Cheung Kong (Holdings) 1 HK

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1 1 HK PROPERTY HONG KONG Maintained NOMURA INTERNATIONAL (HK) LIMITED Perveen Wong, CFA Action Cheung Kong reported strong FY10 results on Tuesday. We believe the two key positives 1) Hutchison s first dividend uplift since 2000; and 2) Cheung Kong s strong balance sheet, with net debt/equity at only 4.5% put Cheung Kong in pole position to benefit from current housing market conditions and Hutchison s continued re-rating. Maintain BUY. Catalysts Hutchison s first dividend uplift since 2000 should send a strong signal that its 3G turnaround is for real. Anchor themes While we expect home prices in HK to continue to rise in 2011, the risks associated have risen to their highest levels since With four out of five bubble indicators flashing AMBER, rather than chasing housing plays, stocks with re-rating stories and CBD office exposure offer a much better risk/reward balance, in our view. BUY Closing price on 29 Mar HK$122.5 Price target HK$161.6 (set on 28 Jan 11) Upside/downside 31.9% Difference from consensus 5.8% FY11F net profit (HK$mn) 22,421 Difference from consensus -2.1% Source: Nomura Nomura vs consensus Our price target is 6% ahead of consensus. Our target discount of 10% is 4pp narrower than CK s historical 14% discount. Pole position Strong results: Two key positives Cheung Kong reported strong FY10 results. In addition to earnings and DPS that beat both Nomura and consensus estimates, there were two key positives that we believe should help sustain Cheung Kong/Hutchison s re-rating. First dividend uplift by Hutchison since 2000 In our opinion, the most important aspect of today s results was Hutchison raising its DPS by 11%. This marks Hutchison s first dividend uplift since We believe this sends a strong signal to the market that Hutchison s 3G turnaround is for real and that earnings have become sustainable. Cheung Kong net debt/equity at only 4.5% While Hutchison provided the first positive, the second was all Cheung Kong. Helped by strong property sales, Cheung Kong s balance sheet has strengthened, with net debt/equity dropping to 4.5% and net debt falling to only HK$12bn. We believe this gives Cheung Kong significant flexibility in its landbanking approach across both Hong Kong and China. BUY maintained, with HK$ price target We believe these two positives should help maintain, if not compress, Cheung Kong s NAV discount. We continue to base our price target on a 10% discount to end-fy11f NAV. Our HK$ price target represents potential upside of 32%; we maintain our BUY rating on Cheung Kong. Key financials & valuations 31 Dec (HK$mn) FY09 FY10 FY11F FY12F Revenue 24,293 32,863 48,553 39,880 Reported net profit 19,618 26,478 22,421 25,024 Normalised net profit 15,864 21,454 22,421 25,024 Normalised EPS (HK$) Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Gearing (%) Earnings revisions Previous norm. net profit 16,693 20,475 24,827 Change from previous (%) Previous norm. EPS (HK$) Source: Company, Nomura estimates Share price relative to MSCIHK (HK$) Mar10 Apr10 May10 Price Jun10 Jul10 Aug10 Absolute (HK$) Absolute (US$) Relative to Index Market cap (US$mn) Estimated free float (%) 52-week range (HK$) 3-mth avg daily turnover (US$mn) Stock borrowability Rel MSCIHK Sep10 Oct10 Nov10 Dec10 Jan11 Feb m 3m 6m (2.8) (2.9) (0.4) , / Easy Major shareholders (%) Li Ka Shing 42.6 Source: Company, Nomura estimates Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 9 to 13. Nomura 1

2 FY2010 results review Pole position Cheung Kong reported a strong set of FY10 results. As we see it, two key positives should put Cheung Kong in pole position to benefit from current market conditions and Hutchison s continued re-rating: 1) First dividend uplift by Hutchison since ) Very strong balance sheet, with net debt/equity at only 4.5% and net debt at HK$12bn. 1) First dividend uplift by Hutch since 2000 In our view, the most important aspect of the earnings announcement was the first dividend uplift by Hutchison in more than a decade (last time in 2000). Hutchison declared a full-year DPS of HK$1.92, up 11% y-y and higher than consensus forecasts of HK$1.854 (top end at HK$2.00). We believe Hutchison s dividend uplift should send a strong signal that Hutchison s 3G turnaround is for real and that positive earnings contribution should be sustainable (3G reported EBIT of HK$2.9bn vs a HK$8.9bn loss last year). As CK has historically paid out all of the dividends that it receives from Hutchison, plus a bit more of its own, CK s dividend was raised 9.3% to HK$2.95 (Nomura est: HK$2.81; consensus est: HK$2.74). We estimate Cheung Kong now pays out HK$2.97bn of its own earnings, up 15% from 2009 s HK$2.6bn. Exhibit 1. First dividend uplift by Hutchison since 2000 HK$mn 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, e 2012e Dividends rec'd from Hutch (LHS) CK declared dividends (LHS) Source: Company data, Nomura estimates Reflecting the higher dividends at both the Hutchison and Cheung Kong levels, we have upped our FY11 and FY12 DPS estimates by 5% and 6% to HK$3.15 and HK$3.35, respectively. 2) Strong balance sheet, with net debt/equity at only 4.5% While Hutchison s dividends provided the first positive, the second key positive is from Cheung Kong itself. Helped by very strong property sales last year, Cheung Kong s net debt decreased to only HK$12bn as of December 2010 (HK$23.1bn as of December 2009). Compared with Cheung Kong s shareholders funds of HK$265bn, Cheung Kong s net debt/equity is only 4.5%. Nomura 2

3 Exhibit 2. Cheung Kong: net debt and net debt/equity (40,000.0) (35,000.0) (30,000.0) (25,000.0) (20,000.0) (15,000.0) (10,000.0) (5,000.0) 0.0 Net Debt (HK$mn) Net Debt/Equity (%) -20% -18% -16% -14% -12% -10% -8% -6% -4% -2% 0% 1998A 1999A 2000A 2001A 2002A 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A Source: Company data, Nomura research In light of our concerns about bubbles in the Hong Kong housing market, we believe Cheung Kong s near net cash balance sheet gives it a lot of flexibility in landbanking both in Hong Kong and China. In pole position to benefit from Hutchison s re-rating With Cheung Kong s own property business and balance sheet performing well, this should help maintain, if not compress, Cheung Kong s holding company discount, we believe. With Hutchison s consensus-beating dividend uplift likely to sustain its continued re-rating, Cheung Kong should benefit indirectly, in our view. Exhibit 3. Cheung Kong: stub value Exhibit 4. Hutchison share of CK s market cap Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 % 130% 120% 110% 100% 90% 80% 70% 60% 50% 40% Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 CK stake in Hutch / CK Mkt Cap (LHS) Hutch share price (HK$) (RHS) Source: Thomson Reuters Datastream, Nomura research Source: Thomson Reuters Datastream, Nomura research Based on a 10% target discount to end-fy11f NAV, our price target of HK$ (unchanged) represents 32% upside potential. We reiterate our BUY rating on Cheung Kong and continue to view it as a good investment in the Hong Kong housing market, with good option value on Hutchison. Nomura 3

4 Exhibit 5. Cheung Kong: NAV discount 20% 10% 0% -10% -20% -30% -40% -50% Average Disc.= -14% Aug-94 Aug-95 Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 NAV Discount Average Discount Source: Nomura research Exhibit 6. Cheung Kong: NAV breakdown Current NAV End-11 NAV (Hutch at (Hutch at (in HK$mn) Methodology HK$88.80) % NAV HK$106.15) % NAV HK development properties DCF at 8% 65,755 19% 74,171 18% PRC development properties DCF at 8% 39,567 11% 42,733 10% Inv. Prop under dev DCF at 8% 4,863 1% 4,863 1% Investment Properties 47,392 13% 60,070 14%...Residential Cap rate at 4.00% 948 0% 1,042 0%...Commercial Cap rate at 4.25% 23,210 7% 25,824 6%...Office Cap rate at 4.25% 17,980 5% 22,296 5%...Industrial Cap rate at 8.00% 241 0% 253 0%...Service Apt. Cap rate at 4.00% 5,013 1% 5,515 1% Hotels 29,802 8% 30,413 7% Hutchision 189,162 53% 226,121 54% Prosperity REIT 337 0% 337 0% F-REIT 492 0% 492 0% CK Life Science 1,438 0% 1,438 0% Tom Group 404 0% 404 0% Treasury latest book value 6,869 2% 6,869 2% Gross Assets 386, % 447, % Net debt (12,007) -3% (12,007) -3% Other assets/liabilities (19,169) -5% (19,169) -5% Total Net Asset 354, % 416, % Shares in issue (m) 2,316 2,316 NAV per share (HK$) Share price (HK$) Discount -20% -10% Source: Nomura estimates Key changes to our forecasts We have raised our DPS estimates by 5-6% for the next two years to reflect a higher payout by Hutchison as well as Cheung Kong. On the earnings front, we have upped our FY11 estimate by 10% and our FY12 estimate by 1%. Most of the uplift is attributable to higher consensus estimates for Hutchison s earnings. At the Cheung Kong level, we have tweaked down FY11F in favour of FY12F to reflect Cheung Kong s latest 2011 completion schedule. Nomura 4

5 Exhibit 7. Cheung Kong: changes to our estimates Net Profit (HK$mn) DPS (HK$) Forward Target Price 2011E 2012E 2011E 2012E NAV (HK$) Prem/(Disc.) Target (HK$) CK previous estimate 20,475 24, % CK new estimates 22,421 25, % Change 1, % 0.00 Change (%) 10% 1% 5% 6% 0% 0% Hutch previous estimate 20,350 26, Hutch new estimate 24,569 26, Change 4, Change attr. To CK (49.97%) 2, CK's own change Note: Hutchison figures are based on consensus estimates Source: Bloomberg consensus estimates, Nomura estimates Results review Cheung Kong s headline net profit was up 35% y-y to HK$26.5bn. Stripping out contributions from Hutchison and revaluations, Cheung Kong s own earnings were up 26% to HK$11.4bn, beating our forecast HK$9.5bn. The key source of the positive variance was a HK$2.2bn gain from the disposal of mbfc to Suntec REIT that we had not included in our forecasts. Exhibit 8. Cheung Kong: FY10 results snapshot (All figures in HK$mn) Fiscal year to Dec 09A 10A YoY Our Est. Variance Operating profits Property sales 5,501 5,631 2% 5,499 2% Property rental 1,062 1,131 6% 1,141-1% Hotels % % Real estate agency and pty mgmt % 114 0% Investment & Finance 1,411 1,147-19% % Others % % EBIT 8,661 8,821 2% 8,000 10% Net interest expense (233) (222) -5% (190) 17% Operating profit 8,428 8,599 2% 7,809 10% Exceptionals and non-recurring 4,550 8,680 91% 0 na Change in inv. Prop FV 4,550 6,470 42% 0 na Gains/loss on disposals 0 2,210 na 0 na Associates 10,624 14,298 35% 11,225 27% Associates - property sales 2,895 3,271 13% 2,617 25% Associates - property rental % 1,211-43% Associates - hotels % 240-2% Associate - Hutchison +CKLS 6,895 10,106 47% 7,156 41% Profit before taxation 23,602 31,577 34% 19,034 66% Taxation total (3,562) (4,776) 34% (1,979) 141% Profit after Tax 20,040 26,801 34% 17,055 57% Minority Interests (422) (323) -23% (363) -11% Net Profit 19,618 26,478 35% 16,693 59% Reconciliation to underlying net profit Headline net profit 19,618 26,478 35% 16,693 59% Add: Change in FV of Inv Prop (4,550) (6,470) 42% 0 na Add: Deferred tax 796 1,446 82% 0 na Underlying net profit 15,864 21,454 35% 16,693 29% Less: Hutchison 6,810 10,011 47% 7,156 40% Cheung Kong Level Earnings 9,054 11,443 26% 9,537 20% Per share information EPS ($) % % Underlying EPS ($) % % DPS ($) % % Source: Company data, Nomura research Nomura 5

6 Valuation methodology and investment risks Our price target of HK$ is based on a 10% discount to our end-fy11f NAV estimate of HK$ Historically, Cheung Kong has traded at an average 14% discount to NAV with a standard deviation of 10%. Investment risks Cheung Kong has many joint development projects with the MTR Corporation. Profitsharing arrangements for MTR projects are kept under confidentiality arrangements. A larger profit-sharing ratio in favour of MTR Corp could result in earnings disappointment for Cheung Kong. Nomura 6

7 Financial statements Income statement (HK$mn) Year-end 31 Dec FY08 FY09 FY10 FY11F FY12F Investment properties 945 1,155 1,264 1,418 1,563 Property development 13,889 21,513 29,297 44,785 35,823 Hotels/serviced apartments 1,383 1,399 2,037 2,085 2,229 Other Revenue Revenue 16,436 24,293 32,863 48,553 39,880 EBIT contributions Investment properties 829 1,062 1,131 1,276 1,407 Property development 4,466 5,501 5,631 4,616 6,650 Hotels/serviced apartments Other income 402 1,738 1, Management expenses EBITDA 6,167 8,661 8,821 7,389 9,610 Depreciation and amortisation EBIT 6,167 8,661 8,821 7,389 9,610 Net interest expense (454) (233) (222) (361) (418) Associates & JCEs 9,220 10,624 14,298 16,077 16,944 Other income ,277 (0) - Earnings before tax 15,125 19,196 26,174 23,106 26,136 Income tax (2,245) (2,910) (4,397) (608) (614) Net profit after tax 12,880 16,286 21,777 22,498 25,523 Minority interests (201) (422) (323) (76) (498) Other items Preferred dividends Normalised NPAT 12,679 15,864 21,454 22,421 25,024 Extraordinary items 350 3,754 5, Reported NPAT 13,029 19,618 26,478 22,421 25,024 Dividends (5,675) (6,254) (6,833) (7,296) (7,759) Transfer to reserves 7,354 13,364 19,645 15,125 17,265 Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) na Price/book (x) EV/EBITDA (x) EV/EBIT (x) EBIT margin (%) Effective tax rate (%) Dividend payout (%) ROA (pretax %) Growth (%) Revenue (17.9) EBITDA (46.1) (16.2) 30.1 EBIT (46.1) (16.2) 30.1 Normalised EPS (50.8) Normalised FDEPS (50.8) Hutchison dividend uplift is flowing through to Cheung Kong Per share Reported EPS (HK$) Norm EPS (HK$) Fully diluted norm EPS (HK$) Book value per share (HK$) DPS (HK$) Source: Company data, Nomura estimates Nomura 7

8 Cashflow (HK$mn) Year-end 31 Dec FY08 FY09 FY10 FY11F FY12F EBITDA 6,167 8,661 8,821 7,389 9,610 Change in working capital (4,446) 6,235 5,090 11,760 2,392 Other operating cashflow (5,099) (238) (1,150) (908) (996) Cashflow from operations (3,378) 14,658 12,761 18,241 11,007 Capital expenditure (923) (953) (1,000) (1,000) (1,000) Free cashflow (4,301) 13,705 11,761 17,241 10,007 Reduction in investments Net acquisitions (994) 3, Reduction in other LT assets 5,245 (1,699) (2,169) (23) - Addition in other LT liabilities Adjustments (2,744) 1,201 1, Cashflow after investing acts (2,735) 17,020 11,761 17,241 10,007 Cash dividends (857) (545) (2,358) (2,624) (2,591) Equity issue Debt issue 7,722 (9,760) 2,665 (29,764) (4,416) Convertible debt issue Others (2,566) (2,465) 1,656 (3,000) (3,000) Cashflow from financial acts 4,299 (12,770) 1,963 (35,388) (10,007) Net cashflow 1,564 4,250 13,724 (18,147) - Beginning cash 5,609 7,173 11,423 25,147 7,000 Ending cash 7,173 11,423 25,147 7,000 7,000 Ending net debt 37,076 23,066 12, (4,026) Source: Nomura estimates Balance sheet (HK$mn) As at 31 Dec FY08 FY09 FY10 FY11F FY12F Cash & equivalents 7,173 11,423 25,147 7,000 7,000 Properties held for sale 64,273 62,999 65,679 52,974 50,582 Accounts receivable 3,904 2,799 2,459 2,459 2,459 Other current assets 880 2, Total current assets 76,230 79,231 93,877 63,025 60,633 Investment properties 15,670 19,433 21,170 22,440 23,787 Other fixed assets (net) 11,624 10,696 10,399 11,399 12,399 Associates 174, , , , ,786 Other LT assets 5,771 7,470 9,639 9,662 9,662 Total assets 283, , , , ,266 Short-term debt 10,991 9,210 15,127 1, Accounts payable 7,812 12,538 18,945 18,945 18,945 Other current liabilities 768 1, (312) (312) Total current liabilities 19,571 22,776 34,705 20,481 19,377 Long-term debt 33,258 25,279 22,027 5,543 2,231 Convertible debt Other LT liabilities 1,359 2,011 2,390 2,390 2,390 Total liabilities 54,188 50,066 59,122 28,413 23,997 Minority interest 4,342 3,805 3,815 1, Preferred stock Shareholders' Equity 10,489 10,489 10,489 10,489 10,489 Other equity and reserves 214, , , , ,597 Total shareholders' equity 225, , , , ,086 Total equity & liabilities 283, , , , ,266 Strong presales have helped drive gearing to 4.5% Leverage Interest cover Gross debt/property assets (%) Net debt/ebitda (x) net cash Net debt/equity (%) net cash Dupont decomposition Net margin (%) Asset utilisation (x) ROA (%) Leverage (Assets/Equity x) ROE (%) Source: Company data, Nomura estimates Nomura 8

9 Any Authors named on this report are Research Analysts unless otherwise indicated Analyst Certification We, and Perveen Wong, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures Mentioned companies Issuer name Ticker Price Price date Cheung Kong (Holdings) 1 HK HKD Disclosures required in the European Union Stock rating Sector rating 29-Mar Buy Not Rated 4,58 Disclosures 4 Market maker Nomura International plc or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer. Disclosures required in Hong Kong 58 Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer. Previous Rating Issuer name Previous Rating Date of change Cheung Kong (Holdings) Neutral 22-Jan-2010 Cheung Kong (Holdings) (1 HK) Rating and target price chart (three year history) HKD (29-Mar-2011) Buy (Sector rating: Not Rated) Date Rating Target price Closing price 28-Jan Aug Mar Jan Jan-2010 Buy Oct Oct-2009 Neutral Aug Aug-2009Buy Aug Mar For explanation of ratings refer to the stock rating keys located after chart(s) Nomura 9

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A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-asia): MSCI Emerging Markets ex-asia. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. Nomura 10

11 A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008) STOCKS A rating of '1' or 'Strong buy', indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. 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SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector - Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-asia. 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Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Buy' recommendation indicates that upside is between 10% and 20%. A 'Neutral' recommendation indicates that upside or downside is less than 10%. A 'Reduce' recommendation indicates that downside is between 10% and 20%. A 'Sell' recommendation indicates that downside is more than 20%. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Nomura 11

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