China Merchants Holdings Pacific

[objective]

It is a good thing that they managed to get financing via the recently issued convertible bond but it is unclear how much they paid DBS for the letter of credit (and interesting why they would need that - isn't China Merchant an SOE?).

The recent acquisition doesn't look cheap - requires a high single digit annual rev growth to make sense - not sure if that is possible. Politically, the trend has been the opposite - govt converting expressways into non-toll roads.

I used to own a good chunk of this stock but have been paring back recently. There are many more interesting yield stocks to own that have better liquidity and less risk (hint: some are in the tech space).

[Nick]

Hi Objective,

Welcome to VB and thanks for sharing your views here.

Beilun Port Expressway is being acquired at 100% gearing implying that a single cent of profit yields infinite ROE. Is this a good way to finance M&A ? The last time an entity attempted to finance an infrastructure investment at 100% gearing was Cityspring acquisition of Basslink in 2007 with series of bank loans and bonds. Since then, it turned to 2 equity fund raising exercise to reduce its gearing. A key difference lies in the capital structure - Beilun M&A will be profitable (approx HK$30 mil core NPAT), the bulk of the cash-flow will be retained at asset and Company level instead of being distributed and hence debt can be repaid in time.

Considering the face value of the bonds is HK$1,163 million and the net proceeds is estimated to be HK$1,133.8 million, I would guess that HK$30 million has gone to DBS for arranging this deal. I believe DBS have higher credit ratings than a typical SOE which is why the coupon rate of 1.25% is much lower than recent 5 year CB issues - 2.5% for Golden Agri and CapitaCommerical Trust.

You are right about the risk. I highly doubt a PRC toll road model is sustainable in the long term. It is likely that in the late 2020s, CM Pacific will have to use their equity and retained earnings to venture into new business if it cannot replenish its portfolio with new roads. We have precedence - CM Pacific was a local hotel stock and then it turned to property player and then into a PRC port player and finally into a toll road player. I guess we have to wait and see how this pans out.

Please feel free to point out any misconceptions I have. Thanks.

[Drizzt]

the china toll road companies have each diversified into property, securities and port businesses.

[objective]

yes - if you consider that toll roads are roughly 20 year concessions, then about 5% of the 'yield' is basically returning you your principal, like an amortising loan. once you adjust for that, the actual yield isn't that high. that's why they either need to keep acquiring other roads, or other businesses

[Drizzt]

i don't think they are returning the amortizing loan or depreciation. What you get as dividends are really their profits after these two items.

technically they are replenishing.

[Nick]

yes - if you consider that toll roads are roughly 20 year concessions, then about 5% of the 'yield' is basically returning you your principal, like an amortising loan. once you adjust for that, the actual yield isn't that high. that's why they either need to keep acquiring other roads, or other businesses

You are mistaking CM Pacific for a REIT or Business Trust.

CM Pacific doesn't pay out all of its cash-flow. The cash-flow (deemed as amortization expense) is retained in the Company. It only pays out its earnings. Using your amortizing loan analogy, it is akin to distributing the loan interest income to your shareholders while retaining the loan principal for future investments. This is why CM Pacific NAV has actually been growing (since some of the profits are retained) while companies that chose to engage in paying out the bulk of its cash-flow in excess of its earnings has seen its NAV plunge - FSLT, K-Green, Cityspring, HWT, HPHT - to name a few.

Looking at their financial figures - since FY 2005 to 1H 2012, they have generated HK$3.056 billion net cash in-flow (after deducting interest and tax expense) and HK$2.025 billion net earnings. In that period, they chose to pay out HK$1.136 billion dividends (excluding HK$0.278 dividend payables to CMG). This figure is clearly less than its NPAT and much lesser than its cash-flow. This enabled it to purchase YTW without raising new equity. As a result, it has seen its NAV grow from HK$3.102 billion in FY 2005 to HK$4.213 billion in 1H 2012. It is clearly not self-liquidating.

If CM Pacific has chosen to go down that route, its dividend yield will probably exceed 20% but that is clearly unsustainable.

[Nick]

The long Chinese Holiday begins and as promised, the China Govt has scrapped toll charges on the entire expressway network in China. This gesture of goodwill has created immense traffic jams around China which may once again highlight the importance of investing in new road capacity and charging tolls to prevent frivolous use. With growing education and country's wealth, the future of toll roads remain uncertain as the waiver of toll fees and failure to renew concession will win support from the masses as a form of social welfare since some of the articles below mentioned that the toll charged in China is one of the highest in the world. Personally, I suspect China will be largely toll-free once the current concessions expires.

Here are some articles from both sides of the camp:

Freedom of road

http://www.chinadaily.com.cn/life/2012-1...794858.htm [Article]

Toll-free holiday for the good of people

http://www.chinadaily.com.cn/china/2012-...793507.htm [Article]

Toll-free roads policy results in traffic jams across China

http://www.chinadaily.com.cn/life/2012-1...796279.htm [Article]

China’s Massive Holiday Traffic Mess

http://www.thedailybeast.com/articles/20...-mess.html [Article]

[Nick]

The EGM to approve the issue of HK$1.163 billion 1.25% CB and the acquisition of Beilun Port Expressway for an initial sum of RMB 890 million will be held on 25 Oct 2012. The circular has been released and it contains details on the proposed M&A target. Based on FY 2011 figures, I expect incremental core NPAT of approximately HK$30 million to CMHP results. Hopefully this figure will grow as debt is repaid at the asset level (reducing interest expense) and traffic volume growth boosting revenue. Crucially, this M&A is being funded solely by debt so the gearing of the Group will rise significantly upon completion.

http://info.sgx.com/listprosp.nsf/bc9c2d...200323d5a/$FILE/China%20Merchant%20Cir_091012.pdf [Circular]

Highway Robbery With Chinese Characteristics

http://blogs.wsj.com/chinarealtime/2012/...teristics/ [Article]

An interesting article highlighting a key risk in toll road investments in China ie govt intervention.

CM Pacific closed at 74.5 cents and the 1H dividend of 2.75 cents will XD on 19 Oct 2012.

(Vested)

[Nick]

China Merchants Holdings (Pacific) reports 7% increase in revenue to HK$418.5 million in 3Q2012

http://info.sgx.com/webcoranncatth.nsf/V...2003F4583/$file/3Q2012-Results.pdf?openelement [SGX Announcement]

http://info.sgx.com/webcoranncatth.nsf/V...2003F4583/$file/3Q2012-PressRelease.pdf?openelement [Press Release]

http://info.sgx.com/webcoranncatth.nsf/V...2003F4583/$file/3Q2012-Add_Info_on_Toll_Road_Operations.pdf?openelement [Toll Ops Info]

http://info.sgx.com/webcoranncatth.nsf/V...2001BDEBD/$file/EGM_Presentation.pdf?openelement [EGM Presentation]

CM Pacific reported relatively stable operating results but was hampered by one off charges resulting in 33% decline in 3Q PATMI to HK$100.1 million. YTW revenue experienced a decline of 1% while profits from its JV remained stable with increase in profits from Guiliu offsetting decline in profits from Guihuang. There was no contribution from Yuyao Highway in FY 2012 and the gain from its disposal will be recognized in 4Q 2012. The property development division in NZ managed to report higher revenues in 3Q and broke even. The Management expects further improvements in the coming quarters from this division. The change in accrual staff expense resulted in one off charges in Sept 2012. There were significantly lower interest income as cash was used to repay debt.

The balance sheet remained healthy but will be increasingly geared after the acquisition of Beilun Expressway. Over the past 12 months, CM Pacific has reduced its consolidated outstanding debt from HK$3.18 billion to HK$2.12 billion currently. It has also paid up the remaining HK$0.57 billion owed to CMG for the acquisition of YTW in July 2011. It collected RMB0.30 billion cash for the sale of Yuyao Highway and the balance RMB0.15 billion will be paid when the disposal is completed in 4Q 2012. Excluding Beilun Expressway, I expect CM Pacific to be debt-free within 2-3 years as it continues to repay the debt facility in the holding company level and the underlying debt in YTW level. Since 3Q 2011, shareholder's equity increased from HK$4.17 billion to $4.38 billion as the Group retains a portion of its profit due to its conservative payout ratio. It holds HK$0.84 billion cash and deposits but it owes dividends to its substantial shareholder amounting to HK$0.28 billion and current tax payables of HK$0.19 billion. The gross gearing (total debt / total assets) is 20%. Personally, this is one aspect of CM Pacific which I find highly attractive - it is able to pay a decent dividend, repay its debt and grow its equity.

CM Pacific continues to generate decent cash-flow from its matured infrastructure assets in 9M 2012. It generated HK$0.63 billion from its core operations (YTW and property development) and received HK$0.32 billion from its JV toll road assets. It has also collected HK$0.36 billion advance payment for the sale of Yuyao Highway. At the same time, it paid HK$0.57 billion to CMG for YTW, HK$1.07 billion debt repayment, HK$0.08 billion interest payment and HK$0.21 billion dividend payment to minority interest in YTW.

Going forward, I expect relatively stable performance though it might be impacted by toll-free holidays and decline in traffic volume if a slow down in the economy strikes. The possibility of unilateral governmental intervention can greatly impact revenue as experienced by MIIF locally. In the long run, the failure to secure new toll roads to replace the concessions expiring in 2020 - 2030 will hinder their business then. A dip in NZ property market will directly impact their property division resulting in larger losses. The acquisition of Beilun Expressway and the issue of the convertible bonds was approved in the EGM yesterday and will further diversify CM Pacific sources of revenue and funding. I suspect the Group will maintain the 5.5 cents dividend going forward while aggressively repaying Beilun debt since this was a 100% geared M&A. CM Pacific closed at 72.0 cents which implies a dividend yield of 7.6% assuming 5.50 cents dividends.

As usual, this represents my own biased views. Feel free to point out any error in the figures or misconceptions in my post.

(Vested)

[Nick]

COMPLETION OF THE PROPOSED ACQUISITION OF NINGBO BEILUN PORT EXPRESSWAY, PEOPLE’S REPUBLIC OF CHINA AND SUPPLEMENTAL AGREEMENT

http://info.sgx.com/webcoranncatth.nsf/V...600327F24/$file/Completion_Announcement.pdf?openelement [Announcement]

CM Pacific should benefit from 7 weeks of contribution from Beilun Port Expressway but partially offset by the interest accrued from the recently issued convertible bonds. The 4Q result will give a clearer picture of the consolidated group's gearing and the terms of the loan facilities.

(Vested)