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27-01-2019, 09:59 PM
There is a common argument these days that there are no more obvious value in the stock market. Charlie Munger would say that it is meant to be difficult if not everyone else would do it. While I don't disagree that general current valuations look rich, there are still cheap stocks out there with a sufficient margin of safety if you are willing to look where no one else looks.
The thesis on 517 HK is a simple one. The current net cash is worth 6.3bn HKD (~1.08bn SGD) which is 50% higher than the current market cap. The company has been a consistent payer of dividends and their dividend payout policy is a minimum payout ratio of 50% although their historical payout ratio has been much higher than this. Current dividend yield based on TTM DPS (0.17 HKD) gives us about 6%. The current cash pile is sufficient to cover this dividend for the next 24 years even if they do not have profits to fund the dividend. So the cash and the dividend gives us protection on the downside.
Now onto earnings, does the company make a profit? Yes they do. While industry trends have not been great in the past few years, 517 HK has recorded profits in every single year since the GFC. 1H 2018 reported an EPS of 0.12 which is similar to 1H 2017. So far so good. To put this into perspective, the performance of Neptune Orient Lines (NOL) during this same period saw losses for several years before it was acquired by CMA CGM in 2015/2016. Using the 2017 EPS, current PE is about 11.9x. The cyclically adjusted PE based on the 10Y average EPS would be about 8.5x, if you believe that current earnings are cyclically low and the 10Y average is reflective of a more sustainable level of earnings.
EPS from 2008 - 2017:
2008: 0.33
2009: 0.56
2010: 0.83
2011: 0.25
2012: 0.24
2013: 0.16
2014: 0.23
2015: 0.22
2016: 0.15
2017: 0.23
So what does the company do? They are basically in the business of providing shipping services of all kind. There are 5 main businesses.
1) Ship Trading Agency Services. They earn a commission for being the middle man in a transaction of a ship. Similar to being a real estate agent. The economics of this business is not great as it largely depends on the cycle and demand has been poor given the oversupply in the market. However, 2017 and 1H2018 so far has seen positive growth in both newbuild and secondhand market so who knows? Maybe we have passed the bottom. Average OPMs are in the 60% range.
2) Marine Insurance. This is a stable but low-growth business as companies need to renew their insurance on their vessels frequently. Nothing fancy but the OPMs have averaged about 70% in the last 5 years. From what I can tell, most of the business is done with the group.
3) Marine Equipment and Spare Parts. Again pretty self-explanatory and they have been growing this business as they try to target customers outside of the COSCO shipping group. The economics here are not great with OPMs at 5% and demand is tied to vessel demand (if there is no demand for the vessel, why bother buying spare parts?)
4) Coatings. Here they manufacture and sell marine coating paint with anti-corrosive characteristics. Here the profitability fluctuates with raw material prices but demand itself is stable as most of it is for maintenance and repairs. They also sell similar products for industrial use and for containers. OPMs are in the low single digit range.
5) Trading business. This is trading mostly for marine fuel and the profits varies with oil price but it accounts for only 4-5% of the profits.
Overall, the business is nothing fancy and not much of a moat around it other than the parent as the captive customer. For most of the businesses, it is not capital intensive and so returns on the underlying business are not bad. Given the huge cash pile, ROE ends up to about 4-5% but ROE excluding cash is in the high teens. The attractive part about the business is the lack of obsolescence risk. Unlike many other industries like banking or retail where the threat of disruption is high, we do not see many tech companies trying to disrupt the shipping industry. It seems pretty likely that the business will still be around in the next few years.
A common question would be "So what is the catalyst?" My answer is I don't know. It could be the company decides to do a big buy back, or the parent company decides that there is no reason for this subsidiary to remain listed and decides to acquire it given the big discount that the market is pricing in. It could be that the shipping industry starts to improve given we have seen much consolidation over the years. My honest opinion would be I don't need a catalyst as long as we have a sufficient margin of safety and we have sufficient amounts of patience to wait for the market to reassess the stock. The net cash alone gives us 50% upside to current share price. Even if I have to wait for 5 years, that works out to about 8.5% p.a. notwithstanding the dividends.
(Needless to say, I am a shareholder with a vested interest in seeing the stock price go up)
For more information:
http://www.coscointl.com/investors/annou...circulars/
The thesis on 517 HK is a simple one. The current net cash is worth 6.3bn HKD (~1.08bn SGD) which is 50% higher than the current market cap. The company has been a consistent payer of dividends and their dividend payout policy is a minimum payout ratio of 50% although their historical payout ratio has been much higher than this. Current dividend yield based on TTM DPS (0.17 HKD) gives us about 6%. The current cash pile is sufficient to cover this dividend for the next 24 years even if they do not have profits to fund the dividend. So the cash and the dividend gives us protection on the downside.
Now onto earnings, does the company make a profit? Yes they do. While industry trends have not been great in the past few years, 517 HK has recorded profits in every single year since the GFC. 1H 2018 reported an EPS of 0.12 which is similar to 1H 2017. So far so good. To put this into perspective, the performance of Neptune Orient Lines (NOL) during this same period saw losses for several years before it was acquired by CMA CGM in 2015/2016. Using the 2017 EPS, current PE is about 11.9x. The cyclically adjusted PE based on the 10Y average EPS would be about 8.5x, if you believe that current earnings are cyclically low and the 10Y average is reflective of a more sustainable level of earnings.
EPS from 2008 - 2017:
2008: 0.33
2009: 0.56
2010: 0.83
2011: 0.25
2012: 0.24
2013: 0.16
2014: 0.23
2015: 0.22
2016: 0.15
2017: 0.23
So what does the company do? They are basically in the business of providing shipping services of all kind. There are 5 main businesses.
1) Ship Trading Agency Services. They earn a commission for being the middle man in a transaction of a ship. Similar to being a real estate agent. The economics of this business is not great as it largely depends on the cycle and demand has been poor given the oversupply in the market. However, 2017 and 1H2018 so far has seen positive growth in both newbuild and secondhand market so who knows? Maybe we have passed the bottom. Average OPMs are in the 60% range.
2) Marine Insurance. This is a stable but low-growth business as companies need to renew their insurance on their vessels frequently. Nothing fancy but the OPMs have averaged about 70% in the last 5 years. From what I can tell, most of the business is done with the group.
3) Marine Equipment and Spare Parts. Again pretty self-explanatory and they have been growing this business as they try to target customers outside of the COSCO shipping group. The economics here are not great with OPMs at 5% and demand is tied to vessel demand (if there is no demand for the vessel, why bother buying spare parts?)
4) Coatings. Here they manufacture and sell marine coating paint with anti-corrosive characteristics. Here the profitability fluctuates with raw material prices but demand itself is stable as most of it is for maintenance and repairs. They also sell similar products for industrial use and for containers. OPMs are in the low single digit range.
5) Trading business. This is trading mostly for marine fuel and the profits varies with oil price but it accounts for only 4-5% of the profits.
Overall, the business is nothing fancy and not much of a moat around it other than the parent as the captive customer. For most of the businesses, it is not capital intensive and so returns on the underlying business are not bad. Given the huge cash pile, ROE ends up to about 4-5% but ROE excluding cash is in the high teens. The attractive part about the business is the lack of obsolescence risk. Unlike many other industries like banking or retail where the threat of disruption is high, we do not see many tech companies trying to disrupt the shipping industry. It seems pretty likely that the business will still be around in the next few years.
A common question would be "So what is the catalyst?" My answer is I don't know. It could be the company decides to do a big buy back, or the parent company decides that there is no reason for this subsidiary to remain listed and decides to acquire it given the big discount that the market is pricing in. It could be that the shipping industry starts to improve given we have seen much consolidation over the years. My honest opinion would be I don't need a catalyst as long as we have a sufficient margin of safety and we have sufficient amounts of patience to wait for the market to reassess the stock. The net cash alone gives us 50% upside to current share price. Even if I have to wait for 5 years, that works out to about 8.5% p.a. notwithstanding the dividends.
(Needless to say, I am a shareholder with a vested interest in seeing the stock price go up)
For more information:
http://www.coscointl.com/investors/annou...circulars/
