VODAF - CK Hutchison: What To Expect In 2023 From This Large Conglomerate?

Summary

• CK Hutchison Holdings Limited made billions of dollars during all previous crises and will likely do so again in a recession.
• It has an excellent balance sheet.
• Our concern about CK Hutchison's dividend policy remains the same, and we prefer to maintain our stance of a hold.

Investment thesis

There are many stormy clouds on the horizon.

War in parts of Europe. Inflation putting pressure on household economies all over the world. Threats of a recession.

China’s health services trying to cope with a large number of people now contracting covid after the relaxation of strict restrictions on the movement of people. It is overwhelming. Will they shut down the world’s second-largest economy and the world’s largest manufacturing hub again?

Despite this and other crises and hard times that history has thrown at us, there are some companies that keep making money. Year in. Year out. Obviously less in some years, but we are still talking about billions of dollars.

CK Hutchison Holdings Limited ( CKHUY ) is one of them.

During the GFC of 2008, CK Hutchison Holdings made HKD 15.5 billion, and when Covid-19 hit us in 2020, its profit was HKD 29 billion.

Thousands of people go to work for them every day of the year, handling containers, making electricity, connecting phone calls, and selling consumer goods.

It will continue to do so this year and make billions of dollars.

Still, we have held off from investing in CKHUY.

Why?

Deals and developments

The pipeline for 2023 has many exciting deals and business developments that could propel SKHUY’s growth for many years to come.

Perhaps the biggest, and most important is:

• A potential merger in the UK’s telecom space.

CK Hutchison Holdings Limited has been in discussions with Vodafone Group Plc (VODPF) since October of last year in relation to a possible merger between their “3 UK” and Vodafone UK. The envisaged transaction would result in CKHUY owning 49% and Vodafone 51% of the combined business. The relative ownership would be achieved through a differential leverage contribution at closing, and no cash consideration will be paid. By combining their businesses, they expect to achieve the necessary scale to be able to accelerate the rollout of full 5G in the UK and expand broadband connectivity to rural communities and small businesses.

Should the deal go through, one would expect both parties to extract cost savings and hopefully also achieve some pricing power due to less competition.

• 88 million 20 ft steel boxes

That is how many TEU, or twenty feet equivalent, container boxes they handled in 2021. This was up 5% from the year before.

To facilitate further growth, they are building more port capacity.

In the middle of 2021, Hutchison Port Holdings Trust ( HCTPF ), of which CKHUY owns 30.7%, announced that it had made a 50/50 JV agreement with Shenzhen Yantian Port Group to construct, develop and operate another terminal at Yantian Port. It will be approximately 120 hectares on the eastern side of their present Yantai port development. It will have about 1,470-meter quay length. The estimated total cost at that time was SGD 2.27 billion.

The rationale is that Yantian International Container Terminal in Shenzhen has become one of the busiest container terminals in China.

China, including Hong Kong, constitutes about 44% of their total global container handling volume.

It is too early to say if there is going to be a growth in the number of containers CKHUY will handle in 2023. Consumers both in China and elsewhere might be less willing to spend. This will affect their results from this division in the short term.

• Artificial Intelligence in the medical field

The use of AI is growing in the field of medicine. Advanced AI algorithms and high-precision molecular modelling is used to predict and design a medicine, including a variety of tumor vaccines that can activate specific immune responses to kill tumors.

Hong Kong-listed CK Life Sciences, which is controlled by CK Hutchison Group’s healthcare, is involved in this field.

In an article in SCMP on the 25th of November 2022, it reported that CK Life Sciences recently joined forces with Chinese medical technology company XtalPi to develop an AI platform for cancer vaccine research and development.

The segment holds promise, as cancer cases worldwide increase amid a lack of fast and effective treatments. The global cancer vaccine market will rise by a compound annual growth rate of 11.53 percent to US$12 billion in 2026 from 2022, according to the press release, which cited Mordor Intelligence

The AI-based drug discovery market is expected to grow to USD 5.6 billion by 2029 from US$626.6 million last year, according to Polaris Market Research.

Returning capital to shareholders

We should not look at returning capital to shareholders in isolation.

It needs to be related to the free cash flow ("FCF") the company generates, more than the EPS which is often used by many companies as a payout ratio.

In our opinion, we also need to look at a company's balance sheet. It is unwise to distribute a large amount of capital if the company itself does not have a healthy balance sheet.

In our previous article on CKHUY in August of 2022, we did point out that their balance sheet was very comfortable with a gearing of just 20.5%. We were told that they will also receive large cash from sales of cell tower assets during the SH of 2022, which will bring down the gearing to 17.5%.

That is a low gearing for any company.

They have stated that they want to accelerate shareholders' return and declared an interim mid-year dividend of HKD 0.84, which was also up 5% from last year.

It will be interesting to see what they decide to do with the dividend for SH 2022. Annual results are usually coming out around the 17th of March.

Especially as we think their payout ratio could be somewhat higher. It has been 31% for the last few years. In view of the low debt, we feel it should be somewhat higher.

As of the 9th of December 2022, the total number of shares repurchased in 2022 was 4.44 million shares. That is only 0.11% of the total outstanding shares as of the end of 2021.

Conclusion and thoughts for 2023

We do like CK Hutchison Holdings Limited’s businesses and how resilient the company is during economic uncertain times.

But we did not like it enough to plonk down any money on it yet.

Why is that?

We still have a concern about whether CK Hutchison Holdings Limited top management and majority owners look after the minority shareholders as well as they look after their own interests. As a side note to this, their directors are certainly well remunerated, with Mr. Canning Fok receiving a bonus of HKD 179 million, the equivalent of USD $23 million, in 2021. Maybe that is the "norm" these days.

We are probably not the only ones that are concerned.

Singapore’s port operator PSA International, fully owned by Singapore state investor Temasek Holdings, is, according to ChannelNewsAsia evaluating selling its multi-billion dollar, 20 percent stake in the ports business of CK Hutchison Holdings. PSA, the world's second-biggest container terminal operator, whose global network encompasses 160 locations in 42 countries, had acquired the stake in the Hong Kong-based conglomerate's ports business for $4.4 billion in 2006.

Their reason for exploring a sale could be totally unrelated to our concern.

However, investors generally don’t want to sell a piece of their good investments unless they have a reason to do so.

Our stance on CK Hutchison Holdings Limited is still a Hold.

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