LHN Limited: Unique Real Estate Equity Play?

Since time immemorial, there have been two rather straightforward business models when it comes to real estate: Rental and Development. For the case of rental specifically, you have tenants locked into lease contracts which more or less guarantees a steady cash flow from your rental properties, and that's exactly what LHN Limited (SGX: 41O) has been doing, dipping its fingers into some pretty special pies. 

Over time, I must admit that I've developed quite an inclination towards high recurring income and cash flow businesses, which naturally led LHN Limited to pique my curiousity. I'm always on the lookout for good deals in the market, and when I noticed the stock's price had plummeted a drastic 15% from a recent high of 0.4SGD to 0.34SGD as of writing this article, I just had to take an in-depth look to see if it's the next bargain buy in the Singapore market. 

Source: LHN Group Facebook

Moving on, to give you some better insight regarding this relatively unknown SGX-Listed company, I'll let the management themselves give you its introduction:

Established in 1991, LHN Group is a real estate management services group with the distinguishing ability to generate value for our space owners and space users through our expertise in Space Optimisation. With Facilities Management Services and Energy Resources complementing our core Space Optimisation business, our space users can look towards our wide range of business solutions to meet the growth of their businesses.

Personally, I think you'll come to find that this company's various segments seem to possess rather compelling business models, which begs the question: What exactly do these segments entail?

Space Optimisation is rather straightforward. Essentially, they identify undervalued properties ranging from Commercial and industrial to Residential and pour in funds to spruce them up, increasing potential rental yield and collecting that sweet, sweet cash flow. Their subsidiaries under this segment include Coliwoo (A Co-Living Apartment Space Concept), Work + Space, and Greenhub. As someone who's had experience looking for a place to store my things while doubling as a productive space, I've heard of Work+Space, and can safely say that they are one of the biggest players in this specific niche. If I'm not wrong, I've heard of Greenhub as well, which offers a virtual office service. 

Coliwoo's Balestier 320 Property (Source: Coliwoo's Website)

Facilities Management Services refers to LHN providing various services ranging from cleaning, building maintenance, and even carpark operation. These all seem like great businesses since it's very likely that the company has secured long-term contracts with their customers, not to mention the carpark operation being sort of a rentalesque business itself. 

Lastly, Energy Resources refers to their sole subsidiary LHN Energy which is a provider of solar energy solutions for buildings. I think this is the weakest part of the business given that I would presume profits are lumpy and highly project dependent. 

If you look at the company as a whole, these three core business segments complement each other. LHN can potentially upsell its various services to its existing consumer base, such as locating its carparks near its investment properties or even incorporating the energy segment's solar systems into its buildings to reduce overhead. Overall, the company undeniably has the potential to make some headway in regards to creating a service ecosystem and improving earning quality. 

Of course, let's start reviewing the balance sheet to see whether this company can weather the high interest rate storm businesses are facing in today's climate. 

Source: FY23 1H Annual Report 

Straightaway, you can see that the majority of the company's assets are tied up to its investment properties, which represents approximately 56% in weightage. Not to mention, significant appreciation has been attributed to these properties, which was the main reason why the company's overall assets increased during the period. Worryingly though, is the fact that lease liabilities and bank borrowings have significantly shot up by 39.2% as a whole within this short span of 6 months. 

Gearing is at 63.5% which is concerning since assets have only recently shot up due to property valuations increasing. Should property values normalise, this may result in an excessively high gearing ratio which may suggest that the company has overleveraged. 

Current assets, which for liquidity purposes I will only take into account cash and equivalents, fixed deposits, and financial receivables, are only able to cover 55% of current liabilities, let alone total liabilities. The company is certainly being aggressive in its expansion. I cannot help but feel that the company was only able to enter into various loan agreements via its higher-than-previously valued properties as collateral, but this company isn't classified as a REIT so in terms of gearing, there's not much restriction.

Despite this, it is fair to acknowledge that the interest coverage ratio is still healthy as it is hovering around x6-7, which should mean that the company has no issues in maintaining its current debt obligations. 

Overall, the balance sheet gives me some mixed feelings. 

Source: FY23 1H Annual Report 

The company's financial performance is rather hard to evaluate as a whole because, on one hand, you have segments such as real estate which you would rather use financial metrics such as AFFO whereas metrics such as gross profit are more suited for its services business. Hence, we'll have to dive deeper into the segments' performances to gain a better understanding of the financial performance of the company.

Hence, in terms of adjusted segment results, I've created this pie chart for LHN's real estate businesses by excluding gains/losses from their property valuations. 

Source: Passive Loss SG

Looking at this, it's quite clear that the majority of the real estate business is attributed to the industrial segment. Even if you solely adjust for valuation loss in the industrials segment because industrial properties in Singapore suffer greatly from shorter leases and thus lease decay, the segment is still the majority of the real estate business. 

Source: LHN Limited FY2022 Annual Report

The company also has its fingers in multiple geographical pies, although the majority of its operations are set in Singapore.

Now, let's talk about the residential segment of LHN. Do me a favour and picture this: When you want to invest in good ole' Singapore property, I bet the first thing that comes to mind (at least to the average Joe) is residential. Yet, it's inaccessible. It requires too much of an upfront investment and too much effort to filter out tenants, and deal with maintenance and is just overall rather unpleasant. Then, you hear about REITs, how they're managed for you, distribute dividends regularly, and require much less capital. However, you come to a startling realisation; there's no Singapore Residential REIT! This is exactly why LHN's Coliwoo segment is so intriguing to me. It indirectly gives you access to the Residential market. 

Source: Edgeprop Singapore

Many of Coliwoo's properties are located in the Core Central Region (CCR) as well, which is typically poised to capture the bulk of Singapore's ample property market growth. Communal spaces offer flexible, relatively affordable, and lavish living arrangements, coupled with the encouragement of fostering that "kampung spirit" many of the youth today yearn for. 

Source: Ministry of Manpower Singapore

Employment Pass holders, who must at least earn $5000 SGD per month and are only reserved for skilled foreign talent, are on an uptrend. It's quite evident that the nation is encouraging more and more professionals to combat the ongoing brain drain. Seems great for Coliwoo. 

Of course, the Co-Living space isn't all sunshine and rainbows. Like with any business, you have your pros and then your cons. You're dealing with individuals each with different circumstances and profiles, which may lead to certain problems. Yes, you're able to command a higher premium, but there's much less security in terms of WALE as compared to renting a property to some large organisation. In other words, more risk for a higher reward. Your tenant turnover is going to be rather high since professionals are easily able to leave Singapore as opposed to families who would have to "uproot" which leads to higher potential administrative expenses as well such as marketing to fill in and lost potential income from vacancies. You're also counting on Singapore's desirability as well, though this is less of an idiosyncratic risk. 

Now that we've got the qualitative aspects of the business out of the way, let's review the company's financial performance over the years!

Information Source: Gurufocus

Overall, the company has seen a mixed financial performance for the last five years in terms of revenue, with a minor uptrend. EPS has been growing quite steadily but I mainly attribute this to the rapid appreciation of their investment properties, likewise with NAV. Since I view LHN more like a REIT, I have also included the Free Cash Flow (FCF) statistics which paint a similar picture to EPS, attributed to higher contributions from their real estate segment. Although the dividend seems inconsistent, there seems to be a nice uptrend with the payout ratio staying roughly the same. I have taken the liberty to run the numbers when using FCF and EPS and it seems that the company does not have a set dividend policy besides setting the payout ratio quite low. Overall, the company seems to be growing quite decently when considering all metrics. 

The next I would like to evaluate is the overall management of the company.

"In addition, our Directors intend to recommend and distribute dividends of not less than 40.0% of our Group's profit attributable to equity holders of our Company excluding non-recurring, one-off and exceptional items, whether as an annual dividend or an interim dividend for the subsequent two financial years comprising FY2023 and FY2024 as we wish to reward Shareholders for participating in our Group's growth." - LHN Logistic's Dividend Policy

I was able to find the above snippet of information on LHN Logistic's website with regards to a temporary dividend policy (or more so guidance) for the next two years or so. Please take note that LHN Logistics is simply a subsidiary of LHN Limited and hence may not necessarily reflect the main company's stance on dividends. Instead, I am simply trying to extrapolate out what could the main company's potential stance be. I find the policy to be quite reasonable since the company is essentially saying that they'll be paying out their earnings excluding disposal gains, investment gains, etc., or the underlying profits from the business operations. I would just like you to take note of the last sentence, in which they state the policy is to reward shareholders. This seems to imply that 40% is actually above the norm, and I speculate that it would return to an approximately 20-30% payout ratio. In terms of rewarding shareholders, I think it is quite fair given that the company seems to be rather aggressive in growth, coupled with the fact that it is heartening to see that the management does indeed take into consideration the shareholders.

For the sake of simplicity for the evaluation, I will simply review the CEO's profile.

"Mr Lim Lung Tieng (also known as Lin Longtian) (林隆田) (“Kelvin”), age 45, is a controlling shareholder of the Company and was first appointed to the Board on 10 July 2014 and was last re-elected on 29 January 2021. He is currently the Executive Chairman, the Executive Director, the Group Managing Director, and a member of the Nominating Committee. Kelvin is also a director of all of the subsidiaries of the Group other than Hean Nerng Facilities Management Pte. Ltd.

Kelvin brings over 20 years of experience in the property leasing, logistics services, and facilities management business. He is primarily responsible for the Group’s business development and overall management, including investment activities, operations, and marketing efforts."

The company's CEO seems to be rather experienced in the field with ample amounts of experience, and since he is 45 years old, I don't think succession is up on the table just yet. It should be noted that the executive director of the company is the sister of the CEO with a controlling interest, and hence the company is classified as a family business in my books. 

Moving forward, the group states that they intend to maximise cost-efficiency by digitalising their operations when possible and expanding their services offered by leveraging their experience in space optimisation. Furthermore, they claim that they will continue to pursue active capital recycling, which I do indeed see based on the news recently.

With regard to growth strategy, I find it relevant to discuss the group's recent disposal of LHN Logistics.

Earlier in August, an offer made by Milkway Chemical was published to purchase all shares of LHN Logistics, which would represent a 28.8 Million dollar cash infusion into the company. When taking into account the number of LHN Limited shares available, this represents a 7 cents per share cash infusion and a 4.4 cents gain per share after the disposal. 

Source: LHN Logistics Website

To give an idea of what the business sold was, I'll bring up this excerpt from the company website.

"Established in 2003, LHN Logistics is a Singapore-based logistics services group with two principal business segments, namely, Transportation Business and Container Depot Services Business. Offering transportation services, container depot management services, and container depot services, the company transports mainly ISO tanks, containers, bulk cargo, petrochemical products, base oils, and bitumen; and provides a wide range of container depot-related services which include container storage, container surveying, container cleaning, container repair and maintenance services for general purpose and refrigerated containers (reefer)."

The impact of the disposal would actually increase EPS by a whopping 5.21 cents and increase NAV per share by 4.31 cents assuming the worst-case scenario of the company bearing 100% of the payment to JTC Corporation due to the transaction when calculating the pro forma financial effects based on FY2022 of the company. 

The reason for the EPS increase is actually due to the fact that from my understanding, after skimming LHN Logistics's recent annual reports, is the fact that the company is actually loss-making. Hence, I find this decision to be quite good on the management's part since it unlocks value by offloading the lagging segment of the business at a premium. LHN Limited has stated that it will use the additional cash to further enhance its core businesses and general working capital purposes.

In conclusion, I view the management favourably. They are streamlining their business segments and expanding on their strengths and what is familiar to them. There is a clear growth strategy set in place by the management with business models that are proven to at least be profitable, unlike Fu Yu Corporation's recent failures in the supply chain management business. The dividend policy is rather reasonable and shows the shareholders are not an afterthought. 

I also find it rather interesting that the company is actually dual-listed, with shares trading on the Hong Kong Stock Exchange (HKEX). To be very honest I am not sure what this serves to accomplish as from my understanding the company only manages two carparks in Hong Kong. Additionally, I noticed from the Hong Kong IPO that the company used the proceeds to purchase Singapore properties, so I'm not seeing the use of the HKD there. This is just something I find good to take note of. 

Pushing on, let's now discuss the stock from a valuation perspective.

I will be analysing LHN Limited's current stock price based on a few different perspectives, which would be comparing the overall valuation to peers, historic multiple valuations, and a Sum of The Parts (SOTP) analysis first to hopefully be able to derive an intrinsic value for the stock. 

I will first tackle the SOTP-based valuation for the company based on results for FY2022, excluding its logistics segment. I will then add the cash and further equivalents to the total price. 

Please take note I am unable to find the net profit for each segment and hence will be using the metric "Profit Before Taxation". Hence, I will try to adjust for this calculation by applying a 17% flat tax rate as per IRAS' policy. Do keep in mind that this would result in oversight with regard to things like tax reliefs/deductions and other corporate actions, but I would think that I am calculating the "worst case scenario" to give a margin of safety for the intrinsic value assessment.

Source: PassiveLoss

I will now explain the thought process behind my methodology in calculating the intrinsic value per share. Essentially, I adjusted earnings for the real estate segment of the business by using the figures I calculated beforehand where I added back things like depreciation and interest expense. Next, I found similar listed businesses to the corresponding segments and used the current relevant metric. For example, for the real estate segments I used the current Price/FFO for the corresponding peer company whereas I used the P/E ratio of the other segments.

To eliminate intersegment sales, I had to use the corporate figure provided in LHN Limited's annual reports and multiply it by the highest metric multiple I am using so that there is some allowance and hence gives some margin of safety to the calculation. Next, it can be argued that the peer companies I have used are big companies with solid track records, and hence command a higher premium. To take into account this fact, I have applied an arbitrary 30% discount to the figure. To be very honest, there is no solid basis on which I apply the 30% discount, I simply think it is a justified figure that provides some safety in terms of calculations. 

Lastly, I simply add the amount of liquid cash equivalents the company possesses to the total value of the company and then divide the entire figure by the total number of shares outstanding, which results in the figure of $1.38 being achieved. I must admit that this figure seems a bit inflated despite my efforts to try to manage it, which is why it would be useful to compare it to a historical valuation analysis and peer valuation analysis.

Source: Gurufocus

We can see that by all metrics available, LHN Limited is currently trading at a discount compared to its historic median. 

Source: PassiveLoss

If we were to use the following median ratios and multiply them by FY2022 results, we can derive the above values. To better visualise the impact of the LHN Logistics disposal, I have used the proforma NAV per unit to calculate the intrinsic value should we use the same median P/B. I have excluded P/CF and P/E calculations for the post-disposal column as that would result in the one-off transaction inflating the results.

Next, for peer-to-peer comparison with regards to multiples valuation, I must admit that it is actually rather hard to find a suitable company to evaluate with a similar business model.

The only company I could think of that would fit LHN Limited's profile is Centurion Corp, which is highly debatable given the fact that it is a company that deals with the worker dormitory business. Hence, I would take this method with a grain of salt, but will still include it for the sake of covering all grounds. 

Source: PassiveLoss

Surprisingly, the valuation is similar, albeit on a lower end. If you take the average of the above-calculated values, we get the IV of 56.5 cents, which seems rather grounded in reality. However, I believe that the IV of the company can be higher than this derived figure as the company has been highly proactive in capital recycling and shifting into more predictable, proven businesses. Consequently, multiples expansion may be a real possibility in the future. 

Overall, I'll be keeping the company on my watchlist. As a value investor, I like to give myself a margin of safety of 20%, which means in theory, my entry price would be anything equal or below to 45.2 cents. Personally, I'm fond of the company's active capital recycling and the fact that it has the largest market share of the co-living business in Singapore is something you won't find anywhere else in the SGX market. Nevertheless, after monitoring small-cap stocks in Singapore, I don't have a very high confidence in such companies maintaining a solid track record of stable earnings. Hence, if I do ever enter, it'll be as a punt. 

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The author is currently not vested in any equities discussed in the article. 

Disclaimer: Please take everything published within this blog with a pinch of salt. Nothing I say here should be misconstrued as any form of financial advice whatsoever. In fact, I am probably the absolute last person you should approach for any sort of advice. All self-computed figures are calculated to the best of my ability, but I cannot guarantee they are 100% accurate, and I am not liable for any investment decisions made based on my content. 

Thank you for reading my blog, and I hope you have learnt something, no matter how seemingly minuscule, ciao!