As opposed to my usual assortment of cheap low quality companies, Steamships (ticker: SST) is a high quality business currently trading below the market value of net assets with incoming strong tailwinds.
Steamships has a long history operating in PNG, this year marks its 100th anniversary. Its controlling shareholder, Swire group (72% interest) of the UK, was founded in 1816. A company that survives and thrives for 100 years is a rare breed and I believe testament to its management and culture.
My thesis for Steamships is predominantly a play on liquid natural gas (LNG).
Steamships has three main divisions as categorised in the annual report:
- Logistics (FY17 – 46% of consolidated revenue).This division has three businesses. Consort lines is the largest operator of coastal shipping in PNG with 16 vessels. Pacific Towing is the leading provider of harbour towing and mooring services, operates 11 tugs and 10 associate vessels in 5 ports across PNG. East West Transport is one of the main multifaceted transport and logistics operator and JV Port Services – which is a collection of joint ventures that provides a full range of stevedoring and handling facilities across many ports in PNG.
- Hotels & Property (FY17 – 32% of consolidated revenue)Coral Hotels with seven hotels (546 rooms) and apartment complexes (129 apartments) is the largest hotel group in PNG. Pacific Palm Properties (PPP) is one of the largest real estate landlords and property developer in PNG. PPP’s business model is to develop strategically located commercial and industrial properties for yield and long term property appreciation.
- Commercial (FY17 – 21% of consolidated revenue)Laga Industries is one of PNG’s largest consumer good business manufacturing and distributing ice cream (Gala ice cream – No. 1 ice cream brand in PNG), vegetable oil, condiments, powdered milk, snack food and beverages. SST also has a 50:50 joint venture with Colgate Palmolive to market and distribute Colgate’s oral, personal and home and fabric care products in PNG.
SST has many leading businesses in logistics, hospitality and consumer products in PNG and therefore its fortunes are highly correlated with the overall PNG economy.
Why do I like it?
There are two main reasons why I think SST is a good bet. The first is its current market capitalisation is backed by property. The second is that I believe earnings are set to double in the next 3-5 years.
As I write this post, SST is trading at a $18.50 a share which gives it an enterprise value of A$710 million or kina $1.78 billion (exchange rate of A$1:K$2.50).
Enterprise value backed solely by the property portfolio
The FY2017 annual report shows the range of market values of its property portfolio:
Investment properties are properties that are leased out and are mostly industrial and commercial properties. Other properties are real estate that are used by the businesses and includes hotel premises, offices and warehouses.
Based on say the mid-point value for the properties (k$1.8 billion), it appears that the market is only appreciating the value of the property portfolio and essentially assigning no value to the logistic and commercial businesses (which represents more than half of the consolidated revenue).
I have no reason to suspect that the reported property values are overstated. I based this opinion on reviewing 1) the rental yields and 2) comparing the growth in reported market values to net book value of the investment properties over a 10 year period.
The chart below shows the rental yields achieved for the investment properties over the past 5 years.
Yes, one can only dream of getting such yields for commercial properties in Sydney or Melbourne. Based on my understanding the above yields are consistent with the market in PNG. Therefore from the rental yield perspective, the reported market values for the investment property do not appear to be bullish. Note that FY2017 rental fell due to a fall in occupancy from 90% in the prior year to 80% in FY2017.
As PPP business model is to develop new properties to lease, I’ve also reviewed the growth in the property portfolio’s net book value (NBV) and reported market value (MV) over the past 10 years. The chart compares the growth in NBV and MV from 2008 to 2017.
The chart shows that the growth in NBV exceeded the growth in MV and that management has not increased the MV since 2013. This suggests that additions to existing property and/or new developments are the main drivers of growth as opposed to revaluation gains.
In this regard, I am quietly confident that the reported market values may even be conservative.
But plenty of conglomerates trade for less than the sum-of-their parts…
Yes, it’s true that many conglomerates trade at a discount to their sum-of-the-parts values. However, in SST’s case I believe there is also a clear earnings catalyst in the next 3-5 years which is likely to double its current earnings.
Let’s take a look at its past earnings and focus on SST’s underlying profits.
Underlying profit more than doubled between 2008 and 2012. The reason? PNG LNG. The PNG LNG project led by ExxonMobil was PNG’s first mega LNG project. Construction of the project began in 2010 when the size of the PNG economy was US$11.6 billion (source: Worldbank). It took four year and US$19 billion to complete the project. Given the size of the project relative to PNG’s economy at that time, the economy doubled from 2010 to 2014 during the project construction period. You can watch this video to understand the scale of this project.
SST benefited from the hive of activity during the construction period with both the hotel and logistics divisions enjoying high utilisation rates. Hotels and apartment rentals did well with the expatriate workers flying in and out of Port Moresby and the logistics division was busy with high levels of cargo and equipment being transported.
Isn’t that history?
PNG is endowed with gas fields which have low extraction cost. For example, the chart below shows the breakeven cost for PNG LNG project being lower than any Canadian or Australian gas project.
The PNG LNG has performed well since commencing operations and has consistently operated above its name plate facility of 6.9 million tonne p.a. (MTPA). So much so that its owners have recently agreed to expand the PNG LNG project which will see it doubling its output to 16 MTPA at a cost of US$13 billion (see Reuters’ report).
Part of this expansion also involves the development of another large gas field called Papua LNG (Elk-Antelope gas field) which is led by Total S.A. The gas resource for Papua LNG is 6.5tcf as compared with PNG LNG of 9tcf (prior to the recent upgrade).
All up, the owners plans to add three more LNG trains, with two underpinned by gas from Elk-Antelope and one underpinned by existing fields and a new P’nyang field operated by Exxon. The map below illustrates the location of these gas fields.
The expansion will result in a total LNG annual output of 16MTPA, slightly larger than Gorgon and equivalent to the North West Shelf in Australia. Asian LNG prices looked to have recovered from their 2016 lows which should provide good incentive for these projects to move ahead.
Once these projects kick-off (in the next 3-5 years), Steamships is well positioned to reap the benefits from its hospitality and logistics divisions and I foresee that profits can exceed the record underlying profit achieved in 2012.
In addition, the following large resource projects in PNG’s pipeline will also benefit Steamships if developed:
- Wafi-Golpu: Newcrest and Harmony JV copper-gold mine estimated to contain 20m oz of gold and 9.4m tonnes of copper.
- Frieda River: Copper-gold mine estimated to contain 19m oz gold and 12m tonnes of copper. This project is led by Guangdong Rising Asset Management, a Chinese state owned enterprise.
Other reasons I like Steamships:
Good professional management
I like Steamships’ management as they have been performed well and taken care of shareholder’s interest. For example, the company has not raised equity capital nor issued a single ordinary share going back as far as I can check to 2002, over the past 14 years Steamships has managed to pay a dividend every year and grew its net asset/ equity at a compound annual grow rate of 11%.
Bear in mind that the property assets make up a large proportion of assets and that the above growth rate is based on book value and not market value. Current market value of the properties is circa k$1 billion (based on the average of the market value range) above the book value so using the market value would result in the net asset’s growth rate exceeding 11%.
Growing property portfolio
Assuming that none of the resource projects get off the ground (which is extremely unlikely), the property development business should still be a value driver. Over the past 10 years the NBV of the property asset has grown by a CAGR of 13.4% (refer to above chart on growth in real estate’s NBV and MV). I understand that the company still has vacant land in good locations to develop.
The property portfolio represents by far the biggest fixed assets on the balance sheet. Out of a total of k$1,168 million of fixed assets in FY2017, the property assets make up k$736 million or 63% of the total value.
Why is Mr. Market undervaluing Steamships?
I think the first reason is the perceived economic risk of operating in PNG. The PNG government has been running a budget deficit for the last few years and government debt has currently increased to circa 30% of GDP (source: PWC PNG 2017 budget report). A current shortage of foreign currency is also causing significant economic problems for PNG’s economy which has arguably been in recession since 2015.
The budget deficit was caused by a significant overestimation of tax revenues from the PNG LNG project by the government. Tax revenues fell short because of subsequent collapse in LNG prices compounded with the generous concessions given by the government. One example of this is that the royalty payments are calculated based on a “well-head value” which allowed for deductions on repayments of the US$19 billion project loan, capital allowance and operating costs. Other tax concessions include a 10 year depreciation allowance, GST exemptions etc, royalties treated as advance payment of income tax. For more information, please refer to this Worldbank report on PNG.
Although the forecast revenue is currently falling short, as the loan and assets are amortised, more and more revenue should flow to the government. So I believe this shortfall in tax revenue to be temporary. Once material tax revenue starts rolling-in, this should alleviate the budget deficits. To give an idea of the size of the potential tax revenue, the 2013 national budget forecast k$2 billion in revenue to the government from this project. This would represent 17% of PNG government’s revenue in FY17.
The second is reason is well its PNG so there is a perception that it could end up a failed state ala Somalia/Yemen/Zimbabwe . I think that the chances of PNG blowing up like those countries is low for four reasons: 1) PNG’s society is very fragmented with more than 800 tribes; there are currently 20 political parties in parliament with the leading party only winning 27 out of the 111 parliamentary seats (not enough to form government). In fact no one party in PNG’s history has ever won enough seats to form government. Therefore I believe it is unlikely that a strongman leader will emerge that can maintain support amongst all the various groups long enough to ruin the country. 2) A common denominator of failed states is internal conflicts/ civil wars. Conflicts in PNG tend to be on a much smaller scale (possibly due to more numerous groups) than compared to say civil wars in some failed African or Middle Eastern countries which absolutely decimated those countries. 3) PNG has an independent judiciary; this is a rare among failed states. 4) If things really do go downhill, Australia is unlikely to sit idle as she can’t afford to have a humanitarian crisis at her doorstep.
The third reason is that some economists believe that the kina is 30% overvalued against the US$ even though the kina has devalued by 25% since June 2014. This may be true but I believe once the project revenue starts flowing and coupled with the new LNG projects, the currency should strengthen considerably over the longer term. At the same time the foreign currency shortage would also be resolved.
The fourth reason is that the stock has very low levels of liquidity and zero institutional following.
I believe this is a quality company currently trading below the market value of its net assets. The stock price is currently depressed due to the poor economic conditions currently being experienced in PNG that is affecting its earnings. However, Steamships’ earnings is likely to get a huge boost from the LNG projects coming on stream in the next 3-5 years given its leading positions in hospitality and logistics. This should see the stock exceed its high of $40 set in June 2014.