Description

Cosco Shipping, a pure play global port terminal operator, is an undervalued toll booth investment with a good balance sheet.  Adjusting for the company’s hidden assets, the company is trading at an EV/EBIT ratio of just 6.5x, far lower than its global peers, and you get paid a 5% dividend while you wait for the market to revalue the stock.

Founded in 1994 and headquartered in Hong Kong, COSCO SHIPPING PORTS Ltd. (HKG: 1199) is a holding company which, through a very recent restructuring that occurred in March 2016, has become one of the world’s leading pure-play marine port terminal operators. Through wholly owned subsidiaries in addition to substantial investments made through joint ventures and various associate partnerships, the Company is involved in the stevedoring of approximately 12% of the total global seaborne container freight traffic as measured in TEUs. In the Greater China market, which includes Mainland China, and Hong Kong, Cosco Pacific (CP) enjoys a 36% share of the overall container traffic movement in-and-out of this industrial power house.

1.      The following table summarizes historical financial and valuation metrics as reported by Factset alongside Pro Forma adjustments to Street consensus estimates metrics to reflect the valuation of the underlying operating business:

Source: Factset; Financials in USDs

On a reported basis, the stock currently trades at a 10.3x EV/EBITDA multiple and a 5.3x EV/Sales multiple. The following table summarizes trading metrics for some global comps:

At first blush, on a reported basis, the stock does not look particularly attractive. The peer group trades at median EV/EBITDA and EV/Sales multiples of 12.0x and 5.2x respectively. At best, COSCO SHIPPING appears modestly undervalued.  However, a substantial portion of the intrinsic value of this business resides in minority investments that contribute to earnings below the EBIT line. The adjusted EV in the summary table presented on the previous page attempts to exclude the book value of these investments to recast adjusted trading multiples. On an adjusted basis, COSCO SHIPPING trades at just 6.5x EV/EBIT, 3.6x EV/EBITDA, and 1.9x EV/Sales.

2.      Looking at historical trading multiples, the stock screens favorably:

COSCO SHIPPING trades at 0.7X Book and supports a 4.9% dividend yield. ROA’s and ROE’s are currently depressed as containerized trade, which enjoyed a decade of double-digit growth, appears to have stalled over the past 18 months:

Global containerized trade, 1996-2015 (million TEUs and percent annual change)

Source: UNCTAD

On a normalized basis, this business ought to be able to generate a 10-12% ROE. Buying the business when it is trading at 0.7x has the potential to generate a 15-18% return for investors.

BALANCE SHEET

As of the end of 2QFY16, the net debt to capital ratio stood at 8.5%. If one includes the various minority and JV investments in port assets, the enterprise appears overcapitalized relative to the operating earnings it generates.

Risks

• The Company facilitates the movement of containers in-and-out of China. The volume of freight, in turn, is tied to the health of the global economy. Growth in global trade has slowed considerably and a full-blown global recession would be problematic for the Company. Having said that, China is aggressively pursuing a strategy to enhance trade linkages with Central Asia, the Baltic countries and others in its immediate neighborhood. This strategy should help cushion CP from further deterioration of demand in Europe and North America.

• The Chinese Government through its ownership of China COSCO Holdings Co. Ltd., (1919-HKG) owns 45.76% of CP. The PRC’s geopolitical and economic interests are likely to trump minority shareholder interests when push comes to shove. However, for now, China is likely to treat foreign investors with kid gloves as it looks to deepen its capital markets.

• Exposure to the Chinese Renminbi which the consensus believes is likely to depreciate. Although it is difficult to make a top-down call on currency, in reading the tea leaves, it appears to me that the Chinese currency is likely to appreciate as the IMF moves towards a reconstitution of SDRs (strategic drawing rights) in the fourth quarter of 2016. This action by the IMF would amount to the Renminbi gaining status as a hard currency. In turn, I would then expect Central Banks to bid up prices of the currency as they adjust their mix of reserve assets. Of course, I am not certain of this outcome and hence perceive it as a risk.

• Future value destruction/misallocation of capital. It is quite likely that CP will look to expand internationally and could continue to invest in projects that the PRC deems support its OBOR strategy.

  In March 2016, China’s National People’s Congress accepted Premier Li Keqiang’s thirteenth 5-year plan for China covering the 2016-2020 time period. In the plan, the Central Government has promulgated a series of strategies to progress two key initiatives – one called “One Belt One Road (OBOR)” and the other “the Yangtze River Economic Belt.”  Both development initiatives are aimed at resurrecting and deepening the old Silk Route which, during the Han dynasty (207 BEC – 220 CE), connected the Middle Kingdom with Romans, Greeks, Turks and Persians. The main driver behind these initiatives is a renewed push to expand and deepen trade linkages between China and the West.

• Weak corporate governance. There are close linkages with COSCO Shipping and the PRC.

Catalyst

Value will out.