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Conglomerates & Transport
We remain positive on passenger driven airlines, hotels and
conglomerates leveraged to Asian consumption and more
negative on cargo and Western-focused stocks
Key themes for 2011 will be sources of earnings growth and how
cash-rich Asian companies utilise surplus cash
Top picks include Singapore Airlines, Jardine Matheson, Pacific
Basin
2011 outlook
Aviation
We forecast our Asian airline coverage will
generate an aggregate 2010 recurring profit of
USD6.8bn, a sharp rebound from recurring losses
in 2009. The earnings recovery has been driven by
a strong pick-up in passenger and cargo demand
which has boosted load factors and yields. Cargo
has been the star performer and has helped the
sector outperform the MSCI AEJ by 22% y-t-d.
While the airline outlook remains good, we
believe profit growth will stall in 2011. In
particular, we expect profit from cargo to fall
y-o-y in 2011. There has been a clear slowdown
in cargo growth while capacity has rebounded and
we believe this will cause load factors and yields
to drop y-o-y in 2011. Our top pick in the sector is
Singapore Airlines, which is more passenger
focused, has significant net cash balances and is
the best value Asian airline.
Hotels
A sector that enjoys the benefits of a travel
rebound but has lagged the airlines is hotels. Since
the occupancy-led recovery in 2010, occupancy
levels have stabilised and we expect hoteliers to
push up room rates. We forecast this will cause a
sharp earnings rebound in 2011. In general, every
dollar of revenue earned from a rate hike is three
times more profitable than that earned from
occupancy increases. In addition, we believe
mergers and acquisitions will be a key theme in
2011 as some of the cash-rich companies may
target competitors still in financial distress from
the recent economic slowdown.
Shipping
We remain generally less enthusiastic about
shipping. Drybulk vessel supply is still huge, and
we forecast that demand growth in 2010-12 will
moderate versus the previous cycle in 2004-08,
resulting in the gap between demand-supply
becoming wider. We do not believe drybulk
shipping rates will return to previous highs, and
expect them to remain rangebound. Container
shipping rates have rebounded from 2009 lows.
However, we believe a sustainable rate recovery
is conditional on liners maintaining price
discipline and curbing capacity as volume growth
starts to decline. With most new orders destined
for this route, we expect Asia-Europe spot rates to
come under pressure as more capacity enters the
market. As Transpacific rate hikes are negotiated
annually, we expect this trade to be more resilient.
Ports
The HSBC port index has outperformed the Hang
Seng Index by 13% year to date. While we
forecast slower growth in port throughput in 2011,
we remain bullish on the Asian port sector’s profit
outlook. We believe the two key profit drivers
will be a turnaround in recent investments in new
terminals and industry-wide tariff increase. With
limited acquisition opportunities for Asian port
operators within China, we believe they will look
for greenfield or brownfield acquisitions outside
China. A key risk is that greenfield investments
may prove to be value-destroying.
Themes for 2011
Winners from Chinese and Asian
growth
In 2011, we expect Chinese and Asian growth will
continue to diverge from developed markets. The
inventory rebuild in 2010 boosted trade with the
West despite relatively weak underlying demand
and allowed air and containerised sea freight to
stage substantial recoveries. As we now believe
restocking is largely complete, our favourite plays
for 2011 will be those that are primarily driven by
Asian demand.
Therefore, we prefer passenger and travel-related
stocks to cargo-driven companies, and
conglomerates with businesses focused in Asia.
Possible inflation and rising commodity prices as
a result of strong Asian growth also tends to be
negative for the airlines and container shipping
companies if fuel prices rise.
Our favourite play on Asian growth is Jardine
Matheson. Almost all its businesses are Asian
focused and it is leveraged to pan-Asian
consumption, commodity prices and HK
investment properties. Our least favourite play is
China Cosco. This company is highly exposed to
Asia-EU container trade and has a large vessel
orderbook locked in at high prices, which will
depress returns in the medium term.
Cash-rich companies
Another theme for 2011 will be how some of our
cash-rich coverage companies use their funds. We
expect cash-rich airlines to return funds to
shareholders as we believe foreign ownership
rules limit the acquisition opportunities in Asia
(and in the rest of the world). In contrast, given
the significant fall in dry bulk vessel prices and
decent returns on assets at the moment, we expect
dry bulk shippers to increasingly acquire more
vessels. Hoteliers are another sector where assets
priced at distressed levels may enter the market.
Finally, the port sector has plenty of potential
investors but a limited pool of attractive assets
and we are wary of greenfield investments,
particularly in transhipment ports.
We argue the best placed is Pacific Basin: it has
cash of USD960m and net cash of USD86m as at
1H10 which it can use to opportunistically acquire
low cost vessels (newbuilds and secondhand) to
maximise returns. Indeed, it recently announced it
will be constructing 10 new handy vessels
consisting of 6 handysize and 4 handymax (and
purchase options for 2 handysize vessels) for
delivery in 2012-13.
A possible loser in this scenario is port operator
China Merchants Holdings International. With
limited acquisition opportunities in China, China
Merchants may increase investments overseas (for
example: Sri Lanka, Vietnam and Nigeria). We
are generally negative on China Merchants’
international expansion, particularly greenfield
investments at transhipment ports, which may
prove to be value-destroying.
Valuation and ratings
Singapore Airlines (SIA SP, OW,
SGD15.42, TP SGD19)
Valuation
We continue to value SIA using our rating to
economic profit multiple which sets an enterprise
value/invested capital multiple using our forecast
ROIC/WACC. Based on this approach, our target
is SGD19 and this plus FY11e DPS of SGD0.80
implies a 28% potential return. At our target, SIA
would trade at 12x FY12e PE, 1.4x P/BV and
provide an FY12e dividend yield of 5%. Apart
from SIA’s compelling value, the key price driver
is likely to be measures to utilise its significant
surplus net cash.
Risks
SIA’s share price tends to be driven by earnings
momentum (0.60 correlation since 2006) and its
performance relative to the MSCI AEJ is highly
negatively correlated with the change in jet fuel
prices. Another downside risk is further expansion
by the Gulf airlines on SIA’s key routes between
Australia and Europe.
Jardine Matheson (JM SP, OW,
USD43.24, TP USD54)
Valuation
JM remains attractively valued at FY11e 12x PE.
Our appraised valuation is USD77/share (from
USD70). We continue to argue that JM should
trade at around the midpoint of its historical range
(2005-8: 28-45% discount to appraised value). We
set our target at USD54, at a 30% discount (from
35%). Our target plus FY11e dividend implies a
28% potential return.
Risks
70% of our appraised valuation comprises Dairy
Farm, HK Land and JC&C. Downside risks are
sharp declines in Asia consumption, reversionary
rents and commodity prices.
Pacific Basin (2343 HK, OW(V),
HKD5.25, TP HKD7.5)
Valuation
We value Pacific Basin at HKD7.5 based on
rating to economic profit (REP) combining
returns and invested capital. We apply a historical
REP multiple of 0.8x and used ROIC/WACC at
1.1x to derive our enterprise value/invested capital
(EV/IC). Our target price implies a potential
return of 48% including dividend yield of 5%. At
our target price, the stock is trading at 1.1x FY11e
BV, which is also the stock’s average trading
multiple (range 0.6-3.1x).
Risks
Pacific Basin’s share price tends to move closely
with the Baltic Dry Bulk Index (0.4 short term
and 0.9 medium term) even when it has locked in
a high portion of revenue at healthy levels. Other
risks to our rating and estimates include handysize
rates weakening due to slower to ship
commodities and/or excess supply due to owners
prolonging use of older vessels or greater than
expected new orders entering the market.
China Cosco (1919 HK, UW(V),
HKD8.49, TP HKD5.9)
Valuation
We value China Cosco at HKD5.9 based on rating
to economic profit (REP) based on enterprise
value equalling to invested capital given the
absence of economic profit and ROIC/WACC of
0.6x. Our target price implies a total negative
return of 31% (zero dividend yield). At our target
price, the stock is trading at 1.0x adjusted FY11e
BV, which is at a discount to its average trading
multiple of 1.8x (range 0.7-5.8x)
Risks
China Cosco’s share price is highly correlated to
the Baltic Dry Bulk Index (0.4 short term and 0.9
medium term) and short-term earnings momentum
(0.7). Other risks to rating and estimates include
capesize rates recovering strongly in 2011-12 due
to massive cancellation or scrapping of vessels or
demand for iron ore rising substantially or port
congestion absorbing capesize capacity.
China Merchants (144 HK, N,
HKD30.65, TP HKD31)
Valuation
After an 18% rise in the share price since its
strong 1H10 results, we argue the stock is now
fully valued. At our unchanged target of HKD31,
it is currently trading at 19x 2011e PE and 1.9x
2011e PB, higher than the long-term historical
average of 15x. Our target price is based on a
sum-of-the-parts valuation (DCF for key ports)
and implies a 3% potential return, including
dividend yield; thus we remain Neutral.
Risks
Key upside risk is higher-than-expected increases
in average container handling tariffs. Key
downside risks include a slowdown in global trade
that causes slower-than-expected port throughput
growth and a de-rating of the port sector. CMHI’s
aggressive international expansion could also pose
a risk in future and it does not have a track record
of managing ports outside Hong Kong and China.
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