In this post I will try to give the big picture of HONMA Golf, that is to say, an analysis of Corporate Governance and Corporate Finance and what this analysis would recommend to the management which could be sound arrogance, but this is a part of the analysis exercise, no more, no less.
It could be said that this post should have been posted before valuation, but I have two reasons why I didn’t it, the first one is that Corporate Finance is a tedious work and sometimes could distract from the main story of the company, and the second reason is simple: link stories and numbers are much more fun.
Let´s start...
Corporate Governance (Ownership & Board)
At March 30th, 2019, HONMA had 609.05 millions of outstanding shares and the significant investors in HONMA are:
- Kouun Holding Ltd (53.2%): Private holding controlled by the founder Mr. Jian Guo Liu, (Individual Large Hdg)
- Charoen Pokphand Group Company Ltd (15%): Thai private company controlled by “Chearavanont” family, (Individual Large Hdg)
- Itochu Corp (6.29%): Japanese public company trading in Tokyo Stock Exchange, (Individual Large Hdg)
- Fosun International Ltd (5.85%): Chinese public company trading in Shangai Stock Exchange and controlled by Mr. Guo Guangchang (Institutional Large Hdg)
These four major investors represent 80.2% of the company, leaving a free float of around 20% available to other holders (private investors, institutional investors and banks with less than 5% of the outstanding shares).
The firm has significant individual holdings and small institutional holding, therefore the marginal investor is “Kouunn Holding Ltd” controlled by Mr. Jian Guo Liu, and I will assume that “Kounn” is diversified.
The board is composed of the 8 members described as follow:
Some conclusions of the table above:
- Majority of directors are insiders
- President and Chairman are the same person
- Not all committees are entirely of outsiders
With all these conclusions above I can´t consider that the board of HONMA is effective in acting as a counterweight to a powerful Chairman/President, Mr Liu Jianguo. Consequently I would recommend to revert these 3 points.
Risk (Cost of equity, Cost of debt & Cost of capital)
As a risk free rate, I used the 10 year Japan government bond rate of -0.157% less Default Spread for Japan of 0.68%, resulting -0.84%.
The average global unlevered beta is 0.83 for Recreation business, as HONMA operates in only one business, I will take an unlevered beta for HONMA of 0.83. Taking into account debt/equity ratio -lease commitments adjustments- gives me the levered beta of 0.87.
To estimate the equity risk premium of HONMA, I looked at HONMA's revenues by regions and applied the equity risk premiums for each of these countries. This results in a weighted ERP for HONMA of 6.67%.
Based on the above risk free rate, beta and ERP, HONMA´s cost of equity in JPY is 4.99%.
The company provides with information about its pre-tax cost of debt between 0.33% and 0.51%, averaging 0.42%.
The market value of debt outstanding is Ұ4,986 million and the market value of equity is Ұ61,581 million.
Based on a cost of equity of 4.99% and a cost of debt of 0.42%, the cost of capital of HONMA is 4.64% and HONMA should only undertake investments that return at least 4.64%, the minimum acceptable hurdle rate.
Capital Structure
HONMA´s debt to capital ratio is 9.11%, lower than average global industry (23.12%) and probably underlevered.
All debt is short-term debt with maturity less than one year. The debt is mainly in USD (62%) and JPY (23%), the rest of debt (14%) is distributed in HKD, TWD, RMB and others. All HONMA debt has a floating rate between 0.33%-0.51%.
A certain level of debt for HONMA has the following advantages and disadvantages:
Optimal Capital Structure & Financing Changes
HONMA´s current debt-capital ratio is 9.19%.
Simulating across various debt-to-capital ratios, and taking to account changes in the levered beta, cost of equity, interest payments, interest coverage ratios, cost of equity, etc, the following is revealed:
Optimal debt-capital ratio (60.00%) is greater than current, and it seems that HONMA is underlevered.
Given its shareholder structure (Mr. Liu Guo hold 53.2% of common shares) and its market capitalization (over HK$4.2 billion), HONMA seems an unlikely target for a takeover.
An EVA to equity and EVA to capital positives (see previous post), could indicate that HONMA has good projects and I would recommend to the company, take additional suitable projects with returns above its hurdle rate, and finances them with additional debt.
I would advise HONMA to align the debt maturities with the durations of those projects (and the respective assets generating cash flows).
For all projects, I would assume lifecycles around 3 years, and thus recommend financing them with longer-term debt and with a mix of currencies related to the project costs and expected revenues.
The more uncertainty HONMA sees in the future and in its newly started projects, the more it should use floating-rate debt.
By raising its debt-to-capital ratio up to around 60%, HONMA could increase its firm value from Ұ52,475 million to Ұ53,053 million, and its stock price from Ұ99.43 to Ұ100.37 (+1%). By doing this, HONMA’s cost of capital would drop to 4.48%, really not too much. Thus I don´t see any significant reduction in the cost of capital to justify any increment on debt.
Dividend Policy
HONMA has returned Ұ6,874 million to stockholders in the last three fiscal years (analyzed from 2016/2017 to 2018/2019) having generated Ұ3,250 million of FCFE in that period.
The reduction of debt and the big increment in working capital in period 2016/2017 explain a negative FCFEE for that fiscal year and the reduction of the aggregate. There isn’t any indication that HONMA plans to stop its dividends, therefore the dividend policy in fiscal year 2016/2017 should not occur again.
