CK Hutchison update (1 HK)
Blue-chip conglomerate facing inflation pressures. Estimated reading time: 18 minutes
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In January 2022, I published a post on Hong Kong conglomerate CK Hutchison. I argued that the company is professionally run but suffered from weak foot traffic in its retail stores during COVID-19 and low energy prices.
Since then, CK Hutchison’s retail traffic has recovered nicely, and energy prices are up. But earnings have still come down. Blame a weak Euro, high inflation and high-interest rates. All are related to Fed policy, in my view.
The company is now transitioning towards a more asset-light company, selling European telecom assets and spending at least a portion of the proceeds on share buybacks. That could help the return on equity rise from the current ~7% level, which explains why the stock trades at 0.3x book.
Assuming that CK Hutchison’s interest payments reprice higher as the debt matures, that margins rebound in the telecom and infrastructure segment as they deal with the higher inflation pressures, and that the retail segment continues to grow post-COVID-19, I get to a mid-single digit P/E. With a 30% payout ratio, the dividend yield would stay around the 5-7% level.
The big wild card is inflation since it affects US monetary and fiscal policy and the strength of the US Dollar. A best-case scenario would be lower inflation, lower US Dollar interest rates and a stronger Euro.
A commonly cited concern about CCP interference is probably exaggerated given 1) CK Hutchison’s incorporation in the Cayman Islands, 2) only 13% exposure to Hong Kong and mainland China, and 3) little evidence of any backlash so far.
1. Quick recap
My initial report on CK Hutchison (1 HK - US$20 billion) was published on January 2022. You can find the link here (no paywall):
At that time, I argued that:
Li Ka-Shing has been an incredible business leader and capital allocator, able to acquire high-quality assets on the cheap and manage them well.
While it is true that Victor Li has now taken over the company, he’s been personally groomed by Li Ka-Shing for over 30 years. Victor is known as a cost cutter and a safe pair of hands.
CK Hutchison has exposure to slow-growing oligopoly industries such as health & beauty retail, port services, utilities, telecom, and energy exploration & production. That said, the return on capital had come down to just 8-9%.
The company suffered during COVID-19 for two separate reasons: a reduction in foot traffic in the company’s retail stores as well as low energy prices, at least during the height of the pandemic in 2020.
I predicted that these challenges would blow over as Omicron spread worldwide and brought some measure of herd immunity to those infected.
Using a sum-of-the-parts approach with a 25% conglomerate discount, I got an intrinsic value of HK$85/share.
However, I also pointed out that if you applied market multiples to each of CK Hutchison’s segments, the calculated intrinsic value would easily exceed the HK$85/share estimate by a wide margin.
I felt at that time that the biggest risk was Li Ka-Shing’s fraught relationship with the top Communist Party leadership. It’s well known that General Secretary Xi Jinping does not like Li Ka-Shing, partly because of his implied support for Hong Kong’s democracy activists and his decision to sell many of his assets in mainland China. On the other hand, CK Hutchison only had 13% total exposure to Hong Kong and China and is no longer incorporated in Hong Kong. It should be seen as a global conglomerate with its main exposure to European infrastructure and telecom assets.
2. Update since early 2022
Since my post on CK Hutchison, the share price has dropped another 24% to HK$42/share:
The headline numbers have been decent, with a rebound in EPS in 2022 but a drop in the first half of 2023:
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