China Merchants Port: Selldown Post Tariff Cuts Overdone
Summary
- China Merchants Port is a leading port operator in China. It has presence in 8 of the top 10 container ports in China.
- The recent selldown is unjustified, given the fundamentally positive industry the company is in.
- There are also several share price catalysts, which could provide further upside to the conservative price target of HK$24.58.
Investment Highlights/The Opportunity
China Merchants Port Holdings Company Limited (OTCPK:CMHHY)(OTC:CMHHF) is a leading port operator in China. It has presence in 8 of the top 10 container ports in China. Its primary listing is on the Hong Kong Stock Exchange ("HKSE") under the ticker code 00144. I recommend interested readers to consider the shares listed on the HKSE due to the much higher liquidity. Its majority shareholder (74 percent ownership), the China Merchants Group, is a Chinese state-owned corporation which also has a majority stake in China Merchants Bank (OTCPK:CIHHF). At HK$18.32, it has a market capitalization of HK$60 billion (US$7.7 billion).
In 2017, China Merchants Port's combined total container throughput was 102.9 million TEUs, an increase of 5.5 percent over the prior year. Its ports in Hong Kong were the outperformers, with the throughput volume rising 12.4 percent year-on-year. It also handled a total bulk cargo volume of 505.8 million tonnes, up 10 percent from 2016.
(Source: Author's illustration using company data)
(Source: Author's illustration using company data)
Despite the healthy operating backdrop, the shares of China Merchants Port continued to trade at a depressed level. To make matters worse, a tariff-reduction announcement on February 1, 2018, by China's National Development and Reform Commission's ("NDRC") coupled with the broader market sell-off in early February sank its share price below HKD18, a multi-year low (see the historical price chart below). This selldown is unjustified given the fundamentally positive industry the company is in, and several share price catalysts around the corner. Nevertheless, the market correction provides investors to get into (or add to their positions) this government-backed blue-chip with a greater safety margin.
(Source: Yahoo Finance)
Apparent Over-reaction To The (Not So) Bad News
On February 1, 2018, China's NDRC cut the benchmark container handling tariff for import and export containers at ports in Guangzhou, Dalian, Yantian, and West Shenzhen (Shekou and Chiwan) by 20% to 33%. This follows the first round of tariff reduction by 11% to 21% on November 15, 2017, for non-transshipment import and export container handling for ports in Tianjin, Shanghai, Ningbo-Zhoushan, and Qingdao. Apart from Yantian, China Merchants Port has operations in all the affected locations. Hence, sentiment towards the company was negatively impacted.
However, market players have apparently over-reacted, sending the share price of China Merchants Port down sharply in early February. Ratings firm Moody's noted (paywall) that China Merchants Port has "already been charging discounted handling tariffs for the major shipping lines, and those tariffs are also broadly in line with the reduced benchmark". Hence, the expected impact to China Merchants Port might actually be rather limited.
Industry Tailwinds
Soon after Xi Jinping became the Chinese President, he has rallied the entire nation towards the Belt And Road Initiative (B&R, formerly known as One Belt, One Road Program) as part of his grand economic plan for the country. Recent reports that China is planning to scrap the two-term limit for the country's presidency bodes well for policy continuity. The Guardian suggested President Xi could stay in office "well into the 2030s".
The Belt And Road Initiative aims to connect about 80 countries across three continents to China, covering about two-thirds of the world's population. The countries involved represent one-third of the global GDP and around one-quarter of the total global trade in goods and services. PwC estimated that the Chinese government could "mobilize up to $1 trillion of outbound state financing" for the B&R over the next 10 years. HSBC forecasted that the B&R would generate trade exceeding $2.5 trillion annually. While it is understandably challenging to quantify the associated benefits to China Merchants Port and for the matter, China, it is only reasonable to assume the former would be a key beneficiary given its leading position among China's port operators.
(Source: Eurasia Review)
Share Price Catalysts
The Xi Jinping administration has been guiding for its State-Owned-Enterprises (SOEs) to streamline their operations and make an actual profit. Previously, the main goal of the SOEs was to ensure employment of the population. The Chinese authorities believe that the layers of management at SOEs should be slashed so that they can react faster to the changes in the market. We have seen the consolidation efforts in the coal/power industry, where last year, the giant coal producer, Shenhua Group, was merged with China Guodian Group, a big-five utility firm, to form the largest utility power company in the world.
The restructuring imperative is expected to spread to the logistics sector including ports. With China Merchants Port being the leading port operator and majorly owned by the state, the company is likely to be the main vehicle to reform the sector. In fact, the management of China Merchants Port has already indicated that they are anticipating the port authorities to introduce acquisition candidates for the company. The management also expressed interest in increasing its stakes in some of its existing minority holdings to extract greater economic interests from its entities. The consolidation would also reduce the competition, enabling the company to improve its negotiation power. With the valuation of the ports at depressed levels due to the tariff reductions in the backdrop, now is an opportune time for China Merchants Port to do M&As.
Since the latter part of last year, China Merchants Port has been working on the disposal of one of its holdings, Shenzhen Chiwan Wharf, back to its parent company. Good progress has been made thus far and the deal is near its final stages, with an EGM arranged on March 19, 2018, to obtain shareholders' approval. The firm will offload its 57.52% stake in Shenzhen Chiwan A-shares for RMB25.47/share and its 8.58% stake in Shenzhen Chiwan B-shares at
HK$13.35/share. At the stated prices, the A-shares are valued at 30.1 times LTM P/E while the B-shares are valued at 13.4 times LTM P/E. Both valuation multipliers are higher than China Merchants Port's 10.4 times 2018e P/E, signifying the hidden value among China Merchants Port's holdings. The successful completion of this deal and possibly others would further unlock shareholder value.
The gross and net amounts of the proceeds from the proposed disposal are HK$5,745 million and HK$4,893 million, respectively. The net proceeds represent around 8 percent of China Merchants Port's market cap. The company intends to use the entire sum of the proceeds on general working capital and to fund possible future investment opportunities in ports and port-related business. The company plans to do so either by the acquisition of existing ports and port-related business or by investing in new green-field projects.
Besides port operations, China Merchants Port has a land in Qianhai which is pending government approval for development. While such talks have surfaced as early as 2013, a positive progress on this front could boost the share price.
If the container volume achieves strong growth like in the past years possibly boosted by the Belt and Road Initiative, the profitability might be better than expected as volume growth offsets margin compression on the tariff cuts.
Price Target
China Merchants Port achieved an EPS of HK$1.756 for 2016, an increase of 13.3 percent over the prior year. I estimate a flat EPS growth for 2017, considering the volume increase offsetting the tariff pressure. This brings us to a P/E ratio of a mere 10.4 times, and a P/B of 0.8 times. This is substantially lower than the historical average of 17.7 times and 1.5 times. To be conservative, I assume another flat year for 2018 but a higher multiple of 14 times (mid-point between the current P/E ratio and the historical level) giving a price target at HK$24.58 (EPS HK$1.756*14), or an upside of 34 percent over the next one year. I expect the multiplier to expand from the current 10.4 times to 14 times once the market players realize the tariff cut impact would be insignificant to China Merchants Port for reasons elaborated in the earlier sections. The bearish market sentiment resulted in the P/E dropping to ~10 times. With the historical average PE at 17.7 times, it does not take a very bullish market to return the stock to a P/E of 14 times. Furthermore, over the next 12 months, the stock's favor with investors might return with any of the share price catalysts materializing.
The management guided for a stable dividend payout policy of 40-50 percent. Taking 40 percent as a conservative estimate, the shareholders of China Merchants Port are rewarded with a forward dividend yield of 3.8 percent.
Variant View
The Chinese government has pushed strongly its Belt-And-Road Initiative globally. Nevertheless, a slower than expected completion of logistics infrastructure in the targeted trade partner countries such as Sri Lanka and Pakistan could delay the anticipated improvement in trading volume and consequently the volume handled by the ports of China Merchants Port. In addition, political tensions or new trade barriers could disrupt trading between China and its trading partners.
While China Merchants Port has already been charging tariffs broadly in line with the reduced benchmark, some customers might make use of the anti-monopolistic slant of the government to push tariffs lower when the time for re-contract comes due.
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Analyst’s Disclosure: I am/we are long CMHHF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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