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COSCO Pacific (1199.HK): Weak in leasing, offset the divesture good news

Friday, September 7, 2007

7047

COSCO Pacific(1199)

Recommendation on 7 September 2007
Recommendation	Neutral
Price on Recommendation Date	$22.000
Target Price	$22.940

Weekly Special - 2333 Great Wall Motor

Divestiture of the shares in Chong Hing Bank

COSCO Pacific (1199.HK) recently announced that it entered into an agreement to dispose its stakes in Chong Hing Bank for HK$ 2,088mn to COSCO. The transaction was at an implied price of HK$24/share, a 33% premium to the bank’s closing price before this announcement. We think this deal would play a positive role for the long-term development of COSCO Pacific.

1H07 largely in line, still feel lack of drivers

According to its interim results, COSCO Pacific (1199.HK) recorded the profit attributable to the shareholders of US$ 148mn over the period under reviewing, a modest 8.9% up yoy; revenue however decreased by 12.9% to US$ 147mn. The decrease was mainly due to the strategic disposal of containers last year. We think it takes time for the company to expand its container fleet, and it is still not clear whether the company will invest any new terminals in near term.

Outlook remain cautious in 2H07, expect improvement after 2008

Even the affluent cash gained from the disposal of stake in Chong Hing Bank, the cash won’t be on board until next year. Therefore, it means little to the core business profit this year, except for the profit gained from disposal. But from 2008 on, we believe COSCO Pacific can recover its container fleet to a competitive capacity, which helps to improve the profit from container leasing.

Divestiture of the shares in Chong Hing Bank

COSCO Pacific (1199.HK) recently announced that it entered into an agreement with COSCO (Hong Kong) to disposal its stakes in Chong Hing Bank for HK$ 2,088mn. The transaction was at an implied price of HK$ 24/share, a 33% premium to the bank’s closing price before this announcement.

As COSCO Pacific is principally engaging in container leasing and management, terminal operation business, the disposal provides an opportunity for the Group to divest its non-core business, and the proceeds from this disposal can be invested in its core business in the future, primarily to new and existing terminals. It is expected that the Group will realize an estimated gain of approximately US$89mn from the disposal. Although no specific acquisition of new terminals has been finalized so far, we think this deal will play a positive role in the long run.

1H07 largely in line, still feel lack of drivers

According to its interim results, COSCO Pacific (1199.HK) recorded the profit attributable to the shareholders of US$ 148mn under the period under review, a modest 8.9% up yoy; revenue however decreased by 12.9% to US$ 147mn. The proposed interim dividend was HK$24.9 cent/share, representing payout ratio of 51.7%. The drop on revenue was mainly due to the strategic disposal of 600,082 TEUs containers last year. Despite that we see in 1H07 the fleet capacity expanded by 11.78% compared with the capacity at the end of 2006, we think it still takes time for the Group to recover from the lose attributable to disposal of container. Meanwhile, the average utilization rate decreased from 96% of 2006 to 94.6% in 1H07, the lowest since 2003. We are cautious whether the drop is actually an alert for over-supply of container globally.

The container terminal operation business developed stably within 1H07, with total throughput increased by 23% to 18.41mn TEUs. Digging into the three terminal areas, each is developing in different trend. COSCO Pacific has its largest exposure in Bohai Rim terminals, within which the throughput increased by 33.1% to 8,128 TEUs, accounting for 44% of total throughput handled. The Pearl River Delta terminals contributed 5709 TEUs, 30.97% of the total with growth rate of 25.58% yoy; and the throughput handled in Yangtze River Delta terminals has only recorded an insignificant growth of 0.96%. In addition, the port-handling fee in each of terminal areas also differs, although the Ministry of Communications authorized the average level of fees. Geographically, rates in Bohai Rim area are lower than the published fees because of the fierce competition between the medium-sized ports located around Bohai Rim ; the fees in Yangtze River Delta led by Shanghai ports stays in line; and fees in Pearl River Delta ports are above the authorized prices, mainly benefited from cost advantage over Hong Kong terminals. Coupled with the above two factors, we see COSCO Pacific diversifies the its ports operating risk by investing all the three ports area, but with biggest emphasis on fastest developing Bohai Rim, the strategy map remains quite competitive in terms of profitability and growth potential.

From observing the import and export trade index compiled by CEIC database, we see no significant retreat in Chinese export trade in terms of trade value, despite the government is strategically adjusting the country’s economic emphasis by discouraging the export of some resource-consuming industry. The import trade index also indicated a benign import environment.

The policy of Northeast China’s revitalization, we believe will be another strong catalyst to the import demand from north China. We estimate throughput volume of the Group can be largely at the pace CAGR of 24% over the next few years.

Outlook remains cautious in 2H07, expect improvement after 2008

As only four months left for FY07, given the sales proceeds from the disposal of Chong Hing Bank be invested into new terminals, we do not think it would make much profit for this year. But note that the cash won’t be on board until the end of this year. We are still expecting new acquisition of terminals from next year on. Besides, we remain cautious on the outlook of container leasing business. On one hand, it takes time for the Group to expand its container fleet and recovering the drop in profit from the disposal of container assets before; on the other hand, we get in fear that the global container fleet actually is becoming over-supplied. In addition, we are still concerning the potential slow down in US economy would make any negative impact to China’s export trade, even though it is still invisible at this stage.

Valuation

Following a detailed review of COSCO Pacific’s 1H07 interim results, we re-estimate COSCO’s growth rate of terminal business to be40% for this year, followed by 25% for 2008 and 20% for 2009; meanwhile, we increase our estimate of its profit from disposal of associates by 1.5%. Based on our valuation model, combined with the above adjustment, we estimated the EPS of 2007 should be HK$ 1.043 (1.5% up yoy) and HK$1.26 for FY08, respectively. Comparing with the other players, particularly with China Merchant (144.HK), which has the very similar profile and business, we think valuation is justifiable at 22X EPS, where we get our new one-year target price of HK$ 22.94, 11.17% up to our previous TP. We therefore reiterate our NEUTRAL rating on COSCO Pacific.

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COSCO Pacific (1199.HK): Weak in leasing, offset the divesture good news

Divestiture of the shares in Chong Hing Bank

1H07 largely in line, still feel lack of drivers

Outlook remain cautious in 2H07, expect improvement after 2008

Divestiture of the shares in Chong Hing Bank

1H07 largely in line, still feel lack of drivers

Outlook remains cautious in 2H07, expect improvement after 2008

Valuation

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