Great Company – The Link REIT (SEHK:823)

**I’ve changed my stance on The Link REIT since October 2nd 2014. You can read the reasons why by clicking here

Why I think The Link REIT is a “Great Company”

Benchmarked against these filters:

Favorable Long Term Economics & “Recession Proof” Company Products / Services: Control of majority of retail space and car park space situated strategically near dense residential areas covered by MTR stations that most ordinary Hong Kong folk can’t live without – 153 medium to lower tier shopping centres amounting to ~11 million square feet of retail space and ~80,000 car park spaces (as of August 8th 2014)

Able and Trustworthy Management: REIT structure that legally restricts The Link REIT from deviating from focusing on income-generating properties. Such strict monitoring enforces predictable and legal management behavior

“A business that any idiot can run” if the company can’t attract/retain great talent: It’s a simple system (buy medium to lower tier shopping centres / car park spaces -> renovate -> collect rent -> repeat) that must be screwed up really badly by idiots in order for it to die

What would cause The Link REIT to fall from “Great Company” status?

1. If The Link REIT sells its property

In the world of Investment Properties (“property (land and/or buildings) held to earn rentals or for capital appreciation (or both)“), if your main mode of income is rental income, your competitive advantage is measured upon how many strategic locations you can own and subsequently earn rent upon.

The only way you can get dislodged legally by competition is if your strategic locations aren’t strategic anymore (very rare, think of your city’s CBD district and see how frequently it changes places), or most importantly, if you decide to sell your strategic locations and risk never getting a chance to get back into those strategic locations. Property owners are legally allowed to not sell its property regardless of how ludicrously high the offer’s value is.

2. If The Link REIT loses its REIT status AND starts diversification away from core operations (eg. Investment Properties)

A simple definition but not entirely accurate definition of what a REIT is legally allowed to do is it can only take part in operations that focuses on income-generating properties. The legal structure forces The Link REIT to run it’s simple, boring but very effective system of “buy medium to lower tier shopping centres / car park spaces -> renovate -> collect rent -> repeat”.

If it loses its REIT status, it gives freedom to management to do basically whatever it deems is in the best interests of the company, which may end up not being the case if it starts diversifying into more sexy businesses that doesn’t increase its competitive advantage as time passes by and/or doesn’t as effectively generate returns for shareholders as boring alternatives (eg. think cyclical businesses like Hotels or Property Development).

I vastly prefer effective systems with sexy shareholder returns than sexy systems with ineffective shareholder returns.

I also purposefully stay away from Hotels, Property Developers or high-tier Investment Property companies because their businesses are highly affected based on the busts and booms of economic cycles and might possibly die during one of the busts. I’d only buy them for short term capital appreciation if there’s no great companies left to buy at discounted prices.

If The Link REIT thus strives to become or enter the fields of Hotels, Property Development and/or high-tier Investment Properties, they become a company that I purposefully wanted to stay away from in the first place.

What’s a “Great Company”?

Warren Buffett describes great companies as those that will “dominate their fields worldwide for an investment lifetime. Indeed their dominance will probably strengthen (over an investment lifetime)” in his 1996 Berkshire Hathaway’s Chairman’s Letter, companies that are worth owning for a full investment lifetime until the qualities that made the company an “Inevitable” deteriorates beyond repair. Of course, I don’t think an “Inevitable” has to dominate globally if all or a majority of its operations can be insurmountable locally (eg. Wells Fargo as of August 8th 2014).

It’s very easy to identify “Great Companies”, but rare to find “Great Companies” at discounted price.

The implications of both statements is that if you find a “Great Company” selling at discounted prices, get in as aggressively as possible because it will get priced way over-valued soon since most people can identify “Great Company” but can’t measure the intrinsic value properly.

An example would be Amazon (as of August 8th 2014), which only gets better and better at predicting what to cross-sell and up-sell with every further purchase done on Amazon which feeds data to its algorithms; everyone can see how it’s a great company that’s really hard to kill. However, it’s P/E ratio of 829.94 (as of August 8th 2014) means that if Amazon can 100% efficiently convert its earnings into book value and/or dividends and that earnings stayed the same forever, it would take 829.94 years for Amazon’s stock to repay its shareholders.

*Disclosure* I own stocks in The Link REIT (as of August 8th 2014)

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