China Shipyards : Cosco Yangzijiang - Sell into strength

We believe that share prices for SGX-listed Chinese shipyards were up recently on the false impression that new orders will pick up upon the Ministry of Communication’s (MOC) initiative to eliminate 17% VAT on vessels built by Chinese yards and ordered by Chinese shipowner. In our opinion, this demand-side stimulus does not resolve the supply-side issues plaguing the shipbuilding industry in China, namely increasing difficulties to get funds for new purchases due to falling collateral values, and oversupply of vessels to pressure freight rates at below breakeven levels. We see the recent share price run-up as an opportunity to sell into strength. Maintain CAUTIOUS on the Chinese shipyards.

Share prices up on old news? Our on-the-ground checks confirmed that the elimination of 17% VAT on vessels built by Chinese yards and ordered by Chinese shipowner has been implemented since 1 January 2009, and is part of the Chinese government's initiative (in November 2008) to eliminate VAT for new capex for all Chinese companies. Hence, the market talk that the Ministry of Communication is considering eliminating the 17% VAT on vessels built by Chinese yards and ordered by Chinese shipowner is just a catch-all extension to this earlier initiative for shipowners' vessel transactions. In our opinion, this VAT cut was mis-intepreted by the equity market as turnaround for Chinese shipyards' fortunes, including Cosco Corp and Yangzijiang.

Supply-side factors are hard to overcome. We believe that this demand-side stimulus will have limited impact on new orders, due to tighter credit lending as collateral values plunge, and operating losses even at the rebounded freight levels. Instead, these unresolved supply-side problems will result in more order delays/cancellations, and create an overhang on the share prices for Cosco Corp (20% order delays/cancellations to-date, vs. our expectation of 40%) and Yangzijiang (zero order delay/cancellation to-date, vs. our expectation of 15%).

Run up in share prices present an opportunity to sell out of Chinese shipyards. The global oversupply of dry bulk carriers in 2009 is imminent, given the general reluctance of shipowners to cancel orders since 4Q08. Maintain FULLY VALUED ratings on Cosco Corp (Fair value is S$0.76) and Yangzijiang (Fair value is S$0.34).

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