We initiate coverage on Westports Holdings Bhd (“WPRTS”)
with an OUTPERFORM call and target price of RM2.85/share. WPRTS is the
operator of Westports, Port Klang, which is situated in close proximity
to the main global shipping lines. Recently, the announcement of an
alliance (P3 alliance) involving three main container lines in the world
is a negative to Westports as CMA CGM, their largest client will reduce
their calls at Westport. However, we believe that the concern is
overdone and we still expect to see growth in throughput in the range of
high single digits to low teens moving forward for WPRTS. Nevertheless,
we are still optimistic due to: (i) favourable shift in global
container trade, (ii) higher-than-average operating efficiency leading
to higher margins, and (iii) sustainable growth on the back of capacity
expansions.
Operator of Westports, Port Klang. Westports, operated by WPRTS is situated in Port Klang, which is in close proximity to the main shipping routes along the Straits of Malacca. It mainly handles container and conventional cargo with other port services such as marine services, rental services and other ancillary services. Since 1996, it has grown their market share of container traffic in Port Klang to 69% over the years. Currently, Westports have six container terminals capable of handling 9.5m TEUs annually with plans to potential to ramp up the capacity up to 16m TEUs per annum.
Favourable shift in industry dynamics. A trend we identified in the industry is the shift of shipping liners’ preferences for larger container ships to achieve higher economies of scale to improve their profitability. Westports have sufficient berth depth and top-notch port infrastructures to handle larger vessels due to their continuous investments in their assets. This will attract more shipping liners to choose WPRTS as transhipment or import/export hub over its peers moving forward.
P3 alliance concern is overdone. Recently investors were concerned with the P3 alliance, which involves CMA CGM, WPRTS’ main client as it may adversely affect the transhipment volume in Wesports. However, we believe that the worse case scenario would be a 500,000 TEUs loss in volume, which we think could be more than compensated from growth in Import/Export volume and other non-P3 transhipment volume (China-Africa, China-Middle East and Intra-SEA routes) and in our base case scenario we have factored in 300,000TEUs loss in P3 volume in FY15E.
Port operator with better than average efficiency. Operationally, Westports is one of the most efficiently run ports in the container port handling industry with higher crane and berth productivity than Northport and Port of Singapore (PSA), which is one of the key competitors of Westports in this industry. On top of that, WPRTS has a higher terminal utilisation rate than its closest competitor, which is situated next to Westports in Port Klang. This shows that the management is efficient in managing its operations leading to the higher profitability. In 2012, WPRTS achieved the highest net profit margin among its peers. (33% vs. peers’ average of 21%)
Long term value with sustainable growth. Using a 2-stage dividend discount model (DDM) based on: (i) first stage growth rate of dividends per share of 10% from FY15 to FY22, (ii) terminal growth rate of 1.3%, (iii) cost of equity of 7.3%, and (iv) beta of 0.6, which is the average adjusted beta of NCB and BIPORT, its peers listed on Bursa Malaysia, we derived a target price of RM2.85/share, implying a potential upside of 12.6%. Given that its valuation is broadly in line with peers on PER basis with forward CY14 PER at 19.6 vs. peer average of 21.0x, we believe that a premium valuation is justifiable for WPRTS given its: (i) higher than average FY12 ROE of 24.4% vs peer average of 15.3% (ii) better than average operational efficiency and (iii) sufficiently deep water berth for transhipment using larger vessels.
1. Investment Merit
Defensive business with growth prospects. We initiate coverage on Westports Holdings Bhd (“WPRTS”) with a OUTPERFORM call and derived a fair value of RM2.85 using two-stage DDM, based on cost of equity of 7.3%, dividend per share growth rate of 10% from 2015 to 2022 and terminal growth rate of 1.3%, implying a potential upside of 12.6%. Valuation of WPRTS is fair on PER basis with forward FY14 PER of 19.6x compared to weighted peer average of 21.0x. We believe that there is long-term value in this stock because: (i) it gives decent net dividend yield of 3.3%, (ii) has potential for growth with capacity expansions which could potentially bring its capacity to 16m TEUs per annum, (ii) better than average operational efficiency and margins, and (iii) defensive business with secured long-term concession.
Strategic port location. Westports, which is operated by WPRTS, is located in Port Klang and is in close proximity to the main shipping route along the Straits of Malacca, one of the busiest waterways in the world. Although both Northport and Westports are located in Port Klang, Westports stands at an advantageous position against Northport geographically as it can be accessed using the southern approach, which has a deeper channel as compared to Northport’s which relies solely the northern approach. This allows larger ships to enter Port Klang through Westports. Adding to their advantage, the time required to go into and depart from Westports’ terminal is one hour lesser as compared to using the northern approach. With shipping liners preferring larger ships due to higher economies of scale and cost management crucial in the uncertain shipping charter market, we believe that Westports will be the preferred port to access Port Klang moving forward and this will in turn benefit WPRTS in terms of container traffic growth.
Throughput will be affected by P3 alliance, but growth is intact. Transhipment volume in Westports will be hit if the P3 alliance is approved by the authorities in 2014 as WPRTS’ main customer, CMA will reduce its vessel calls in the port from ten to six. However, we believe that the concern on this is overdone as the potential P3 transhipment volume that will be diverted is expected to be at 500,000 TEUs in 2015 in the worst case scenario as guided by the management. We believe that WPRTS will still able to deliver what we have imputed in our forecast which implies high single-digit growth in throughput due to: (i) higher growth from other routes (China-Africa, China-Middle East and Intra-SEA routes), (ii) possibly higher volume per vessel calls by CMA which implies that the volume drop for Westports may not be directly proportional to drop in vessel calls, and (iii) high efficiency of Westports with reasonable port tariffs.
Long-term concession secured with robust expansion potential. Under the Privatisation Agreement with Government of Malaysia and Port Klang Authorities (PKA), WPRTS’ concession period for operating and maintaining Westport will be ending in 31 August 2024, which gives at least 11 years of earnings certainty to WPRTS. On top of that, the government has agreed to extend the concession up to 2054, subject to fulfilment of certain conditions, including completion of works of new terminals within a specified timeline. WPRTS is planning to add three more container terminals (CT6, CT7 & CT8) on top of its six existing terminals, which will increase its capacity for container cargo by 68% to 16m TEUs per annum from 9.5m TEUs per annum currently. Given the bright growth prospects for container throughput especially in the SEA region, WPRTS may be able to continue growing both their top line and bottom line at a higher rate than the global container traffic growth rate in the future.
One of the most efficient port operators in the world. In an environment where cost management is crucial for Malaysian ports where tariffs are regulated by the relevant authorities, Westports stands out among its regional peers with a terminal utilisation rate at 76%, second only to Port of Tanjung Pelepas (PTP) in the Straits of Malacca. On top of that, Westport’s crane and berth productivity are in the top three lists among its global peers. This shows that WPRTS, Westport’s is a strong operator which in turn translates into higher profitability. We believe that with an excellent management team in place, WPRTS’ profits will be able to sustain its growth in the long run as more capacities are added along the way.
Ample room for tariff increases. Malaysian ports such as Westports and PTP have lower container tariffs in general than Singapore port due to capacity constraints in Singapore and price regulation of tariffs by the Malaysian government. Compared to Singapore, WPRTS’ import/export tariffs rate is 36% lower whereas for transhipment tariffs WPRTS average rate is 51% cheaper. In the event that ports in Malaysia reach full capacity and relationships with global shipping clients improves further, we believe there is a lot of room for upward revisions of tariffs by the authorities and Westports will definitely benefit in terms of revenue growth.
Port Klang, proxy to secular Malaysian growth story. With 10m TEUs of throughput in 2012, Port Klang, where Westports is situated is ranked the 12th largest container port in the world. Its throughput accounted for 4% of the total throughput in the top 15 container ports globally. As for Malaysian total traffic, Port Klang has the highest market share at 48% followed by PTP at 36%. For Import/Export (gateway) traffic, Port Klang has 50% market share and this bodes well for WPRTS as a large portion of their container revenue is from gateway traffic. Since 2001, gateway traffic has grown at a CAGR of 6% and we have noticed that there is strong correlation between Malaysian GDP growth and growth in gateway traffic. In the past, WPRTS’ throughput growth is above the growth in overall gateway traffic and Malaysian GDP growth with CAGR of 13.2% in period from 2002 to 2012. With expected GDP growth of 5.5% and 5.7% in 2014 and 2015 respectively, we believe that WPRTS’ throughput is poised to register growth of 8% in both of the years which is reasonable looking at historical numbers.
The most profitable port among similar container port operators. In 2012, WPRTS achieved the highest net profit margin (33%) excluding construction revenue and management fee among its peers. This indicates that WPRTS is arguably the port operator with the best cost management in the container industry despite limitations on the container tariffs which is capped by the authorities. We believe that this is due to the management’s top class capability and investments in best-in-class port infrastructure like twin-lift quay cranes with the longest outreach for ship-to-shore gantry cranes available and advanced IT solutions like COSMOS, their container terminal operations systems.
3. Industry Outlook
Container industry outlook
Containerisation. Since 1950s, containerisation is used as a mode of transportation of goods mainly due to its cost effectiveness. Containerisation coverage has expanded to a wide spectrum of products with industrial products, chemicals, agricultural commodities, raw materials, refrigerated goods and project cargo.
Players going bigger. The expansion of international merchandise trade demands vessels with larger sizes to get better economies of scale and lower unit costs. Due to the advance of technology, vessels are getting bigger with average container vessel size increasing three-fold in the past two decades. Large vessels with capacity of more than 18,000 TEUs are now sailing the seas. WPRTS’ container terminals have maximum berth depth of 17.5m and CT6 terminal, which commenced operations in March 2013, is able to handle larger vessels with capacities up to 18,000 TEUs. Therefore, in the long run, WPRTS will benefit from the trend as more and more players start switching to vessels of bigger size.
Resilient growth in global container market. According to Drewry Maritime Advisors, global container throughput has increased at a CAGR of 8.4% from year 2000 to 2012 until the global financial crisis hit the global economy in late 2008. In 2009 the global container throughput dropped 9% YoY as trade was adversely affected by the economic downturn. However, the container market staged a recovery in 2010 with container throughput growing by 15% YoY over 2009. Since then, container volumes have resumed their growth. Drewry Maritime Advisors has projected growth of 5-6% per annum to 678.2m TEUs by 2014 and further growth at the similar growth rate to 716.8m TEUs in 2015, primarily driven by Far East and SEA regions.
Rising prominence of Far East and SEA regions. In terms of global container trade, the Far East region’s share of global container throughput has increased over time, approaching 39% in 2012 with a CAGR of 10.5% from 2002 to 2012, which is 2.2 percentage points higher than the world CAGR in the same time period. South East Asia (SEA) region’s share of global volume, on the other hand, remained constant around 14% since early 1990s. However, we expect global container traffic for the SEA region to grow in excess of the world as the ASEAN Economic Community (AEC) will start in 2015. With more intra-region and inter-region trades expected, this will drive the container traffic up in the region.
Port Klang, proxy to secular Malaysian growth story. With 10m TEUs of throughput in 2012, Port Klang, where Westports is situated, is ranked the 12th largest container port in world. Its throughput accounted for 4% of the total throughput in the top 15 container ports globally. As for Malaysian total traffic, Port Klang has the highest market share with 48% followed by PTP at 36%. For Import/Export (gateway) traffic, Port Klang has 50% market share and this bodes well for WPRTS as a large portion of their container revenue is from gateway traffic. Since 2001, gateway traffic has grown at a CAGR of 6%.
More growth in transhipment traffic. Port Klang and PTP dominate Malaysian transhipment volumes but PTP has a higher share of total volume than Port Klang. Since 2001, both transhipment traffic of Port Klang and PTP has grown at CAGRs in excess of 13%, which is much higher than CAGR of gateway traffic of Malaysia. We expect Port Klang’s container traffic to continue growing at similar pace in the coming years and its share of total Malaysian container volume may increase as PTP reaches full capacity. This will spur growth for WPRTS as their throughput growth is closely related to the growth of Port Klang container traffic as Northport, its neighbour, is constrained by capacity.
Conventional cargo port industry in Malaysia overview
Conventional- Dry Bulk and Liquid Bulk. Aside from container cargo services, WPRTS also provides conventional services like dry bulk, liquid bulk(petroleum & petrochemical products), break bulk services, Roll-on Roll-off (RORO) services (wheeled cargo, such as automobiles) and cement services.
Growth drivers of conventional - Dry Bulk Import and Crude Oil Export. The dry bulk segment in Malaysia is mainly driven by imports at Malaysian ports, the biggest supplier being Indonesia. With inflation expected to remain stable amid decent GDP growth, volume for dry bulk, which is tied to imports in Malaysia is expected to grow at rates similar to historical rates. As for liquid bulk, the main driver of trade is the export of crude oil by Malaysia mainly to Australia and several Asian economies. Malaysia also imports crude oil, especially from Middle East and Vietnam. However, Malaysia imports are more inclined to petro-products meaning refined petroleum products. Although the market environment for dry and liquid bulk remains uncertain, we expect these segments to continue growing albeit at a lower rate amidst bleak shipping industry outlook.
For Import/ Export conventional cargo volume to continue growing. The primary hinterland for WPRTS’ conventional cargo mainly consists of industrial zones located in Selangor and Negeri Sembilan, which drive the demand for dry bulk and break bulk cargo. On the other hand, as for liquid bulk, the demand is mainly derived from major international oil marketing, refining and chemical storage firms operating tank farms in WPRTS’ terminal. With the Malaysian economy growing rather strongly despite global macro headwinds, the conventional cargo industry is expected to continue growing at a healthy rate and this will benefit WPRTS as well in terms of conventional cargo volume.
5. Comparison with peers
Competing against Northport, its neighbour, for Import/Export traffic. WPRTS is facing competition mainly from three container port terminals, namely Northport, PTP and PSA (Ports of Singapore Authority) which are all located in Straits of Malacca along the major East-West Trade lane. Like WPRTS, Northport is situated at Pork Klang and we believe that WPRTS’ closest competitor for Import/ Export container traffic is Northport because of its proximity to WPRTS. Both Westport and Northport are close to the capital city of Kuala Lumpur with several industry parks and suburban areas in immediate vicinity.
PTP, the main competitor for transhipment. However, for transhipment traffic volume which usually involves larger container ships, Northport does not compete with WPRTS due to the depth limitation of Northport, which is only 12 metres. Westport, on the other hand, has a channel of at least 17 metres deep. Therefore, shipping lines with container ships that require more than 12 metres of water depth will have to enter Port Klang using the southern approach where WPRTS operates. The main competitors for WPRTS on transhipment container volumes are PTP and the Port of Singapore.
Efficiency at the top end. In terms of terminal utilisation, WPRTS is higher than Northport and PSA but lower than PTP. On the other hand, WPRTS is better than all three of its peers in terms of crane productivity at 148,932 TEU per crane per annum. For berth productivity, WPRTS is more efficient than both Northport and PSA and on par with PTP. Overall, this shows that for terminal productivity, WPRTS is better than most of its peers and is on par with PTP. This is evident that WPRTS’ management has done an excellent job on managing the Westport terminal which made it one of the most efficiently managed container ports in the world. This is expected to make customer retention and acquisition easier for WPRTS as compared to its peers.
WPRTS has no problem of capacity constrain. For WPRTS, there is room for capacity expansion as there is still empty land in the area where WPRTS operates for more container terminals (CT7, CT8 and CT9) with total planned area of 169.5ha to be developed. However, for Northport, all of the land nearby is occupied and at the moment they are unable to expand their capacity through building of more container terminals. This puts WPRTS in a better position to benefit from the growth of container traffic in Port Klang moving forward as more capacity additions start to kick in the next few years. This makes us confident that WPRTS’ share of total Port Klang container traffic will increase in the future and this will definitely drive its container throughput growth higher.
WPRTS, bigger than Northport in dry bulk and liquid bulk. Among the ports for conventional cargo, WPRTS has the longest berth size of approximately three km. On top of that, WPRTS has more superior infrastructure in terms of capacity than Northport for dry bulk terminal with longer berth length, number of jetties and higher maximum draft. Same goes for the liquid bulk terminal with WPRTS having larger capacities. However, for the break bulk terminal, Northport has slightly longer berth length and number of berths than WPRTS. We opine that WPRTS is moving in the right direction as the dry bulk and liquid bulk made up for a significant amount of total Import/Export cargo as compared to break bulk cargo for Malaysia in 2011 and there is more room for growth for WPRTS in those segments than Northport.
One of the fastest growing and most profitable ports. With a CAGR of 22% for its top line for the period 2010-2012, WPRTS is one of the fastest growing ports among its peers, similar to Shanghai Port, which is the world’s top container terminal in 2012, and second only to POT, which has a slightly higher CAGR of 24% in the same time period according to Drewry Maritime Advisors. Moreover, WPRTS achieved the highest net margin among its peers in 2012. This shows that WPRTS is the best in class in terms of managing costs and one of the fastest growing companies in 2010-2012.
Container tariff regulated, making cost management crucial. For both Northports and Westports, the maximum published tariffs are the same as they are regulated by the Port Klang Authority. However, PSA’s tariff rates for laden Import/Export traffic are more than two times of those of Westports and PTP (51% higher) due to space constrain and long-term relationship with major clients. On the other hand, Westports and PSA have similar rates for empty Import/Export traffic but PTP’s rate is lower. As for transhipment tariffs for both laden and empty container traffics, Westports has lower rates than PTP and Singapore in general. This shows that there is still ample room for upward adjustment of tariffs for this segment by Port Klang Authorities in the future when traffic volume grows to a point where there is insufficient capacity to satisfy the demand which will in turn benefit WPRTS.
6. Financial Analysis
a) P&L
Container handling services, the main revenue driver. In 2012, container revenue accounted for 82% of total operational revenue, which excludes construction revenue. This makes WPRTS a port operator with businesses skewed to container handling services. The 2nd biggest contributor to WPRTS’ operational revenue is conventional revenue, which makes 10% of the total revenue. Therefore, growth in container and conventional cargo volume is crucial for WPRTS’ growth in the top line.
Double-digit top line growth driven by container and conventional revenue. Revenue excluding construction revenue has grown at CAGR of 12.1% from 2010 to 2012 due mainly to 13% CAGR of core revenue, including container and conventional services revenue in the same time period. On top of that, higher revenue per tonne for break bulk and liquid bulk segments has also contributed to the growth in top line. On the other hand, marine services revenue grew at a lower CAGR of 6.1% while rental revenue remained flattish during the past three years. Construction revenue experienced phenomenal growth from 2010 to 2012 with a 3-year CAGR of 35.8% due to more construction works of port-related infrastructure under the Privatisation Agreement with the relevant authorities. We believe that the surge in construction revenue is mainly due to land reclamation works done for CT6 and CT7 and construction works of CT6 Phase II wharf and yard zones.
Construction revenue distorts gross margins. Excluding construction revenue and cost, WPRTS’ gross profit margin has remained steady in the range of 54-58% in the period from 2010 to 2012, with 3-year gross profit CAGR of 8.9% due to higher container volume and conventional revenue. However, if construction revenue and cost are included in the analysis, gross margin would drop 11.7 percentage points in the same period from 56.5% to 44.8% as construction revenue does not contribute to the gross profit of WPRTS as the construction works of Westports’ infrastructure are contracted out to third parties, leading to construction revenue and costs being equal.
Drop in other incomes affecting PBT margin. PBT margin dropped 9.5 percentage points from 38.6% to 29.1% in the same period of time due to lower other incomes and higher administration & other expenses. We believe that the main reason causing the drop in PBT is the decline in other incomes (which is down 34.4% in 2012 from 2010). The other income primarily consists of payments due from conventional cargo customers being unable to meet guaranteed conventional throughput commitments and investment gains on mostly money market instruments. However, we believe that as throughput improves and utilisation rates on new capacities improve, PBT margin will improve subsequently. On top of that, lower other income also means more customers are able to meet their commitments which in turn are positive for WPRTS.
Net profit benefiting from tax allowances. Despite a drop in PBT from 2010 to 2012, the net margin dropped at a slower rate due to higher tax allowance and incentives as a result of Investment Tax Allowance on CAPEX spending on capacity expansions resulting in lower effective tax rate.
b) Balance sheet
Analysis of gearing ratios. As of 30 June 2013, WPRTS’ outstanding borrowings stand at RM700m, which consists of 20-year Sukuk Musharakah Medium Term Note (SMTN II) with available issuance of an aggregate nominal value of RM2b. This implies a gearing ratio of 0.46.
Improving working capital position. WPRTS has been managing their working capital well in the period of 2010-2012. Total receivables turnover days dropped to 60 days in FY12, representing 20% drop from 75 days in FY10 due to improved customer collection whereas trade payable turnover days remained flattish for the same time period. This indicates that WPRTS is managing its working capital well.
7. Key Assumptions and Earnings Estimates
Revenue to grow in line with expected global traffic growth. We expect WPRTS’ revenue to grow to RM1,729.6m in FY14, implying a 2-year CAGR of 7.6% on the assumptions of: (i) total container throughput 2-year CAGR of 8.2%, (ii) stable container revenue per TEU due to government control, and (iii) 5.2% assumed 3-year CAGR of conventional revenue. We believe that our revenue assumptions are justified given that the expected global container traffic throughput growth in the next two years will be at the range of 5%-6% which is in line with what we have assumed.
Earning growth to be robust. We have projected WPRTS’ net profit to grow at 2-year CAGR of 10.4% from FY12 to FY14 driven by: (i) growth in container throughput and conventional cargo volume, (ii) savings of management fee due to termination of Management Service Agreement, and (iii) improvement utilisation rate in container terminals.
Tax incentives to continue. On the other hand, we have also assumed 8% effective tax rate for the same period as we expect them to continue enjoying the tax allowance and incentives from CAPEX as in previous years as they have plans to add three more container terminals in the next 10 years, which results in higher CAPEX.
Gearing up for expansions. We expect WPRTS to draw down RM200m and RM100m in FY13 and FY14 from SMTN facility respectively to fund capacity expansions as we do not think that the free cash flow generated by the company per annum is sufficient as they are likely to pay out 75% of their profits to the shareholders. Based on our forecasts, the gross debt/equity ratio is expected to be maintained at c. 0.4x in FY13 and FY14 in order to sustain the expansion of terminals.
Decent dividend yield on 75% payout. In the prospectus, the management has indicated that they may pay out at least 75% of the profits to the shareholders annually. Based on our calculations, we expect WPRTS to pay out dividends of 8.3 sen and 9.7 sen a share for FY13 and FY14, respectively, implying 3.3% and 3.8% dividend yield at the current share price. Given that the company still have plans to expand capacity in the medium-term, we do not think that the dividend payout ratio will exceed 75% in the next few years.
8. Valuation/Recommendation
DDM to value the stock. Given that the company is expected to pay out 75% or more out of their profits for dividends and based on its defensive business model, we think that the DDM is the most suitable method to value WPRTS.
OUTPERFORM with target price of RM2.85 based on 2-stage dividend-discount model valuation. We derived a fair value of RM2.85 per share, implying a potential upside of 12.8% from the current price at the time of writing. This is based on cost of equity of 7.3% (beta of 0.6 which is derived from the average adjusted beta of NCB and BIPORT and market risk premium of 5.9%). For the first stage, we have imputed a growth of 10% annually on the dividends per share starting from FY15 extending to FY22 as we believe that earnings will grow substantially as capacity utilisation improves. Subsequently, we have assumed a terminal growth rate of 1.3% which we believe is a conservative assumption to arrive at the terminal value.
9. Risks
Failure to maintain Privatisation Agreements. WPRTS has a Privatisation Agreement with Government of Malaysia (GOM) and Port Klang Authority (PKA) to maintain and operate Westports and comply with all plans, policies and their directives which contain certain clauses for termination of agreement. In the event of non-compliance of certain obligations and covenants, they will terminate the Privatisation Agreement. On top of that, GOM has the right to terminate the Privatisation Agreement without any reason if they consider that it is necessary to safeguard the national interest. We believe that the risk of this happening is minimal given WPRTS’ robust track record and plans to expand capacity in their terminals in Port Klang.
Unavailability of tax incentives and exemptions from GOM. Currently, WPRTS is eligible for certain tax incentives and exemptions from GOM for CAPEX with certain conditions to be satisfied when the incentives are in effect. If the conditions are not met before the expiry dates of the tax allowance, these exemptions and allowances will no longer be available to WPRTS and this will affect their bottom line adversely. WPRTS are entitled to claim the Investment Tax Allowance (ITA) between Year of Assessment 2010 and Year of Assessment 2014. WPRTS intends to apply for an extension of qualifying period from GOM to Year of Assessment 2019. We are confident of their ability to secure the extension as they are expected to continue their CAPEX spending in similar magnitudes with the past for the next few years for capacity expansion, which fulfils one of the conditions set in the Privatisation Agreement with the authorities.
Loss of major customers. WPRTS’ largest customer, CMA CGM Group, the world’s third largest container shipping group, has contributed more than 10% of the group’s total revenue for FY10-FY12. On top of that, the group’s top five largest clients accounted for 40.4% of their total revenue over the same time periods. If WPRTS is unable to retain its major customers, future revenue will be impacted substantially and subsequently profits will drop substantially if they are unable to replace their major customers in time. However, given WPRTS’ top class efficiency and strong track record, we believe that the group will be able to retain their major customers in the long term assuming that they are able to maintain their track record and performance.
P3 alliance. The P3 alliance involves the three largest container carriers in the world: MAERSK, MSC & CMA CGM with total TEUs of 2.6m, which comprises of 15% of the total global fleet. MAERSK is expected to have more control in the alliance as it takes up the highest share of P3 network fleet volume. Due to be approved by authorities possibly in 2H14, P3 is expected to cause a loss of container volume in Port Klang as the alliance will see total weekly services (Asia-EU and Asia Mediterranean) shrinking from 30 to 26, with vessel calls in Westports reducing from 10 to 5. This has raised concerns in the market as the outlook for growth in WPRTS will be uncertain in 2015.
Things might not be as bad as expected. Currently, CMA contributes c. 1.5m TEUs of container traffic to Westports with P3 volume at 1m TEUs which is 14% of Westports total volume in FY12. As vessel calls will be cut into half, the management indicates that the worst case scenario will be a loss of 500,000 TEUs volume in 2015, which translates into 7.2% of total 2012 volume. However, we believe that this may not be the case as the volume drop might be offset by higher volume per vessel, which also makes sense for CMA to improve efficiency and reduce costs. Therefore, we believe that the drop in volume will not be linear and it might be in the range of 250,000-300,000 range. Notwithstanding, it is premature to assess the impact of the volume drop now on WPRTS’s bottom line as the alliance is yet to be approved and most of it is expected to be only felt by WPRTS in 2015.
Do not ignore growth from other routes. Apart from Asia-EU and Asia Mediterranean services, CMA still has several routes with promising growth prospects: China-Africa, China-Middle East and Intra-SEA routes. Despite the uncertainties in the global market, we believe that these routes have ample room for growth in the long-run and this may help to cushion volume losses from Asia-EU and Asia Mediterranean routes. In the period up to 9M13, the volume from these routes is growing at double digits and we believe that it is sustainable in the long run. Therefore, we are still confident that WPRTS will make up for the losses and given that it is one of the most efficiently container ports in the world, its fundamentals remain intact.
Overcapacity in global shipping industry. There is a risk of overcapacity in the global container shipping market as according to Drewry Maritime Advisors, the amount of new container ships on order as of June 2013 was equivalent to 19.7% of the then existing global container fleet capacity. As a result, we cannot discount of the possibility of excess capacity in the industry for the next few years which might trigger a drop in container freight rates and subsequently shipping lines will pressure container terminal operators to provide lower pricing or reduce shipping volume to cut costs. However, looking at the tariff rates complied by Drewry Maritime Advisors, WPRTS has cheaper pricing compared to PTP and PSA, which puts WPRTS in a position whereby the downward pressure in pricing might be lower than the other two. Better still, we think that WPRTS might even benefit from the overcapacity as more shipping lines may switch to Port Klang from PTP and PSA for transhipment as they seek to lower costs through choosing lower ports with lower tariffs.
10. Appendix
Company background
Westport began operations in 1996, handling container and conventional cargo besides providing a variety of port services: marine services, rental services and other ancillary services. Besides growing to control 69% of container traffic in Port Klang and 34% in Malaysia with facilities about 25 berths, Westport is also principally involved in investment holding and provision of management services to their subsidiaries WMSB, and VTCM. The principal activity of WMSB is port development and management of port operations while VTCM is a dormant entity.
Source: Kenanga
Operator of Westports, Port Klang. Westports, operated by WPRTS is situated in Port Klang, which is in close proximity to the main shipping routes along the Straits of Malacca. It mainly handles container and conventional cargo with other port services such as marine services, rental services and other ancillary services. Since 1996, it has grown their market share of container traffic in Port Klang to 69% over the years. Currently, Westports have six container terminals capable of handling 9.5m TEUs annually with plans to potential to ramp up the capacity up to 16m TEUs per annum.
Favourable shift in industry dynamics. A trend we identified in the industry is the shift of shipping liners’ preferences for larger container ships to achieve higher economies of scale to improve their profitability. Westports have sufficient berth depth and top-notch port infrastructures to handle larger vessels due to their continuous investments in their assets. This will attract more shipping liners to choose WPRTS as transhipment or import/export hub over its peers moving forward.
P3 alliance concern is overdone. Recently investors were concerned with the P3 alliance, which involves CMA CGM, WPRTS’ main client as it may adversely affect the transhipment volume in Wesports. However, we believe that the worse case scenario would be a 500,000 TEUs loss in volume, which we think could be more than compensated from growth in Import/Export volume and other non-P3 transhipment volume (China-Africa, China-Middle East and Intra-SEA routes) and in our base case scenario we have factored in 300,000TEUs loss in P3 volume in FY15E.
Port operator with better than average efficiency. Operationally, Westports is one of the most efficiently run ports in the container port handling industry with higher crane and berth productivity than Northport and Port of Singapore (PSA), which is one of the key competitors of Westports in this industry. On top of that, WPRTS has a higher terminal utilisation rate than its closest competitor, which is situated next to Westports in Port Klang. This shows that the management is efficient in managing its operations leading to the higher profitability. In 2012, WPRTS achieved the highest net profit margin among its peers. (33% vs. peers’ average of 21%)
Long term value with sustainable growth. Using a 2-stage dividend discount model (DDM) based on: (i) first stage growth rate of dividends per share of 10% from FY15 to FY22, (ii) terminal growth rate of 1.3%, (iii) cost of equity of 7.3%, and (iv) beta of 0.6, which is the average adjusted beta of NCB and BIPORT, its peers listed on Bursa Malaysia, we derived a target price of RM2.85/share, implying a potential upside of 12.6%. Given that its valuation is broadly in line with peers on PER basis with forward CY14 PER at 19.6 vs. peer average of 21.0x, we believe that a premium valuation is justifiable for WPRTS given its: (i) higher than average FY12 ROE of 24.4% vs peer average of 15.3% (ii) better than average operational efficiency and (iii) sufficiently deep water berth for transhipment using larger vessels.
1. Investment Merit
Defensive business with growth prospects. We initiate coverage on Westports Holdings Bhd (“WPRTS”) with a OUTPERFORM call and derived a fair value of RM2.85 using two-stage DDM, based on cost of equity of 7.3%, dividend per share growth rate of 10% from 2015 to 2022 and terminal growth rate of 1.3%, implying a potential upside of 12.6%. Valuation of WPRTS is fair on PER basis with forward FY14 PER of 19.6x compared to weighted peer average of 21.0x. We believe that there is long-term value in this stock because: (i) it gives decent net dividend yield of 3.3%, (ii) has potential for growth with capacity expansions which could potentially bring its capacity to 16m TEUs per annum, (ii) better than average operational efficiency and margins, and (iii) defensive business with secured long-term concession.
Strategic port location. Westports, which is operated by WPRTS, is located in Port Klang and is in close proximity to the main shipping route along the Straits of Malacca, one of the busiest waterways in the world. Although both Northport and Westports are located in Port Klang, Westports stands at an advantageous position against Northport geographically as it can be accessed using the southern approach, which has a deeper channel as compared to Northport’s which relies solely the northern approach. This allows larger ships to enter Port Klang through Westports. Adding to their advantage, the time required to go into and depart from Westports’ terminal is one hour lesser as compared to using the northern approach. With shipping liners preferring larger ships due to higher economies of scale and cost management crucial in the uncertain shipping charter market, we believe that Westports will be the preferred port to access Port Klang moving forward and this will in turn benefit WPRTS in terms of container traffic growth.
Throughput will be affected by P3 alliance, but growth is intact. Transhipment volume in Westports will be hit if the P3 alliance is approved by the authorities in 2014 as WPRTS’ main customer, CMA will reduce its vessel calls in the port from ten to six. However, we believe that the concern on this is overdone as the potential P3 transhipment volume that will be diverted is expected to be at 500,000 TEUs in 2015 in the worst case scenario as guided by the management. We believe that WPRTS will still able to deliver what we have imputed in our forecast which implies high single-digit growth in throughput due to: (i) higher growth from other routes (China-Africa, China-Middle East and Intra-SEA routes), (ii) possibly higher volume per vessel calls by CMA which implies that the volume drop for Westports may not be directly proportional to drop in vessel calls, and (iii) high efficiency of Westports with reasonable port tariffs.
Long-term concession secured with robust expansion potential. Under the Privatisation Agreement with Government of Malaysia and Port Klang Authorities (PKA), WPRTS’ concession period for operating and maintaining Westport will be ending in 31 August 2024, which gives at least 11 years of earnings certainty to WPRTS. On top of that, the government has agreed to extend the concession up to 2054, subject to fulfilment of certain conditions, including completion of works of new terminals within a specified timeline. WPRTS is planning to add three more container terminals (CT6, CT7 & CT8) on top of its six existing terminals, which will increase its capacity for container cargo by 68% to 16m TEUs per annum from 9.5m TEUs per annum currently. Given the bright growth prospects for container throughput especially in the SEA region, WPRTS may be able to continue growing both their top line and bottom line at a higher rate than the global container traffic growth rate in the future.
One of the most efficient port operators in the world. In an environment where cost management is crucial for Malaysian ports where tariffs are regulated by the relevant authorities, Westports stands out among its regional peers with a terminal utilisation rate at 76%, second only to Port of Tanjung Pelepas (PTP) in the Straits of Malacca. On top of that, Westport’s crane and berth productivity are in the top three lists among its global peers. This shows that WPRTS, Westport’s is a strong operator which in turn translates into higher profitability. We believe that with an excellent management team in place, WPRTS’ profits will be able to sustain its growth in the long run as more capacities are added along the way.
Ample room for tariff increases. Malaysian ports such as Westports and PTP have lower container tariffs in general than Singapore port due to capacity constraints in Singapore and price regulation of tariffs by the Malaysian government. Compared to Singapore, WPRTS’ import/export tariffs rate is 36% lower whereas for transhipment tariffs WPRTS average rate is 51% cheaper. In the event that ports in Malaysia reach full capacity and relationships with global shipping clients improves further, we believe there is a lot of room for upward revisions of tariffs by the authorities and Westports will definitely benefit in terms of revenue growth.
Port Klang, proxy to secular Malaysian growth story. With 10m TEUs of throughput in 2012, Port Klang, where Westports is situated is ranked the 12th largest container port in the world. Its throughput accounted for 4% of the total throughput in the top 15 container ports globally. As for Malaysian total traffic, Port Klang has the highest market share at 48% followed by PTP at 36%. For Import/Export (gateway) traffic, Port Klang has 50% market share and this bodes well for WPRTS as a large portion of their container revenue is from gateway traffic. Since 2001, gateway traffic has grown at a CAGR of 6% and we have noticed that there is strong correlation between Malaysian GDP growth and growth in gateway traffic. In the past, WPRTS’ throughput growth is above the growth in overall gateway traffic and Malaysian GDP growth with CAGR of 13.2% in period from 2002 to 2012. With expected GDP growth of 5.5% and 5.7% in 2014 and 2015 respectively, we believe that WPRTS’ throughput is poised to register growth of 8% in both of the years which is reasonable looking at historical numbers.
The most profitable port among similar container port operators. In 2012, WPRTS achieved the highest net profit margin (33%) excluding construction revenue and management fee among its peers. This indicates that WPRTS is arguably the port operator with the best cost management in the container industry despite limitations on the container tariffs which is capped by the authorities. We believe that this is due to the management’s top class capability and investments in best-in-class port infrastructure like twin-lift quay cranes with the longest outreach for ship-to-shore gantry cranes available and advanced IT solutions like COSMOS, their container terminal operations systems.
3. Industry Outlook
Container industry outlook
Containerisation. Since 1950s, containerisation is used as a mode of transportation of goods mainly due to its cost effectiveness. Containerisation coverage has expanded to a wide spectrum of products with industrial products, chemicals, agricultural commodities, raw materials, refrigerated goods and project cargo.
Players going bigger. The expansion of international merchandise trade demands vessels with larger sizes to get better economies of scale and lower unit costs. Due to the advance of technology, vessels are getting bigger with average container vessel size increasing three-fold in the past two decades. Large vessels with capacity of more than 18,000 TEUs are now sailing the seas. WPRTS’ container terminals have maximum berth depth of 17.5m and CT6 terminal, which commenced operations in March 2013, is able to handle larger vessels with capacities up to 18,000 TEUs. Therefore, in the long run, WPRTS will benefit from the trend as more and more players start switching to vessels of bigger size.
Resilient growth in global container market. According to Drewry Maritime Advisors, global container throughput has increased at a CAGR of 8.4% from year 2000 to 2012 until the global financial crisis hit the global economy in late 2008. In 2009 the global container throughput dropped 9% YoY as trade was adversely affected by the economic downturn. However, the container market staged a recovery in 2010 with container throughput growing by 15% YoY over 2009. Since then, container volumes have resumed their growth. Drewry Maritime Advisors has projected growth of 5-6% per annum to 678.2m TEUs by 2014 and further growth at the similar growth rate to 716.8m TEUs in 2015, primarily driven by Far East and SEA regions.
Rising prominence of Far East and SEA regions. In terms of global container trade, the Far East region’s share of global container throughput has increased over time, approaching 39% in 2012 with a CAGR of 10.5% from 2002 to 2012, which is 2.2 percentage points higher than the world CAGR in the same time period. South East Asia (SEA) region’s share of global volume, on the other hand, remained constant around 14% since early 1990s. However, we expect global container traffic for the SEA region to grow in excess of the world as the ASEAN Economic Community (AEC) will start in 2015. With more intra-region and inter-region trades expected, this will drive the container traffic up in the region.
Port Klang, proxy to secular Malaysian growth story. With 10m TEUs of throughput in 2012, Port Klang, where Westports is situated, is ranked the 12th largest container port in world. Its throughput accounted for 4% of the total throughput in the top 15 container ports globally. As for Malaysian total traffic, Port Klang has the highest market share with 48% followed by PTP at 36%. For Import/Export (gateway) traffic, Port Klang has 50% market share and this bodes well for WPRTS as a large portion of their container revenue is from gateway traffic. Since 2001, gateway traffic has grown at a CAGR of 6%.
More growth in transhipment traffic. Port Klang and PTP dominate Malaysian transhipment volumes but PTP has a higher share of total volume than Port Klang. Since 2001, both transhipment traffic of Port Klang and PTP has grown at CAGRs in excess of 13%, which is much higher than CAGR of gateway traffic of Malaysia. We expect Port Klang’s container traffic to continue growing at similar pace in the coming years and its share of total Malaysian container volume may increase as PTP reaches full capacity. This will spur growth for WPRTS as their throughput growth is closely related to the growth of Port Klang container traffic as Northport, its neighbour, is constrained by capacity.
Conventional cargo port industry in Malaysia overview
Conventional- Dry Bulk and Liquid Bulk. Aside from container cargo services, WPRTS also provides conventional services like dry bulk, liquid bulk(petroleum & petrochemical products), break bulk services, Roll-on Roll-off (RORO) services (wheeled cargo, such as automobiles) and cement services.
Growth drivers of conventional - Dry Bulk Import and Crude Oil Export. The dry bulk segment in Malaysia is mainly driven by imports at Malaysian ports, the biggest supplier being Indonesia. With inflation expected to remain stable amid decent GDP growth, volume for dry bulk, which is tied to imports in Malaysia is expected to grow at rates similar to historical rates. As for liquid bulk, the main driver of trade is the export of crude oil by Malaysia mainly to Australia and several Asian economies. Malaysia also imports crude oil, especially from Middle East and Vietnam. However, Malaysia imports are more inclined to petro-products meaning refined petroleum products. Although the market environment for dry and liquid bulk remains uncertain, we expect these segments to continue growing albeit at a lower rate amidst bleak shipping industry outlook.
For Import/ Export conventional cargo volume to continue growing. The primary hinterland for WPRTS’ conventional cargo mainly consists of industrial zones located in Selangor and Negeri Sembilan, which drive the demand for dry bulk and break bulk cargo. On the other hand, as for liquid bulk, the demand is mainly derived from major international oil marketing, refining and chemical storage firms operating tank farms in WPRTS’ terminal. With the Malaysian economy growing rather strongly despite global macro headwinds, the conventional cargo industry is expected to continue growing at a healthy rate and this will benefit WPRTS as well in terms of conventional cargo volume.
5. Comparison with peers
Competing against Northport, its neighbour, for Import/Export traffic. WPRTS is facing competition mainly from three container port terminals, namely Northport, PTP and PSA (Ports of Singapore Authority) which are all located in Straits of Malacca along the major East-West Trade lane. Like WPRTS, Northport is situated at Pork Klang and we believe that WPRTS’ closest competitor for Import/ Export container traffic is Northport because of its proximity to WPRTS. Both Westport and Northport are close to the capital city of Kuala Lumpur with several industry parks and suburban areas in immediate vicinity.
PTP, the main competitor for transhipment. However, for transhipment traffic volume which usually involves larger container ships, Northport does not compete with WPRTS due to the depth limitation of Northport, which is only 12 metres. Westport, on the other hand, has a channel of at least 17 metres deep. Therefore, shipping lines with container ships that require more than 12 metres of water depth will have to enter Port Klang using the southern approach where WPRTS operates. The main competitors for WPRTS on transhipment container volumes are PTP and the Port of Singapore.
Efficiency at the top end. In terms of terminal utilisation, WPRTS is higher than Northport and PSA but lower than PTP. On the other hand, WPRTS is better than all three of its peers in terms of crane productivity at 148,932 TEU per crane per annum. For berth productivity, WPRTS is more efficient than both Northport and PSA and on par with PTP. Overall, this shows that for terminal productivity, WPRTS is better than most of its peers and is on par with PTP. This is evident that WPRTS’ management has done an excellent job on managing the Westport terminal which made it one of the most efficiently managed container ports in the world. This is expected to make customer retention and acquisition easier for WPRTS as compared to its peers.
WPRTS has no problem of capacity constrain. For WPRTS, there is room for capacity expansion as there is still empty land in the area where WPRTS operates for more container terminals (CT7, CT8 and CT9) with total planned area of 169.5ha to be developed. However, for Northport, all of the land nearby is occupied and at the moment they are unable to expand their capacity through building of more container terminals. This puts WPRTS in a better position to benefit from the growth of container traffic in Port Klang moving forward as more capacity additions start to kick in the next few years. This makes us confident that WPRTS’ share of total Port Klang container traffic will increase in the future and this will definitely drive its container throughput growth higher.
WPRTS, bigger than Northport in dry bulk and liquid bulk. Among the ports for conventional cargo, WPRTS has the longest berth size of approximately three km. On top of that, WPRTS has more superior infrastructure in terms of capacity than Northport for dry bulk terminal with longer berth length, number of jetties and higher maximum draft. Same goes for the liquid bulk terminal with WPRTS having larger capacities. However, for the break bulk terminal, Northport has slightly longer berth length and number of berths than WPRTS. We opine that WPRTS is moving in the right direction as the dry bulk and liquid bulk made up for a significant amount of total Import/Export cargo as compared to break bulk cargo for Malaysia in 2011 and there is more room for growth for WPRTS in those segments than Northport.
One of the fastest growing and most profitable ports. With a CAGR of 22% for its top line for the period 2010-2012, WPRTS is one of the fastest growing ports among its peers, similar to Shanghai Port, which is the world’s top container terminal in 2012, and second only to POT, which has a slightly higher CAGR of 24% in the same time period according to Drewry Maritime Advisors. Moreover, WPRTS achieved the highest net margin among its peers in 2012. This shows that WPRTS is the best in class in terms of managing costs and one of the fastest growing companies in 2010-2012.
Container tariff regulated, making cost management crucial. For both Northports and Westports, the maximum published tariffs are the same as they are regulated by the Port Klang Authority. However, PSA’s tariff rates for laden Import/Export traffic are more than two times of those of Westports and PTP (51% higher) due to space constrain and long-term relationship with major clients. On the other hand, Westports and PSA have similar rates for empty Import/Export traffic but PTP’s rate is lower. As for transhipment tariffs for both laden and empty container traffics, Westports has lower rates than PTP and Singapore in general. This shows that there is still ample room for upward adjustment of tariffs for this segment by Port Klang Authorities in the future when traffic volume grows to a point where there is insufficient capacity to satisfy the demand which will in turn benefit WPRTS.
6. Financial Analysis
a) P&L
Container handling services, the main revenue driver. In 2012, container revenue accounted for 82% of total operational revenue, which excludes construction revenue. This makes WPRTS a port operator with businesses skewed to container handling services. The 2nd biggest contributor to WPRTS’ operational revenue is conventional revenue, which makes 10% of the total revenue. Therefore, growth in container and conventional cargo volume is crucial for WPRTS’ growth in the top line.
Double-digit top line growth driven by container and conventional revenue. Revenue excluding construction revenue has grown at CAGR of 12.1% from 2010 to 2012 due mainly to 13% CAGR of core revenue, including container and conventional services revenue in the same time period. On top of that, higher revenue per tonne for break bulk and liquid bulk segments has also contributed to the growth in top line. On the other hand, marine services revenue grew at a lower CAGR of 6.1% while rental revenue remained flattish during the past three years. Construction revenue experienced phenomenal growth from 2010 to 2012 with a 3-year CAGR of 35.8% due to more construction works of port-related infrastructure under the Privatisation Agreement with the relevant authorities. We believe that the surge in construction revenue is mainly due to land reclamation works done for CT6 and CT7 and construction works of CT6 Phase II wharf and yard zones.
Construction revenue distorts gross margins. Excluding construction revenue and cost, WPRTS’ gross profit margin has remained steady in the range of 54-58% in the period from 2010 to 2012, with 3-year gross profit CAGR of 8.9% due to higher container volume and conventional revenue. However, if construction revenue and cost are included in the analysis, gross margin would drop 11.7 percentage points in the same period from 56.5% to 44.8% as construction revenue does not contribute to the gross profit of WPRTS as the construction works of Westports’ infrastructure are contracted out to third parties, leading to construction revenue and costs being equal.
Drop in other incomes affecting PBT margin. PBT margin dropped 9.5 percentage points from 38.6% to 29.1% in the same period of time due to lower other incomes and higher administration & other expenses. We believe that the main reason causing the drop in PBT is the decline in other incomes (which is down 34.4% in 2012 from 2010). The other income primarily consists of payments due from conventional cargo customers being unable to meet guaranteed conventional throughput commitments and investment gains on mostly money market instruments. However, we believe that as throughput improves and utilisation rates on new capacities improve, PBT margin will improve subsequently. On top of that, lower other income also means more customers are able to meet their commitments which in turn are positive for WPRTS.
Net profit benefiting from tax allowances. Despite a drop in PBT from 2010 to 2012, the net margin dropped at a slower rate due to higher tax allowance and incentives as a result of Investment Tax Allowance on CAPEX spending on capacity expansions resulting in lower effective tax rate.
b) Balance sheet
Analysis of gearing ratios. As of 30 June 2013, WPRTS’ outstanding borrowings stand at RM700m, which consists of 20-year Sukuk Musharakah Medium Term Note (SMTN II) with available issuance of an aggregate nominal value of RM2b. This implies a gearing ratio of 0.46.
Improving working capital position. WPRTS has been managing their working capital well in the period of 2010-2012. Total receivables turnover days dropped to 60 days in FY12, representing 20% drop from 75 days in FY10 due to improved customer collection whereas trade payable turnover days remained flattish for the same time period. This indicates that WPRTS is managing its working capital well.
7. Key Assumptions and Earnings Estimates
Revenue to grow in line with expected global traffic growth. We expect WPRTS’ revenue to grow to RM1,729.6m in FY14, implying a 2-year CAGR of 7.6% on the assumptions of: (i) total container throughput 2-year CAGR of 8.2%, (ii) stable container revenue per TEU due to government control, and (iii) 5.2% assumed 3-year CAGR of conventional revenue. We believe that our revenue assumptions are justified given that the expected global container traffic throughput growth in the next two years will be at the range of 5%-6% which is in line with what we have assumed.
Earning growth to be robust. We have projected WPRTS’ net profit to grow at 2-year CAGR of 10.4% from FY12 to FY14 driven by: (i) growth in container throughput and conventional cargo volume, (ii) savings of management fee due to termination of Management Service Agreement, and (iii) improvement utilisation rate in container terminals.
Tax incentives to continue. On the other hand, we have also assumed 8% effective tax rate for the same period as we expect them to continue enjoying the tax allowance and incentives from CAPEX as in previous years as they have plans to add three more container terminals in the next 10 years, which results in higher CAPEX.
Gearing up for expansions. We expect WPRTS to draw down RM200m and RM100m in FY13 and FY14 from SMTN facility respectively to fund capacity expansions as we do not think that the free cash flow generated by the company per annum is sufficient as they are likely to pay out 75% of their profits to the shareholders. Based on our forecasts, the gross debt/equity ratio is expected to be maintained at c. 0.4x in FY13 and FY14 in order to sustain the expansion of terminals.
Decent dividend yield on 75% payout. In the prospectus, the management has indicated that they may pay out at least 75% of the profits to the shareholders annually. Based on our calculations, we expect WPRTS to pay out dividends of 8.3 sen and 9.7 sen a share for FY13 and FY14, respectively, implying 3.3% and 3.8% dividend yield at the current share price. Given that the company still have plans to expand capacity in the medium-term, we do not think that the dividend payout ratio will exceed 75% in the next few years.
8. Valuation/Recommendation
DDM to value the stock. Given that the company is expected to pay out 75% or more out of their profits for dividends and based on its defensive business model, we think that the DDM is the most suitable method to value WPRTS.
OUTPERFORM with target price of RM2.85 based on 2-stage dividend-discount model valuation. We derived a fair value of RM2.85 per share, implying a potential upside of 12.8% from the current price at the time of writing. This is based on cost of equity of 7.3% (beta of 0.6 which is derived from the average adjusted beta of NCB and BIPORT and market risk premium of 5.9%). For the first stage, we have imputed a growth of 10% annually on the dividends per share starting from FY15 extending to FY22 as we believe that earnings will grow substantially as capacity utilisation improves. Subsequently, we have assumed a terminal growth rate of 1.3% which we believe is a conservative assumption to arrive at the terminal value.
9. Risks
Failure to maintain Privatisation Agreements. WPRTS has a Privatisation Agreement with Government of Malaysia (GOM) and Port Klang Authority (PKA) to maintain and operate Westports and comply with all plans, policies and their directives which contain certain clauses for termination of agreement. In the event of non-compliance of certain obligations and covenants, they will terminate the Privatisation Agreement. On top of that, GOM has the right to terminate the Privatisation Agreement without any reason if they consider that it is necessary to safeguard the national interest. We believe that the risk of this happening is minimal given WPRTS’ robust track record and plans to expand capacity in their terminals in Port Klang.
Unavailability of tax incentives and exemptions from GOM. Currently, WPRTS is eligible for certain tax incentives and exemptions from GOM for CAPEX with certain conditions to be satisfied when the incentives are in effect. If the conditions are not met before the expiry dates of the tax allowance, these exemptions and allowances will no longer be available to WPRTS and this will affect their bottom line adversely. WPRTS are entitled to claim the Investment Tax Allowance (ITA) between Year of Assessment 2010 and Year of Assessment 2014. WPRTS intends to apply for an extension of qualifying period from GOM to Year of Assessment 2019. We are confident of their ability to secure the extension as they are expected to continue their CAPEX spending in similar magnitudes with the past for the next few years for capacity expansion, which fulfils one of the conditions set in the Privatisation Agreement with the authorities.
Loss of major customers. WPRTS’ largest customer, CMA CGM Group, the world’s third largest container shipping group, has contributed more than 10% of the group’s total revenue for FY10-FY12. On top of that, the group’s top five largest clients accounted for 40.4% of their total revenue over the same time periods. If WPRTS is unable to retain its major customers, future revenue will be impacted substantially and subsequently profits will drop substantially if they are unable to replace their major customers in time. However, given WPRTS’ top class efficiency and strong track record, we believe that the group will be able to retain their major customers in the long term assuming that they are able to maintain their track record and performance.
P3 alliance. The P3 alliance involves the three largest container carriers in the world: MAERSK, MSC & CMA CGM with total TEUs of 2.6m, which comprises of 15% of the total global fleet. MAERSK is expected to have more control in the alliance as it takes up the highest share of P3 network fleet volume. Due to be approved by authorities possibly in 2H14, P3 is expected to cause a loss of container volume in Port Klang as the alliance will see total weekly services (Asia-EU and Asia Mediterranean) shrinking from 30 to 26, with vessel calls in Westports reducing from 10 to 5. This has raised concerns in the market as the outlook for growth in WPRTS will be uncertain in 2015.
Things might not be as bad as expected. Currently, CMA contributes c. 1.5m TEUs of container traffic to Westports with P3 volume at 1m TEUs which is 14% of Westports total volume in FY12. As vessel calls will be cut into half, the management indicates that the worst case scenario will be a loss of 500,000 TEUs volume in 2015, which translates into 7.2% of total 2012 volume. However, we believe that this may not be the case as the volume drop might be offset by higher volume per vessel, which also makes sense for CMA to improve efficiency and reduce costs. Therefore, we believe that the drop in volume will not be linear and it might be in the range of 250,000-300,000 range. Notwithstanding, it is premature to assess the impact of the volume drop now on WPRTS’s bottom line as the alliance is yet to be approved and most of it is expected to be only felt by WPRTS in 2015.
Do not ignore growth from other routes. Apart from Asia-EU and Asia Mediterranean services, CMA still has several routes with promising growth prospects: China-Africa, China-Middle East and Intra-SEA routes. Despite the uncertainties in the global market, we believe that these routes have ample room for growth in the long-run and this may help to cushion volume losses from Asia-EU and Asia Mediterranean routes. In the period up to 9M13, the volume from these routes is growing at double digits and we believe that it is sustainable in the long run. Therefore, we are still confident that WPRTS will make up for the losses and given that it is one of the most efficiently container ports in the world, its fundamentals remain intact.
Overcapacity in global shipping industry. There is a risk of overcapacity in the global container shipping market as according to Drewry Maritime Advisors, the amount of new container ships on order as of June 2013 was equivalent to 19.7% of the then existing global container fleet capacity. As a result, we cannot discount of the possibility of excess capacity in the industry for the next few years which might trigger a drop in container freight rates and subsequently shipping lines will pressure container terminal operators to provide lower pricing or reduce shipping volume to cut costs. However, looking at the tariff rates complied by Drewry Maritime Advisors, WPRTS has cheaper pricing compared to PTP and PSA, which puts WPRTS in a position whereby the downward pressure in pricing might be lower than the other two. Better still, we think that WPRTS might even benefit from the overcapacity as more shipping lines may switch to Port Klang from PTP and PSA for transhipment as they seek to lower costs through choosing lower ports with lower tariffs.
10. Appendix
Company background
Westport began operations in 1996, handling container and conventional cargo besides providing a variety of port services: marine services, rental services and other ancillary services. Besides growing to control 69% of container traffic in Port Klang and 34% in Malaysia with facilities about 25 berths, Westport is also principally involved in investment holding and provision of management services to their subsidiaries WMSB, and VTCM. The principal activity of WMSB is port development and management of port operations while VTCM is a dormant entity.
Source: Kenanga
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