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(0357.HK HK$ 5.90) March 7, 2012
March 7, 2012
Shares Out: 473.2M
Market Cap: HK$ 2,806.15
Concept: 1. Monopoly business trading at 6.31x consensus 2012 FCF and 1.1x TBV 2. Privileged business model with best-in-breed operating margins 3. Increased passenger traffic should add meaningfully to earnings 4. Current dividend yield of 6.2% provides downside protection 5. Merger with HNA Airport is a catalyst – should result in meaningful rerating Summary: Hainan Meilan International Airport Company Limited (HMIA) is a leading airport operator in the People’s Republic of China (PRC). HMIA currently trades at ~ 6x trailing EBITDA and a 35-60% discount to peers Beijing Capital International Airport Co. Ltd. (SEHK: 694) and Shanghai International Airport Co., Ltd. (SHSE: 600009). The stock is cheap because Hainan is a leisure island reliant on inbound domestic tourists and Haikou is currently regarded as a secondary city. In addition, HMIA has been losing market share to Sanya Phoenix Airport (Sanya), especially after the competitor completed its expansion in 2007. Sanya is located on the southern tip of Hainan Island and is closer to tourist hotspots. In 2010, HMIA announced it was buying out Sanya. I believe the acquisition is accretive and would do a great deal to integrate the two networks and smooth out competition issues. Post-acquisition, HMIA will monopolize air traffic in and out of Hainan Island, giving the company significant pricing power in terms of negotiating landing and franchise fees. Both the Haikou Meilan and Sanya are controlled by the same entity, Hainan Airlines Group Co. Ltd, which also owns a number of smaller regional airports. As the company is the sole listing platform for the group’s airport interests, I believe that the probability that other related assets may be injected into the listed company, including Sanya, is extremely high. Additionally, the acquisition of HNA Airport can result in a meaningful rerating of the stock as HMIA comes to be viewed as a regional airport company, rather than a secondary destination. I also see a meaningful increase in tourist volumes to the island. In 2010, the State Council announced that Hainan Province would be developed into an International Tourism Island. The measures introduced as a result encompass providing tax rebates for Chinese citizens, instituting more generous visitor visa policies, and the opening up of international air routes. The consensus analyst projection for annual traffic growth to Hainan following the introduction of these measures is 9%, while passenger throughput and cargo tonnage for the Chinese market is forecast to grow at a rate of 7.4% per year over the next 20 years . My model assumes an average annual growth in passenger throughput from 2012 – 2017 of 7.9%. Airports are predominantly fixed-cost businesses. The majority of expenses link to the cost of operating and maintaining fixed assets, such as runways and terminals, rather than traffic volumes. Consequently, as traffic grows, I
1 A forecast made by Boeing. http://www.boeing.com/companyoffices/aboutus/
enjoying about 30 percent off regular prices is significant. Historically. in CY2010. Social safety nets play a key role in consumption.2% to 5. 2012 and 2013 respectively. If investors are willing to look through the short –term risks. to a level that would justify the purchase of HMIA shares at the current valuation. As outlined in detail below.15x TBV. notes that China’s middle class (incomes of $8. I expect that as the government upgrades the provision of pension. health insurance. HMIA’s debt ratio. China's 12th Five-Year Plan: Consumer Markets . while the Hang Seng Composite Mid Cap Index fell 27% . HMIA has $553. I estimate FCF to be RMB0.23.000) is projected to rise from 135 million to over 200 million by 2015. much of it was used to acquire a 24. I project an average 300-400 bp improvement in EBITDA margins between FY2012 and FY2016 from the FY2010 margin of 50. This rise can be supported not only by liquidation of China’s huge stock of domestic savings (China’s household sector holds the equivalent of the combined GDP’s of Brazil. Following the acquisition of the remaining 30% stake for RMB 1. resulting in improved EBITDA margins. However.9M. will rise.67M in cash and no borrowings under its lines of credit. Using a conservative estimate of RMB 57M for capex in FY2011 and 2012 (which takes into account the increased spending to expand capacity in international terminal and west-side passage at Meilan). I am concerned about deterioration in the quality of HMIA’s balance sheet post the HNA airport acquisition. at a minimum.000 . which is far less credit and resource intensive. The cornerstone of the new 5-year plan introduced by the National People’s Congress is boosting consumer spending . HMIA is expected to generate healthy cash flows. HMIA should benefit from several long-term trends. Investing in companies that specifically serve domestic demand such as HMIA (97% of FY2011 arrivals were Chinese nationals) is an effective way to exploit this opportunity. One of the key parts of my thesis is the ability of the company to increase revenues from non-aeronautical activities.5x versus a mean of 3. which currently comprise only 32. trading at 6x consensus 2012 FCF. India and Russia in bank deposits) but also rapid productivity and personal income growth. while total debt to trailing EBITDA stood at 1.65% lower versus 1H10 figures.16% as at end-2009. and 1.1x for a peer group of 25 global airport management companies.expect HMIA to demonstrate increases in productivity against its fixed-cost basis.4% of HMIA revenues. The National Bureau of Statistics of China states that tax-free shopping could increase Hainan’s annual tourist traffic by 20%-25%. I recognize the significant near-term risk of a deceleration in Chinese GDP as plunging fixed income investment overwhelms less cyclical consumption. public education. April 2011. the island’s first airport duty-free mall opened in Meilan Airport in 2011 and average daily turnover is set to exceed RMB 6 million. combined with a dividend yield of 6.28 in FY2010. and consumption per person by 15%-20%. Following the announcement of the new tax regime. The low valuation.2%. Total debt at end-1H11 was 467. should provide investors with considerable downside 2 2 KPMG. Establishment of the citizen tax exemption policy. would increase to 43.April 2011 . excise taxes and business taxes. McKinsey and Co.28%. 5. management is attacking operating margin “leaks” by reducing the size of its workforce through increased automation and franchising secondary activities such as advertising and parking.1%. calculated as total liabilities over total assets. China’s 12th Five-Year Plan.5% stake in HNA Airport for RMB 989M. I believe the company can sustain such a debt level. and Taiwan in the latter half of the 20th century). Actual per share FCF was RMB 0.43 and 0. Currently. Korea. HMIA shares are inexpensive. which allows tourists to claim rebates on customs duties.the Shanghai SE Composite declined 20. Chinese consumer spending will increase.2%. As fixed investment in the mainland slows. with the intensive liquidation of Chinese stocks in 2011 . As passenger throughput and revenues from non-aeronautical activities increase. 50% of Chinese purchases of high-end luxury items were made overseas.4X EBITDA. In 1H11 employee benefit costs were 19.$30.90% versus a debt ratio of 6. HMIA’s sales should grow and its margins increase.211M via a proposed A-share listing in Shanghai. RMB 0. While HMIA had net cash of RMB 935M as at end2010. However.I believe the market has priced in this risk. Additionally. Considering that interest rates on borrowing in H1FY2011 ranged from 3. and affordable housing (as occurred in Japan.52 in 2011. HMIA’s balance sheet has been fortress-like. HMIA is generating solid free cash flow. and that given HMIA’s business model little or no capital is tied up in inventory. domestic consumption.
4%. Using a mid-cycle P/B ratio of 1.6x. ground handling services and passenger services. car parking. we have used a DCF valuation to establish a target price of $10.8% respectively compared to FY2010. Eligible tourists can claim rebates on customs duties.whatsonsanya. while aircraft movement and cargo volumes increased by 10. In FY2011. According to HMIA announcements.000 sq. Company Background: Hainan Meilan International Airport Company operates the airport terminal and associated facilities at the international airport located 15 km outside Haikou. tourism services. Our price target implies potential upside of 78% in a 24-month period. and its terminal building. The airport began operations in 1999. Hainan citizens and foreigners) above 18 years of age leaving Hainan province. and cargo volumes – even during the global economic crisis of 2008 and the H1N1 outbreak of 2009. Its non-aeronautical businesses include leasing of commercial and retail spaces. However. located on the same latitude as Hawaii. The accretive acquisition of HNA Airport could also meaningfully improve results and lead to a rerating of the stock as HMIA multiples mirror those of regional airport companies. At HKD$5.90. the provincial capital of Hainan province in South China. Discussion: 1. I value the combined company at HK$ 11. advertising.9%.protection. a P/FCF multiple of 9.55 for HMIA shares. The program is applicable for all persons (including China domestic tourist. cargo handling and the sale of duty-free goods.5x.5 implies a post-acquisition price of HK$ 11. The company is engaged in both aeronautical and non-aeronautical businesses.6% of revenues and non-aeronautical services accounted for the remaining 32. http://www. The following key measures aimed at increasing travel to the island are expected to increase passenger throughput to the island’s two major airports to 50 million passengers by 2020 . Nationwide the airport is ranked 19th in terms of passenger and cargo throughput. passenger volumes increased by 15. the number of tourists traveling to Hainan is set to surge after the State Council approved measures in 2009 to promote the island as an international tourist destination. pro-forma end-2009 book value post-acquisition is RMB 5. franchising of airport related business. and lastly. the risk reward profile seems attractive. These multiples are all below the average of HMIA’s competitors. Based on our 2013 estimates. aircraft movement. and a P/TBV of 1.3% and 9.60. Total revenue was RMB 453M in FY 2010 (January 2011). excise taxes and 3 Passenger volumes at Hainan's two airports hit 10 million in 2011. The aeronautical business of the Company consists of the providing terminal facilities. HMIA could generate substantial cash (and reduce debt) through the increases in non-aeronautical revenue largely due to the tax rebates introduced in 2011. There are numerous ways in which HMIA investors could win: increasing traffic should lead to both higher earnings and a higher multiple. we can estimate the value of the combined entity using its P/B ratios versus a peer group of global airports. our target price implies an EV/EBITDA multiple of 8x. with a floor area of 399.30 (HK$ 7. Its runways can accommodate airplanes as large as the B747-400.74). and 18th in terms aircraft movement in 2011. of which aeronautical services accounted for 67. 29 Dec 2011. The airport has seen strong growth in all three revenue drivers– passenger throughput. While we do not have enough information on privately held HNA Airport to use a discounted cash flow approach.6 million passengers per year. Current prices do not reflect the potential for the company to benefit from an increase of tourist traffic to Hainan.60.com/news-19456-passenger-volumes-at-hainan-stwo-airports-hit-10-million-in-2011. 3 • Establishment of the citizen tax exemption policy in April 2011. Following the acquisition of HNA Airport. Hainan is China’s only tropical island.html . The airport has seen rapid growth in passenger and cargo throughput in recent years. As I detail in the report. I prefer to use P/B ratios instead of P/Es because any earnings approach is distorted by different positions of airports in their capex cycle. meters can handle 9.
such as runways and terminals. 2.4% of HMIA revenues. such as jewelry. HMIA has purchased a 24. http://news. an affiliate of HMIA.chinamedia. Current rules stipulate that tour members coming from 21 approved countries with at least five members may be granted 15-day visas upon arrival.S.business taxes. watches. Since the approval the Freedom III. and intends to purchase a 30% stake in HNA Airport from HNA Group. December 23. and V traffic rights by the Civil Aviation Administration of China (CAAC) in 2003.com/news . The majority of expenses link to the cost of operating and maintaining fixed assets. international flights and passenger numbers on the island have increased considerably. Chinese holidayers splurge on luxury goods overseas. perfumes. Hainan Opens An Offshore Duty-Free Shop at Meilan Airport. 5 4 • More favorable visitor visa policies. which currently comprise only 32.2B. 06 Feb 2012.57% y/y .com/english/china/2012-02/06 5 China News Center. and clothing. that the number of approved countries be raised to 26. as traffic grows. handicrafts. enjoying about 30 percent off regular prices. along with permitted stays of up to 30 days. according to a report released by the World Luxury Association Chinese consumers spent 7. dollars on luxury goods overseas during the new year holiday. 50% of Chinese purchases of high-end luxury items was made overseas. To authorize more international air routes as a means of attracting as greater number of foreign tourists. rather than traffic volumes.in 2010. • • Airports are predominantly fixed-cost businesses.5% stake in HNA Airport for RMB 2. Figure 1 Shareholding structure of HNA Airport before the transaction Source HMIA announcement Figure 2 Shareholding structure of HNA Airport after the transaction Source HMIA announcement 4 Biz China Weekly Issue No. and consumption per person by 15%-20%. cosmetics. 31. In 2010.2 billion U. a third party.xinhuanet. 2011. resulting in improved EBITDA margins. One of the key parts of our thesis is the ability of the company to increase revenues from non-aeronautical activities. IV. by acquiring a 54. Additionally. HMIA announced its intention to buy out its only competitor the Sanya Phoenix Airport (Sanya). The island’s first airport duty-free mall opened in Meilan Airport in 2011 and average daily turnover is set to exceed RMB 6 million . http://www. Investment in infrastructure. The rebates are a significant development . The National Bureau of Statistics of China states that tax-free shopping could increase Hainan’s annual tourist traffic by 20%-25%. It has been proposed that this be extended to groups of as few as two members. The program covers imported goods in a total of 18 categories. an increase of 28.5% stake from Kingward. Consequently. I expect HMIA to demonstrate increases in productivity against its fixed-cost basis. To date. following an A-share offering.
5% of Sanya. an airport less than 200 kilometers away from Meilan Airport. Following the A-share offering.1x FY2009 book value and 21x FY 2009 earnings – to be cheap. while the Hang Seng Composite Mid Cap Index fell 27% . the combined entity should deliver higher operating profit overall due to increased traffic. According to HMIA announcements and based on FY2009 figures.0 3. but no operating margin improvement. Return on assets and equity are expected to fall 5% and 2% respectively.0 PB 2. HMIA will become the controller of HNA Airport Group. will allow HMIA to resolve the horizontal competition issue of “one island. giving the company significant pricing power in terms of negotiating landing and franchise fees. Though Meilan Airport used to be one of the ten largest airports in the PRC.com . However. Wuhan.delayed the planned issue of 200M new A shares and HMIA’s acquisition of an additional 30% of HNA Airport. the Civil Aviation Administration of China (CAAC) laid out the strategic direction of national airport network based on three national airline hubs (Beijing.8 20. eight PRC airports. Shanghai and Guangzhou) and six regional airline hubs (Shenyang. the price did represent a discount to that of many PRC-listed airports prevailing as of May 7. While I do not consider the acquisition price – 1. wholly or in part. HNA Airport looks highly geared versus HMIA.5 18. HNA Airport owns.6 36. Hubs – major airports that serve as feeders for smaller regional airports – tend to be the most profitable airports primarily because hubs command premium prices for landing fees and attract quality tenants to occupy terminal space . 2010.the Shanghai SE Composite declined 20.6 2. These airports have lower profitability than Sanya and HMIA. it was not selected as one of the airline hubs. The US Airport Hierarchy and Implications for Small Communities.0 1. Thus. The acquisition is significant because in 2009. I view the acquisition as positive. 6 Hainan Meilan International Airport H’ Beijing Capital International Airport H’ Shanghai International Airport A’ Guangzhou Baiyun International Airport A’ Shenzen Airport A’ Xiamen International Airport A’ PE 26.2 68. Based on the announcement. Besides effectively controlling 36. acquiring Sanya.4 19. HMIA will gain access to seven other airports. with substantial traffic growth potential. Total assets are expected to increase by 375%. Sanya is the largest airport owned by HNA Airport and accounts for over half of HNA’s total earnings and net assets.4 1. the largest being Lanzhou Zhongchuan Airport in the capital city of Gansu province and Yichang Sanxia Airport near the Three Gorges Dam tourist destination. respectively.and third-tier. due likely to higher finance costs incurred by HNA Airport versus HMIA. on a pro-forma basis. Xi’an.sagepub. This is offset by higher unit cost. Chengdu.9 The intensive liquidation of Chinese stocks in 2011 . shareholders’ equity is expected to double post-acquisition. two airports” and reduce the effects of the diversion of traffic volume by Sanya. The remaining seven airports are second.2%. the HNA 6 Aisling Reynolds – Feighan. their combined passenger throughput and aircraft movement grew 30% and 22% y-o-y. as HNA Airport has lower returns than HMIA. on a pro-forma basis. Meanwhile. In addition to benefiting from economies of scale. the acquisition would raise HMIA’s operating profit by 155% and net profit by 58%. net profit is expected to fall 9ppt. I believe the merger will be successfully completed since both the Hainan Meilan and Sanya airports are controlled by the same entity. However. August 2008. HNA Airport has higher revenue per passenger than HMIA. http://usj. HMIA will monopolize air traffic in and out of Hainan Island. This decision would have limited HMIA’s ability to grow organically.Post-acquisition.8 2. Kunming and Urumchi).
This represents an earnings drag for HMIA.6. Wall Street Journal.30 (HK$ 7. most notably in the Middle East and China.5 implies a postacquisition price of HK$ 11. • State assistance helped HMIA earn net margins of 50. Recent BRIC underperformance Asian and Brazilian markets have traded poorly for the past eighteen months. Sanya. China’s household sector holds the equivalent of the combined GDP’s of Brazil.74). 7 7 Natasha Brereton-Fukui. increasing tax rates to 25%.3 billion in bonds in the first two weeks of 2012.5% . A cooling off in Chinese real estate is equity bullish.Group. These policies usually work in China. Bond issuance by countries in Asia and Latin America is finding far better reception than that of the developed nations. 2012. tourism and economic development. Using a mid-cycle P/B ratio of 1. I believe. and into wider employment through increased business opportunities. However. 3.8% in FY2010. I prefer to use P/B ratios instead of P/Es because any earnings approach is distorted by different positions of airports in their capex cycle. Governments. the State Council decided to extend the levy to 31 December 2015. Asset-based Valuation of HMIA Post-acquisition While we do not have enough information on privately held HNA Airport to use a discounted cash flow approach. http://online. however. To me. this tax reduction period will expire in January 2014.2% to 5. the true source of sovereign risk is being reevaluated. Airport management companies are capital intensive and returns on capital tend to be highest for companies that receive government assistance.wsj. Besides the ability to borrow cheaply from provincial banks – interest rates on bank borrowing in H1FY2011 ranged from 3. These benefits outweigh small returns on capital available for national governments. 4. pro-forma end-2009 book value post-acquisition is RMB 5. are launching mutual and exchange traded funds in the growing market for Yuan denominated bonds. Reversal of Fortunes in Debt Market. Additionally. In H1FY2011. Emerging government entities sold $11. Indonesia and the municipality of Shanghai can regularly access the credit markets. HMIA benefits from a preferential tax rate of 11%. the highest in its peer group of 25 global airport management companies. have been willing to subsidize the development of airports since the benefits to a country of well-developed airports extend beyond airport revenue. • The Ministry of Finance levies airport fees of RMB50 per domestic and RMB70 per international ticket with 48% of the fees going directly to subsidize growth at first tier airports such as HMIA and the balance used to finance secondary airports and air traffic control development.1% . India and Russia in bank deposits. and even smaller issuers like the Philippines. will continue to benefit from the 50% tax reduction until January 2017. under the new EIT law. but this should change as their central banks inject liquidity into their banks.com/article . Investing in China – A top down perspective. Moreover. this signals that the investment is beginning to flow back to emerging markets. Large global investment managers such as Blackrock Inc. My model takes into account both changes in the enterprise tax rate and the airport fee regime. January 12. government policy makers have proposed market friendly reforms such as investing state pension assets in stocks. we can estimate the value of the combined entity using its P/B ratios versus a peer group of global airports.HMIA benefits from government assistance in the following forms. In late 2010. Airport fees constituted 20% of revenues. According to HMIA announcements. Brazil just sold a $750 million global bond issue at 3.
gmo.9M hits). utilities and capital depreciation charges. based on FY2009 numbers. 6. Secular trend in domestic consumption I believe one of the most compelling investment opportunities over the next few years is likely to be in companies that serve domestic demand within emerging markets. Gersch. The value of China’s emerging middle class. in our view. in my opinion.mckinseyquarterly. is the significant capital expenditure outlay required to increase capacity at Sanya by 2013/2014. such as terminals. http://www. No discussion of Chinese stocks today is complete without addressing the issue of financial statement fraud (a Google search of the term RTO fraud returned 2. Once in that range. As poor countries get richer. 2011. While we have insufficient data on privately held HNA Airport to precisely model the dilution. However.com/America/GMOInsights 10 Bloomberg News. while 11 10 9 8 8 Diana Farrell. McKinsey Quarterly.bloomberg. Obviously.zerohedge. and Sky People Fruit Juice – which claimed to own the largest Kiwi fruit plantation in Asia. https://www.which overstated its Yunnan timber investments by approximately $900 million . China’s economy cannot continue to grow debt at recent rates and government will be called upon to recapitalize the nation’s banks. Savings rates usually rise until countries reach a range of $3. The Sanya acquisition is likely a short-term negative due to EPS dilution. the expansion of facilities. The biggest negative.com 9 Arjun Divecha. GMO Insights. Extend Lead. The designed capacity of the Meilan terminal is 9. indicates a base case post-acquisition dilution of 13. and Elizabeth Stephenson. a study of the more prominent frauds such as SinoForest . For example. results in an increase in costs that include labor. I believe that the world is in the midst of a massive shift in demand from the developed world to emerging markets. notes that China’s middle class (incomes of $8. Markets rarely anticipate this kind of non-linear growth. 2012.6M passengers per year. Once capacity constraints are reached. John Paulson Could Lose Up To $650 Million On Latest Alleged Chinese Fraud. Domestic consumption is far less credit and resource intensive. http://www. savings rates begin to decline and consumption becomes a larger part of GDP growth as society starts to provide a social safety net. capacity of the international terminal and west-side passage at Meilan will also have to be significantly expanded.000) is projected to rise from 135 million to over 200 million by 2015 .$30. maintenance.7% on reported earnings. 5.com/news 11 Zero Hedge. It can be supported not only by liquidation of China’s huge stock of domestic savings but also rapid productivity and personal income growth. June 2006. Additionally. Capturing Domestic Demand in Emerging Markets Neither Small Caps Nor Multinationals Are a Good Proxy. they save as much as they can.000 during the past decade. Jan 10. However.000 per capita GDP . Further strengthening the economic case is a shift in demographics: a record number of people are coming into their earning years in emerging markets at the same time that baby boomers are starting to retire in the developed world.There are a number of risks to an investment in HMIA.com/article . http://www. while Chinese per capita GDP quadrupled from $1. Fifty percent of all emerging markets (by market capitalization) are now in this sweet spot of shifting from savings to consumption.McKinsey and Co.000 to $10. As a result. per capita consumption of all goods and services rises in a highly non-linear fashion. auto sales rose from one million vehicles per year to over 17 million .000 to $4. China 2010 Auto Sales Reach 18 Million. Jan 4. Ulrich A. the market is pricing in a far too severe growth slowdown. At this level of wealth.000 . proforma EPS numbers released by HMIA.
1% to RMB289. Additionally.3% in 1H11 vs. Capital IQ AFTER MERGER Shares (m) 238 94 36 9 96 200 473 % 35% 14% 5% 1% 14% 30% 100% 7.5x on a TTM basis. Finally.8M.1% vs. they do significantly reduce the probability that HMIA is a fraud.caac. Most fraudulent Chinese companies misrepresented the size of their productive assets. reported data on passenger throughput and aircraft movement can be verified with the Civil Aviation Administration of China (CAAC) .7M. For the first half of FY 2011. Gross margin increased to 62. This compares with RMB 243. and the data appear to be consistent with HMIA filings.4% to RMB 26. 12 Roddy Boyd. free cash flow was RMB110. HMIA has paid a dividend every year since it listed its H shares in 2003.3% y/y at RMB 6M. reveals a common thread. while cargo throughput increased 2.05M.gov. 13 12 BEFORE MERGER Shares (m) % Parent 238 50% Oriental Patron Financial Group 94 20% UBS 36 8% Other long-term investors 9 2% Other H-shareholders 96 20% A .thefinancialinvestigator.1% in the prior year. 60. EBIT increased 16. revenue increased by 10.cn/English/Data . or $0.7M. Sky People And The Case Of The Disappearing Documents. Passenger throughput increased 6. Net interest expense and other income were up 54.4%. debt was RMB 475.7% y/y. SG&A was flat y/y at 10. I failed to find a single Chinese company reported as being an RTO fraud that paid dividends consistently.5M compared to RMB -736. At 6/30/11.1M. http://www. Book value was per share. while sales from ground handling services increased 11. ended June 30 (1H11). +41% y/y.3% to RMB 80.1%. cash was RMB 553.9% y/y. Net debt was RMB -78. Total debt/EBITDA was 1. How They Do It: The White Shoe Lawyers. Shareholding Structure Before and After the A-share issue Source. Further. HMIA announcement. long-term institutional shareholders control most of the free float.documents filed with the State Administration of Industry and Commerce (SAIC) revealed the company to be 10% of the size stated in its SEC filings .23 per share.2M.com 13 http://www. which were often difficult to verify. As a % of sales.2M.55 in 1H11. After applying a normalized tax rate of 12. EPS was RMB 0. due partly to promotional measures established in 2010 by the provincial government.5% and dividing by average shares of 473.2M. Recent results In the most recent interim report. largely due to the debt accumulated to acquire the 24% stake in HNA Airport from Kingward.0% to RMB 30M.52 in the first half of 2010. The EBIT margin was 55. Revenue from aircraft movement fees increased 8. SG&A increased 1.2M.5% y/y to RMB 159. We note that the first fiscal semi-annual reporting period is not a seasonally strong period for HMIA.7M at 6/30/10.8% to RMB 24. Revenue from passenger charges increased 14. 52.6M or $0.Shareholders 0 0% Total 473 100% Table 2. While the quality of reporting by Chinese mid-caps and small caps does leave much room for improvement and none of the mitigants stated above definitively preclude financial statement manipulation. HMIA’s productive assets consist of the Hainan Meilan and Sanya airports.
FCF would be RMB 206. an increase of 17.4%. HMIA shares appear to be inexpensive based on several valuation metrics. 2012). These increases are driven by the reduced diversionary effect of Sanya capacity expansion and a y/y increase in nonaeronautical revenue of 10. especially as the ranks of the Chinese middle-class grow. primarily driven by increased passenger throughput offsetting a slightly higher overall marketing spend. and the proposed merger has received shareholder approval.8. we expect EBIT margins to remain steady in the 49.5% rate.01% vs.17M. I also believe that the probability of the merger going through is extremely high. Subtracting tax at a 12.17.9% .3M. essentially flat y/y. For FY 2013. This would result in EBIT of $417. These increases are driven by the fact that Sanya has reached its terminal capacity and diversionary pressures should be minimized until capacity expansions are completed in 2014.9% margin in 2012. 31.4% range (my model includes a 300bp drag in FY2012 from expanding capacity at Hainan) compared to 50. a slight increase y/y largely due to fixed-cost leverage.9M (flat y/y) to arrive at a pretax income of RMB 275. while revenues from aircraft movements and cargo throughput revenue increases by 10.2%. I recognize that HMIA trades at a discount to peers for valid reasons – Hainan is a leisure island heavily reliant inbound domestic tourists and Haikou is currently regarded as a secondary city.tax incentives and other promotional efforts to market Hainan as an international tourist destination will lead to increases in inbound traffic over the long-term. we arrive at net income of RMB 147.2% to RMB 131. our assumptions are as follows: Total revenue increases 17. HMIA is undervalued both on a relative and absolute basis.44 in 2012. 94M respectively.9M. HMIA trades at 6. or a 49. For 2012.6M. Our gross margin remains flat largely because we do not envisage any increase in airport and logistic service fees in 2012. Financial assumptions For FY 2012 (ended Dec.4% to RMB117.49. the rollout of duty-free stores appears to be on track.7M. As we detailed in the report.7M or RMB 0. while revenue from aircraft movement and cargo throughput should increase by 5. I believe that HMIA will be able to grow traffic meaningfully due to the heavy promotional efforts of the provincial government. 11.0% to RMB 662. Barring a severe downturn in the domestic economy.86M and RMB 67. we estimate a consolidated gross margin of 85. I also believe that the HMIA is favored by certain secular tailwinds .2M. However. and should add substantially to the top-line. I think these forecasts are readily achievable if not conservative. Average shares should be flat y/y. Based on estimated capex of RMB 62.6M and RMB 76.4% to RMB 192.3% margin compared a 49.3M. the HNA group. 85. or RMB 0. A current .31x consensus FCF for 2012.6% to RMB 779.1% and 6.1x TBV and 5. Both Hainan Meilan and Sanya are controlled by the same parent entity.1M.6% y/y. Next we subtract net interest expense of RMB 184. Based on expected capex of RMB 53M. We have modeled a drag of 300400bp from the ramp up in utility and repair and maintenance expenses given the capex cycle of HMIA.4M or RMB 0.9M or a 49.9M. I think the risk reward equation for HMIA is attractive.1% to RMB 229.9M.8% in the most recent 12-month period. Revenue from passenger charges should increase by 8. Average shares should be flat y/y. Revenues from passenger charges should increase by 17. +57% y/y.6M. FCF would be RMB 239. Next we subtract net interest expense of RMB 185.82% margin in 2011. Next we estimate SG&A to be RMB 53M. however. we arrive at net income of RMB 231M.0% and 6. our assumptions are as follows: Total revenue increases 14. This results in EBIT of RMB 330.43x 2012 consensus EBITDA. or RMB 0.31.5% rate.6M (up 180% y/y given the reduction in cash and increase in debt incurred to acquire the 24% stake in HNA Airport) to arrive at a pretax income of RMB 183. For 2013.53. or a 53. Most importantly.50 in 2013.60% in 2011. we estimate a consolidated gross margin of 87.94% margin compared to RMB 288. The shares also are valued at 1. HMIA’s PRC-listed peers have margins in the 30% range. Subtracting tax at a 12. I believe that the acquisition of HNA Airport can result in a meaningful rerating of the stock as HMIA comes to be viewed as a regional airport company. Next we estimate SG&A to be RMB 62.
Thus. Using our 2012 forecasts.2% in addition to the relatively low valuation should provide investors with downside protection.8%. It is important to point out that PBY operates in a seasonal business in which 2H results are typically greater than those achieved during the 1H period. This implies a total return of 78.55 based on a DCF valuation for HMIA.dividend yield of 6. Financial Models . 12. we have established a price target of HK$10. PBY shares could potentially be volatile during the seasonally weak first half of FY 2012.