I recently posted a write-up (paywall) on Focused Compounding about Suria Capital Holdings Bhd (KLSE:SURIA), a Malaysian port concession operator. Below is a recap of the other port concession companies in Malaysia which I also looked at. As some of these are reasonably good businesses which may become cheap in the future I’ve summarised my thoughts below. The density and diversity of port operations in the region may also make this information useful when analysing port operation companies in other regions.
The reasons I ended up buying SURIA rather than a basket of Malaysian port companies are:
- SURIA’s concession deal is special. In addition to its own operations, the company collects 90% of the fees payable to the Sabah state government on the cargo handled at facilities it doesn’t construct and maintain. You can build your own wharf in Sabah but you will still need to pay SURIA,
- SURIA currently faces little to no competition for existing domestic cargo volumes. Note – the planned transshipment facility and cruise terminals will need to compete for customers.
- Underlying gross profit for the main part of the business is very consistent. Fortunately the accounting treatment obscures this.
- The state government sets SURIA’s port tariffs and also owns half the company. Tariff negotiations are likely to be less antagonistic than at other ports.
- Capital spend is reasonably predictable through to 2032.
- SURIA’s non-core property development and contracting businesses have limited downside and significant potential upside.
- Taking the above into account, SURIA sells for a low multiple (EV/EBIT of around 6) at a time when cargo growth is depressed but likely to recover.
- SURIA’s comps have a larger market cap and are correspondingly more expensive.
SURIA aside, there are four KLSE-listed companies which own port operations: Bintulu Port Holdings Bhd (BIPORT), Westports Holdings Bhd (WPRTS), MMC Corporation Bhd (MMCCORP)and IJM Corporation Bhd (IJM). The most useful way for investors to differentiate between all five is to look at their competitive situation.
Port concession operators manage government-owned ports that have been privatised. There are a number of different models for this but the one in use in Malaysia consists of:
The government receives a combination of the following benefits:
- It no longer needs to manage the commercial operation of the port and maintain the port infrastructure.
- Up-front payment.
- A percentage or fixed rate based on cargo volumes.
- Lease payments.
- New infrastructure which is built at the operator’s cost and handed over for free at the end of the concession period.
In return, the port operator:
- Collects various fees from ships based on cargo volumes loaded/unloaded, size of the ship, number of passengers etc.
- Can sub-contract parts of the operation.
- Sub-lets land and buildings to maritime service providers.
- May receive other items which were inserted to sweeten the deal. For example, SURIA received 99-year leases on development land next to one of its ports, WPORTS received a federal government grant for dredging work and 60% tax rebates on capex work for a recent project. BIPORT also received a grant for the construction of Samalaju port.
As I mentioned, SURIA’s existing cargo volumes are derived from the local hinterland – there is no container transhipment of cargo from one ship to another. The roads connecting SURIA’s hinterland to the neighbouring state’s ports are long and in poor condition. SURIA’s customer base is reasonably fragmented in dollar terms but in tonnage terms it has one major customer in the bulk oil loading buoys at Kimanis. Best read the write-up for more details on that.
BIPORT’s operations at Bintulu in Sarawak state are larger than all eight ports that SURIA operates combined. The Petronas LNG terminal accounts for nearly 40% of revenues. Petronas is also the largest shareholder at 29% with the Sarawak state government second at 40%. BIPORT doesn’t need to compete with other ports for shipping volumes (no transshipments and hinterland transport is similar to SURIA’s situation) but there is more chance of related party conflicts here than there is with SURIA.
MMCCORP and WPRTS are very different to SURIA and BIPORT in that their ports are on the Malayan Peninsula, not Borneo. Road transport on the Peninsula is good and Singapore is nearby – competition is a much larger factor here. The world’s busiest shipping lane passes by these terminals and they have grown in line with Asia’s economic growth.
WPRTS is a single port container and conventional cargo operator. It’s located at Port Klang, the main port area for Kuala Lumpur. Around ⅔ of WPRTS container volume is transshipment to/from other regions in Asia.
MMCCORP is the largest of the five companies. It owns operations in North Port Klang (near WPRTS location), Tanjung Pelepas and Pasir Gudang (both just across the causeway from Singapore), Penang and Malacca. Of these, Malacca and Pasir Gudang cater solely to local cargoes, Penang has less than 10% transshipment, North Port is around 50% transshipment and Tanjung Pelepas handles mostly transshipment cargoes (around 94%).
Finally, IJM owns 60% of the JV which operates Kuantan port which is the only sizable port on the east coast of the Peninsula. Kuantan is an import/export port. Containers form a relatively small part of the volume shipped.
The percentage transshipment volume is a rough approximation of how much of each port’s cargo could theoretically move elsewhere. In practice, the amount by which it moves is not that large. For example, the largest change in recent times was CMA-CGM line moving part of their transshipment business from Port Klang (WPRTS) to Singapore in 2017. That reduced WPRTS transshipment volume by 16% but increased import/export volumes have since replaced the entire volume lost. Likewise, when Maersk moved their transshipment operation from Singapore to Tanjung Pelepas in 2001, Singapore’s container volumes dropped by around 11%. However, these volumes were replaced by overall growth within two years, even whilst Tanjung Pelepas grew volumes at a steady rate. If I was to try and forecast transshipment volumes for one of these ports I would put it at equal to expected regional GDP growth (say mid single digits) with 15 to 20% error bars.
Competition also limits the tariffs that can be charged on container transshipment volumes. For example, Singapore’s transshipment rate is 23% less than its import/export rate – and this is regularly discounted by a further 20%. Another example, WPRTS container handling charge for transshipment is 39% less per lift than for import/export containers.
A last comment on transshipment. There are a number of ports in the region planning to build transshipment facilities. BIPORT and SURIA are among them, as are a number in Indonesia, one in Myanmar and one in Vietnam. I don’t know if any of these will succeed in taking volume away from the existing transshipment ports but I suspect they will make it even more difficult to increase transshipment tariffs.
Returns on Capital
Not all of these companies are simple to analyse. SURIA, BIPORT and WPRTS are more or less pure-play port operators. MMCCORP and IJM are not – they both have other infrastructure and construction businesses which weigh heavily on results. I may attempt to analyse MMCCORP later as it appears cheap on a P/B basis. For the rest of this write-up I will discuss the pure-play port operators only.
Operationally, these are very profitable businesses. SURIA’s port operation gross margins are a little over 50% despite not having increased tariffs for many years. WPRTS range from 44 to 60% and BIPORT’s are around 55%. The main input cost (by an order of magnitude) is labour at which ranges from 17% of revenue for BIPORT to 40% of revenue for WPRTS. SURIA’s are 20%. The difference in those figures is roughly in line with the mix of container versus bulk cargo at those ports.
Cash fixed costs are relatively low – 11% of revenue for WPRTS, 13% for SURIA and 28% for BIPORT. These ports could lose a lot of cargo volume and still be profitable.
The crux issue for all of the single-concession companies is that they look more like a project than a steady-state business. Normally a good quality business has reasonably granular capex requirements and operating cash flows can be guesstimated out to 10, maybe 15 years in the future. A single-port concession is the opposite – the capex is very large relative to the size of the business but the worst-case operating cash flows are reliable out to the end of the concession, up to 30 years in the future.
Other implications of this are:
- From a free cash flow point of view the business looks terrible early on in the concession when there is a lot of new infrastructure to build and fantastic toward the end of the concession when there is less capex but the business is paradoxically less certain due to the risk of not winning a concession renewal.
- When I calculate the ROIC for individual capex projects I find a wide range of variance. E.g. 5% and 16% for adjacent container berths built consecutively at WPRTS. This is because some big-ticket items such as reclamation works must be completed for say, all four berths that a company plans to build before the first berth can be completed. The fourth berth may be completed a decade or more later.
- The operator will need to deleverage as the end of the concession approaches. Despite the reliable operating cash flows, the single-concession companies can’t lever up to the same extent as a company with a multitude of concessions of various expiry dates such as MMCCORP or a 99-year license period such as Sydney Airport.
- Care needs to be taken when scaling construction costs from one company or port to another. WPRTS container berths cost less than half of what SURIA’s cost on an annual capacity basis. This is because WPRTS handles main-line container ships which are much larger (and better utilise wharf space) compared to the smaller ships that visit SURIA’s ports. WPRTS’s revenue per container is half that of SURIA’s – the economies of scale from handling larger ships are consumed by the high competition for transshipment cargo.
I think the best way to value SURIA, BIPORT and WPRTS is to treat them as a project rather than as a perpetuity.
The quick and dirty way to do this is to assume that management did their DCF correctly when negotiating the concession and when approving further capital projects. If we can believe this is true then we can assume the ROIC over the remainder of the concession should be approximately equal to the discount rate used.
SURIA have previously reported an ROI target of 10% for new projects and a discount rate of 11.5% when valuing their concession assets. BIPORTS uses a discount rate of 8% (2017: 9%) to value its concession assets. WPRTS doesn’t disclose the discount rate or target ROI. If you believe the management team is competent then I believe it’s a reasonable assumption (in this industry and region) that they are only approving projects that have an estimated ROIC of at least 8%, maybe higher. That matches the returns from the handful of projects I have looked at from these companies. I doubt any of these companies are achieving concession-long blended ROICs in the late teens percentages or higher.
The other method is to go through the concession agreement, estimate the capex costs (if they aren’t given explicitly), do an NPV calculation through to the end of the concession period and use trial-and-error (or Excel goal-seek) to find the discount rate needed to get an NPV of zero given the current share price. I did that for SURIA because they are quite explicit in their estimates of remaining capex, mainly because the amount they must spend is specified in the privatisation agreement. It also allowed me to come up with an expected worst-case scenario in case they build all of their projects but they don’t result in any new income. It’s not possible to be as precise for the other two companies as they don’t provide the same level of detail through to the end of their concessions.
Apart from the risk of competition mentioned above, the other main non-financial risk is that of re-regulation of the ports. Since Malaysia began privatising ports in 1996 only one has returned to public hands: Kemaman Port, located on the eastern side of the Peninsula. Kemaman was previously managed by Eastern Pacific Industrial Corporation Bhd but was taken over by the Terengganu state government. This is only one data point but given that the takeover price was a 77% premium to the three-year average share price I think the risk of losing money this way is low.
Financially, WPRTS and BIPORT both carry net debt to EBITDA ratios of less than two. SURIA’s is around than one. Although these levels are low compared to other concession businesses, they would be an issue in the last few years of the concession period. None of the three companies are currently in that position.
After SURIA, the next safest of the three companies is BIPORT, mainly due to the transshipment issue. BIPORT is also the second cheapest but it still trades at a slight premium to book. If I wanted to bet on long-term secular growth in Asia then WPRTS is likely to provide more exposure to that – but I’m not interested in it at its current price of six times book value.
Disclosure: The author holds KLSE:SURIA at the time of writing. This is not a recommendation to buy or sell any securities, nor is it financial advice. All information presented is believed to be reliable and is for information purposes only. Do heaps of your own research before purchasing any security.