Disclosure: Roland owns shares of Millennium & Copthorne Hotels and Hargreaves Services.
In this post I’m going to look at one of two new stocks I’ve recently added to my value portfolio. A second post will follow, covering the second addition.
Buying stocks which trade at big discounts to their tangible net asset value is often riskier than Ben Graham devotees (of whom I am one) would have you believe.
Although it’s worked out well for me with Hargreaves Services, the liquid and heavily-analysed nature of modern markets means that mid-cap or larger stocks rarely trade at big discounts without good reason.
Notwithstanding this risk, I’ve recently added FTSE 250 hotel group Millennium & Copthorne Hotels (LON:MLC) to my portfolio. This luxury hotel group was founded as CDL Hotels International in 1989, as a subsidiary of the Singapore-based Hong Leong group.
Today, MLC is controlled by City Developments Ltd (SES:C09), a Singapore-based property group with a market cap of £5.4bn.
I think it’s fair to say that the whole enterprise is essentially a family business: both MLC and City Developments were founded by members of the Kwek family, which runs the Singapore-based Hong Leong group.
The opportunity on which I’ve based my purchase is that at 450p, Millennium & Copthorne currently trades at a 54% discount to its tangible book value of 989p per share. That’s despite having a strong balance sheet and an improving outlook.
MLC’s shares have historically traded at a discount of around 20% to book value (e.g. in 2015, book value was c.700p and the share price was about 580p). This suggests to me that the current discount is exceptional and should narrow as and when the firm’s profits recover. My calculations suggest that a return to a 20% discount to NAV would imply 50% upside from a share price of 450p.
Although trading has been disappointing over the last year, I don’t see this as a reason to write down the value of a large portfolio of upmarket hotels in prime city locations across the world.
In the short term, the current valuation doesn’t seem excessive. I’m also reassured by the group’s low level of gearing:
- 2017 forecast yield of 1.8%
- 2017 forecast P/E of 15.7
- Net debt of £710m, versus fixed assets of £4.3bn.
One other point in favour is that analysts’ forecasts have recently been upgraded for both 2017 and 2018. This graph from Stockopedia shows the recent improvement in City sentiment:
What could go wrong?
As far as I can see, there are four main risks:
1. A bid is unlikely: MLC’s majority-owned structure means that a bid from an external buyer is very unlikely. In last year’s third-quarter update, management reiterated its commitment to a long-term ownership strategy: “The Group has a long term perspective and considers asset ownership as key to its strategy.”
2. No shortcuts: This commitment to asset ownership also means that MLC is unlikely to turbocharge its returns in the way that its FTSE 100 peer InterContinental Hotels has done. InterContinental’s franchise/management model makes it hugely profitable, but net fixed assets have shrunk from £2.2bn in 2012 to just £857m at the end of 2016.
My reading of MLC’s Asian owners is that they are shrewd and share my view that over the long term, the value of prime real estate in major cities is only ever likely to rise. They won’t exchange this advantage for shorter-term profits.
3. Valued by yield, not assets: Points 1 and 2 could mean that the market only values MLC by its dividend yield. As this is already low, at about 1.8%, the shares could stagnate until the company lifts the payout.
4. Not very profitable? MLC’s business will continue to struggle in an indifferent global market. In my view, this is a short-term risk that’s unlikely to be a longer-term problem. Improved management, currency shifts and other cyclical factors should mean that profits reflect the quality of the assets.
Points one through four are all valid risks that could limit the profitability of my investment. But in my view, none of them imply any particular downside risk. Even if the shares don’t go up, the risk of a long-term decline seems low to me.
On that basis I’ve added Millennium & Copthorne Hotels to my portfolio. I see this as a safe long-term buy with decent upside potential from asset backing and improvements to profits.
Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.