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]) 2 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 3 CK Group: the makings of one big, happy family: 24 January 2018 4 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? 5 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. 6 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.