CK Hutchison: Superman Comes Super Cheap

Summary

• CK Hutchison is a solid collection of businesses, curated by one of the world's greatest investors, available at a spectacular price.
• The stock is pound-the-table cheap at 5x recurring earnings.
• Ongoing value extraction from the portfolio, and the potential for significant acceleration in capital returns, provide catalysts for extracting value.
• CK Hutchison is one of the best risk/return trades in the market, with downside covered and potential to trade 2-3x higher.

A legendary investor, this self-made nonagenarian is one of the richest men in the world yet famous for his frugalness. His track record of value creation spans decades, but his conglomerate – and life’s work – trades at near record low valuations as investors lust after hyped-up technology ‘memestonks’ and turn their nose at his collection of old world stable cash flow generators.

Guess who? If you guessed Warren and Berkshire (NYSE:BRK.B), you’re not wrong. But I want to introduce you to Li Ka-Shing and CK Hutchison (PINK:OTCPK:CKHUY).

Simply put, CK Hutchison is a collection of good (but not great) assets at an absolutely stonking pound-the-table cheap price of 5x recurring earnings and 0.45x book value. Your downside is well protected by a collection of relatively defensive cash cow assets and an absolute bargain basement valuation. Your upside comes from ongoing value harvesting across the portfolio, a potential acceleration of capital returns and the potential for a valuation re-rating, and you could double or triple your money. In my view, it’s one of the best risk/return trades in the market.

Why now? CK Hutchison has recently agreed to dispose its cellular tower assets in Europe, whereby it will receive proceeds of around US$11.5bn versus its US$27bn market cap. The company has been modestly increasing capital returns of late, and this inflow gives them the strategic opportunity to go big in buybacks or a special dividend, which at such a low valuation would be materially accretive. An update on capital allocation should accompany the full year earnings announcement in March.

CK Hutchison and Li Ka-Shing: Superman’s Collection

For readers unfamiliar with the bluest of blue chips in Hong Kong, I provide a brief overview of the highlights below, but would refer to you their filings for further details.

Any overview of the company would be deficient without mentioning its renowned founder, Li Ka-Shing. Li Ka-Shing has proven his investment savvy over and over throughout his 60+ year business career, proving to be both an astute buyer and seller of assets. He made his first fortune in the 1950s, manufacturing fake plastic flowers for export. He then went all-in on Hong Kong property in the 1960s and 1970s, arguably one of the best trades of the last century. He used his proceeds to take over one of the formerly British trading house conglomerates, leading the company to become the world’s largest independent operator of ports as shipping grew. He was then early to the mobile telecommunications business, before becoming (in a personal capacity) an early investor in Facebook, Siri and Zoom, among others.

In short, Li Ka-Shing knows how to make money – so much so, he is dubbed Superman in his native Hong Kong for his business prowess. And Superman has selected the portfolio of assets that comprise CK Hutchison today.

CK Hutchison: the company today

Following a restructuring in 2015, CK Hutchison is one of Li Ka-Shing’s two main business arms, and the company that holds the majority of his non-property investment interests.

2019 EBIT Breakdown (Source: CK Hutchison Annual Report). 2020 results are yet to be released. 1H20 results saw some COVID-19 related impacts but contribution percentages of the businesses are similar.

CK Hutchison divides itself into six segments, but it really has three main sources of value: telecommunications, infrastructure (including ports), and a health and beauty retailer.

The telecommunications business comprises around 30% of earnings, and is primarily 3 Europe, a mobile carrier across six European markets. In my view, this is the lowest quality area within CK Hutchison as the cellular business itself is difficult and their markets are relatively competitive, although CK Hutchison’s financial backing is arguably an area of competitive advantage. Of late, the company has disposed its tower assets in Europe (for US$11.5bn) and is looking to participate in consolidation in most of their markets.

The infrastructure business – comprising their majority ownership of listed CK Infrastructure (PINK:OTCPK:CKISY), along with their sizable ports operation (largest independent operator of ports in the world – is what it sounds like; a solid, stable cash flow generator. CK Infrastructure is primarily regulated power, water and pipeline assets in the UK and Australia, and the ports business is spread around the world.

The health and beauty retailer – Watsons – has very solid market positions in most of its markets. Earnings primarily come from Western Europe, China and Asia. In markets like Western Europe and Hong Kong, it’s essentially a low-cost low-margin scale everyday retailer. In mainland China, it’s pivoting upscale as it looks to position itself in a highly price competitive e-commerce penetrated market, but aside from the mainland China challenges, Watsons is a very solid business. To give a sense, last year Bloomberg reported minority owner Temasek was considering selling 10% of Watsons with a sticker price of $3bn, implying a $30bn valuation for the unit – that’s implying a 15x EBITDA multiple.

The company also owns a sizable shareholding in Husky Energy (PINK:OTCPK:HUSKF), a Canadian oil producer, and various other smaller investments. Despite being headquartered and listed in Hong Kong, the majority of the company’s earnings and value derives from operations in Europe, particularly the UK.

CK Hutchison is listed on the Hong Kong exchange, and ADRs are available in the USA (although the ADRs are relatively illiquid). The current market valuation is a US$27bn market cap (around $100bn enterprise value - $27bn of net debt and significant minority interests), implying a valuation of 5x recurring EPS, 5x EV/EBITDA and around 0.45x book value, on a book value which was largely marked to market in the 2015 restructuring.

Why’s It So Cheap?

I can’t explain exactly why a collection of solid cash flow generative businesses, curated by one of the world’s greatest investors, trades for 5x earnings in a zero interest rate world, but I’m going to do my best to try. I think it comes down to complexity, politics and investor attention.

Complexity

CK Hutchison has an undeniably complex structure. It owns certain assets outright, it owns majority interests in other assets, it owns ownership stakes in listed entities which themselves have minorities with unclear economics. It’s pretty messy, and if you can fully understand the operational drivers and economics by looking at their accounts, you’re doing a better job than me. I’d argue they are undecipherable, and their investor relations team could really do a lot better in explaining how a shareholder is positioned across the conglomerate.

Nevertheless, I’m comfortable for two reasons. One, the proven earnings power of the business is pretty consistent. In the four years post-reformation of CK Hutchison, it has consistently delivered profits after tax of US$4-5bn on a market cap today of US$26bn. The businesses are steady and that multiple just makes no sense for the business quality, regardless of complexity. Secondly, and perhaps more importantly – shareholder interests are aligned. Li Ka-Shing owns 30% of CK Hutchison’s stock, and almost all of the ownership of subsidiary interests is via the CK Hutchison vehicle. While I can’t discern exactly how cash flows through the structure, I am comfortable ‘Superman’ is setting the company up in a way that will ensure his interests, and thus mine, are protected.

Politics

CK Hutchison is in a political no-mans land. Li Ka-Shing appears to be on the nose in Beijing, due to his less than 100% full throated support for China’s policy approach in Hong Kong, and his historical divestment out of mainland Chinese assets in the early part of the century. This could mean CK Hutchison is missing out on the significant inflows into Hong Kong from mainland Chinese investors, many of which are stated owned or controlled.

At the same time, CK Hutchison’s Hong Kong headquarters and links to China is increasingly a political constraint in making acquisitions and investments in its historically favoured developed world Western markets. As an example, a bid for Australian pipeline owner APA Group (PINK:OTCPK:APAJF) in 2018 was rejected on foreign ownership concerns. With acquisitions historically being a key lever of growth, it makes sense that it trades at a discount to where it would otherwise trade – but the current valuation is just discounting way too much.

Investor Attention

CK Hutchison has always traded at a discount to the sum-of-its-parts and versus market earnings and boom multiples, but it hasn’t always been this extreme. Over 2016-2018, CK Hutchison traded at around HKD100 a share, nearly double its current HKD53/share valuation. A likely factor here is the mania in the Hong Kong market for high growth China technology ‘memestonks’, such as the recent Kuaishou IPO (PINK:OTCPK:KUASF), which trades at an eye-popping US$215bn market cap for what is essentially a TikTok clone – that’s a mere 3.5x increase on its IPO price in 2 weeks! With the Hong Kong market massively rewarding high growth loss-making China tech plays, it’s not surprising to see an old-world blue chip increasingly neglected.

What’s the upside case?

CK Hutchison is not a growth company. It’s not going to get that much bigger on an absolute basis, and it’s never going to trade at 50x earnings. However, there’s a compelling case for it as a highly attractive risk/return bet with limited downside and potential upside of 150%+ over the medium term should it continue to extract value from its portfolio and accelerate its capital returns to shareholders.

Portfolio Optimisation

Across its portfolio, CK Hutchison has a lot of chips to play, and it’s increasingly more active in driving value creation through disposals or consolidation. The major event of the past year was the agreed disposal of cell tower assets from its 3 Europe business to Cellnex (GREY:OTCPK:CLNXF), for post-tax proceeds to the company of around US$11.2bn. Again, this is a company with a US$27bn market cap, so we’re talking about some real value monetisation. While smaller, the company also brokered the merger of Husky Energy and Cenovus in Canada, and has announced it’s looking at merging its Indonesian telecommunication business with a local competitor, Ooredoo.

There’s a lot more the company can do, with potential needle-movers including local market listings of infrastructure assets and a listing of the retail arm Watsons. When your headstock trades at 5x earnings, and the market value of your collection of assets on a standalone basis is meaningfully in excess of that multiple, any value realisation will be significantly value accretive.

Capital Returns

Over recent years, the company has paid a steadily increasingly dividend (currently yielding around 5%) and made sporadic token efforts at buybacks. With the bargain basement valuation, a strong credit rating, and significant incoming proceeds from disposals, there’s room for the company to get a lot more active.

Key to the thesis is whether they do prove to do so. CK Hutchison has already announced they’ll consider a buyback with the proceeds from the cell tower disposal, at least to offset the earnings per share dilution, but also announced they intend to repay some of the outstanding debt.

However, at this valuation and on this balance sheet, I don’t see the debt as an issue and I’d like to see the company do a lot more on capital returns. They are somewhat constrained by liquidity, with the annual turnover of the stock amounting to ~50% of the register, but a buyback at 20% of average daily volume could still see them repurchase around 10% of shares outstanding a year. My preferred option would be a special dividend from disposal proceeds, which would accelerate this capital return and further improve the valuation attractiveness of the remaining equity.

The decision on the use of proceeds from the tower disposal, and the commentary around capital returns along with the full year results announcement in March, could be key catalysts.

Valuation Re-Rating

Beyond specific catalysts from portfolio optimisation or capital returns, it’s hard to give a specific reason why the valuation should re-rate. However, when a portfolio of stable assets curated by one of the world’s greatest investors is trading at 5x recurring earnings, you can’t rule out the possibility. Essentially, this market valuation is implying a risk level of the earnings stream which is not consistent with the defensive, stable, cash generative nature of the company’s assets, so consistent operating performance may see it re-rate back to historical valuation levels from 2016-2018 of around HKD100/share, implying nearly 100% upside to current levels.

Where Should it Trade?

Book value per share today is around HKD120, and recurring earnings per share today are around HKD10-11/share. If CK Hutchison traded at today’s book value – not an unreasonable ask, considering ‘Superman’ assembled the portfolio – that would imply upside of nearly 130% to today’s price and still only be at a very defendable earnings multiple of around 12x.

Over the next 2-3 years, I expect the company to continue extracting value out of their portfolio through disposals, with disposals of Watsons and infrastructure assets being potential value creation catalysts to watch. The company will also continue to accrete earnings across its portfolio. Through a combination of these factors, it’s not unreasonable to forecast value at around HKD150/share in 2-3 years, a near 200% increase on today’s levels.

However, CK Hutchison has consistently traded at a discount. What could really supercharge the share price and unlock the valuation discount would be a clear and sizable capital returns programme, whether it be through dividends or buybacks. There are some positive signals from the company in this regard, but they’re yet to do anything meaningful.

The decision on the deployment of the cell tower disposal proceeds, and commentary on capital returns with full year results, could be key catalysts in turning a solid value play into strong share price performance.

Wrapping It Up

To put it simply - CK Hutchison is a collection of solid businesses curated by one of the world’s greatest ever investors trading at 5x normalised earnings. It’s not compounding intrinsic value at 20% a year, and the capital returns are modest today – but at 5x earnings, it’s just pound-the-table cheap. A lot would need to go wrong for you not to be able to get your money back over time, and you’ve got upside from portfolio optimisation, capital returns and a potential valuation rerating.

It’s may not have 10 bagger potential, but I think CK Hutchison is one of the best risk/return trades in the market with real upside potential should it work out.