Cosco - Fair valuation on depressed earnings

Key catalyst: Clinch of offshore conversion projects. Cosco has recently clinched Modec’s offshore conversion project, affirming its capability to undertake these projects. We note that Modec has identified other contract work opportunities for Petrobras, including a Floating Storage RegasificationUnit, a Tension Leg Platform and FPSO for Petrobras’ Papa Terra oil field, in its website. We think any contract win would put Cosco in good standing to explore further working opportunities. Separately, we note that Cosco is finalising two other FPSO conversion projects at a potential value of US$150m.

Maiden newbuild expected for delivery in 3Q09. According to Sevan’s recent annual report, Sevan Driller 1 is currently 90% completed at Cosco, with expected delivery in 3Q09. The successful completion and delivery of this maiden cylindrical drilling rig would enhance Cosco’s track record. Furthermore, we understand Cosco has been awarded the contract to build Sevan’s second cylindrical drilling rig.

Still, we do not deny that the near-term outlook is bleak, with more order cancellations expected… So far, Cosco announced the cancellation of 5 bulk carrier orders and deferment of 26 others (excluding the orders from parent Cosco Group). While we expect some cancellations from parent, Cosco Group, as HK-listed China Cosco Holdings has indicated plans to cancel or defer bulk carriers in its recent results’ guidance, we believe the market has already factored in these negative announcements.

We are reverting our valuations to mid-cycle P/E multiples from trough P/B valuations. Cosco is currently trading at a P/E of 16.3x/13.2x on FY09F/10F EPS, a premium to the Chinese and Singapore peers. In view of the higher investor risk appetite and the potential offshore order flow, we peg a valuation parameter of 12x P/E on FY10F earnings for its shipbuilding/ conversion and offshore and NAV of the 12 bulk carriers under its shipchartering business arm, deriving a target price of S$1.14 (from S$0.92 previously). We upgrade Cosco from SELL to NEUTRAL, given the balanced risk-reward and fair valuations.

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