CK Group: the Makings of One Big, Happy Family

Hong Kong Real Estate/Utilities 24 January 2018

CK Group: the makings of one big, happy family

Will CKI end up being the Li family’s third USD50bn-plus company?

Dennis Ip (852) 2848 4068 [email protected]

Don Lau Jonas Kan (852) 2848 4469 (852) 2848 4439 [email protected] [email protected]

See important disclosures, including any required research certifications, beginning on page 87.

CK Group: the makings of one big, happy family: 24 January 2018

Table of contents

Page

1 2015-17: A review of the re-organisation 5

2 2018-20E: What will happen over the next 3 years? 21

3 Post 2020: ultimate positioning 41

4 Appendix 61

Company Section:

CK Asset 67

Cheung Kong Infrastructure 71

Power Assets 76

HK Electric Investments 81

Please also see:

Cheung Kong/Hutch’s Bold Move: Cheung Kong Infrastructure: what’s cooking?: Q&A on the prospect of the group becoming a global play, Q&A on why we think a CKI/PAH merger should be on the with a valuation to match menu for the CK Group. 9 February 2015 21 July 2015 Dennis Ip, CFA (852) 2848 4068 ([email protected]) Jonas Kan, CFA (852) 2848 4439 ([email protected]) Scott Chui (852) 2848 4443 ([email protected])

CK Group: the makings of one big, happy family: 24 January 2018

Contributing Three years have passed. Where are we now? Daiwa Analysts:

Jonas Kan, CFA On 9 January 2015, Cheung Kong Group announced another major re-organisation (852) 2848 4439 (after its restructuring exercises in 1987 and 1997) which we see as the beginning of its [email protected] “Chapter 3” -- a phase of “asset realisation and the building of a strong market position in all of its core businesses” following 2 decades (from 1993-2014) of extensive Dennis Ip, CFA business-building of its 5 core businesses on a global scale. (852) 2848 4068 [email protected] In our February 2015 thought piece, Q&A on the prospect of the group becoming a Don Lau, CFA global play, with a valuation to match, we put forward our view that this re-organisation (852) 2848 4469 was of symbolic importance not only just for Cheung Kong Group. We saw it as the first [email protected] major attempt made by a family business group in Hong Kong, and arguably Asia, to pursue a modernisation of its capital management as well as its position in the global capital markets.

This current thought piece takes an in-depth look at the journey this major Hong Kong business group has been on over the past 3 years, and the path it may pursue in the years ahead. We focus on 2 of its key businesses: infrastructure and property.

For Cheung Kong Property (CKP), now renamed CK Asset Holdings (CKA), we think it is now facing arguably the “best problem” a corporation could face: too much cash returning in the years ahead and how to maximise the return from such surplus cash under a low interest-rate environment.

To contend with this issue, we would not be surprised if CKA reverted to being like the old Cheung Kong Holdings and maintained a large treasury portfolio, engaged in nurturing new businesses while continuing to pursue its property ambitions at the same time. Such a move would have important implications for Cheung Kong Infrastructure (CKI) and the group’s ambitions in the global infrastructure scene, as we believe CKA would throw its weight behind CKI, potentially creating a win-win situation for the shareholders of both companies.

Hence, the thesis of this thought piece: despite its capital constraints, CKI has significant opportunities open to it ahead in our view, and we see it remaining the entity within Cheung Kong Group that will lead the group’s global ambitions in the infrastructure business. If the various parameters we outline turn out to work in its favour, we envisage CKI becoming one of the world’s largest infrastructure investment companies by the time of its 30th birthday in 2026.

As such, we could be witnessing the emergence of the third USD50bn-plus company under the Li family, alongside CKA and Cheung Kong Hutchison.

In this report, we reaffirm our Buy (1) on CKA (1113 HK, HKD75.0) with a new 12-month TP of HKD85.2 (from HKD83.0), on an unchanged 30% discount applied to our new end- 2018E NAV of HKD121.70. On the utilities side, we raise our TP for CKI (1038 HK, HKD66.55, Buy [1]) to HKD86.0 (from HKD85.0), after lifting our earnings forecasts; it remains our top pick given its defensive yield gap in a rising interest-rate environment. We lower our TP for PAH (6 HK, HKD66.5) to HKD61.5 (from HKD64.1), but raise that for HKEI (2638 HK, HKD7.2) to HKD6.15 (from HKD5.9) after fine-tuning earnings. We remain bearish on both stocks in light of their inability to maintain their yields given limited M&A upside and looming SoC return cuts, and hence reiterate our Underperform (4) ratings.

Jonas Kan, Head of HK/China Property Research Dennis Ip, Head of HK/China Power, Utilities, Renewables & Environment (PURE) Research

CK Group: the makings of one big, happy family: 24 January 2018

2015-17: A review of the re- organisation

CKA: same model, but greater strength CKI: failed?

CK Group: the makings of one big, happy family: 24 January 2018

CK Asset Holdings: 2015-17 A step backward or just a return to what it used to be?

“Invest within your circle of competence. It’s not how big the circle that counts, it’s how well you define the parameters.”

- Warren Buffett

Tried to go the pure property company route, but …

One consequence of Cheung Kong Group re-organisation announced on 9 January 2015 was the creation of a pure property company to be known as CK Property. All the previous non-property assets and businesses under Cheung Kong Holdings would be moved to Cheung Kong Hutchison, including its stake in Hutchison Whampoa, Cheung Kong Life Science, its newly established aircraft leasing businesses, and even its treasury operations. What was proposed under the reorganisation was completed, but the group has continued to evolve since then.

The Cheung Kong Group re-organisation in January 2015

Source: Company Notes: (1) Calculated based on the average closing price of Cheung Kong and Hutchison shares for the 5 trading days up to and including 7 January 2015 and the average closing price of Husky for the 5 trading days up to and including 6 January 2015

In return, CK Property would become a much enlarged property company, as apart from the property assets Cheung Kong already owned, it would take on a large pool of property assets, including all the 13m sq ft of investment properties owned by Hutchison in the past, Hutchison’s 77m sq ft landbank in China and 2m sq ft landbank in London, Singapore and the Bahamas plus some 5,320 hotel rooms.

Effectively, Cheung Kong Group ended up with a much larger property division which doubled its China landbank and saw an over 3-fold rise in its annual gross rental income. Effectively, it moved from being primarily a residential developer in Hong Kong to an all-round property company with a sizeable investment property portfolio and recurrent income as well. This was on top of its significantly enlarged presence in China property and the hotel industry in Hong Kong, in addition to some initial exposure to the London and Singapore property markets.

Hence, from the perspective of the development of Cheung Kong Group’s property businesses, this re-organisation represented a quantum leap in Cheung Kong Group’s size and potential, making it a much stronger player in the property industry compared with the standalone property arm of either Cheung Kong or Hutchison before.

CK Group: the makings of one big, happy family: 24 January 2018

Significant expansion in the size and scale of Cheung Kong Group’s property division as a result of the re-organisation announced in January 2015

Source: Company Notes: 1) For FY13, 2) as at 30 November 2014, 3) for rental properties, excluding hotels, 4) for development properties, excludes agricultural land and projects under planning stages, 5) on attributable basis, 6) in terms of GFA, including hotels, and 7) in terms of number of rooms

However, in as much as this exercise greatly strengthened the long-term potential and financial resources of Cheung Kong Group’s property businesses, it entailed one consequence, which is that the new CK Property subsequently had too much cash coming back. This re-organisation took place at a time when the group was in monetisation mode after its ambitious landbanking in both Hong Kong and China which started in 2004 or arguably earlier; and the group’s property sales in both China and Hong Kong have boomed since January 2015, which has generated a growing cash pile for the group.

At the same time, the rental portfolio previously owned by Hutchison was cash-generative immediately after the merger, and the group’s investments in the property markets in both Hong Kong and China were so favourable that it has been able to realise over HKD60bn from the disposal of non-core property assets at a 2-3% gross cap rate since 2004. As such, finding ways to deploy its abundant surplus cash was one issue faced by Cheung Kong Group after the announcement of its re-organisation on 9 January 2015.

CKP: achieved contract sales 2012 2013 2014 2015 2016 2017E 2018E (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) HK 26.0 4.7 23.0 30.0 14.7 45.0 22.0 China 24.0 33.0 16.0 25.0 54.5 25.8 41.0 UK 0.0 0.0 0.0 0.7 0.8 1.2 1.6 Singapore 0.0 0.0 0.0 0.3 0.0 0.0 0.5 Total 50.0 37.7 39.0 56.0 70.0 72.0 65.1

Source: Company, Daiwa forecasts

CKP/ Cheung Kong: proceeds raised from commercial properties in China GFA Achieved price Achieved psf price Year Properties Cities Stake (sq ft) (CNY/HKD) (HKD/sq ft) 2007 The Center Shanghai 26% 963,336 CNY4.4bn 4,922 2008 Seasons Villas Shanghai 50% 1,150,830 CNY4bn 3,948 2010 Oriental Plaza Beijing 51% 6,162,881 HKD13.1bn 4,168 2012 Shenyang Lido Hotel Shenyang 70% nd CNY980m na 2012 Oriental Finance Centre Shanghai 100% 2,368,058 HKD9,360m 3,953 2013 Metropolitan Plaza Guangzhou 50% 956,997 HKD3.05bn 3,187 2014 Metropolitan Plaza Chongqing 50% 1,511,515 HKD4,976m 3,292 2016 Century Link Shanghai 50% 3,044,066 CNY20bn 7,556

Source: Company

CK Group: the makings of one big, happy family: 24 January 2018

CKP/ Cheung Kong: proceeds raised from disposal of non-core assets Year Assets Type Method Buyer Stake Proceeds 2011 HPH Trust (HPHT SP) Ports Spin-off IPO 26% USD5.5bn 2011 Hui Xian REIT (87001 HK) Property Spin-off IPO 50% CNY10.5bn 2012 Shenyang Lido Hotel Hotel Outright sale Hui Xian REIT 100% CNY980m 2013 Kingswood Ginza Property Outright sale Fortune REIT 100% HKD5.8bn 2013 Oriental Financial Centre, Shanghai Property Outright sale China Everbright 100% CNY7.1bn 2014 Metropolitan Plaza Property Outright sale Hui Xian REIT 100% CNY3.91bn 2016 Century Link Property Outright sale China Life consortium 50% CNY20bn 2017 The Center (~75% owned) Property Outright sale PRC consortium 100% HKD40.2bn

Source: Hong Kong Economic Times, SCMP, Daiwa

Then about 18 months after the announcement of its re-organisation, in August 2016, Cheung Kong Property stated in the Chairman’s Statement of its interim results announcement, that it would consider opportunities outside the traditional property arena if it could not find attractive enough opportunities in the property space to deploy its surplus capital. To follow is an extract from CKA’s 2016 interim results announcement.

“… As it is presently challenging to identify property investments with reasonable returns in the current cyclical stage of the property market, the Group will also pursue other global investments to extend our reach to new business areas. Serious consideration has been had to new business opportunities that meet the investment criteria set out in our 2015 Annual Report. This meets the objective of generating revenue from different sources to balance the cyclical impact on cash flow associated with property development. Our diversification initiative is always guided by the principle of “advancing while maintaining stability” to optimise capital utilisation and maximise returns for shareholders. Negotiations on certain potential investments of different business nature are under way. These investments should provide further impetus to the long-term sustainable growth of the Group.

Then, in December 2016, CK Property announced that it would buy back its aircraft leasing businesses from Cheung Kong Hutchison at cost (USD988m), and in May 2017, it announced that it would form a 40/40/20 consortium with CKI and Power Assets to acquire 100% of the DUET Group for AUD7.41bn (USD5.5bn), which was followed by a series of investments in the realm of global infrastructure such as Reliance Home Comfort and Ista, which brought CK Asset’s total investment in infrastructure to USD14bn (on a gross basis) or USD8.3bn (on an attributable basis).

Evolution of Cheung Kong Group’s non-property businesses Date Event Aug 2016 Announced that it would consider opportunities outside of the property arena Dec 2016 Bought back its aircraft leasing businesses from CKH at cost May 2017 Formed a 40/40/20 JV with CKI and Power Assets to acquire DUET Group for AUD7.41bn July 2017 Took a 100% stake in Reliance Home Comfort for CAD2.8bn Sold 25% stake in Reliance Home Comfort to CKI for CAD715m Formed a 65/35 JV with CKI to take a 100% stake in Ista for EUR4.5bn Declared to change its name to CK Asset

Source: Company, Daiwa

On 14 July 2017, it further declared that it was going to change its name to CK Asset Holdings (CKA), “with a view to aligning CKPH’s name with the name of the other listed companies within the CK group and to better reflect CKPH’s strategy to achieve long-term sustainable business growth and value creation for the CKPH shareholders through property businesses and the pursuit of quality investments worldwide with stable recurring revenue, such as infrastructure investment, property investment, and aircraft leasing…”.

This proposal was subsequently approved by CK Property shareholders and became effective on 24 August 2017. We see it as a declaration by its board that it is more important that CK Property (now CKA) has the flexibility to deploy its capital in ways it sees fit and appropriate to create value for its shareholders, rather than being constrained solely by opportunities in the property space.

Was this pivot really a “degeneration”? The truth is probably more subtle and complex

To some, this pivot by Cheung Kong Group was seen as a “degeneration”. Many argued that it had promised investors it would become a pure property company, only to change back to a conglomerate-like one just 2 years later; while others claimed Cheung Kong Group had taken “two steps forward and one step back” and thereby created confusion among the investment community, leaving investors wondering what it, or its property arm, was up to?

CK Group: the makings of one big, happy family: 24 January 2018

We can see the logic of these arguments but our read is that the situation is probably more subtle than it appears. We do not think it is fair to say the group has purposely misled investors. After all, it did try to remain a pure property company for almost 2 years, and during that period, the cash it received from property sales continued to boom. We believe it is only legitimate for a company’s management to constantly seek ways to generate a greater return on capital.

We are also of the view that it is just not necessary, nor desirable, for long-term shareholders of a company to see its management deploying capital in certain areas just for the sake of it. This is especially the case for the property industry given that a piece of land can well be a liability in the commercial sense. After all, companies invest in order to generate returns for shareholders. Hence, conceptually, to the extent that a management’s actions could create value for its shareholders on a risk-adjusted basis, we think it is hard to say it is hard to argue with; or at least, there should be a case for investors and shareholders giving a certain “benefit of the doubt” to such endeavours.

A more balanced view ….

In our view, no company generally does well in all businesses; and history tells us that there are long-term and sustaining competitive benefits associated with a company being dedicated to certain businesses and being able to continue to improve its products, resulting in expanding market share and scale economies over time. Admittedly, diversification into new areas can distract management and result in a company being weaker than it could be in both its traditional and new businesses.

We appreciate the above business logic and acknowledge that some of the greatest companies in the world excel by being focused and dedicated to what they are best at. However, before we pass judgement on Cheung Kong Group and assume that it is now departing from its circle of competence, we take a deeper look into what really is Cheung Kong Group’s core area of competence in the property business. Is it in product excellency? Is it in scale economies or customer loyalty? Or is it in dominance in certain geographical locations or property segments?

While a few property companies in the world excel in the above areas, it does not appear to us that the above routes characterise the path Cheung Kong has taken. We prefer to think “outside of the box” of the traditional perspective of looking at property companies when analysing Cheung Kong as a property company.

In our opinion, the property industry is large and deep enough to accommodate many different kinds of business models, and changes in technology, among others, mean that there is always room for new business models to emerge in the business. While pure property companies like Unibal Rodamco, Westfield, Simon Property, Boston Property and Mitsubishi Estate excel at their core business of managing and renting commercial properties, the business model adopted by Brookfield, which is not entirely a pure property company, is different, yet it has also excelled, probably more so than some of the pure property companies, in the area of capital allocation.

We believe that, conceptually, investors should not have any pre-set ideas as to what a property company must be like, and pro-active and astute managers should always be mindful of the need to adapt to changing business circumstances and be alert to the possibilities brought about by applying more creativity and imagination to the existing business model of a property business.

CK Group: the makings of one big, happy family: 24 January 2018

Global property stocks ranked by market capitalisation (USDbn) 80 70 60 50 40 30 20 10

COLI

Ventas

ProLogis Land CR

CKAsset

SMPrime LinkREIT Wheelock

Avalonbay

Health Health Care

China VankeChina

Daiwa Daiwa House

Poly Poly Property

Weyerhaeuser Public StoragePublic

Mitsui FudosanMitsui

SimonProperty SHK Properties

New World DevNewWorld

Anerican Anerican Tower

HongkongLand

CountryGarden

Swire PropertiesSwire

Henderson Land

MitsubishiEstate

SumitomoRealty

Unibail-Rodamco

Boston Boston Properties Equity Equity Residential

General GrowthGeneral Prop Source: Bloomberg Note: as of 22 January 2018 Business profile of Brookfield Investments

Source: Company

And it is in this spirit that we analyse the issue of CK Property’s pursuit of non-property investments and the change in its name to CK Asset. In our view, Cheung Kong has adopted a special business model in global property that is useful to understand and analyse.

Is the Cheung Kong business model for property really about timely land purchases and capital recycling?

In our opinion, an important characteristic of the property business is that it is capital-intensive and entails considerable leverage which is a double-edged sword. Hence, to a property company, while a piece of land is always an asset in the accounting sense, it can well be a huge liability in the business sense; and decisions on land purchases can well mean make-or-break scenarios for major property companies.

Olympia and York, which at one point was considered one of the largest property companies in the world, almost went bankrupt because of its massive investment in land in Canary Wharf in London in the 1980s. Similarly, Hongkong Land, which was the largest property company in Hong Kong for many decades, nearly went bust in the early 1980s mainly because of its purchase of the massive site in Central which it later developed into Exchange Square.

In hindsight, both the Canary Wharf and Exchange Square sites turned out to be valuable pieces of property whose value eventually met or even exceeded expectations. However, just because the land was acquired at the wrong time and that the balance sheets of these 2 companies at the time were not well-capitalised enough to undertake such endeavours, such land purchases almost led to the downfall of these 2 property companies.

CK Group: the makings of one big, happy family: 24 January 2018

In short, being able to manage land purchase decisions gives a property company an important competitive edge, in our view. As Warren Buffett put it, “The worst investments are those where you tie up your money for a long time that you could have been using better some place else.” Our view is that, in the property business, land purchases (at the right price, at the right size, and at the right time) are arguably one of the most important aspects of the property development business, and this is especially the case in the Hong Kong property market where the cost of land can easily comprise 60% or more of the total development cost of a project.

In our opinion, Cheung Kong’s business model in property is as much about land as it is about flats. And it is probably in this area that Cheung Kong Group has excelled in the residential property development business. We do not think it has the best property product in the industry; nor do we think it has the best credentials and track record in terms of using large-scale property projects to transform locations; and nor do we think it is fully dedicated to the business of managing commercial properties for rental income growth and capital value appreciation in the long term.

Characteristics of CK’s approach to the property business - Big emphasis on managing its net residential landbank position along the cycle - Big emphasis on entering the land market before flat prices start to surge - Ideal situation would be buying a sizeable initial bundle of land at the low point of the cycle and then using high asset turnover to get sales proceeds from the sale of flats to scale up its net landbank position - Big emphasis on the relative value of land versus flats and is arguably a market price neutral strategy - Big emphasis on cost control and asset turnover which would result in a greater portion of the value of the land being reflected in the achieved sales value of the flats - Emphasis appears to be as much on the value of the land as the sales value of the flats

Source: Daiwa

That said, we consider Cheung Kong’s track record strong in terms of the timing of its land purchases, decisiveness to take bold moves during times when the outlook for the market remained mixed, its determination to undertake large-scale projects, its choosing of property markets to enter and property segments to invest in at different stages of the property cycle, its discipline in land purchases, capital allocation, financial discipline, the ability to enhance its market position in the industry over time, and its ability to negotiate land premiums and property sites with land- owners and the government.

Importantly, to its shareholders, its property business has provided impressive returns. All along, it has remained moderately or lowly geared and has not taken on much financing risk. The group has not raised any equity capital since 1996 and at the same time, has kept on raising its DPS to shareholders. Still, it has been able to build up a China landbank and Hong Kong hotel and serviced suites portfolio which generate impressive returns. As such, in terms of using the property industry as a way to generate returns and enhance equity capital for its shareholders to invest in either property or new industries (which would bring synergistic benefits to its property business over time), we think Cheung Kong has done an impressive job, and has arguably adopted a special model in global property.

Cheung Kong has never spelt out clearly what its business model is. However, our read on what it has done over the years is that its business model has put significant emphasis on land purchases, especially the importance of getting the right timing to buy land in volume . As such, in a way, the development of Cheung Kong could be seen as a story about how it manages its landbank and how it has used the proceeds it has monetised from land purchases/or the sale of flats to invest and build up many new businesses.

Below we present a summary of our read of Cheung Kong’s stance toward landbanking during different stages of the Hong Kong residential property market. As we see it, the group has been strategic in terms of its thinking when it comes to land purchases, and has a track record of making determined moves during times of uncertainty.

CK Group: the makings of one big, happy family: 24 January 2018

Major land purchases made by CK in the past Period Flat prices Major events Our read on Cheung Kong's landbanking strategy 1967-1969 Downcycle 1967 riots Moves all capital earned from manufacturing to active landbanking 1969-1972 Upcycle Lists Cheung Kong on the HK Stock Market in 1972 1973 Downcycle Oil crisis and stock Active use of shares issuance, joint-ventures and asset turnover to scale up landbank market crash ambitiously 1974-1982 Upcycle Moves onto taking over British companies towards the later phase of this period; culminates in the acquisition of Hutchison Whampoa in 1979 1982-1984 Downcycle Mrs Margaret Thatcher Actively negotiates the land premiums required for large-scale residential projects with one main visited Beijing example being Whampoa Garden 1984-2Q89 Upcycle Joint Declaration Active landbanking, culminating in the commissioning of Cheung Kong Group 's 4 mega-sized signed on 1984 residential property projects towards the late 1980s: Sceneway Garden, Laguna City, South Horizons and Kingswood Villa The Cheung Kong Group undertakes a mega-sized rights-issue to raise funds to finance these 4 property projects and Hutchison's expansion to overseas 2Q89-4Q89 Downcycle June 4th Incident 1Q90-1Q94 Upcycle CK not active in adding to its residential landbank while the amount of sales proceeds raised from its 4 mega-sized projects continues to rise. It then parks its investment in subscribing for convertible bonds of PRC and small HK companies as well as subscribing for Hutchison shares in 2 share placements in 1991 and 1992 2Q94-3Q95 Downcycle 4Q95-3Q97 Upcycle Joins with Hutchison to actively acquire residential landbank in HK 4Q97-2Q03 Downcycle Attack on dollar peg Active selling of flats but at the same time, is also actively buying land. CK was the buyer of the and a surge in Hibor last large-scale residential site for sale in HK before land sales were suspended in 2002 3Q03-2Q08 Upcycle Actively buying land in HK and is a determined bidder in the first land auction when land sales resume in 2004. Active in selling flats but also active in buying more residential sites Also actively buying land in China. 3Q08-4Q08 Downcycle Lehman crisis 1Q09-now Upcycle Has not been a net buyer of residential sites in HK and has become more like a net seller in the past few years Announced Cheung Kong Group re-organisation in Jan 2015 which resulted in, among other things, CKP taking over all the property assets previously owned by Hutchison. This doubled CK's China landbank and more than tripled its annual gross rental income

Source: Daiwa

For example, when land prices in Hong Kong plunged after the 1967 riots, Cheung Kong Group aggressively channelled all the profits it had made from manufacturing into land purchases. When many players hesitated about the oil crisis and stock market crash in 1973, Cheung Kong aggressively increased its landbank through active use of share issuances and the formation of joint-ventures with land owners, which elevated its positon from a medium- sized player when it was first listed in 1972 into one of the largest and most promising and upcoming property companies in Hong Kong by the late 1970s.

More importantly, while the signing of the Sino-British Joint-Declaration in 1984 merely meant just the end of the worst property market downturn in Hong Kong which started in 1981, Cheung Kong made use of the opportunity of uncertainty to buy land and negotiate land premiums for mega-sized property development projects (such as the Whampoa Garden redevelopment project). It was the pioneer in Hong Kong in terms of developing large-scale mass residential projects and secured 4 mega-sized projects in the 1980s – South Horizons, Laguna City, Sceneway Garden, Kingswood Villa – which underpinned a surge in its property sales profits from the late 1980s onwards and secured its position as the largest property developer in Hong Kong at that time.

While Cheung Kong’s restraint from paying aggressive prices for land in the early 1990s resulted in a decline in its relative position in the Hong Kong residential property market from 1992 onwards, it was active in rebuilding its position in the industry from 1996 onward – partly through leveraging on the capital of Hutchison Whampoa, a company to which it deployed a lot of capital during the early 1990s when it received huge amounts of cash from property sales but hesitated to deploy it to buy land at prevailing market prices.

One more point to note is that, while the 70% collapse in Hong Kong residential property prices during 4Q97-2Q03 hurt many property companies in Hong Kong, the situation faced by Cheung Kong seemed to be much better. Indeed, it appears that the group might have benefited from this crash in certain ways. For while Cheung Kong saw low margins or losses on the projects it acquired from the mid-1990s onwards, it appears that during this period, it was active in channelling the cash raised from active property sales into buying land where prices had fallen more than that of land – Cheung Kong was a determined bidder and winner of the last large-scale residential site for sale before land sales were suspended in 2002 (the Tiu Keng Leng site in Tseung Kwan O).

Hence, from the perspective of its overall net position in terms of residential landbank in Hong Kong, Cheung Kong’s placing strengthened after the property market collapse of 4Q97-2Q03.

CK Group: the makings of one big, happy family: 24 January 2018

And this brings us to another important aspect to understanding the Cheung Kong business model. What matters the most to the group is the cost of its initial bundle of land in each market, and the group is arguably residential- property-price-neutral once it has built up its landbank size to its desired level. This is because if it purchased the same amount of land through using the cash it receives from selling flats, it is arguable that its net exposure to the residential property market would be the same as the period before it sold its flats – the total net size of its residential landbank is the same, what is different is the proportion of such landbank, ie, whether such land is in the form of flats, properties under development or merely land. In this light, we believe Cheung Kong’s business model for the residential property development business is arguably to be property-price neutral, in that it is really focusing more on the relative prices between land and completed flats rather than the absolute price level of the flats.

As such, falling flat prices may not be really that detrimental to the economics of its businesses in so far as lower prices of flats would often result in an even greater magnitude of decline in the price of land, which would enable those who can sell flats earlier and faster than others to have the cash to buy more land earlier than many others. Hence, for Cheung Kong, or anyone practising this special kind of businesses model, falling flat prices could even turn out to be a blessing in disguise. This is because, although the achieved ASPs of its units would be lower, for developers which are financially strong, they often buy more land at even lower prices.

Indeed, provided that land prices fall more than flat prices (which is normally the case) and that land prices are lower than flat prices (which is also normally the case), Cheung Kong can end up having a larger residential landbank than before without having to tie up as much capital as others. This would also mean that if it is willing to deploy the full amount of the cash it raises from the sale of flats, or also move the capital previously parked elsewhere into land purchases, it could end up having a much larger residential landbank which is more geared to any upturn after a down-cycle.

It appears that such was the situation for Cheung Kong after the residential property market downturn in 4Q97- 2Q03, and in this sense, one might say that its model provides a certain hedge to a decline in residential property prices. In any case, once land auctions resumed in Hong Kong in 2004, Cheung Kong was an aggressive and determined bidder and paid a premium price to win the Ma On Shan site for sale in the first land auction in Hong Kong after the 6-year downturn. It then kept on bidding at premium prices (one notable example is the over HDK10bn price it paid for the Homantin site in 2005 which it later developed into Celestial Heights) for several more years. Similarly, it was also an ambitious and determined buyer of land in China during 2004-07 which resulted in it becoming the Hong Kong company with one of the largest development landbanks in China.

Is the Cheung Kong business model for property really about a prudent but ambitious way to ride the rise in land values?

Contrary to popular belief, we do not think Cheung Kong Group excels at maximising the achieved ASPs of its properties for sale. Rather, we think it excels mainly in securing the right entry point in a property upcycle and in financial discipline, which ensures that it always stays in a strong financial position and allows it to take bold moves to buy land in size in the early stage of the cycle when most others hesitate or just do not have the financial strength to match Cheung Kong.

In this light, we believe Cheung Kong’s greatest strength in the property development business in Hong Kong and China lies in picking the entry point to secure a large initial bundle of land, which has often turned out to be the early stage of a sustained property upcycle. Then, it uses high asset turnover to ensure that it is faster than peers to get back the cash, and then it uses such proceeds to continue to scale up and increase its landbank as long as the cycle still offers a favourable outlook for land purchases on a risk-adjusted basis.

We think it followed this strategy in the Hong Kong residential property sector in the time windows of 1967-70, 1973-78, 1984-1991, 1996-2007, and in China in 2004-07, during which it entered the market at an early stage and then continued to scale up its landbank. As such, we believe Cheung Kong’s business model in property development is really about the entry price, asset turnover and capital recycling.

CK Group: the makings of one big, happy family: 24 January 2018

Residential property prices in Hong Kong *Nov 2017: 10,000 HKD9,562/sq ft

8,000

6,000 Mega upcycle Mega downcycle

4,000

2,000

Dec-86 Dec-03 Dec-80 Dec-81 Dec-82 Dec-83 Dec-84 Dec-85 Dec-87 Dec-88 Dec-89 Dec-90 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-79 Source: Midland, Daiwa Notes: *provisional figure

As such, under its model for the property development business, the group does not need to achieve the best timing in selling property assets, as long as it can find attractive and better ways to deploy the cash. As such, we see Cheung Kong Group as being mindful of the risk in the property industry, and appears to prefer to miss the opportunity than take on the risk of buying land to embark on new projects with which it is not comfortable. After all, it appears to us that its business model is about capital-recycling and putting capital where the return outlook is the strongest on a risk-adjusted basis. So when it judges that recycling back the capital to land may not generate the best risk-adjusted return for the time being, it looks for something else – historically, it appears that it has parked such money into treasury operations, or invest further in group companies or invest in nurturing new businesses.

Evolution of Cheung Kong Group’s non-property businesses

I Initial bundle of land II Scaling up landbank size through asset turnover III Monetising the value of land acquired in early days IV Raising cash to prepare for the next round of major land acquisition

Source: Daiwa

In this light, we think it is arguable that Cheung Kong Group’s business model for property development is like using a manufacturing model in residential property development as a way to get the most from the change in land values across the property cycle. We believe its key focus in the property business is to buy an initial bundle of land at the right price at the right time and at the right size, and then focus on asset turnover to get back capital, and buy more land when it judges the cycle to be still in favour of scaling up landbank.

The focus on asset turnover and scale probably means Cheung Kong Group doesn’t focus as much on the product and does not have the patience to spend many years assembling sites in a piecemeal manner. However, it appears that, for shareholders, these inadequacies are balanced by greater efficiency in capital deployment. This is because as long as the property market is still in its upcycle, it makes sense from the return perspective to have as much capital in land as possible because the capital value of land should be more geared to the upside than say completed flats. As such, when the cycle is still in an upswing, it would be better from a capital growth perspective to have capital held in 2x sq ft of land than 1x sq ft of flats – it consumes the same amount of capital, but the NAV growth prospects would be stronger.

CK Group: the makings of one big, happy family: 24 January 2018

The relationship between land and flat prices in the property cycle

Source: Daiwa

Moreover, for shareholders, Cheung Kong’s model is safe and yet the returns can be much higher than those from the manufacture and sale of flats – for land values are much more geared to the property cycle than flat values. Indeed, if one can be as efficient in the manufacturing process and achieve a rapid asset turnover and capital recycling, it is conceivable that one could significantly scale up its business without taking on too much leverage. And we think this is what Cheung Kong has done in its property business.

For our read is that since the late 1990s, it has built up a sizeable presence in China property and Hong Kong hotels, while at the same time, seeing rising dividends and remaining lowly geared. To shareholders, we think this is a credible and legitimate way to get the most from what the property market can offer.

CKP/Cheung Kong: DPS record for the past 10 CKP/Cheung Kong: net gearing ratio for the past years 10 years (HKD) 20% 4.0 3.5 16% 3.0 2.5 12% 2.0 8% 1.5 1.0 4% 0.5 0.0 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Company Source: Company

The merits and de-merits of Cheung Kong Group’s model on property business Pros Has built up a sizeable China landbank and HK hotel portfolio and delivered growing DPS but without having to raise any equity (no equity fund raising since 1996) and any major debt (remained lowly geared throughout these years) Shareholders' exposure to the risk related to HK residential property prices is low given the group’s low entry point, and that after land prices have surged, it tends to finance land purchases through proceeds raised from the sale of flats. Subsequently, the group tends to become a net seller of residential property assets and use the cash to finance new investments (such as CKI, HK hotel and serviced suites portfolio, CK Life Science, aircraft leasing, etc.) ; sponsoring the development of group companies (Hutchison in the 1990s and CKI now); or park the cash in treasury investments, until the opportunity for another round of major land purchases emerges Does not need to tie up a lot of capital and human resources to build and manage commercial properties It is more efficient and less risky to acquire a rental and recurrent income stream through M&A of property companies and infrastructure assets if one can secure such opportunities. The taking over of Hutchison's property portfolio has enabled CK to have a sizeable rental portfolio and rental income stream without having to spend too much capital, human resources or time Cons Product excellency may not be the aspect which commands the highest priority as the group’s emphasis seems to be on land and timing to buy land in size Lack of opportunities to build up expertise and human resources in managing commercial properties

Source: Daiwa

CK Group: the makings of one big, happy family: 24 January 2018

Seen in this light, we think the keys to the Cheung Kong way of running a property business are entry point and asset turnover – it waits for opportunities where it can buy in volume and at an attractive price; and it uses fast asset turnover to ensure that it can scale up its landbank at a faster pace than others, hence reaping more from the value created by a property upcycle.

We see such a business model as prudent and yet also ambitious, as it involves taking bold decisions in the face of uncertainties and quickly turning the land into cash to buy even more land. A company would need to feel confident about the sector’s outlook for the next 5 years or more to commit to such an endeavour. As such, such a business model may not be appropriate once the property cycle has reached or passed its middle phase where the room for a further rise in prices and volume becomes less certain.

Historically, Cheung Kong Group has tended to be ambitious and aggressive during the early phase of a property cycle, and then turned progressively more prudent and selective as the upcycle has progressed over time.

We think this stance enhances the safety and prudency of the company but also means that from time to time, it ends up in a situation where it has more cash than it needs, such as the period when the monetisation of the lower- cost land it purchased started but it hesitated to deploy the full amount of capital for landbank expansion (we believe it entered this phase around 1990 in the previous cycle, and about 2011 in the current cycle).

We think this is one reason that historically, Cheung Kong has had a large treasury portfolio and a track record of deploying capital to nurture new businesses when it judged that doing so could yield a greater return than investing a lot more in land. In our view, it is against this background that it acquired Hutchison, and built up Cheung Kong Infrastructure, and its hotel division as well as its China businesses.

As such, we believe Cheung Kong has adopted a special model in global property and should be analysed and seen as such. Overlooking this aspect could give rise to misconceptions, in our view.

Misconceptions about Cheung Kong’s business model for property Mainstream views Our alternative interpretations Cheung Kong is bearish on The CK business model on property is more about entry price and desired size for its initial bundle of land than the the property markets of both achieved selling price of the flats. Its business model is arguably residential property price neutral and what matters most is HK and China the land/ flat relative price rather than the absolute price of the flats. The CK business model is about capital recycling and snowballing the gains. The sale of assets and flats is a regular business and reflect its perception toward relative reward/risk profile of having more land versus making treasury investments or sponsoring group companies or new businesses. However much CK has sold in terms of HK and China property assets, it still has over 20m sq ft of property assets in HK and over 100m sq ft of property assets in China. Cheung Kong is abandoning The CK group has engaged in the property business for over 50 years and historically, the industry has enabled it to build the property business up its equity base quickly which has allowed it to diversify into new areas and overseas. There has also been time in the past during which CK has been more restrained in buying land during certain periods but could become an active buyer after an adjustment in the market. We think property is still an industry which offers the potential to generate respectable returns for companies which can read the land price cycle well and as such, we do not think we can infer from what it has done so far that it is abandoning the industry. Cheung Kong is trying to Sponsoring and co-investing with group companies has been a feature of Cheung Kong Group for many years. CK has become an infrastructure helped to strengthen Hutchison's development in the past and we think helping CKI is not inconsistent with what the group company has done in the past. Infrastructure assets generate recurrent income and its nature may not be that different from rental income stream. Some property companies like Brookfield Investment also has significant investments in infrastructure businesses.

Source: Daiwa

In this light, we think it is arguable that having a large treasury operation has always been one main features of the Cheung Kong business model for property. As such, one might wonder whether attempting to become a pure property company might represent a departure from the business model it has practised for a long time.

We can see why the group has tried to make such a move, as the re-organisation resulted in Cheung Kong Group having a much larger investment property portfolio than before, leading to it more closely resembling conventional property companies. With the surge in its recurrent rental income base after its re-organisation in 2015, it will be in a much stronger financial position than before to raise its dividend over time, which we expect would gain more investor recognition. And we also think the group, like many other Hong Kong property companies, has been frustrated by the large NAV discount assigned to its equity market valuation, and so would like to take the re- organisation opportunity to address this NAV discount issue.

In this light, we could say that the idea of a pure property company was seen as an attempt by Cheung Kong to accommodate the capital market’s expectations and try a slightly different path. But when CKA discovered that such a path did not work well, it returned to its own and proven way of running the business.

CK Group: the makings of one big, happy family: 24 January 2018

We note that at a CKA analyst briefing in March 2017, Finance Director Edmond Ip made the following remark: “when we did the re-organisation, every one said once we become a pure property company, the NAV discount on the Cheung Kong property would be reduced notably. So we turned the company into pure property company, yet the removal of the NAV discount has not happened and such a discount might have even widened after our re- organisation exercise. So, we need to think about whether we still need to be restricted by the idea of a pure property company…. ”

Is CKA returning to the old Cheung Kong way of running the property business?

In this light, CKA’s move to have some non-property investments could be seen as a return to the old Cheung Kong way of running its property business. And it is now pursuing a similar strategy but with the support of much- enhanced financial resources and asset backing, as a result of its reorganisation exercise.

In our opinion, CKA’s investments so far can be seen as largely treasury investments for securing a higher return on its surplus cash before it sees an attractive enough opportunity in the property space where it can deploy a substantial amount of capital. But our view is that a sizeable treasury portfolio has been the feature of Cheung Kong Holdings’ investment strategy in the past; and hence what CKA has been doing (in terms of putting capital outside the traditional boundaries of property) could be seen as a continuation of Cheung Kong Holdings’ snowballing of its capital and allocation of capital which generates the highest return on a risk-adjusted basis.

CK Asset: non-property investments Date Company Business Consortium Total consideration July 2017 Acquired a 100% interest in Ista A fully integrated energy management CKP (65%) / CKI (35%) EUR4.50bn services provider in Europe (HKD41.40bn) Acquired 100% of Reliance Home A home water heater and related services CKP CAD2.80bn Comfort provider in Canada (HKD17.16bn) On-sold 25% of Reliance Home CAD715m (HKD4.39bn) Comfort to CKI May 2017 Acquired 100% in DUET Group Owner and operator of energy utility assets CKP (40%) / CKI (40%) / AUD7.41bn in Australia, the US, UK and Europe PAH (20%) (HKD42.69bn) Dec 2016 Acquired 100% interest in CK Aircraft leasing CKP USD988m (HKD7.69bn) Capital & Harrier Global

Source: Company

We also note that, historically, Cheung Kong Group has a record of sponsoring the development of its group companies or co-investing with them when it has surplus cash. This practice is not new to the group. For example, when Cheung Kong’s property business was kicking off surplus cash in the early 1990s, Hutchison was hit by challenges in its overseas investments. Subsequently, Cheung Kong threw its weight behind Hutchison by underwriting Hutchison’s 2 share placements in 1991 and 1992, which gave it the capital to revitalise.

In this light, we would argue that sponsoring the development of CKI does fall into Cheung Kong Holdings’ traditional strategy. We think its investments in infrastructure projects can also be seen as part of its treasury investments as well. That is, taking stakes in infrastructure projects on behalf of CKI arguably resembles lending money to a borrower it knows very well and whose repayment capability it feels secure about. At the same time, business-wise, having a strong financial partner helps CKI markedly.

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong Infrastructure: 2015-17 CKI-PAH plan rejected: M&A potential not fully realised

On 24 November 2015, the CKI-Power Assets (PAH) merger plan collapsed as 22% of PAH’s minority shareholders voted against the proposal, exceeding the 10% opposing vote limit. Meanwhile, the proposal only obtained 51% supporting votes, failing to meet the 75% criteria at the court meeting. We see 2 major reasons for the failure of the merger plan:

1. PAH’s minority shareholders were unwilling to share the HKD69bn idle cash, recycled from the HKEI’s IPO, with CKI’s shareholders. 2. The premium for the offered PAH-to-CKI swap ratio was too insignificant, despite the proposed swap ratio rising from 1.05x to 1.066x, at lower than the independent proxy advisor, ISS’s, recommended 1.09-1.20x.

Looking back, we believe No.1 is a more valid fundamental reason for the merger push-back, as PAH’s minority shareholders might have believed CKI would be more advantageous with the “free” cash they were entitled to after the merger. PAH’s minority shareholders might also have believed that PAH would make better use of the cash for big-ticket M&A with CKI – CKI’s management later (in 2016) did try to acquire National Grid (GBP10bn) and Ausgrid (c.AUD10bn for 50.4% stake), a year before the cashing out period of CKP and PAH (on special dividend).

However, we would emphasize that this CKI-PAH deal was a “merger”, not a “privatisation”, hence there should not be any NAV or valuation premium assigned for any merged parties (either PAH or CKI). In 2012-13, the PAH-to- CKI forward PER ratio was maintained at 1.3x, representing a 1.066x PAH-to-CKI share price ratio in September 2015, after accounting for PAH’s earnings loss on HKEI’s disposal and CKI’s earnings enhancement from the newly acquired UK Rail (previously known as Eversholt), a rolling-stock leasing company.

Therefore, the argument for CKI’s management taking advantage of the trough CKI-to-PAH share price ratio is not justified, in our view, and we see no valuation grounds for the ISS’s recommended 1.09-1.20x ratio based on the trailing 12-18 months CKI-to-PAH share price ratio. For any merger case, we should compare the valuations, not share prices!

st PAH-CKI’s PER & share-price ratio (2008-15), before the 1 merger attempt

1.7 PAH-CKI's forward PER ratio surged PAH- after PAH's spin-off of HKEI, with an CKI's 1.6 expectation of signficant M&A forward 1.5 PER ratio fell back 1.4 to 1.3x without 1.3 singifican t M&A 1.2 1.1 1.0 PAH-CKI's share price ratio keeps declining given 1) CKI has more M&A earnings growth than PAH; 0.9 2) PAH disposed of HKEI stake 0.8 0.7 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 PAH/CKI PER ratio PAH/CKI price ratio Offered PAH-CKI share price swap ratio (1.066x) in 2015

Source: Daiwa Note (1): The continuous drop of PAH-CKI’s share price ratio is due to the PAH’s asset disposal while CKI is completing M&As Note (2): We believe the surge of PAH-CKI forward PER ratio from 1.3x (2013) to 1.6x (2014-1H15) is due to the expectation that PAH will complete significant big-ticket M&As using its HKD69bn idle cash, and hence more M&A growth than CKI, which was not realized, and hence the PAH-CKI forward PER ratio returned to 1.3x level

After the collapse of the CKI-PAH merger deal in 2015, PAH chose to delay its special dividend plan, which Canning Fok (PAH’s chairman) had promised, during HKEI’s IPO special general meeting in January 2014, would be made within 2 years, given Fok was bidding for 3 projects requiring the HKD69bn idle cash. However, CKI/PAH was only able to complete 1 small deal – Husky’s oil pipeline (HMLP), from group company Husky Energy, in 2016. In 2017, Cheung Kong group company CK Property (since re-named CK Asset Holdings), replaced PAH as the leading partner to acquire overseas infrastructure assets, given CKA had a huge pile of HKD200bn of sales (or HKD60-70bn of cash) recycled from the multi-year contract sales of residential property and disposal of commercial property. We believe it made perfect sense for CKA to replace PAH to invest in global infrastructure assets, given the Li family has a much higher 30.3% ownership in CKA compared to their small 8.9% effective stake in PAH.

CK Group: the makings of one big, happy family: 24 January 2018

Therefore, we believe the Li family will prioritise investment opportunities for CKA in case both companies face the same “problem” – an opportunity cost of the huge pile of idle cash.

So what did PAH’s shareholders get in 2016-17 after the collapse of the merger deal at end-2015?

- A HKD12.5/share special dividend, after the idle cash had sat on PAH’s balance sheet for 3-3.5 years, making only a c.1% interest return. - HKD8/share idle net-cash remained on the balance sheet as of October 2017, almost 4 years after the HKEI’s spin-off, making only a c.1% interest return for shareholders. - PAH’s shareholders were only able to acquire HKD10/share worth of assets (60% less than CKI’s) earning a 10% yield.

And what did CKI’s shareholders get in 2016-17?

- 38.89% of cash under PAH, in the form of a HKD12.5/share special dividend and HKD8/share of idle cash - But they lost 61.11% of this HKD44bn net-cash to achieve a 5% real cash return.

PAH: total consideration spent on M&A from CKI: total consideration spent on M&A from 2010-Oct 2017 2010-Oct 2017

CKI+PAH CKI PAH

c.40% cash for c.100% as dividend 100% cash for 10% yield assets Absolute weighted return: 10% yield assets Absolute weighted 1% (bank interest) average return: 2% or others yield stocks Absolute return: 5%

Source: Daiwa research Source: Daiwa research Note: Assume WACC is 5%, hence a 10% yield asset generates a 5% absolute return Note: Assume WACC is 5%, hence a 10% yield asset generates a 5% absolute return

In addition, an unmerged-CKI also now needs to rely on CKA to lead big-ticket M&A offers given a smaller-CKI is not able to make an unconditional offer for any multi-billion USD deal which is classified as a major transaction, and hence minority shareholders’ approval is a pre-requisite.

In conclusion, we believe neither PAH nor CKI have maximised the outcomes of their HKD69bn idle cash (or HKD44bn net) – 100% of this HKD69bn capital to achieve 8-9% real cash return – after the CKI-PAH merger was rejected in November 2015. In our view, CKI also lost an opportunity to form a bigger entity (also a bigger equity base for a bigger balance sheet) to lead Cheung Kong Group’s global M&A deals, and achieve the status as the biggest global infrastructure company by 2020E (its 25th anniversary).

Cheung Kong Group: global infrastructure investment since 2010 Years of acquisition Consideration CKA (1113 HK) CKHH (1 HK) CKI (1038 HK) PAH (6 HK) LKSF (private) Seabank Power 2010 GBP423.4m 0.00% 0.00% 25.00% 25.00% 0.00% UKPN 2010 GBP5.75bn 0.00% 0.00% 40.00% 40.00% 20.00% Meridian Cogeneration Plant 2011 CAD45.7m 0.00% 0.00% 100.00% 0.00% 0.00% Northumbrian Water 2011 GBP4.5bn 0.00% 40.00% 40.00% 0.00% 20.00% West and Wales Utilities 2012 GBP2.0bn 0.00% 30.00% 30.00% 30.00% 10.00% EnviroWaste 2013 NZD490m 0.00% 0.00% 100.00% 0.00% 0.00% AVR 2013 EUR946m 0.00% 35.00% 35.00% 20.00% 10.00% Park'N Fly 2014 CAD762m 0.00% 50.00% 50.00% 0.00% 0.00% Envestra 2014 AUD2.4bn 0.00% 27.50% 45.00% 27.50% 0.00% Eversholt 2015 GBP1.6bn 0.00% 50.00% 50.00% 0.00% 0.00% Iberwind 2015 EUR288m 0.00% 0.00% 50.00% 50.00% 0.00% Husky's oil pipeline (HMLP) 2016 CAD2.6bn 0.00% 14.07% 16.25% 48.75% 0.00% Duet Group 2017 AUD7.3bn 40.00% 0.00% 40.00% 20.00% 0.00% Reliance Home Comfort 2017 CAD2.82bn 75.00% 0.00% 25.00% 0.00% 0.00% Ista 2017 EUR5.1bn 65.00% 0.00% 35.00% 0.00% 0.00%

Source: Daiwa research

CK Group: the makings of one big, happy family: 24 January 2018

CKI/PAH road map since 2010 Phase 1 Phase 2 Phase 3 Strong asset building period 1st asset consolidation attempt Continuous asset building, but led by CKA Completed a total HKD68bn-worth of… After PAH spin off HKEI, PAH is too similar to Given an unmerged-CKI fails to meet the revenue test, and …global infrastructure deals… CKI, while PAH traded at a 20% premium to likely the asset test to avoid minority shareholders’ approval …co-invested with PAH to leverage PAH’s CKI on PER in 2010-13. Therefore, CKI/PAH to initiate unconditional offers for big-ticket M&A targets, balance sheet... try but fail to merge the two companies and cash-rich CKA takes a leading role in recent big-ticket deals effectively spend the HKD69bn of idle cash such as Duet, Reliance and Ista CKI Market cap: 2x from USD8bn to USD16bn under PAH CKI-PAH market cap ratio: up from 0.70x to 0.95x Completed a total HKD40bn-worth of… Completed a total HKD25bn-worth of… …global infrastructure deals… …global infrastructure deals… …co-invested mainly with CKA …co-invested with PAH Market cap: flat at USD23bn on Brexit’s impacts 38.89% Market cap: 45% up from USD16bn to USD23bn CKI-PAH market cap ratio: remains at 1.20x CKI-PAH market cap ratio: up from 0.95x to 1.20x

2010-13 2014 2015 2016 2017

Co-invest period Value realisation period Pure bank function for CKI Completed a total HKD40bn-worth of… HK Electric, a 45% profit contributor as of In 2016, PAH attempts to proceed with more M&A, …global energy infrastructure deals… 2013, faces a potential SoC return cut (from delaying the promised special dividend by 1 year. …led by CKI and also support CKI in 9.99% to 8%) starting from 2019 massive M&A In 2017, CKA generates HK50-60bn pa of contact sales PAH (M&A completion: 69% of CKI) Interest rates are at their lowest point post the during the significant property disposal period for the 2008 global financial crisis group without attractive landbank bidding opportunities, Market cap: 45% up from USD12bn to USD17bn CKA replaces PAH as the partner, and leader (given IPO of HKEI as a stapled unit trust at bigger size than CKI), of the global infrastructure HKD5.5/share to recycle HKD56bn cash investments.

Without HKEI, PAH is redundant as HKEI Continuous special dividends (HKD5/share in Jan 2017 stands as yield-play investment choice for the and HKD7.5/share in July 2017) group’s infrastructure assets, while CKI remains the most leveraged to M&A PAH’s share price remain resilient even after paying special dividends, as market expects more special Only completed HKD6bn-worth of… dividends to come …global energy infrastructure deals… …led by CKI Only completed HKD16bn-worth of… …global energy infrastructure deals… (M&A completion: 23% of CKI) …such as 20% minority stake of Duet

Market cap: 15% up from USD16bn to USD19bn (2016: M&A completion: 3x of CKI) Cash/Net-cash: HKD69bn/HKD44bn (2017: M&A completion: 22% of CKI)

Market cap: 3% down, despite distributed 18% of its market cap as special dividend in 2017

Source: Daiwa

PAH: total consideration spent on M&A from CKI: total consideration spent on M&A from 2010-Oct 2017 2010-Oct 2017 (HKDm) (HKDm) 35,000 40,000 30,000 35,000 30,000 25,000 25,000 20,000 20,000 15,000 15,000 10,000 10,000 5,000 5,000 0 0 2010 2011 2012 2013 2014 2015 2016 2017E 2010 2011 2012 2013 2014 2015 2016 2017E (YTD) Cash spent Corporate debt Cash spent Corporate debt (YTD)

Date Type Cash spent Corporate debt Total consideration Date Type Cash spent Corporate debt Total consideration Jun-10 Seabank Power Network GBP211.7m NA GBP211.7m Jun-10 Seabank Power Network GBP211.7m NA GBP211.7m Oct-10 UKPN GBP1bn GBP1.31bn GBP2.3bn Oct-10 UKPN GBP1bn GBP1.31bn GBP2.3bn Sep-12 West and Wales Utilities GBP204m GBP404mn GBP608m Apr-11 Meridian Cogeneration CAD45.7m NA CAD45.7m Sep-13 AVR EUR112m EUR77m EUR189m Oct-11 Northumbrian Water GBP880m GBP905mn GBP1.8bn Sep-14 Envestra AUD667m NA AUD667m Sep-12 West and Wales Utilities GBP204m GBP404mn GBP608m Nov-15 Iberwind EUR144m NA EUR144m Apr-13 EnviroWaste NZD340m NZD150m NZD490m Jul-16 Husky's oil pipeline (HMLP) CAD866m CAD409m CAD1.275bn Sep-13 AVR EUR198m EUR133m EUR331m May-17 Duet Group* AUD1.46bn NA AUD1.46bn Jul-14 Park'N Fly CAD381m NA CAD381m Total HKD37.8bn HKD23.9bn HKD61.7bn Sep-14 Envestra AUD667m NA AUD667m Mar-15 Eversholt GBP570m GBP730m GBP1.3bn Source: Company, Daiwa research Nov-15 Iberwind EUR144m NA EUR144m Jul-16 Husky's oil pipeline (HMLP) CAD289m CAD136m CAD425bn May-17 Duet Group AUD2.92bn NA AUD2.92bn Aug-17 Reliance CAD705m NA CAD705m Nov-17 Ista EUR1.8bn NA EUR1.8bn Total HKD88.0bn HKD44.8bn HKD132.8bn Source: Company, Daiwa research

CK Group: the makings of one big, happy family: 24 January 2018

2018-20E: What will happen over the next 3 years?

CKA: waiting on property; growing on infrastructure CKI: another merger attempt with PAH

CK Group: the makings of one big, happy family: 24 January 2018

CK Asset Holdings: 2018-20E Waiting on property; growing on infrastructure

Based on our analysis of Question 1, we believe Cheung Kong Group’s property businesses were greatly strengthened in terms of both recurrent rental income and asset backing after the re-organisation in 2015. Subsequently, the company attempted to position itself as a pure property company, which many had expected would result in a notable narrowing of the NAV discount on its equity market valuation.

Impact of combining CKP and Hutchison Property Cheung Kong Hutchison Cheung Kong Property Group* Property Group* Property* Investment properties Rental properties in HK, China & overseas ~4m sq ft ~13m sq ft ~17m sq ft Development properties Development landbank in HK ~8m sq ft - ~8m sq ft Development landbank in China ~80m sq ft ~77m sq ft ~158m sq ft Development landbank overseas) ~3m sq ft ~2m sq ft ~5m sq ft Total ~91m sq ft ~79m sq ft ~170m sq ft Hotel and serviced suites No. of hotel rooms in HK 8,710 3,440 12,150 No. of hotel rooms outside HK 650 1,880 2,530 Total 9,360 5,320 14,680 Property management Properties under management in HK China 21m sq m REITs and asset managers Stake in Fortune REIT 28.0% Stake in Prosperity REIT 19.3% Stake in Hui Xi’an REIT 46.2% ARA Asset Management 7.8% Hui Xi’an Asset Management 30.0%

Source: Company Notes: *Figures are based on corporate presentations in Jan-May 2015 and are not updated with the most current figures

This narrowing of the NAV discount, however, did not occur while the monetisation of its property assets in both Hong Kong and China has gathered further momentum over the past 3 years. Thus, this situation raises a major question for the group: how to deploy its surplus cash in ways other than bank deposits given that the group moved its treasury operations to CKH after the re-organisation.

This issue is made more complex by the fact that all along, Cheung Kong Group’s approach to land purchases has not been mechanical in that it just simply deployed all incoming cash to land purchases. We think Cheung Kong Group has adopted a special model in the property business: that of waiting for the right time to buy land in scale.

In this light, our read is that with CKA gradually moving away from the pure property company model after giving this idea a trial, it is simply returning to the traditional Cheung Kong model for the property business which has served the group well over the past few decades.

The Cheung Kong business model for the property business

As we remarked in Question 1, Cheung Kong Group has pursued a special model in global property, focused on getting the timing right to buy land, allocate capital and recycle capital. It has tended to make bold and determined moves when the property market is judged to be at the early stage of the cycle, and adopted a high asset turnover approach to scale up its landbank along the way, until it judges that the reward/risk profile of further net land purchase is no longer attractive enough. Then the group enters a monetisation mode which entails it: 1) parking the surplus cash in its treasury operations to secure a higher yield while at the same time waiting for the right landbanking opportunities to emerge, 2) investing in group companies, and 3) nurturing new investments.

As and when it judges that attractive enough opportunities have emerged in the property space, Cheung Kong Group can monetise its investments in the 3 above sources to re-invest in the property businesses. This approach resembles the Cheung Kong model for the property business, and the base case of our analysis assumes it will continue to use such a business model in the years ahead, though at the same time adapting to changing business circumstances.

CK Group: the makings of one big, happy family: 24 January 2018

Unlikely to return to being a major net purchaser of land in Hong Kong and China in the near future

In our opinion, the group has already completed phase one of what we characterise as the Cheung Kong model on property development or simply land banking.

In retrospect, Cheung Kong Group started to scale up its landbank once land sales resumed in Hong Kong in 2004, paying what was seen as a premium price at the time to obtain the Ma On Shan site for sale in the first auction since land sales resumed. Subsequently, Cheung Kong was a prominent and determined bidder in various land auctions and paid premium prices, including HKD10bn for the Homantin site in 2005.

Later on, Cheung Kong also won the tender for various MTRC projects which resulted in it becoming the developer with the largest residential landbank by the late 2000s, a reversal of the situation back in the early 1990s when it fell to the No.3 or No.4 position at one point.

We think this development of becoming the largest landbank owner is worth noting, because we see strategic elements to Cheung Kong’s landbanking strategy and contend that the first phase of Cheung Kong’s landbanking actually dates back to the 1980s. And importantly, looking at the issue from this perspective throws more light on its strategy for Hong Kong now and in the coming years, as well as what the group has done in its non-property businesses throughout these years.

Evolution of Cheung Kong Group’s non-property businesses

Source: Daiwa

Historically, we believe Cheung Kong has got a lot of its land from forming joint-ventures with land owners and making use of the landbank resources of the companies it has acquired. In the late 1980s, it completed 4 mega- sized projects – Sceneway Garden, Laguna City, South Horizons and Kingswood Villa – which made it the largest residential developer in Hong Kong in the 1980s.

However, from the early 1990s onwards, it was not keen to buy more land and as such, its relative market position fell from No.1 to about No.3 or No.4 in the industry by the mid 1990s; and during the early 1990s when it had substantial sales proceeds coming back from property sales, it used that money to subscribe to convertible bonds issued by the smaller companies and red chips; investing to build up Cheung Kong Infrastructure as well as supporting Hutchison in its 2 share placements in 1992 and 1993.

Cheung Kong only started to become active in landbanking in Hong Kong after the property market correction in 1Q94-4Q95. In retrospect, Cheung Kong’s pricing strategy could have been one factor behind the residential property correction at that time because it was Cheung Kong’s sale and pricing strategy for the Bayshore Towers in Ma On Shan which triggered a more severe and widespread price correction in the market.

CK Group: the makings of one big, happy family: 24 January 2018

That said, Cheung Kong together with Hutchison Whampoa became an active buyer of residential landbank in Hong Kong when overall market sentiment had yet to fully recover. From 2H95 onwards, Cheung Kong and Hutchison became active buyers of land in Hong Kong.

Importantly, although 4Q97-2Q03 saw the most severe residential property market correction in Hong Kong, our read is that Cheung Kong more or less stuck to what we characterise as the Cheung Kong model. Indeed, one may also wonder whether the rapid and severe correction in residential property prices in Hong Kong during 4Q97-2Q03 was partly due to Cheung Kong’s pricing strategy. For it was its pricing strategy for the Tierre Verde in Tsing Yi which triggered a widespread residential price correction in Hong Kong from early 1998 onwards, and in subsequent years, whenever Cheung Kong had major projects to launch, it tended to undercut market prices.

That said, from the perspective of the development of Cheung Kong’s Hong Kong residential property business and Hong Kong landbank, such price cutting and asset turnover-oriented strategy was not without its merits. The government at the time had adopted a stance of no floor price on land, and its land sale prices included a few large quality sites in urban areas.

As such, during this market downturn, while Cheung Kong may have had to sell flats at prices cheaper than original expectations, it used the cash to buy more land, which actually enhanced its relative position in the industry. As such, we believe Cheung Kong Group’s relative position in the Hong Kong residential property development industry has been enhanced since the downturn of 4Q97-2Q03.

We also note that Cheung Kong was a determined bidder for the Tiu Keng Leng site for tender in 2002 which was the last major site for sale before the government suspended land sales in 2H02. And Cheung Kong was also a determined bidder for the first land sale in Hong Kong once land sales resumed in 2004.

In all, we believe Cheung Kong was keen to boost its net Hong Kong residential landbank from 1996 onwards and such an endeavour continued for about 10 years, up to about 2007. From that point onward, the amount of residential landbank bought by Cheung Kong was more or less matched by the amount it sold during the year, and over the past few years, its stance became more like a net seller.

CKP/Cheung Kong: annual land purchases and CKP/Cheung Kong: cumulative change in completion of projects in Hong Kong residential landbank in Hong Kong (sq m) (sq m) 800,000 1,600,000 600,000 1,400,000 1,200,000 400,000 1,000,000 200,000 800,000 0 600,000 (200,000) 400,000 200,000 (400,000)

2005 2013 2000 2001 2002 2003 2004 2006 2007 2008 2009 2010 2011 2012 2014 2015 2016

2003 2007 2000 2001 2002 2004 2005 2006 2008 2009 2010 2011 2012 2013 2014 2015 2016

Completion Acquistion Net change

Source: Company, Daiwa estimates Source: Company, Daiwa estimates

Importantly, if such an analysis is valid, then Cheung Kong has probably already finished phase one of its Hong Kong landbanking. Traditionally, Cheung Kong is more a developer for mass market units and we do not expect it to try to become a developer of luxury or high-end units anytime soon. Against this background, and our expectation that more Chinese developers will be keen to build up their Hong Kong landbanks, we do not expect Cheung Kong to resume being a major net buyer of residential landbank in Hong Kong any time soon; albeit that it could buy enough land to match its sales volume to ensure that it would still have a sufficient presence in the industry.

Similarly, we also believe Cheung Kong has already completed phase one of its landbanking in China. In retrospect, Cheung Kong was determined and ambitious in terms of its China landbanking from 2004-07, during which time it carried out a massive scaling up of its China landbank. In retrospect, the amount of land it acquired from 2004-07 would likely take more than 20 years to complete based on its completion volume at that time (under 0.5m sq.m a year).

CK Group: the makings of one big, happy family: 24 January 2018

Such an ambitious landbanking strategy suggests to us that it made a judgement that land in China was undervalued in 2004-07 and so it spent about USD3bn to buy all the land it needed in China for many more years to come. It is arguable that as such, it took a one-off risk on the China property market, with the level of such risk determined by the cost of such an initial bundle of land.

CKP/Cheung Kong: annual land purchases and CKP/Cheung Kong: cumulative change in completion of projects in China residential landbank in China (sq m) (sq m) 10,000,000 25,000,000 8,000,000 20,000,000 6,000,000 4,000,000 15,000,000 2,000,000 10,000,000 0 (2,000,000) 5,000,000 (4,000,000)

2004 2013 2000 2001 2002 2003 2005 2006 2007 2008 2009 2010 2011 2012 2014 2015 2016

2003 2007 2011 2015 2000 2001 2002 2004 2005 2006 2008 2009 2010 2012 2013 2014 2016

Completion Acquistion Net change

Source: Company Source: Company

In our opinion, Cheung Kong Group’s landbanking phase for Hong Kong and China is already over and the group has been in monetisation mode for some time and looks unlikely to change course in the foreseeable future.

That said, our basic assumption is that we do not expect Cheung Kong to withdraw entirely from the Hong Kong residential property market, as we believe Cheung Kong’s business model on property is not universally applicable and Hong Kong is one of the few cities in the world where a developer can raise tens of billions annually by selling mass market projects, wherein Cheung Kong’s speciality lies.

As such, we expect it to still buy land periodically if only for ensuring that it still has a meaningful presence in the Hong Kong residential property market and can scale up quickly once the government offers more land for mass market projects; which could turn the flat-land-price relationship back to a more normal stage to allow some more built-in development margin for the developers.

As for China, our read is that Cheung Kong Group acquired land aggressively from 2004-07 and still has abundant landbank in China. Nearly all Chinese developers recorded high flat sales in 2016 and 2017 and have the financial resources to bid for more land, while many local governments seem unwilling to sell land at lower prices. Under such circumstances, our view is that the chance of CKA resuming major net purchases of land in China is low.

CKP/Cheung Kong: net change in the size of its Hong Kong landbank (sq m) 2,000,000

1,500,000

1,000,000

500,000

(500,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Net change Cumulative landbank

Source: Company, Daiwa estimates

CK Group: the makings of one big, happy family: 24 January 2018

CKP/Cheung Kong: net change in the size of its China landbank (sq m) 25,000,000

20,000,000

15,000,000

10,000,000

5,000,000

0 (5,000,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Net change Cumulative landbank

Source: Company, Daiwa estimates

As such, when it comes to property, the markets where it could buy more land are London and Singapore, where it already has initial bundles of land, dating back to 20 years ago in the case of London. However, traditionally, Cheung Kong has focused on mass market projects and cities where it can gain a significant market position, and we hesitate to assume the group has the ambition to be a major players in these 2 cities. On the whole, our assumption is that CKA will remain in wait mode in the near future, while continuing to monetise its property assets in Hong Kong and China.

That said, Cheung Kong is far from being an entity that just sits on cash and waits for opportunities to come. Compared with other business groups, one advantage of Cheung Kong is that it also has large-scale non-property businesses and that it has many listed companies in the group. We expect the group to focus on these other areas while waiting for landbanking opportunities to emerge.

We expect the following 3 major features to characterise the development of CKA in 2018-20E.

1. Sustained share buyback and constant rise in DPS

One of our base assumptions is that CKA has already moved on to monetisation mode for its property business in both Hong Kong and China; and what this implies is that it had substantial cash resources coming back over the past few years, and this is now set to continue over the next few years.

Source: Company, Daiwa forecasts

CKP/Cheung Kong: residential contract sales in Hong Kong (HKDm) (No. of units) 40,000 6,000

5,000 30,000 4,000

20,000 3,000

2,000 10,000 1,000

0 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Total consideration (LHS) No. of units (RHS)

Source: Centaline, Daiwa

CK Group: the makings of one big, happy family: 24 January 2018

CKP/Cheung Kong: proceeds raised from sale of commercial properties in China GFA Achieved price Achieved psf price Year Properties Cities Stake (sq ft) (CNY/HKD) (HKD/sq ft) 2007 The Center Shanghai 26% 963,336 CNY4.4bn 4,922 2008 Seasons Villas Shanghai 50% 1,150,830 CNY4bn 3,948 2010 Oriental Plaza Beijing 51% 6,162,881 HKD13.1bn 4,168 2012 Shenyang Lido Hotel Shenyang 70% nd CNY980m na 2012 Oriental Finance Centre Shanghai 100% 2,368,058 HKD9,360m 3,953 2013 Metropolitan Plaza Guangzhou 50% 956,997 HKD3.05bn 3,187 2014 Metropolitan Plaza Chongqing 50% 1,511,515 HKD4,976m 3,292 2016 Century Link Shanghai 50% 3,044,066 CNY20bn 7,556

Source: Company

CKP/Cheung Kong: proceeds raised from disposal of non-core assets Year Assets Type Method Buyer Stake Proceeds 2011 HPH Trust (HPHT SP) Ports Spin-off IPO 26% USD5.5bn 2011 Hui Xian REIT (87001 HK) Property Spin-off IPO 50% CNY10.5bn 2012 Shenyang Lido Hotel Hotel Outright sale Hui Xian REIT 100% CNY980m 2013 Kingswood Ginza Property Outright sale Fortune REIT 100% HKD5.8bn 2013 Oriental Financial Centre, Shanghai Property Outright sale China Everbright 100% CNY7.1bn 2014 Metropolitan Plaza Property Outright sale Hui Xian REIT 100% CNY3.91bn 2016 Century Link Property Outright sale China Life consortium 50% CNY20bn 2017 The Center (~75% owned) Property Outright sale PRC consortium 100% HKD40.2bn

Source: Hong Kong Economic Times, SCMP, Daiwa

Non-core properties now under CKA Property Usage Location GFA (sq ft) The Center Office Central 1,218,162* China Building Office Central 258,756 Tower 1, The Harbourfront Office Hunghom 431,152 Tower 2, The Harbourfront Office Hunghom 431,841 Hutchison Telecom Tower Office Tsing Yi 300,338 Wonderful Worlds of Whampoa Retail Hunghom 1,714,006 Aberdeen Centre Retail Aberdeen 345,026 Victoria Mall Retail Tsimshatsui 143,040 United Centre (various shops) Retail Admiralty 37,803 Rambler Crest Retail Tsing Yi 44,175 Hunghom Bay Centre Retail Hunghom 80,422 Chun Fai Centre Retail Tai Hang 32,373 Fine Mansion Retail Happy Valley 13,704 Conic Investment Building Industrial Hunghom 327,414 Cavendish Centre Industrial Aberdeen 342,923 Watson Centre Kwai Chung Industrial Kwai Chung 687,295 Watson Centre Fo Tan Industrial Shatin 280,923 Fanling Sheung Shui Town Lot 97 Industrial Sheung Shui 142,416 Provident Villas Residential Pokfulam 19,343 23 Coombe Road Residential The Peak 6,124 Baguio Villa Residential Pokfulam 12,967 6,870,203

Source: Company, Daiwa * Disposal transaction yet to be completed

Our read is that a share buyback represents one attractive way for the group to deploy its surplus cash.

On 18 March 2016, the then CK Property initiated a share buyback and so far the amount it has spent has culminated in USD1.1bn, surpassing Link REIT as the company that has spent the largest amount on a share buyback. While many family property companies appear to be hesitant about share buybacks, we see them as an effective way to address the issue of the NAV discount on Hong Kong property companies.

Indeed, using sales proceeds raised from the sale of property assets to buy back shares that trade at a discount to underlying NAVs is tantamount to selling less-core assets at full price and then buying more of the better-quality ones at discounted prices, in our view. What safer and easier way to create value for shareholders than this?

As Warren Buffett put it, share buybacks is one of the safest ways to create value for shareholders when the shares are trading at a substantial discount to the underlying business values. Yet, while share buybacks seem to represent a big psychological barrier for many families in Hong Kong, our read is that Cheung Kong Group , which historically has been one of the most forward-looking and advanced-thinking companies in Hong Kong, is well aware of the value of share buybacks and appears determined to carry out share buybacks continuously.

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong Group: share buybacks since its reorganisation Date No. of shares Avg price Total cost % of issued bought (m) (HKD) (HKDm) shares CK Hutchison 17-Nov-16 0.78 92.847 72.7 0.02% 18-Nov-16 1.22 94.872 115.5 0.03% Total 2.00 94.079 188.2 0.05% CK Property Mar 2016 13.5 46.725 632 0.35% May 2016 0.6 45.237 29 0.02% Dec 2016 21.5 51.376 1,105 0.56% Jan 2017 23.8 51.174 1,218 0.62% Mar 2017 23.7 53.970 1,282 0.63% Apr 2017 33.9 53.604 1,819 0.90% May 2017 20.8 56.828 1,182 0.56% Jun 2017 24.2 61.165 1,481 0.65% Total 162.2 53.941 8,748 4.29%

Source: HKEx, Daiwa

Indeed, we see one aspect of Cheung Kong Group reorganisation as the prelude to a sizeable share buyback programme. In Appendix V of the Offer Document related to Cheung Kong Group reorganisation, it was stated that under the Companies Ordinance in Hong Kong, “a redemption of buy back may only be funded out of the company’s distributable profits.” By way of contrast, if a company is incorporated in the Cayman Islands, it is possible that its share buyback can be founded by its share premium account as well, provided that “the company shall be able to pay its debts as they fall due in the ordinary course of business.”

Amount credited to share premium account of CKH [HKD331.7bn (note 1)]

Source: Company

In this light, one merit of the group’s change of domicile to the Cayman Islands in 1H15 is that the scale of its share buybacks would no longer be restricted by the Companies Ordinance and it would be free to undertake a massive share buyback.

Indeed, under a low interest-rate environment, if a company intends to see a continuous rise in its DPS over time, a share buyback would save it a considerable amount of cash for paying dividends to shareholders. In this light, if the group continues to pay a high DPS, it would make sense for it to pursue a share buyback programme.

Another dimension to note is that the Li family’s stake in CKA is not the most secure post the reorganisation, in our opinion. While we do not see any threat to the family’s control over the group any time soon, we believe it would be in the interests of the Li family to see its stake at a higher level – note that nowadays, the market cap of Tencent alone is larger than the combined market cap of all listed Hong Kong property companies. We would see a share buyback as the most effective way for the family to raise its effective stake in CKA, which would be beneficial for all shareholders including the Li family.

CK Group: the makings of one big, happy family: 24 January 2018

2. Becoming a financial sponsor for group companies, especially CKI

While we believe share buybacks is the easiest and one of the most attractive ways for Cheung Kong Group to deploy its surplus capital, we do not expect buybacks to become the most important activity of the group.

For one thing, we believe Chinese families are still concerned that share buybacks may look like financial engineering and they generally prefer to use capital to invest in the real business. Besides, because of the regulatory requirements, there is a limit as to how many CKA shares the group can buy back. For the creeper’s rule in Hong Kong states that for companies where the major shareholder owns less than 50% of the company, they are allowed to raise their effective stake in the company by no more than 2% over a 12-month period.

Given that the Li family now owns about 31.5% of CKA, the company would be able to buy back at most around 6% of the company’s outstanding shares, which would be about 20m shares. As such, we estimate the maximum amount of capital the group could spend on share buybacks annually would be in the HKD10-15bn range.

Share buybacks would provide one outlet for the group’s surplus cash, but would not be able to exhaust it. As such, we think the group would consider opportunities related to its group companies. And indeed, it has set a precedent for so doing.

For example, during the 1990-95 period when Cheung Kong had abundant cash coming back and Hutchison faced challenges in its overseas investments, Cheung Kong gave Hutchison a helping hand by participating in the latter’s 2 share placements in 1991 and 1992. And Cheung Kong has continued to buy Hutchison shares on the open market ever since.

CKA could take similar action this time, although the target would more likely be CKI, which has almost used up all its financial resources and would need shareholders’ approval to commit to any major new investments. Under such circumstances, we believe CKA would continue to act as CKI’s financing partner and ensure that CKI would not have to give up bidding for attractive projects just because of capital constraints. In fact, since May 2017, CKA has invested over USD7bn in joint projects with CKI and we expect to see more of this type of activity in the years to come.

CK Asset: non-property investments Date Company Business Consortium Total consideration July 2017 Acquired 100% interest in Ista A fully integrated energy management CKP (65%) / CKI (35%) EUR4.50bn services provider in Europe (HKD41.40bn) Acquired 100% in Reliance Home A home water heater and related services CKP CAD2.80bn Comfort provider in Canada (HKD17.16bn) On-sold 25% in Reliance Home CAD715m (HKD4.39bn) Comfort to CKI May 2017 Acquired 100% in DUET Group Owner and operator of energy utility assets CKP (40%) / CKI (40%) / AUD7.41bn in Australia, the US, UK and Europe PAH (20%) (HKD42.69bn) Dec 2016 Acquired 100% interest in CK Aircraft leasing CKP USD988m (HKD7.69bn) Capital & Harrier Global

Source: Company

3. Nurture new investments

Other than being the financing partner of CKI, our read is that CKA would continue to nurture new investments, which again is not without precedent for Cheung Kong Group: CKI was created under such circumstances, as was the group’s hotel and serviced suites business.

We note that since the beginning of 2017, CKA has invested in some so-called in-building infrastructure projects and we expect it to continue to pursue opportunities of this kind. These projects would lie somewhat between the expertise of CKI and CKA and we believe that all options are open for these investments.

In the future when the timing is right, we would not be surprised if CKI bought out these projects from CKA when it found major opportunities in the land market, or when it wanted to boost the scale of CKI to the next level – a situation which we discuss in greater detail in the next section.

CK Group: the makings of one big, happy family: 24 January 2018

CKP: foundation of its portfolio of hotels and serviced suites Hong Kong Date Site GFA Price Accommodation (sq ft) (HKDm) value (HKD/sq ft) Mar 1998 STTL 461, Ma On Shan 614,520 120 196 Aug 2001 KIL No. 11110, Hung Hom Bay Reclamation area 1,156,483 1,090 943 Oct 2001 KIL No. 11103, Hung Hom Bay Reclamation area 1,283,546 655 510

Source: Company

CKP: current portfolio of hotels and serviced suites Hong Kong Location Stake GFA (sq ft) No. of rooms Year of opening Serviced suites Harbourview Horizon Hunghom 100% 1,283,930 1,662 2005 Harbourfront Horizon Hunghom 100% 1,156,527 1,980 2006 Horizon Suite Hotel Ma On Shan 100% 602,784 831 2002 The Apex Horizon Kwai Chung 100% 228,089 360 2007 3,271,330 4,833 Hotels Harbour Grand Kowloon Hunghom 100% 510,935 555 1995 Harbour Plaza Metropolis Hunghom 100% 461,313 821 2002 Sheraton Hong Kong Tsimshatsui 39% 666,830 782 1974 The Kowloon Hotel Tsimshatsui 100% 329,486 736 1985 Harbour Grand Hong Kong North Point 100% 444,995 828 2008 Harbour Plaza North Point North Point 100% 343,081 669 1999 Harbour Plaza 8 Degrees To Kwa Wan 100% 230,565 704 2009 Rambler Garden Hotel Tsing Yi 100% 211,114 800 2003 Rambler Oasis Hotel Tsing Yi 100% 213,235 822 2003 Harbour Plaza Resort City Tin Shui Wai 98% 662,126 1,102 1999 4,073,680 7,819 Total 7,345,010 12,652

Source: Company

CKP: landbank in London Total GFA Attri. GFA Year of Projects Location Stake (sq ft) (sq ft) completion Chelsea Waterfront on Lots Road Chelsea 95% 48,499 46,074 2016 95% 106,334 101,017 2017 95% 58,287 55,373 2017 95% 89,374 84,906 2018 95% 230,209 218,699 2018 95% 270,664 257,131 2019

A site at Convoys Wharf Convoys Wharf 100% 3,093,216 3,093,216 2020

Source: Company

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong Infrastructure: 2018-20E CKI-PAH merger still the pre-requisite for CKI to lead global infrastructure M&A for the group

Since its establishment in 1996, CKI has benefited from the management expertise of founder Victor Li, who engineered CKI’s acquisition of HK Electric (a cash-cow integrated electricity company) in 1997, which provided a cash dividend and also a co-investment balance sheet for starting its global infrastructure investment journey, first in Australia in the early 2000s, and then in the UK in the early 2010s. In particular, 39%-owned PAH has been a “bank” for CKI since its establishment, and we expect PAH to distribute another special dividend (c.HKD7.5/share) to CKI by 1H18E, to cash out all the HKD57bn cash raised through the IPO of HK Electric Investments (HKEI) in 2014.

However, CKI still needs further help from Victor, as a standalone company without having merged with PAH. In 2017, CKA took the lead within Cheung Kong Group in global infrastructure investment through submitting unconditional offers and taking majority stakes in Duet, Reliance and Ista. For the recent 3 transactions in 2017, CKA took a 100% stake first and then held an AGM to sell 25-40% of each stake to CKI.

Cheung Kong Group: global infrastructure investments pending for 2018-20E Years of CKA CKHH CKI PAH LKSF acquisition Consideration (1113 HK) (1 HK) (1038 HK) (6 HK) (private) Seabank Power 2010 GBP423.4m 0.00% 0.00% 25.00% 25.00% 0.00% UKPN 2010 GBP5.75bn 0.00% 0.00% 40.00% 40.00% 20.00% Meridian Cogeneration Plant 2011 CAD45.7m 0.00% 0.00% 100.00% 0.00% 0.00% Northumbrian Water 2011 GBP4.5bn 0.00% 40.00% 40.00% 0.00% 20.00% West and Wales Utilities 2012 GBP2.0bn 0.00% 30.00% 30.00% 30.00% 10.00% EnviroWaste 2013 NZD490m 0.00% 0.00% 100.00% 0.00% 0.00% AVR 2013 EUR946m 0.00% 35.00% 35.00% 20.00% 10.00% Park'N Fly 2014 CAD762m 0.00% 50.00% 50.00% 0.00% 0.00% Envestra 2014 AUD2.4bn 0.00% 27.50% 45.00% 27.50% 0.00% Eversholt 2015 GBP1.6bn 0.00% 50.00% 50.00% 0.00% 0.00% Iberwind 2015 EUR288m 0.00% 0.00% 50.00% 50.00% 0.00% Husky's oil pipeline (HMLP) 2016 CAD2.6bn 0.00% 14.07% 16.25% 48.75% 0.00% Duet Group 2017 AUD7.3bn 40.00% 0.00% 40.00% 20.00% 0.00% Reliance Home Comfort 2017 CAD2.82bn 75.00% 0.00% 25.00% 0.00% 0.00% Ista 2017 EUR5.1bn 65.00% 0.00% 35.00% 0.00% 0.00% : : : Less stake than CKA; Minority stake

: 2018-20 : Majority stake 0.00% but more stake for energy 0.00% : : : than PAH assets

Source: Daiwa research Note: In 2015 CKH-HWL reorganization, all non-property assets were transferred to CK Hutchison Holdings (1 HK), which holds 75.7% of CKI

According to the Chapter 14 of the HKEx listing rules, a company has to fulfil 5 ratio requirements (involving assets, consideration, profits, revenue and equity capital) to not require minority shareholders’ approval for any big-ticket M&A. If any parameter of the above-mentioned 5 ratios for the targeted company exceeds 25%, it is classified as a major transaction which then requires the acquirer to hold an AGM to obtain minority shareholders’ approval; and hence the M&A project would be exposed to the public, alerting more potential bidders. Even though CKI has been aggressively accumulating assets since 2010, it still frequently fails the ratios test given most of its meaningful assets are not consolidated under a co-investment arrangement with PAH. Therefore, CKI usually needs another non-direct holding group company to lead any big-ticket M&A, such as CK Holdings, on Northumbrian Water and Eversholt, before the re-organisation in 2015; or CKA after the re-organisation. We estimate any M&A targets, whose consideration is over USD2bn, would need CKHH/CKA to take the lead in the bidding.

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong Group: organisation chart After reorganising Cheung Kong and Hutchison Before reorganising Cheung Kong and Hutchison Before CKI merges with PAH Before 9-June-2015 Current

The Li family The Li family

30.15% 31.5% 43.42%

Cheung Kong CK Hutchison, CK Asset, CKA (Holdings) ,CKH CKHH (1113 HK) (1 HK) (1 HK) 49.97% 75.67% (Effective stake: 21.70%) (Effective stake: 22.81%) Co-investment partners Hutchison, HWL CKI

(13 HK) (1038 HK) investment partners investment

- 75.67% 38.87%

Co (Effective stake: 16.42%) (Effective stake: 8.87%)

CKI Co Power Asset - (1038 HK) investment partners (6 HK)

38.87% (Effective stake: 6.38%)

Power Asset (6 HK)

Source: Daiwa research Note: In 2015 CKH-HWL reorganization, all non-property assets were transferred to CK Hutchison Holdings (1 HK), which holds 75.7% of CKI

Cheung Kong Group: JV formation trend for global infrastructure investment (2018-20E) After reorganising Cheung Kong Holdings and Hutchison Whampoa 0% The Li family (Effective stake: 28%) 30.15% 31.5%

Before reorganising Cheung Kong Holdings and CK Hutchison CK Asset Hutchison Whampoa (1 HK) (1113 HK) 70% 75.67% 0% (Effective (Effective stake: 22.81%) The Li family (Effective stake: 21%) stake: 18%) 30% CKI Non- 43.42% (1038 HK) (Effective stake: 7%) energy 38.87% Cheung Kong 20% assets (Holdings) (Effective stake: 8.87%) (Effective (1 HK) stake: 9%) Power Assets 49.97% (6 HK) (Effective stake: 21.70%) 0% Hutchison Energy The Li family (Effective (13 HK) stake: 23%) 30.15% 31.5% 75.67% Assets (Effective stake: 16.42%)

CKI 40% CK Hutchison CK Asset (1038 HK) (Effective (1 HK) (1113 HK) stake: 7%) 75.67% 40% 38.87% (Effective stake: 22.81%) (Effective (Effective stake: 6.38%) stake: 12%) CKI 40% Power Assets 40% (1038 HK) (Effective (6 HK) (Effective stake: 9%) stake: 2%) 38.87% Energy (Effective stake: 8.87%) assets 20% Power Assets (Effective (6 HK) stake: 2%)

Source: Daiwa estimates

CK Group: the makings of one big, happy family: 24 January 2018

Nowadays, we have seen more Chinese-based companies, such as Beijing Enterprises Group, China Everbright Group and China Yangtze Power, bidding for overseas mid-ticket-size global infrastructure assets (USD0.5-2.0bn). Therefore, we believe the competition for mid-size assets could be fiercer in the future. In 2017, all of CKA’s completed deals (Duet, Reliance and Ista) exceeded USD2.5bn (or USD1.0bn for a 40% stake).

Recent reports on China-based SOE bidding on global infrastructure assets Date Potential bidders Assets Expected consideration Jul-17 CKI, State Grid of China, China Southern Grid, China Yangtze Power Elenia Oy - Finnish electricity distributor EUR3bn Sep-17 CKI, Beijing Enterprises Group, China Everbright Group Cory Riverside Energy - UK waste-to-energy company Over GBP1bn Sep-17 Beijing Enterprises Water (371 HK, Buy [1]), China Everbright Water (CEWL SP, not rated) Trility Group - Australian water company AUD250m

Source: Daiwa research

In 2018-20, it will be in CKA’s interest to aggressively invest in global infrastructure assets with CKI, given it has a huge HKD200bn in contract sales (or HKD60-70bn of recycled cash) to invest. It would also be in the best interests of Victor Li to allocate more investment opportunities to CKA, in which he owns a 30.3% stake, much higher than his mere 8.9% effective stake in PAH. However, if CKA explored any attractive property or landbank investment opportunities, it might need to slow down the investment pace of its non-property global infrastructure assets.

Under such a scenario, investors might assume that PAH would take the initiative to obtain a higher stake in any future M&A deals with its net-cash balance sheet, should CKA need to shift its focus back to property. However, we believe Victor Li’s well-proven preference for global infrastructure assets, evidenced by CKI’s over 8% 2001-16 net- asset CAGR, compared with only 5% for the other 5 main Cheung Kong Group businesses (ports, property, retail, energy and telecom), will preclude PAH from taking a significant stake in any future M&A deals, as we believe the mission of PAH to support CKI ended after the spin-off of HKEI.

We believe Victor Li will not need PAH (a smaller CKI) to co-invest in global infrastructure assets with CKI in the future. PAH is redundant, in our view, given investors who prefer consistent M&A growth will own CKI, and those who prefer yield will own HKEI. In the future, CKI’s co-investment partners are likely to be CKA, or CK Hutchison (CKHH) in case CKI becomes an associate company for CKHH should there be a successful CKI-PAH merger.

As such, Victor Li would likely prefer the 22.8%-owned CKI to complete more global infrastructure investments, rather than 8.9%-owned PAH, in case the 30.3%-owned CKA needs to step down as the infrastructure global investment leader for Cheung Kong Group.

CK Group: the makings of one big, happy family: 24 January 2018

Will a second attempt at a CKI-PAH merger finally take place?

In our previous special report, “What’s cooking – Q&A on why we think a CKI/PAH merger should be on the menu for Cheung Kong Group ” published on 21 July 2015 (50 days before the official announcement of the first CKI- PAH merger attempt), we argued that Cheung Kong Group would be able to use the HKD69bn idle cash from PAH to CKI to engage in big M&A deals. Given that PAH no longer has the significant idle cash after paying out HKD26.7bn in special dividends in 2017, we believe the only remaining reason for a CKI-PAH merger is whether CKI can realise valuation enhancement through merging with PAH.

In forward PER terms, CKI has traded at average discounts of 23% to PAH and 19% to peer CLP Holdings (2 HK, HKD78.4, Hold [3]) since 2010, despite having a superior EPS CAGR of 12% for 2010-17E (1% for PAH, 5% for CLP, on our forecasts) and being more active in M&A (CKI’s M&A activity in 2017 totalled HKD37bn for 3 deals; PAH’s totalled HKD8bn for 1 deal co-invested with parent CKI; CLP recently spent HKD5bn for a 17% stake in Yangjiang Nuclear in China under CGN Power). We attribute CKI’s historical valuation discount to its smaller market cap (20% below CLP’s), lower free float (51-62pp lower than its peers’) and thin trading volume (36-41% lower than its peers’), apart from the market sentiment favouring high-yield stable USD-bond like assets in 2016-17, under a strong USD and low interest-rate investment environment.

Hong Kong utilities: comparison of market cap, Hong Kong utilities: forward PER comparison free float, trading volume and forward PER CKI PAH CLP 35 Market cap (USD m) 23,480 18,671 26,226 Premium over CKI -20% 12% 30 Free float 22.91% 61.13% 71.41% Premium over CKI 38ppt 49ppt 25 Free float market cap (USD m) 5,378 11,414 18,728 20 Premium over CKI 112% 248% 3M average trading volume (USD m) 15.21 23.66 25.59 15 Premium over CKI 56% 68% Current forward PER 13.4x 18.6x 15.5x 10 Premium over CKI 39% 16%

5 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 CKI PAH CLP HKCG

Source: Company, Bloomberg, Daiwa Source: Bloomberg, Daiwa forecasts

Hong Kong utilities: market cap and free float Hong Kong utilities: 3-month average trading volume (USDm) (USDm) 30,000 71.4% 80% 50 70% 25,000 61.1% 40 60% 20,000 30 50%

15,000 40% 20 26,226 23,480 30% 10,000 18,671 10 22.9% 20% 5,000 10% 0 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 0 0% CKI PAH CLP CKI PAH CLP Source: Company, Daiwa Source: Company, Daiwa

After the spin-off of HKEI in 2014, the earnings profiles of CKI and PAH are now broadly similar, but Cheung Kong Group has recently allocated shares in new global infrastructure projects acquisition opportunities to CKA and CKI than to PAH. If market sentiment turns favourable towards inflation-linked growth-style investments which can offer a stable yield gap under a rising interest-rate environment, we believe the valuation gap between CKI and PAH/CLP would narrow, which is likely in 2018-20E. See our Hong Kong utilities sector report, “The race is on for an attractive yield gap” published on 24 January 2017, for more details.

CK Group: the makings of one big, happy family: 24 January 2018

Before the GFC in 2008, under a high interest-rate environment, PAH-CKI’s forward PER ratio traded mostly below 1.0x, as CKI was considered by investors to have greater M&A growth potential than PAH. However, since 2010, under a low interest-rate environment favouring high-yield stocks, PAH-CKI’s forward PER ratio has traded in a range of 1.0-1.6x.

In 2011, while CKI and PAH co-invested in UK energy assets, with more overseas global infrastructure asset disposals post the 2008 GFC, the PAH-CKI forward PER ratio was 1.0-1.2x. In 2012-13, when more countries joined the US’s tapering programme which ushered in a low interest-rate environment, the CKI-PAH forward PER ratio rose to 1.3x.

Looking ahead to 2018-19, if Cheung Kong Group allocates fewer M&A opportunities to PAH to grow PAH’s earnings, while interest rates rise to a similar level as before the GFC (at 3-4% for 10-year US treasury yield, current: 2.35%), we would see the CKI-PAH forward PER gradually falling towards 1.0x, or even below 1.0x; particularly as PAH has a higher 33.37% stake in HKEI, compared with CKI’s 13.06%, and given HKEI is facing a SoC return cut from 9.99% currently to 8% in 2019. Therefore, PAH will be likely only able to maintain its current ordinary DPS, and hence its yield gap and valuation, on account of insufficient M&A growth and a declining return of its 33.37%-owned HKEI. In 2008-09, when interest rates were 1pp higher than in 2016-17, and PAH was facing a SoC return cut from 13.5% to 9.99%, PAH traded at a lower forward PER than CKI for most of the time.

PAH-CKI’s PER & share-price ratio (2008-17 YTD) In 2008, PAH-CKI In 2009, PAH- In 2010, PAH-CKI forward In 2011, PAH-CKI In 2012-13, In 2014, PAH- In 2015, In 2016, PAH- Post 2017, PAH-CKI's forward PER ratio CKI forward PER ratio surged from forward PER ratio tapering globally CKI's forward PAH-CKI's CKI's forward forward PER ratio looks surged from 0.8x PER ratio below 0.9x towards 1.2x stayed at 1.0-1.2x; saw interest rates PER ratio forward PER ratio rose set to dip to below 1.3x to 1.2x as market dropped from due to global QE leading a CKI and PAH wee declining, favouring surged to 1.6x PER ratio to 1.5x on after exhausting all sentiment turned 1.2x to 0.9x on very low interest rate agressively adding high-yield after PAH's fell back to strong cash, without much defensive after SoC return cut environment, favouring overseas (mainly companies. PAH spin-off of 1.3x expectations ordinary DPS growth, global financial for HKEI from PAH as it has higher yield UK) infrastructure was rerated given it HKEI, with an without of special given HKEI's SoC return crisis 13.5% to projects has higher expectation of singificant dividends; cut (from 9.99% to 8%), 1.7 9.99% ownership of HKEI signficant M&A M&A also, CKI in rising interest-rate 1.6 would be more envirnment 1.5 affected by Brexit 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 PAH/CKI PER ratio PAH/CKI price ratio

Source: Daiwa research Note (1): The fair PAH-CKI forward PER ratio, under a high interest rate environment, was around or below 1.0x Note (2): The fair PAH-CKI forward PER ratio, under an downtrend interest rate and co-investment cycle, was 1.0-1.2x Note (3): The fair PAH-CKI forward PER ratio, under bottom interest rate and strong USD environment cycle was 1.3x

CKI and PAH: yield gap trends US interest rate environment (%) (%) 2.0 4.5 1.8 4.0 Credit crunch 1.6 1.4 3.5 1.2 3.0 1.0 Further quantitative 0.8 2.5 easing 0.6 2.0 0.4 1.5 0.2 0.0 1.0

Current Average 2018E Average 2019E

Jul-14 Jul-09

Oct-15 Oct-10 Apr-13

Jan-12 Jun-12 Jan-17 Jun-17

Feb-09 Mar-11 Feb-14 Mar-16

Dec-09 Nov-12 Dec-14

Sep-08 Aug-11 Sep-13 Aug-16 May-15 CKI PAH May-10

Source: Company, Daiwa estimates Source: Company, Daiwa estimates

Therefore, we see an opportunity for the CKI-PAH forward PER ratio to narrow in 2018-20E, introducing an opportunity for CKI to merge with PAH, becoming a bigger company to lead global infrastructure investment within Cheung Kong Group .

CK Group: the makings of one big, happy family: 24 January 2018

How could a merged CKI-PAH benefit CKI, PAH and the Li family?

PAH: more M&A, more efficient use of its HKD69bn of cash Based on the current market value of PAH, we estimate CKI would have to issue 850-1,300m new shares to PAH’s minority shareholders (61.13%), assuming a 0.90-1.38x CKI-PAH forward PER merger ratio. We believe the minority shareholders would likely accept a merger proposal, since a merger would give PAH’s shareholders more exposure to M&A opportunities, and carry the promise of EPS (and DPS) growth, which would enhance ROE (from currently 8% to CKI’s 11%) and maintain the yield gap amid a rising interest-rate environment.

CKI: improved free float, bigger market cap, and bigger equity base for M&A A merger of CKI and PAH would theoretically create a global infrastructure giant with a HKD300-330bn market cap (c.USD40bn). Apart from the elimination of the holding-company discount, CKI’s current shareholders would benefit from a merger through an HKD135-160bn market capitalisation enhancement, with the free float increasing from 24.33% as at 22 October 2017 to 38.3-50.2%. As a result, we believe CKI’s 2018E PER could be rerated from 13.5x to 17.0-18.5x. By way of comparison, its local peers are trading at the following 2018E PERs currently: PAH (18.4x), CLP (15.5x) and HKCG (25.5x); and its global utilities peers have the following 2018E PERs: United Utilities (UU LN; 18.2x), National Grid (NG LN; 15.5x), and Ausnet Services (AST AU; 23.8x). We would expect a rerating to flow from the likely almost doubling of CKI’s market cap, together with enhanced share trading volume. At the same time, CKI would increase its equity base by 50-75% from HKD115bn to HKD170-200bn, providing it with more headroom to gear up for further M&A opportunities (estimated as HKD60bn before reaching 125% see- through net-debt-to-equity gearing) without the need for equity financing.

The Li family (Victor Li): more leverage on future M&A Through a merger with PAH, the Li family (Victor Li) would focus its global infrastructure M&A through a listed company in which it had greater ownership (CKA and CKHH: each c.30%, CKI: 15-17%), instead of PAH’s 8.87%. In a few years, Victor Li would likely succeed his father, Li Ka Shing, as the chairman of both CKA and CKHH, and hence would likely prefer to grow its global infrastructure business using both CKA and CKHH, rather than PAH, to introduce a less complex corporate structure.

Through a potential CKI-PAH merger, we also see the possibility of CKI issuing new shares to Victor Li, for him to: 1) have more direct ownership in CKI (from 15-17% to 15-27%), and 2) to de-consolidate the merged CKI’s debt (with less than 50% ownership, current: 75.67%) under CKHH’s balance sheet.

Positive impact on PAH, CKI, CKHH and the Li family of a CKI/PAH merger More exposure to M&A opportunities as the target assets are not limited to energy projects, to enhance its ROE from 8% currently to CKI’s 11%, amid the imminent SoC return cut (from 9.99% to 8%) for its 33.7%-owned HKEI, to achieve continuous ordinary DPS growth to PAH maintain its yield gap under a rising interest rate environment Enhancement of its market capitalisation from c.HKD145bn (or c.USD18.5bn) to c.HKD300-330bn (or c.USD40bn) Elimination of the holding company discount Enhancement of its market capitalisation from c.HKD175bn (or c.USD22.5bn) to c.HKD300-330bn (or c.USD40bn) CKI Increase of its free float from 24.33% to 43.4-49.9% Potential forward-PER rerating from 13.5x to 17.0-18.5x Enhance of its equity base by 60-90% for more room to gear up its balance sheet for M&As Li family More direct-ownership for future global infrastructure investment with CKA & CKHH (Victor Li) Effective stake of CKI would drop from 75.67% to below-50%, and hence it would not need to consolidate the debt under CKI as CKI would CKHH become an associate, in case CKI issued additional shares through the CKI-PAH’s merger exercise Source: Daiwa research

CK Group: the makings of one big, happy family: 24 January 2018

Overview of Li Ka Shing’s Hong Kong-listed assets following reorganisation of CKH and HWL, and potential merger of CKI and PAH After reorganising Cheung Kong and Hutchison After CKI merges with PAH Our thoughts After reorganising Cheung Kong and Hutchison Before reorganising Cheung Kong and Hutchison Before CKI merges with PAH The Li family Before 9-June-2015 Current 30.15% The Li family The Li family CK Hutchison, CKHH 30.15% 31.5% 43.42% (1 HK) 49.98-56.62% Cheung Kong CK Hutchison, CK Asset, CKA (Effective stake: 15.07-17.07%) (Holdings) ,CKH CKHH (1113 HK) (1 HK) (1 HK) CKI + Power 49.97% 75.67% Assets (Effective stake: 21.70%) (Effective stake: 22.81%) Co-investment partners Or Hutchison, HWL CKI

(13 HK) (1038 HK) investment partners investment

- 75.67% 38.87% The Li family

Co (Effective stake: 16.42%) (Effective stake: 8.87%)

CKI Co Power Asset

- 30.15% (1038 HK) investment partners (6 HK) 0.14-11.69% CK Hutchison, 38.87% CKHH (Effective stake: 6.38%) (1 HK) <50% Power Asset (6 HK) CKI + Power Assets

Total effective stake from Li family: 15.21-26.76%

Source: Daiwa estimates

CK Group: the makings of one big, happy family: 24 January 2018

CKI: financial impact of potential merger with PAH (Unit: HKD m unless otherwise stated) 2008-09 level 2010-11 level 2012-13 level Current High interest rate (Credit crunch (Global QE period) Start of rising period period) interest rate period SoC return cut Before re-org SoC return cut 10-yr US rate: 3.50% 10-yr US rate:3.00% 10-yr US rate:2.00% 10-yr US rate:2.35% PAH/CKI fair forward PER ratio 0.90 1.07 1.20 1.38 2018E CKI's EPS (HKD/share) 5.12 5.12 5.12 5.12 2018E PAH's EPS (HKD/share) 3.70 3.70 3.70 3.70 PAH/CKI share price ratio 0.65 0.77 0.87 1.00 PAH's total number of shares (m) 2,134 2,134 2,134 2,134 PAH's free float percentage 61.13% 61.13% 61.13% 61.13% PAH's number of share to be merge (m) 1,305 1,305 1,305 1,305 CKI's new issued no. of shares (m) 848 1,008 1,131 1,303 CKI's number of shares before merging PAH (m) 2,520 2,520 2,520 2,520 CKI's number of shares after merging PAH (m) 3,368 3,528 3,650 3,822 CKI's dilution 25% 29% 31% 34%

Free float impacts on CKI CK Hutchison's number of share on CKI before merging PAH (m) 1,907 1,907 1,907 1,907 CK Hutchison's share of CKI before merging PAH 75.67% 75.67% 75.67% 75.67% CKI's free float before merging PAH 24.33% 24.33% 24.33% 24.33% CK Hutchison's share of CKI after merging PAH 56.62% 54.05% 52.24% 49.88% CKI's free float after merging PAH 43.38% 45.95% 47.76% 50.12%

EPS impacts on CKI 2018E CKI's recurring earnings before merging PAH 12,880 12,880 12,880 12,905 2018E PAH's recurring earnings before being merged with CKI 7,879 7,879 7,879 7,894 Additional PAH's earnings for CKI 4,817 4,817 4,817 4,825 2018E CKI's recurring earnings after merging PAH 17,696 17,696 17,696 17,730 2018E CKI's EPS before merging PAH (HKD/share) 5.11 5.11 5.11 5.12 2018E CKI's EPS after merging PAH (HKD/share) 5.25 5.02 4.85 4.64 2018E CKI's EPS dilution after merging PAH 2.8% -1.9% -5.2% -9.4%

Valuation impacts on CKI PAH's current market cap (HKD bn) 141 141 141 141 PAH's 2018E PER 17.9x 17.9x 17.9x 17.9x PAH's merger 2018E PER valuation 11.6x 13.8x 15.5x 17.9x PAH's potential valuation de-rated from current level -34.9% -22.6% -13.2% 0.0% De-rated PAH's PER premium to CKI's -10.0% 7.0% 20.0% 38.3% CKI's current market cap (HKD bn) 167 167 167 167 CKI's 2016E PER 12.9x 12.9x 12.9x 12.9x CKI's 2018E PER after merging PAH 17.0x 17.5x 18.0x 18.5x CKI's market cap after merging PAH (HKD bn) 301 310 319 328 CKI's market cap enhancement after merging PAH 135 143 152 161 CKI's implied share price after merging PAH (HKD/share) 89.51 87.96 87.43 85.81 Our CKI's target price (HKD/share) 85.20 85.20 85.20 85.20 CKI's current share price (HKD/share) 66.20 66.20 66.20 66.20 CKI's merged share price upside (from current share price) 35% 33% 32% 30% Additional upside from our CKI's TP 5% 3% 3% 1% For CKI becomes a CKHH's associate company Offered PAH-CKI forward PER ratio 0.90 1.07 1.20 1.27 PAH-CKI's share price swap ratio 0.65 0.77 0.87 1.00 CKI's number of shares before merging PAH (m) 2,520 2,520 2,520 2,520 CK Hutchison's number of share on CKI before merging PAH (m) 1,907 1,907 1,907 1,907 CK Hutchison's share of CKI before merging PAH 75.67% 75.67% 75.67% 75.67% CKI's new issued no. of shares (m) 848 1,008 1,131 1,303 CKI's number of shares after merging PAH (m) 3,368 3,528 3,650 3,822 CKI's number of shares after merging PAH, for CKHH's 50% ownership (m) 3,813 3,813 3,813 3,813 Minimum additional new issued shares for CKI becomes a CKHH's associate company (m) 446 286 163 (9) Additional funds raised (HKDm) 29,514 18,912 10,804 (593) Additional stake issued, assumed for Victor Li 11.69% 7.49% 4.28% -0.23% CKI's free float after merging PAH and new share issuances 38.31% 42.51% 45.72% 50.23% Li's stake on CKHH 30.15% 30.15% 30.15% 30.15% Li's stake on CKI after merging PAH 17.07% 16.30% 15.75% 15.04% Li's stake on CKI after merging PAH with new share issuances to dilute CKHH's stake on 26.77% 22.57% 19.35% 14.84% CKI below 50%, with Victor Li subscribe all new issued shares CKI's free float after merging PAH with new share issuances to dilute CKHH's stake on CKI 38.31% 42.51% 45.72% 50.23% below 50%, with Victor Li subscribe all new issued shares

Source: Daiwa estimates

CK Group: the makings of one big, happy family: 24 January 2018

One key issue regarding the merger of PAH and CKI is that it would significantly increase CKI’s reported net-debt- to-equity gearing, from 22% to 79-92% on our estimates, given CKI would need to consolidate the off-balance- sheet debt associated with merging the minority stakes of the overseas assets it co-owns with PAH, because the shareholdings of these assets would exceed 50% upon the merger. We estimate there would be a combined HKD159bn in off-balance-sheet debt under overseas assets for CKI and PAH post a merger.

However, CKI needs to pull back when its reported net-debt-to-net-total-capital approaches 20%. We understand credit-rating agencies usually take off-balance-sheet debt into consideration when assigning credit ratings, as CKI had a “lower” investment-grade credit rating with a “stronger” 9% (PAH: 21%) reported 2014 net-debt-to-equity ratio prior to the spin-off of HongKong Electric in 2014.

In fact, credit-rating agencies consider associate earnings as subordinated, and as such, if the merger succeeds, PAH earnings would not be discounted, which would be beneficial for CKI’s credit rating. Therefore, if CKI merges with PAH and they consolidate their financial accounts, CKI might have more headroom to raise its debt ratio before triggering a potential downgrade from its current investment-grade credit rating (though still likely investment grade); particularly as the 95-112% see-through net-debt-to-equity gearing ratio we calculate for the merged CKI is actually lower than the unmerged CKI’s ratio of 104-122%.

Following a CKI/PAH merger, we estimate the combined entity’s reported net-debt-to-equity ratio would be 79-92% (see-through gearing: 95-112%).

Therefore, we do not believe that a rise in the reported net-debt-to-equity ratio, after consolidating the off-balance- sheet debt, would affect CKI’s existing investment-grade credit rating. Actually, we see CKI being able to take on an additional HKD60bn in M&A deals as a merged entity with PAH, which would enable it to take over CKA’s leadership role in M&A (2017: CKA spent HKD56bn, CKI spent HKD35bn).

CKI and PAH: selected overseas assets overview CKI's Company PAH's CKI's effective CKI's effective stake Company Assets name Countries Assets type stake classification stake stake after merging with PAH classification HK Electric Investment HK Integrated HK power generation, 0.00% NA 33.37% 12.97% 33.37% Associate distribution and transmission Seabank Power UK Power plants 25.00% Associate 25.00% 34.72% 50.00% Associate Northern Gas Network UK Regulated gas distribution 50.00% Subsidiary 50.00% 69.44% 100.00% Subsidiary UK Power Network UK Regulated power distribution 40.00% Associate 40.00% 55.55% 80.00% Subsidiary Northumbrian Water Group UK Regulated water utilities 40.00% Associate 0.00% 40.00% 40.00% Associate WWU UK Regulated gas distribution 30.00% Associate 30.00% 41.66% 60.00% Subsidiary Eversholt UK Rolling-stocks leasing 50.00% Associate 0.00% 50.00% 50.00% Associate Aqua-tower Australia Regulated water utilities 49.00% Associate 0.00% 49.00% 49.00% Associate Envestra Australia Regulated gas distribution 44.98% Associate 27.51% 55.67% 72.49% Subsidiary Victoria Power Networks Australia Regulated power distribution 26.99% Associate 27.93% 37.85% 54.92% Subsidiary SA Power Networks Australia Regulated power distribution 26.99% Associate 27.93% 37.85% 54.92% Subsidiary Barra Topco Australia Regulated power transmission 100.00% Subsidiary 0.00% 100.00% 100.00% Subsidiary Duet Australia Regulated power and gas utilities 40.00% Associate 20.00% 47.77% 60.00% Subsidiary Wellington Electricity New Zealand Power plants 50.00% Subsidiary 50.00% 69.44% 100.00% Subsidiary EnviroWaste New Zealand Waste collection 100.00% Subsidiary 0.00% 100.00% 100.00% Subsidiary AVR The Netherlands Waste-to-energy 35.00% Associate 20.00% 42.77% 55.00% Subsidiary Iberwind Portugal Wind farm 50.00% Subsidiary 50.00% 69.44% 100.00% Subsidiary Ista Germany Smart-meter and energy efficiency 35.00% Associate 0.00% 35.00% 35.00% Associate Stanley Power Canada Power plants 50.00% Subsidiary 50.00% 69.44% 100.00% Subsidiary Park'N Fly Canada Car park operation 50.00% Associate 0.00% 50.00% 50.00% Associate Husky midstream pipeline Canada Oil pipeline 16.25% Associate 48.75% 35.20% 65.00% Subsidiary Reliance Home Comfort Canada HVAC 25.00% Associate 0.00% 25.00% 25.00% Associate Power plants in China China Power plants 0.00% NA 100.00% 38.87% 100.00% Subsidiary Toll roads and bridges in China China Toll roads 100.00% Subsidiary 0.00% 100.00% 100.00% Subsidiary Ratchaburi Power Thailand Power plants 25.00% NA 0.00% 25.00% 25.00% Associate

Source: Companies, Daiwa research

CK Group: the makings of one big, happy family: 24 January 2018

CKI and PAH: off-balance-sheet debt On balance sheet debt (m) Net debt in LC Stake Net debt in HKD CKI HK 23,387 100% 23,387 PAH HK (18,955) 100% (18,955) CKI + PAH HK 158,667 100% 158,667 Off balance sheet debt in 2017E (unit: m) Net debt in LC CKI's stake Net debt in HKD PAH's stake Net debt in HKD Combined CKI and PAH stake Net debt in HKD HK Electric Investment HK 41,023 0.0% - 33.3% 13,677 33.3% 13,677 Northern Gas Network UK 1,715 47.1% 8,049 41.3% 7,056 88.4% 15,105 UK Power Network UK 6,514 40.0% 25,969 40.0% 25,969 80.0% 51,939 Northumbrian Water Group UK 2,746 40.0% 10,946 0.0% - 40.0% 10,946 WWU UK 2,900 30.0% 8,671 30.0% 8,671 60.0% 17,341 Eversholt UK 1,814 50.0% 9,040 0.0% - 50.0% 9,040 Victoria Power Networks Australia 4,212 23.1% 5,812 27.9% 7,036 51.0% 12,848 SA Power Networks Australia 3,327 23.1% 4,590 27.9% 5,557 51.0% 10,148 Envestra Australia 2,480 45.0% 6,672 27.5% 1,168 72.5% 7,840 AVR The Netherlands 670 35.0% 2,043 20.0% 4,081 55.0% 6,124 Park'N Fly Canada 111 50.0% 333 0.0% - 50.0% 333 Husky midstream pipeline Canada 545 16.3% 530 48.8% 1,591 65.0% 2,121 Duet Australia 5,962 40.0% 14,265 20.0% 7,132 60.0% 21,397 Ista Europe 1,562 35.0% 4,766 0.0% - 35.0% 4,766 Power Assets - on-balance sheet cash HK (17,672) 38.9% (6,873) n.a. n.a. n.a. n.a.

Total off balance sheet debt CKI 94,814 PAH 81,938 CKI + PAH 29,390

Total debt (includes off balance sheet) CKI 118,201 PAH 62,983 CKI + PAH 192,489

Source: Companies, Daiwa research

Impact on CKI’s net-debt ratio from a potential merger with PAH (Unit: HKDm unless otherwise stated) Offered PAH-CKI merger forward PER 0.90 1.07 1.20 1.27 CKI's 2017E net debt before merging with PAH, net of off-balance sheet debt 24,894 24,894 24,894 23,387 PAH's 2017E net debt, net of off-balance sheet debt (17,672) (17,672) (17,672) (18,955) CKI's 2017E off balance sheet debt 94,814 94,814 94,814 94,315 CKI's 2017E off balance sheet debt, including PAH's off balance sheet debt 115,804 115,804 115,804 117,222 PAH's 2017E off balance sheet debt 81,938 81,938 81,938 81,950 CKI's 2017E total reported net debt 119,708 119,708 119,708 117,702 CKI's 2017E total net debt (including PAH's off balance sheet debt) 140,698 140,698 140,698 140,609 PAH's 2017E total net debt 64,266 64,266 64,266 62,995 CKI's 2017E net debt after merging with PAH, net of off-balance sheet debt 158,667 158,667 158,667 158,667 CKI's 2017E total net debt after merging with PAH 192,489 192,489 192,489 192,501 CKI's equity including perpetual securities - before merging with PAH 115,457 115,457 115,457 117,074 CKI's equity including perpetual securities - after merging with PAH 171,589 182,192 190,300 203,313 CKI's net-debt-to-equity gearing before merging with PAH 22% 22% 22% 20% CKI's see-through net-debt-to-equity gearing before merging with PAH 104% 104% 104% 101% CKI's see-through net-debt-to-equity gearing before merging with PAH, incl. PAH's off balance sheet debt 122% 122% 122% 120% CKI's net-debt-to-equity gearing after merging with PAH 92% 87% 83% 78% CKI's see-through net-debt-to-equity gearing after merging with PAH 112% 106% 101% 95%

Source: Companies, Daiwa research

Further headroom for a merged CKI’s M&A NAV % change in NAV 2018E earnings % change in 2016E net 2018E Net-debt-to- 2018E See-through net- 2018 overseas capex sensitivity analysis (HKD/share) from base case (HKDm) profit from base case equity gearing debt-to-equity gearing Base case 88.0 0% 17,730 0% 87% 106% 15,000 93.9 7% 18,930 7% 93% 113% 30,000 99.9 14% 20,130 14% 97% 117% 45,000 105.8 20% 21,330 20% 101% 121% 60,000 111.8 27% 22,530 27% 105% 125%

Source: Companies, Daiwa research

CK Group: the makings of one big, happy family: 24 January 2018

Post 2020: ultimate positioning

CKA: twin powerhouses with global ambitions

CKI+PAH: global infrastructure company

CK Group: the makings of one big, happy family: 24 January 2018

CK Asset Holdings: long term Twin power houses with global ambitions

In our opinion, the Cheung Kong Hutchison Group is a business builder and investor at heart, and while the group tried the idea of positioning itself as a pure property company, it later discovered that the business practicalities it faces are not conducive to it moving further along that path.

Indeed, we believe CKA is returning to a more traditional-like Cheung Kong model in running its property business, which is more about leveraging on the nature of the property business and timing the property cycle to quickly build up its equity base and continue to “snowball” its equity base and recycle capital. It achieves this through: 1) nurturing other property markets or segments, 2) sponsoring the development of group companies, 3) nurturing new investments, and 4) building up large-scale treasury operations.

As such, assuming CKA is returning to the old Cheung Kong way, we expect its investments in infrastructure to be like treasury operations or activities that will sponsor the development of CKI and the group’s overall ambitions in the global infrastructure market.

While such a business model is unusual in the global property space, it has served the group well in the past. Seen in this light, we consider the whole cycle of its property model to involve 5 stages, as shown in the following table.

Different phases of Cheung Kong Group’s business model on property Securing a decisive entry Getting the right timing to buy a sizeable pool of land at market or even premium prices during the low point of the property cycle. Scaling up its desired landbank Using the cash from fast asset turnover to buy more land and scale up its landbank. Maintaining its desired landbank level The amount of land bought is similar to the amount sold. Monetising the gains from early entry Becoming more like a net seller of land. Waiting for another entry opportunity During this phase, it may: - park surplus cash in treasury investments - invest or co-invest with group companies - explore new businesses to invest in - sell non-core assets at NAV and buy back shares that trade at a discount to NAV

Source: Daiwa

We believe Cheung Kong has already entered the monetisation stage for its property development business in Hong Kong, and is unlikely to turn into a major net buyer of residential land in Hong Kong or China in the foreseeable future, unless there is a major correction in land prices.

However, our interpretation is that Cheung Kong Group, for all the controversy surrounding its pivot away from being a pure property company is not deviating from the path or strategy it has been pursuing for many decades. We believe it is still on its way to achieving the 6 things below (also outlined in our January 2015 thought pieces), albeit more subtly than it first appeared.

Below, we outline the 6 major areas we think Cheung Kong Group will pursue in Chapter 3 of its development (see also our Thought Piece in February 2015, Cheung Kong/Hutch’s Bold move):

1) Seek greater recognition from the capital markets on the investment value of its 2 listed flagships 2) Capitalise on mis-pricing and reorganisation opportunities within its listed securities 3) Create a principal listed vehicle for each of its core businesses 4) Pursue M&A opportunities globally 5) Raise its dividend payouts, with potential for the family to raise its stakes, and the listed companies to conduct share buybacks 6) Undertake special distribution of shares in its various businesses as and when they are mature enough

CK Group: the makings of one big, happy family: 24 January 2018

Comparison of the 3 chapters of Cheung Kong Group Chapter Period Remarks Focus Chapter 1 1971-1992 Emerging as the largest business group in Hong Kong. Hong Kong Chapter 2 1993-2014 Massive business building on a global scale, creating a global conglomerate with an Global important market position in 6 industries and the creation of a strong residential property developer in Hong Kong and China, as well as one of the largest owners of hotel rooms in Hong Kong. Chapter 3 2015 and Asset realisation and creation of global players in at least 6 major industries (ports, Global in business aspiration beyond retail, property and hotel, energy, infrastructure and telecom). Increasingly recognised by the stock market as a global company with at least 6 core Greater attention being paid to businesses, as well as a veteran business builder and investor, savvy in capitalising get greater market recognition on opportunities related to mis-pricing of its group companies or other industry peers. to view it as a modern premier global corporation. Continuous group re-organisation and M&A to unlock and create value for shareholders. Using the 2 listed vehicles as the flagship for expanding its core businesses and entering new areas.

Source: Daiwa

Looking into the future, we expect Cheung Kong Group to eventually consist of a number of separate companies (such as the ones in the table below), each of which is owned by the Li family directly and has its own global ambitions, but would be structurally and organisationally managed by veteran professionals in their particular fields rather than family members, if the family deemed this to be desirable for the group in the long term.

The principal listed vehicles for each of Cheung Kong Group’s core businesses Principal listed Business vehicles Remarks Property CKA CKA (formerly CK Property) could spin-off its China business or hotel division Infrastructure CK Infrastructure We see reorganisation opportunities within this division as well as new investment opportunities in the market Energy Husky Energy The family still has a 29.3% stake in Husky Energy Ports Not yet clear Hutchison Port Holdings Trust is already listed in Singapore but the group still has many port assets which are not yet included in Hutchison Port Holdings (HPH) Trust Presently, Hutchison has an 80% stake in the unlisted Hutchison Port Holdings, which is also 20% owned by PSA in Singapore Telecom Not yet established Assuming the group can eventually acquire another operator in the UK, the enlarged 3 UK could be spun off as the principal listed vehicle for its telecoms division and it may eventually acquire all of the group's telecom assets in Europe and potentially other markets as well Retail Not yet established A global health & beauty retailer that could be listed any time Hutchison currently owns 80% of the unlisted AS Watson, with the remaining 20% is owned by Temasek

Source: Daiwa

As such, the Li family would become the major shareholder and manager of only some of its businesses (ie, those not managed by veteran professionals). For some of its businesses, the family could take on the role of a large shareholder and investor, similar to some large institutional investors’ roles in their largest holdings. However, unlike these institutional investors, the Li family would be able to exert greater influence over these companies’ managements than the investing institutions. Moreover, we foresee the Li family being able to take over or take back the management of these companies if the family deems their performance to be unsatisfactory – an option that is probably not open to investing institutions.

In this light, in 20-30 years’ time, the Li family’s position in the investing world could bear some resemblance to major investing institutions, and the family would likely have a greater understanding and appreciation of the function and importance of investing capital in corporate development. Hence, we would argue that Cheung Kong Group’s re-organisation announced in January 2015 could be the first attempt made by a major family business group in Hong Kong, and possibly Asia, to explore and establish a proper position for the group in the global investing world.

In this sense, we see this reorganisation as a major breakthrough and an event of great symbolic importance to the development of family business groups in Hong Kong, and possibly Asia. For all along, we believe these family business groups have been seeking a proper way to work with the global capital markets.

In many ways, these family business groups in Hong Kong just do not need the global capital markets, if they do not have much aspiration to move up to the next level and expand beyond their existing territories. That said, some of the world’s largest and most important companies are listed and property will probably become an even more capital-intensive industry in the future. In this light, we believe these family property companies need to decide on their desired place in the global capital markets and investing world eventually; otherwise it would be better for them to just privatise.

CK Group: the makings of one big, happy family: 24 January 2018

Historically, we see Cheung Kong Group as one of the most far-sighted and forward-looking major family business groups in Hong Kong. We hence are not surprised that it would become the first to see the issue of the most appropriate relationship between the family and the global capital markets and the global capital market’s role, if any, in the family’s businesses as a legitimate and important business issue; and that it would be the first business group to make a serious attempt to address this issue.

Our view 3 years ago, though, was that CK Property would pursue its global ambition in global property in its own way, as its financial resources and asset base were substantially strengthened after taking over the entire property portfolio of Hutchison Whampoa.

CKP: the property arm created post the reorganisation

Source: Company Note: 1. Certain non-qualifying overseas shareholders will not receive CKH Holdings shares and/ or CK Property shares 2. After completion of the listing 3. Property valuation as at 28 February 2015 4. Assuming aggregate attributable market value based on the Group’s attributable interests as at 8 May 2015 (32.3% stake in Hui Xi’an REIT, 28.0% stake in Fortune REIT, 19.3% stake in Prosperity REIT and 7.8% stake in ARA Asset Management) and market data as at 8 May 2015 closing. As at 8 May 2015, the Group’s ownership interest in Hui Xian REIT was c.46.0%, including c.28.2% stake held by Hui Xi’an Holdings Limited, which was c.33.4% held by Cheung Kong and c.17.9% held by Hutchison respectively

We however did not expect the amount of cash CKA realised from property sales to exceed HKD50bn annually over the past 3 years, nor did we expect The Centre to be sold for HKD40.2bn, and nor that it would have raised over HKD150bn in property and asset sales over the past 3 years. The pace and determination of the Chinese developers in terms of establishing a presence in Hong Kong has also surprised us somewhat, and probably Cheung Kong Group as well – we think this provides the context to understand why over the past few years, CKA has made sizeable investments in businesses outside the traditional boundary of the property industry.

CK Asset: disposal of stake in The Center Announced 1 Nov 2017 Location Queen’s Road Central, Central Property type 73-storey Grade A office building % owned by CKA ~75% (~48 office floors, some retail shops & carparks) Year of completion 1998 Attributable GFA 113,170 sq m / 1.22m sq ft Attributable LFA 113,431 sq m / 1.22m sq ft (including 1,271 sq m / 13,700 sq ft retail) No. of car parking spaces 402 Buyer China Energy Reserve & Chemicals Group, together with some local investors Consideration (HKD) 40.2bn (33,000/sq ft) Carrying value (HKD) 19.8bn (at 31 Dec 2016) Co est'd gain on disposal (HKD) 14.5bn (based on carrying value at 30 Jun 2017)

Source: Company, Daiwa

CK Group: the makings of one big, happy family: 24 January 2018

CK Property: achieved contract sales 2012 2013 2014 2015 2016 2017E 2018E (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) (HKDbn) HK 26.0 4.7 23.0 30.0 14.7 45.0 22.0 China 24.0 33.0 16.0 25.0 54.5 25.8 41.0 UK 0.0 0.0 0.0 0.7 0.8 1.2 1.6 Singapore 0.0 0.0 0.0 0.3 0.0 0.0 0.5 Total 50.0 37.7 39.0 56.0 70.0 72.0 65.1

Source: Company, Daiwa forecasts

CK Property/Cheung Kong: proceeds raised from the sale of commercial properties in China GFA Achieved price Achieved psf price Year Properties Cities Stake (sq ft) (CNY/HKD) (HKD/sq ft) 2007 The Center Shanghai 26% 963,336 CNY4.4bn 4,922 2008 Seasons Villas Shanghai 50% 1,150,830 CNY4bn 3,948 2010 Oriental Plaza Beijing 51% 6,162,881 HKD13.1bn 4,168 2012 Shenyang Lido Hotel Shenyang 70% nd CNY980m na 2012 Oriental Finance Centre Shanghai 100% 2,368,058 HKD9,360m 3,953 2013 Metropolitan Plaza Guangzhou 50% 956,997 HKD3.05bn 3,187 2014 Metropolitan Plaza Chongqing 50% 1,511,515 HKD4,976m 3,292 2016 Century Link Shanghai 50% 3,044,066 CNY20bn 7,556

Source: Company

CK Property/Cheung Kong: proceeds raised from disposal of non-core assets Year Assets Type Method Buyer Stake Proceeds 2011 HPH Trust (HPHT SP) Ports Spin-off IPO 26% USD5.5bn 2011 Hui Xian REIT (87001 HK) Property Spin-off IPO 50% CNY10.5bn 2012 Shenyang Lido Hotel Hotel Outright sale Hui Xian REIT 100% CNY980m 2013 Kingswood Ginza Property Outright sale Fortune REIT 100% HKD5.8bn 2013 Oriental Financial Centre, Shanghai Property Outright sale China Everbright 100% CNY7.1bn 2014 Metropolitan Plaza Property Outright sale Hui Xian REIT 100% CNY3.91bn 2016 Century Link Property Outright sale China Life consortium 50% CNY20bn 2017 The Center (~75% owned) Property Outright sale PRC consortium 100% HKD40.2bn

Source: Hong Kong Economic Times, SCMP, Daiwa

Non-core properties now under CKA Property Usage Location GFA (sq ft) The Center* Office Central 1,218,162 China Building Office Central 258,756 Tower 1, The Harbourfront Office Hunghom 431,152 Tower 2, The Harbourfront Office Hunghom 431,841 Hutchison Telecom Tower Office Tsing Yi 300,338 Wonderful Worlds of Whampoa Retail Hunghom 1,714,006 Aberdeen Centre Retail Aberdeen 345,026 Victoria Mall Retail Tsimshatsui 143,040 United Centre (various shops) Retail Admiralty 37,803 Rambler Crest Retail Tsing Yi 44,175 Hunghom Bay Centre Retail Hunghom 80,422 Chun Fai Centre Retail Tai Hang 32,373 Fine Mansion Retail Happy Valley 13,704 Conic Investment Building Industrial Hunghom 327,414 Cavendish Centre Industrial Aberdeen 342,923 Watson Centre Kwai Chung Industrial Kwai Chung 687,295 Watson Centre Fo Tan Industrial Shatin 280,923 Fanling Sheung Shui Town Lot 97 Industrial Sheung Shui 142,416 Provident Villas Residential Pokfulam 19,343 23 Coombe Road Residential The Peak 6,124 Baguio Villa Residential Pokfulam 12,967 6,870,203

Source: Company, Daiwa Note: *The Center was sold in 2017

In our opinion, Cheung Kong Group has been fine-tuning its business strategy in light of the larger-than-expected cash inflow from property sales, and more severe-than-expected competition for sites; and we have also fine-tuned our expectations for the group’s corporate actions and strategies in light of the above, as well as our read about what the group has been doing in terms of investing in non-property businesses and its partnership relationship with CKI.

On the whole, our view on the group’s long-term development is that the end-game remains the same, but the route it takes will be more subtle and potentially faster than what we have thought.

CK Group: the makings of one big, happy family: 24 January 2018

A twin powerhouse?

If the 1997 Cheung Kong Group restructuring was about creating a vertical structure to maximise leverage within the group, we see the 2015 reorganisation as more about creating a lateral structure, facilitating all shareholders (including the Li family) to realise the value from the group’s decades-long business building and investing, and ensuring that the group’s major businesses keep on growing, even if one day the Li family decides it does not want to manage some of its businesses.

Before 2017, we thought CKA (then CK Property) would follow a path to becoming a global property company, and that it would mainly be CK Hutchison that would be the principal vehicle driving the creation of this ultimate structure of the group. However, in the light of the financial resources CKA has realised over the past 3 years and could realise over the next 3-5 years, we now expect CKA to play a more active role in that process. As such, CKA could become another powerhouse driving the materialisation of each of the group’s core business, becoming a sizeable global player with a market value of over USD50bn.

Cheung Kong Group: a single powerhouse structure; Li family empire: current organisational structure

The Li Family

30.15% 31.5%

Accumulating larger stake CK Property (renamed CK Hutchison through share buyback, at 2% as CK Asset) (1 HK) per annum under the (1113 HK) “creeper” rule

75.67% Energy – Ports – Hutchison Telecoms – The 3 Others – Infrastructure – Retail – AS Watson Husky Energy Port Holdings Group life science, CKI (not listed) (HSE CN) (not listed) (not listed) aircraft leasing, etc (1038 HK) 38.87% Power Assets (6 HK) 33.37% HKEI (2638 HK)

Source: Companies, Daiwa research

Li family empire: potential future twin powerhouse organisational structure

The Li Family

Stake: >30% 30.15% 31.5% Stake: >30% CK Hutchison CK Asset (1113 HK) – Infrastructure – Other mature businesses which are (1 HK) – real estate and CKI listed conglomerate investments (1038 HK)

Yieldco for Other mature businesses yet to be Other incubated HKEI Yieldco for Yieldco for Infrastructure listed businesses (2638 HK) UK assets Australia assets assets

Source: Daiwa estimates

CK Group: the makings of one big, happy family: 24 January 2018

Infrastructure first?

The first area where we see CKA playing a more active and important role is in the group’s infrastructure business; and indeed it already seems to be taking on this role. In many ways, this is a logical development because CKI was originally a business developed by Cheung Kong when it had abundant surplus cash realised from its massive landbanking in Hong Kong in the 1980s.

In our opinion, given that Hutchison has staged a significant turnaround since the early 1990s and that it has been the principal vehicle of the group to develop its non-property businesses, all along Cheung Kong has been keen to lift its stake in Hutchison from the mid-30% level back in the early 1990s to the maximum level without having to trigger a general offer.

Evolution of Cheung Kong’s stake in Hutchison (1992-March 1997)* No. of Hutchison Changes Amount Hutchison total CK's stake Date Event shares held by CK (m) (m) (HKDm) no. of shares (m) in Hutchison Aug 92 Bought 214m [email protected] 1,445.8 214.8 3,201 3,354.1 43% May 93 Bought 113.7m shares @HKD18.30 1,559.4 113.7 2,081 3,616.9 43% 1H94 Bought 63.5m [email protected] 1,622.9 63.5 2,032 3,619.6 45% Jun 95 Sold 30.3m @HKD39.14 1,592.6 (30.3) (1,186) 3,614.9 44% Feb 96 Bought 22.7m shares @HKD49.20-50.50 1,615.3 22.7 1,148 3,617.8 45% Apr 96 Bought 16.09m shares @HKD49.20 1,631.4 16.1 791 3,617.8 45% May 96 Bought 0.59m shares @HKD46.50 1,632.0 0.6 27 3,617.8 45% Jul 96 Bought 12.60m shares @HKD46.70-47.80 1,644.6 12.6 598 3,617.8 45% Mar 97 Exchanged CKI stake for Hutchison shares 1,898.9 254.3 14,878 3,872.1 49% Apr 97 Bought 34.7m [email protected] 1,933.5 34.7 1,980 3,873.6 50% May 97 Bought 1.1m [email protected] 1,936.5 1.1 68 3,873.6 50% Total 703.8 25,618

Source: SCMP, HK Economic Journal Note: *the Cheung Kong group restructuring was announced in March 1997

While Cheung Kong and the Li family have kept on buying Hutchison shares in the open market since about 1993, it would still take a lot of time and capital to reach the their desired level. In this light, we think one reason for the Cheung Kong Group reorganisation in 1997 was for Cheung Kong to quickly beef up its stake in Hutchison; and it achieved this by selling its stake in CKI to Hutchison Whampoa (thus raising Cheung Kong’s stake in Hutchison to 49.96%, marginally below the 50% trigger point for a general offer), which also represents a way for Cheung Kong Holdings to realise the value of its investment in CKI and raise capital to finance its landbanking in Hong Kong.

Against this backdrop, the old Cheung Kong (Cheung Kong Holdings) has had a long association with CKI, as well as a record of co-investing with group companies and realising the value of their investments through selling the stake to another group company.

Cheung Kong and Hutchison’s joint investments in the past (1994 to 1999)* Date Project Nature Mar 94 Harbour Plaza North Point 61/39 hotel and property JV Aug 95 77 Broadcast Drive 50/50 property JV Sep 95 Tierra Verde 20/50 property JV Sep 95 The Paramount 35/65 property JV Feb 96 Monte Vista 50/50 property JV Nov 96 Hung Shui Kiu 50/50 property JV Jan 97 Tung Chung Phase Three 50/50 property JV Mar 97 Group restructuring Sold stake in CKI to Hutchison Jun 97 Wan Hoi Road 50/50 property JV Mar 98 Ma On Shan 51/49 hotel JV Apr 98 Canton Road 42.5/42.5 property JV 2H98 Tsing Yi Resort Takes a 30% stake in Hutchison’s Tsing Yi project 2H98 Montevetro, London Takes a 22.5% stake in Hutchison’s property project 2H98 Belgravia Place, London Takes a 42.5% stake in Hutchison’s property project 2H98 Albion & Bridge Wharves, London Takes a 45.0% stake in Hutchison’s property project 1994-99 China property projects Forms JVs with Hutchison for various property projects in China 1994-99 Various hotel and serviced apartments projects Forms JVs with Hutchison

Source: Company reports, Daiwa Note: * before Hutchison started to invest substantially in the telecom businesses in Europe

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong and Hutchison’s joint-purchase of sites in the past* % Total GFA Attri. GFA Total cost Attri. cost Psf cost Date Address owned Type Location (sq ft) (sq ft) (HKDm) (HKDm) (HKD/sq ft) Apr 98 Victoria Towers 42.5% Resi Tsimshatsui 1,025,000 435,625 2,893 1,230 2,822 Jul 98 Nob Hill 50% Resi Lai King 560,000 280,000 700 350 1,250 Jan 99 Tiger Balm Villas 100% Resi Tai Hang 13,715 13,715 100 100 na Mar 99 Laguna Verde, additional GFA 50% Resi Hunghom 400,000 200,000 560 280 1,400 May 99 Tung Chung Phase III, additional GFA 50% Resi Lantau 1,130,435 565,218 780 390 690 May 99 Cheung Sha Wan Shipyard redevelopment 100% Resi Cheung Sha Wan 1,775,175 1,775,175 1,530 1,530 862 Jun 99 Beacon Hill Rd 100% Resi Kowloon Tong 780,161 780,161 3,240 3,240 4,153 Oct 99 Lot 27, Tin Shui Wai 100% Resi Tin Shui Wai 801,970 801,970 555 555 692 Dec 99 Hoi Fai Rd, West Kowloon Reclamation 100% Resi Tai Kok Tsui 560,505 560,505 1,340 1,340 2,391 Apr 00 J/O Hing Wah St West & Sham Shing Rd 50% Resi West Kowloon 1,556,216 778,108 1,900 950 1,221 Oct 00 Area 40, Road Twisk, Tsuen Wan 50% Resi Tseun Wan 827,644 413,822 835 418 1,009 9,430,821 6,604,299 14,433 10,382

Source: SCMP, HK Economic Journal, Daiwa Note: * before Hutchison started to invest substantially in the telecom businesses in Europe

Overall, the Cheung Kong Group has a track record of co-investing with its group companies. The favoured vehicle was Hutchison back in the early 1990s; now, it appears to us that the vehicle will be CKI. We expect CKA to sponsor the development of CKI until opportunities in the property space emerge.

Would CKA refocus on property if the opportunity arises?

Some market observers are of the view that the Cheung Kong Group is exiting from Hong Kong and China, as well as the property business, and we acknowledge that CKA has been a net seller of property assets in Hong Kong and China in recent years. However, our view is that property has been the group’s core business for 5 decades, and the group has developed a way of running the business that has served it well. Against this backdrop, it seems unlikely that it would consider exiting the business entirely.

Based on our read of Cheung Kong’s business model for property, absolute property price levels do not seem to matter that much, contrary to many observers’ expectations. What we think matters to the group ultimately is the entry point and entry price, ie, the cost of its initial bundle of land. Then the game becomes about using asset turnover to leverage up the group’s landbank portfolio as well as its flat-land price relationship.

In our opinion, having made large gains from ambitious landbanking in Hong Kong (2004-07) and China (2004-07), the group is now waiting for the next opportunity – especially in the realm of relative prices between flats and the land price relation – to emerge. We think such an opportunity could arise when some players in Hong Kong or China decide to exit the business quickly.

At the same time, we believe the group is waiting for M&A opportunities in the property space. It has stated that it wants to boost its recurrent income and if there are opportunities whereby some REITs or property companies with large rental income streams become available for sale, we would see CKA being a serious bidder.

In the meantime, CKA could park its surplus cash in treasury investments. We note that Cheung Kong Holdings (the old Cheung Kong) had substantial investments in the convertible bonds of red chips back in the early 1990s. At the time, this raised the question of where Cheung Kong was heading. Then, from 1995 onwards, the group monetised these investments in convertible notes and turned to landbanking in Hong Kong.

In our opinion, Cheung Kong is not a developer known for luxury products, and its expertise in residential property development lies more in executing large-scale mass market projects. Opportunities to buy such land in scale and at discounted prices have been few and far between in recent years. But as and when the government comes out with the supply of more such land, it is not inconceivable that CKA would return to pursue a net increase in its Hong Kong residential landbank, in our view.

Likewise, for China, if a major correction in land prices occurred, we would not be surprised if CKA again became a net buyer of residential landbank in China, though to the extent that this happens, we think it is more likely to come from M&A of companies or the landbank portfolios of larger Chinese property companies.

CK Group: the makings of one big, happy family: 24 January 2018

Herein also lies what we see as one major focus of CKA in the years ahead: pursuing M&A opportunities globally, especially of companies that have large and sustainable rental income streams. In our opinion, such opportunities will emerge sooner or later given that over a decade of low interest rates has likely encouraged over-borrowing and we would not be surprised to some see REITs or property companies in the world facing financial pressure over the next few years.

This brings us to another point: the importance of the equity-market valuation or currency value of the company’s shares. While sheer sales proceeds from property sales and the sale of non-core investment properties would mean that CKA probably has over HKD100bn in capital it could deploy through cash on hand and borrowings, our view is that the equity-market valuation is still important to CKA, as a company cannot rely solely on borrowings if it is to pursue M&A opportunities involving property companies that have among the largest rental income streams.

As such, we believe that a sustained programme of share buybacks is important to CKA’s business prospects in that we see share buybacks as an attractive and effective way to protect the equity-market valuation of a company. In this light, our expectation is that CKA will keep on buying shares back so long as its shares trade at a notable discount to its NAV. As and when the NAV discount of CKA becomes appreciably smaller, or is even eliminated, the company’s ability to pursue accretive M&A in the global property arena would greatly strengthened.

Meanwhile, if large-scale M&A opportunities do not arise over the next few years, we do not think this would spell the end of CKA’s property business because we see it as a legitimate business model if CKA keeps on raising its exposure to the non-residential segment and infrastructure investments.

Major moves made by the Li family regarding Cheung Kong Group companies in the 1990s Date/Period Actions Our interpretation 1991-96 Cheung Kong’s stake in Hutchison rose from 40.3% in 1991 to 45.4% Cheung Kong thought Hutchison undervalued and wanted to at the end of 1996 strengthen its control over it Mar 97 Cheung Kong Group restructuring. Cheung Kong sold CKI to Cheung Kong sought to tap into Hutchison’s big cash pile and, Hutchison for HKD5bn cash and another 3.5% of Hutchison equity, at the same time, raised its Hutch stake cheaply raising Cheung Kong’s stake to 48.9% Mar - May 97 Cheung Kong and the Li family trust increased their combined Firming family control of Hutchison Hutchison shareholding to more than 50%. Cheung Kong lifted its Hutch stake again in May May 00 The Li family proposed to inject HKD1.48bn worth of Singaporean This gave the Li family an excuse to obtain a waiver from the properties into Cheung Kong in exchange for another 0.81% stake at Stock Exchange regarding the mandatory general offer. HKD79.75 a share Thereafter, the family could raise its stake in Cheung Kong by 5% a year without triggering a general offer Jun 00 Li Ka-Shing bought 12m Cheung Kong shares for HKD1.04bn, at an The Li family thought Cheung Kong undervalued and wanted average price HKD86.25 a share to take advantage of the opportunity offered by MSCI’s decision to exclude Cheung Kong from its index Jul - Oct 00 Li Ka-Shing and Victor Li bought equity-linked notes of Cheung Kong, To enjoy the higher interest rate and to raise their stake in the exercise price ranging from HKD79.20 to HKD81.90 a share Cheung Kong at an attractive price

Source: SCMP, HK Economic Journal, Daiwa

CKP: impact(1) of a share buyback on cash flow, NAV and DPS Annual interest Cash extra expenses or NAV Dividends Outstanding no. NAV required# annual income per share Li Family & for 2015 DPS of shares (m) (HKDm) (HKDm) lost* (HKDm) (HKD) Trust’s stake (HKDm) (HKD) 3,860 390,864 - - 101.3 30.20% 5,404 1.4 3,846 390,232 (632) - 101.5 30.30% 5,404 1.4 3,840 389,911 (935) (19) 101.5 30.30% 5,404 1.41 3,820 388,958 (1,869) (37) 101.8 30.50% 5,404 1.41 3,800 388,004 (2,804) (56) 102.1 30.60% 5,404 1.42 3,780 387,051 (3,738) (75) 102.4 30.80% 5,404 1.43 3,760 386,098 (4,673) (93) 102.7 31.00% 5,404 1.44 3,740 385,145 (5,607) (112) 103 31.10% 5,404 1.44 3,720 384,192 (6,542) (131) 103.3 31.30% 5,404 1.45 3,700 383,238 (7,476) (150) 103.6 31.50% 5,404 1.46 3,680 382,285 (8,411) (168) 103.9 31.60% 5,404 1.47 3,660 381,332 (9,345) (187) 104.2 31.80% 5,404 1.48 3,640 380,379 (10,280) (206) 104.5 32.00% 5,404 1.48 3,620 379,426 (11,214) (224) 104.8 32.10% 5,404 1.49

Source: Daiwa Note: * we assume 2% pa # assuming an average price of HKD46.725 which was the average price CKP has paid for the first batch of shares it has bought back in March 2016 (1) estimates based on the company’s outstanding shares and the Li family’s stake immediately after its group re-organisation, see our initiation report on 25 May 2016

CK Group: the makings of one big, happy family: 24 January 2018

CKP/Cheung Kong: impact(1) of a combination of share buyback and dividend rise^ Outstanding no. Amount of shares Annual dividends DPS Dividend Li Family & of shares (m) to be cancelled (m) (HKDm) (HKD) yield** (%) Trust’s stake 3,860 - 5,404 1.40 2.8% 30.2% 3,846^^ (13.5) 5,904 1.54 3.1% 30.3% 3,840 (20.0) 6,404 1.67 3.3% 30.3% 3,820 (40.0) 6,904 1.81 3.6% 30.5% 3,800 (60.0) 7,404 1.95 3.9% 30.6% 3,780 (80.0) 7,904 2.09 4.2% 30.8% 3,760 (100.0) 8,404 2.24 4.5% 31.0% 3,740 (120.0) 8,904 2.38 4.8% 31.1% 3,720 (140.0) 9,404 2.53 5.1% 31.3% 3,700 (160.0) 9,904 2.68 5.4% 31.5% 3,680 (180.0) 10,404 2.83 5.7% 31.6% 3,660 (200.0) 10,904 2.98 6.0% 31.8% 3,640 (220.0) 11,404 3.13 6.3% 32.0% 3,620 (240.0) 11,904 3.29 6.6% 32.1%

Source: Daiwa Note: ** assuming HKD50/share for CKP for simplicity ^ the table refers to the impact of every HKD500m rise in annual dividend and every repurchase of 20m shares ^^ the current number of O/S shares after the share repurchase in March 2016 (1) estimates based on the company’s outstanding shares and the Li family’s stake immediately after its group re-organisation, see our initiation report on 25 May 2016

CKP: cumulative impact(1) of continuous share buybacks and dividend rise in 3 and 5 years Annual interest Outstanding Cash extra expenses or NAV Dividends for no. of NAV## required# annual income per share Li Family & s/holders*** DPS Dividend Date shares (m) (HKDm) (HKDm) lost* (HKDm) (HKD) Trust’s stake (HKDm) (HKD) yield**(%) Jun 2015 3,860 390,856 - - 101.3 30.2% 5,404 1.40 2.8% Apr 2016 3,846 390,232 (632) - 101.5 30.3% 6,404 1.66 3.3% Dec 3,260 361,708 (28,035) (1,346) 111.0 35.7% 8,404 2.58 5.2% 2018E Dec 2,860 340,215 (46,725) (2,804) 119.0 40.7% 11,404 3.99 8.0% 2020E

Source: : Daiwa Note: * we assume 2% pa ** assuming HKD50/share for CKP for simplicity *** assuming an annual increase of HKD1bn from the level of HKD5,404m (HKD1.40/share) in 2015 # assuming an average price of HKD46.725 which was the average price CKP has paid for the first batch of shares it had bought back in March 2016 ## we have assumed a static NAV for simplicity and illustration purposes (1) estimates based on the company’s outstanding shares and the Li family’s stake immediately after its group re-organisation, see our initiation report on 25 May 2016

CK Group: the makings of one big, happy family: 24 January 2018

Major M&A deals in global property: Unibal’s proposed acquisition of Westfield

Source: Unibal

In our view, Cheung Kong Group’s business model is rare in the global property market but not entirely without precedent. For example, we see some resemblance between the business models of CKA and Brookfield, in that both put a lot of emphasis on capital allocation.

We note too that Brookfield is a multi-asset class property company and has significant exposure to infrastructure businesses. In our opinion, the recurrent cash flow to CKA and Brookfield from their infrastructure businesses may not be so different from rental income streams. As such, going forward, it is possible that CKA could become more like Brookfield than traditional companies over time.

CK Asset: PBR since listing (x) 1.2 Current PBR = 0.99x

1.0

0.8

0.6

0.4 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Source: Company, Bloomberg, Daiwa

CK Group: the makings of one big, happy family: 24 January 2018

CK Asset: share-price performance since listing (HKD) 80

30 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Source: Bloomberg

Another reorganisation in the medium term?

We expect CKA to pursue more infrastructure investments over the next few years; and as major M&A opportunities emerge in the global property space, we could see CKA once again becoming more active in the property side of the business. If this situation were to arise, we could see CKA monetising its investments in infrastructure projects to raise cash and pursue its ambitions in global property. In our view, it is too early to say much on how this would be done, but we spell out some possibilities below.

Against this backdrop, we think we could see a medium-sized reorganisation within Cheung Kong Group in the next few years. We call it “medium-sized” because we believe a re-organisation would only involve the group’s infrastructure businesses and not the entire group, which was the situation in 1997 and 2015.

In our opinion, the simplest way for such a reorganisation to happen would be for CKA to sell its stakes in infrastructure projects to CKI for cash. If the amount involved were too large (would exceed USD10bn, on our estimates), we could see a major fundraising exercise on the part of CKI which would dilute CK Hutchison’s stake in it to below 50%, or CKA accepting part of the consideration to be satisfied by CKI shares.

Afterwards, both CKH and CKA could embark on a special distribution of their CKI shares, which would result in the Li family owning a 30%-plus stake in CKI, giving the Li family their third USD50bn-plus listed vehicle. We see infrastructure as probably the most likely to become this third entity.

Meanwhile, other than CKI embarking on a major equity fundraising to pay for CKA’s infrastructure assets, we think it is not inconceivable that CKA would acquire CKH’s stake in CKI, to be satisfied by cash, or partly by cash and partly by shares. However, if a share issuance by CKA were involved, we think a pre-requisite would be that the Li family’s stake in CKA would be notably higher than 32% now (we believe the Li family would probably not accept a stake below 30% in CKA, ie, the regulatory threshold to trigger a general offer).

If such a scenario were to unfold, we think another pre-requisite is that CKH would have to have identified major capex in the years ahead, which we believe could be related to consolidation opportunities in the European telecom sector. In other words, we believe CKA could be a force that CKH could call upon to fund its global ambitions in the telecom business, if it deems the opportunity attractive enough.

And if CKA ended up owning CKI directly, we think the next step would likely be CKA consolidating the infrastructure investments in CKA and CKI into one vehicle, with one scenario possibly being like the CK and Hutchison merger, whereby shareholders of CKA and CKI were given an opportunity to vote on the basis of relative valuation between the 2, just like the Cheung Kong Group re-organisation in 2015. Then, after putting all of the group’s infrastructure assets under one vehicle, CKA could distribute its infrastructure assets to shareholders, just as it did under the 2015 reorganisation – first consolidating all of the group’s property assets under CKH and then distributing CKP shares as the next step.

Whatever the case, we think a useful step forward for the group would be to strengthen the balance sheet of CKI. As such, we believe a reorganisation involving PAH is likely – an issue to which we now turn.

CK Group: the makings of one big, happy family: 24 January 2018

Cheung Kong Infrastructure: long-term consolidation of global infrastructure assets for Cheung Kong Group

Based on CKI’s latest corporate presentation materials, we understand its investment mandate is “essential services/assets with regulatory regimes or with long-term offtake arrangements”. For unregulated assets, we note that “exclusivity” seems to be CKI’s key criteria when seeking target assets, as reflected in CKI’s recent investments in Eversholt (one of 3 rolling-stock leasing companies in the UK, with a 28% market share), Reliance Home Comfort (one of 2 major HVAC equipment providers in Canada) and Ista (one of the top-2 smart meter companies in Germany and continental Europe). Yet it passed up an opportunity to co-invest with parent CKHH in an aircraft business that has over 10,000 aircraft owners around the world. Therefore, it is no surprise that CKI’s earnings are some of the most defensive (together with ports) within the group.

In view of its profit contribution, we expect CKI to become the most important business for CKHH, especially after the 2015 reorganisation of Cheung Kong Holdings and Hutchison. As such, we note that CKI’s EBIT contribution to CKHH surged from 30% in 2013 to 46-48% in 2015-16 (2001-11: 14-27%).

CK Group: the makings of one big, happy family: 24 January 2018

CKHH: EBIT 70,000 CKI still saw an EBIT CAGR of 11.1% over 2001-16 (CKHH's average: 6-7%), representing a 46% EBIT 60,000 proportion for 2016 (other business segments: 7-25%). Its EBIT volatility (the standard deviation of its EBIT growth is 17% ) is also one of the lowest among the 6 businesses under CK Hutchison (14-952%) 50,000

40,000 17,528 16,643 13,478 23,477 30,000 7,404 18,215 22,162 6,905 8,454 6,136 7,353 20,000 6,675 5,605 5,921 4,990 10,000 4,589

-10,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Ports Property Retail CKI Husky Telecom

2001-13 2014-16 2001-16 EBIT (HKDm) 2001 2002 2003 2004 2005 2006 … 2010 2011 2012 2013 2014 2015 2016 CAGR CAGR CAGR Ports 5,791 6,626 7,597 8,956 10,219 11,395 … 7,207 8,226 7,681 7,358 7,944 7,957 7,567 2.0% 0.9% 1.8% Property 1,717 2,570 3,121 3,003 3,939 5,667 … 8,847 9,517 10,521 13,659 - - - 18.9% NA NA Retail 537 1,031 2,305 3,202 3,261 2,720 … 7,866 9,330 10,357 11,771 13,023 12,328 12,059 29.3% 0.8% 23.1% CKI 4,589 4,990 5,605 5,921 6,675 6,136 … 8,454 13,478 16,643 17,528 18,215 23,477 22,162 11.8% 8.1% 11.1% Husky 1,899 2,084 3,462 2,793 6,140 8,305 … 3,073 8,614 7,427 7,208 6,324 2,229 3,429 11.8% -21.9% 4.0% Telecom 719 969 1,195 162 2,789 2,648 … (1,598) 254 898 958 (85) 2,602 3,185 2.4% 49.3% 10.4% Others ------… ------NA NA NA Finance and investment 6,457 6,200 6,250 8,989 5,491 6,920 … 810 470 1,914 1,259 3,000 1,822 1,174 -12.7% -2.3% -10.7% Established businesses 21,709 24,470 29,535 33,026 38,514 43,791 … 34,659 49,889 55,441 59,741 48,421 50,415 49,576 8.8% -6.0% 5.7% 3 Group - (2,070) (18,310) (38,449) (26,880) (19,996) … 2,931 1,481 3,145 4,856 6,892 11,664 11,664 NA 33.9% NA Consolidated EBIT 21,709 22,400 11,225 (5,423) 11,634 23,795 … 37,590 51,370 58,586 64,597 55,313 62,079 61,240 9.5% -1.8% 7.2%

EBIT proportion 2001 2002 2003 2004 2005 2006 … 2010 2011 2012 2013 2014 2015 2016 Ports 38% 36% 33% 37% 31% 31% … 21% 17% 14% 13% 17% 16% 16% Property 11% 14% 13% 12% 12% 15% … 26% 19% 20% 23% 0% 0% 0% Retail 4% 6% 10% 13% 10% 7% … 23% 19% 19% 20% 29% 25% 25% CKI 30% 27% 24% 25% 20% 17% … 25% 27% 31% 30% 40% 48% 46% Husky 12% 11% 15% 12% 19% 23% … 9% 17% 14% 12% 14% 5% 7% Telecom 5% 5% 5% 1% 8% 7% … -5% 1% 2% 2% 0% 5% 7%

2002-13 2003-16 2002-16 EBIT YoY growth 2001 2002 2003 2004 2005 2006 … 2010 2011 2012 2013 2014 2015 2016 S.D S.D S.D Ports 14% 15% 18% 14% 12% … -31% 14% -7% -4% 8% 0% -5% 16% 6% 14% Property 50% 21% -4% 31% 44% … 38% 8% 11% 30% -100% NA NA 34% NA NA Retail 92% 124% 39% 2% -17% … 38% 19% 11% 14% 11% -5% -2% 39% 9% 37% CKI 9% 12% 6% 13% -8% … 22% 59% 23% 5% 4% 29% -6% 18% 15% 17% Husky 10% 66% -19% 120% 35% … -23% 180% -14% -3% -12% -65% 54% 68% 49% 66% Telecom 35% 23% -86% 1622% -5% … -424% -116% 254% 7% -109% -3161% 22% 501% 1568% 952% Established businesses 13% 21% 12% 17% 14% … -8% 44% 11% 8% -19% 4% -2% 19% 12% 18% Consolidated EBIT 3% -50% -148% -315% 105% … 30% 37% 14% 10% -14% 12% -1% 111% 12% 99% Source: Companies, Daiwa research Note: In 2014, CKHH disposed property assets to CK Holdings, renamed as CK Property during re-organisation in 2015 and later renamed as CK Asset in 2017.

CK Group: the makings of one big, happy family: 24 January 2018

In conclusion, we think CKI offers CKHH the following 2 benefits, among the 5 non-property businesses (ports, retail, infrastructure, energy, telecoms):

1. A high proportion of net assets, at c.35-40% of CKHH’s overall assets (vs. 10-30% for the others).

2. Steady 11% EBIT CAGR (vs. CKHH: 6-7%), despite 6-8% YoY declines in EBIT for 2006, 2009 and 2016, due to the asset disposal of 3 Australian electricity grids to Spark Infrastructure in 2006, and the lowering of the SoC permitted return for HKEI in 2009, and the Brexit announcement in 2016 resulting in a 20% depreciation of the GBP against the HKD reporting currency in 2H16. The standard deviation of its YoY 2001-16 EBIT growth is one of the lowest among the 5 non-property businesses under CKHH, at 17%, compared with a range of 14-952% for the 4 other business segments (18% for CKHH’s established businesses).

We see Victor Li’s preference for global infrastructure assets as further proven by the total HKD99.6bn investment by CKA in 3 assets (Duet, Reliance Home Comfort, Ista) in 2017.

Before CKI becomes a bigger entity (by merging with PAH), while CKA is still in the cash-out stage of its Hong Kong and China property portfolio, we believe CKA will continue to take the lead among Cheung Kong Group companies in global infrastructure asset investments, likely over the next 3 years.

In the long term, once CKA identifies significant property investments, we believe it will pass the torch to CKI, which could by then be a bigger merged CKI+PAH, to take the lead in submitting unconditional offers. As a result, CKI would take majority stakes in small-ticket infrastructure assets co-investing with group companies (CKHH, CKA and the Li family), or take minority 40% stakes in big-ticket infrastructure assets to keep the merged CKI’s see-through net-debt-to-equity gearing within 125% (currently 122% including PAH’s off-balance-sheet debt).

Cheung Kong Group: JV formation trend for global infrastructure investment (long term) After a potential CKI-PAH merger 0% (Effective stake: The Li family 19.7-27.9%) 30.15% 31.5% 0.1-11.7% CK Hutchison CK Asset (1 HK) (1113 HK) After reorganising Cheung Kong Holdings and 49.9% Total effective stake: Hutchison Whampoa (Effective stake: 15.1%) 30% 15.2-26.8% 0% (Effective The Li family (Effective CKI + PAH stake: 9%) stake: 28%) (1038 HK) 30.15% 31.5% 70% (Effective Infrastructure CK Hutchison CK Asset stake: 10-19%) assets (1 HK) (1113 HK) 70% 75.67% (Effective stake: 21%) (Effective stake: 22.81%) 0% 30% (Effective stake: (Effective stake: CKI 30% The Li family The Li family (1038 HK) (Effective Infrastructure 19.7-24.3%) 45.2-49.8%) stake: 7%) 30.15% 31.5% 30.15% 31.5% 38.87% assets (Effective stake: 8.87%) 0.1-11.7% 0.1-11.7% Power Assets CK Hutchison CK Asset CK Hutchison CK Asset (6 HK) (1 HK) (1113 HK) (1 HK) (1113 HK) 30% 49.9% Total effective stake: (Effective (Effective stake: 15.1%) 30% OR Total effective stake: 15.2-26.8% 15.2-26.8% stake: 30%) 30% (Effective 49.9% 30% (Effective stake: 15.1%) (Effective CKI + PAH CKI + PAH (Effective stake: 9%) (1038 HK) (1038 HK) stake: 9%) stake: 5%) 40% 40% (Effective Mega (Effective stake: Mega stake: 6-11%) Infrastructure 6-11%) Infrastructure assets assets

Source: Daiwa estimate

In the meantime, CKHH and CKA hold some stakes in CKI’s co-investment, and in case CKI does not come across many M&A opportunities in a given period, an asset injection from parent CKI or PAH could occur in order to support a continuous rise in CKI’s DPS. We estimate an injection of the infrastructure assets would be value- accretive for both CKI and CKA/CKHH, as long as CKI’s 1.3-1.5x forward PBR were higher than CKHH/CKA’s 0.7- 0.9x.

We expect a merged CKI to generate c.HKD12bn (based on 2018E financials) in cash flow which should support an estimated HKD8.4-9.5bn of DPS from the merged CKI.

CK Group: the makings of one big, happy family: 24 January 2018

CKA, CKHH and CKI’s PBR (x) 2.0

1.5

1.0

0.5

0.0 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 CKA CKHH CKI Source: Companies, Daiwa research

Cheung Kong Group: global infrastructure investment portfolio

Stakes could be injected to CKI to further consolidate global infrastructure assets

Source: Company, Daiwa research

In the long term, we believe CKI will act as a strong and growing cash cow (combined CKI and PAH: HKD12bn pa cash flow), able to distribute steady dividends to the Li family, while the Li family ultimately could create a principal listed vehicle for each of its core businesses, such as:

1. A separately listed global telecom company called CK Telecom. 2. A separately listed global retail company called CK Retail, if the Li family sees a value opportunity to re- start its proposal to divest its A.S. Watson stake.

CK Group: the makings of one big, happy family: 24 January 2018

Major listed companies within Cheung Kong Group Effective stake (%) Effective stake (%) Effective stake (%) CKH level Next layer The next layer Remarks Property Hong Kong 30.15% - - Unlisted, under CK Property China 30.15% - - Unlisted, under CK Property Overseas 30.15% - - Unlisted, under CK Property Hotels 30.15% - - Unlisted, under CK Property

Infrastructure CK Infrastructure 78% - - Power Asset Holdings 30% 39% - HK Electric Investment 10% 13% 34%

Energy Husky Energy 40% - - The family still has 29.3% stake in Husky Energy

Ports Hutchison Port Holdings 80% - - Unlisted. PSA in Singapore has a 20% stake in it HPH Trust 28% - - HPH owns 35% of HPH Trust

Telecom 3 UK 100% - - Now pursuing to acquire O2 in the UK 3 Italy 97% - - Unlisted 3 Sweden and 3 Denmark 60% - - Unlisted 3 Austria 100% - - Unlisted Hutchison Telecom (HK) 65% - - Hutchison Telephone (HK) 49% 75.9% - Vodafone Hutchison Australia 44% - - Hutchison Telecom Vietnam 100% - - Unlisted Hutchison 3 Indonesia 65% - - Unlisted

Retail AS Watson 80% - - Unlisted. Temasek has a 20% stake

Source: Company, Daiwa

In the long term, CKHH is likely to hold 5 major non-property listed companies for the Li family – CKI (infrastructure), Husky Energy (energy), Hutchison Port Holdings (ports), CK Telecom (a listed global telecom company potentially to be established based on the existing 3 UK), and CK Retail (a listed global retail company potentially to be established based on the existing A.S. Watson). In a final move, we think the Li family might pursue another restructuring exercise similar to the one involving CKH and HWL (formerly Hutchison Whampoa) in early 2015, with the goal of further reducing the holding company discount assigned to CKHH as a conglomerate of 5 major listed companies.

Apart from CKA (actually CKP), which is directly owned by the Li family, we would expect the likes of CKI and CK Telecom to be directly owned by Li Ka-shing, based on the valuation and size of the businesses, while CKHH would hold immature business segments and develop new segments on its own. These arrangements would allow for more effective buybacks and dividend distributions for the Li family, as well.

In summary, CKHH would become a conglomerate investment vehicle for the Li family, CKP a property investment vehicle, and CKI an infrastructure investment vehicle, with other businesses ready to be put under CKHH and directly held by the Li family as opportunities arise.

CK Group: the makings of one big, happy family: 24 January 2018

Li family empire: current organisational structure

The Li Family

30.15% 31.5%

Accumulating larger stake CK Property (renamed CK Hutchison through share buyback, at 2% as CK Asset) (1 HK) per annum under the (1113 HK) “creeper” rule

Source: Companies, Daiwa research

Li family empire: future organisational structure

The Li Family

Stake: >30% 30.15% 31.5% Stake: >30% CK Hutchison CK Asset (1113 HK) – Infrastructure – Other mature businesses which are (1 HK) – real estate and CKI listed conglomerate investments (1038 HK)

Yieldco for Other mature businesses yet to be Other incubated HKEI Yieldco for Yieldco for Infrastructure listed businesses (2638 HK) UK assets Australia assets assets

Source: Company, Daiwa estimates

Apart from a corporate reorganisation to eliminate CKHH’s holdings in CKI for the Li family, we see CKI potentially establishing a yieldco for its overseas assets. As a result, CKI could own a listed trust, HKEI, for its electricity businesses in Hong Kong, which are stable (limited asset growth, mature market), and form another yieldco for its infrastructure business in another mature overseas market (say in the UK or Australia), which would expand continuously through acquisitions in that country.

We envisage CKI being a strong dividend cow for the Li family in the long term, given its defensive regulated and “exclusive” infrastructure assets, as demonstrated by the low 3% standard deviation of its EBIT-over-net-asset ratio, compared with 9-142% for other assets, over 2002-16. We see the Li family establishing more trusts or yieldcos for its assets, apart from the likes of HKEI, HPH Trust and Fortune REIT.

After its incubation as an emerging business segment under the Cheung Kong Group, CKI, a ‘baby’ 21 years ago, appears ready to emerge as a strong global infrastructure firm, through more compelling M&A with the support of CKA, a bigger balance sheet through merging with PAH, and more cash to recycle from the HKEI and overseas infrastructure assets, with further corporate restructurings.

In so doing, we expect the Cheung Kong Group to create the biggest global infrastructure company by its 30th anniversary in 2026E.

CK Group: the makings of one big, happy family: 24 January 2018

Our thoughts on CKI’s development Period Action Rationale 29-Jan-2014 Spin-off of HEC under PAH To unlock the value of the electricity business, which faces an SoC return cut from 9.99% to 8% from October 2018. To introduce a bigger equity base to lead the global infrastructure M&A within the CK group, in which we believe CKA Near term Merger of CKI and PAH would refocus on its property investments when land-banking accumulation or acquisition opportunities arise. CKI would (2018-20) also be rerated to peers’ current valuation while having a larger business and capital base. Medium term Armed with a bigger equity base post its merger with PAH for another HKD60bn in M&A headroom, CKI pursues CKI continuously acquires overseas infrastructure assets (2020-25) overseas infrastructure asset M&A while relying less on group companies’ support going forward. Yieldco set up for overseas assets to recycle cash for further The yieldco could lower CKI’s cost of equity, allowing it to pursue lower-return projects while earning a fair real return. Long term M&As (from 2026, CKI is favoured by the Li family, given infrastructure assets are regulated and so offer defensive earnings and dividends. CKI’s 30th Re-organisation of CKI, whereby it is controlled directly Therefore, CKI’s valuation should be higher than that of its parent, CK Hutchison. A directly controlled CKI under the Li birthday) under the Li family rather than CKHH family would also offer more visibility on dividends and buybacks for the family.

(USDm) (HKD/share) 40,000 2.50 USD35bn Long term – yieldco is set up after spending the HKD76bn 35,000 CKI’s estimated market cap if it were to merge with PAH: cash on overseas M&A Long term – reorganisation of CKI , whereby it is controlled 2.00 30,000 Medium term – CKI directly by the Li family, rather continuously acquires overseas than CKH utchison (Chapter infrastructure assets 3.4) Start of Chapter 3: (Chapter 3.3) 2014.1.29 – spin-off of HK 25,000 Chapter 2: Electric under PAH co-investment in overseas (Chapter 3.1) 1.50 infrastructure assets with group 20,000 companies PAH and CKG Near term– Merger of CKI and PAH (Chapter 3.2) 1.00 15,000 1996.7.17 – Listed on HKEx 10,000 0.50 5,000

0 - July-96 July-99 July-02 July-05 July-08 July-11 July-14 July-17 July-20 July-23 July-26 Dividend per share - RHS Market capitalisation - LHS

Source: Daiwa

CK Group: the makings of one big, happy family: 24 January 2018

What are our investment recommendations for the next 12 months?

We have Buy (1) ratings on CKA and CKI, and Underperform (4) ratings on PAH and HKEI.

CKA (1113 HK, Buy [1]). We believe capital management holds a key to the valuation of Hong Kong property companies, and we see CKA as a leading stock on the theme of modernisation of the capital management of family property companies (or business groups) in Hong Kong (and Asia). We expect CKA to continue to monetise property assets at NAV and buy back shares at a discount to its NAV, which we believe would work well for all shareholders, including the Li family. We reaffirm our Buy (1) call and new 12-month TP of HKD85.2, from HKD83.0, based on an unchanged 30% discount applied to our new end-2018E NAV estimate of HKD121.7. Key risk: disappointing returns from new investments.

CKI (1038 HK, Buy [1]). CKI is our top pick in the Hong Kong Utilities Sector, as we believe it offers a defensive yield gap amid a rising interest-rate environment thanks by virtue of its inflation-hedged overseas earnings. Also, its newly-acquired stakes in DUET, Reliance Home Comfort and Ista are set to contribute on a full-year basis this year, which we expect to support mid-teen EPS growth in 2018. More, as we expect the ratio of CKI and PAH’s PER multiples to rise in the upcoming interest-rate upcycle, with CKI’s multiple likely to rise (currently 13x) and PAH’s likely to decline (currently 18x), we believe CKI will propose a CKI-PAH merger for a second time. If a merger were to go through, we would expect CKI to be rerated further to 17-18x PER, in line with the multiples typically commanded by global infrastructure players. Hence, we reaffirm our Buy (1) rating and raise our 12-month SOTP- based TP from HKD85 to HKD86. Key risk: a further fall in the GBP, given we estimate 57% of CKI’s 2018E profits will come from the UK.

PAH (6 HK, Underperform [4]). After paying out a likely special dividend of HKD7.5 by 1H18, we expect PAH to be derated amid the forthcoming interest-rate upcycle, given that: 1) there will be no further M&A upside for PAH and hence won’t be able to defend its yield gap, and 2) the loss of investment appeal to investor, as investors seeking yield would favour HKEI (5% yield, vs. PAH’s c.4%) while those seeking M&A activity would prefer CKI, Hence, we reaffirm our Underperform (4) rating on PAH, but revise our 12-month SOTP-based TP from HKD64.1 to HKD61.5. Key upside risk: substantial M&A allocation to PAH rather than CKI or CKA.

HKEI (2638 HK, Underperform [4]). Among the Hong Kong utilities names that we cover, HKEI looks set to be the major loser, with its 2019E yield gap seen narrowing by 1.7pp from the 2.9% currently (vs. peers’ 0.5-0.8pp; GDI is an exception, where we see the yield gap widening by 1.2pp). Our view reflects our belief that the company would not be able to maintain its DPS of HKD0.4 in 2019 (when the cut in SoC return from 9.99% to 8.00% takes effect) through borrowing, as it will need to earmark some borrowing capacity for: 1) its net capex of c.HKD2bn over the 2019-23 cycle on new gas-fired units, and 2) a c.HKD1.5-2bn potential investment in its LNG receiving terminal, in order not to exceed its debt ceiling of c.HKD50bn (2018E debt balance: HKD43bn). Hence, we reiterate our Underperform (4) call on HKEI but slightly raise our 12-month DDM based TP to HKD6.15 (from HKD5.90) on our less conservative dividend assumptions in light of HKEI’s willingness to maintain part of its DPS through borrowing. Key risk: smaller-than-expected dividend cut in 2019E and slower-than-expected interest rate hikes.

CK Group: the makings of one big, happy family: 24 January 2018

Appendix

Hong Kong utilities: looking for an attractive yield gap

CK Group: the makings of one big, happy family: 24 January 2018

The race is on for an attractive yield gap in a rising interest-rate environment

The yield gap, which we consider to be an important gauge of the appeal of the Hong Kong Utilities Sector, is currently at 1.6%, 0.7SD above its past-10-year-average. We expect the sector’s yield gap to remain under pressure, as the US and Hong Kong are likely entering an interest-rate upcycle, and fall to 1.1% in 2019E, only 0.2SD above the historical mean of 0.9%. In this context, it is not surprising the market is turning cautious on the Hong Kong Utilities Sector.

At the company level, however, we think that in the next 2 years some stocks under our coverage could have yield gaps that still exceed their historical averages, driven by robust and stable DPS growth. We recommend companies with attractive yield gaps, like GDI (270 HK, HKD11.46, Outperform [2]), HKCG (3 HK, HKD15.38, Outperform [2]), and CKI (driven by M&A).

Hong Kong Utilities: historical yield gap (%) Hong Kong Utilities: yield gap (%) trend

3.0 2.2 2.5 +1SD 2.0 1.7 1.6 1.6 1.5 1.0 1.2 0.5 1.1 0.0 0.7 Mean -0.5 -1.0 0.2 -1.5 -1SD -2.0 -0.3 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Current Average 2018E Average 2019E Sector yield gap Mean Yield gap Mean -1SD +1SD

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 1.6%, 0.7SD above historical average Note: Sector yield gap could fall from current 1.6% (0.7SD above past-10-year mean) to 1.1% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. (0.2SD above past-10-year mean)

Hong Kong Utilities Sector: yield gap comparison Current 2018E 2019E 2019E Rank yield gap vs. historical yield gap vs. historical yield gap vs. historical Decline from current GDI 1 2.5% +1.8SD 3.1% +2.2SD 3.7% +2.7SD +1.2pp HKCG 2 -0.1% +0.5SD -0.2% +0.4SD -0.6% +0.2SD -0.5pp CKI 3 1.3% +0.6SD 1.1% +0.2SD 0.7% -0.3SD -0.6pp PAH 4 1.8% +0.7SD 1.7% +0.4SD 1.0% -0.7SD -0.8pp CLP 5 1.3% +0SD 1.0% -0.4SD 0.5% -1.1SD -0.8pp HKEI 6 2.9% -1.5SD 2.9% -1.6SD 1.2% -3.7SD -1.7pp

Source: Companies, Daiwa research

GDI: historical yield gap (%) GDI: yield gap (%) trend

4.0 4.0 3.0 3.5 3.7 2.0 3.0 3.1 1.0 2.5 2.5 0.0 2.0 -1.0 1.5 +1SD -2.0 1.0 -3.0 0.5 Mean -4.0 0.0 -0.5 -1SD

-1.0

1/1/2007 7/1/2007 1/1/2008 7/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012 7/1/2012 1/1/2013 7/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 1/1/2016 7/1/2016 1/1/2017 7/1/2017 1/1/2018 270 Mean -1SD +1SD Current Average 2018E Average 2019E

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 2.5%, 1.8SD above historical average Note: GDI’s yield gap could fall from current 2.5% (1.8 SD above past-10-year mean) to Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. 0.9% (0.6SD above past-10-year mean)

CK Group: the makings of one big, happy family: 24 January 2018

CKI: historical yield gap (%) CKI: yield gap (%) trend

3.0 1.8 2.5 +1SD 2.0 1.6 1.5 1.4 1.0 1.3 1.2 0.5 1.1 0.0 1.0 Mean (0.5) 0.8 (1.0) 0.7 (1.5) 0.6 (2.0) 0.4

0.2

1/1/2008 7/1/2012 1/1/2018 7/1/2007 7/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012 1/1/2013 7/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 1/1/2016 7/1/2016 1/1/2017 7/1/2017 1/1/2007 0.0 -1SD 1038 Mean -1SD +1SD Current Average 2018E Average 2019E

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 1.3%, 0.6SD above historical average Note 1: CKI’s yield gap could fall from current 1.3% (0.6 SD above past-10-year mean) to 0.7% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. (0.3SD below past-10-year mean) Note 2: CKI’s yield gap can be widened again with M&As

HKCG: historical yield gap (%) HKCG: yield gap (%) trend

2.0 0.5 +1SD 1.0 0.0 0.0 (0.1) (0.2) -1.0 -0.5 Mean -2.0 (0.6) -1.0 -3.0

-4.0 -1.5 -1SD

-2.0

7/1/2007 1/1/2010 1/1/2011 7/1/2012 1/1/2007 1/1/2008 7/1/2008 1/1/2009 7/1/2009 7/1/2010 7/1/2011 1/1/2012 1/1/2013 7/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 1/1/2016 7/1/2016 1/1/2017 7/1/2017 1/1/2018 3 Mean -1SD +1SD Current Average 2018E Average 2019E

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 0.1%, 0.5SD above historical average Note: HKCG’s yield gap could fall from current 0.1% (0.5 SD above past-10-year mean) to- 0.6% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. (0.2SD above past-10-year mean)

CLP: historical yield gap (%) CLP: yield gap (%) trend

3.0 2.5 2.5 2.0 2.0 +1SD 1.5 1.0 1.5 0.5 1.3 Mean 0.0 1.0 1.0 -0.5

-1.0 0.5 0.5 -1SD

7/1/2013 7/1/2017 7/1/2007 1/1/2008 7/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012 7/1/2012 1/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 1/1/2016 7/1/2016 1/1/2017 1/1/2018 1/1/2007 0.0 2 Mean -1SD +1SD Current Average 2018E Average 2019E

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 1.3%, equivalent to the historical average Note: CLP’s yield gap could fall from current 1.3% (equivalent to the past-10-year mean) to 0.5% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation (1.1SD below past-10-year mean)

CK Group: the makings of one big, happy family: 24 January 2018

PAH: historical yield gap (%) PAH: yield gap (%) trend

3.5 2.5 3.0 2.5 2.0 +1SD 2.0 1.8 1.7 1.5 1.5 Mean 1.0 0.5 1.0 0.0 1.0 -1SD -0.5 0.5 -1.0 0.0

Current Average 2018E Average 2019E

7/1/2008 1/1/2011 7/1/2013 1/1/2016 7/1/2007 1/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 7/1/2011 1/1/2012 7/1/2012 1/1/2013 1/1/2014 7/1/2014 1/1/2015 7/1/2015 7/1/2016 1/1/2017 7/1/2017 1/1/2018 1/1/2007 6 Mean -1SD +1SD

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 1.8%, 0.7SD above historical average Note: PAH’s yield gap could fall from current 1.8% (0.7 SD above past-10-year mean) to 1.0% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. (0.7SD below past-10-year mean)

HKEI: historical yield gap (%) HKEI: yield gap (%) trend

6.5 6.0 6.5 5.5 5.0 5.5 +1SD 4.5 4.5 4.0 Mean 3.5 3.5 -1SD 3.0 2.9 2.9 2.5 2.5 2.0 1.5 1.2

0.5

4/29/2015 7/29/2017 1/29/2014 4/29/2014 7/29/2014 1/29/2015 7/29/2015 1/29/2016 4/29/2016 7/29/2016 1/29/2017 4/29/2017

10/29/2015 10/29/2016 10/29/2017 10/29/2014 Current Average 2018E Average 2019E

2638 Mean -1SD +1SD

Source: Bloomberg, Daiwa Source: Bloomberg, Daiwa Note 1: current yield gap at 2.9%, -1.5SD below historical average Note: HKEI’s yield gap could fall from current 2.9% (1.5 SD below past-10-year mean) to 1.2% Note 2: we use the US 10Y T-bill yield as the bond yield in our calculation. (3.7SD below past-10-year mean)

CK Group: the makings of one big, happy family: 24 January 2018

Company section

Hong Kong Real Estate 24 January 2018

CK Asset (1113 HK) CK Asset

Target price: HKD85.20 (from HKD83.00) Share price (23 Jan): HKD75.00 | Up/downside: +13.6%

Receding investor resistance over time

CKA is moving back to being like the old Cheung Kong, in our view Jonas Kan, CFA (852) 2848 4439 An unusual model, but has proven to work well for its shareholders [email protected] Reaffirming our Buy (1) rating with a new TP of HKD85.2

What's new: We have examined the strategic direction of CK Asset (CKA) Forecast revisions (%) in the context of the evolution and development of the Cheung Kong group Year to 31 Dec 17E 18E 19E and its infrastructure businesses. We have come to the view that CKA Revenue change - - - would become like the old Cheung Kong Holdings in terms of its strategy Net profit change - - - Core EPS (FD) change - - - on the property business and companies within the group. Source: Daiwa forecasts

What's the impact: Offering a safe and successful model on property for Share price performance shareholders. We take the view that CKA and the Cheung Kong Group, all (HKD) (%) along, have practised a rather special model for the property business, 75 115 which we believe suits the group and offers an attractive risk-reward profile 69 110 for its shareholders. Our read is the group has done well in its landbanking 63 106 phase in both HK and China and it has now entered into the stage of 56 101 50 96 monetising such landbank. We believe this would offer its shareholders a Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 safe and credible way to gain exposure to the property sector of HK and CK Asset (LHS) Relative to HSI (RHS) China, as well as the group’s credentials in capital deployment.

12-month range 50.35-75.00 CKA will likely be backing CKI’s ambition in global infrastructure. We Market cap (USDbn) 36.33 believe that doing so should benefit both companies. We also think that this 3m avg daily turnover (USDm) 43.84 is consistent with the business philosophy of the old Cheung Kong Shares outstanding (m) 3,787 Major shareholder Li family & Trust (30.3%) Holdings which has a past record of supporting expansion of the major companies under it upon entering the monetising phase (such as during the Financial summary (HKD) 1990s). As such, we are optimistic about the prospects of CKI becoming Year to 31 Dec 17E 18E 19E one of the largest infrastructure companies in the world and its relation with Revenue (m) 69,779 88,136 90,116 CKA could resemble what Hutchison was for Cheung Kong in the past. Operating profit (m) 29,397 36,758 37,942 Net profit (m) 19,146 25,173 25,500 Core EPS (fully-diluted) 5.055 6.647 6.733 Likely to stay as a leading player for the theme of capital management EPS change (%) 7.8 31.5 1.3 modernisation of HK property companies. We believe that CKA will likely Daiwa vs Cons. EPS (%) (7.1) 4.8 3.8 PER (x) 14.8 11.3 11.1 keep on buying back shares which is also consistent with the Cheung Kong Dividend yield (%) 2.3 2.6 2.7 Group’s traditional emphasis on capital allocation and recycling. We DPS 1.750 1.950 2.050 reiterate our long-held view that selling non-core assets at market prices PBR (x) 1.0 0.9 0.9 EV/EBITDA (x) 9.0 6.8 6.1 and buying back shares that are trading at a discount to NAV is a safe and ROE (%) 6.9 8.6 8.2 effective way to reduce the “HK discount” on property companies’ valuation. Source: FactSet, Daiwa forecasts

What we recommend: We reaffirm our Buy (1) rating with a new 12-month TP of HKD85.2 (from HKD83), based on a 30% discount applied to our end-2018E NAV estimate of HKD121.70. Key risk: disappointing returns from new investments.

How we differ: Unlike some, we see capital management modernisation as one of the major keys to the valuation of HK property stocks and believe that CKA’s model is a valid, though unconventional, way to run the property business. As such, we expect investor resistance to CKA’s strategy to lessen over time.

See important disclosures, including any required research certifications, beginning on page 87

CK Group: the makings of one big, happy family: 24 January 2018

Financial summary Key assumptions Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Property sales revenue (HKDm) n.a. n.a. 26,348 49,059 56,804 48,661 62,060 63,260 Gross rental income (HKDm) n.a. n.a. 2,331 5,138 7,430 7,818 7,325 7,520 Hotel and serviced suites revenue n.a. n.a. 2,895 4,005 4,850 4,722 4,992 5,192 (HKDm)

Profit and loss (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Property sales revenue n.a. n.a. 26,348 49,059 56,804 48,661 62,060 63,260 Gross rental income n.a. n.a. 2,331 5,138 7,430 7,818 7,325 7,520 Other Revenue n.a. n.a. 3,548 4,596 5,676 13,300 18,751 19,336 Total Revenue n.a. n.a. 32,227 58,793 69,910 69,779 88,136 90,116 Other income n.a. n.a. 537 500 347 783 806 835 COGS n.a. n.a. (12,985) (32,587) (41,552) (37,584) (48,159) (48,819) SG&A n.a. n.a. (6,944) (4,127) (2,731) (2,972) (3,377) (3,520) Other op.expenses n.a. n.a. (286) (508) (569) (609) (648) (670) Operating profit n.a. n.a. 12,549 22,071 25,405 29,397 36,758 37,942 Net-interest inc./(exp.) n.a. n.a. (815) (549) (645) (1,625) (2,170) (2,263) Assoc/forex/extraord./others n.a. n.a. 2,878 1,409 (28) 0 0 0 Pre-tax profit n.a. n.a. 14,612 22,931 24,732 27,772 34,588 35,679 Tax n.a. n.a. (2,313) (6,568) (6,306) (8,220) (8,989) (9,739) Min. int./pref. div./others n.a. n.a. (248) (795) (394) (406) (426) (440) Net profit (reported) n.a. n.a. 12,051 15,568 18,032 19,146 25,173 25,500 Net profit (adjusted) n.a. n.a. 12,051 15,568 18,032 19,146 25,173 25,500 EPS (reported)(HKD) n.a. n.a. n.a. n.a. 4.688 5.055 6.647 6.733 EPS (adjusted)(HKD) n.a. n.a. n.a. n.a. 4.688 5.055 6.647 6.733 EPS (adjusted fully-diluted)(HKD) n.a. n.a. n.a. n.a. 4.688 5.055 6.647 6.733 DPS (HKD) n.a. n.a. 0.000 1.400 1.530 1.750 1.950 2.050 EBIT n.a. n.a. 12,549 22,071 25,405 29,397 36,758 37,942 EBITDA n.a. n.a. 12,835 22,579 25,974 30,006 37,406 38,612

Cash flow (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Profit before tax n.a. n.a. 14,612 22,931 24,732 27,772 34,588 35,679 Depreciation and amortisation n.a. n.a. 286 508 569 609 648 651 Tax paid n.a. n.a. (975) (3,866) (6,851) (7,768) (8,532) (8,532) Change in working capital n.a. n.a. 6,993 6,787 11,976 16,850 15,620 15,840 Other operational CF items n.a. n.a. (7,292) (8,442) 624 1,609 2,158 2,251 Cash flow from operations n.a. n.a. 13,624 17,918 31,050 39,072 44,483 45,890 Capex n.a. n.a. (296) (483) (14,384) (28,250) (23,520) (23,120) Net (acquisitions)/disposals n.a. n.a. 3,298 3,216 0 0 0 0 Other investing CF items n.a. n.a. 124 6,030 0 0 0 0 Cash flow from investing n.a. n.a. 3,126 8,763 (14,384) (28,250) (23,520) (23,120) Change in debt n.a. n.a. (9,194) 45,951 0 0 0 0 Net share issues/(repurchases) n.a. n.a. 0 0 (2,056) (10,000) (10,000) (10,000) Dividends paid n.a. n.a. (5,861) (33,266) (5,834) (6,440) (7,216) (7,216) Other financing CF items n.a. n.a. (1,410) (4,337) (1,223) (1,284) (1,349) (1,349) Cash flow from financing n.a. n.a. (16,465) 8,348 (9,113) (17,724) (18,565) (18,565) Forex effect/others n.a. n.a. 0 0 0 0 0 0 Change in cash n.a. n.a. 285 35,029 7,553 (6,902) 2,398 4,205 Free cash flow n.a. n.a. 13,328 17,435 16,666 10,822 20,963 22,770 Source: FactSet, Daiwa forecasts

CK Group: the makings of one big, happy family: 24 January 2018

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Cash & short-term investment n.a. n.a. 10,354 45,861 62,601 72,780 86,005 88,520 Inventory n.a. n.a. 73,259 153,301 137,548 128,624 125,923 123,381 Accounts receivable n.a. n.a. 1,810 12,335 12,655 13,125 13,860 14,520 Other current assets n.a. n.a. 1,210 0 0 0 0 0 Total current assets n.a. n.a. 86,633 211,497 212,804 214,529 225,788 226,421 Fixed assets n.a. n.a. 9,928 18,614 33,695 34,610 34,422 33,848 Goodwill & intangibles n.a. n.a. 0 0 0 0 0 0 Other non-current assets n.a. n.a. 86,655 141,694 150,337 171,641 190,948 208,695 Total assets n.a. n.a. 183,216 371,805 396,836 420,780 451,158 468,964 Short-term debt n.a. n.a. 250 5,772 4,378 0 0 0 Accounts payable n.a. n.a. 4,502 14,785 17,396 15,620 15,820 15,980 Other current liabilities n.a. n.a. 78,044 16,070 21,983 17,375 17,786 17,980 Total current liabilities n.a. n.a. 82,796 36,627 43,757 32,995 33,606 33,960 Long-term debt n.a. n.a. 350 55,217 65,798 87,256 98,084 96,394 Other non-current liabilities n.a. n.a. 999 10,274 11,007 11,235 11,356 11,521 Total liabilities n.a. n.a. 84,145 102,118 120,562 131,486 143,046 141,875 Share capital n.a. n.a. 0 3,860 3,824 3,787 3,787 3,787 Reserves/R.E./others n.a. n.a. 96,254 259,236 266,375 279,272 298,004 316,877 Shareholders' equity n.a. n.a. 96,254 263,096 270,199 283,059 301,791 320,664 Minority interests n.a. n.a. 2,817 6,591 6,075 6,235 6,320 6,425 Total equity & liabilities n.a. n.a. 183,216 371,805 396,836 420,780 451,157 468,964 EV n.a. n.a. 231,204 293,621 282,448 271,212 254,243 236,496 Net debt/(cash) n.a. n.a. (9,754) 15,128 7,575 14,476 12,079 7,874 BVPS (HKD) n.a. n.a. n.a. n.a. 70.243 74.742 79.688 84.671

Key ratios (%) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales (YoY) n.a. n.a. n.a. 82.4 18.9 (0.2) 26.3 2.2 EBITDA (YoY) n.a. n.a. n.a. 75.9 15.0 15.5 24.7 3.2 Operating profit (YoY) n.a. n.a. n.a. 75.9 15.1 15.7 25.0 3.2 Net profit (YoY) n.a. n.a. n.a. 29.2 15.8 6.2 31.5 1.3 Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. n.a. n.a. 7.8 31.5 1.3 Gross-profit margin n.a. n.a. 59.7 44.6 40.6 46.1 45.4 45.8 EBITDA margin n.a. n.a. 39.8 38.4 37.2 43.0 42.4 42.8 Operating-profit margin n.a. n.a. 38.9 37.5 36.3 42.1 41.7 42.1 Net profit margin n.a. n.a. 37.4 26.5 25.8 27.4 28.6 28.3 ROAE n.a. n.a. 25.0 8.7 6.8 6.9 8.6 8.2 ROAA n.a. n.a. 13.2 5.6 4.7 4.7 5.8 5.5 ROCE n.a. n.a. 25.2 10.3 7.5 8.1 9.4 9.1 ROIC n.a. n.a. 23.7 8.4 6.7 7.0 8.7 8.4 Net debt to equity n.a. n.a. n.a. 5.8 2.8 5.1 4.0 2.5 Effective tax rate n.a. n.a. 15.8 28.6 25.5 29.6 26.0 27.3 Accounts receivable (days) n.a. n.a. 10.2 43.9 65.2 67.4 55.9 57.5 Current ratio (x) n.a. n.a. 1.0 5.8 4.9 6.5 6.7 6.7 Net interest cover (x) n.a. n.a. 15.4 40.2 39.4 18.1 16.9 16.8 Net dividend payout n.a. n.a. n.a. n.a. 32.6 34.6 29.3 30.4 Free cash flow yield n.a. n.a. 4.7 6.1 5.9 3.8 7.4 8.0 Source: FactSet, Daiwa forecasts

Company profile

CK Asset (formerly called Cheung Kong Property) is a new entity created by the Cheung Kong Group reorganisation announced on 9 January 2015, which, among other things, resulted in the creation of 2 separate companies for the global capital markets: one a global conglomerate named CK Hutchison, and the other a pure property company, namely Cheung Kong Property. The company was listed on the Hong Kong Stock Exchange in June 2015 by way of introduction. CK Asset is currently one of the largest property companies in Hong Kong, with a 14m sq ft rental portfolio, 212m sq ft of development landbank, and some 12,625 hotel rooms in Hong Kong, China and overseas.

CK Group: the makings of one big, happy family: 24 January 2018

CK Asset: disposal of stake in The Center Cheung Kong Group: share buybacks since its reorganisation Announced 1 Nov 2017 Date No. of shares Avg price Total cost % of issued Location Queen’s Road Central, Central bought (m) (HKD) (HKDm) shares Property type 73-storey Grade A office building CK Hutchison 17-Nov-16 0.78 92.847 72.7 0.02% % owned by CKA ~75% (~48 office floors, some retail shops & carparks) 18-Nov-16 1.22 94.872 115.5 0.03% Year of completion 1998 Total 2.00 94.079 188.2 0.05% Attributable GFA 113,170 sq m / 1.22m sq ft CK Property Attributable LFA 113,431 sq m / 1.22m sq ft Mar 2016 13.5 46.725 632 0.35% (including 1,271 sq m / 13,700 sq ft retail) May 2016 0.6 45.237 29 0.02% No. of car parking spaces 402 Dec 2016 21.5 51.376 1,105 0.56% Buyer China Energy Reserve & Chemicals Group, together with Jan 2017 23.8 51.174 1,218 0.62% some local investors Mar 2017 23.7 53.970 1,282 0.63% Apr 2017 33.9 53.604 1,819 0.90% Consideration (HKD) 40.2bn (33,000/sq ft) May 2017 20.8 56.828 1,182 0.56% Carrying value (HKD) 19.8bn (at 31 Dec 2016) Jun 2017 24.2 61.165 1,481 0.65% Co est'd gain on disposal (HKD) 14.5bn (based on carrying value at 30 Jun 2017) Total 162.2 53.941 8,748 4.29%

Source: Company, Daiwa Source: HKEx, Daiwa

CKI: total consideration spent on M&A CK Asset: new business ventures Total Date Company Business Consortium Total Date Type Cash spent Corporate debt consideration consideration Jun-10 Seabank Power Network GBP211.7m NA GBP211.7m July Acquired 100% A fully integrated energy CKP (65%) / EUR4.50bn Oct-10 UKPN GBP1bn GBP1.31bn GBP2.3bn 2017 interest in Ista management services CKI (35%) (HKD41.40bn) Apr-11 Meridian Cogeneration Plant CAD45.7m NA CAD45.7m provider in Europe Oct-11 Northumbrian Water GBP880m GBP905mn GBP1.8bn Acquired 100% in A home water heater and CKP CAD2.80bn Sep-12 West and Wales Utilities GBP204m GBP404mn GBP608m Reliance Home related services provider in (HKD17.16bn) Apr-13 EnviroWaste NZD340m NZD150m NZD490m Comfort Canada Sep-13 AVR EUR198m EUR133m EUR331m On-sold 25% in CAD715m Reliance Home (HKD4.39bn) Jul-14 Park'N Fly CAD381m NA CAD381m Comfort to CKI Sep-14 Envestra AUD667m NA AUD667m May Acquired 100% in Owner and operator of energy CKP (40%) / AUD7.41bn Mar-15 Eversholt GBP570m GBP730m GBP1.3bn 2017 DUET Group utility assets in Australia, the CKI (40%) / (HKD42.69bn) Nov-15 Iberwind EUR144m NA EUR144m US, the UK and Europe PAH (20%) Jul-16 Husky's oil pipeline (HMLP) CAD289m CAD136m CAD425bn Dec Acquired 100% Aircraft leasing CKP USD988m May-17 Duet Group AUD2.92bn NA AUD2.92bn 2016 interest in CK Capital (HKD7.69bn) Aug -17 Reliance CAD705m NA CAD705m & Harrier Global

Nov-17 Ista EUR1.8bn NA EUR1.8bn Total HKD88.0bn HKD44.8bn HKD132.8bn

Source: Company, Daiwa forecasts Source: Company

CK Asset: PBR since listing CK Asset: share-price performance since listing (x) (HKD) 1.2 80 Current PBR = 0.97x 70 1.0 60 0.8 50 0.6 40

0.4 30

Jun-15 Jun-16 Jun-17

Mar-16 Mar-17

Dec-15 Dec-17 Sep-15 Sep-16 Dec-16 Sep-17

Source: Company, Bloomberg, Daiwa Source: Bloomberg

Hong Kong Utilities 24 January 2018

Cheung Kong Infrastructure (1038 HK) Cheung Kong Infrastructure

Target price: HKD86.00 (from HKD85.00) Share price (23 Jan): HKD66.55 | Up/downside: +29.2%

Set for strong 2018E on tariff hike, M&A contribution Dennis Ip, CFA (852) 2848 4068 Mid-teen 2017-18E EPS growth on stable GBP, tariff hike, M&A support [email protected] Ultimate goal is merging with PAH to lead global infrastructure M&A Don Lau, CFA (852) 2848 4469 Reiterating Buy (1); lifting TP to HKD86.0; resilient yield gap and M&A [email protected]

What's new: In our view, CKI will continue to partner with CKA to co-invest Forecast revisions (%) in global infrastructure assets until it merges with PAH to form a bigger Year to 31 Dec 17E 18E 19E entity, which we believe is likely in 2019-20E. We prefer CKI to other Hong Revenue change (0.8) (0.7) (0.7) Net profit change 1.6 2.3 1.3 Kong power companies (PAH, CLP, HKEI) amid the rising-interest-rate Core EPS (FD) change 1.6 2.3 1.3 environment, given earnings from CKI’s overseas regulated assets are Source: Daiwa forecasts inflation-hedged. As such, we believe CKI will be able to keep its absolute ROIC constant, leading to a more defensive yield gap. Share price performance

(HKD) (%) What's the impact: 2017-19E — M&A, tariff hikes to fuel EPS growth. 75 105 The UK’s RPI index has surged from 1.6% to 4.0% after a c.15% fall in the 71 98 GBP against the USD since the Brexit vote in June 2016. Thus, we believe 68 90 64 83

CKI’s regulated UK assets will see a c.2.5% YoY tariff rise from March 60 75 2018. Moreover, owing to the 7% appreciation of the GBP in 2017 (or 1.3% Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 rise since our report of 28 July 2017), we lift our 2017-19E EPS by 1-2%. CK Infra (LHS) Relative to HSI (RHS)

For 2018, we expect full-year contributions from CKI’s recently acquired stakes in Duet, Reliance Home Comfort and Ista (total consideration of 12-month range 61.00-73.50 HKD35bn for 25-40% stakes). In 2019, should the US hike interest rates Market cap (USDbn) 21.45 further, we believe continuous tariff hikes in CKI’s UK/Australia regulated 3m avg daily turnover (USDm) 16.09 Shares outstanding (m) 2,520 assets would provide a hedge against inflation pressure. Major shareholder CK Hutchison (75.7%)

2019-20: potential CKI-PAH merger. PAH is facing a situation similar to Financial summary (HKD) 2008-09, with HKEI’s return facing a cut in a rising interest-rate Year to 31 Dec 17E 18E 19E environment. We believe funds will flow to Hong Kong utilities offering more Revenue (m) 5,455 5,590 5,727 defensive DPS growth, such as CKI, HKCG and GDI, which can maintain Operating profit (m) 2,201 2,164 2,215 Net profit (m) 11,364 12,905 13,423 their yield gaps. Should a merger occur, we estimate CKI’s forward PER to Core EPS (fully-diluted) 4.510 5.122 5.327 be rerated from 13x currently and PAH’s would be derated from 18x EPS change (%) 17.9 13.6 4.0 currently, creating a 1x ratio. After a merger, we think the larger CKI could Daiwa vs Cons. EPS (%) 7.2 10.7 10.1 be rerated to a PER of 17-18x, in line with global infrastructure peers. Also, PER (x) 14.8 13.0 12.5 Dividend yield (%) 3.6 3.8 3.9 it would be able to regain its leadership in infrastructure M&A from CKA, DPS 2.375 2.497 2.625 and further consolidate infrastructure assets under CKA and CKHH should PBR (x) 1.4 1.4 1.3 the group companies require capital (CKA and CKHH are trading at lower EV/EBITDA (x) 23.0 17.0 11.1 ROE (%) 10.2 10.7 10.6 forward PBRs of 0.7-0.8x vs. CKI’s 1.4x). We see CKI’s PER being rerated Source: FactSet, Daiwa forecasts amid an upturn in interest rates while the Hong Kong SoC return cut approaches, with a potential CKI-PAH merger acting as a further catalyst.

What we recommend: We reaffirm our Buy (1) rating and lift our SOTP- based 12-month TP from HKD85.0 to HK86.0, after fine-tuning up our 2017-19E EPS by 1-2%. Key downside risk: a further fall in the GBP, given that we estimate 57% of CKI’s 2018E profit will be from the UK.

How we differ: Unlike the market, we are focused on upcoming events and believe Brexit and the US interest-rate upcycle will not affect CKI’s UK long-term earnings.

See important disclosures, including any required research certifications, beginning on page 87

Cheung Kong Infrastructure (1038 HK): 24 January 2018

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook CKI: historical net-profit growth and outlook

We forecast CKI’s recurring net profit to rise by a CAGR of (HKDm) 12% over 2016-19E, driven by a stabilising GBP and 15,000 recent M&A. In addition, given that most UK businesses 10,000 under CKI are regulated assets whose returns are inflation- linked, and the UK RPI had surged to 4.0% as of 5,000 December 2017 (from 1.6% in May 2016 before the Brexit 0 vote), we expect a c.2.5% tariff hike in regulated UK gas/water/power assets in 2018E, which we would see (5,000) supporting 14%/4% recurring earnings growth for 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E UK Australia 2018/19E. HK - SoC Mainland China New Zealand HK - Infrastructure materials Unallocated items PAH Source: Company, Daiwa forecasts

Valuation CKI: 12-month forward PER bands

CKI is trading at a 2018E PER of 13x, at its past-10-year PER (x) average forward PER and at a c.28% discount to the 22 2018E PER of PAH (18x). We expect the valuation gap 20 between CKI and PAH to narrow after PAH distributes the 18 17.6x Avg+2SD last c.HKD7.5/share special dividend, which would clear its 16 idle cash balance, likely by 1H18. We consider CKI’s 15.3x Avg+1SD 14 valuation to be attractive in the medium term and see a 13.0x Avg 12 case for its discount to PAH to narrow as early as 2018E, 10.8x Avg-1SD once tariffs for the regulated UK assets start to increase 10 due to the rising RPI (4.0% vs. 1.6% 18 months ago). A 8 8.5x Avg-2SD successful 2nd merger attempt between CKI and PAH Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 would create a HKD40-50bn mega global infrastructure Source: Bloomberg, Daiwa forecasts company, and could lead to a re-rating of CKI to trade at a 2018E PER of 17-18x, on our estimates.

Earnings revisions CKI: Bloomberg-consensus EPS forecasts

The Bloomberg consensus revised up its 2017-18 EPS (HKD) forecasts for CKI by 2-9% in 2017, reflecting the 4.7 acquisitions of a 40% stake in Duet, 25% stake in Reliance 4.6 4.5 Home Comfort, and 35% stake in Ista. The upward 4.4 revisions to CKI’s 2017-18 EPS forecasts in 2017 were 4.3 much higher than PAH’s 1-3%, given PAH’s spending on 4.2 M&A was only 24% of CKI’s in 2017. 4.1 4.0

3.9

Jul-17 Jul-17

Apr-17 Oct-17 Oct-17

Jan-17 Jan-17 Jun-17 Jan-18

Mar-17 Feb-17 Mar-17

Dec-17 Aug-17 Sep-17 Nov-17 Dec-17

May-17 May-17 2017E EPS 2018E EPS 2019E EPS

Source: Bloomberg

Cheung Kong Infrastructure (1038 HK): 24 January 2018

Financial summary Key assumptions Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Average net electricity tariff in HK (HK 130.90 134.60 134.90 134.90 133.40 110.38 112.48 130.56 cents per kWh) - for HEC HK SoC fixed assets (HKD m) - for 49,345 49,137 49,198 49,482 49,971 50,984 50,837 51,224 HEC Total HK SoC capital expenditure (HKD 2,613 1,973 2,252 2,516 2,799 2,950 3,083 3,740 m) - for HEC

Profit and loss (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales of infrastructure material 2,192 2,642 2,161 1,980 2,004 2,029 2,054 2,080 EnviroWaste 0 886 1,362 1,279 1,376 1,530 1,640 1,752 Other Revenue 1,913 1,490 2,448 2,298 1,941 1,896 1,895 1,895 Total Revenue 4,105 5,018 5,971 5,557 5,321 5,455 5,590 5,727 Other income 439 544 2,420 537 1,237 480 419 445 COGS (3,028) (4,369) (3,999) (2,622) (3,622) (3,539) (3,650) (3,763) SG&A 0 0 0 0 0 0 0 0 Other op.expenses (54) (169) (262) (243) (226) (194) (194) (194) Operating profit 1,462 1,024 4,130 3,229 2,710 2,201 2,164 2,215 Net-interest inc./(exp.) (732) (765) (906) (726) (560) (577) (596) (625) Assoc/forex/extraord./others 9,326 11,995 28,993 9,147 8,050 10,680 11,900 12,396 Pre-tax profit 10,056 12,254 32,217 11,650 10,200 12,305 13,469 13,986 Tax 19 58 (26) 8 8 8 8 8 Min. int./pref. div./others (648) (673) (538) (496) (572) (572) (572) (572) Net profit (reported) 9,427 11,639 31,653 11,162 9,636 11,741 12,905 13,423 Net profit (adjusted) 9,427 11,639 29,405 11,162 9,636 11,364 12,905 13,423 EPS (reported)(HKD) 3.930 4.771 12.975 4.442 3.824 4.660 5.122 5.327 EPS (adjusted)(HKD) 3.930 4.771 12.053 4.442 3.824 4.510 5.122 5.327 EPS (adjusted fully-diluted)(HKD) 3.930 4.771 12.053 4.442 3.824 4.510 5.122 5.327 DPS (HKD) 1.689 1.860 2.048 2.156 2.260 2.375 2.497 2.625 EBIT 1,462 1,024 1,882 3,229 2,710 2,201 2,164 2,215 EBITDA 1,516 1,193 2,144 3,472 2,936 2,395 2,358 2,409

Cash flow (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Profit before tax 10,056 12,254 32,217 11,650 10,200 12,305 13,469 13,986 Depreciation and amortisation 54 169 262 243 226 194 194 194 Tax paid 19 58 (26) 8 8 8 8 8 Change in working capital 469 1,228 334 (896) 596 (228) 1,842 115 Other operational CF items (8,686) (10,957) (29,901) (6,926) (6,799) (10,103) (11,304) (11,771) Cash flow from operations 1,912 2,752 2,886 4,079 4,231 2,175 4,208 2,532 Capex (680) (405) (292) (294) (303) (303) (303) (303) Net (acquisitions)/disposals (2,681) (5,445) (6,345) (9,185) (287) (35,320) 0 0 Other investing CF items 4,113 4,746 6,139 8,234 5,303 16,750 6,134 6,148 Cash flow from investing 752 (1,104) (498) (1,245) 4,713 (18,873) 5,831 5,845 Change in debt (3,495) 3,040 7,195 (12) 135 0 0 0 Net share issues/(repurchases) 4,604 0 0 4,600 0 0 0 0 Dividends paid (3,760) (4,294) (4,599) (5,228) (5,492) (5,694) (5,985) (6,291) Other financing CF items 1,020 (1,419) (3,839) (1,397) 306 15,602 (1,129) (1,158) Cash flow from financing (1,631) (2,673) (1,243) (2,037) (5,051) 9,908 (7,114) (7,449) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 1,033 (1,025) 1,145 797 3,893 (6,790) 2,926 928 Free cash flow 1,232 2,347 2,594 3,785 3,928 1,872 3,905 2,229 Source: FactSet, Daiwa forecasts

Cheung Kong Infrastructure (1038 HK): 24 January 2018

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Cash & short-term investment 6,980 5,958 7,108 7,897 11,790 5,000 7,926 8,854 Inventory 150 215 175 165 139 156 160 164 Accounts receivable 1,014 1,162 1,204 793 628 681 0 0 Other current assets 47 1,443 825 423 982 982 0 0 Total current assets 8,191 8,778 9,312 9,278 13,539 6,819 8,085 9,018 Fixed assets 1,477 2,408 2,452 2,379 2,404 2,210 2,016 1,822 Goodwill & intangibles 0 2,966 2,877 2,525 2,554 2,677 0 0 Other non-current assets 78,874 85,756 111,429 117,920 109,413 138,987 149,025 160,413 Total assets 88,542 99,908 126,070 132,102 127,910 150,692 159,126 171,252 Short-term debt 24 44 1,690 15 9,901 9,901 9,901 9,901 Accounts payable 2,972 4,413 4,749 3,432 3,837 3,726 5,590 5,727 Other current liabilities 295 583 132 234 99 0 0 0 Total current liabilities 3,291 5,040 6,571 3,681 13,837 13,627 15,491 15,628 Long-term debt 11,089 12,985 16,947 17,162 6,944 18,486 18,486 18,486 Other non-current liabilities 781 1,285 806 700 942 1,466 1,422 6,601 Total liabilities 15,161 19,310 24,324 21,543 21,723 33,579 35,399 40,715 Share capital 2,496 2,496 2,440 2,520 2,651 2,651 2,651 2,651 Reserves/R.E./others 70,796 78,018 99,229 107,984 103,498 114,423 121,037 127,847 Shareholders' equity 73,292 80,514 101,669 110,504 106,149 117,074 123,688 130,498 Minority interests 89 84 77 55 38 39 39 39 Total equity & liabilities 88,542 99,908 126,070 132,102 127,910 150,692 159,126 171,252 EV 99,487 94,008 72,152 62,023 66,623 54,990 40,164 26,840 Net debt/(cash) 4,133 7,071 11,529 9,280 5,055 23,387 20,462 19,533 BVPS (HKD) 29.359 33.003 41.674 43.972 42.129 46.465 49.090 51.793

Key ratios (%) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales (YoY) 17.5 22.2 19.0 (6.9) (4.2) 2.5 2.5 2.5 EBITDA (YoY) (0.7) (21.3) 79.7 61.9 (15.4) (18.4) (1.5) 2.2 Operating profit (YoY) 0.3 (30.0) 83.8 71.6 (16.1) (18.8) (1.7) 2.3 Net profit (YoY) 21.7 23.5 152.6 (62.0) (13.7) 17.9 13.6 4.0 Core EPS (fully-diluted) (YoY) 16.2 21.4 152.6 (63.1) (13.9) 17.9 13.6 4.0 Gross-profit margin 26.2 12.9 33.0 52.8 31.9 35.1 34.7 34.3 EBITDA margin 36.9 23.8 35.9 62.5 55.2 43.9 42.2 42.1 Operating-profit margin 35.6 20.4 31.5 58.1 50.9 40.4 38.7 38.7 Net profit margin 229.6 231.9 492.5 200.9 181.1 208.3 230.9 234.4 ROAE 14.2 15.1 32.3 10.5 8.9 10.2 10.7 10.6 ROAA 11.4 12.4 26.0 8.6 7.4 8.2 8.3 8.1 ROCE 1.8 1.1 1.8 2.6 2.2 1.6 1.5 1.4 ROIC 2.0 1.2 4.1 2.8 2.3 1.7 1.5 1.5 Net debt to equity 5.6 8.8 11.3 8.4 4.8 20.0 16.5 15.0 Effective tax rate n.a. n.a. 0.1 n.a. n.a. n.a. n.a. n.a. Accounts receivable (days) 68.4 79.1 72.3 65.6 48.7 43.8 22.2 0.0 Current ratio (x) 2.5 1.7 1.4 2.5 1.0 0.5 0.5 0.6 Net interest cover (x) 2.0 1.3 2.1 4.4 4.8 3.8 3.6 3.5 Net dividend payout 43.0 39.0 15.8 48.5 59.1 51.0 48.8 49.3 Free cash flow yield 0.7 1.4 1.5 2.3 2.3 1.1 2.3 1.3 Source: FactSet, Daiwa forecasts

Company profile

CK Infrastructure Holdings (CKI) is an infrastructure and utilities conglomerate with investments in Hong Kong (via Power Assets Holdings), the UK, Australia, mainland China, New Zealand, the Netherlands, Portugal Germany, and Canada. Its core assets are involved in power generation, power distribution, gas distribution, water utilities, toll roads, car parks, waste treatment facilities, rolling- stocks leasing, smart-meter, HVAC leasing and infrastructure materials.

Cheung Kong Infrastructure (1038 HK): 24 January 2018

Valuation

CKI: SOTP valuation Business Segment Valuation Skate Ownership HKD/share % Value Regulated Businesses 98% Power Assets Holdings Our target price 38.87% 20.2 20% Australia DCF at 7.4% 23.07-49% 16.7 17% UK DCF at 7.5% 4.75-50% 44.3 44% Canada, The Netherland, Portugal, New Zealand and others DCF at 7.7% 25-50% 17.5 17% Unregulated Businesses 2%

Mainland China Toll-roads DCF at 10.0% 33.5-66% 1.4 1% Hong Kong Infrastructure Materials DCF at 10.5% & 40-100% 1.0 1% PE ratio comparable Corporate value 101.3 100% (Perpetual capital securities) (6.0)

Net Cash / (Debt) (9.3)

Net asset value (TP) 86.0

Source: Bloomberg, Daiwa estimates

Hong Kong Utilities 24 January 2018

Power Assets (6 HK) Power Assets

Target price: HKD61.50 (from HKD64.10) Share price (23 Jan): HKD66.50 | Up/downside: -7.5%

Derating approaching upon last special dividend Dennis Ip, CFA (852) 2848 4068 Valuation premium over parent CKI likely to diminish with… [email protected] …slow M&A growth amid rising-interest-rate environment Don Lau, CFA (852) 2848 4469 Reiterating Underperform (4) call; lowering TP to HKD61.50 [email protected]

What's new: Since the collapse of the CKI-PAH merger in November 2015, Forecast revisions (%) PAH’s forward PER ratio has been at a 30% premium to CKI’s. We believe Year to 31 Dec 17E 18E 19E the premium will narrow in 2018 after PAH declares its likely last special Revenue change 1.4 1.5 1.5 dividend. Net profit change 2.4 2.2 (2.2) Core EPS (FD) change 2.4 2.2 (2.2)

Source: Daiwa forecasts What's the impact: Cashing out to support parent CKI’s M&A instead of investing in itself. In 2017, PAH distributed HKD12.5/share in special Share price performance dividends, injecting HKD10.4bn into CKI for a record M&A year (40% of (HKD) (%) Duet, 25% of Reliance Home Comfort and 35% of Ista). In our sector 80 105 report, we conclude that Victor Li’s global infrastructure M&A focus is on 76 94 30.3%-owned CKA and 22.8%-owned CKI, rather than 8.9%-owned PAH. 72 83 As a result, PAH only spent HKD8.4bn on M&A (20% stake in Duet), 76% 68 71 64 60 less than CKI’s HKD35bn and 85% less than CKA’s HKD60bn. Jan-17 Apr-17 Jul-17 Oct-17 Jan-18

Pwr Assets (LHS) Relative to HSI (RHS) 2018: shrinking yield gap, valuation premium to CKI set to narrow, followed by another CKI-PAH merger proposal. After distributing the 12-month range 65.25-78.75 likely final HKD7.5/share special dividend by 1H18, PAH risks becoming a Market cap (USDbn) 18.15 redundant company (a smaller CKI) without cash, with investors preferring 3m avg daily turnover (USDm) 19.62 yield wanting to own HKEI (5% yield, vs. PAH’s c.4%) and those preferring Shares outstanding (m) 2,134 Major shareholder Cheung Kong Infrastructure (38.9%) M&A activity wanting to own CKI, in our view. Without the cash for future M&A earnings growth, PAH’s annual HKD5 bn in FCF would not be Financial summary (HKD) sufficient to honour a c.HKD6bn dividend payment for 2018E, without Year to 31 Dec 17E 18E 19E considering sustainable YoY ordinary DPS growth. Therefore, PAH’s yield Revenue (m) 1,092 992 992 gap looks set to narrow by 0.8pp, more than CKI’s contraction of 0.6pp, Operating profit (m) 2,329 1,254 1,254 Net profit (m) 7,735 7,894 7,679 amid a rising-interest-rate environment in 2018E. From 2019E, PAH’s Core EPS (fully-diluted) 3.624 3.699 3.598 33.7%-owned HKEI is set to have its SoC return cut from 9.99% to 8%. In EPS change (%) 20.5 2.1 (2.7) 2008, when HKEI’s SoC return was last cut (from 13.5% to 9.99%), amid a Daiwa vs Cons. EPS (%) 0.9 0.0 (1.6) PER (x) 18.3 18.0 18.5 higher-interest-rate environment, the ratio of PAH-CKI’s forward PER was Dividend yield (%) 4.8 4.3 4.3 below 1.0x. Thus, we believe PAH’s forward PER would derate towards, or DPS 3.224 2.885 2.843 even below, CKI’s level. Thereafter, Victor Li could propose another merger PBR (x) 1.5 1.5 1.5 EV/EBITDA (x) 19.2 34.4 32.6 to PAH, and PAH’s minority shareholders would not have much negotiating ROE (%) 7.3 8.4 8.0 power without the HKD69bn cash the company had in 2015. Source: FactSet, Daiwa forecasts

What we recommend: We reaffirm our Underperform (4) rating on PAH, but revise down our SOTP-based 12-month TP from HKD64.10 to HKD61.50 and fine-tune our 2017-19E EPS by -2% to 2%. Key upside risk: substantial M&A allocation to PAH, instead of CKI or CKA.

How we differ: Unlike the Bloomberg consensus, which expects PAH’s final HKD7.5/share special dividend to lead to a higher share price, we believe PAH is over-valued and will effectively become redundant after paying out the special dividend (which will likely be the last one from its cash from the IPO and subsequent sale of its stake in HK Electric).

See important disclosures, including any required research certifications, beginning on page 87

Power Assets (6 HK): 24 January 2018

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook PAH: net-profit breakdown by geography vs that of CKI Following our earnings revisions for 2018-19E for both (HKDm) PAH or CKI, mainly a result of our recently revised GBP 14,000 exchange rate, we forecast PAH’s net profit to be stable 11,000 over 2018-19E, compared with an average 9% rise for CKI. 8,000 This is because CKI has more M&A potential and less of a 5,000 stake in HKEI, which is set to see its SoC return cut (from 2,000 (1,000) 9.99% to 8%) starting from October 2018, with the 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E c.HKD200m earnings loss from the Zhuhai power plant Canada, New Zealand, Thailand, Others after expiry of the offtake contract. Mainland China UK Australia Our 2017E core net profit excludes the HKD970m gain HK CKI from the sale of two houses that served as staff quarters Source: Company, Daiwa forecasts for PAH’s former managing director Tso, given this is not recurring.

Valuation PAH and CKI: 12-month forward PER bands PAH trades at a 2018E PER of 18x, over 0.6SD above its 25.0x 1.8x past-10-year average PER (16.2x). The premium valuation 1.6x vs. PAH’s historical norm likely reflects its HKD60bn of idle 20.0x cash after disposing its stake in HKEI; its ex-cash PER is 1.4x 17x, c.2.7SD over its 2008-13 average cash-based PER of 15.0x 1.2x 13x, before the spin-off of HKEI in early 2014. Thus, PAH- 1.0x CKI’s forward PER ratio has surged from 0.8x to 1.4x, 10.0x which we think is unjustified; we believe PAH’s ratio will .8x derate from 19x to CKI’s 13x, once PAH cashes out its 5.0x .6x balance sheet with special dividends in 2018, and the Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 company is likely to see a repeat of its distressed valuation CKI - LHS PAH - LHS PAH - CKI forward PER ratio - RHS of 2008, given at that time HKEI’s SoC return was also cut Source: Company, Daiwa forecasts (from 13.5% to 9.99%) amid high interest rates.

Earnings revisions PAH: Bloomberg-consensus EPS forecasts Since the beginning of 2017, the Bloomberg consensus (HKD) has revised up its 2017-18 EPS forecasts for PAH by 1-3% 3.8 YTD after incorporating the newly acquired 20% stake of 3.7 Duet. Nevertheless, the consensus EPS upward 3.6 adjustments of 2017-18 EPS forecasts for PAH, however, are much lower than CKI’s 2-9%, given CKI has spent 3x 3.5 more capital on M&A despite PAH having a stronger 3.4 balance sheet.

3.3

Jul-17

Apr-17 Oct-17

Jun-17 Jan-17 Jan-18

Feb-17 Mar-17

Aug-17 Sep-17 Nov-17 Dec-17 May-17 2017E EPS 2018E EPS 2019E EPS

Source: Bloomberg

Power Assets (6 HK): 24 January 2018

Profit and loss (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales of electricity in Hong Kong 10,364 10,176 676 0 0 0 0 0 Other revenue 36 46 1,455 1,308 1,288 1,092 992 992 Other Revenue 0 0 0 0 0 0 0 0 Total Revenue 10,400 10,222 2,131 1,308 1,288 1,092 992 992 Other income 1,515 1,577 53,688 (207) (221) 1,244 269 269 COGS (423) (2,247) (156) (6) (5) (6) (6) (6) SG&A 0 0 0 0 0 0 0 0 Other op.expenses (3,210) (3,485) (1,092) 143 (810) 0 0 0 Operating profit 8,282 6,067 54,571 1,238 252 2,329 1,254 1,254 Net-interest inc./(exp.) (648) (692) (434) (264) (248) (248) (248) (248) Assoc/forex/extraord./others 4,665 6,226 6,961 6,747 6,401 6,629 6,888 6,673 Pre-tax profit 12,299 11,601 61,098 7,721 6,405 8,710 7,894 7,679 Tax (835) (814) (13) 11 12 0 0 0 Min. int./pref. div./others 71 388 (80) 0 0 0 0 0 Net profit (reported) 11,535 11,175 61,005 7,732 6,417 8,710 7,894 7,679 Net profit (adjusted) 11,535 11,175 8,077 7,732 6,417 7,735 7,894 7,679 EPS (reported)(HKD) 5.404 5.236 28.584 3.623 3.007 4.081 3.699 3.598 EPS (adjusted)(HKD) 5.404 5.236 3.784 3.623 3.007 3.624 3.699 3.598 EPS (adjusted fully-diluted)(HKD) 5.404 5.236 3.784 3.623 3.007 3.624 3.699 3.598 DPS (HKD) 2.450 2.550 2.680 2.700 2.720 3.224 2.885 2.843 EBIT 8,282 6,067 54,571 1,238 252 2,329 1,254 1,254 EBITDA 10,200 8,048 54,722 1,240 253 2,329 1,254 1,254

Cash flow (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Profit before tax 12,299 11,601 61,098 7,721 6,405 8,710 7,894 7,679 Depreciation and amortisation 1,918 1,981 151 2 1 0 0 0 Tax paid (835) (814) (13) 11 12 0 0 0 Change in working capital (329) 608 374 (204) 750 0 0 0 Other operational CF items (5,829) (5,113) (59,417) (5,660) (6,442) (6,381) (6,640) (6,425) Cash flow from operations 7,224 8,263 2,193 1,870 726 2,329 1,254 1,254 Capex (2,613) (1,973) (86) 0 0 0 0 0 Net (acquisitions)/disposals (2,471) (2,277) 26,313 7,254 (5,215) (8,360) 0 0 Other investing CF items 3,146 2,281 18,616 15,912 (40,633) 50,286 3,799 3,805 Cash flow from investing (1,938) (1,969) 44,843 23,166 (45,848) 41,926 3,799 3,805 Change in debt 497 (1,181) 0 0 0 0 0 0 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid (4,951) (5,292) (5,485) (5,741) (5,805) (32,483) (6,881) (6,157) Other financing CF items 38 61 10 0 0 486 486 486 Cash flow from financing (4,416) (6,412) (5,475) (5,741) (5,805) (31,997) (6,395) (5,671) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 870 (118) 41,561 19,295 (50,927) 12,257 (1,341) (612) Free cash flow 4,611 6,290 2,107 1,870 726 2,329 1,254 1,254 Source: FactSet, Daiwa forecasts

Power Assets (6 HK): 24 January 2018

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Cash & short-term investment 6,140 7,894 61,291 68,149 61,710 27,469 26,128 25,516 Inventory 1,114 948 0 0 0 0 0 0 Accounts receivable 1,740 1,647 810 394 161 111 111 111 Other current assets 827 5 0 0 0 0 0 0 Total current assets 9,821 10,494 62,101 68,543 61,871 27,580 26,239 25,627 Fixed assets 44,408 44,063 14 12 12 11 11 11 Goodwill & intangibles 0 0 0 0 0 0 0 0 Other non-current assets 47,417 50,680 74,159 66,803 67,894 78,893 81,981 84,850 Total assets 101,646 105,237 136,274 135,358 129,777 106,484 108,231 110,488 Short-term debt 5,311 500 0 0 0 0 0 0 Accounts payable 3,760 4,109 2,698 2,078 2,595 2,595 2,595 2,595 Other current liabilities 339 343 2 41 46 46 46 46 Total current liabilities 9,410 4,952 2,700 2,119 2,641 2,641 2,641 2,641 Long-term debt 19,282 21,845 10,204 9,405 8,514 8,514 8,514 8,514 Other non-current liabilities 9,492 8,963 282 237 211 1,768 1,778 2,422 Total liabilities 38,184 35,760 13,186 11,761 11,366 12,923 12,933 13,577 Share capital 2,134 2,134 6,610 6,610 6,610 6,610 6,610 6,610 Reserves/R.E./others 61,328 67,343 116,478 116,987 111,801 86,952 88,688 90,301 Shareholders' equity 63,462 69,477 123,088 123,597 118,411 93,562 95,298 96,911 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 101,646 105,237 136,274 135,358 129,777 106,484 108,231 110,488 EV 118,870 111,768 16,775 16,636 21,791 44,831 43,084 40,828 Net debt/(cash) 18,453 14,451 (51,087) (58,744) (53,196) (18,955) (17,614) (17,002) BVPS (HKD) 29.735 32.553 57.672 57.911 55.481 43.838 44.652 45.407

Key ratios (%) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales (YoY) 2.1 (1.7) (79.2) (38.6) (1.5) (15.3) (9.2) 0.0 EBITDA (YoY) 2.8 (21.1) 579.9 (97.7) (79.6) 820.6 (46.2) 0.0 Operating profit (YoY) 2.4 (26.7) 799.5 (97.7) (79.6) 824.2 (46.2) 0.0 Net profit (YoY) 6.3 (3.1) (27.7) (4.3) (17.0) 20.5 2.1 (2.7) Core EPS (fully-diluted) (YoY) 6.3 (3.1) (27.7) (4.3) (17.0) 20.5 2.1 (2.7) Gross-profit margin 95.9 78.0 92.7 99.5 99.6 99.5 99.4 99.4 EBITDA margin 98.1 78.7 2,567.9 94.8 19.6 213.4 126.5 126.5 Operating-profit margin 79.6 59.4 2,560.8 94.6 19.6 213.4 126.5 126.5 Net profit margin 110.9 109.3 379.0 591.1 498.2 708.6 796.1 774.5 ROAE 18.9 16.8 8.4 6.3 5.3 7.3 8.4 8.0 ROAA 11.7 10.8 6.7 5.7 4.8 6.5 7.4 7.0 ROCE 9.7 6.7 48.5 0.9 0.2 2.0 1.2 1.2 ROIC 9.8 6.8 70.0 1.8 0.4 3.3 1.6 1.6 Net debt to equity 29.1 20.8 n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 6.8 7.0 0.0 n.a. n.a. 0.0 0.0 0.0 Accounts receivable (days) 49.9 60.5 210.4 168.0 78.6 45.5 40.9 40.9 Current ratio (x) 1.0 2.1 23.0 32.3 23.4 10.4 9.9 9.7 Net interest cover (x) 12.8 8.8 125.7 4.7 1.0 9.4 5.1 5.1 Net dividend payout 45.3 48.7 9.4 74.5 90.5 79.0 78.0 79.0 Free cash flow yield 3.2 4.4 1.5 1.3 0.5 1.6 0.9 0.9 Source: FactSet, Daiwa forecasts

Company profile

Power Assets Holdings (PAH) is a utilities conglomerate with a 33.7% stake in Hongkong Electric Company, one of the two integrated power utilities in the city regulated by the government. It also owns energy assets such as power-generation, power-distribution and gas-distribution businesses in the UK, Australia, Mainland China, New Zealand, the Netherlands, Portugal, Canada and Thailand.

Power Assets (6 HK): 24 January 2018

Valuation

PAH: SOTP valuation Business Segment Valuation Stake Ownership HKD/share % Value HK Electric Our target price 33.37% 8.43 16% Australia DCF at 9.9% 20-27.93% 12.76 24% UK DCF at 10.2% 25-50% 29.01 55% Mainland China DCF at 14.8% 45.0% 0.55 1% Canada, The Netherlands, New Zealand, Thailand and others DCF at 10.6% 12.5-50.0% 1.86 4% Corporate value 52.61 100% Net Cash / (Debt) 8.88 Target price 61.50

Source: Bloomberg, Daiwa estimates

Hong Kong Utilities 24 January 2018

HK Electric Investments (2638 HK) HK Electric Investments

Target price: HKD6.15 (from HKD5.90) Share price (23 Jan): HKD7.20 | Up/downside: -14.6%

Nowhere to escape the yield gap crunch Don Lau, CFA (852) 2848 4469 2018 special rebate means HKD2.1bn “interest-free” loan is gone [email protected] Not likely to maintain its HKD0.4 DPS through borrowing in 2019E Dennis Ip, CFA (852) 2848 4068 Reiterating Underperform (4) rating; raising TP to HKD6.15 [email protected]

What's new: Daiwa’s US economist, Mike Moran, expects further hikes in Forecast revisions (%) the Fed Funds Rate after the 25bps hike on 15 December. We estimate the Year to 31 Dec 17E 18E 19E US 10-year Treasury yield to rise from 2.6% currently to 3.0%/3.65% by Revenue change (2.3) (4.9) (6.3) end- 2018/19. Among the Hong Kong utilities names we cover, HKEI Net profit change 7.4 6.3 (9.2) Core EPS (FD) change 7.4 6.3 (9.2) should see its 2019E yield gap narrow the most (1.7pp vs. peers’ 0.5pp to Source: Daiwa forecasts 0.8pp), as we don’t think the company would be able to maintain its DPS amid the SoC return cut. This note marks a transfer of analyst coverage. Share price performance

(HKD) (%) What's the impact: Raising debt to finance HKD2.1bn 2018 special 7.5 110 rebate. On 12 December, HKEI announced the electricity tariff adjustment 7.2 101 for 2018, increasing basic tariff/net tariffs by 0.2%1.9% YoY. In particular, 7.0 93 HKEI has to provide a special rebate of HK20cents (HK16cents/4cents for 6.7 84 6.4 75 fuel/rent rebate). As a result, HKEI would need to draw a total of HKD2.1bn Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 from its fuel-clause recovery and A/P accounts, on our estimates, HK Elec I (LHS) Relative to HSI (RHS) essentially as interest-free loans (interest on the fuel-clause recovery account surplus is charged at 1m HIBOR) from the public. Given HKEI’s 12-month range 6.43-7.42 limited cash balance (1H17: HKD316m), we believe it will need to finance Market cap (USDbn) 8.14 the rebate with debt, which we estimate will cost an additional c.HKD65m in 3m avg daily turnover (USDm) 4.17 annual interest expenses, representing 2%/3% of its 2018/19E net profit. Shares outstanding (m) 8,836 Major shareholder Power Assets Holdings Limited (33.7%)

Yield-gap set to shrink to lowest since IPO. Unlike some peers, which Financial summary (HKD) should be able to shore up their 2018-19 yield gaps with DPS hikes, HKEI Year to 31 Dec 17E 18E 19E will likely cut its DPS from 2019, given: 1) the SoC return is to be cut from Revenue (m) 11,631 11,550 10,479 9.99% to 8%, effective January 2019, 2) its limited cash balance, and 3) its Operating profit (m) 5,213 5,128 4,013 Net profit (m) 3,472 3,331 2,270 high dividend payout ratio (2016:100%). Although it could leverage its strong Core EPS (fully-diluted) 0.393 0.377 0.257 financials to maintain its HKD0.4 DPS temporarily through debt financing, we EPS change (%) (3.5) (4.1) (31.9) argue HKEI would only borrow a limited amount and pay a DPS of HKD0.32. Daiwa vs Cons. EPS (%) 0.5 (4.3) (8.3) PER (x) 18.3 19.1 28.0 Note: it has to earmark some borrowing capacity for: 1) its net capex of Dividend yield (%) 5.6 5.6 4.5 c.HKD2bn over the 2019-23 cycle on new gas-fired units, and 2) c.HKD1.5- DPS 0.400 0.400 0.323 2bn potential investment on LNG receiving terminal, in order not to exceed its PBR (x) 1.3 1.3 1.3 EV/EBITDA (x) 12.9 13.1 15.1 debt ceiling of c.HKD50bn (2018E debt balance: HKD43bn). Hence, we ROE (%) 7.0 6.7 4.6 expect HKEI’s yield gap to narrow from 2.9% now to 1.2% in 2019, the Source: FactSet, Daiwa forecasts lowest since its IPO and 3.7SD below its 2014-17 average yield gap.

What we recommend: We reiterate Underperform (4) but slightly raise our 12-month DDM based TP to HKD6.15 (from HKD5.90) on our less conservative dividend assumptions in light of HKEI’s willingness to maintain part of its DPS through borrowing. Also, we adjust 2017-19E EPS by -9% to 7% to factor in the latest tariff and fuel costs. Risks: lower-than-expected dividend cut in 2019E, slower-than-expected interest rate hikes.

How we differ: Our 2018-19E EPS are 4-8% below the consensus due to our higher-than-market financing cost assumptions.

See important disclosures, including any required research certifications, beginning on page 87

HK Electric Investments (2638 HK): 24 January 2018

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook HKEI: YoY trend of revenue, finance cost, net profit, and distribution

With the basic tariff set to decline on the back of the 40% reduction in the SoC permitted return from 9.99% to 8%, 30% effective from January 2019, we forecast HKEI’s revenue 20% to decline at a 2.8% CAGR over 2016-19E. Also, we 10% expect its finance cost, which is not included in calculation 0% of SoC permitted return, to rise at a 9.4% 2016-19E CAGR (10%) on: 1) HKEI’s rising debt balance, and 2) higher interest (20%) rates. As a result, we expect the company’s net earnings to (30%) fall by a 14.2% 2016-19E CAGR. We expect the (40%) 2015 2016 2017E 2018E 2019E company’s distributable income to decline by a milder 7% YoY revenue YoY finance cost 2016-19E CAGR (vs. 8% CAGR previously), as HKEI is YoY net profit YoY Distribution likely to boost its payout ratio through borrowing. Source: Company and Daiwa estimates

Valuation HKEI: yield gap (%) Currently, HKEI is trading at a yield gap of 2.9%, 1.5 SD below its 2014-17 average yield gap. In 2019E, facing a 6.5 double whammy of continued rate hike and DPS cut, the 5.5 yield gap is likely to narrow to 1.2%, or 3.7SD below the +1SD 4.5 average yield gap, on our estimates. Mean 3.5 -1SD 2.9 2.9 2.5

1.5 1.2 0.5 Current Average 2018E Average 2019E Source: Company and Daiwa estimates

Earnings revisions HKEI: Bloomberg consensus earnings forecasts revisions

Under the SoC framework, HKEI is subject to a fixed return (HKD) on net asset and the only primary variable is financing cost. 0.40

Hence, the 2017-18E EPS consensus forecasts have been 0.35 stable, with only 4/%5% YTD upward revisions to 2017/18E EPS since the beginning of 2017. As for 2019E 0.30 EPS, the Bloomberg consensus made a downward 0.25 revision of 7% in late-April, during which the new SoC

return for 2019 to 2033 was announced to be 8%. 0.20

Jul-16 Jul-17

Apr-16 Oct-16 Apr-17 Oct-17

Jun-16 Jan-17 Jun-17 Jan-18

Mar-17

Feb-17

Aug-16 Sep-16 Nov-16 Dec-16 Aug-17 Sep-17 Nov-17 Dec-17

May-16 May-17

2017E EPS 2018E EPS 2019E EPS

Source: Bloomberg

HK Electric Investments (2638 HK): 24 January 2018

Financial summary Key assumptions Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Electricity sold (mn kWh) n.a. n.a. 10,955 10,879 10,792 10,640 10,546 10,452 Basic tariff (HK cents per kWh) n.a. n.a. 101.8 102.6 105.5 108.9 109.1 99.8 Fuel clause charge (HK cents per kWh) n.a. n.a. 33.1 32.3 27.9 23.4 23.4 30.8 Unit fuel costs (HK cents per kWh) n.a. n.a. 44.0 34.0 28.8 36.5 38.3 48.4 Capex (HKD mn) n.a. n.a. 2,252 2,516 2,799 2,950 3,083 3,740 Permitted rate of return (%) n.a. n.a. 10.00 9.95 9.95 9.95 9.95 8.00 Effective interest rate (%) n.a. n.a. 2.1 2.2 2.3 2.6 2.8 3.0

Profit and loss (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales of electricity n.a. n.a. 11,165 11,165 11,373 11,584 11,503 10,432 Electricity-related income n.a. n.a. 21 51 53 53 53 53 Other Revenue n.a. n.a. (682) (6) (6) (6) (6) (6) Total Revenue n.a. n.a. 10,504 11,210 11,420 11,631 11,550 10,479 Other income n.a. n.a. 74 32 27 27 27 27 COGS n.a. n.a. (4,832) (5,189) (5,369) (5,503) (5,485) (5,526) SG&A n.a. n.a. (766) (811) (918) (942) (963) (967) Other op.expenses n.a. n.a. 0 0 0 0 0 0 Operating profit n.a. n.a. 4,980 5,242 5,160 5,213 5,128 4,013 Net-interest inc./(exp.) n.a. n.a. (891) (979) (979) (1,033) (1,178) (1,289) Assoc/forex/extraord./others n.a. n.a. 0 0 0 0 0 0 Pre-tax profit n.a. n.a. 4,089 4,263 4,181 4,179 3,951 2,724 Tax n.a. n.a. (709) (750) (757) (690) (652) (449) Min. int./pref. div./others n.a. n.a. (179) 78 175 (18) 32 (5) Net profit (reported) n.a. n.a. 3,201 3,591 3,599 3,472 3,331 2,270 Net profit (adjusted) n.a. n.a. 3,201 3,591 3,599 3,472 3,331 2,270 EPS (reported)(HKD) n.a. n.a. 0.392 0.406 0.407 0.393 0.377 0.257 EPS (adjusted)(HKD) n.a. n.a. 0.392 0.406 0.407 0.393 0.377 0.257 EPS (adjusted fully-diluted)(HKD) n.a. n.a. 0.392 0.406 0.407 0.393 0.377 0.257 DPS (HKD) n.a. n.a. 0.364 0.400 0.400 0.400 0.400 0.323 EBIT n.a. n.a. 4,980 5,242 5,160 5,213 5,128 4,013 EBITDA n.a. n.a. 7,698 8,035 7,948 8,082 8,106 7,114

Cash flow (HKDm) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Profit before tax n.a. n.a. 4,089 4,263 4,181 4,179 3,951 2,724 Depreciation and amortisation n.a. n.a. 2,718 2,793 2,788 2,869 2,978 3,101 Tax paid n.a. n.a. (847) (846) (845) (690) (652) (449) Change in working capital n.a. n.a. 429 124 (19) (219) (117) 125 Other operational CF items n.a. n.a. 1,340 2,649 2,921 (366) (203) 1,315 Cash flow from operations n.a. n.a. 7,729 8,983 9,026 5,773 5,957 6,816 Capex n.a. n.a. (1,662) (2,237) (2,760) (2,950) (3,083) (3,740) Net (acquisitions)/disposals n.a. n.a. 0 0 0 0 0 0 Other investing CF items n.a. n.a. (32,849) 1,147 66 108 108 108 Cash flow from investing n.a. n.a. (34,511) (1,090) (2,694) (2,842) (2,975) (3,632) Change in debt n.a. n.a. 9,093 (779) (7,504) 0 0 0 Net share issues/(repurchases) n.a. n.a. 23,453 0 0 0 0 0 Dividends paid n.a. n.a. (1,461) (3,517) (3,538) (3,538) (3,538) (2,850) Other financing CF items n.a. n.a. (1,069) (855) (952) (1,053) (1,199) (1,315) Cash flow from financing n.a. n.a. 30,016 (5,151) (11,994) (4,591) (4,737) (4,165) Forex effect/others n.a. n.a. (1) (1) 1 0 0 0 Change in cash n.a. n.a. 3,233 2,741 (5,661) (1,660) (1,755) (981) Free cash flow n.a. n.a. 6,067 6,746 6,266 2,823 2,874 3,076 Source: FactSet, Daiwa forecasts

HK Electric Investments (2638 HK): 24 January 2018

Financial summary continued … Balance sheet (HKDm) As at 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Cash & short-term investment n.a. n.a. 4,630 6,157 316 356 301 320 Inventory n.a. n.a. 933 882 985 1,010 977 984 Accounts receivable n.a. n.a. 1,135 1,160 1,225 1,248 1,239 1,124 Other current assets n.a. n.a. 0 0 0 0 0 0 Total current assets n.a. n.a. 6,698 8,199 2,526 2,613 2,517 2,428 Fixed assets n.a. n.a. 64,802 64,521 64,432 64,598 64,789 65,513 Goodwill & intangibles n.a. n.a. 40,288 40,095 39,904 39,711 39,518 39,325 Other non-current assets n.a. n.a. 1,023 900 1,488 1,488 1,488 1,488 Total assets n.a. n.a. 112,811 113,715 108,350 108,410 108,311 108,754 Short-term debt n.a. n.a. 520 900 335 651 330 0 Accounts payable n.a. n.a. 2,488 2,586 2,735 2,563 2,405 2,422 Other current liabilities n.a. n.a. 850 2,643 4,439 3,019 1,618 1,618 Total current liabilities n.a. n.a. 3,858 6,129 7,509 6,233 4,353 4,040 Long-term debt n.a. n.a. 47,349 46,317 39,344 40,728 42,749 44,079 Other non-current liabilities n.a. n.a. 12,413 12,257 11,592 11,610 11,578 11,583 Total liabilities n.a. n.a. 63,620 64,703 58,445 58,572 58,680 59,702 Share capital n.a. n.a. 8 8 8 8 8 8 Reserves/R.E./others n.a. n.a. 49,183 49,004 49,897 49,831 49,624 49,043 Shareholders' equity n.a. n.a. 49,191 49,012 49,905 49,839 49,632 49,051 Minority interests n.a. n.a. 0 0 0 0 0 0 Total equity & liabilities n.a. n.a. 112,811 113,715 108,350 108,410 108,311 108,754 EV n.a. n.a. 106,860 104,681 102,984 104,644 106,399 107,380 Net debt/(cash) n.a. n.a. 43,239 41,060 39,363 41,023 42,778 43,759 BVPS (HKD) n.a. n.a. 5.567 5.547 5.648 5.640 5.617 5.551

Key ratios (%) Year to 31 Dec 2012 2013 2014 2015 2016 2017E 2018E 2019E Sales (YoY) n.a. n.a. n.a. 6.7 1.9 1.9 (0.7) (9.3) EBITDA (YoY) n.a. n.a. n.a. 4.4 (1.1) 1.7 0.3 (12.2) Operating profit (YoY) n.a. n.a. n.a. 5.3 (1.6) 1.0 (1.6) (21.7) Net profit (YoY) n.a. n.a. n.a. 12.2 0.2 (3.5) (4.1) (31.9) Core EPS (fully-diluted) (YoY) n.a. n.a. n.a. 3.6 0.2 (3.5) (4.1) (31.9) Gross-profit margin n.a. n.a. 54.0 53.7 53.0 52.7 52.5 47.3 EBITDA margin n.a. n.a. 73.3 71.7 69.6 69.5 70.2 67.9 Operating-profit margin n.a. n.a. 47.4 46.8 45.2 44.8 44.4 38.3 Net profit margin n.a. n.a. 30.5 32.0 31.5 29.8 28.8 21.7 ROAE n.a. n.a. 13.0 7.3 7.3 7.0 6.7 4.6 ROAA n.a. n.a. 5.7 3.2 3.2 3.2 3.1 2.1 ROCE n.a. n.a. 10.3 5.4 5.6 5.8 5.6 4.3 ROIC n.a. n.a. 8.9 4.7 4.7 4.8 4.7 3.6 Net debt to equity n.a. n.a. 87.9 83.8 78.9 82.3 86.2 89.2 Effective tax rate n.a. n.a. 17.3 17.6 18.1 16.5 16.5 16.5 Accounts receivable (days) n.a. n.a. 19.7 37.4 38.1 38.8 39.3 41.2 Current ratio (x) n.a. n.a. 1.7 1.3 0.3 0.4 0.6 0.6 Net interest cover (x) n.a. n.a. 5.6 5.4 5.3 5.0 4.4 3.1 Net dividend payout n.a. n.a. 92.8 98.5 98.3 101.9 106.2 125.6 Free cash flow yield n.a. n.a. 9.5 10.6 9.8 4.4 4.5 4.8 Source: FactSet, Daiwa forecasts

Company profile

HKEI is an investment trust that was established in 2013 and listed on the Hong Kong Stock Exchange in the form of share-stapled units (SSU) in January 2014. HKEI’s principal asset (acquired in January 2014) is its 100% ownership of Hongkong Electric Company (HEC), which is one of Hong Kong’s 2 power-generation companies. HEC has an installed capacity of 3,737MW and provides electricity to Hong Kong Island, Ap Lei Chau, and Lamma Island.

CK Group: the makings of one big, happy family: 24 January 2018

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Jiro IOKIBE (852) 2773 8702 [email protected] Shipbuilding; Steel Co-head of Asia Pacific Research Mike OH (82) 2 787 9179 [email protected] John HETHERINGTON (852) 2773 8787 [email protected] Banking; Capital Goods (Construction and Machinery) Co-head of Asia Pacific Research Iris PARK (82) 2 787 9165 [email protected] Craig CORK (852) 2848 4463 [email protected] Consumer/Retail Regional Head of Asia Pacific Product Management SK KIM (82) 2 787 9173 [email protected] Paul M. KITNEY (852) 2848 4947 [email protected] IT/Electronics – Semiconductor/Display and Tech Hardware Chief Strategist for Asia Pacific; Strategy (Regional) Thomas Y KWON (82) 2 787 9181 [email protected] Kevin LAI (852) 2848 4926 [email protected] Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Games Chief Economist for Asia ex-Japan; Macro Economics (Regional) Olivia XIA (852) 2773 8736 [email protected] TAIWAN Macro Economics (Hong Kong/China) Rick HSU (886) 2 8758 6261 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design (Regional) Head of Automobiles; Transportation and Industrial (Hong Kong/China) Nora HOU (886) 2 8758 6249 [email protected] Leon QI (852) 2532 4381 [email protected] Banking; Diversified financials; Insurance Regional Head of Financials; Banking; Diversified financials; Insurance (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Yan LI (852) 2773 8822 [email protected] IT/Technology Hardware (PC Hardware) Banking (China) Kylie HUANG (886) 2 8758 6248 [email protected] Anson CHAN (852) 2532 4350 [email protected] IT/Technology Hardware (Handsets and Components) Consumer (Hong Kong/China) Helen CHIEN (886) 2 8758 6254 [email protected] Adrian CHAN (852) 2848 4427 [email protected] Small/Mid Cap Consumer (Hong Kong/China) Jamie SOO (852) 2773 8529 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Gaming and Leisure (Hong Kong/China) John CHOI (852) 2773 8730 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Alex LIU (852) 2848 4976 [email protected] Capital Goods; Utilities

Internet (Hong Kong/China) SINGAPORE Carlton LAI (852) 2532 4349 [email protected] Ramakrishna MARUVADA (65) 6228 6742 [email protected] Small/Mid Cap (Hong Kong/China) Head of Singapore Research; Telecommunications (China/ASEAN/India) Dennis IP (852) 2848 4068 [email protected] David LUM (65) 6228 6740 [email protected] Regional Head of Power, Utilities, Renewable and Environment (PURE); PURE (Hong Kong/China) Banking; Property and REITs Daniel YANG (852) 2848 4443 [email protected] Royston TAN (65) 6228 6745 [email protected] Power, Utilities, Renewable and Environment (PURE) – Solar and Nuclear (China) Oil and Gas; Capital Goods Jonas KAN (852) 2848 4439 [email protected] Jame OSMAN (65) 6228 6744 [email protected] Head of Hong Kong and China Property Transportation – Road and Rail; Pharmaceuticals and Healthcare; Consumer (Singapore) Cynthia CHAN (852) 2773 8243 [email protected]

Property (China) JAPAN Michelle WANG (852) 2773 8842 [email protected] Yukino YAMADA (81) 3 5555 7295 [email protected] Transportation – Industrial and Logistics (China) Strategy (Regional) Fiona LIANG (852) 2532 4341 [email protected] Transportation – Railway; Construction and Engineering (China) Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES Micaela ABAQUITA (63) 2 737 3021 [email protected] Property Gregg Ilag (63) 2 737 3023 [email protected] Utilities; Energy

CK Group: the makings of one big, happy family: 24 January 2018

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CK Group: the makings of one big, happy family: 24 January 2018

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CK Group: the makings of one big, happy family: 24 January 2018

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Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association