John Keells Holdings (JKH), the largest in market capitalization at the Colombo bourse completed a cash call of LKR 23.1 bn and would be raising a further LKR16.7 bn via two subsequent warrants in FY16 and FY17. The fresh equity would finance c. 37% of the total project cost of the integrated resort (IR) costing c. USD820 mn. The balance would be funded through retained equity, property and debt including a USD300 mn syndicated loan drawn down in tranches over a 3 year time horizon. The IR project which is under construction would be completed in 2 phases and once fully operational in FY22e, would be a game changer accounting for c.65% of the company's PPE with a target annual ROE of 30%.
With the company having secured the total funding for the fresh property project the risk of completion has been negated. Monies raised through additional equity is safely in the company coffers generating around LKR1.5 bn in annual interest income, the syndicated loan would be drawn down in USD100 mn tranches to finance the initial 30 months of construction cost while internal cash pile would facilitate the completion of the project. In FY15 and FY16 the company would take the form of a money man and generate c.LKR2.5 bn in annual interest income which would contribute around 20% to consolidated earnings and maintain the group profitability.
Currently assets of the company are deployed in Leisure (30%), Financial Services (20%), Property (18%), Transportation (11%), Consumer (7%) and Other (11%) sectors, while the hospitality sector provides 54% of the consolidated EBIT. With the IR project coming online in 5 years, the company would transform itself to a large scale property player while we believe divesting other sectors other than Leisure might be strategies which could be considered to boost shareholder returns and the track record of the company also doesn't suggest otherwise.
Having associate stakes in a container terminal and Nations Trust Bank PLC while owning strong consumer products and brands the company could unlock significant value by way of timely divestiture and focus on the key sector. Such a strategy could easily drive up the ROE's from the c.9.5% levels to near 25% levels on a recurrent basis beyond FY22.
The currently dominating Leisure sector would see its EBIT grow near 9% YoY to LKR5.9 bn in FY15e and c.7% YoY to LKR6.3 bn in FY16e whilst the Property sector would witness EBIT of LKR1.2 bn each in FY15e and FY16e owing to revenue streams generated through FY15e-FY17e by way of its currently ongoing condominium projects, 475 unit mid-level 'OnThree20' and 65 unit premium level 'Seventh Sense'.
While revisiting our forecasts which included interest costs to be incurred by the Waterfront Project, considering company strategies where JKH would receive approvals from relevant authorities and tax bodies to capitalize its interest payments until the commencement of operations in Waterfront in FY19e, we revise up our forecast FY15e and FY16e profit figures as discussed in previous reports. Therefore we expect recurring net profit for FY15e at LKR12,968.1 mn (up 14.4% YoY on a recurrent basis) and forecast FY16e recurring earnings at LKR14,397.7 mn (up 11.0% YoY on a recurrent basis). The stock trades on 17.9x forecast FY15e recurrent net profit (vs. the broad market earnings multiple of 11.0x) and 16.9x estimated FY16e recurrent net profit. Given the headwinds seen by the company to grow its earnings in the coming 12-18 months we maintain Neutral in the short term whilst taking into account the integrated resort which would dramatically change the outlook for the group in the medium to long term, we maintain overweight for the next 3-5 years.
The operations of the property arm consist of the two apartment projects, OnThree20 and Seventh Sense together with renting of K-Zone mall space and the integrated resort which is under construction. OnThree20, a 475 unit project has been 90% pre-sold and is due to be completed in 4QFY15 (early 2015) whilst Seventh Sense, a luxury high end 65 unit project which is 70% pre-sold is due to be completed in 1QFY16.
JKH being a key property developer and outright seller has now come to the forefront to develop its valuable prime land bank to build up a highly valued accretive property company. The group has identified the capacity constraints in the capital city and is constructing an integrated resort to be a fully fledged landmark developer. Upon embarking on this, group would strengthen its position as the number 1 property company developing, selling, managing and operating the said property.
The sector has seen a revenue CAGR of c.26%, FY10-FY14 on the back of income from various successful property projects done such as Emperor and Monarch. Meanwhile we expect a negative revenue CAGR of c.1.9%, FY14-FY16E due to the reduction of revenue streams arising from the completion and handing over of the current ongoing projects, OnThree20 and Seventh Sense. Further the sector has been yielding high levels of EBIT margins (20% in FY14) and ROCEs although in FY14 due to the capital infusion into the sector a low ROCE of 3.5% was seen (vs 8% ROCE for FY13).
The sector has witnessed growth in the past years due to the lesser competition seen and the company brand name. However presently and going forward, a glut can be seen in the residential market due to the increase in supply, although the premium and luxury segments remain somewhat unaffected. Despite these challenges, JKH has been able to pre-sell both its current projects successfully.
Waterfront Integrated Resort Project
With steps undertaken to monetize the idling land bank, the project would generate large cash flows in the future given the scale of the project. Thus the property arm of the group would see higher levels of ROEs generated in the long term. The group's c.10 acre prime land block at its previous headquarters in the heart of Colombo would be developed as a large mixed development complex, where construction began in May 2014. The majority of land, 7 acres is jointly owned by its subsidiaries, Ceylon Cold Stores (CCS : LKR155.00), John Keells PLC (JKL : LKR74.50), John Keells Properties and the project company, Waterfront Properties whilst the remaining 3 acres have been leased out (99 years) from the government. Thus JKH would have effective ownership of 96.7% in the project.
The integrated resort which would be constructed at USD820 mn in total would be completed in 2 phases over 5-8 years. The total built up area would be in total of 4.5 mn sqft and would consist of,
Phase I (USD650 mn)
• Approx. 800 room five star luxury hotel
• Convention Centre to cater closer to 2,500 guests at a given time
• Circa 400,000 sqft Shopping Mall with rentable area of 250,000 sqft
• Approx. 150,000 sqft Entertainment and Gaming facility situated with access to both hotel and retail area
• Residential Tower I which will house approx. 240 luxury condominiums
• A car park facility with near 2,500 slots
Phase II (c.USD170 mn)
• Residential Tower II which will house approx. 200 serviced or residential apartment units
• Office complex with an area of approx. 400,000 sqft
The project has been promised various tax reliefs under the Strategic Development Projects Act including,
- Profits earned by the projects would be tax exempt for a period of 10 years. The tax exempt period would commence in the first year in which the project company makes a profit or 3 years after commencement of commercial operations.
- Immediately following this period, for a further 15 years for Waterfront Properties and Queensbury and 12 years for Crown Project, the project company would be taxed at 6% or 50% of the prevailing tax rate of the tourism sector (whichever is the lowest).
- Dividends distributed to shareholders to be tax exempt for a period of 10 years.
- Withholding tax on interest paid on foreign loans and debt obtained for capital expenditure and on technical fees to be tax exempt.
- During the construction period, VAT on imported and locally purchased goods and services of the project, PAYE tax for foreign employees, customs duty and port and airport development levy on project related items and construction industry guarantee fund levy to be tax exempted.
Project valuations
Based on estimations, we have forecasted earnings for the IR considering cash inflows as EBIT generated from the project from FY16E onwards till FY29E taking into account 7 years of construction (both phases) and 12 years of operations (FY19E to FY30E).
In the first year of operations of phase I, we expect an EBIT margin of c.30% in FY19E for revenues generated from the 800 hotel rooms at an year round ARR of USD200 and expected occupancy level of 65%. The retail space is considered on an expected unit rent of LKR1,276 per sqft for 250,000 sqft and a 50% occupancy level for FY19E.
Further we assume pre-selling of 40 residential apartment units in phase I would take place from FY16E-FY19E at a selling price of USD250 per sqft for each 1,200 sqft sized apartment. The 200 serviced apartment units of phase I is assumed to generate a daily rental of USD150 and 60% occupancy in FY19E.
The most lucrative business in the IR being the casino space would be a rental model at a rental of LKR2,552 per sqft in FY19E. No earnings are assumed for the gaming facility on a Gross Gaming Revenue basis.
Thus the Waterfront project is valued as generating LKR28.50 per share on a discounted cash flow valuation for post warrant shareholders given the assumptions considered in the calculation. It is expected to witness high levels of success similar to international projects such as Marina Bay Sands, Singapore and Resorts World Genting, Malaysia which enjoys high EBITDA margins of +35%. Meanwhile the Waterfront casino facility when completed would match the size of the Singaporean properties (150,000 Sqft) thus largely attracting the Indian sub-continent and other tourists from the region. Given that the three proposed casino projects kick off in the country, by 2020E tourist arrivals to Sri Lanka could be boosted up by around 40% whilst earnings also could be increased by c.50% from the current level of USD1,375 per tourist recorded in 2013 (vs USD1,038 in 2012). Thus JKH which has become the first mover in this new segment would see itself becoming the dominator in the city hotel segment as the large conglomerate has finally grabbed the opportunity to uncover its valuable land bank. Hence we believe that possible floating of the Waterfront project could be expected in the long term.
(Softlogic Stockbrokers' Equity Research)
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