Is Hutchison Port Holdings Trust Currently Overvalued?

Hutchison Port Holdings Trust (SGX: NS8U), an owner of container ports in Hong Kong and China, is trading at US$0.545 as of the time of writing (11:17 am).

But, is Hutchison Port Holdings Trust really worth US$0.545 a unit? Asked another way, is the value of the trust on a per unit basis really around the neighbourhood of US$0.545?

The art of value

A business trust’s value should be a key deciding factor for investors when it comes to making an investing decision.

There are two main ways for investors to estimate the value of a business trust. One method works forward, in that an investor will try to estimate the growth rates that a business trust will achieve in important financial metrics like its distributions per unit, earnings per unit, or cash flow per unit.

The other works backward, in that we can look at a business trust’s current price and work out how much growth the market’s expecting the trust to achieve. From that, we can determine if the market’s expectations are reasonable or ridiculous.

Moving backwards

In this example, we’d be using a variant of a simple dividend discount model called the Gordon Growth Model to figure out how much growth the market’s expecting from Hutchison Port Holdings Trust’s future distributions.

A dividend discount model is meant to value a company based on the total amount of dividends that the firm would distribute to shareholders from now till perpetuity; the Gordon Growth Model simply adds in a factor to account for the future growth of a company’s dividends. The formula for the Gordon Growth Model is shown below:

Share Price = Expected Dividend Per Share One Year From Now / (Discount Rate – Dividend Growth Rate)

Hutchison Port Holdings Trust’s annual distribution per unit (DPU) for the fiscal year ended 31 December 2014 (FY2014) was HK$0.41, unchanged compared to a year ago. But, the trust’s DPU for the first-half of 2015 had dropped by 16% from a year ago. If we assume that the DPU for the whole of 2015 will also be 16% lower than that seen in 2014, then Hutchison Port Holdings Trust’s distribution for 2015 will be around HK$0.34 per unit.

As for the Discount Rate, the textbook method – which follows the Capital Asset Pricing Model (it’s perfectly acceptable to not follow the CAPM when trying to estimate the value of a stock, but I’d still use the model in here for the sake of completeness) – is to incorporate the risk-free rate as well as the beta of Hutchison Port Holdings Trust.

The risk-free rate is normally taken to be the 10-year government bond yield; currently, the yield on a 10-year Singapore government bond is around 2.7% and so, that shall be our risk-free rate.

Meanwhile, the beta of any stock is simply a measure of a stock’s volatility in relation to a broad market index; in Hutchison Port Holdings Trust’s case, data taken from investing research outfit Reuters has the beta figure pegged at 0.93.

With the explanations out of the way, here’s how the formula for the Discount Rate looks like:

Discount Rate = Risk Free Rate + Beta (Market Return – Risk Free Rate)

You’d notice that there’s one last variable in the Discount Rate formula which I have not discussed, and that is the Market Return.

The Market Return is simply the long-term return of the stock market as a whole. In this exercise, I’d be using the long-run return of the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI). Since its inception in April 2002, the SPDR STI ETF has generated a total annual return (inclusive of reinvested dividends) of 7.11%.

So, when we input all the relevant figures into the Discount Rate formula, we’d end up with a Discount Rate of 6.8% for Hutchison Port Holdings Trust.

The next thing we have to do now is to punch all the numbers we have obtained so far into the Gordon Growth Model. This is what we’d end up with:

0.545 = (0.34/7.75) / (0.068 – Dividend Growth Rate)

As you can see, the only variable now that’s now unknown in the Gordon Growth Model is Hutchison Port Holdings Trust’s future growth in distribution. After some basic arithmetic, we thus arrive at the conclusion that the market expects the trust’s distributions to shrink at an average pace of 1.25% per year over the long-term future.

So what’s the value?

We can then use the expected growth rate of (-1.25%) and compare it against our own assessment of what Hutchison Port Holdings Trust may be able to achieve. Over the past two years from 2012 to 2014, the trust’s DPU has fallen at an alarming rate of 10.5% per year on average.

So, based on all the above assumptions, if you expect Hutchison Port Holdings Trust to be able to grow its distributions at a faster clip than (-1.25%) annually, the trust will be undervalued at US$0.545. But, if you’re not confident at all about Hutchison Port Holdings Trust’s growth and think that its future distributions will decline at an even steeper pace, then US$0.545 might be too high a price to pay.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any companies mentioned.