Abstract: after meeting with the management of Lujin Infrastructure, we see several positive factors: (1) the company has a clear plan for how to expand the highway business after the proposed break-up and fund-raising; (2) the management is confident that property sales will increase by 30% this year. On the other hand, assuming that venture capital invests about 50% of its shares by issuing new shares (at 1.5 times book value), the company's net debt-to-equity ratio will fall to just 13.8% from 67.8% at the end of 2016. Considering the dividend yield of 6%, the current market-to-book ratio of 0.63 times 2016 is still attractive. Management's goal is to maintain a dividend ratio of 40%. If the company announces the details of the split plan, it is expected to become a catalyst for share prices.
After raising funds, there is an opportunity to expand the highway business.
The highway business of Lujin Infrastructure in the mainland has been very mature. The company has two potential ways to expand: (1) to acquire highway projects to be completed in the mainland, and (2) to expand existing highways (two-lane to three-lane, three-lane to four-lane, etc.). New highways and widened existing highways can enjoy a discount of 25 years after they are put into use. The target internal rate of return for its highway business is 12%.
For overseas expansion, management is looking for opportunities in Kuala Lumpur, Malaysia to capture the opportunities brought about by the "Belt and Road Initiative" policy. The company's expertise in infrastructure and real estate development applies to these projects.
Target property sales to grow by 30% this year; adopt a low-inventory strategy to generate cash flow; infrastructure replenishes land mainly through acquisitions, as the prices of many auctions and bids are getting higher and lower, leading to narrowing profit margins. The company's target customers are those who want to upgrade their living environment. The company used to work with local governments to convert agricultural land into residential land, but now it is more inclined to buy it. The target internal rate of return for the company's real estate business is 15%.
In terms of policy risk, since most of the company's projects are in the suburbs, there is less pressure than developers who focus on the city center. The company adopts a low inventory strategy because it wants to generate cash flow from property sales to invest in new projects.
About 70% of the company's real estate development projects are located in the Yangtze River Delta region near the Shanghai-Nanjing Highway, and another 20% in the Bohai area. Property sales last year were 18 billion yuan; the company aims to grow 30 per cent this year.
With an increasing share of the Hong Kong real estate market, the Wong Chuk Hang project will become the flagship project of Lujin Infrastructure in the Hong Kong property market. As the company's chief architect is from Hong Kong, even if this is the company's first property development project in Hong Kong and has a joint venture with another Chinese company, the design, construction and delivery of the project will not be a problem. In addition, the company's major shareholder Huiji Group [610.HK; unrated] is a local contractor, so Lujin's relationship in the engineering industry may help the company manage construction budget and quality control.
The company is interested in conducting more bids and auctions in the future. The company will continue to adopt its usual strategy of real estate business in China, adopt a very cautious attitude in selecting locations, and try not to invest land in prime locations at extremely high prices.
Like many other Hong Kong property developers, Lujin Infrastructure is also interested in the forthcoming residential tender held by the Government, such as site 6567 at area 1K, Kai Tak, Kowloon (tender closing date and time: 12:00 on 12 May 2017).
Valuation
Lujin Infrastructure currently has a market capitalization of HK $8.35 billion. If we conservatively assume that the value of the venture at the time of the listing is equivalent to a price-to-book ratio of HK $9 billion, assuming that new shares account for 50 per cent of the issued share capital, this means that the value of the real estate business will be only HK $5.2 billion (assuming a 30 per cent discount for the split holding company), which is still well below the book value of the real estate business of HK $8.8 billion. The company achieved a 9.5% return on equity in 2016 and is expected to exceed 10% this year as property sales accelerate this year. For double-digit returns on equity, it is not a very aggressive goal for the property business to achieve a price-to-book ratio of 0.8 to 1. This represents a total value of about HK $10.2 billion to HK $11.95 billion (HK $3.15 billion from Ventures and HK $7.04 billion to HK $8.8 billion from the real estate business), representing a rise of 12% to 43%.
