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Morningstar | SIPG’s 3Q Boosted by Noncore Investments; Port Earnings Remain Weak on Tariff Cut

Shanghai International Port Group’s, or SIPG’s, strong 24% growth in third-quarter net profit to CNY 1.6 billion was mostly boosted by noncore investment. The result, however, implies a 10% fall in its core port earnings in the third quarter, despite a decent 5.5% year-over-year growth in container throughput and marginal 1% improvement in dry-bulk volume. This is in line with our expectations, suggesting a 4.5% fall in average handling tariff following the NDRC’s decision to cut port handling tariffs from November 2017, and it is better than the NDRC guided 19.4% tariff cut for SIPG. While we see rising uncertainty from the prolonged U.S.-China trade war, which may weaken shipping activity, we think SIPG’s diversification into the financial and property businesses (which contributes more than 50% of the company’s bottom line), should offset part of the earnings downside, and we expect the company’s monopoly and the highly developed regional economy to keep the port on a stable growth pace over the midterm.

We maintain both our core profit forecasts and our fair value estimate of CNY 6.50 per share for SIPG, but we fine-tuned our net profit forecast in 2018 to CNY 11.8 billion, to factor in the company’s recent announcement on selling the “Star Harbor” property project with an expected net profit of 1.2 billion. We think the shares are slightly undervalued at the current level, trading at 1.6 times price/book, lower than our valuation of 1.9 times and its 10-year average of 2.3 times price/book, with an estimated 2018 dividend yield of 4.8%.

According to the NDRC, SIPG’s tariff will be cut by 19.4% to CNY 480/TEU. But the cumulative nine-month performance suggests the actual impact was about 4-5% only; perhaps because 1) about 50% of SIPG’s container throughput volume is transshipment and domestic cargos, which are not affected by the tariff cuts; and 2) tariff discounts has been offered to favorable clients and the effective tariff was already lower than the NDRC guided tariff. As such, we estimate the company’s port segment gross profit to fall by CNY 573 million, or 7.6%, in 2018. Positively, SIPG’s diversification into property development is paying off, and we estimate the company’s four property projects should bring a total of CNY 3.4 billion net income during 2018-20, which includes a CNY 1.2 billion net profit from the sale of “Star Harbor” project according to SIPG’s recent announcement. These should help mitigate much of its port income drop, and we expect SIPG’s net income to rise 3% year over year, to CNY 11.8 billion in 2018. The tariff cuts have little impact on our wide moat rating on SIPG, which is underpinned by the company’s well-located port assets, with return on invested capital of 14.2% in 2018, well above the company’s cost of capital of 7.7%.

SIPG's non-port investments have jumped in recent years. Its 6.5% holdings in the Bank of Shanghai places it as the second-largest shareholder of the bank, and it has further expanded its investment in banks via a 4.1% subscription in Postal Savings Bank’s IPO. These investments have brought in a total of CNY 1.1 billion investment income in the third-quarter 2018, making up about 51% of the company’s recurring net profit (versus. 0.5% in 2012). In addition, with a few property projects in the pipeline, we expect SIPG’s property investment to bring over CNY 3 billion net profit to the company in the next three years. As such, we expect SIPG’s non-port investments to continue to be the key growth driver over the next five years.