Sun Hung Kai Financial Institutional Research Introduction: In a search for lower costs and better profitability, companies are broadening their manufacturing and supplier networks geographically; more non-core functions are being outsourced and supply chains are being redesigned to reduce working capital and improve responses to changes in customer demand. Managing this increased complexity is beyond the expertise of a lot of companies; however third-party logistics providers (3PL) are well positioned to offer services to help their customers address many of these goals. Conclusion: Kerry Logistics has become a leading Asian 3PL provider by leveraging its warehouses and IT platform to offer increasing amounts of value added services to drive improvements in operating margins. Valuation is attractive vs. its global peer group. Our target price of HK$14.67 is based on our SOTP valuation. Our valuation separates the Hong Kong warehouse business, which we value at HK$3.15/share based on a 7% cap rate. The rest of the business we value at HK$11.52/share, which is 17X our 2016 core-EPS (ex-property revaluation and HK warehouses) of HK$0.68. Three Reasons to Buy Increasing Value-Added Services The company has vertical specific knowledge in Lifestyle, Electronics, Food & Beverage, Fast Moving Consumer Goods, Industrial, Automotive, and Pharmaceutical & Healthcare, which it expects to leverage to win customers and to penetrate further into the customers’ supply chain and offer higher margin services. Sector Tailwinds The industry’s globalization trends that are resulting in more geographically distributed supply chains and manufacturing bases, policy-driven changes in logistics in China, ecommerce and growing Asian consumption are all supportive of the industry growth. Investment to Add to Sales Growth The company is targeting 3-4 new self-owned logistics centres a year (approx. GFA of 1m sq.ft), which should boost the total GFA by 2-3%. In addition, GFA will be added through leasing as well as M&A. The company should be able to deliver steady revenue growth of 7-10% over the medium term. Risks Logistics will be impacted by changes in economic growth in China and Asia. The sector is attracting capital which is pushing up the cost of acquisitions and could result in warehouse overcapacity. The company may not have the management capability to capture the opportunities in the sector. Figure 1: Financial summary Financial summary (HK$)FY12FY13FY14EFY15EFY16ERevenue ('000)19,294,77519,968,74321,217,49023,359,27525,251,888Gross margin (%)13.96%14.41%14.45%14.50%14.55%Core OP ('000)1,290,0141,408,8821,554,5331,759,1731,974,289Core OP Margin (%)6.69%7.06%7.33%7.53%7.82%Net profit ('000)870,7441,834,5221,129,1361,280,5131,434,421Net-profit growth (%)22.81%71.55%-38.45%13.41%12.02%EPS - HK¢0.831.400.670.760.85EPS growth - (%)69.60%-52.23%13.41%12.02%P/E - x8.718.116.014.3P/B - x1.410.981.171.091.01Dividend yield (%)1.1%1.1%1.3%1.5%ROE - (%)13.57%16.84%8.13%8.62%9.01% Source: Company and Sun Hung Kai Financial Nicholas Studholme-Wilson (852) 3929-6156 nicholas.studholme@shkf.com Reports available at: http://www.shkresearch.com http://www.thomsonreuters.com http://www.capitaliq.com http://www.themarkets.com Bloomberg Code: <shkr> Target Price HK$14.67 12m Rating Buy (21% upside) Theme Services Kerry Logistic (636 HK): Creating Value from Knowledge Logistic Services 12 January 2015 INSTITUTIONAL RESEARCH Price Chart 5.06.07.08.09.010.011.012.013.014.015.0Jan 14Apr 14Jul 14Oct 14Jan 15(HK$)Stock priceHSI perf. rebased to sh. price Sources: Bloomberg and Sun Hung Kai Financial Key Data Price – HK$ 12.18 52W high/low – HK$ 14.48/11.00 Mkt cap – HK$m (US$m) 20,599 (2,656) Shares in issue – millions 1,691.2 Free float – % 28.3 3M avg. t/o– HK$m (US$m) 18.7 (2.4) Major shareholder Kerry Properties Ltd 42.47% Sources: Bloomberg and Sun Hung Kai Financial FY13 Revenues: HKD 19.97 bn Logistics Operations43%Hong Kong Warehouse2%International Freight Forwarding55% Kerry Logistics (636 HK): Creating Value from Knowledge 12 January 2015 Sun Hung Kai Financial Institutional Research 2 Investment Thesis 1. Increasing Value Added Services By offering higher value services to their customers, the company can drive operating margins for logistic services from 10% to 11% over the next 2 years. The focus on reducing fixed-costs and falling trade barriers has continued to push companies to outsource and a broader geographic distribution of the supply-chain. Increasing amount of functions being done by third parties and a growing network of suppliers is leading to increased complexity, which companies need to manage. Unless end-demand is well communicated it is becoming all too easy to make incorrect demand forecasts extrapolated from information coming from t