Description

I think Xinghua is a compelling opportunity.  As a recently spun off port with ~50% EBITDA margins trading under ~6x FCF, it may be one of the cheapest infrastructure assets in the world and is controlled by a Singaporean family with an excellent governance track record.  By all means skip to the valuation section if that isn’t enough to get you to paragraph #2.

River Transshipment Ports

There are two basic business models in ports: transshipment (hub) and transit (spoke).  To use an analogy with airports, transshipment ports are like the connecting airports (think Atlanta) of the seas, with shippers dropping off their cargo to wait for the next ride towards the final destination.

One lesser-known fact about maritime transport is how widely used river networks are to ship certain products.  Before trains, waterways were really the only game in town for major inland transportation of goods, and this helps explain the location of many major cities.  Even with the adoption of planes, trains and automobiles, the humble river barge is still basically the cheapest way to transport bulk commodities from inland production centers to the ocean (or vice versa).

This process uses a transshipment port, not least because barges are not suitable for crossing an ocean and ocean-going vessels can’t travel up the Mississippi (or really any river).  This logistics chain involves bulk goods being A) loaded onto barges and moved down-river before B) being offloaded at a transshipment port near the end of the river/beginning of the ocean and C) being loaded onto a much larger ship for ocean transport.  That whole process works equally well in reverse, where the barge picks up goods instead of dropping them off.

Background

Around the time of Singapore’s founding, Ng Kor Cheong was urged by his grandmother to make something of himself and enter the world of business.  With the help of a $3,000 loan he entered the hardware supply business and, over time, grew his holdings to include the dominant Singaporean concrete supplier, a respected ship-builder, and a port just to the west of Shanghai.  As is frequently the case in Singapore, he worked to pass the business reigns to his children who continue to own ~60% of the company.

His company (Pan-United) was listed on the Singapore Stock Exchange (SGX) in 1993 and has basically paid dividends every year since, with typical payout ratios around 30-50%.  In 2004 the family felt the share price didn’t appropriately value their conglomerate and they spun off their shipbuilding subsidiary to highlight value. 3 years later, that business was sold for ~$650m SGD in a huge windfall for shareholders (and at ~10x the initial price of the spun out shares).

In my opinion, communication with minority shareholders about the business has generally been very good and the family has a ~25 year track record of good governance.

Since 2004, Pan-United has basically consisted of two unrelated businesses: Singaporean concrete (decent but cyclical) and a transshipment port about ~100km west of Shanghai at the mouth of the Yangtze River.

In 2017, Pan-United announced that it would spin off its port business (Xinghua) to shareholders, but that the new company would be listed on the Hong Kong (vs. Singaporean) exchange.  This actually made sense given that many Chinese ports are listed in Hong Kong, with local investors familiar with the industry. However, in my opinion this has created a funny “technical” dynamic to the spinoff, where many Singaporean holders simply opted to have their new shares automatically sold and receive the resultant cash.  Meanwhile, there has been no road-show or explanation of the situation to traditional Hong Kong market participants. It is my belief that legacy Singaporean investors were generally more familiar with, and more interested in, the concrete business (which dominated the revenue of the group) and that at the moment natural sellers of Xinghua exist while natural buyers are not yet aware of the situation.  This may be responsible for creating a large gap between the market price of the stock and the intrinsic value of the asset.

Xinghua Port Holdings

Xinghua operates a transshipment port near Shanghai at the mouth of the Yangtze River, one of the most important river arteries in the world for global trade.

Unfortunately for Xinghua, China is far more “capable” of building new ports than other countries (where such construction permitting is hard), and many neighboring ports have been built or expanded since Pan-United first built the facility in the 1990s.  This makes the business tougher but the rising tide of inland economic growth has lifted all boats, and Xinghua has done well over time showing healthy growth and margins.

While Xinghua acts as a transshipment hub for multiple commodities (wood, steel, etc.), its most significant cargo is pulp.  Pulp imports to China have been growing for a long time which is expected to continue in the coming decade since demand is driven more by wiping butts and blowing noses than building tier 2 cities.  Unlike many other bulk goods (such as coal or steel) pulp should be handled carefully, kept clean, and stored indoors. While this isn’t rocket science, pulp generally requires some specialization, and since the cost of transshipment relative to the product value is small, Xinghua has a nice niche in this category.

It is easy to put Xinghua’s business quality to the “smell test” which it handily passes.  The port has grown its revenue with a ~7% and ~9% CAGR over the past 5 and 10 years respectively while, more tellingly, maintaining an average EBITDA margin in the high 40% range.  These types of figures are not uncommon in the port industry, but serve as a good sanity check for the asset’s quality despite nearby competitive ports.

Unsurprisingly, ports generally trade at very high multiples (similar to other infrastructure) reflecting their business quality and technological resilience.  A select sample of publicly traded ports outside of China have average EV/EBITDA and PE multiples of about ~11x and ~19x respectively, and these may actually be skewed low given that some are government controlled or have limited concession lives remaining.  Publicly listed Chinese ports meanwhile have average EV/EBITDA multiples above ~10x in Hong Kong despite being SOEs.

There are reasons to think Xinghua could eventually trade at higher multiples than its local peers, given that it is controlled by a profit-oriented Singaporean family with a strong governance track record versus an SOE that will re-invest all earnings towards one-belt-one-road initiatives.  On the flip side, Xinghua is a smaller business than most other listed ports, which could augur a more depressed multiple (although most listed ports are basically just a single asset).

In any case, the important thing is that Xinghua appears to be exceedingly cheap on a relative and absolute basis.  This seems both unusual and appealing considering that it is a good asset in a good industry run by good partners.

Valuation

Xinghua currently sells with a market cap of ~730m RMB and an EV of ~1320m RMB ($115m and $210m USD).  On a trailing basis, this represents an EV/EBITDA of ~5.8x and a PE of ~7x.

Based on my estimate of maintenance capex, Xinghua trades at around ~5.5x P/FCF (~18% LTM FCF yield) with only ~2.6x net debt/EBITDA for a company that grew revenue ~8% last year.

Using the company’s guidance of a ~40% dividend payout ratio, the yield should be nearly ~6% going forward (among the highest in the listed port space).

These valuation metrics seem pretty wild.  If the FCF yield to owners is ~18% (and grows) with management treating minority shareholders fairly, the investment results seem likely to be quite acceptable over time.  If the “technical aspects” of the spinoff are what is causing this nice business to trade at these levels, then there could also be a natural re-rating of the shares once the local market has learned about the business.

To put this in perspective, if the stock traded at ~14x PE or ~11x FCF, the stock might approximately double.  Arguably even after re-rating to those levels, a ~9% FCF yield for a growing port is still quite attractive.

These valuation multiples seem highly attractive for a good business run by trustworthy people where the most logical explanation of the current price is technical factors.  I also feel that management will help explain the Xinghua story to the Hong Kong market in 2018, which could help improve the businesses’ valuation (Pan-United communicated regularly with shareholders, published investor presentations, and even hosted analysts on facility tours).

The biggest risks are everything China related (economy slows down, build more ports, etc.).  There are already a large number of ports serving the greater Shanghai/Yangtze River area and some new ports have impacted Xinghua’s market share in certain types of cargo (notably lumber a few years back).  Another risk in the longer-term is the land leases underlying the ports, which will start expiring in stages within the coming decades. These land leases are similar to those underlying almost all Chinese property (vs. an infrastructure concession) so this port may end up being perpetually owned by Xinghua, or eventually taken back by the state like a concession, or something in between.

Given the above, I think the risk-reward of the situation is appealing.

KPIs (RMB):

Illustrative – Current Trading Multiples:

Illustrative Investment Potential From Multiple Rerating:

Disclosure

Have ownership interest in Xinghua Port Holdings at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on the authors buying or selling activities for this or other stocks. The author may buy or sell shares of Xinghua Port Holdings without notice for any reason at any time.

Catalyst

Perhaps the abatement of spinoff dynamics