Idea of the Week: The Charm of Conglomerates - A Quality Tool Seeking Stable Returns

The bond yield can be divided into two parts: risk-free rate + credit spread. The credit spread is viewed as an indicator of bond default risk and corporate bond pricing. The higher the default risk, the larger the credit spread, and vice versa.

In the world of corporate bonds, a company's default risk can change significantly over time. Individual companies may experience deteriorating credit conditions due to poor management. Additionally, the changes in the environment of specific industries may lead to a substantial worsening of a company's operating conditions and financing environment, ultimately resulting in the company's inability to repay debts and leading to a debt default.

So, are there companies with stronger resilience that can withstand the risk in a single industry? Such companies certainly exist, and they are conglomerates. The conglomerates we refer to are truly cross-industry enterprises with a high degree of risk diversification, rather than companies that focus on one core industry with minor involvement in others. We believe that ideal choices are conglomerates engaged in industries with low correlation, where a single industry accounts for no more than 30% to 40% of either revenues, profits or assets.

The advantage of business diversification lies in the broad sources of revenues and profit. Even if a single industry enters a downturn, the company still has other businesses as a buffer, preventing rapid deterioration in revenue, profitability and debt repayment ability. Through support from other businesses' revenues, cash flows and even financing, the company has greater abilities to withstand downturns in individual industries. Thus, conglomerates align well with the core logic of bond investment - pursuing stability, not seeking rapid growth, but avoiding failure.

Besides the business diversification, these conglomerates generally possess a variety of assets across different industries and types. In the event of a liquidity crisis at the group level or in individual subsidiaries, these conglomerates have more flexibility in response and execution, in terms of selling assets, business restructuring, negotiating debt financing with banks or creditors and raising funds through equity financing, they generally perform better than companies who focus on a single industry.

Of course, the quality of management decisions and the integrity of major shareholders are crucial determining factors. If the management aggressively and blindly increases leverage to invest in different industries, or habitually takes a "gambler's mentality" by betting on the development of individual industries or making reckless investments, these so-called conglomerates still have a greater chance of experiencing debt crisis or even facing bankruptcy risks.

However, due to the large and diversified asset scale of these conglomerates, shareholders and creditors may find it more difficult to monitor the entire companies. Some companies with poor management could risk major shareholders or the management misappropriating the assets of listed companies. Therefore, the bond investors still need to analyze the company's development, as well as its operational and credit conditions.

The following are the conglomerates to which investors should pay attention:

1. CK Hutchison

CK Hutchison is a global conglomerate with main businesses in ports, retail, infrastructure, telecommunication and energy, accounting for its EBITDA of around 13%, 15%, 28%, 25% and 19% respectively.

CK Hutchison’s EBITDA in 2023 was around HKD 104.9 billion, decreased by 12% YoY, mainly due to the tower disposal in the UK in 2022 and the high base effect caused by the acquisition gain from the Indonesian telecom business. Excluding the impact from these factors, the Group’s EBITDA only decreased 1% YoY. The operating free cash flow increased 20% YoY to HKD 39.5 billion. Overall, CK Hutchison’s businesses are resilient and well-diversified in terms of businesses and regions. The profitability and cash flow performances are stable.

After CK Hutchison sold a number of telecommunication businesses in the past two to three years, the net debt dropped to HKD 220.3 billion. The net gearing ratio was lower to 33%. The net debt / EBITDA and net debt / operating free cash flow were 2.1 times and 5.6 times respectively. The leverage level was decent. Its interest coverage ratio was high at 8.5 times, with a lower cost of borrowing of 3.2%. The credit metrics were strong. Overall, the credit risk was low.

CK Hutchison’s bond yields are around 5.0% to 5.5% (see Table 1), higher than treasury yields of around 30 bps to 90 bps. They have a certain attractiveness. The bonds are suitable for stable income seekers.

Table 1: CK Hutchison’s USD Bonds

Related Article: Idea of the Week: CK Hutchison—A Conglomerate that can Pass the COVID Stress Test! Yield Reach 5.7%

2. NWS Holdings

NWS Holdings ("NWS") mainly engages in roads, construction, insurance, logistics, facility management and other investments (including strategic investments and dividends from JVs and associates), accounting for around 28%, 14%, 14%, 12%, 4% and 27% of its adjusted attributable operating profits.

As a result, in the first half of FY2024, NWS’s adjusted EBITDA increased 44% YoY to HKD 3.72 billion. With the full relaxation of COVID restriction policies and normalization after COVID, the road and insurance segments had a strong growth, and the facility management segment turned losses into profits.

About the credit profile, NWS's credit metrics are still strong even if we take into account incoming dividend payments (special dividends and interim dividends) and redemption of perpetual bonds. Although its net gearing ratio and net debt/adjusted EBITDA increased to 59.7% and 3.0x respectively, its overall leverage is still under control. In particular, the net debt/adjusted EBITDA of only 3.0x is reassuring to creditors. After repayment of the perpetual bonds with a higher coupon, the Group's interest coverage ratio will rise to 6.0 times, demonstrating a strong interest payment ability.

NWS still has an undrawn credit facility of HKD 10.3 billion available for operation or refinancing, reflecting the Group’s decent liquidity. With the Group’s stable business models in most of the segments, it has a higher visibility in profits and cash flows, its overall default risk is still low.

The NWS’s bond, NWSZF 4.250% 27Jun2029 Corp (USD), still has a yield to maturity of 6.4%. Investors who seek a stable return could consider this bond.

Related Article: Idea of the Week: NWS Holdings—Probably Acquired By Parent Company and Lays Golden Eggs

3. Rakuten Group

The core business of Rakuten Group consists of three segments, namely E-commerce, financial services as well as mobile telecom. The Group's operating performance improved across the board in 2023, with the e-commerce and financial services segments growing at a high-quality and rapid pace. Loss in the mobile telecom sector notably narrowed and the group is expected to reach the breakeven points from 2025 onwards. We are positive about the group's prospects.

Given the early stage development of mobile telecom, the high capital expenditure results in a somewhat tight liquidity. Owing to a decent capability of refinancing, Rakuten raised a large amount of funds in 2023 through equity financing and the IPO of a subsidiary. Considering that the group owns a lot of valuable assets. Including Rakuten securities and Rakuten life insurance, either through IPOs or equity sales are potential sources of liquidity.

Coupled with the fact that entering into a profitable position of the telecommunication mobile telecom is just around the corner with a lower cash bleeding, we believe the overall credit risk remained at a manageable level.

Based on the group's favorable prospects and relatively sound credit quality, we believe the investment risk of bonds due in 2027 is still under control. The bond, RAKUTN 11.250% 15Feb2027 Corp (USD), is currently yielding at around 7.8%, and the bond is available in Bond Express.

Related Article: Idea of the Week: Rakuten Group, a Rare Opportunity to Capture 9% Return (New on Bond Express)

4. Fosun International

Fosun International has four major business segments, including health (pharmaceutical products and medical services), happiness (consumer goods and tourism), wealth (insurance, asset management, and real estate), and Intelligent Manufacturing (resources, environment, technology, and manufacturing). The Group’s cash proceeds from asset disposal ensure the Group’s liquidity and on-time debt repayment.

Fosun International only has a total of approximately USD 2.84 billion of offshore debt maturing in the next four years. The bond maturity profile is fairly evenly distributed. Considering that the market value of the Group's listed companies is over USD 8 billion, it is not difficult for the Group to continue to sell these assets for debt repayment. After the Group repaid a total of 10 offshore and onshore bonds, the Group's peak debt repayment period already passed.

Fosun International’s operating performance was fair. Its annual dividend income from its subsidiaries amounted to around RMB 7 billion, which will provide the Group with a decent cash flow. As of the end 2023, Fosun’s debt in the parent level was RMB 88.8 billion, down 9.3% YoY, reflecting the effectiveness of deleveraging. At the moment, Fosun still has assets held for sale of around RMB 70 billion to RMB 80 billion and targets to lower the debt to RMB 50 billion level in the next 1-2 years.

In view of the Fosun International having diversified business locations, diversified businesses, wider sources of financing, regular dividend income and a large number of listed companies' shareholdings and assets for sale, the Group’s default risk should be manageable. We believe that the Group will be able to repay the offshore bonds on time.

Fosun International’s bonds are yielding over 8% (see Table 2), suitable for investors who seek for high yields.

Table 2: Fosun International’s Bonds

Related Article: With Fosun International’s “Weight-loss” Actions, could it Resolve its Debt Crisis?

5. Reliance Industries

Reliance Industries is India's largest private conglomerate, with businesses including retail, telecommunications, petrochemicals and oil and gas, accounting for approximately 14%, 34%, 39%, and 13% of its EBITDA respectively.

In terms of revenue, for the fiscal year 2024 (April 2023 to March 2024), the Group's revenue was 10.0 trillion rupees, an increase of 2.6% YoY. Its EBITDA margin increased by 210 bps YoY to 17.9%, showing a fairly good overall operational performance.

Regarding the credit profile, as of the end of March 2024, the Group's total assets were 17.5 trillion rupees. Its net gearing ratio and net debt/EBITDA were low at 12.6% and 0.65 times respectively, indicating a low leverage level. The group's average cost of borrowing was 7.2%, which is considered low among Indian companies. The interest coverage ratio was also high at 5.5 times, reflecting a very healthy credit status.

Therefore, investors may consider bonds with different maturities, among which the "RILIN 2.875% 12Jan2032 Corp (USD)" offers a yield to maturity of 5.3%.

6. Jardine Matheson

Jardine Matheson is a multinational conglomerate with a Singapore background. The Group's businesses include financial services, grocery retail, engineering and construction, automotives, real estate and hospitality.

Jardine Matheson engages in these businesses through holdings in various subsidiaries, including Astra, Hongkong Land, Jardine Pacific, Jardine Motor Interests, DFI Retail Group, Jardine Cycle & Carriage and Mandarin Oriental Hotel Group. These subsidiaries contribute approximately 44%, 22%, 9%, 8%, 7%, 6%, and 4% to the Group's earnings respectively. Amongst them, Astra is a conglomerate engaged in automotive, financial services, industrial equipment and agriculture businesses, demonstrating the Group's highly diversified operations.

In 2023, Jardine Matheson's total revenue was USD 36 billion, a slight decrease of 4% YoY. However, the core profit attributable to shareholders increased by 5% YoY to $1.66 billion. The operational performance was stable.

As of the end of 2023, Jardine Matheson's net debt was USD 8.4 billion, with a low net gearing ratio of 15% and a net debt / EBIT of only 1.5 times, indicating a very low leverage level. The group has unutilized credit facilities of up to USD 9 billion, available for new project investment or debt refinancing. Additionally, its interest coverage ratio was high at 8.3 times, demonstrating good interest payment ability. Overall, the Group's credit position is sound.

Therefore, investors may consider "JMHLDS 2.500% 09Apr2031 Corp (USD)", which currently offers a yield to maturity of 5.3%, about 80 basis points higher than the yield of government bonds with similar maturities.

7. CITIC Limited

CITIC Limited is a Chinese conglomerate with a central state-owned enterprise background. Its business is mainly divided into five categories: financial services, advanced intelligent manufacturing, advanced materials, new consumption and new-type urbanization. In terms of revenues, these five businesses account for approximately 39%, 7%, 39%, 8%, and 6% of its total revenue respectively.

Within each category, CITIC Limited has subsidiaries engaged in different industries. For example, the financial services segment include banking and securities businesses, and the advanced materials segment include the manufacture of specialty steel, mining and energy businesses. This diverse portfolio effectively reduces the risk associated with any single industry.

In 2023, CITIC Limited's total revenue reached RMB 680.8 billion, an increase of 2.6% YoY. During the same period, EBITDA slightly decreased by 0.5% YoY to RMB 133.6 billion. The overall performance was stable, thanks to its resilience in its business models. The Group was not significantly affected by the weakening Chinese economy or the pressure of narrowing net interest margins in the banking business.

As of the end of 2023, CITIC Limited's interest coverage ratio (calculated by the Group's EBITDA and the Group-level interest expenses) was high at 11.0 times, indicating good interest payment ability. Its total debt to total equity ratio slightly increased to 56%, which was still at a controllable level. More importantly, CITIC Group (one of China's large central state-owned enterprises) holds about 73% of CITIC Limited's shares. The central state-owned background significantly enhances the financing ability of CITIC Limited and its subsidiaries. CITIC Limited's default risk was in a relatively low level.

Investors may consider CITIC Limited's bonds (see Table 3), which offer a yield to maturity of about 5.0%, approximately 30 to 40 basis points higher than US treasuries. These are suitable for investors seeking stable returns.

Table 3: Some CITIC Limited’s Bonds

8. Icahn Enterprises (IEP)

Icahn Enterprises (IEP) is a conglomerate and investment company. Its earnings structure can be broadly divided into two parts: the segmental results of its subsidiaries and the returns from its investment portfolio.

In terms of the asset distribution (in terms of attributable part), as of the end of May 2024, the investment portfolio, energy, automotive, other segments and holding company assets accounted for approximately 27%, 26%, 17%, 12% and 18% of its total assets respectively. Additionally, IEP's investment portfolio is quite diversified, which could effectively reduce the impact of any single industry on the company.

About the credit profile, as shown in Table 4, if we consider its investment portfolio as cash equivalents, IEP can be considered as a net cash company. The solvency is strong. Considering that IEP also has a stake in CVR Energy and other subsidiaries (valued at around USD 4.9 billion), IEP's asset portfolio provides a buffer for the future, even if the investment portfolio might incur losses or if the company continues to pay high dividends.

Table 4: IEP’s Credit Metrics at the Holding Company Level

Investors might consider IEP's bonds, IEP 5.250% 15May2027 Corp (USD), with a yield to maturity of 7.5%.

Related Article: Idea of the Week: Corporate Raider Being Sniped–Will Icahn Enterprises Bring Investment Opportunity?

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