Hong Kong Conglomerates Sector at tough valuations

The major HK conglomerates (shown below) are now trading at ~0.7x P/B and this compares to their long term historical average of ~1.2x P/B. Despite their defensive nature we believe that the conglomerates have been thrown out with the bathwater, with many names now trading back at their cheapest in over 20 years. We believe that many stocks are trading near distressed levels despite strong recurring cash flows such as Hutchison, Shanghai Industrial, NWD and NWS Holdings.

Examples of refinancing issues have been widespread, none more so than at LVS but Asia's conglomerates historically have had very strong relationships with creditors and have had few or no problems in refinancing. Average net gearing for the regional conglomerates is a modest 38% in 2009E.

As corporate growth slows, we brought down our HK conglomerates' estimates by 33% for 2009 and 20% for 2010 in November. For all our Buys, though, we are cognizant that estimates still need to be cut across the Street before stocks can really rally again.

We have incorporated a WTI oil price of US$60 into our estimates, which reduced our Husky earnings at Hutch by approximately 50% in 2009. The perfect storm hitting Cathay Pacific despite lower oil has affected our earnings at Swire and CITIC. While a weaker CPO price is one more negative factor affecting Jardines’ 09 outlook.

Our rental assumptions for HK property players such as Swire and Wharf now assume retail sales slump in HK and spot rentals fall ~30% in 2009. We have also reduced selling price assumptions (again) for these players and pushed out by a year completion of Hutch’s China property projects (previously expected for 2009).
While the macro situation remains ugly in Macau, LVS' construction delays reduce by 67% and 84% the additional supply of Hotel rooms and Gaming tables that had previously been expected for 2009.

The HK conglomerates have had a history of cutting dividends in previous downturns, and we do expect some names to cut into this cycle. We expect Swire and CITIC Pacific to be the most likely candidates to cut (CITIC is almost guaranteed to cut) due to a mixture of Cathay Pacific and weakness in property.

However we do expect the sector’s 4% dividend yield to be generally more defensible in 2009 than previously. Gearing is lower than in previous cycles, especially for the likes of NWD, Hutch and Jardines, and the companies are generally in stronger positions structurally with regard to their sectors.

New World Development – Reformed Bad Boy: Has a poor track record having cut consistently about when the company was restructured between 1997 and 2001; however, we believe its core earnings are at significantly lower risk in the current cycle. NWS Holdings and NW Department stores in particular will provide the bulk of earnings, and these are fairly resilient to a downturn.

Swire – At risk: Swire cut in 1999 and looks at risk considering the company pays out of core earnings and in 2009, Cathay Pacific and property portfolios will both be struggling.

CITIC Pacific – Set to cut dividend: Cut in 2001 and investors can expect no dividend in 2009 considering AUD $ losses on Accumulators and Cathay Pacific.

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