Company report Industrials Air Freight & Logistics abc Equity – Hong Kong Global Research Kerry Logistics Network (636 HK) Underweight (V) Initiate at UW(V): The world’s local logistics provider Target price (HKD) 11.75 Growth driven by mainland China, profitability driven by Share price (HKD) 12.98 Forecast dividend yield (%) 0.9 Hong Kong Potential return (%) -8.6 Yet the reality is that contract logistics is a low margin Note: Potential return equals the percentage difference between the current share price and business and growth is likely to be hotly contested the target price, plus the forecast dividend yield Dec 2012 a 2013 e 2014 e Initiate with an Underweight (V) rating and multiple-based HSBC EPS 0.00 0.53 0.57 HSBC PE 24.3 22.9 HKD11.75 target price Performance 1M 3M 12M Absolute (%) 27.0 Relative^ (%) 34.3 KLN is a solid company with a good track record and strong positioning in Hong Kong Note: (V) = volatile (please see disclosure appendix) where it is the No 1 third-party logistics (3PL) provider. It is well positioned to capitalize on growth in the Chinese domestic market, and the business it conducts there, it is arguably conducting well. But we believe there is a disconnect between KLN’s valuation, market expectations and the realities of operating an asset heavy, contract logistics-led 28 January 2014 freight forwarding model. Julia Winarso* Analyst Contract logistics is a low margin, competitive business: KLN’s profitability is largely HSBC Bank plc driven by Hong Kong logistics and its warehousing business, where it acts as landlord. +44 20 7991 2168 [email protected] These account for, we calculate, c58% of its net profit. This is a structurally mature, low growth market, but defensible. Mainland China logistics accounts for just 21% of KLN’s Mark Webb* Head of Conglomerate and Transport profit, equating to a 4% margin. This is an industry standard margin – so KLN is faring no Research, Asia Pacific better nor worse than peers. Mainland China is an attractive market for growth; The Hongkong and Shanghai Banking Corporation Limited underpenetrated, with massive inefficiencies to be capitalized on by 3PLs. But it is +852 2996 6574 competitive and fragmented, and scale does not necessarily confer an advantage when [email protected] tendering for contracts. There is definite potential in China, but translating growth into Satheesh Kailasam* profitability may not be simple. KLN’s asset heavy model means it will need to invest to Associate fulfil growth ambitions, while the rationale for property ownership in mainland China Bangalore where space is not scarce, is less obvious. View HSBC Global Research at: http://www.research.hsbc.com Initiate at UW(V) and target price of HKD11.75: Since listing on 18 December 2013, *Employed by a non-US affiliate of KLN shares have risen 27.3%. It trades ahead of its peer group at 22.9x 2014e PE vs. the HSBC Securities (USA) Inc, and is not sector average of 20.5x. We forecast 8.1% earnings growth for 2014-15e for KLN. To put registered/qualified pursuant to FINRA regulations into context, this compares to CH Robinson and KNIN, two much higher return Issuer of report: HSBC Bank plc companies, on 19.8x and 23.6x 2014e earnings with forecast CAGRs of 9.6% and 6.9% Disclaimer & over 2014-15 respectively. Our peer multiple-based valuation gives us a target of HKD11.75 per share (20.7x 2014e earnings). Disclosures This report must be read with the disclosures and the analyst certifications in Index^ HANG SENG INDEX Free float (%) 42 the Disclosure appendix, Index level 21,976 Market cap (USDm) 2,825 and with the Disclaimer, RIC 0636.HK Market cap (HKDm) 21,935 Bloomberg 636 HK which forms part of it Source: HSBC Source: HSBC Kerry Logistics Network (636 HK) Air Freight & Logistics abc 28 January 2014 Financials & valuation Financial statements Valuation data Year to 12/2012a 12/2013e 12/2014e 12/2015e Year to 12/2012a 12/2013e 12/2014e 12/2015e Profit & loss summary (HKDm) EV/sales n/a 1.0 1.1 1.0 EV/EBITDA n/a 10.6 11.7 10.8 Revenue 19,295 20,659 22,165 23,596 EV/IC n/a 1.2 1.4 1.3 EBITDA 1,657 1,879 2,046 2,195 PE* n/a 19.5 22.9 21.2 Depreciation & amortisation -367 -438 -460 -486 P/Book value n/a 1.4 1.6 1.5 Operating profit/EBIT 1,555 1,941 1,586 1,709 FCF yield (%) n/a 0.3% 2.9% 3.4% Net interest -38 -55 -52 -42 Dividend yield (%) n/a 1.0% 0.9% 0.9% PBT 1,657 2,031 1,664 1,803 HSBC PBT 1,392 1,531 1,664 1,803 Note: * = Based on HSBC EPS (fully diluted) Taxation -305 -337 -369 -404 Net profit 1,069 1,384 958 1,035 HSBC net profit 804 884 958 1,035 Price relative 16 16 Cash flow summary (HKDm) 15 15 Cash flow from operations 871 1,209 1,425 1,562 Capex -1,468 -1,182 -813 -843 14 14 Cash flow from investment -1,693 -1,602 -813 -843 13 13 Dividends 0 -177 -177 -192 Change in net debt 835 708 -790 -562 12 12 11 11 Balance sheet summary (HKDm) 10 10 Intangible fixed assets 1,774 1,774 1,774 1,774 Jan-14 Kerry Logistics Network Rel to HANG SENG INDEX Tangible fixed assets 6,599 6,908 7,261 7,618 Current assets 7,389 7,960 8,529 8,857 Source: HSBC Cash & others 2,940 3,167 3,457 3,518 Total assets 22,468 23,948 25,000 25,821 Operating liabilities 8,887 4,801 4,913 5,026 Note: price at close of 27 Jan 2014 Gross debt 1,965 2,900 2,400 1,900 Net debt -975 -267 -1,057 -1,618 Shareholders funds 8,358 12,679 13,783 14,627 Invested capital 3,934 8,674 9,195 9,705 Ratio, growth and per share analysis Year to 12/2012a 12/2013e 12/2014e 12/2015e Y-o-y % change Revenue 20.3 7.1 7.3 6.5 EBITDA 15.5 13.4 8.9 7.3 Operating profit 22.5 24.8 -18.3 7.8 PBT 20.5 22.6 -18.1 8.3 HSBC EPS 6.3 8.1 Ratios (%) Revenue/IC (x) 6.1 3.3 2.5 2.5 ROIC 33.3 19.1 13.8 14.0 ROE 10.2 8.4 7.2 7.3 ROA 6.7 7.6 5.6 5.7 EBITDA margin 8.6 9.1 9.2 9.3 Operating profit margin 8.1 9.4 7.2 7.2 EBITDA/net interest (x) 43.3 34.4 39.4 52.9 Net debt/equity -8.8 -1.7 -6.1 -8.8 Net debt/EBITDA (x) -0.6 -0.1 -0.5 -0.7 CF from operations/net debt Per share data (HKD) EPS reported (fully diluted) 0.00 0.83 0.57 0.61 HSBC EPS (fully diluted) 0.00 0.53 0.57 0.61 DPS 0.00 0.11 0.11 0.12 Book value 0.00 7.65 8.16 8.66 2 Kerry Logistics Network (636 HK) Air Freight & Logistics abc 28 January 2014 Overview Growth driven by mainland China, profitability still driven by Hong Kong But contract logistics is a low margin business and growth is likely to be hotly contested Initiate with an UW(V) rating; target price at HKD11.75 “Asia Specialist, China Focus, Shareholding structure Other Public Kerry Group Global Network” shareholders shareholders Limited of KPL Kerry Logistics Network Limited (KLN) is ~56% ~44% headquartered in Hong Kong and is the largest Hong Kong-based international third-party logistics (3PL) provider. It also has extensive Kerry Directors and Properties operations across Greater China and other subsidiaries Limited (KPL) countries in Asia. It is principally engaged in integrated logistics and international freight ~33.4% ~23.8% ~42.5% ~0.3% forwarding. It currently has more than 400 service locations across 35 countries and territories in Kerry Logistics Asia, Australia, Europe and the Americas. KLN Network Limited (KLN) was listed on the HKSE on 18 December 2013 Source: KLN, Bloomberg, HSBC under the ticker 636 HK. It is 42.5% owned by Kerry Properties Ltd which itself is listed on the HKSE (683 HK) and 23.8% by Kerry Group Ltd. This gives KLN a 33.4% free float. 3 Kerry Logistics Network (636 HK) Air Freight & Logistics abc 28 January 2014 It’s complicated HSBC estimate of recurring profit breakdown in 2012 TJ Log Other Revenue breakdown (2012) * 8% -1% CCT 12% Logistics operations 39% HK 53% PRC Intl freight 21% forw arding 58% AAT HK 5% w arehouse Source: Company and HSBC estimates 3% *Revenue including intersegment revenues Source: KLN, HSBC KLN is a beneficiary of the increasing complexity of supply chains and outsourcing trends. KLN EBIT breakdown (2012)* offers supply chain solutions to simplify and Intl freight streamline operations for its customers in order to forw arding 21% cut costs and to allow them to focus on their own core competences. It benefits from the mismatch in supply and demand, orders and production and Logistics operations sales and inventory that its customers seek to 51% minimise. HK Investment view w arehouse 28% KLN is a solid company with a good track record and strong positioning in Hong Kong *Segment revenues include intersegment revenues Source: KLN, HSBC where it is the No 1 3PL provider.