Protests and profit warning mix it up for MTRC

Business | Ivan Tong 22 Jul 2019

Shares of MTR Corporation (0066) fell 2.7 percent to HK$54.2 last Friday, after a two-month increase in its share price by about 20 percent.

The drop came after the railway operator issued its first profit warning since listing in 2000, and revealed it would make a provision of HK$2 billion for the beleaguered Shatin to Central Link project.

The 2.7 percent decline is not significant, though it might cause short-term selling pressure and provide investors a buying opportunity.

The market should not freak out about such warnings. There's no quantitative guideline on profit warnings, and Hong Kong Exchanges and Clearing (0388) does not spell out how one should read a profit warning or positive profit alert from listed firms. While the mainland regulator clearly defines profit warnings and has quantified standards, investors here are advised to figure out what is the warning's all about and what negative impact it could have on MTRC's prospects.

Firstly, while MTRC has been plagued by the scandal over shoddy work at Hung Hom station for a long time now, its share price has been little affected and it continued to rise over the last two months.

This shows that shareholders are not losing much sleep over the impact of the Hung Hom scandal on the company's financial performance.

Institutional investors are more concerned about how long the Shatin to Central Link will be delayed.

MTRC has now announced the HK$2 billion provision and a partial opening of the Link at the beginning of next year. This eliminates uncertainties while the impact of this profit warning is predictable, so the selling pressure may have just been an adjustment to the share price which had risen significantly.

MTRC's total provision of HK$2.43 billion for the first half of this year - including HK$430 million for a joint venture in the United Kingdom announced in May - is equivalent to about 52 percent of the consolidated profit from the underlying business for the first half last year, and 22 percent for 2018.

In other words, assuming there will be no growth in MTRC's profit this year, the provisions will slash 22 percent of its profit for 2019.

While the figure is not small, it is not too large either, given the company's market value.

However, the HK$2 billion worth of provisions is based on an estimation of the costs arising from the problems at Hung Hom, and the MTRC is said to be looking at ways to recover this sum from Leighton Contractors, the main contractor on the project.

So there is a chance of a write-back but not in the near future, as any legal action could be complex and protracted.

Unless we have evidence that the provisions will a bottomless pit, we should not worry. MTRC is backed by the SAR government as its major shareholder, its financial strategies are robust, and its twin-track development of transport and property have optimistic prospects.

The warning has sent more investment houses underweight than overweight but while CLSA lowered MTRC's rating to "sell" the broker maintained its target price of HK$49, which is only 9.6 percent lower than last Friday's close of HK$54.2. This is not a steep fall as its price has risen by more than 33 percent this year.

We should not generalize about the impact of profit warnings on listed companies.

Hang Seng Index heavyweight AIA (1299) did not issue a profit warning even though it saw a 50 percent decline in interim net profit last year. The market accepted the fall because the new business value of an insurance company was a more accurate indicator of its prospects.

Investors should not just go by the book as this profit warning will have a limited impact on MTRC and won't shake its foundations.

On a lighter note, don't fret too much about the warning but do pay heed to the weekly protests in Hong Kong, which have seen MTR stations packed to the gills. The sharp increase in passenger numbers could be the silver lining on the cloud hanging over this blue-chip stock!

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