LSB Industries, Future Bright and the Fed

I built a couple of models and read a bunch of books since the last post here. I usually try to take notes or write an immutable summary, otherwise I forget or remember things differently as time passes and prices move.

• LSB Industries (20/12/2016)
• Update on Future Bright (07/22/2017)
• On Federal reserve (08/01/2017)

Fly-be to the moon, let me play with stars

Flybe is a regional airline that operates mostly in UK. There are a number of publications about this airline, including this one that talks about Brexit.

Saad Hammad replaced Jim French as the CEO in August 2013. Saad brought better aircraft utilization, unit cost reductions, a sensible idea of what types of aircraft to fly and how to finance them. He improved revenue management, which is evidenced in greater load factors and yields. The airline is on course to profitability.

The competition on 80% of the routes is self-driving, trains and buses. Flying with Flybe is faster and often not more expensive. It is these routes that I call “core” in the table below. New non-core routes usually take 18-24 months to stop losing money.

Some routes are flown in Europe. The latest figure is 40%.

The share of business travelers on all routes is between 40% and 50%.

Given the aircraft committed for the near-term, the range of outcomes for 2017, or even a typical year, is:

	Low	Base	High
Seats, m	9.08	11.49	12.63
Load factor, %	64.13%	70.37%	73.94%
Passenger yield, GBP	68.62	69.43	70.13
Operating cost before fuel and rent, GBP	(38.40)	(33.53)	(33.09)
Aircraft rent per seat, GBP	(8.90)	(7.04)	(6.40)
Effective fuel expense per seat 2017, GBP	(6.74)	(6.74)	(6.74)
Aircraft utilisation, block hours per day	5.30	6.37	7.00
Core routes share	80.00%
Non-core routes RPS discount compared to network average	30.00%
Profit per core seat	(6.73)	5.21	9.53
Profit per non-core seat	(23.23)	(13.11)	(9.92)
Profit per seat, network	(7.92)	3.83	8.04
EBITDAR, network	47.86	163.77	221.38
FCF, network	(67.16)	25.57	71.66
FCF, core routes(incl. group costs and e195)	(33.56)	49.49	91.55
FCF, non-core routes	(33.59)	(23.93)	(19.89)
Value of core routes	(223.76)	329.96	610.30
Value of non-core routes,b.-even in 3 years	(50.91)	(36.26)	(30.14)
Value of business per share @ 15%	(1.27)	1.36	2.68
Value of business per share @ 10%	(1.79)	2.11	4.08

A number of things needs to go wrong at the same time for the “Low” scenario. This scenario approximates 2013.

“Base” scenario is the case of a moderate stress. “High” scenario is the case where the level of operations of 2015 and 2016 is sustained. Operating metrics for the Q1-Q2 FY2017 fell in between these two scenarios.

Flybe’s earnings are most sensitive to load factor, passenger yield, operating expenses and aircraft utilisation. They can be influenced by management to a significant degree. Most of the assumptions in “Low” are from the Jim French era.

It’s unlikely that the next couple of years are going to be close to “Low”, based on the number of things that need to go wrong at the same time and Saad’s performance so far. Should it happen, Flybe should be able to comfortably survive at least 2 “Low” years in a row.

Successful Flybe attracts competition. A major airline will have to decide between two alternatives: enter and compete with Flybe on short routes in small airports using a specific type of aircraft or take advantage of Flybe’s White Label or codeshare programs. The latter two are going to become more attractive, as Flybe takes on residual value risk in owning a higher proportion of its aircraft and reducing costs further.

The fuel expense is going to drop due to the $100-per-barrel era hedges finally expiring. If Flybe had to pass the savings to consumers due to price pressure from train, driving or airlines, then it would have been experiencing tremendous pressure on yields and load factors at the moment. That doesn't appear to be happening - both are close to 70. If the fuel savings need to be passed on, then the value becomes one fourth of the base case.

At least 0.30 GBP per share can be attributed to excess cash. The key risks are execution and macro events. I own FLYB shares.

Added October 7th:
I think Flybe earns 15m FCF in 2017. Its business is worth 1.49-2.38 (15%-10% cost of capital).
At 100m, market believes in no FCF improvement. But the profitability of the routes is set to improve with E195 jets going away in 2017-2019. In addition to that, new routes shall mature in 18-24 months.

It's worth .55-.68 as a UK-only airline with core routes only, 8m annual scheduled seats, charges for excess planes and with excess cash.

A brief summary of Future Bright (HK 0703)

Another investment which made sense to me is a Macau company called Future Bright. Again, I have to thank red's blog for discovering the name. 

Good

Future Bright historically delivered high ROIC thanks to its well positioned restaurants. Their square footage is going to increase significantly in the next 3-4 years and the level of sales should not be much worse than in the past. In addition, thanks to the prominent position of the company's food business and well connected CEO, it is highly probable that Future Bright will get some industrial catering business as the eight planned casinos are opening.

Cheap

The current market wide downturn is transitionary.

At 1.11 HKD, it traded below the value of the developing land that was just purchased, its reasonably re-evaluated premium real estate that the company rents out, and excess cash. By my calculations the company is worth no less than 2x that. If the industrial catering goes well, it is worth 4x that.

Keck Seng Investments Hong Kong Ltd - Hidden assets

I bought shares of Keck Seng Investments holding. It’s a simple idea that I was pointed to, for which I’m grateful. 

I would like to record the reasoning here and a minimum required set of conclusions. This time I didn’t want to use complicated spreadsheets, which distract me from what’s important -- understanding the business.

Keck Seng is a company which owns hotels, as well as other kinds of commercial and real-estate properties, across multiple countries. The countries where it is present are US, Canada, Japan, Vietnam, China, Singapore, and Macau.

There are already good write ups about Keck Seng on which I have relied:

• “Keck Seng Investments” on VIC
• “Keck Seng: 4-Star Real Estate Play Offers 5-Star Return With 149% Upside To NAV” [webarchive] on Seeking Alpha and its update [webarchive]

Its revenue is derived from the hotel operations, leasing out properties, and Macau club operations. The revenue is thus recurring to a significant degree and has been increasing as they continue to acquire more properties.

There are three parts to Keck Seng’s valuation: business earning power, net non-operating assets, and properties held for sale.

Unlevered FCFs attributable to equity (numbers are in HKD millions)

2 hotels, Vietnam	115.28
2 hotels, Canada	4.91
Holiday Inn, PRC	0
Best Western, Japan	13.31
2 hotels, US	204.35
	332.94
EV (3% growth)	4756.28
Debt	1819.79
= Equity	2936.49

Net non-operating assets mainly consist of cash:

Trading securities	9.51
Cash	1468.24
Taxation recoverable	10
Taxation payable	-22
Company’s debt	-39
	1426.75

Properties held for sale are apartments in the complex called Ocean Gardens, Macau. The management is holding off selling it until the Hong Kong - Zhuhai - Macau bridge is completed, which should increase the price of the apartments. It is due in 2016-2018.

Apartments have been carried on the books at their historical cost and are not revalued. According to the Statistics and Census Service of Macau the average price per sq. foot as of Q4 2014 has reached 8000 MOP. Assuming 12% tax rate, 5% transaction cost, accounting for only 70.61% owned subsidiary and discounting the future cash flow from 2017, the effective price per sq foot becomes 3687.43 HKD.

Keck Seng is going to sell at least 298026.03 sq ft in Macau. Based on these assumptions the value of this cash flow should be at least 1098.95 HKD.

Hotels	2936.49
Non-operating assets	1426.75
Properties held for sale	1098.95
	5462.19
per share	16.05

Keck Seng is also good about paying the dividends. On average it have been paying out 35% of the FCF. It currently trades at 1.8% yield, but there’s an expectation of a dividend raise priced in.

Value of equity @ various dividend yields

6%	1942.15
4%	2913.22
2%	5286.45

Current market capitalization is equal to the value of the two 100% owned hotels in San Francisco and New York: $90 mil USD for “W San Francisco” plus $265 mil USD for “Sofitel New York”. The former is across from the Moscone Center and was bought in 2009 at a likely depressed price. The latter is in Manhattan and was bought just 6 months ago. This provides margin of safety.

I have established a ~15% position and my average cost is 7.99.