Li Ka-shing’s UK companies may be shielded from negative effects of drop in sterling thanks to local currency borrowings
The pro-Brexit referendum result could deal a moderate blow to the bottom lines of tycoon Li Ka-shing’s companies due to the fall of pound sterling as their British earnings are translated into the stronger Hong Kong dollar, according to analysts.
But since these companies have borrowed in sterling to finance their projects and operations, there is a “natural hedge” in their assets and liabilities, limiting the impact on their debt repayment burden, according to ratings agency S&P Global
“The most immediate risk would be a potential large depreciation in pound sterling, which would reduce cash flows to CK Huchison Holdings (CKHH), Cheung Kong Infrastructure (CKI) and Power Assets as they are translated at a lower rate compared with the [Hong Kong dollar],” S&P said. “The impact, however, would materialise only if the depreciation is prolonged for more than a year.”
Sterling on Friday dropped as much as 12 per cent to a 30-year low as the voting results trickled in, before easing back for an 8 per cent decline late Friday.
S&P’s analysts estimated that 34 per cent of CKHH’s earnings before interest, taxes, depreciation and amortisation (ebitda) is from Britain, while around 25 per cent of its debt is in sterling. Since both earnings and debt are lower when translated into Hong Kong dollar, there is some “natural hedge” to the earnings downside risk, the ratings agency said.
CKHH is Li’s flagship holding company, whose British investments span regulated utilities, telecommunications, retail and ports, viewed by analysts as being defensive against economic volatility.
However, Citi analyst Anil Daswani downgraded CKHH to “hold” from “buy”, saying the profit margin on the company’s European retail business would drop by 1 percentage point, while throughput will decline 20 per cent at its UK port in Felixstowe and Europe Container Terminal in Rotterdam in 2018.
Daswani also estimated that for every 5 per cent depreciation of the sterling against the Hong Kong dollar, CKHH’s net profit for next year would fall by 4 per cent.
Evan Li, HSBC’s head of Asia Pacific utility and alternative energy research, said in a client note that CKI derived 73 per cent of its earnings from the UK last year, compared to 62 per cent for Power Assets. Both companies are controlled by Li under CKHH.
Power Assets invests primarily in regulated energy industries such as electricity generation and supply, as well as natural gas distribution in the UK, while CKI has a wider investment scope that also cover non-energy sectors like rail rolling stock supply, water supply and sewage treatment.
“If the [sterling’s volatility] is long lasting, the dividend repatriation from the British projects to Hong Kong could be affected, [resulting in] a potential one-off hit to dividend per share growth,” Li wrote.
He projected that CKI and Power Assets’ earnings for this year could drop 6 to 8 per cent if sterling drops 15 per cent from the pre-referendum level on a sustained basis, so that each pound buys only US$1.25.
CKI shares tumbled as much as 8.3 per cent before closing 5.5 per cent lower on Friday at HK$69.90. Power Assets closed 4.8 per cent lower at HK$70.
UBS head of Asian utilities research Simon Powell, who had a “sell” recommendation on CKI as early as March citing its exposure to depreciation risk of sterling and Australian dollar against the US dollar, said the share price decline was not surprising given the prospective currency translation loss.
Li Ka-shing told reporters three months ago when CKHH reported its annual results that he would scale back investments in the UK in what he then considered the unlikely event of a British exit from the European Union.
CKHH’s spokesman did not respond directly to a query whether Li maintains the same stance after the referendum results were out.
“We are confident that our UK businesses – which are strongly focused on providing vital goods and services to UK communities - will continue to thrive,” the spokesman said.
Powell added that he did not know whether in the wake of the Brexit vote CKI and Power Assets would be more eager to bid for the 50.4 per cent stake in Australian power distributor Ausgrid put on the bloc by the New South Wales state government.
“They have been working hard to pursue the opportunity and there are not a lot of similar assets for sale ... as long as they are not overpaying, investors should welcome investments that provide better yields than holding a large amount of cash,” Powell said.
Power assets had a cash pile of HK$68 billion at the end of last year after stake sale in its Hong Kong electricity unit during the past two years. The company is under pressure from shareholders to either declare a generous special dividend or find suitable acquisitions to put the cash to work.
China’s state-owned monopoly power distributor State Grid Corporation, CKI and Power Assets are among suitors planning to submit bids for the stake estimated to be worth A$10 billion (HK$58.04 billion), according to Australian media reports.