Asian Equities Analyst, Logistics & Transport, Tracking Traffic

Daniel Hellberg

Asian Equities Analyst, Logistics & Transport

Equity Bottom-Up

Kerry Logistics Network / Equity Bottom-Up

<ul><li>In this note we re-visit a theme introduced in our May note, <a href="https://www.smartkarma.com/insights/global-logistic-properties-glp-sp-may-provide-an-antidote-to-china-s-congestion-woes" target="_blank" data-smartkarma-citation="insights:3778">Global Logistic Properties (GLP:SP) May Provide an Antidote to China’s Congestion Woes</a>. The central idea of that piece was that companies focused on helping domestic-oriented businesses overcome congestion and other problems that plague China's cargo transportation systems should experience strong demand growth in the medium term. Here we review the main points of that theme and introduce another way to play it: <a href="https://www.smartkarma.com/entities/367" target="_blank" data-smartkarma-citation="entities:367:1">Kerry Logistics Network Ltd (636 HK)</a>. </li><li>A transportation network built to serve external trade frustrates Chinese domestic logistics customers, whose needs differ from those of importers and exporters. In our view, traffic congestion has become an obstacle to higher rates of economic growth, particularly in the domestic economy.</li></ul><ul><li>As Chinese domestic demand continues to outpace external trade growth, companies focused on optimizing the flow of goods within China should deliver surprisingly strong earnings in the medium-term. To capitalize on this trend we recommend investors consider buying Kerry Logistics Network (KLN), which derives about 2/3 of its revenue from Greater China and much of the rest from developing Asia. Although KLN is not a pure play on Chinese domestic logistics demand (it also serves importers, exporters, and other geographies), we believe Chinese domestic demand growth will be a major earnings driver in 2016-17.</li></ul><ul><li>China’s surface transportation networks are optimized for the import of bulk raw materials and the export of consumer goods, mostly in standardized shipping containers.</li></ul><ul><li>These networks supported three decades of strong growth in external trade, but they fail to meet the needs of domestic logistics users, who tend to ship more frequently and in smaller quantities.</li></ul><ul><li>Besides this mismatch between China’s established logistics networks and domestic users’ needs, all Chinese logistics users face increasing congestion, shipping delays, and pollution. China's traditional approach to improving transportation -- adding rail track and roads – simply won’t work any more.</li></ul><ul><li>As domestic activity in China continues to outpace growth in external trade, attention will focus on modernizing cargo hubs and warehouses in and around China’s large cities. The objectives are to speed the flow of goods and handle greater volumes using existing facilities.</li></ul><ul><li>Over the next few years, companies involved in overcoming the problems that plague users of China’s domestic logistics networks should enjoy demand growth that exceeds the rates of GDP growth and even private consumption growth. These companies should generate surprisingly strong earnings growth in 2016-17, in our view.</li></ul><ul><li>Trading at just 12x 2016e EPS and 8x EV/EBITDA, we view KLN as an inexpensive mid-cap name with attractive exposure to growing demand for modern logistics, modern warehousing, and express parcel delivery in China and elsewhere in developing Asia. Our sum-of-parts valuation gives a target price of just over HK$15, representing 36% upside from KLN's closing price on Friday, August 19th.</li></ul><ul><li>We are less enthusiastic about medium-term growth prospects for KLN's International Freight Forwarding segment. Competition here remains intense, in our view, and margins are low to begin with. Still, we strongly prefer KLN to capital intensive, asset-heavy transportation businesses such as shipping companies or container terminal operators. This latter group of businesses suffers inordinately as the growth of China's external trade slows (see our note <a href="https://www.smartkarma.com/insights/is-china-s-container-traffic-going-ex-growth-update-on-china-merchants-port-holdings-144-hk" target="_blank" data-smartkarma-citation="insights:4797">Is China’s Container Traffic Going Ex-Growth? Update on China Merchants Port Holdings 144:HK</a>).</li></ul>

In this note we re-visit a theme introduced in our May note, Global Logistic Properties (GLP:SP) May Provide an Antidote to China’s Congestion Woes. The central idea of that piece was that companies focused on helping domestic-oriented businesses overcome congestion and other problems that plague China's cargo transportation systems should experience strong demand growth in the medium term. Here we review the main points of that theme and introduce another way to play it: Kerry Logistics Network Ltd (636 HK). A transportation network built to serve external trade frustrates Chinese domestic logistics customers, whose needs differ from those of importers and exporters. In our view, traffic congestion has become an obstacle to higher rates of economic growth, particularly in the domestic economy.As Chinese domestic demand continues to outpace external trade growth, companies focused on optimizing the flow of goods within China should deliver surprisingly strong earnings in the medium-term. To capitalize on this trend we recommend investors consider buying Kerry Logistics Network (KLN), which derives about 2/3 of its revenue from Greater China and much of the rest from developing Asia. Although KLN is not a pure play on Chinese domestic logistics demand (it also serves importers, exporters, and other geographies), we believe Chinese domestic demand growth will be a major earnings driver in 2016-17.China’s surface transportation networks are optimized for the import of bulk raw materials and the export of consumer goods, mostly in standardized shipping containers.These networks supported three decades of strong growth in external trade, but they fail to meet the needs of domestic logistics users, who tend to ship more frequently and in smaller quantities.Besides this mismatch between China’s established logistics networks and domestic users’ needs, all Chinese logistics users face increasing congestion, shipping delays, and pollution. China's traditional approach to improving transportation -- adding rail track and roads – simply won’t work any more.As domestic activity in China continues to outpace growth in external trade, attention will focus on modernizing cargo hubs and warehouses in and around China’s large cities. The objectives are to speed the flow of goods and handle greater volumes using existing facilities.Over the next few years, companies involved in overcoming the problems that plague users of China’s domestic logistics networks should enjoy demand growth that exceeds the rates of GDP growth and even private consumption growth. These companies should generate surprisingly strong earnings growth in 2016-17, in our view.Trading at just 12x 2016e EPS and 8x EV/EBITDA, we view KLN as an inexpensive mid-cap name with attractive exposure to growing demand for modern logistics, modern warehousing, and express parcel delivery in China and elsewhere in developing Asia. Our sum-of-parts valuation gives a target price of just over HK$15, representing 36% upside from KLN's closing price on Friday, August 19th.We are less enthusiastic about medium-term growth prospects for KLN's International Freight Forwarding segment. Competition here remains intense, in our view, and margins are low to begin with. Still, we strongly prefer KLN to capital intensive, asset-heavy transportation businesses such as shipping companies or container terminal operators. This latter group of businesses suffers inordinately as the growth of China's external trade slows (see our note Is China’s Container Traffic Going Ex-Growth? Update on China Merchants Port Holdings 144:HK).

Kerry Logistics Network: Undervalued Mid-Cap Play on Rise of Modern Logistics in China, SE Asia

Japan

Kintetsu World Express Inc. provides distribution services across the globe including international air forwarding, ocean freight forwarding, third party logistics, customs brokerage, warehousing, and truck transportation services. Items transported include PC, semi-conductor, other electronic products, textile products, medical devices, and chemical products.

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Kintetsu World Express (9375 JP)

Kerry Logistics Network: Undervalued Mid-Cap Play on Rise of Modern Logistics in China, SE Asia

In this note we re-visit a theme introduced in our May note, Global Logistic Properties (GLP:SP) May Provide an Antidote to China’s Congestion...

Daniel Hellberg

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