Strong numbers. NCB posted strong results, with core earnings surging 60% q-o-q and 36% y-o-y on the back of 8% and 10% growth in revenue respectively. In 2Q, there were exceptional items totaling RM12.2m as a result of the unwinding of discounts arising from the provision of concession liability. The impressive earnings were largely attributed to lower amortization charges due to the extension in the company's lease term, coupled with the turnaround in its logistics segment. Using EBITDA as a gauge, the growth was still commendable at 6% y-o-y and 12% YTD. It is worth noting the 32% q-o-q climb in EBITDA was bolstered by improved revenue from the logistics segment, as well as better economies of scale.

1H container volume lower but logistics segment lifts revenue. Northport recorded a 2.6% drop in container volume handled to 1.56m TEUs from 1.6m TEUs previously in 1H2012 as a result of global economic headwinds and intensifying competition with Westport. While this puts pressure on container revenue growth, we gather from our discussions with management that yields had somewhat picked up, thanks to higher port charges, which helped to cushion the overall decline in container volume to only a 1% dip in revenue. Revenue from NCB's logistics segment also picked up significantly (up by 45% YTD), in line with the expansion undertaken by the company in its warehousing, trucking, freight forwarding and project logistics segments, and to a certain extent, the revision of some of its logistic services rates. While container volume ended lower in 1H, we expect volume to pick up in 2H as the economy picks up pace, thus offsetting the drop to a flat growth in full-year volume. For FY13 and FY14, we expect the container volume handled to grow by 6% and 3% respectively.

Haulage segment no longer hauling in losses. The haulage segment has been showing consistent profits since turning around last year. As of 2Q, the segment's PBT surged 58% y-o-y to RM3.3m vs a PBT of RM2.1m last year after terminating its non-profitable accounts.

NCB may land 3rd terminal. The Port Klang Master Development Plan for the next 20 years identifies five possible locations for a third terminal - Pulau Che Mat Zin, Klang Bar Channel, Old Klang Bar Channel, Carey Island and Kampung Batu Laut. It is uncertain at this juncture whether PKA would award the 3rd terminal concession to NCB or Westport, or to another operator. As Westport has a sizeable hinterland for further development, we are of the view that the chances are high that the third terminal mooted by the Government will land in NCB's hands.

But may involve entry of a new player. We also note that Glenn Marine, owner and operator of the Port Klang Cruise Centre (PKCC) in Pulau Indah, has proposed to convert the current cruise terminal into Port Klang's third container port. The entry of a new player will turn up the competition and put more heat on NCB, which is already losing market share to Westport. Nonetheless, we don't see this as a threat to NCB as the potential for container growth in the coming years - at least in the longer term - will give rise to a market big enough for all three players. Our recent meeting with Glenn Marine reveals that it has received consent from the Port Klang Authority and the Economic Council, pending the nod from the cabinet. Glenn Marine, which sits on privately owned landbank along the coast on which it is currently erecting a cruise terminal between North Port and West Port, is allocating RM1.5bn to develop a 1.5km wharf with an annual capacity of 3m TEUs. While some approvals have been granted, the setting up of the port has met some heavy resistance from the existing port operators nearby.

New lease, concession terms yet to be unveiled. We note that NCB's lease on its port concession will expire in 2013 although a 30-year renewal for operating the port has been granted in principle. Management remains in the dark over the new terms, which are likely to be unveiled before year-end. As a yardstick to gauge how much NCB will need to fork out for the concession, the cost to privatize NCB's ports in 1986 and 1992 amounted to RM471m for a 21-year lease. As such, for a 30-year concession and including inflation on the pricing, our earnings assumption is based on the new port concession potentially amounting to RM800m.

Capital management. We see NCB likely to undertake capital management to optimize its capital structure and costs by raising sizeable funds for the new port concession given that its cash stood at RM673m in 1Q. This will be allocated to paying a special dividend and capex for the new berth to be completed in two years. NCB may raise RM400m over a 15-year tenure, which would change its capital structure to 26% debt/equity. This will help lower its weighted average cost of capital given the cheaper funding from the bond market.

Still a cash cow. Despite the sizeable costs involved in relation to concession fees due to the government, we see NCB as a cash cow given its stable port business. The company will consistently generate at least RM300/annum in free cash flow to equity over the next few years and reimburse RM120-150m in the form of dividends to its shareholders. Given its stable cash generating business, the port operator should be able to maintain a consistent payout ratio of at least 60% as dividend, for an immediate yield of 7% over the next few years based on the current share price.

FY14 earnings to be hit by higher amortization. We revisit our NCB model after a revamp to reflect the change in the accounting standards for IC 12 on its concession assets. We now expect the company to post earnings of RM187m for FY12, representing an earnings growth of 9% y-o-y, boosted by the turnaround of its haulage business. Note that due to the higher amortization charges to reflect the new port concession, NCB's bottomline is expected to drop to RM168.2m in FY14. Nonetheless, on the EBITDA level, its earnings from 2013 to 2014 would be flat after accounting for higher costs.

Upgrade to BUY. We upgrade NCB Holdings to BUY from SELL previously. We have changed our valuation methodology to DCF to reflect its cash generating potential. Premised on a cost of equity of 11% and terminal growth of 0%, we value NCB at RM5.59 (previously SELL, at FV of RM3.12 premised at 12x PE), which gives an upside of 31%. Our FV implies a FY13 PE multiple of only 13.4x, representing a 10% discount to regional container ports. Currently, the stock is trading at a forward multiple of only at 10.7x/10.3x on its FY12/FY13 earnings respectively. To spur its potential upside, NCB also offers an attractive net dividend yield of at least 6.5% per annum, based on a payout of 60%. BUY!

Source: OSK