In the grand chessboard of international trade, ports serve as essential moves, firmly rooted at the confluence of land and sea, and are the core hubs of the global logistics chain.

In the current complex and volatile economic environment, with the rising trend of trade protectionism, what investment potential and risks do port stocks, represented by Shanghai International Port Group (600018), truly hold?

Let's explore this together.

Chapter One: Analysis of Financial Fundamentals

Shanghai International Port Group maintains a low debt ratio, consistently around 30-40% in recent years (31% in Q3 2024), which is notably different from other state-owned heavy asset stocks.

Although the debt ratio is low, this is mainly due to vast non-current assetsIn terms of interest-bearing loans and income-generating funds, they are on a comparable scaleConsequently, Shanghai Port’s annual interest payments can exceed hundreds of millions, with past financial expenses accounting for approximately 1.9% of revenues (narrowed to around 1% in 2024).

Such stocks typically exhibit excellent operational cash flowShanghai Port's cash collection from sales and services exceeds its revenue by over one fold, with net operating cash flow roughly equivalent to net profitThis aspect is straightforward, as the business model dictates everything.

Receivables amounting to over 4 billion represent about 11% of annual revenue, with aging mostly within a year

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The scale of receivables has remained relatively steady over the years, hovering around 3 billion.

(2) Non-current Asset Situation

Shanghai Port Group has over 150 billion in non-current assets, with significant entries including: long-term equity investments (80.9 billion), other non-current financial assets (4.2 billion), investment properties (5 billion), fixed assets (38.2 billion), ongoing construction projects (5.6 billion), intangible assets (13.6 billion), and long-term prepaid expenses (4.3 billion). This reveals its asset structure characteristics.

1. Long-term equity investments mainly focus on two areas: one involves joint ventures related to the industry, such as shipping, warehousing, and container logistics companies; the other involves financial associates, including Postal Savings and Shanghai Bank, etc.

Consequently, Shanghai Port Group generates substantial returns on investments annually (7.1 billion in 2023, 12 billion in 2022), constituting over 40% of total profit.

2. Other non-current financial assets primarily consist of fund investments (86%), with a small portion in listed and non-listed equity investmentsThe value fluctuations in this asset category can impact the profit and loss statement, presenting a risk exposure.

From the above, it is evident that Shanghai Port Group's equity investments are overly weighted, lacking some fixed-income financial products, resulting in fluctuations in asset fair value affecting profitability.

3. The bulk of fixed assets comprises port facilities, equipment, and handling machinery, followed by buildings and vessels

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Ongoing construction mainly involves terminal development and renovations.

4. Intangible assets consist primarily of land use rights, while long-term prepaid expenses include previously paid costs related to port and external facility constructions.

Additionally, I tend to treat inventory in current assets as non-current assets when analyzingShanghai Port has 9.6 billion in inventory, a substantial figure. The inventory mostly accounts for the real estate development costs or products, constituting around 70%, mostly tied to the Shanghai Riverside City real estate project, which poses a hidden risk! The rest pertains to land from the Yangshan reclamation project, making up about 25%.

(3) Dividend, Financing, and Profit Retention Situation

Shanghai Port Group’s dividends are mediocre, typically distributing around 30% of profits as dividends, which is not particularly high compared to other port stocks or even state-owned enterprisesFortunately, Shanghai Port's valuations are relatively low, with a price-to-earnings ratio of about 10 times, resulting in a dividend yield of 2-3%.

In 2024, the company increased the interim report dividends, projecting a noticeable rise in total annual dividends, with yields expected to reach 3.5-4%.

The company currently possesses over 80 billion in undistributed profits, constituting a whopping 63% of its market value

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While there's room for increased dividends, the company’s cash reserves are somewhat low (most earnings have transformed into equity assets), limiting the extent of potential dividend increases.

The firm was listed in 2006, with capital raises occurring in 2011 and 2015, which hasn't been frequentThe 2015 increase was for an employee stock ownership plan, while the 2011 one was for asset acquisitions.

(4) Performance Growth Trends and Drivers

Shanghai Port Group achieved overall listing in 2006 through the stock swap merger with its listed subsidiary, Shanghai International Container (G Port), resulting in a significant leap in revenue and profit at that time.

The performance trend has generally been upwardParticularly, the revenue trend is stable, with minimal fluctuations (excluding 2020), whereas profit variability is considerably higher.

Revenue has consistently shown uplifts approximately every five years, although with slow pace, achieving an annualized growth rate of only 2.92% over the past decade, restricted by port saturation. Profit volatility, apart from being influenced by revenue variations and scale effects, primarily stems from significant changes in investment returns and asset fair valuationsHowever, the net profit growth trend after excluding non-recurring gains remains quite stable.

In the third quarter report of 2024, Shanghai Port reported a revenue growth of 5.81%, with profit increasing by 3.98%, whereas the net profit excluding non-recurring items decreased by 2.9%. In 2023, revenue saw a slight increase of 0.73%, but profit declined by 23.34%. The preceding year of 2022 experienced an 8.72% growth in revenue and a 17.31% rise in profit.

1. Compared to peers, Shanghai's performance is not deemed exceptional, with Qingdao Port, Ningbo Port, and Guangzhou Port exhibiting significantly better performance stability and trends.

2. Not all large ports can achieve effortless success. Tianjin Port, for instance, is witnessing a downward trend in performance, mirroring the economic stagnation in that region over recent years.

(5) Expense Control and Profit Quality

In 2023, the gross profit margin was 37.4% (Qingdao Port at 35.61%, Ningbo Port at 29.58%), and the net profit margin was 37.3% (Qingdao Port at 30.36%, Ningbo Port at 19.89%), while the return on equity stood at 11.25% (Qingdao Port at 12.7%, Ningbo Port at 6.36%).

Shanghai Port’s net profit margin exceeds its gross profit margin due to significant contributions from investment income

Overall, among peers, the profitability of Shanghai International Port Group is commendable, justified by Shanghai's unique locational advantages.

Looking at the first three quarters of 2024 regarding the three major expenses, Shanghai Port Group shows average expense controlSales expenses are negligible, only accounting for 0.28%. Administrative expenses stand at 8.16% (Qingdao Port at 5.41%, Ningbo Port at 9.02%). Financial expenses are at -1.08% (Qingdao Port at -0.34%, Ningbo Port at -0.65%).

Chapter Two: Business and Management Analysis

(1) Characteristics of the Port Business:

1. Infrastructure-dependent and capital-intensive: Port operations heavily rely on large-scale infrastructure, including terminals, berths, yards, and handling equipmentThese infrastructures are foundational for conducting business and dictate port throughput capacity and service qualityTo remain competitive, ports must continuously upgrade and innovate technologically, which is a costly endeavor.

2. Significant economies of scale, with noticeable marginal benefits/losses:As port cargo throughput increases, unit costs gradually decline, allowing for improved economic benefitsLarge ports can attract more vessels to dock, leading to more efficient resource use, distributing fixed costs and boosting profitabilityAdditionally, being large in scale enhances a port's significance in the logistics network, drawing more logistics companies and traders, fostering a virtuous cycle.

3. Favorable natural conditions determine fortune:The site selection and development of ports are highly influenced by natural conditions such as water depth, shoreline length, geological conditions, and climate

Excellent natural conditions are vital for attracting large vessels and can also lower construction and operation costs.

4. Geographical advantage and economic hinterland determine everything:Ports are not only the distribution centers for goods but also the convergence points for information, capital, and other factorsThe development of a port is closely related to the economic development level, industrial structure, and trade scale of its localityPorts in economically developed coastal areas usually experience higher transaction volumes and greater development potential due to more vibrant manufacturing and trading activities driving demand.

5. High integration of services and operations:Ports provide services encompassing cargo unloading, warehousing, transportation, distribution, customs declaration, and inspection, forming a complete supply chain service systemIn addition, they also supply supporting services like pilotage, towing, fueling, and servitudes for vessels, along with various living services for crew membersThe growth of ports spurs the development of related local industries, such as port-based industry, real estate, and logistics services, creating a cooperative development dynamic between ports and cities.

6. Highly sensitive to policies:The port industry is greatly influenced by national and local policies, including port planning, shoreline approvals, taxation policies, and trade policiesFor instance, national support for pilot free trade zones can promote the trade and logistics business of related ports.

(2) Structure of Port Business:

Globally, port business models are quite similar, with few main types, such as container handling, port logistics, warehousing and storage, ship services, customs, and commercial services, among others.

Differences in the business structures of different ports arise from unique geographical advantages and varying regional economic structures.

For instance, Shanghai Port stands out in the container business, operating multiple high-grade container-specific terminals, consistently ranking first globally in container throughput for several years

Meanwhile, Qingdao Port excels in handling bulk cargo such as metal ores and coal, becoming one of the key transfer hubs for bulk goods in the North.

In the first half of 2024, the business composition of Shanghai Port Group was as follows: containers accounted for 41%, port logistics 28%, port services 10%, bulk cargo 4.1%, and other segments 22%.

Over a longer timeline, nearly all business lines have become mature, offering limited growth prospects unless new assets are acquired.

Chapter Three: Shareholder and Management Analysis

The shareholding of Shanghai Port Group is highly concentrated, with the top ten shareholders holding a staggering 92%, consisting mainly of various state-owned enterprises in ShanghaiThe willingness for these enterprises to sell their holdings is minimal, resulting in a highly stable share structure.

Company executives are predominantly from state-owned enterprises, government positions, and public institutions, leaving little to analyzeTheir compensation levels are relatively standard, significantly higher than those of executives from Guangzhou Port, Qingdao Port, and Ningbo Port.

However, the company has a stock incentive plan and an employee stock ownership plan, with several executives holding direct shares, which is relatively uncommon among state-owned enterprises of this kind.

Chapter Four: Valuation and Investment Strategy

1) In recent years, port stocks have been recovering

Although the growth rates differ, the bottom line is that they are all increasing, which is the best news for stable advantage assets.

2) Valuation of stocks varies widelyGiven the excellent port locational conditions of Shanghai, its return on equity ranks high, yet its price-to-earnings ratio is only around 10 times, placing it lower in comparison.

1) Since the pandemic, Shanghai Port’s recovery rate in performance has noticeably outpaced the growth rate of its stock prices, leading to an overall decrease in valuation.

2) Currently, Shanghai Port’s price-to-earnings ratio is at a historical low, with the lowest valuation in 2022 (a year of very good performance), approximately around 7 times P/E ratio.

1) Stock selection approach:

In choosing port stocks, besides examining financial fundamentals, one should also consider locational advantages and port conditionsUndoubtedly, the port conditions of Shanghai are unparalleled, and in addition, the fundamental data of Shanghai Port is also among the best (as analyzed above).

Currently, the valuation of Shanghai Port Group is quite low, presenting a high likelihood of valuation recovery, making it a promising investment target.

2) Investment strategy:

Given the high maturity level of the port business, unless there are additional assets injected, the growth potential of port stocks is relatively ordinary

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