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Morningstar | Raising Our Growth Outlook for CK Hutchison but Lowering Our FVE to HKD 118

No-moat CK Hutchison, or CKHH, posted a decent interim performance, with a welcome improvement in its retail operations leading to a 13% rise in EPS. Coupled with the acquisition of the remaining 50% in Wind Tre, its Italian mobile telco asset, we expect CKHH’s free cash flow to grow at a five-year average 5.4%, an improvement over our prior forecast of 5% growth. The company raised its interim DPS by 11.5% and can well afford to increase its payout, although we've kept this at 31% for 6.6% average annual growth, revised up from our prior 6% assumption.  Overall performance was largely in line, with interim net profit making up 48% of our full-year estimated net profit, so we have left our 2018 forecast largely unchanged. However, we lower our fair value estimate to HKD 118 from HKD 125, mainly due to a lower valuation of CKI and some other listed investments. CKHH remains one of our Best Ideas, trading at just 0.7 times price/book with globally leading ports and infrastructure assets. We think the company is relatively well insulated from macroeconomic hiccups.

We tweak our post-2018 earnings forecasts higher by 2%-5% mainly to reflect our revised assumption that revenue per store growth is recovering for its retail arm. This had been declining over the past five years, and the company revealed that its new-format stores, which deploy a stronger social-media push, and loyalty program have helped boost average purchases by 2-3 times. We now expect its retail segment operating income growth to be 180 basis points higher at 4.7% over our projected five-year period. As a result, we now see its retail segment helping to make up for slowing infrastructure and energy segment contribution. The cut in our valuation of CKI is driven mainly by lower post-2018 income on reduced Power Assets Holdings contribution, which is detailed in our update on CKI, dated Aug. 3.

Management highlighted that its ports operation is relatively resilient to ongoing trade war concerns by guiding that if China trade falls to zero, its operating profit would only show a 2% negative impact because activity is likely to pick up elsewhere. Ports segment EBITDA grew 9% in the first half, which is in line with our full-year expectation. Surprisingly, the number of 20-foot equivalent units, or TEUs, handled was flat, which does point to continued competition in our view, but the mix of activity has improved boosting margins. We still forecast a cyclical recovery in ports operating income, with growth to stay strong in 2019 at 9% before slowing, but the tail risk for this has increased if the trade war impact is prolonged and dampens global sentiment.

The main driver of 2019 income growth should come from Wind Tre. Having complete 100% ownership gives CKHH greater control to exact cost cuts, which it indicated has been slower than expected. In addition, Wind Tre should see increased wholesale revenue from the provision of network space to Iliad. Thus, although it has lost customers to Iliad, this is slightly mitigated by higher wholesale income. We have not fully reflected this potential into our numbers yet but will do so in a deeper dive over the next few months.