Order cancellations and deferrals have begun: Two orders have been cancelled and a further ten have been deferred; incidentally this is equivalent to the sum-total of all shipbuilding orders won by COSCO in 2008. That the affected orders were all won in mid-2007 is all the more alarming given that orders placed in 2008 would be less expensive to cancel for COSCO’s clients. We expect further cancellations and/or deferrals through the remainder of 2009.
Balance sheet write-downs expected: As steel plate and ship engine prices have come off over the past two quarters, COSCO will be forced to mark to market its inventory. Given prices have dropped 30–40%, we estimate a write- down of S$118m, which would lead to a 27% drop in net profits vs. 2007. We suspect this is the main reason behind COSCO’s profit warning on 30 December 2008.
Valuation not compelling yet: Assuming the write-down, the stock is trading at 8.6x FY08, with marginal growth in FY09; this suggests the stock is still expensive. Even without any write-down, the stock is trading at 6.7x FY08, with negative earnings growth likely over the next year, not to mention a significant drop in newbuilding order wins.
FY08E and FY09E EPS have been reduced by 18.7% and 8.2%, respectively, while FY10 EPS has been raised by 29.9% to reflect deferred profit recognition.
12-month price target: S$0.65 based on a DCF methodology. We remain bearish on shipbuilders and believe there is further downside to the COSCO share price. Long-only investors best avoid COSCO while long-short investors should consider a long SMM/Short COS pair trade.
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