China Merchant Pacific is a China Toll Road operator listed in Singapore currently spotting a high dividend yield of 6.1%
This morning I went to its AGM and this evening it release its Q1 report. You can view the report here.
Here is a review of the investment thesis and some updates from the AGM.
Before reading this, you may want to revisit some older articles on China Merchant Pacific (CMHP)
- Investing in the economic moat of toll roads: CMHP
- CMHP: Dividend Yield on Track
- Purchase of Beilun
- Purchase of Jiu Rui
Forecast Annual Net Profit
Net profit for the quarter attributable is HKD$ 128 mil versus HKD$ 112 mil last year.
While is dangerous to annualize we should be looking at an estimate of HKD$ 512 mil full year net profit.
If convertible bond is converted (see below), this will save HKD$ 14 mil in interest expense. This will bring a forecast net profit to HKD$ 526 mil if all RCPS and convertible bond is converted.
Forecast Annual Free Cash Flow
Based on the quarterly cash flow statement, as well as 2012 annual cash flow statement, operating cash flow forecast could work out to be HKD$ 1.55 billion annually.
Annual tax expense will come up to HKD $240 mil.
Interest expense paid on debt comes up to HKD $140mil.
This leave a free cash flow of 1550-240-140 = HKD$ 1170 mil for allocation.
Without the conversion of a convertible bond, the gearing of CMHP is rather high.
From the latest quarterly balance sheet, there are 3.4 billion long term debt and 1.65 billion short term debt.
The long term debt is what is left over from the debt used to fund Yong Tai Wen underlying, Yong Tai Wen at the parent level, Beilun underlying.
As of now I have no idea how come there is a large increase in short term debt to 1.65 billion.
Cash stands at $2.2 billion.
Net debt = 3.4 + 1.65 – 2.2 = HKD$ 2.85 billion
The net debt to asset is 20%.
If the 1 billion convertible shares are converted, the net debt will be reduced to HKD $ 1.85 billion
The net debt to asset would be 13%.
AGM: Debt Guidance
What I learn from the AGM today is that the net debt to equity at 40-45% is a worry for much investors.
The CEO Mr Jiang highlighted that, the other toll roads in China are rather geared to the benchmark of 70% net debt to equity.
CMHP have remain conservative by choosing not to go above 60%.
My take is that I always thought this 45% is referring to net debt to asset.
Even if its 60%, the net debt level would have been HKD $4.2 billion, which is 30% net debt to equity.
That is rather low, almost similar to Cache Logistics, Starhub and Frasers Centerpoint Trust
The Extent of Share Dilution
CMHP current outstanding shares is 718 mil shares.
The majority shareholders have 135 mil RCPS shares (preference shares) that is yielding 1.25% that have yet to be converted. They are really doing us a great favor not converting.
In addition as part of the financing capital plan for acquisition of Beilun, a HKD $1014 mil, 1.25% convertible bond. It is convertible at SGD $0.84. At current price of SGD $0.88 it is convertible.
At an exchange rate of 1 SGD to 6.3 HKD, the convertible bond will be converted to 201 mil shares. Converting will reduce the leverage.
If both RCPS and Bonds are converted then total number of shares is 718 + 135 + 201 = 1054 mil shares.
Ability to pay dividends
CMHP pays out SGD 5.5 cents as dividends. At a share price of SGD 88 cents this works out to be a dividend yield of 6.25%.
This could be rather attractive to folks.
To pay out that dividend, they would require HKD$ 246 mil if undiluted.
If diluted due to the conversion of RCPS and bond, they will require HKD$ 365mil.
Based on our forecast net profit of HKD$ 526mil, the undiluted payout ratio is 46%. If diluted, the payout ratio is 69%.
Based on the annual free cash flow projection of HKD$ 1170 mil, both sets of dividends can be paid.
As a gauge, a 6 cents dividend they will require 400 mil. The net profit allows them to pay 7.9 cents dividend if fully diluted. That is a 8.9% earnings yield.
One feature compare to the REITs is that on the parent and underlying level, the debt financing term is very short.
They will have to amortize or pay off debt at Yong Tai Wen and Beilun level.
From the quarterly cash flow statement, the debt repayment profile is as follows
2012 Q1: 329 mil
2012 Q2: 304 mil
2012 Q3: 448 mil
2012 Q4: ? mil
2013 Q1: 466 mil
That is quite an aggressive streak.
The projected free cash flow is 1170 mil. Assume that it is fully diluted, the cash flow after paying off 365 mil in dividend is 805 mil.
This 805 mil will be used towards paying down debts.
Excluding the convertible bond, outstanding debt could be 1.8 bil. With this it will take 2.25 years to pay off all the debt.
The parent can of course delay the RCPS conversion so that debt can be cleared off sooner.
Clearing the debt have the benefits. For one, under the hands of good capital allocators it can be rather useful.
800 mil from T+3 onwards are cash flow that they can redeploy
- can go towards paying more dividends
- Saving to purchase more toll roads
- Other accretive acquisitions
- Repurchase their own shares aggressively
- Yong Tai Wen: 2030, 16.5 years left
- Guiliu: 2024, 10.5 years left
- Guihuang: 2027, 13.5 years left
- Jiurui: 2033, 19.5 years left
- Beilun: 2027, 13.5 years left
The business model revisit
This business model is rather unique in the sense that it looks to me as a financial engineering exercise:
- Used debt to acquire accretive cash flow generating roads with 12-20 year duration with an IRR of > 10%
- Use the cash flow to aggressively pay off the debt in a short duration
- When debt is paid off, the free up cash flow can buy more accretive assets (since there is a lifespan to these toll roads)
The model is different from REITs
- The concession duration is shorter than REIT’s land lease (30 years to free hold)
- The IRR required for the shorter duration is much higher. You would at least expect 12% versus a REITs 4-6%
- REITs pay out 90% of their free cash flow, this model pays out 30% of free cash flow
- Ample room to reduce debt risks
AGM: The prospect of parent converting RCPS and Convertible Bond
Update (28 Apr 2013): A forumer from Valuebuddies management to speak to Mr Jiang after the AGM. One of the question asked was the prospect of RCPS. He indicate that they will convert but the complication of converting is that the Parent owns even more of CMHP.
This means that there might be an impetus to push CMHP shares above 84 cents so that they can be converted. Once that happens, the parent ownership level goes down.
AGM: The appeal of MIIF’s Hua Nan Expressway and management’s evaluation of acquisition prospects
Update (28 Apr 2013): Forumer also highlighted that CMHP have commented that they walked away from Hua Nan Expressway as they see Guangdong province and the pricing presents significant risk for it to be an attractive acquisition.
It has to be a very significant discount before CMP is interested. This for me and most is big because, when you see these purchase of Yong Tai Wen, Beilun and Jiu Rui, you wonder if they are making fast acquisitions not for our benefits.
They could just as easily purchase this expressway. It gives us an idea that a proper evaluation of the price paid versus value the management have taken versus the guys MIMAL.
This also give more confidence in perhaps the cash flow generating ability of Beilun and Jiu Rui.
AGM : No indication from government on toll free national holiday effect
CEO indicate that there are 20 days public holiday that can potentially be toll free for passenger vehicles.
Till now they have not gotten indication from the government that this will affect them.
Share holders were concern that MIIF’s Hua Nan Expressway was very affected by toll revision.
To that, CEO indicate that the reason is Hua Nan’s toll fees are substantially higher than that of theirs.
In any case, 3-4 years ago, government have reduce the tax rates for the toll roads somewhat as a balance to these toll rates revision to balance off.
AGM: Carry trade effect
CEO have indicated that its not quite possible to borrow in the cheaper USD interest rates to finance the purchase of the roads.
In any case, RMB have appreciate annually 3%, so by borrowing cheaper at parent level and gaining cash flow in RMB, they have already made a decent gain.
If you look the other way, a depreciation of RMB will have adverse impact on profits as well.
AGM: Would explore overseas assets
CEO have indicated that if the proposition is attractive, they would consider overseas acquisitions.
AGM: Insurance against calamities are too expensive
The premiums to insure an entire toll road against calamity is too expensive. Further more it does not make sense to insure the whole roads, when perhaps only a section of it will be damage by an earthquake.
Its good to know that there aren’t adverse impact to the roads from toll free holidays, impairments.
I will be worried if Yong Tai Wen does not show some more improve earnings. It does look a mature asset and this quarter have faired a little bit worse.
CMHP is a good yielding stock which is managing its debt in a prudent manner while trying to allocate its capital to purchase more assets.
Based on the actions of the management, I think the profile of the cash flow and dividend could dramatically change 2 years from now.
I do see them paying 5.5 cents for 1 more year and perhaps raise dividend to 6 cents.
In the long run their net debt are likely to be kept in the range of 2.5 billion.