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This report is the second in our series of reports on China’s logistics industry going global. In our first report Logistics industry going global (I):

Cross-border e-commerce logistics companies opening a new chapter

published on December 9, we analyzed the market size, industry landscape and several variables of the cross-border e-commerce logistics industry, and discussed investment themes. In this report, we focus on Sinotrans, the largest freight forwarding company in China's cross-border logistics market. We believe Sinotrans has the potential for a valuation re- rating, driven by the growth of cross-border e-commerce platforms.

Reasoning The market has undervalued DHL-Sinotrans. 1) We think DHL- Sinotrans is a solid asset with strong earnings and high growth:

DHL-Sinotrans' revenue and net profit grew at CAGRs of 10.4% and 12.1% over 2013-2022, with the return on equity (ROE) and return on assets (ROA) averaging 79.0% and 42.8%. We estimate that over the past 10 years, total assets of DHL-Sinotrans accounted for 5% of those of DHL Express, and that it contributed 10.5% of DHL Express' revenue and 18.6% of its EBIT.

2) Unlike the market, we believe DHL-Sinotrans may regain growth in

2024, considering that it uses the pricing mechanism of DHL Express (annually adjusted base price + fuel surcharge + emergency situation surcharge), and its cross-border e-commerce business volume will likely grow. We expect DHL-Sinotrans' operating profit to decline 12.0% YoY to Rmb1.64bn in 2023 and rise 7.5% YoY to Rmb1.77bn in 2024.

We believe the firm's freight forwarding business enjoys greater stability in earnings than the market believes: 1) Sea freight and shipping agency are the cornerstones of the freight forwarding

business. The two segments together accounted for about 55% of the operating profit of the freight forwarding business in 2022. We believe their unit earnings are not closely correlated with sea freight rates, and will rise steadily as more services are provided.

2) Earnings of air freight and rail freight businesses fluctuated to some extent, but the impact was moderate. If unit earnings of air freight

and rail freight forwarding businesses fall to the pre-2020 level in 2024　　(about 17% lower than our assumption for 2024), the combined impact will lead to a 1.1% decline in overall operating profit, in our view.

Sinotrans is trading at a discount of at least 20% to its competitors.

Sinotrans is trading at 9.4x 2023e and 8.4x 2024e P/E in the A-share market, implying a discount of at least 20% to both domestic and international freight forwarders. In addition, the market only values DHL- Sinotrans as a traditional freight forwarder, while the three major international express delivery companies are trading at 15.7x 2023e and 14.0x 2024e on average, more than 60% higher than Sinotrans' current valuation. We think the firm’s valuation may recover after the market fully recognizes the value of DHL-Sinotrans and the firm's freight forwarding business.

Financials and valuation

We keep our earnings forecasts largely unchanged. We expect attributable net profit to fall 4.7% YoY to Rmb3.88bn in 2023 and grow 11.9% YoY to Rmb4.34bn 2024. A-shares are trading at 9.4x 2023e and 8.4x 2024e P/E. H-shares are trading at 5.0x 2023e and 4.5x 2024e P/E.

We maintain an OUTPERFORM rating, and our target prices for the A- shares of Rmb6.2 (implying 11.7x 2023e and 10.4x 2024e P/E with 24.7% upside), and for the H-shares of HK$4.06 (implying 7.0x 2023e and 6.3x 2024e P/E with 37.2% upside).

The firm's dividend payout ratio rose from 31.7% in 2019 to 48.4% in 1H23, and its dividend yield is 5.2% in 2023 and 5.8% in 2024 for the A- shares, and 9.5% in 2023 and 10.7% in 2024 for the H-shares.

Risks

Sharp decline in air freight rates; lower-than-expected GMV of cross- border e-commerce; disappointing international trade volume.