CK Hutchison part 3
Infrastructure segment risk and wrapping up
I mentioned in my article on CK Hutchison, that the group was optimistic on the infrastructure segment.
In this article, I want to dig deeper into infrastructure. The main risk related to energy infrastructure and electricity assets is the supply and price of energy. We saw in the UK that some energy providers went bankrupt because they could not pass on the cost increases to the consumers. I will try to understand better the prospects of this segment and its risks.
Here is the infrastructure segment in a nutshell:
CK Hutchison holds a 75.67% interest in CK Infrastructure Holdings Limited (CKI) (stock code: 1038)
CK Hutchison holds direct infrastructure assets. These represent 1.6% of infrastructure EBIT in 2020, so I am going to stop the analysis there.
CKI has a strong balance sheet with good acquisitions opportunities.
Breakdown of the business:
PAH means power assets holdings, which is mostly UK and Australia. It is a subsidiary of CKI holdings.
Power assets trades at a PE ratio of about 15 and a large dividend yield, showing the market confidence in its prospects.
Last year, CKI conducted some acquisitions, but they are done by the subsidiaries themselves and are small. Usually for shareholders, small acquisitions are better than large ones where there is a risk to overpay and targets are unlisted. CKI subsidiaries also conduct organic growth, for example a new treatment facility, a new pipeline, a new solar farm, pipeline. That is a positive.
The business is segmented by geography and not by category of infrastructure:
The UK business appears to be based mostly on Electricity, Gas and Water distribution.
The Australian Business appears to be mostly Electricity distribution and Gas distribution
The continental Europe is Metering and waste from Energy business
The Chinese business is road tolls and cement.
Risk factors #1 Energy prices
Being aware of the rise in natural gas prices in Europe and Asia, I am concerned about the effect on the Gas and Electricity business of CK Hutchison.
I searched in the annual reports of CK Hutchison, CK Infrastructure, and Power Assets for risk factors and energy prices as keywords. The only risk factor I saw relating to energy prices was the following paragraph from the CK Infrastructure annual report regarding Canadian Midstream Assets:
It was in the news quite a bit that some UK energy suppliers went bankrupt because of fixed prices for customers but free floating costs including natural gas. A web search found this note by Fitch explaining that power Networks are not at risk but Utilities are. CKI owns power networks in the UK.
So the great thing, this risk is not affecting the group. We assume it is the same for Australia networks as it is not in the risk factors.
Risk factors #2 Cement in China:
Luckily China is 4% of revenue including Hong Kong. With the bubble bursting in Chinese real estate, I think that Chinese Cement is probably toast for a few years.
Risk factors #3 Regulatory resets:
A lot of the businesses have had new prices regulated on the downside due to public pressure on spending, inflation, low interest rates. After 2021, this should subside.
However profit growth has taken a hit due to this.
Risk factors #4 Capital allocation:
in 2017, CKI acquired Duet group in Australia for 7.4 Billion AUD, or 15.5 times PE.
in 2018, CKI planned to acquire APA group in Australia for 13 Billion AUD. This was at a 55 PE ratio! I read in a few comments online that Victor Li and CKI had lost the plot for bidding at overvalued prices:
However, I think that the multiple was high is due to D&A and it was at 13.3 times operating cash flow and 3.7% dividend yield.
The acquisition failed and the current market cap is 12 Billion with a dividend yield of 3.6%. The dividend growth is very slow.
I think that the capital allocation is decent but not great in terms of price. The company should grow slowly due to the high prices paid and slow organic growth.
The infrastructure segment of CK Hutchison is a boring slow grower and very defensive part of the business. It does not impair the CK Hutchison undervaluation thesis.
It is not an exciting growth business either, due to regulatory resets hurting profit growth, and we need to see how the small acquisitions will impact next year profits.
Here is an interview by Victor Li describing the value of CKI shares.
We learn that CKI:
..plans to implement several merger and acquisition projects, and it will only accelerate the overall pace when the pandemic eases and it will be easier for CKI to send personnel to conduct on-site due diligence.
However the multiple could be high and provide a weak ROIC like 5% on a 20 Pe ratio for example, plus slow growth.
Conclusion on CK Hutchison:
The company has also a good energy business (I did not cover Cenovus energy but head to Seeking Alpha to read several good write ups - the company has large reserves, refineries, low capex compared to shale oil, and is undervalued Disc:LONG).
CK Hutchison is a very undervalued stable business. However, I do not see a reason to buy and hold CK Hutchison once it would reach a correct PE ratio. This is because the business is unexciting in terms of long term growth. I have many stocks on my buy deck.
If the management team can do some radical changes in the way the business is doing, with stronger growth, less focus on telecom and more on Capex light business, it would be different.
In the Mean time, Asian Century Stock has released an analysis of the company, focusing on many points that I have not covered, like valuation comparisons, shareholders alignment and a detailed history. I highly recommend reading it.
The company has recovered quite a bit of its share price in 2022, like many other value stocks I own like $BTI and Canadian Energy (Cenovus, Vermillion. This is part of a rotation to value and possibly due to improved prospects in the energy segment.
That concludes my review of CK Hutchison, A stock that I plan to hold until a decent PE ratio is attained for the company.
My next piece will be about the great rotation to value and how I am now looking at a few tech niche stocks again to get more growth at a reasonable price into the mix. Growth is always valuable and part of my analysis. Any market correction has some excess to it.
Thanks for reading!
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