7 insights from our visit to United Overseas

When a foreign company is listed on the ASX, it invariably raises a few question marks: Why are they listed here? Will the government remain friendly? Can we trust management? Does the business even exist? These questions become even more pertinent in emerging markets like Malaysia.

They're also questions that are difficult to answer from an annual report. So most investors simply don't bother; answering the questions takes time, and it's not clear if you'll be rewarded for it. But for these reasons, those that do seek answers may be rewarded.

So it was that we recently found ourselves in Kuala Lumpur to attend the annual meeting of United Overseas Australia (UOS). We added the company to our Buy list last September and you can read why in our initial review. In summary, over 30 years, CS Kong and Jimmy Kong - no relation - have turned $2m into a property empire worth around $1bn. They've grown shareholder wealth at more than 20% a year - and they've done it without taking on debt.

We wanted to understand more about how they did it and to clear away some of those nagging concerns; and the only way to do that was to head over to Kuala Lumpur (or that's what I told the boss in any case).

Over the course of my holiday business trip, I visited a number of the company's ongoing developments and sales offices, attended annual general meetings of UOS and its subsidiary United Overseas Development (UOA) and spoke with the founders and several members of the management team. Here's what I learned.

#1: Asian growth is key

It was always a thorn in the side of our investment case: how does a property developer - a business not typically known for sustainable competitive advantages - generate such handsome returns?

The Kongs are clearly one reason, but another is the Asian growth story. Well located property tends to do well over time, but especially so when the economy is booming. Real economic growth in Malaysia has averaged 5.4% a year since 1987 - a period including the Asian financial crisis. United Overseas has no doubt been a beneficiary.

We're no experts, but greater Kuala Lumpur's burgeoning population, the country's proximity to China, its developed infrastructure and the business-friendly environment (The 'Ease of Doing Business Index' ranked Malaysia 15th globally - above Australia) appear to be supportive of this trend. If the next thirty years are as strong as the last, UOS should do well.

#2: Changing political environment is a curveball

The ousting of Najib Razak following the infamous 1MDB saga means there's a new regime in Malaysia under Mahathir Bin Mohamad. It's important, because the government is often heavily involved with large-scale property developments - through approvals for projects, as well as the development of surrounding infrastructure like train stations.

It's not yet clear how the change might affect the company. Management was generally welcoming of the change, but told us that there had been a clear slowdown in approvals. Whereas development had previously been haphazard, the new government appears to be taking a more systematic approach.

As for the practical implications, the approvals process is only forward-looking, so it doesn't affect the company's current project pipeline. CS and PL (or Jimmy) Kong have also had experience with a Mahathir government, as he was also prime minister from 1981 to 2003. And the additional red tape could make life more difficult for smaller players.

On the other hand, a recent stoush with the tax office is notable for its timing - so it's still too early to foresee if the change will be for the better.

#3: Glut in KL, but opportunities abroad

It's clear there's a glut of residential and commercial property in Kuala Lumpur. CS Kong told attendees at the AGM that he believes it could take eight years to work through it. Prices for condominiums have fallen, eating into United Overseas' gross margins. And smaller players that are unable to pay land taxes or develop are struggling.

Given the oversupply, the Kongs haven't bought any land in the Klang Valley - as Greater Kuala Lumpur is known - for some time. And the company's avoidance of debt means it's able to ride out a weak period.

But they are taking the opportunity to increase their presence elsewhere. An ASX listing gives the company some clout to open doors in new lands. They've recently taken to Vietnam, most recently with the purchase of a $33m block of land. They'll develop a 30 storey office tower there, and the opportunity looks particularly interesting because there's a shortage of A-grade office space in the country.

The Kongs are also familiar with the Australian market. They studied in Perth before starting UOS and Jimmy Kong's son lives here. The company has developments in Leederville and East Perth well under way - and they appear to be doing well, with the purchases made during recent market troughs at opportunistic prices.

There are others, too, but Kuala Lumpur will remain the company's base, so property prices there remain key. The good news for shareholders is that the Kongs have plenty of cash to take advantage of market weakness. In their own words, they tend to 'look for overbuilding, then wait for opportunities to pop up' - so market oversupply is today's curse but tomorrow's blessing.

#4: A contrarian investment philosophy

We also quizzed the two on their investment philosophy. In a nutshell, CS Kong explained that they 'find areas where prices become depressed and conditions look ugly'. They're looking for niches - areas that are unloved, underexplored or ignored.

The best example of this is the flagship development Bangsar South, where the company has developed a miniature city. Jimmy convinced CS to purchase the land - 75 acres, 15 minutes from the CBD - for under $30m fifteen years ago. At the time, it was an unloved squatter colony. But the pair saw potential and got to work developing office space, hotels, apartments and key infrastructure. Today, because of the amenities they've created, the suburb is thriving. That same land - excluding the buildings - is probably worth more than $400m today.

#5: Concerns remain over succession

So we think management has a sound philosophy, and the thirty-year track record supports that. At the meetings, they appeared sharp, bright and in good health. But their shares will end up in the hands of their children at some stage. So what happens then?

To better understand the succession planning, we spoke to a number of lower level management. We didn't get any clear answers, other than that the senior positions would likely be filled by internal appointments - but not necessarily by one of the family. It was interesting how long many of the people we spoke to had been with the company - hearing that somebody had been with the company for ten years was the norm.

Every year, the company celebrates long-tenured employees, and invariably there are a list of 10, 15 and 25-year employees that collect awards - so there's plenty of talent to choose from.

Still, in Thinking Fast and Slow, Daniel Kahneman explains that it's uncommon for very tall fathers to have even taller sons. That is, outliers are less likely to be followed by even greater outliers. It's also known as reversion to the mean.

We think that applies here. In terms of capital allocation, the Kongs are clearly outliers, so it's unlikely their successor(s) will be as good. A change in management would prompt us to revisit the investment case.

#6: Reported NTA understated

That's a problem for the future, and perhaps the far future. At present, though, the company appears firmly undervalued. It trades at just 67% of net tangible assets, and our trip suggested that the undervaluation is more widespread than we thought.

A huge number of properties are accounted for as inventory, despite the fact that UOS's commercial inventory is already 70% tenanted. With plenty of completed and tenanted property carried at its original cost - we're confident the numbers underestimate the true value of these assets.

#7: Not deserving of the 'speculative' tag

Ordinarily, a Malaysian property developer qualifies as a speculative prospect. We no longer feel that's the case with UOS for three reasons.

The first is that Malaysia offers a key advantage over developments in Australia. Unlike in Australia, where a purchaser can walk away from a 10% deposit, purchasers in Malaysia must chip in at each stage of completion. They have a lot more skin in the game earlier on.

The second is that the company refuses to take on debt, which will likely remain the case as long as the current board is in place. Chairman Alan Winduss explained that they 'like to sleep well'.

The third, of course, is the high level of insider ownership. If something goes wrong, at least they'll be hurting more than we are.

The company's assets remain exposed to political risk, as well as property prices and economic conditions. But after meeting the Kongs, visiting a number of sites and getting a greater understanding of the business, we're happy to remove the speculative tag. We're also increasing our price guide a little.

We do, however, note the very low liquidity, and strongly encourage members to use limit orders to avoid chasing the price higher. Read here for a practical guide. BUY.

Disclosure: The author owns shares in UOS.

Note: Our Model Growth and Model Income portfolios own shares in UOS.