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Morningstar | CSP's Strong 1H Slightly Beats; Raising FVE to HKD 9.80 on Capital Expenditure Cuts

No-moat Cosco Shipping Ports', or CSP's, decent first-half results reveal an accelerating port operation, driven by strong throughput volume growth with benefits from global trade recovery and the Ocean Alliance. The company's core profit rose 70% year over year to USD 169 million in the first half, on the back of strong 26.5% throughput volume growth from a year ago. This is slightly above our expectations, owing to stronger-than-expected throughput growth. We lift our earnings forecasts in 2018 and 2019 by 8% and 3%, respectively, to USD 265 million and USD 298 million, factoring in a 20% drop in U.S. throughput volume because of the trade war. In addition, management is cutting acquisition and capital expenditure plans to USD 751 million from USD 3.3 billion in 2018, and no more than USD 1.2 billion in 2019, because of the uncertainty surrounding the trade war. Despite the reduced investment plans, growth is not likely to be impeded, as the company is already on track to expand its asset base by 60% to USD 9.5 billion by 2020 from USD 6 billion in 2016. As such, we anticipate little change to our throughput and revenue growth assumptions, even with a trade war resolution. Consequently, we raise our fair value estimate to HKD 9.80 per share from HKD 9.30 to reflect the improved cash flows.

Despite the 25% rise in share price over the past two months versus a 2% decline in the Hang Seng Index, we think CSP's shares are still slightly undervalued currently, trading at only 0.6 times price/book, lower than our valuation and its five-year average of 0.7 times price/book. We think the company's low valuation and its visible growth outlook, which targets to increase its terminal assets by 50% by year-end 2021, are attractive. In addition, the slower acquisition pace will improve the company's cash flows, underpinning the upside for dividend payouts.

Overseas ports continue to lead the growth, with throughput volume rising 51% in the first half, driven by initial contributions from Noatum Port in Spain, and strong throughput volume growth at Piraeus Terminals in Greece and Kumport Port in Turkey supported by the establishment of the Ocean Alliance. In addition, CSP also saw its organic growth at domestic terminals accelerate to 9% year over year in the first half, compared with 7% a year ago and 1.3% growth for full-year 2016. This is in line with China's export recovery and reaffirms our view that port activity likely bottomed in second-half 2016. We remain positive on CSP's throughput growth, and we expect the support from both Ocean Alliance and parent Cosco Shipping, as well as a continued recovery in global spending, to drive an average of 6%-8% organic throughput growth over the next five years. However, we think the U.S.-China trade war may add uncertainty in global trade activities in the second half, and we also see risks from foreign exchange movements, as CSP derives the majority of its revenue in Chinese yuan and euro terms, while its reporting currency is the U.S. dollar.

With the aim of encouraging a recovery in foreign trade, the Chinese port sector's antitrust investigations have concluded with 11%-33% handling tariff cuts on foreign-traded cargos for seven major ports from 2018. While the tariff cuts will pressure these port operators' profitability, we think the downside is also limited for CSP. According to the National Development and Reform Commission, the tariff on eastern Shenzhen terminals will be cut to CNY 980 per 20-foot equivalent unit from CNY 1,400, or 30%. We expect overall revenue to be affected by around 3%, as the company’s eastern Shenzhen exposure accounts for only 30% of the group's overall throughput, and 40% of the volumes are transshipment and domestic trade cargos. The company's first-half results also suggest that downside risk is very limited.