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Morningstar | CK Infrastructure Possible European Asset Spin-Off Is Neutral for No, Dropped APA Bid Lowers Our FVE

Cheung Kong Infrastructure’s, or CKI’s, business strategy has been to build and expand its operations through the acquisition of utility assets with stable and predictable income streams. From its initial core holding in Hong Kong Electric, which is now held through 38.9%-owned Power Assets Holdings, or PAH, CKI now derives more than 60% of its income from its U.K.-based investments. We estimate that its Hong Kong-based activities now make up less than 30% of total profit, with the balance mainly coming from Australia. CKI’s geographically diverse earnings means that it is susceptible to currency headwinds, and the fall in the pound sterling and euro since 2014 has curtailed earnings growth. As these headwinds abate, we think CKI will see earnings growth recover.Regardless, underlying profitability is relatively stable, with its regulated assets subject to government-set returns. This means that exceptional returns on its invested capital are unlikely, but CKI has been able to find efficiencies in certain areas to help bolster returns. This includes benefiting from lower debt cost in some instances, additional returns from the provision of shareholders’ loans to some investee companies, and shared management resources in markets where it owns multiple assets. As a result, the company has been able to sustain a return that is above its cost of capital and to meet its own target internal rate of return on equity of 8%-10%.An attempt in 2015 to merge with PAH was not supported by the latter’s shareholders, and we think the two companies are unlikely to attempt another merger in the near term although with PAH having likely completed the payouts of its excess cash to shareholders, we believe there should be less resistance by minorities. Given the shared assets between the two companies, we would not be surprised to see CKI absorb PAH eventually. In the mean time, we anticipate that CKI will continue to benefit from a stable dividend stream from PAH, and that these funds, as well as CKI’s own cash flow, will be adequate to support future acquisitions.