Is There Money To Be Made In This Multinational Conglomerate?

Management theories have long been bashers of the conglomerate business structure, but not without valid grounds. They argued that companies should focus on their core competencies, rather than trying to do many things at the same time, as it can be difficult for managers to adequately cope with the different demands of specialised markets. It's a plausible argument, but historical evidence has shown that conglomeration does not necessarily doom investors to sub-par investment performance – think Berkshire Hathaway. The unfocused leviathan helmed by Warren Buffett has given its shareholders an annualised total return of 10.5% since May 1996, representing more than two percentage points above the S&P 500 Index (in USD terms as of 31 May 2017). Berkshire is certainly not an isolated example, and we examine in this article another successful conglomerate that is worth a closer look – CK Hutchison Holdings (HKEX.1).

Multinational Conglomerate Led By Li Ka-shing

While CK Hutchison was only formed in recent years, it is no stranger to investors. Founded by business tycoon Li Ka-shing, the conglomerate originated from two separate companies, Cheung Kong Holdings and its associate firm Hutchison Whampoa. Following a major reorganisation in 2015 aimed at unlocking value for shareholders, the companies were merged to form a new investment holding company, which is the CK Hutchison as we know it today, that commands a market capitalisation of approximately HKD 390 billion (as of 7 June 2017). The property assets of Cheung Kong and Hutchison Whampoa were combined and spun off as Cheung Kong Property Holdings (HKEX.1113), while the non-property businesses were injected into CK Hutchison. Li Ka-shing remains the largest shareholder and serves as the chairman of the newly established entities.

CK Hutchison's five core business segments comprise ports and related services, retail, infrastructure, energy and telecommunications. It is the world's leading port operator, with interests in 48 ports across 25 countries. The conglomerate also operates 13,300 retail outlets across Asia and Europe, under brands such as Watsons, ParknShop supermarkets, and Fortress electrical appliances stores. Through its listed subsidiary Cheung Kong Infrastructure (HKEX.1038), CK Hutchison has investments in various infrastructure assets, with a focus on regulated utilities, providing such services as electricity generation, natural gas distribution and water service provision. It also has significant interests in the energy and telecommunications sectors through its ownership in Husky Energy, one of Canada's largest integrated energy companies, as well as Hutchison Asia Telecommunications, which owns the '3' brand and provides telecommunications services across Asia and Europe.

Here are some reasons why CK Hutchison could find a place in your portfolio.

1. Diversified Asset Portfolio Aids Resilience

CK Hutchison boasts a well-diversified portfolio of businesses across its five core operating segments. While its revenues are generated primarily from its wide network of retail outlets, the conglomerate's fortunes do not depend on any one single source. As such, a prolonged downturn in any one of its division is unlikely to be catastrophic for CK Hutchison, as losses suffered by a struggling business will most probably be offset by the income raked in by its other ventures. In contrast, a major industry downturn will have severe repercussions for pure-play stocks, some of which may not be able to survive the lengthy decline.

Furthermore, CK Hutchison's asset portfolio is spread out across different geographical markets, a plus point for investors given that economic uncertainty or political turbulence in a single country can affect the performance of all stocks in that particular market. Despite having its roots in Hong Kong, the conglomerate has expanded its influence beyond domestic shores over the years. Its operations now span the globe, with exposure to various Asian and European markets (Chart 1).

Chart 1: Business And Geographical Breakdown Of CK Hutchison's Revenues

Diversification has been key to CK Hutchison's resiliency. 2016 shaped up to be a difficult year for companies in the oil and gas industry, many of which are struggling amidst a sustained low price environment that has driven many oil and gas companies to the brink. Husky Energy was also negatively affected by the less than favourable industry conditions, reporting an adjusted net loss of CAD -0.69 per share last year. CK Hutchison, however, was not affected by its loss-making energy unit. In fact, its adjusted earnings per share of HKD 8.61 was a 14.9% increase from 2015, supported by growth in its other business units.

While it does not guarantee against losses, companies with well-diversified asset portfolios often survive a downturn in the markets better than those that are not diversified. In the case of CK Hutchison, diversification has enabled the conglomerate to reduce overall earnings volatility, especially in the face of economic downturns.

2. High-Quality Defensive Businesses Anchor Recurring Income

A large part of CK Hutchison's businesses, including retail, infrastructure and telecommunications, are defensive in nature, operating in industries that are largely insulated from the business cycle, and whose profits are less correlated to the overall strength of the economy. Its network of 13,300 retail outlets across Asia and Europe sell mainly daily necessities, pharmaceutical drugs and mass-market beauty products, which are mostly non-discretionary – items that consumers are unlikely to cut back on even when times are tough. The same could be said of its telecommunications segment, as mobile network and Internet usage are unlikely to decline significantly during cyclical downturns. Its portfolio of utility and user-pay assets under its infrastructure division also tend to generate stable and consistent cash flows.

As a result, CK Hutchison has been able to generate positive free cash flows to equity over the past few years – with the exception of 2011 when it paid down a substantial portion of its debt – which were more than sufficient to support its stable dividend pay-outs (Chart 2). The conglomerate's beta of 0.67 since the reorganisation is also a reflection of its defensive attributes.

Chart 2: Cash Flow Generative Businesses Help Support Stable Dividend Pay-outs

Moreover, most of CK Hutchison's businesses command strong competitive positions in their respective markets. They are typically well-known and established companies that have sound business models, strong balance sheets and cash flows, and have historically shown to generate consistent growth. To name a few, its retail subsidiary A.S. Watson Group, which also counts Temasek Holdings as one of its investors, is the largest retailer of health and beauty products globally, while Cheung Kong Infrastructure is a global infrastructure powerhouse with a portfolio of infrastructure investments that span eight countries. The presence of high barriers to entry in industries like infrastructure or telecommunications, which CK Hutchison has operates in, also ensures that profitability and cash flows are not jeopardised by the potential entry of new competitors.

3. Disciplined Financial Management

CK Hutchison has a strong liquidity position, with its balance sheet flushed with a HKD 156.3 billion cash pile as of end December 2016. The conglomerate also has a fairly high cash ratio of close to 1.0, which means it is able to pay off all its current liabilities using cash. The ratio is above the peer average of about 0.90, and dwarfs that of Jardine Matheson, Wharf Holdings (HKEX.4) and Swire Pacific (HKEX.19), all of which are similar in market capitalisation to CK Hutchison (Table 1). With a net debt-to-equity ratio of 27.8 that is just below the peer average of 28.7, CK Hutchison's balance sheet also does not seem to be excessively leveraged. Its healthy balance sheet and strong cash flow generation should put the conglomerate in good stead to take advantage of any acquisition opportunities that may arise.

Table 1: Strong Financial Standing Relative To Peers

Of interesting note is CK Hutchison's low borrowing costs relative to other conglomerates, due to its investment-grade credit rating and its ability to tap offshore debt markets at a lower cost compared to domestic sources. The conglomerate has also been refinancing its more expensive debt with bonds issued at a much lower coupon rate, which has in turned helped CK Hutchison to lower its interest costs. At 3.95%, CK Hutchison's weighted average fixed coupon rate compares favourably to the peer average of 4.70%, with Jardine Matheson, CITIC and Wharf all having higher borrowing costs of 5.74%, 5.00% and 4.01% respectively.

A Well-Steadied Conglomerate

CK Hutchison had its beginnings as a plastic manufacturer. Through the years, it went from niche to juggernaut, developing itself into a leading real estate investment company and branching out into such diverse businesses as port operations, retail, infrastructure, energy and telecommunications. While its real estate business has since been spun off, CK Hutchison remains a diversified conglomerate that has been flourishing under the leadership of Li Ka-shing, whom at the age of 88 remains in good health to helm his business empire. There will come a time when the 'superman' of Hong Kong hands over the reins to his successors, but even as a changing of the guard gets underway, shareholders can take heart that Li Ka-shing leaves behind a well-steadied ship that will sail through the test of economic hardship and time with much aplomb.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

The Research Team is part of iFAST Financial Pte Ltd.