Suria Capital Holdings Bhd (KLSE:Suria): A Cheap, Conservatively FInanced Port Concession Operator
Writeup by Warwick Bagnall
www.oceaniavalue.com
Suria has some sell-side analyst coverage so I wouldn’t say it is a totally overlooked stock. But it has several features which make it a quick pass for many investors: top line revenue is up and down by >50% in many years (the company reluctantly books some capex as revenue), it is small (~116 MM USD market cap) and it is illiquid (~4% annual share turnover). You can’t buy more than a few thousand USD per day of stock without moving the price. Half of the float is owned by a controlling shareholder. Its shares are listed in a small country which isn’t covered by the more popular discount brokerages. Suria is not worth the hassle for most investors, even those that haven’t been turned off Malaysian businesses by Billion Dollar Whale.
For those who are not put off by Suria’s obscurity, this is a very robust business with reasonable growth prospects at a cheap price. Suria’s main business is operating the port concession for the eight ports in Sabah (the northern part of Borneo, part of Malaysia). And the controlling shareholder I mentioned above is the Sabah state government, who also happens to set the concession tariffs.
Main Business – Port Operations
Port operations provide the majority of Suria’s revenue and are the most predictable part of the business. The port operations concession was granted in 2003 for a period of 30 years with an option of a second 30 years. The concession allows Suria to charge tariffs on all ships loading or unloading cargo or passengers in Sabah waters based on various factors such as the tonnage handled, length of the ship, number of passengers etc.
In return, Suria pays the government a percentage of some of the tariffs charged and lease fees for land use. Suria originally paid MYR 210 MM to buy the concession and has also paid for long term leases of parcels of port land (more on that later).
Suria is obliged to spend MYR 1.363 billion in capital on upgrading port facilities over the duration of the concession. All bar about MYR 300 MM of this has been spent at the time of writing (December 2019). Government loans with interest rates around 4% and generous terms such as 10-year repayment holidays have formed much of the funding for the capital projects. The balance has been funded through Islamic debt with profit margins of 5.15 to 5.85%.
The tariffs and lease costs are set by the Sabah Ports Authority, a division of the government and are supposed to be reviewed every five years. They are under review at the time of writing. Strangely, it looks like the existing tariffs were set in the 1970s and this is the first time they have been escalated since then. This means employees (Suria’s main cash expense) consume about 5 percentage points more of revenue than they did 10 years ago. Despite that, Suria’s cash operating margins from port operations are the same as they were 10 years ago. The cash operating margin for port operations is also very consistent at slightly above 50%. The coefficient of variation is 0.04.
Except for cruise liner charges, Suria is only influenced by competition to the extent that goods to and from Sabah can be shipped through neighbouring ports. The probability of that happening currently is zero. Port tariffs are in the order of a few ringgit (around USD 1) per tonne. Roads in East Malaysia are terrible. Even with the planned Pan-Borneo highway there is such a large gap between road and sea transport costs that it would take a huge increase in tariffs before a shipper in Sabah considers shipping through one of the ports in neighbouring Sarawak or Brunei instead.
Some of Suria’s future capital spend is aimed at attracting trans-shipment revenue which would need to be competed away from other ports. There’s a reasonable possibility of success for that project but I wouldn’t count on it for valuation purposes.
The concession price and lease charges were determined using a DCF model to come up with a figure for a reasonable return to Suria at a price that was fair to the people of Sabah. There’s an interview on Youtube with the current managing director (Ng Kiat Min) where she discusses this – it’s worth watching. We don’t know all of the assumptions that were used to calculate the value of the concession. What we do know is the discount rate for valuing the concession assets prior to 2014, 11.5%. In recent years this figure has been omitted from Suria’s reporting but this is a useful insight into the state government’s concept of fairness. Having said that, the tariff increase is taking a long time and may be on hold until Sabah’s economy shows signs of improvement.
Suria’s return on invested capital and capital allocation for the port operations are complicated. To deal with this, I’m going to split the balance sheet into tangible assets, intangible concession assets and synthetic assets.
In terms of tangible assets, Suria has surprisingly few non-financial assets. There is around MYR 4 MM of motor vehicles, 1.7MM of storage and and 4.6 MM of fittings and office furniture. Suria has grown non-concession equity and generated dividends to shareholders equivalent to a return of CAGR 11.88% since 2005.
The intangible concession assets are the wharves, hardstand areas, buildings etc that need to be handed back at the end of the concession period. These assets make up around half of Suria’s balance sheet and are valued using a DCF. Suria has spent MYR 1.036 billion in concession capex since 2005. Most of that was required to upgrade the existing facilities and around 50% of that spend was just to move the container port from downtown Kota Kinabalu to Sapangar Bay.
Since 2005, port operations revenue has grown from MYR 146 MM to MYR 239 MM in 2018. However, you could argue that some or most of that revenue growth would have happened whether the port was upgraded or not as the existing wharves has spare capacity.
Furthermore, Suria is more closely aligned with the state government than most other port operators, even in Malaysia. I believe that part of the justification for allowing Suria some very unique concessions (synthetic assets, discussed later) is that some of the concession capex is speculative in terms of the growth in cargo volumes needed to justify the 10% IRR that Suria states as its capex project hurdle rate.
To give you an idea, here is an outline of Suria’s upcoming concession capex spend:
Sapangar Oil Jetty Expansion
Sapangar oil jetty mainly handles incoming refined oil products for the adjacent Petronas, Shell and Petron tank farms. Suria has already spent 45 MM to build 2 berths which handle a little over a million tonnes of product – their full capacity. Two more berths costing MYR 95 MM are planned. This will more than double the wharf capacity as the new wharf will handle vessels double the size of the current wharf. Growth in throughput for this wharf is driven by local growth in fuel usage. At the current tariff rates, liquid products generate an average of MYR 8.70 per tonne in wharfage and handling charges. Without discounting cash flows, and assuming 50% operating margins that means 22 million tonnes of extra petroleum volume needs to be imported to pay off the new wharf. At capacity, that will take 11 years. I don’t foresee a high ROIC for this project.
Sapangar General Cargo & Container Wharf Expansion
Suria has already spent 570MM to build four berths with capacity of 500,000 TEU and plans to build a further five berths to increase capacity to 1,250,000 TEU. There are also plans to build a 1.95 million tonne general cargo wharf at Sapangar by 2020 which will be increased to 2.83 million tonnes capacity by 2026. General cargo volumes are currently 1.164 million tonnes.
Revenue per TEU handled is around MYR 280. If we assume 50% GM then 4.1 million TEUs need to be handled to pay back the original project. If we further assume that all of the unaccounted for capex spend (MYR 232 MM) needs to be paid off through increased container volumes (not an unreasonable assumption if you consider that general cargo volumes through the existing port at Kota Kinabalu are not increasing) then a further 1.7 million TEUs of new volume will need to be handled to pay off the new general cargo and container berths at Sapangar. That’s less than a one-year payback at full capacity but it is likely to take many years to reach full capacity unless the new facility attracts significant trans-shipment volumes
A company which makes investment decisions solely on the merits of each individual project would probably build the container wharf expansion and not build the oil wharf expansion. It might build the general cargo wharf project to make room at Kota Kinabalu port for Suria’s cruise ship terminal project (see below) but more likely it would just exit the general cargo business. In return for compromising in this area, Suria has been given something to balance the score, the synthetic assets.
You won’t find the term “synthetic assets” in Suria’s reporting – that’s just what I call them. What you will find is very little discussion of the 10 million tonnes of crude oil that is exported from Sabah annually, generating around MYR 18 MM in gross profit for Suria. This oil is loaded into crude oil tankers at anchor at Kimanis, a port which Suria seems to have spent no money at. If you dig further, you will see that Suria can collect tariffs at any cargo facility in Sabah waters, even those that it does not operate. Only 10% of these charges need to be passed on to the government. Needless to say, the ROIC for this segment of the business is infinite.
In effect, Suria acts as a tax collector for the state government with some of the taxes passed directly to constructing infrastructure which should benefit Sabah in the long term. There is a long-running dispute between the state and federal governments regarding the quantum of royalties paid to Sabah for oil extracted within her waters. The port tariff system is one small way that the Sabah government can even the score on this issue. There is a balance though – Sabahans frequently complain that their cost of living is much higher than peninsular Malaysia. Thus port tariffs on imports can only increase at the same rate as local wages, maybe less. Tariffs on exports are a much more likely target for increases.
Growth Prospects – Port Operations
Sabah’s ports mainly handle petroleum, palm oil products and general freight. These are not large ports – Bintulu port (operated by KLSE:BIPORT) in neighbouring Sarawak handles a tonnage larger than the eight Sabah ports combined, mainly due to the LNG plant located there. The largest revenue earner for Suria is container handling (44% of 2018 revenue) followed by palm oil (19%) petroleum (15%) and general cargo (13%). Of these, container and petroleum tonnages are growing at low single digit rates whilst other commodities are flat and likely to stay that way. Palm oil plantation area is at its expected maximum. Sabah has sufficient petroleum reserves to cover maintain production at current rates for the rest of the concession period and the subsequent one.
Like the rest of Malaysia, Sabah’s economy is heavily dependant on palm oil and petroleum. Those commodities are depressed at the moment and you can see that reflected in Sabah’s GDP growth figures. If (when) commodity prices increase, I believe local GDP growth will significantly increase, dragging container and general cargo volumes with it. Sabah is one of the poorest states in Malaysia – provided commodity price increases make their way into the pockets of local workers there is plenty of room for improvements in living standards to drive growth. There is little in the way of manufacturing so container volumes are driven by domestic demand – 71% of the containers leaving the port are empty.
Side Businesses
Suria also has a property development division. Two JVs have been signed with developers for two parcels of land next to Kota Kinabalu port which were acquired as part of the concession deal. In total the JV agreements guarantee Suria a minimum of MYR 522 MM in income or 18% of the gross sales, whichever is larger. Not bad for an initial outlay of MYR 142.1 MM and a maximum project duration of 10 years, through to 2026. That gives a conservative ROIC of around 14% (some payments have been/will be received in less than the 10 year period of the entire project). The developer has provided the funds for construction and the first two towers of the development are more than 75% pre-sold.
One parcel of port land remains to be developed into a cruise ship terminal. This parcel will cost Suria MYR 48.48 MM, 50% of which has already been paid. Suria previously announced that the terminal will be funded by either debt or equity raising but they haven’t announced the scope of the project. To get an idea of the order of magnitude, MMC Corporation Bhd (KLSE:MMC) which operates the cruise ship terminal in Penang recently announced a MYR 155 MM redevelopment JV in conjunction with Royal Caribbean Cruises (NYSE:RCL). Penang receives around a million cruise ship passengers per year. Suria’s existing facility receives only 27,000. The most Suria has ever received is 148,000 in 2014 when Star Cruise Lines used Kota Kinabalu port as an operational base.
Suria operates a local ferry terminal that generates around MYR 1MM in annual operating profit and a bunkering/services division that earns money when higher oil prices bring offshore service vessels to the region and break even or lose a little money the rest of the time. None of these businesses earn a reasonable return on capital and the most important thing (seeing as I am valuing Suria based on earnings power) is that nothing more is invested in them. At the moment that seems to be the case.
The final side business is construction management. Suria has won contracts to construct a rail line upgrade and solar energy plant for the state government. No details are given on the final profit to be expected but the rail project is around 50% complete and showing a modest profit so far. This segment appears to tie up very little capital so I’m putting it down as having zero value until proven otherwise rather than being a negative.
Safety
Suria carries MYR 95 MM of debt, MYR 56 MM of cash and 66 MM of unlisted unit trust investments. The company could repay this from earnings in less than 1.5 years. Suria’s policy is to maintain a gearing ratio (net debt divided by net debt plus total capital) of less than 50%. The gearing ratio reached a high of 55% in 2012 and has been trending downwards since. It’s currently 10%. This is tiny in comparison to what it can service and miniscule compared to similar businesses. Jeff’s writeup on Sydney Airport provides a good comparison of what can be accomplished when leverage is enthusiastically applied to a concession business. All of Malaysia’s port concession operators carry a lot more debt than Suria on a debt-to-equity basis. Past behaviour suggests management uses leverage for project financing rather than as a way to boost ROE. Fiscally speaking this is a very safe business but not as capital efficient as it could be.
Management doesn’t have a large stake in the company. The CEO owns a small stake and I’m not sure if it was acquired using cash or via the employee share scheme which operated in 2015. Having said that, management’s remuneration is very reasonable and their history of decisions seems quite sensible. The only thing I don’t understand is the 1-for-5 bonus issue they made in 2018 – that seems like an odd thing to do if they may need to raise capital to fund the cruise terminal in the near future.
One management risk unique to Suria is their relationship with the state government. It is possible that they decide to embark on further concession capex in areas where the cargo volumes are speculative. The main thing that gives me comfort in this area is that there aren’t many possibilities for this type of spend except for further expansion of the Sapangar container facility.
The final risk that I want to mention is that of piracy and terrorism at three of the ports on the east coast of Sabah which are in close proximity to the southern Philippines. I’m mentioning this for completeness – it sounds like a big problem but in practice it has had little impact. For example, the largest incident was in 2013 when a group of 250 or so terrorists arrived by sea, took over a village near Lahad Datu and proceeded to kill people between Sandakan and Tawau as they tried to evade capture.
Many shipments were stuck on the dock for a couple of weeks (including one of mine) as the workers were too scared to go to work. The episode took several months to be cleaned up (including a major military campaign by the Malaysians) but if you look at Suria’s revenue you cannot see any impact. This is because there are no reasonable alternative routes for cargo in and out of Sabah. If you want to ship goods then you have to pay Suria, even if you have to put up with very delayed service.
Valuation
Following conventional accounting, Suria’s 2018 EPS was MYR 0.15 and the share price is currently around MYR 1.40. That EPS figure includes MYR 0.13 for amortisation of the concession asset and MYR 0.03 for impairment of a fertiliser loader that is no longer in use – owner earnings are more like MYR 0.26 per share. In comparison with the other listed port operators in Malaysia, Suria’s P/E of <8 (excluding the impairment) is cheap. Compared with concession businesses in general it is very cheap. If the only business Suria was ever going to have was the operation of the existing concession and that concession would need to be purchased anew in 2032 then P/E (or perhaps EV/EBIT) would be a reasonable valuation figure to use. However it assumes the second concession term will be purchased on similar terms and pricing to the first.
I’d prefer not to make that assumption. It’s simpler and less risky for me to come up with an expected worst case valuation by assuming:
- Owner earnings (operating cash flow less concession capex, less estimated maintenance capex, less tax) of around MYR188.5 MM (MYR 0.26/share) from port operations.
- Zero growth in owner earnings.
- The balance of the compulsory concession capex is spent by the end of 2022, as is the outstanding amount on the port land for development.
- Concession ends after 2032. No residual value of the assets after that time.
- No profits whatsoever from the side businesses.
- The existing amount of leverage is maintained and the existing non-concession assets are completely consumed to extinguish the existing debt.
Normally I don’t do DCFs because you need to make too many assumptions to price a business accurately. But here I am using some pretty conservative assumptions and a DCF makes it simpler to deal with the large but known costs for the concession capex.
At the current share price that gives me a yield to 2032 of around 8% if none of the earnings are re-invested. As I mentioned, that is my expected worst case. The absolute worst case for any business is it going to zero but I think the probability of Suria returning less than the above figure over the rest of the concession period is very low. There are some things that are likely to improve upon that return:
- Short of a major political change, Suria will continue to hold the concession after 2032. Based on the current deal, the new concession terms may be such that the company is able to achieve a return on investment which is slightly better than the market index but much safer.
- Suria’s owner earnings are likely to grow. Almost surely they will match inflation as container volumes increase and local wage growth facilitates tariff hikes. The 8% yield mentioned above is likely a real yield, not a nominal one.
- It’s likely that the property developments will produce a positive return, even if the return is less than that forecast due to an unexpected recession. If the minimum guaranteed revenue is achieved then this would result in around MYR 0.59 of after-tax income per share, spread over the period from now until 2026. I would like to think that Suria can find similarly attractive projects to re-invest the profits from these projects but it’s more likely these are distributed to shareholders.
- The bunkerage business is likely to return a positive profit if oil exploration and construction activities resume and the contracting business may have a positive return.
Suria should provide a running yield of at least 8% real (my DCF) or more likely 13% gross (EPS less impairments). Fairly priced, Suria should sell for at least MYR 2.60. I’m happy to buy it at the current price. The hard part would be deciding at what price to sell. That calculation should become easier once the property developments and container wharf expansion are complete.
Disclosure: The author owns shares in Suria at the time of writing. This is not a recommendation to buy or sell any securities, nor is it financial advice. All information presented is believed to be reliable and is for information purposes only. Do heaps of your own research before purchasing any security.