EUR 850.00 For Business Accounts Only

Morningstar | More Utility Investments Through Economic Benefits Agreements; CKA Balance Sheet Still Strong

CK Hutchison Holdings, or CKHH, announced a transaction involving respective economic benefits agreements with three CK entities. The transaction calls for CK Asset Holdings; or CKA; CK Infrastructure, or CKI; and Power Assets Holdings, or PAH, to pay considerations totaling HKD 22 billion to CKHH, in exchange for 90% of the economic benefits derived from a portfolio of utility businesses held by CKHH. Economic benefits are defined as dividends, proceeds from share buybacks, and interest and principal payments of shareholder loans. The transaction is the economic equivalent of injecting these utility assets into CKA, CKI, and PAH on a proportional basis. The motivation of this transaction is to allow CKHH to maintain reasonable balance sheet leverage after the additional stake acquisition in Wind Tre. CKA, with its strong balance sheet, will take the largest share and is entitled to 40% of the economic benefits in exchange for a consideration of HKD 9.6 billion. The transaction will raise CKA’s earnings by about 3% for 2019 onward. As CKA still derives most of its earnings from the moaty property businesses in Hong Kong, we maintain our narrow economic moat rating for the company. At this point, our fair value estimate of HKD 81 is unchanged.

For CKA, its balance sheet remained solid with net gearing declining to 6% at interim, down from 10% at year-end. The decline in gearing was due to the sales proceeds from the disposal of the Center. Management had stated that the company will continue to seek suitable investment opportunities to deploy the capital, with a focus on recurrent income. However, some degree of reinvestment into real estate development is necessary for CKA, given such projects' quick and high returns, to balance the portfolio of recent utility investments.

Reflecting that, the company successfully won a bid for a development project located next to the Wong Chuk Hang MTR station for HKD 13 billion in early August, the company’s first large land bank acquisition in Hong Kong in two years. With the addition of 40% share in the economic benefits agreements, we expect gearing to increase to mid- to high-single-digit at year-end, still leaving plenty of scope for more land bank acquisitions in Hong Kong, should suitable opportunities arise.

Currently, CKHH, through its wholly owned subsidiaries, holds interests in the following assets: 50% of Park ’N Fly, 40% of Northumbrian Water, 27.5% of Australian Gas Network, 30% of Wales & West Gas, 50% of UK Rails, and 35% of Dutch Enviro Energy. CHKK will bundle these assets together and distribute CKHH’s entitled economic benefits, including dividends, share buyback proceeds, and interest and principal payments received. The proceeds will be distributed pro rata 40%, 30%, and 20% to CKA, CKI, and PAH, respectively. Accordingly, CKA, CKI, and PAH will pay considerations of HKD 9.6 billion, HKD 7.2 billion, and HKD 4.8 billion to CKHH in exchange for the economic benefits.

The portfolio of businesses generated aftertax earnings of HKD 2.0 billion in 2017, with a net asset value of HKD 17 billion. Before the proposed transaction date, CKHH will inject HKD 7 billion in equity by way of capitalizing intercompany loans due to CKHH. Hence, the portfolio of the businesses will generate a ROE of 8.3%, with further upside based on the additional equity injection, resulting in lower interest expenses.