Solid earnings growth momentum. We forecast recurring profit to rise at a 7%CAGR in 2016-18e, underpinned by (1) a strong rebound in Husky’s earnings on theback of an oil price recovery (USD74/b WTI in 2018e), (2) a 10% EBIT CAGR in retail inlocal currency terms on store network expansion, and (3) steady growth across thegroup’s stable businesses, with a 4-5% EBIT CAGR in 3 Europe, infrastructure and portsin local currency terms, offset by further currency headwinds (GBP/USD to 1.10 by end-2017e). If we had adopted the spot GBP/USD rate and consensus oil price forecast, wewould arrive at an 8% net profit CAGR, which suggests strong underlying growthmomentum across the group’s businesses.
　　Well positioned for M&A and dividend increase. With stable capex, we expectfree cash flow to increase with earnings growth. We forecast FCF yield to rise from5.2% to 5.9% in 2016-18e, supporting our forecast of a rising dividend yield from2.8% in 2016e to 3.5% in 2018e. Further, with an under-geared balance sheet, weestimate that the group is in a position to raise up to c.HKD80bn in 2016-17e. Thiscould be deployed in M&A or distributed to shareholders via more dividends. Webelieve the group is most likely to invest in infrastructure and aircraft leasing in thenear term, while keeping an eye out for further telecom consolidation opportunities.
　　Expected Wind-3 Italy merger approval – a potential near-term catalyst. Recentmedia reports (e.g. Reuters, 8 July) indicate this merger is increasingly likely to beapproved by the 8 September deadline. The proposed merger would provide ac.HKD4bn swing in CKH’s attributable share of 3 Italy’s FCF, while we estimate thatthe deal could add 7% and 4-5% to group EBITDA and net profit. Our analysis alsosuggests that market disruption from Iliad’s entry would be manageable, with mildrevenue erosion only partially offsetting cost synergy benefits.
　　We initiate coverage of CKH with a Buy rating and a target price of HKD110.Despite strong performance in the past two months, the stock is still down 9% yearto-date, underperforming the Hang Seng Index (up 3% over the same period). Dividingthe NAV into stable cash cows (ports, infrastructure and telecom) and cyclicalbusinesses (mainly retail and energy), we argue that investors are effectively gettingthe cyclical businesses at a 70% discount. Our target price is set at a 15% discountto our NAV of HKD129 per share, implying a 13.7x 2017e PE.