Cosco - More delays and cancellations may come

Even though Cosco has announced a series of cancellations and delays, we expect more of them in the months ahead as its customers face a tight credit environment and at current BDIY rates the vessels they ordered will be operating at a loss. We do expect better execution as Cosco has now delivered its first vessel and several of the delayed vessels have been moved to the Dalian yard, which is the group’s most sophisticated yard. Outlook for Cosco’s businesses remains bleak. SELL.

Since the start of December Cosco has announced cancellations and delivery delays almost on a weekly basis. 4.5% of the company’s US$8.1B order book has been cancelled while deliveries have been delayed for 11% of the order book. In total we expect close to 20% of Cosco’s orders to get cancelled as a results of ship owner’s inability to obtain credit for the vessels they purchased and the fact that the new builds will be operating at a loss when they enter the market due to the still very low BDIY rates.

Cosco’s execution is improving. According to Clarkson Research the company has delivered its first vessel, a 57,000dwt bulk carrier, to China Cosco. This vessel was built at the Zhoushan yard, which is Cosco’s newest yard that was facing significant delays in the development. Cosco also moved construction for 6 bulk carriers from the Zhoushan yard to the Dalian yard, which is the company’s oldest and most advanced yard. Nevertheless, we still expect Cosco to make losses on its first few vessels due to cost overruns.

While Cosco has very diversified business segments, the outlook for each of them is negative. Cosco will suffer from order cancellations and margin pressures on its shipbuilding and offshore engineering businesses. The BDIY remains below break-even points for its shipping business. Ship repair revenues will drop as ship-owners won’t be paying premiums for fast turnarounds any more.

Cosco’s stock will remain under pressure until the company gives more details on its profit warning for its 2008 results and provides clarifications on the provision its will be taking for doubtful debts. Cosco is trading near the bottom of its PE and PB bands. However, we believe this is justified given the current risk in the company. SELL.

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