CK Hutchison: The Price Is Wrong

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About: CK Hutchison Holdings Limited (CKHUY), CKHUF
by: Bernard Keightley
Summary

Latest telco reorganization moves CK Hutchison a step closer to unlocking value of telecom assets.

Overall Hong Kong market weakness on political concerns has depressed valuations.

Sustainable 5% dividend yield for patient, long-term investors.

Share price catalysts include the resolution of political issues in Hong Kong and further corporate exercises.

CK Hutchison (OTCPK:CKHUF) (OTCPK:CKHUY) should be on the radar of investors as it is trading at attractive valuation multiples and a steep discount to its NAV. The company is ripe for the picking after recently announcing a reorganization of its telecom assets, separating the tower assets from the operating companies - this latest initiative could be a sign that value is set to be unlocked from this perennially undervalued conglomerate. With new chairman Victor Li, who took over from his father Li Ka-Shing last year, now in place and looking to stamp his mark on the conglomerate, having missed out in Canada and Australia last year, the organization could be set for a makeover - CK Hutchison's shares are now looking very compelling.

Telecom assets reorganization – signs of things to come?

The main talking point during the recent earnings call (webcast available here) was CKHUF’s reorganization of its telecom businesses. To recap, CKHUF formed CK Hutchison Group Telecom Holdings (CKHT) in July to consolidate its Europe and Hong Kong telecom operations. CKHT will form a tower company CK Hutchison Networks (CKHN) by year-end, which will hold the Group’s 28,500 tower sites across Europe (with the option to include a further 9,300 sites in Asia), making it the fourth-largest tower company in Europe.

Source: Company Data

The immediate impact of this restructuring is the lowering of its finance cost. A recent example of this was the refinancing of the $11 billion debts of Wind Tre which has resulted in interest savings of $110 million.

However, for investors, the most exciting aspect of the new structure should be the fact that it raises the flexibility for CKHUF to spin off the tower assets. During the earnings call, CKHUF highlighted the valuation of tower assets in selected transactions across Europe. Based on the range of $200k-$400k per site given by the company, the tower assets would fetch $5-$11 billion, or $1.20-$2.80 per CKHUF share.

In my view, a value unlocking exercise by CKHUF would the single biggest catalyst for the stock. Much has been said about its conglomerate structure, and the issues that comes with it. The subsidiaries of CKHUF are all professionally and independently managed, but the market is not rewarding this fact because of its conglomerate structure.

Spinning off the tower company would send a clear message to investors that CKHUF is ready to operate in a more efficient structure and will go a long way towards closing the discount to NAV. It would also give Victor Li, the Chairman who took over from his father Li Ka-Shing last year, a chance to stamp his mark on the company.

Attractive and sustainable dividends

Admittedly, narrowing the NAV discount, much like a restructuring exercise, will be a gradual process and take time to materialise. Fortunately, shareholders of CKHUF will be paid for their patience. CK Hutchison has consistently paid dividends to its shareholders, and at current price, that distribution equals to almost 5% dividend yield. This is higher than most of its conglomerate peers in Hong Kong.

It is also sustainable. The company generates healthy operating cash flow each year, approximately $8 billion, which is utilized to service its loans and pay dividends. Current leverage ratio of 2.1x is reasonable and below management’s target of 2.5x. Cash on the balance sheet amounted to $18 billion, providing more cushion to the dividend payout. Given the low yield environment that investors are currently facing, a stock which is paying close to 5% sustainable yield looks very attractive.

Source: Company Data

Hong Kong selloff creates an opportunity to Buy

Much like other stocks traded on the Hong Kong market, CK Hutchison has been affected by the unrest on the city’s streets over the extradition bill. Hang Seng Index has lost more than 5% since the protests escalated on June 12th. CKHUF has performed even worse, declining 12.4% during the same period.

Source: Bloomberg

This is despite the company generating only 3% and 1% of its EBITDA and EBIT from Hong Kong, respectively. Therefore, management sees limited impact from deterioration in HK’s operating environment amid current turbulence on the streets.

However, when macro events such as these occur, investors tend to take risk off the table and wait on the fringes. Which is why I believe that once the dust has settled on the political issues surrounding Hong Kong, investors will return and halt the weakness in share price. Contrarian investors should take the current weakness as an opportunity to buy the shares at a cheap price.

Conclusion

A sum-of-the-parts calculation (see table below) values CKHUF at $16.00 per share. Currently, the shares are trading at a 45% discount to fair value. This discount should gradually narrow as CKHUF announces more value unlocking exercise.

CKHUF NAV Estimate

NAV (US$ mn)

NAV/Share(US$/share)

% of NAV

Hutchison Telecommunications Hong Kong Holdings Limited (HTHKH)

670

0.17

1.1%

3G Europe

22,379

5.80

36.3%

Hutchinson Australia

942

0.24

1.5%

Hutchinson Asia

3,846

1.00

6.2%

Telecom subtotal

27,837

7.22

45.1%

Hutchison Port Holdings

(HPHT)

565

0.15

0.9%

Rest of the World

11,727

3.04

19.0%

Ports subtotal

12,292

3.19

19.9%

Retail subtotal

20,272

5.26

32.9%

CK Infrastructure Holdings Limited (CKI)

15,159

3.93

24.6%

Husky Energy

3,147

0.82

5.1%

Other projects

831

0.22

1.3%

Energy & Infrastructure subtotal

19,138

4.96

31.0%

Adjusted net debt

(17,835)

(4.62)

-28.9%

NAV

61,703

16.00

100.0%

Source: Own Research

In my view, the reorganization of telecom assets is just the first step of many that the company can take to streamline its businesses. Recent weakness in the share price, attributable to the general market decline in Hong Kong due to political news, should be seen as a buying opportunity. Investors will also receive sustainable dividends whilst waiting for the NAV discount to narrow, which at the current price, is approaching a 5% dividend yield.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.