We often write about patience and discipline as being keys to successful investing. But, as we have learned with Hutchison (HTA) this is not always the case. Our judgement was wrong on this stock and patience cost us dearly.
| "However, an oppressive capital structure has seen the share price barely raise a pulse, despite significant operational progress." |
The frustrating point is that Hutchison the company continues to perform extremely well in a highly competitive market. The company's '3' brand is a market leader and a great success in the 3G phone market.
However, an oppressive capital structure has seen the share price barely raise a pulse, despite significant operational progress.
The structure we are referring to is the negative equity position on the company's balance sheet, which means there are more liabilities (in Hutchison's case, debt) than assets. While negative equity is not exactly a sign of health, the situation is slightly different in Hutchison's case. The company's lenders are not banks and with the backing of the Hong Kong based parent, the administrators are not about to be called in.
We have been concerned over this unwieldy capital structure for some time, especially given the additional spending needs of building the 3G network and phasing out the 2G network. At the Annual General Meeting last May, the company provided some indication the balance sheet issues would be re-evaluated. However, with the 2006 full year results release last week, the company repeated its intention to improve the capital structure 'during 2007'.
There's still 10 months left in the year and only $23 million left in the bank. With funds needed to expand and upgrade the 3G network during 2007, we believe a large capital raising is imminent. How such an announcement could impact the share price is difficult to forecast.
In the short term, we would likely see share price weakness, with new equity issued at a discount to the prevailing share price. But following such a large equity raising (some of the proceeds of which could pay down debt), the market might warm to Hutchison's strategic value.
Alternatively, the parent company could inject a significant portion of equity and thus provide Hutchison with a vote of confidence. In short, there are a number of scenarios for the company.
But at the end of the day, we believe the risk of further downward pressure on the share price is too great. The company continues to burn cash at a rate of knots and we believe watching from the sidelines is more prudent than sticking with the story.
Since its inclusion in the Fat Prophets Portfolio more than two years ago, Hutchison's share price performance has obviously been a disappointment. Although prices stabilised above 23 cents last year, a turnaround in momentum has proved elusive. Instead, prices extended the downward trend to a low of 22.5 cents in January, with a new four year low of 21.5 cents achieved this month.
Consensus Valuation Estimates
|
2007 |
2008 |
| Price to earnings ratio |
0 |
0 |
| Net dividend yield |
0% |
0% |
| Price to book value |
-0.1 |
-0.1 |
| Return on Equity |
18.4% |
12.7% |
Source: Bloomberg
Hutchison has proved to be a poor recommendation and given the lack of investor support for the stock, we believe there is a risk of further price falls in the months ahead. Accordingly, Fat Prophets recommend selling Hutchison around $0.215.
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