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Morningstar | SIPG’s Noncore Investment Drives First-Half Growth; Tariff Cut Pressures Port Earnings

Shanghai International Port Group's, or SIPG's, strong 32% growth in first-half net profit to CNY 3.2 billion was mostly boosted by a one-off revaluation gain of its investment in Postal Savings Bank, while recurring earnings remain largely flat, despite 4.6% year-over-year growth in container throughput. This is in line with our expectations, suggesting a 4.5% fall in average handling tariff following the National Development and Reform Commission's, or NDRC's, decision to cut port handling tariffs by 11%-33% for freight-trade cargos at seven major ports. We expect SIPG's port operation gross margin to narrow to 49% in 2018 from 56% in 2017, but we anticipate little impact to the company’s monopoly advantages and maintain our wide moat rating. SIPG's share price has fallen almost 30% since November, reflecting market concerns on earnings because of the tariff cuts and a rising risk of slower growth in global trade from the U.S.-China trade war. We think SIPG's diversification into the financial and property businesses, along with a moderate recovery in import and export demand, 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 medium term.

We maintain our earnings forecasts and our fair value estimate of CNY 6.50 per share for SIPG, and we project the company’s recurring profit to decline 3% to CNY 11.2 billion in 2018. We think the shares are slightly undervalued at the current level, trading at 1.7 times price/book, lower than our valuation of 2 times and its 10-year average of 2.3 times price/book, with an estimated 2018 dividend yield of 4.4%.

According to the NDRC, SIPG’s tariff will be cut by 19.4% to CNY 480 per 20-foot equivalent unit, or TEU. We expect this to reduce the company’s port segment profit by CNY 1.2 billion in 2018, assuming 50% of the company’s container throughput volume comprises transshipment and domestic cargos, which are not affected by the tariff cuts. However, SIPG’s diversification into financial and property development is paying off, and we estimate the launching of four property sales projects in the coming three years should bring a total of CNY 4.8 billion to the company during 2018-20. This should offset most of the drop in port income, and we expect SIPG’s net income to decline only 3% year over year, to CNY 11.2 billion in 2018. We think the tariff cuts will also have little impact on SIPG’s wide economic moat rating, underpinned by the company’s well-located port assets, with return on invested capital of 13.5% in 2018, well above the company’s cost of capital of 7.6%.

SIPG's nonport investments have grown quickly in recent years. Its 6.5% holdings in the Bank of Shanghai place 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 1.9 billion investment income in first-half 2018, making up about 55% of the company’s recurring net profit (versus 0.5% in 2012). As these investments provide additional higher-margin income streams, we project SIPG’s return on invested capital to rise to 13.5% in 2018 from 9.6% in 2012. In addition, with a few property projects in the pipeline, we expect SIPG’s property investment to bring over CNY 2 billion net profit to the company in the next three years. As such, we expect SIPG’s nonport investments to remain the key growth driver over the next five years.

Although SIPG’s income and cash flow stream is sizable enough to stomach continued losses at its Shanghai SIPG football club, this is not looking to be a wise investment and will likely keep international investors wary of the company. The Shanghai SIPG football club saw a net loss of CNY 367 million in first-half 2018. We think the second half may see better performance, with the club in the quarter-finals of the China Super League, and we expect SIPG to achieve break-even earnings for full-year 2018. However, future losses would not surprise us, given the track record of other leading clubs. For example, Guangzhou Evergrande-Taobao Football Club, one of the league’s best teams, posted five years of net losses despite winning silver.