2023-10-27 11:42:57 ET
Summary
- CK Hutchison Holdings' share price has dropped 18% since March, but the company still offers great value.
- FH 2023 financial results show a 13% decrease in EBITDA and a 41% drop in net earnings, but free cash flow increased by 26%.
- We elaborate on whether the stock is a value trap.
- Risks associated with being perceived as a Chinese company in Hong Kong needs consideration.
Investment Thesis
In our previous analysis of CK Hutchison Holdings Limited (CKHUY) titled "A Safe Harbour In Stormy Times" back on the 23rd of March this year, we continued our Hold stance which started back in July of 2021.
The share price is down 18% since our call in March, against the S&P 500 being up 6.5% and the Hang Seng Index, where CK Hutchison is one of its constituents, is down 13%
CKHUY share price 23 October 2023 (SA)
We have in the past pointed out that CKHUY offers great value.
Now, with the company coming out with their FH 2023 results, we want to revisit the thesis and ask if it is the time to upgrade it to a Buy.
FH 2023 Financial Results
CKHUY is a conglomerate with business interests in a wide range of industries. When we look at the top line, their revenue in the FH 2023 was in line with the FH of 2022. It was only 3% less.
However, their EBITDA came in at HK$ 61.15 billion, which was 13% lower on a Y-o-Y basis.
Pessimists and naysayers argue that CKHUY is a Chinese company and that China is "un-investable".
CK Hutchison Holdings Limited is domiciled in Cayman Island. It does have its head office in Hong Kong, but when we look at where most of its businesses are, we do get a different picture.
CK Hutchison Holding - FH 2023 EBITDA by geographical distribution (Data from CK Hutch, graph by author)
Interest expenses and finance costs increased as much as 21% from HK$9.68 billion to HK$11.74 billion in FH 2023. The average cost of debt went up from 1.8% at the end of FH 2022 to 2.9% at the end of FH 2023. Fortunately, their gearing is low, which means that the negative effect of higher interest costs was not too damaging.
Net earnings dropped by 41% from HK$19.10 billion to HK$11.20 billion. The big difference can be explained by a one-off non-cash item last year of HK$6.20 billion from a gain in the value of an Indonesian telecommunication business merger. When this is excluded, the drop in earnings falls to 13%.
What we want to focus on is the free cash flow. In terms of the FCF, the picture gets rosier. The FCF increased from HK$6.07 billion in FH 2022 to HK$7.62 billion in FH 2023. That is an improvement of 26%.
Management decided to reduce the interim dividend from HK$0.84 per share a year ago to HK$0.756 for the current year. The TTM dividend is HK$ 2.84 which gives us a very attractive dividend yield of 7.2%
The main reason that we titled our previous article "A Safe Harbor in Stormy Times" is due to their conservative balance sheet. Metaphorically, it is also fitting, as they are the world's largest port operator, hence the safe harbor.
It is always interesting to look at a company's cash position in relation to its share price. After all, if you can buy a company at a price that is close to what they have in cash, you get all the other assets for next to nothing.
As of the end of June this year, CKHUY had HK$ 128.7 billion in cash or cash equivalents. With 3.3 billion shares outstanding, it works out to cash per share of HK$ 33.60 against the current share price in Hong Kong, as of 25th October, was HK$ 39.70
Net debt, after deducting for the cash is HK$ 138 billion. If we look at total liabilities it works out to HK$ 352.1 billion. The total equity is HK$662.3 billion. As such, we get a solid debt-to-equity ratio of 0.53
Their balance sheet and financial position are still very good.
Update on their Telecom assets
In June 2023, their telecom group reached an agreement with Vodafone to merge with their 3 UK operation.
Merger Vodafone UK and 3UK (Hutchison Holding presentation 15 Jun 2023)
Vodafone will hold 51% and 3 UK the balance. The transaction is expected to be earnings and cash flow accretive. CKHUY will also receive a one-time cash payment of £1.7 billion once the deal is completed.
The deal is expected to close before the end of 2024.
In Italy their telecom company 3 Group Europe already has 18.3 million active mobile phone customers. In May 2023, they entered into an agreement with a PE firm to establish a J/V to provide wholesale mobile and fixed communications services business in Italy. This will deliver to the group cash receipts of about €2.44 billion, if and when it is approved by regulatory bodies.
Great Value Proposition, Or A Value Trap?
We enjoy reading articles from many of the SA community's excellent analysts. One of them is John Kingham. In his last article, titled "The FTSE 250 Is Looking Very Cheap ", he rightfully explained that there are now many good value propositions amongst the top UK companies.
We do agree. However, we came to think of all the various companies on our watch list, of which there are many companies that now look not just cheap but extremely cheap.
The stock market in Hong Kong has lots of companies trading at share prices far lower than their book values when compared to the price to book at other stock markets. That is not new news. It has been that way for decades.
CKHUY is one of them. Here is a condensed recap of their valuation and how it compares with the broader market both in Hong Kong and in the U.S.
CK Hutchison Holding updated valuation versus HSI, and S&P 500 (Data from Hutchison Holding, Yahoo Finance, HK Exchange, and Standard & Poor. Compilation by author)
On paper, when purely looking at the fundamentals, CKHUY does offer very good value.
The low price to earnings is attractive.
Another way to look at it is the free cash from the operation, which does include the cost of financing but not investments and amortization. In the FH of 2023, this was HK$ 5.48 per share. If the SH 2023 will be about the same, we get a price-to-free cash-from-operation ratio of only 3.55.
The most attractive value proposition is the price to book of only 0.30.
This is not based on tangible book value, as goodwill is accounted as assets. For CKHUY, this is a considerable asset. As of the 30th of June 2023, it amounted to HK$ 270.5 billion. If we strip out this and look at P/NTBV we still get a ratio of 0.38.
We also believe that their valuation of all their fixed assets of only HK$ 116 billion is much lower than market value. Most of their fixed assets are infrastructure assets such as ports and power plants, which are recorded in the books at cost with depreciation over time.
On the topic of whether CKHUY is a value trap, we have been asking ourselves one question. After all, we do have some skin in the game in the form of ownership in some of their affiliated companies.
Is it just a coincidence that the two biggest book value losses in our portfolio are in companies controlled by CK Hutchison and CK Assets?
Here is how shareholder value has eroded over several different time frames.
CK Hutchison Holding and affiliated companies share price development over a 10-year period (Data from Yahoo Finance. Compilation by author)
We can see that CKHUY has fared worse than the Hang Seng Index over a longer period like five to ten years. Their real estate arm CK Assets (CHKGF) on the other hand has done better.
Risk to Thesis and Conclusion
We have shown you past performances which is not all that uplifting.
However, the past is not a good guide as to what might happen in the future.
There is a risk that CKHUY will always be seen as risky and associated with China, even though it is not their greatest generator of income. Do they deserve this? We do not think so.
Another factor that could be contributing to the poor share price is the conglomerate discount people often talk about. Companies that have tried to be "everything for everyone" in the past have often failed.
Our conclusion is that as an income-generating asset, it should continue to perform well for its shareholders. That does not mean we will never see reductions in dividends when business cycles hit low levels.
Back to the question raised in the headline.
Should you buy CKHUY now at 30 cents on the dollar?
We believe the share price will be quite closely correlated to the general stock market in Hong Kong. If Hong Kong can regain confidence amongst investors the trend will turn.
But there is a risk this may not happen.
As a holding company with such a large global presence, they could always choose to delist and list elsewhere. Singapore comes to my mind. But we believe that CK Hutchison Holding is so much a part of Hong Kong that we see this possibility as fairly unlikely.
On the basis of pure fundamentals, we are tempted to upgrade our stance, but with the uncertainty surrounding whether it is a real "value trap" we have to maintain our Hold stance for now.
We do hope to hear from the SA community as to whether they believe CKHUY is a value trap or not.
All comments are appreciated.
For further details see:
Should You Buy CK Hutchison Holdings Now For Thirty Cents On The Dollar?