Its previous association of the HNA Group, which suffers from a crushing debt burden caused by over-expansion, has caused investors to shy away, unfairly, and therefore, pushing valuations down to levels that can’t be ignored
SINGAPORE (Jan 23): We have picked a few stocks in property, infrastructure and construction. For example, we like Hainan Meilan International Airport. Its previous association with the HNA Group, which suffered from a crushing debt burden caused by over-expansion, has perhaps caused investors to shy away unfairly. But it has also pushed valuations down to levels that can’t be ignored.
Hainan Meilan Airport (HMA), as the name suggests, operates Meilan Airport on Hainan island in South China. The two main business segments of HMA, are the aeronautical (terminal facilities, ground handling and passenger services) and non-aeronautical (leasing of commercial and retail spaces, franchising of airport related business, advertising, car parking, cargo handling and sales of consumable goods) business. The International Air Transport Association (IATA) forecasts 8.2 billion air travellers in 2037, representing a CAGR of 3.5%. Region-wise, Asia-Pacific is expected to grow the fastest, at a CAGR of 4.8% with China projected to displace US as the world’s largest aviation market in terms of air traffic in the mid-2020s.
Airports inherently are a long-term value industry, given their industry-specific moats. This includes the fact that operating an airport requires a licence from the state or federal government, which usually includes considerations such as scarcity of land and potential overcrowding of flight pathways – leading to airport operators usually operating solely within a city or province.
HMA’s operating cash flow (OCF), net profits and revenue have been growing at a much faster pace compared to the share price over a five year period. The CAGR for revenue, net profits and OCF respectively were 17.8%, 12.7% and 15.4% respectively compared with the share price CAGR of 2.7%, which suggests that HMA is potentially undervalued. Dividends and free cash flow on the other hand are rather unattractive for the time being due to HMA’s capital expenditure plans for the second expansion phase of the Meilan Airport. HMA’s airport aviation traffic, which is a good indicator of the fundamental business performance, has also grown steadily over the past 10 years with cargo, aircraft and passenger traffic recording a CAGR of 10.0%, 10.2% and 12.5% respectively (see Charts 1-3).
Earnings yield (the reciprocal of P/E) and OCF yield are at 19.8% and 39.0% respectively, well above the benchmark Chinese risk free rate of 3.1%. The company’s balance sheet is also strong, with a debt to equity ratio of 50.7%, interest coverage ratio of 4.8 times, and a price to NAV of just 0.56 times. Retained earnings have also grown at a CAGR of 17.1% over the last 5 years, signalling an increasingly strong core equity component in the balance sheet. Perhaps the most convincing investment case for the company is how cheap it is compared to its regional peers. HMA trades at a steep 80% discount for P/E and EV/ebitda versus peers.
Hainan, like Shenzhen, is a special economic zone (SEZ). SEZs are geographical regions that have different economic laws compared to the rest of China, designed to experiment with reform and opening up. In 2019, Hainan stepped up the development of tourism and sports and accelerated the construction of various tourism projects. One of these projects is Haikou International Duty-Free City, on the west coast of Haikou City to be completed in 2023. Also, offshore tourist duty-free shopping policy is a special preferential policy granted by the state to Hainan. HMA ought to benefit from these initiatives, given that it will bring in more traffic into Hainan through the Meilan airport.
In 2019, HMA underperformed the Hang Seng Index largely because of negative sentiment associated with one of its shareholders, HNA Group. HMA was previously HNA Infrastructure Company before a name change to Regal International Airport, and then to HMA. HNA Group’s effective stake in HMA to be only 11.52% and HNA group is not HMA’s largest shareholder.
At current prices, HMA is significantly undervalued, underpinned by its strong fundamentals. Analysts have a target price of HK$9.61 ($1.67), an attractive 52.3% upside from its current trading price of HK$6.31. We estimate the fair value of the stock to be around HK$8.10, or in other words, a 28.5% potential upside from the current trading price. Investors looking for a cheap stock need look no further.
