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Summary of China Travel International (CTS) Analysis by Bank of America Merrill Lynch

Core Content

Bank of America Merrill Lynch (BofAML) initiated coverage of China Travel International (CTS) with an Underperform rating and a Price Objective (PO) of HK$2.64, based on a target P/B of 0.9x for 2015E BPS. The analysis highlights several key factors influencing the stock's valuation and performance outlook.

Main Points

1. Exposure to Hong Kong Hotels

• CTS's Hong Kong/Macau hotel segment contributes ~20% of earnings.
• The Hong Kong hotel industry has experienced a sharp deceleration in RevPAR growth, with a -4.7% YoY decline in Jan 2015.
• This decline is attributed to a shift in Chinese outbound tourism from Hong Kong/Macau to Japan/Korea.
• The downturn in the hotel segment could offset potential gains from restructuring and tourism real estate.

2. Restructuring and Tourism Real Estate Potential

• The company has a history of restructuring, which has positively impacted its performance in the past.
• The potential from M&A and tourism real estate has been fully priced in by the market.
• The company's first tourism real estate project, Zhuhai OSR, is expected to be pre-sold in 2H 2015, but execution risks remain.
• Zhuhai OSR is located 1.5 hours from downtown Zhuhai, in a less favorable area with lower property prices.
• The lack of nearby tourism resources may limit its competitive advantage in the market.
• Successful projects such as the Songshan Shaolin and Shapotou have contributed positively to profitability, but previous investments in Zhuhai and Xianyang OSR remain loss-making.

3. Valuation and Financial Metrics

• The stock is trading at a demanding valuation of 0.88x 2015E P/B and 13.7x P/E.
• The 2016E ROE is estimated at 6.9%, which is low compared to other sectors.
• The dividend yield is expected to increase from 1.95% in 2013 to 3.31% in 2016.
• The free cash flow yield is also expected to improve, from 1.93% in 2013 to 1.23% in 2016.
• The company has a net cash position, which may limit reinvestment opportunities and contribute to low ROE.

4. Investment Thesis and Risks

• The Underperform rating is based on earnings risk from the HK hotel segment, execution risk in restructuring and tourism real estate, and the fact that potential gains from these projects have already been priced in.
• Key risks include better-than-expected restructuring, recovery in hotel RevPAR, and successful property launches, which could limit downside.
• Key potential catalysts include further deceleration in hotel RevPAR, weaker earnings, and underperformance in the tourism real estate segment.

5. DCF Valuation

• A discounted cash flow (DCF) model was used to estimate the value per share.
• The DCF model assumes a 4% long-term growth rate and a 10% WACC.
• The estimated value per share is HK$2.49, which is lower than the current price of HK$2.57.
• The DCF sensitivity analysis shows that the value per share is sensitive to changes in WACC and long-term growth rate.
• The terminal value is based on the assumption that the company will sell all the GFA of its projects by 2021 and acquire more tourism real estate projects.

6. Company Overview

• CTS operates in travel agency, travel document, tourism site operations, transportation, power generation, golf course, and art performances.
• It has adopted a tourism-focused strategy and is gradually increasing exposure to tourist site operations and tourism real estate projects.

7. Historical Performance and Valuation

• The stock rose 65% in 2014 due to accelerated restructuring and transformation into a more tourism-focused company.
• The current valuation is below the long-term average of 1.0x P/B, suggesting potential for upside.
• The ROE has been improving, from 6.2% in 2013 to 6.9% in 2016, but still lags behind industry standards.

Key Information

• 2014-2017E earnings CAGR is estimated at 8%.
• Free Cash Flow (FCF) is expected to grow from HK$278mn in 2014 to HK$178mn in 2016.
• The EV/EBITDA ratio has decreased from 9.0x in 2014 to 6.1x in 2016.
• The Net Debt-to-Equity Ratio has been negative in recent years, indicating a net cash position.
• The free float is 42.4%, suggesting limited dilution.
• The market cap is HK$14,431mn, with a 52-week range of HK$1.48-HK$2.97.
• The average daily volume is 6,620,952, indicating moderate liquidity.

Conclusion

CTS is a tourism-focused company with potential for growth through restructuring and tourism real estate. However, the execution risk associated with its first tourism real estate project and declining hotel performance due to HK/Macau market conditions may limit its upside. The current valuation suggests that the market has already priced in potential gains, and the company may face further earnings risk in the medium term. The DCF model estimates the value per share at HK$2.49, which is slightly below the current price, suggesting potential for further de-rating.