Here’s Why I’d Avoid MTR Shares

In Hong Kong, the sole subway train operator MTR Corporation Limited (SEHK: 66) runs a world-class transport system. The firm is also a constituent stock of Hong Kong’s Hang Seng Index.

Traditionally, MTR has been perceived by investors as an infrastructure and rail stock. However, historically, it has actually made most of its profits from property development and rental revenues.

Herein lies a major problem I have with it. If investors are looking to buy shares of MTR based on its reliability and profitability as a rail operator, then it’s a misleading investment thesis.

I believe it’s actually more plausible to say it’s a real estate company.

As my Foolish colleague Lorretta wrote, its “rail + property development” model has been highly successful. However, I disagree that this means MTR will be resilient over the longer term.

Here’s why I think long-term investors should be avoiding MTR shares.

Too dependent on property

Clearly, for many companies, Hong Kong property has been a lucrative business to have been a part of over the past decade. MTR is no exception.

However, now that the tide has turned and Covid-19 and ongoing political protests have hammered sentiment, is the long-term outlook so rosy? I don’t believe so and it’s here where MTR has a big weakness.

For 2019, the company’s net profit fell 25.5% year-on-year to HK$11.93 billion. Nearly half of this reduced profit number came from property development.

Fall in visible earnings

Property development is notorious for delivering “lumpy” revenues and profits so any given year of profit doesn’t represent sustainable and long-term growth (at least for property firms in Hong Kong).

What I found more interesting for MTR was that in 2019 its recurrent profit fell an astounding 44.8% year-on-year to HK$4.98 billion.

These recurring profits are a better measure of a company’s sustainability. The visibility of earnings, such as recurring revenues and profits, in a time of uncertainty (such as now) is crucial. It’s clear that MTR doesn’t have this.

Political risk

What’s more, whether investors like it or not, MTR has now become a political hot potato. Given it was a target of protestors’ anger last year, even if Covid-19 subsides, there’s no guarantee that political unrest won’t disrupt its network again.

In fact, in its 2019 results, MTR management stated that the impact of the protests on the company amounted to HK$2.3 billion.

These losses arose from reduced passenger numbers and rent cuts as well as the HK$600 million that was required on repairing damaged stations.

Longer term, I think this structural hindrance will weigh on MTR. Given the government is the majority shareholder of the firm, and considering how widely disliked the local government is, it will always be susceptible to being targeted politically.

Avoid for the long term

A lot of the factors I’ve mentioned above cannot, unfortunately, be easily mitigated or controlled by MTR management.

Rental rates and property in the city will no doubt take a hit in 2020 from Covid-19 and the volatile political impasse. Furthermore, there’s no guarantee that the city’s property market will see a V-shaped recovery.

For all these reasons, I strongly believe investors should be aware of the risks attached to MTR before deciding to put their money into its shares.