Credit FAQ: A Closer Look At CK Hutchison Group's Credit Quality (2024)

CK Hutchison Holdings Ltd. is navigating rough seas. The diversified conglomerate is one of Hong Kong's largest and most global business groups. As such, it is exposed to a range of industries, geographies, and currencies.

The group mainly operates in infrastructure and utilities, telecommunications, ports and related services, and retail businesses. It does this with its major consolidated subsidiaries, such as CK Infrastructure Holdings Ltd. (CKI; 76% owned), CK Hutchison Group Telecom Holdings Ltd. (CKHGT; 100% owned), Hutchison Port Holdings Ltd. (80% owned), A.S. Watson Holdings Ltd. (75% owned), and major affiliates such as Hutchison Port Holdings Trust (HPHT; 30% owned). The group operates in about 50 countries across the world with significant business exposure in Europe.

In this report, we address key investor questions on the strategies and operational outlook for group companies amid a depreciating euro and British pound, rising interest rates, and soaring energy costs.

Frequently Asked Questions

Will CK Hutchison experience foreign exchange (forex) losses due to the depreciation of the euro and British pound against the Hong Kong dollar?

Yes, that's likely because the company generally adopts a natural-hedge strategy. Our estimate for a 10% drop in adjusted EBITDA in 2022 has captured a 10%-15% depreciation in the euro and British pound against the Hong Kong dollar during the period. We note that because CK Hutchison generally does not participate in forex contracts with periodic settlement, the cash impact from forex movements should be minimal.

In our view, a depreciation in the euro will not materially affect CK Hutchison's leverage, as measured by debt-to-EBITDA. This is because the company's euro exposure in EBITDA and debt broadly matches. In 2021, 35% of CK Hutchison's attributable underlying EBITDA was from Europe excluding the U.K., while 42% of the company's debt was denominated in euro.

However, a depreciation in British pound will push up CK Hutchison's leverage. This is because the company has a much higher sterling exposure for EBITDA than its debt. In 2021, 23% of CK Hutchison's attributable underlying EBITDA was from the U.K. while only 5% of its debt was denominated in the U.K.'s currency.

What's the company's liability management strategy amid interest rate hikes?

We believe CK Hutchison has been utilizing its excess cash to reduce debt. Its gross debt dropped to HK$288 billion as at June 30, 2022, from HK$327 billion as at Dec. 31, 2021. Meanwhile, its cash and liquid investments also dropped to HK$120 billion from HK$161 billion over the same period. By our forecast, CK Hutchison's adjusted debt will reduce to HK$314 billion by end-2022, from HK$341 billion in 2021.

In our view, CK Hutchison will use part of the cash proceeds from its asset disposals during 2022 for further debt reduction. This includes €2.3 billion cash proceeds from a telecom tower disposal in the U.K. and the HK$4.5 billion cash proceeds attributable to CK Hutchison (including CKI) related to the partial stake sale of Northumbrian Water Group Ltd.

That said, an increase in lease liabilities arising from the disposal of telecom tower assets in Europe will partially offset CK Hutchison's debt reduction. This is because we treat the service fees from the management service agreement between Cellnex and CKHGT as an operating lease.

Will CK Hutchison's interest cost rise sharply amid interest rate hikes?

No, not for the next 12 months at least. This is because about 75% of the company's borrowings at the consolidated level are in fixed-rate debt as at June 30, 2022. In the first half of 2022, CK Hutchison's average cost of debt moderately rose to 1.8% from 1.6% in the same period last year.

We forecast CK Hutchison's EBITDA interest coverage ratio will be at 7.7x-8.0x over 2022-2023. For major subsidiaries, CKHGT and CKI, fixed-rate debt accounts for about 79% and 50% respectively of their borrowings at the consolidated level. For CK Hutchison's port affiliate, HPHT, fixed-rate debt accounts for 86% of its total borrowings.

Will the inflationary environment hit CK Hutchison's core businesses?

We expect a muted impact on CK Hutchison's flagship infrastructure/utilities platform, CKI. With operations mainly in the U.K. (53% of profit in 2021) and Australia (23%), most of CKI's assets operate under transparent and consistent regulatory regimes. They generate predictable cash flows within each regulatory period.

These regulatory frameworks also entail tariff mechanisms that protect the operators against volume and cost risks. Any unexpected cost hikes or volume reduction would be recovered through increased tariffs in the subsequent years, despite some negative impact on cash flows in the interim.

Next year, three regulated assets (U.K. Power Network Holdings Ltd. in April 2023, and two gas networks in Australia in July 2023) are scheduled for regulatory resets. Although we expect revenue and profit from these assets to drop on the back of the resets, the permitted price growth from other assets due to inflation may help mitigate the hit.

For CK Hutchison's flagship telecom platform, CKHGT, we believe rising energy prices could dent its profitability. We estimate the high energy price will squeeze CKHGT's EBITDA margin by 200-300 basis points in 2023. This is because intense market competition, particularly in Italy, could limit CKHGT's ability to pass through higher utility costs to consumers.

Other costs such as rising wages could be better managed through digitalizing and automating marketing and customer service functions. By our estimate, utility costs account for one-tenth of CKHGT's total operating costs. Some of such utility costs are unhedged.

Although rising energy costs will likely increase the operating costs of CK Hutchison's port businesses, the effect could be mitigated by cost-saving measures including automation and digitalization, as well as potential tariff hikes in 2023.

For the retail businesses, a high inflationary environment may weaken its customers' spending power. CK Hutchison's strategy is to attract customers through its loyalty programs and by offering products at good value. To maintain its profitability and margins, the company strictly manages its costs and strives to effectively utilize its online sales channel.

What's the outlook for CK Hutchison's investment and acquisition strategies?

Overall, we don't anticipate the group will be particularly aggressive over the next 12 months.

CKI: CKI may continue to look for accretive acquisition opportunities, particularly on regulated businesses, but sizable acquisitions won't be likely over the next 12 months. This is because we expect the company will adhere to its prudent investment strategy amid a rising funding cost environment. Having said that, CKI's stake sale in Northumbrian Water has provided CKI with additional war chest of HK$4.2 billion. In our view, CKI would more likely look for bolt-on acquisitions at the project level. Year to date, CKI has made investments of approximately HK$2 billion, relatively stable compared with HK$2.5 billion in 2021 and HK$1.5 billion in 2020.

CKHGT:CK Hutchison will continue to focus on the strategy of in-market consolidation. CKHGT is in discussions with Vodafone Group about a possible combination of their telecom businesses in the U.K. (with CKHGT owning 49% stakes in the potentially merged business). However, we have not factored in the potential merger into our base case since the discussions are still in the early stages and the merger will need to pass several milestones before completion. In particular, the merger of major telecom operators in the U.K. will require regulatory review and approval. We believe uncertainties related to the potential transaction are high.

Ports: CK Hutchison would likely focus on diversifying its revenue in this niche through expanding its logistic businesses. We expect the capital expenditure of its port businesses to be stable over 2022-2023.

Retail: We believe the group will optimize its store network in 2023 by focusing more on new-store quality rather than quantity.

Table 1

This report does not constitute a rating action.