China Port Sector
SECTOR REVIEW
Growing pains
Container terminal operators are likely to face softening demand growth,
driven by external and internal factors. The high earnings growth era is
behind us, in our view. While we believe an uncertain macro environment
will continue to takes its toll, current valuations are well below their
historical average, suggesting weakening growth is largely priced in.
■
Slowing earnings growth is largely priced in. We expect container
terminal port operators’ organic earnings to slow from a CAGR of above
20% in 2005-07 to the low-teens or high single-digit in 2008-09E, reflecting:
1) softening demand growth, 2) no further tariff rises and 3) cost hikes. After
a significant share price correction, the sector now trades at 15.0x 12-month
forward P/E versus a two-year (2008-09E) earnings CAGR of 12.6%, with all
stocks trading at or below their historical average P/E.
■
Demand/supply analysis indicates overcapacity and tariff cut unlikely.
Our base-case scenario assumes China’s coastal container throughput
growth (which is highly geared to its foreign trade) will slow to 11-12% p.a. in
2008-09E. Our port-to-port count of major container terminal projects in the
pipeline indicates most coastal ports will be able to hold up utilisation above
90%, except Tianjin and Xiamen. We believe the risk of tariff cuts is low,
given high utilisation and the industry’s oligopoly nature.
■
Spot safe and value plays. With uncertain global economic growth, we
suggest investors can pocket money in safe and value plays. We initiate
coverage on Dalian Port with an OUTPERFORM rating, given its better
earnings mix with exposure to China’s rising oil demand. We believe the
market underestimates China Merchants’ (CMIH) strong competitiveness
which should continue to help it to achieve above-average earnings growth,
while Cosco Pacific looks attractive, due to implied low port valuations and
recovering leasing earnings. We remain UNDERPERFORM on Shanghai
Int’l Port Group and NEUTRAL on Shenzhen Chiwan Wharf ‘B’, and initiate
coverage on Tianjin Port Dev. and Xiamen Port, both with a NEUTRAL.

Growing pains
Spot safe and value plays
Given uncertain global economic growth, and particularly the risk of weaker European
economies, we are only selective buyers of Chinese port stocks. We suggest investors
can pocket money in relatively safe and value plays. Dalian Port (DP) is our top sector pick,
given its better earnings mix with high exposure to China’s rising oil demand, thereby
making it least sensitive to weaker container demand. We believe the market has
underestimated China Merchants’ (CMHI) strong competitiveness, which should continue
helping it win market share and achieve above-average earnings growth, while Cosco
Pacfic (CP) looks attractive, due to its implied low port valuations and recovering leasing
earnings. We continue our UNDERPERFORM on Shanghai International Port Group
(SIPG) due to its rich valuation and our NEUTRAL on Shenzhen Chiwan Wharf (SCW) ‘B’,
and initiate coverage on Tianjin Port Dev. (TPD) and Xiamen Port (XIPC), both with a
NEUTRAL. CP and SCW ‘B’ are good yield plays with high dividend yield estimates.
Softening demand growth, inevitable
1H08 container throughput growth, especially at Shanghai and Shenzhen, reflects the
impact from the US recession and China’s troubled low-end manufacturing export sector.
We expect China’s coastal container throughput growth, which is highly geared to China’s
export growth, to slow from 22.5% p.a. in 2005-07 to 11-12% p.a. in 2008-09E, reflecting:
1) slower global consumption, 2) limited room for further increases in containerisation in
China and 3) the great cost pressures facing China’s low-end manufacturing export sector,
which has been struggling for survival.
Differentiating ports: who will see more resilient
container volume growth
We believe ports in the Pearl River Delta (PRD) and Yangtze River Delta (YRD) will see
more of a slowdown in container throughput growth than the Bohai Bay in 2008-09E, given
the former’s higher exposure to the US and to the low-end manufacturing industries, while
the latter has lower exposure to the US and higher exposure to heavy machinery
industries. Over the medium-to-long term, the growth of PRD and YRD ports depends
largely on the transformation of their regional economies and their capability to reach to
inland areas through intra-modal transportation. We note that both the governments of
Shanghai and Guangdong are aware of the challenges and are launching a few strategies.
The risks of overcapacity and tariff cuts are low
Our port-to-port count of China’s major container terminal projects in the pipeline
concludes that most key coastal ports are growing capacity moderately, just slightly ahead
of demand growth, and thereby holding utilisation at above 90%. Even under our worstcase
scenario of 6-7% p.a. throughput growth in 2008-09E, utilisation could still stay at
70%. On our radar screen, only Tianjin and Xiamen are expanding more aggressively,
which would pressure utilisation. The risk of tariff cuts is low, in our view, given the healthy
utilisation and the industry’s oligopoly nature.
Valuations look undemanding
We expect container terminal port operators’ organic earnings to slow from above a 20%
CAGR in 2005-07 to the low teens in 2008-09E, reflecting: 1) softening demand growth,
2) no further tariff rises and 3) cost hikes. After share price corrections, the sector trades at
15.0x 12-month forward P/E versus a two-year (2008-09E) earnings CAGR of 12.6%, with
all stocks at or below their historical average P/E. Stocks, such as SCW ‘B’ and CP, which
have a longer listing history, trade even very close to the lows in the last trough of 2001.

The high demand growth era ends
With the slowdown of global GDP growth, China’s high containerisation and a possible
structural downtrend of China’s export sector, we expect the high growth of China’s
container port industry to be behind us. We forecast China’s container throughput growth
to slow to 11-12% p.a. in 2008-09E from a CAGR of 22.5% in 2005-07.
Slowing global GDP growth
The US recession has caused the slowdown of China’s export trade. While China’s export
still grew 20% YoY in US dollar terms in January to May 2008, the slowdown has been
more reflected in boxes handled by ports in the YRD and the Pearl River Delta PRD.
January to May 2008 container throughput growth at Shanghai, Ningbo and Shenzhen
deteriorated to 10.4%, 17.0% and 8.0% YoY, respectively, from 2007’s full-year growth of
20.4%, 32.4% and 14.7%. With less exposure to the US and to low-end consumer
products, the Northern ports saw more resilient growth in January to May 2008.
Our economists do not expect the US’s economy to recover until 2H09. Furthermore,
inflationary pressure and an interest rate hike mean the high growth of the European
Union (EU) is not sustainable, in our view. A slowing EU economy would further chill
China’s export trade. China’s June PMI new export orders index reached a new low, which
is a sign of further weakness in exports, in our view.