDP growth slowdown in 2001, with GDP growth decelerating to 0.1% from 10.5% the decelerating to 0.1% from 10.5% the year earlieryear earlier

• Residential property prices are 65% Residential property prices are 65% below their 1997 peaks. They have below their 1997 peaks. They have been hurt by oversupply and anemic been hurt by oversupply and anemic demand. demand.







AgendaAgenda


Real Estate Industry in AsiaReal Estate Industry in Asia• ChinaChina

– Many opportunities due to rapid economic Many opportunities due to rapid economic growth, rising per capita income and flood of growth, rising per capita income and flood of foreign investment.foreign investment.

– Real estate sector is highly profitable – Real estate sector is highly profitable – averaging 20% margins.averaging 20% margins.

– Property boom nearing bubble proportionsProperty boom nearing bubble proportions• In 2002, investment in real estate rose 36.6% while fixed-In 2002, investment in real estate rose 36.6% while fixed-

asset investment rose only 24%asset investment rose only 24%• Real estate vacancy rate at 26%Real estate vacancy rate at 26%

– The vacancy rate in the US is only 7%The vacancy rate in the US is only 7%– The international warning level is 10%The international warning level is 10%

Real Estate Industry in AsiaReal Estate Industry in Asia• Hong KongHong Kong

– Asian financial crisis has led to economic Asian financial crisis has led to economic contractioncontraction• Falling property prices and wage ratesFalling property prices and wage rates

– Nearly half their peakNearly half their peak– Flooded property marketFlooded property market

• 20,000 completed and 30,000 incomplete private 20,000 completed and 30,000 incomplete private residential flats for sale on the marketresidential flats for sale on the market

• Property is no longer a major investment vehicleProperty is no longer a major investment vehicle

Real Estate Industry in AsiaReal Estate Industry in Asia• Future OutlookFuture Outlook

– Homes are more affordable – mortgage Homes are more affordable – mortgage payments comprise smaller share of income.payments comprise smaller share of income.

– Residential property prices 65% below their Residential property prices 65% below their peak in 1997.peak in 1997.

– The low tax rate in Hong Kong as compared to The low tax rate in Hong Kong as compared to other major international cities allow its other major international cities allow its citizens to have more disposable income.citizens to have more disposable income.

Foreign Market Foreign Market DevelopmentsDevelopments• Joint agreements with Hutchison Joint agreements with Hutchison

Whampoa to develop properties in Whampoa to develop properties in Mainland China.Mainland China.

• Other foreign marketsOther foreign markets– SingaporeSingapore– United KingdomUnited Kingdom







AgendaAgenda


Investment Risks of ChinaInvestment Risks of China• Economic RisksEconomic Risks

– SituationSituation• Significant growth of economySignificant growth of economy

– GDP is expected to increase to an average of 7.9% in 2003GDP is expected to increase to an average of 7.9% in 2003– Domestic demand is being stimulated through an expansionary public investment programDomestic demand is being stimulated through an expansionary public investment program

• ConcernsConcerns– Different program carry on at the same timeDifferent program carry on at the same time

• strengthening the financial systemstrengthening the financial system• developing legal and regulatory framework for the economydeveloping legal and regulatory framework for the economy• promoting the role of private sectorpromoting the role of private sector

• RisksRisks– Targeted long-term growth remain largely uncertainTargeted long-term growth remain largely uncertain

Investment Risks of ChinaInvestment Risks of China• Country RisksCountry Risks

– SituationSituation• Accession to the WTOAccession to the WTO• Reexamining existing laws and statutes in Reexamining existing laws and statutes in

accordance with the framework of the WTOaccordance with the framework of the WTO

– RisksRisks• Revised laws are relatively new and untested, the Revised laws are relatively new and untested, the

enforcement of these laws under the improving law enforcement of these laws under the improving law system of China involve significant uncertaintysystem of China involve significant uncertainty

Investment Risks of Hong Investment Risks of Hong KongKong

• Economic RisksEconomic Risks– SituationSituation

• Slowly recovered economySlowly recovered economy– 0.6% in 2001, 2.3% in 20020.6% in 2001, 2.3% in 2002

• Low interest rateLow interest rate– 2% per year2% per year

– RisksRisks• Increase in interest rateIncrease in interest rate

– No more tendencies for interest rate to decreaseNo more tendencies for interest rate to decrease– However, with a slowly recovery market, However, with a slowly recovery market,

government might not plan to increase interest rategovernment might not plan to increase interest rate– Investors better offInvestors better off

Investment Risks of Hong Investment Risks of Hong KongKong• Country Risks and ConcernsCountry Risks and Concerns

– Suffering from Asia Financial Crisis since 1997Suffering from Asia Financial Crisis since 1997– Weakening demand of economyWeakening demand of economy– Drop in exportsDrop in exports– However, market has been slowly recovered However, market has been slowly recovered

since 2002since 2002

• New Risks: SARSNew Risks: SARS– Currently Hong Kong and China have the Currently Hong Kong and China have the

highest number of infected patientshighest number of infected patients

Investment Risks of Cheung Investment Risks of Cheung KongKong• Currency Exchange Rate RisksCurrency Exchange Rate Risks

– Most of Cheung Kong’s operations are located in Most of Cheung Kong’s operations are located in Hong KongHong Kong

– Economic downturns in Hong Kong since 1997Economic downturns in Hong Kong since 1997– Deflation observed in the marketDeflation observed in the market– However, Hong Kong dollar remained constant However, Hong Kong dollar remained constant

because of Linked Exchange Rate Systembecause of Linked Exchange Rate System

• ConcernsConcerns– A big share of business invested in China and A big share of business invested in China and

LondonLondon– Restrictions on currency exchange might limit Restrictions on currency exchange might limit

Cheung Kong’s ability to utilize its revenue to fund Cheung Kong’s ability to utilize its revenue to fund business activitiesbusiness activities

Investment Risks of Cheung Investment Risks of Cheung KongKong• Company Risks and ConcernsCompany Risks and Concerns

– Reported increasing net profit during the past Reported increasing net profit during the past decadesdecades

– The increase of net profit slowed down during The increase of net profit slowed down during recent yearsrecent years• Economic downturns in the worldEconomic downturns in the world• The real estate market in Hong Kong has become The real estate market in Hong Kong has become

saturatedsaturated• Difficulties in obtaining larger market sharesDifficulties in obtaining larger market shares• Losses from subsidiaries companies such as Tom.comLosses from subsidiaries companies such as Tom.com







AgendaAgenda


Liquidity Liquidity • Current Ratio > 1 for the Past 3 YearsCurrent Ratio > 1 for the Past 3 Years

– High level of LiquidityHigh level of Liquidity– IncreasingIncreasing

• Decreasing Quick Ratio Decreasing Quick Ratio – Using cash and securities to pay off liabilities Using cash and securities to pay off liabilities

and purchase inventoriesand purchase inventories

Leverage RatioLeverage Ratio• Increasing Long Term Debt RatioIncreasing Long Term Debt Ratio

– Relies more on equity than debt financingRelies more on equity than debt financing• Lower Debt-to-Assets RatioLower Debt-to-Assets Ratio

– Advantage in borrowing additional fundsAdvantage in borrowing additional funds• Interest Coverage RatioInterest Coverage Ratio

– Dramatic decrease from 88.18 to 6.87 Dramatic decrease from 88.18 to 6.87 • Negative Operating Cash Flow to Total Negative Operating Cash Flow to Total

Liability Liability

ProfitabilityProfitability• Profit MarginProfit Margin

– Over 100% in 1999 and 2000 but decreasing Over 100% in 1999 and 2000 but decreasing – Low in percentage of operating profitLow in percentage of operating profit– Volatile Volatile

• Decreasing Return on AssetsDecreasing Return on Assets• Return on EquityReturn on Equity

– Decreased from 46% to 6% in 2000Decreased from 46% to 6% in 2000







AgendaAgenda


CAPMCAPM

• Risk-free Rate – 10 Risk-free Rate – 10 year Exchange year Exchange Fund Notes = Fund Notes = 4.40%4.40%

• Market Return – Market Return – Hang Seng Index = Hang Seng Index = 8.83%8.83%

• Beta = 1.079Beta = 1.079• CAPM = 9.18%CAPM = 9.18%

Hang Seng Index

Date Adj. Close*

Dec-88 2,687.40

Dec-89 2,836.60

Dec-90 3,024.00

Dec-91 4,297.30

Dec-92 5,512.40

Dec-93 11,888.40

Dec-94 8,191.00

Dec-95 10,073.40

Dec-96 13,451.50

Dec-97 10,722.80

Dec-98 10,048.58

Dec-99 16,962.10

Dec-00 15,095.53

Dec-01 10,598.55

Dec-02 9,561.63

(Geometric Avg.) 8.83%

Altman’s Z-score – Cost of Altman’s Z-score – Cost of DebtDebt

• Z-score = 6.72 Z-score = 6.72 EM Score = 3.25 + 6.56(X1) + EM Score = 3.25 + 6.56(X1) +

3.26(X2) + 6.72(X3) + 1.05(X4)3.26(X2) + 6.72(X3) + 1.05(X4)

• Bond Rating = ABond Rating = A

• Cost of Debt = 6.2%Cost of Debt = 6.2% Cost of Debt = Risk free rate + Cost of Debt = Risk free rate +

Default spreadDefault spread

WACC & Goldman ModelWACC & Goldman Model

Equity-to-Total Capital 88.50%

Debt-to-Total Capital 11.50%

Cost of Equity 9.18%

Cost of Debt 6.20%

Tax Rate 9.10%

WACC 8.77%

HK Risk Free Rate 4.40%

US Risk Free Rate 3.93%

SYS 0.47%

Beta 1.079

World Market Return 8.07%

World Market Premium 4.14%

Int'l Cost of Capital 9.35%

WACC Goldman Model

Why DDM?Why DDM?• Stable Growth – See following tableStable Growth – See following table• Dividend – long term earning power & ProfitabilityDividend – long term earning power & Profitability• Dividend vs. EPS – foreseeabilityDividend vs. EPS – foreseeability• Suitable for non-controlling perspectiveSuitable for non-controlling perspective

1996 1997 1998 1999 2000 2001

DPS $1.38 $1.62 $1.16 $1.38 $1.60 $1.60

Growth of DPS 3.00%

Justified Value of StockJustified Value of Stock• DDM Formula: DDM Formula: Current EPS * (1+Growth of Earnings) * Current EPS * (1+Growth of Earnings) *

Payout Ratio / (Cost of Equity - Growth of Payout Ratio / (Cost of Equity - Growth of Earnings) Earnings)

• Current EPS – Obtained from BloombergCurrent EPS – Obtained from Bloomberg• Payout Ratio – Most recent yearPayout Ratio – Most recent year• Growth of Earnings – Growth of DPSGrowth of Earnings – Growth of DPS• Cost of Equity - CAPMCost of Equity - CAPM

Justified Value of Justified Value of StockStock

HK$26.68HK$26.68

Value of Stock TodayValue of Stock TodayHK$44.60HK$44.60

Sensitivity AnalysisSensitivity AnalysisGrowth RateGrowth Rate

• Key driver of the value Key driver of the value of stockof stock

• As the economic As the economic outlook improves, outlook improves, higher growth rate higher growth rate assumption can be assumption can be achievedachieved

Equity BetaEquity Beta • Linear RelationshipLinear Relationship• Less SensitiveLess Sensitive

Cheung Kong HoldingsEquity Beta vs. Value of Stock

$20.00

$24.00

$28.00

$32.00

$36.00

$40.00

0.80 0.85 0.90 0.95 1.00 1.05 1.10 1.15 1.20 1.25

Equity Beta

Value

of Sto

ck

Cheung Kong HoldingsGrowth Rate vs. Value of Stock

0.00

50.00

100.00

150.00

200.00

250.00

300.00

Growth Rate

Valu

e of

Sto

ck

Stock Valuation Suggests… Stock Valuation Suggests… • Based on the numerical calculation alone, Based on the numerical calculation alone,

we conclude with a SELL recommendation we conclude with a SELL recommendation for Cheung Kong. for Cheung Kong.

• However, there is more to the value of the However, there is more to the value of the stock than just numbers…stock than just numbers…







AgendaAgenda


Brand ImageBrand Image• Corporate Governance Corporate Governance

– Ticker: 0001Ticker: 0001– Publicized in 1972 Publicized in 1972 – Today: Market Cap of HK$ 405 BillionToday: Market Cap of HK$ 405 Billion– Diversification Diversification

• Li Ka ShingLi Ka Shing– Hong Kong’s Wealthiest ManHong Kong’s Wealthiest Man– World’s 23World’s 23rdrd – Single Largest Shareholder: 36.53%Single Largest Shareholder: 36.53%– Successful DealmakerSuccessful Dealmaker

Stable Dividend GrowthStable Dividend Growth• Market RecessionMarket Recession• Average Rate for Bank Deposit < 1%Average Rate for Bank Deposit < 1%• Invest in Defensive StocksInvest in Defensive Stocks

– Utilities, Health Care, Consumer Staples, High Utilities, Health Care, Consumer Staples, High Dividend Yield…etc. Dividend Yield…etc.

• Stable Dividend DistributionStable Dividend Distribution– Cheung Kong: 3.0% Dividend GrowthCheung Kong: 3.0% Dividend Growth

• Pay Premium for Constant ReturnPay Premium for Constant Return

Instability of Earnings Per Instability of Earnings Per ShareShare• Fluctuation of Payout Ratio Fluctuation of Payout Ratio • Earnings Dependent on Associates and Earnings Dependent on Associates and

Jointly Controlled Entities Jointly Controlled Entities • 49.9% Interest in Hutchison Whampoa49.9% Interest in Hutchison Whampoa

– Sold off the British telecom operator, Sold off the British telecom operator, Orange PLC resulted in $22 Billion Profit Orange PLC resulted in $22 Billion Profit for Shareholder In 1999 for Shareholder In 1999

• Rapid growth of EPS from 1998’s 2.66% to Rapid growth of EPS from 1998’s 2.66% to 25.84% in 1999 25.84% in 1999

Hong Kong Property MarketHong Kong Property Market• Diminishing and Saturated MarketDiminishing and Saturated Market• Government PolicyGovernment Policy

– Subsidized apartment vs. Private Subsidized apartment vs. Private FlatFlat

• Cheung Kong’s Surviving TechniquesCheung Kong’s Surviving Techniques– Mark-to-Market Pricing StrategyMark-to-Market Pricing Strategy– Market Development – China, UK…Market Development – China, UK…

etc. etc.







AgendaAgenda


RecommendationRecommendation

Cheung Kong Holdings

HOLD

Questions?Questions?

jackie chan: “should i give them the money or the stock?”

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