Great leap forward
PUCintendsto boostits revenue across the region by increasing its stake in CXP.This decision is probably the most important one management has to make in recent times to lock inthe company’s longer-term prospects.
Its latest stake upsize in CXP has the potential to add 14-15% to our FY14-15 EPS after accounting for interest costs from any debt taken. Our target price accordingly climbs, still based on residual income. Upgrade to Outperform from Neutral with catalysts expected from earnings contributions from very chunky MRT projects in the BBR segment and its improved earnings profile.
Integral part of PUC
CXP is an integral part of PUC, being its second-largest source of earnings. CXP contributed 9% to group revenue and 16% to group PATMI in FY12. Its operating momentum is expected to continue in the next few years.
Creating efficient capital structure
We previously argued that PUC could raise shareholders’ value by optimising its capital structure. Its latest stake acquisition is the first step towards that, we believe, and is the clearest manifestation of management’s deviation from its usual conservative style. Assuming that cash is upstreamed from SCDC (estimated at S$10m), the implied cost of its stake upsizing is S$91m. We think PUC could fund this by borrowing S$60m and using S$31m from its cash hoard. If PUC were to fund its entire acquisition with debt, its net gearing would only increase to 0.12-0.14x in FY13-14. This should still be comfortable for management, we believe, with PUC’s highest-ever gearing being 0.2x in 2004.
Upgrade to Outperform
This latest deal is meaningful and can add to earnings. Projected dividend yields of 4.6% are not in danger. We upgrade the stock to Outperform from Neutral. Apart from the consolidation of CXP’s financials, other catalysts for the stock could include earnings contributions from very chunky MRT projects (Downtown lines 2 & 3 and the new Thomson line).
1.1 PUC raised its CXP stake to 85.5%
PUC has entered into a sale-and-purchase agreement with Macquarie International Infrastructure Fund Limited (MIIF) to acquire 18m shares in Singapore Changshu Development Company Pte Ltd (SCDC) for S$101m in cash. This will raise PAN's effective shareholding in Changshu Xinghua Port Co Ltd (CXP) from 51.3% to 85.5%.
Under the SPA, Petroships Investment Pte Ltd, an existing shareholder of SCDC, will acquire the balance 2m shares from MIHL for S$11.22m, which will increase its effective stake in CXP to 9.5%. The Chinese local government, through Jiangsu Changshu Economic Development Group, remains a shareholder with its 5% share in CXP. Completion of the SPA is conditional upon the approval of the shareholders of MIIF.
1.2 What is CXP?
Located in Changshu city, Jiangsu, China, CXP is a multi-purpose port equipped to handle bulk and break bulk cargoes. It operates eight berths with a total berth length of 1.7km for vessels up to 100,000 dwt. CXP sits on a 1 sq km site with yard storage of 608,147 sq m and 14 warehouses on a total built-up area of 107,300 sq m. Its 249,000 sq m general-cargo yard, 50,000 sq m container yard and a 370,000 sq m temporary stacking yard are able to accommodate up to 6,000 TEU containers. CXP handles steel finished products, logs, pulp & paper and general cargoes. Located on the southern bank of the Yangtze River, it is one of the top 10 river ports in China, serving the high-growth industrial cities of Suzhou, Wuxi and Changshu. Its hinterland covers provinces like Shanghai, Jiangsu and Anhui in the Yangtze River Delta.
1.3 Integral part of PAN
Not all river ports in China are blessed with CXP’s water depth and land size. Upstream river ports tend to have shallower waters as a consequence of siltation and are unable to accommodate larger vessels. In addition, CXP sits on a large land site of around 1 km sq m, on which it is able to develop warehouses and provide third-party logistics services to clients. These services include storage, packing and distribution. CXP hires third-party tug-&-barge operators to distribute unloaded products to upstream river ports that are closer to product destinations. We think these are major deciding factors affecting port choice, other than proximity to end-destinations, port charges, reliability and efficiency of handling.
CXP is PUC’s second-largest earnings contributor, contributing 9% to group revenue and 16% to group PATMI in FY12.
2.1 Volume handled to grow 5.5-10% yearly
We think that port-logistics earnings can continue to grow at 5.5-10% annually from 2013 to 2015. We do not foresee a major shift in demand for steel and volumes should remain largely similar to 1H13 levels. We have estimated a moderate 5% decline in steel volumes handled for FY13. However, the outlook for logs and pulp & paper is more sanguine, with volume handled jumping 15% and 10% yoy respectively in 1H13, mirroring Chinese import data. We expect this operating momentum to continue, with logs and pulp & paper still the main growth propellers for port logistics.
3.1 Economics of CXP acquisition
We agree with PUC’s rationale for its higher stake, namely, to build up its port-logistics division, which is in line with its plans to increase revenue streams. We understand that management is looking at a combination of internal cash and debt to fund its stake acquisition. Though the headline price looks high at 20x CY12 P/E, a better way to appreciate CXP’s valuation is to strip out interest elements from the calculations and look at CXP’s operational earnings, as the bulk of PUC’s debt is port-business-related. The implied EV/EBITDA for this deal falls in line with its peer valuations, at 14x.
3.2 Optimising capital structure
We previously argued that PUC would be able to raise shareholders’ value by optimising its capital structure. Its latest acquisition is the first step in that direction, we believe, and is the clearest manifestation of management’s deviation from its usual conservative style.
Assuming that cash in SCDC (estimated at S$10m) is upstreamed, the implied cost of its stake upsizing is S$91m. We think that PUC could fund this with S$60m borrowing and S$31m of internal cash.
Were PUC to fund its entire acquisition by debt, its net gearing would only increase to 0.12-0.14x in FY13-14 – still very comfortable for management, given that PUC’s highest-ever gearing was 0.2x in 2004.
3.3 Dividend payoutsnot jeopardised
PUC has been rather generous with its dividend payments. DPS had grown from 1.6Scts in FY02 to 3.5 Scts in FY12. PUC had also dished out special dividends to investors from 2004 to 2006. In the thick of the GFC, DPS was reduced from 4.45 Scts to 3.8 Scts in 2008 and subsequently to 3 Scts in 2009. In 2Q13, PUC declared 1.5 Scts/share. Assuming similar payouts in 2012, investors could look to pocket around 2.5 Scts/share when PUC releases its 4Q13 results early next year. In consideration of its future capital requirements and cash-flow generation, we think there is scope for PUC to raise its dividend payments to 4 Scts/share going forward.
4. VALUATION AND RECOMMENDATION
4.1 Upgrade to Outperform
This latest deal which costs S$101m could add 14-15% to PUC’s FY14-15 net earnings after accounting for additional interest costs, in our estimation. Projected dividend yields of 4.6% are not in danger, in our view.
We have a higher target price of S$1.08 after our adjustments, still based on residual income. Upgrade to Outperform from Neutral. Apart from the consolidation of CXP’s financials, other catalysts for the stock could include earnings contributions from very chunky MRT projects (Downtown lines 2 & 3 and the new Thomson line).
Publish date: 20/09/13