Cosco - still struggling ahead

Another quarter of disappointment: Net profit of S$37 (-71% Y/Y) for 2Q09 was 26% below our and consensus estimates, with no clear sign of earnings recovery ahead due to on-going weak execution, in our view. Reversal of a previous bad debt provision at Cosco Shipyard Group amounting to S$25.9MM provided a ~S$13.2MM boost to group net income. Interest income rose 6 times on higher borrowings. Total borrowings of S$1.2B were almost double the S$657MM at end-2008 as the company geared up to fund yard expansion and make up for the mismatch in liabilities duration when it previously funded yard capex with customer advances. Net cash now stands at S$672MM, and customer advance payment is at ~S$2.4B.

Newbuilding effectively unprofitable for now: Management guided that gross margin for newbuilding for 1H09 was at 1% as a result of still less than optimal execution. 11 vessels will go on sea trial soon and are expected to be delivered this year, comprising 3 for third parties owners and 8 for China Cosco. Management highlighted that it does not expect further cancellation from China Cosco post the recent cancellation of 8 vessels and the amendment of delivery schedule for 3. 39 vessels are underconstruction.

Shipping contributed major part of earnings: Earnings from the 12 dry bulk vessels contributed about 42-43% of the company’s net income with 8vessels on short-term charter, 3 on spot charter and 1 expected to come off its previously locked-in high charter rates in August.

Do not expect major offshore surprises: As Cosco is still unable to perform turnkey rig-building, participation in potential Petrobras pipeline will be indirect via contracts like hull construction similar to the Sevan 650.

Reduce Jun-2010 SOTP PT to S$0.66 as we trim our 2010 and beyond gross margin assumption for conversion to 18%, offshore to 15% and newbuilding to 8%, cutting earnings estimate by 35%/28%/17% for FY09E/FY10E/FY11E. The current order backlog of 100 dry bulk vessels may continue to pose a drag to its operational efficiency and earnings as it continues to struggle to move up the learning curve. Maintain UW.

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