Chinese Shipyards - a real recovery in ship orders is still far away

JES and YZJ are still getting enquiries for bulk carriers, containerships and tankers. Global new ship orders rebounded from zero in May to 1.83m dwt in June. That said, ytd order level is significantly lower than historical levels.

New YZJ shipyard in Jiangsu.

• The yard has a 1.9-km deepwater coastline, a 1,508,857 sqm production area, and a dry dock that can accommodate up to two 100,000 dwt and two 50,000 dwt vessels at any one time. The shipyard employs about 15,000 workers, of which 15-20% are contract workers.

• We attended the launching ceremony of a 92,500 dwt dry bulk carrier - Chanchal Prem. The ship is one of the 16 bulkers ordered from YZJ’s shipyard by Liberty Maritime International. Shipyard management has guided gross margin of these ships at 20%.

• Shipbuilding enquiries are mainly on tankers, dry bulk carriers and containerships, particularly reefers (for transporting refrigerated containers).

• While YZJ has no order cancellation to date, it recently acceded to the requests of its clients to change four containerships into dry bulk carriers.

• China’s taxation laws require local shipowners to pay an additional 20% on ship purchases while foreign shipowners are exempted. Thus, local shipowners would form JVs with foreign partners or use their overseas units to buy ships.

• Two Panamax dry bulk carriers costing US$70m each were delivered to Guangdong Yuedian in Apr 09 and early July. These high-value ships have a gross margin of 40-50%.

JES’ shipyard.

• The shipyard has a gross land area of 167,000 sqm and a coastline 720m long. The yard has two slipways to accommodate one 100,000 dwt vessel each.

• The new dry dock, which is under construction, can accommodate up to three Capesize dry bulk carriers or two Very Large Crude Carriers (VLCCs) when it becomes operational by end-09.

• Recently, JES’ clients cancelled orders for three dry bulk carriers with a total value of US$127.0m.

• Shipbuilding enquiries are mainly on dry bulk carriers and reefers.

• Net orderbook as at 31 Mar 09 stood at US$1.03m for 34 vessels to be delivered in 2009-12.

According to Clarksons, global new ship orders rebounded to 1.83 mdwt in Jun 09 from zero in May 09, of which 87%, or 1.6m dwt, are contracted to Chinese shipbuilders. Ytd, most of the global newbuild orders are mainly for tankers and Very Large Ore Carriers (VLOC).

Low order wins ytd. While the strong orderbooks for some shipyards can keep them busy until 2012, the global contract wins ytd of 3.4 mdwt are significantly low compared with a year ago (Jun 08: 19.0 mdwt). Ytd, COSCO (S), JES and YZJ have not secured any newbuild orders.

Slippage remains an issue. Tight global liquidity remains an issue although it has eased somewhat. Some shipowners are still facing difficulties in securing credit to finance newbuilds. Recently, JES’ clients cancelled orders for three dry bulk carriers and COSCO (S) announced last week that it has acceded to the requests of two European clients on delayed deliveries of eight dry bulk carriers by some 3-9 months. Shipyards are still facing a high risk of order cancellations and delays.

We believe a real recovery in ship orders is still far away. The massive 547.3m dwt (9,277 ships) contracted over the past three years will lead to an oversupply of ships, with some of these starting to hit the waters. The Singapore-listed Chinese shipyards are trading at average PEs of 14x for 2009 and 16x for 2010. In view of the low contract wins globally ytd and the risk of order cancellations or delays, we remain UNDERWEIGHT on Chinese shipyards and maintain SELL on COSCO (S) with a fair price of S$0.95 based on sum-of-the-parts valuation.

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China Shipbuilding - Valuation No Longer Cheap

Valuation no Longer cheap; current premium unsustainable: Although global shipbuilding industry experienced zero new orders in May, shipbuilding stocks delivered a mixed performance. From May 6 to June 11, Japanese shipbuilding stocks gained 39%, followed by Chinese names’ 26% advance while Koreanpeers lost 11%. Such performance is contrary to the fundamentals, given Japan is continuously losing market share to China and Korea. We understood the market might play a sector rotation strategy and temporarily prefer laggard performers with weak fundamentals but cheap valuations. However, after the strong gain in May, Chinese shipbuilding stocks are now trading at 2.4x 09e P/B and 1.8x 10e P/B, which is no longer cheap and even higher than Hyundai Heavy and Samsung Heavy. We see such a valuation premium as unsustainable and expect downside risk at current level.
Stimulus cannot heal all wounds: On June 4, China released the detailed shipbuilding stimulus plan. Without incremental positive measures, the detailed plan reiterate government’s stance to protect order book via offering buy-side financing or purchasing aborted vessel. However, we don’t think the stimulus package can heal all wounds as the total contract value of China’s backlog exceeded US$140bn, or 20% of China’s incremental loan in 2008. Even considering that an aborted vessel can be purchased at a 40% discount to the contract price, it is still difficult to find sufficient capital to protect all the backlog. Our backlog allocation analysis on page 2 suggests that nearly 50% of the orders are placed in state-owned shipyards, which should be the priority during government rescue.

Containership price underperformed again in May: New-building price of containership experienced bigger correction than any other vessel segment in May (Exhibit 7 on page 4). We recommend investors take profits on Yangzijiang, as in comparison to the other shipyards, it is more likely to face negative headwinds with a larger new-building price correction.

Yangzijiang with its 52 year track record

Yangzijiang significantly improved the efficiency of its existing yard over the past year. On top of this it started producing larger, more complex vessels at its new yard. The company reduced the production cycles for its containerships and bulk carriers by 7 to 30%. This is the result of extensive new worker training programs and the adoption of new engineering technology. At the new yard it delivered 4,250 TEU containerships and 92,500dwt bulk carriers more than double the size of previous vessels.

Thanks to its 52 year track record Yangzijiang delivered 27 vessels in 2007 or 3% of the total Chinese shipbuilding output. So far this year the company has delivered 16 vessels and is on schedule to deliver another 24 vessels by the end of the year. In 2008 the company was only using 25% of its new yard’s capacity, so it has enough space to deliver 40 vessels in 2009 and 45 in 2010.

Yangzijiang has consistently collected cash for the vessels under construction. Out of its US$6.9 billion order book as of the end of 2008, the company had received US$3B or 44% in cash payments. It had only recognized US$0.7B in revenues for the vessels under construction; the remainder remains a liability on its order book. Hence, we believe that the 6 months delivery delays that the company has been granting to some of its customers should not create a cash constrain especially since Yangzijiang is in a 67% net cash position.

We increased our PE-derived target price from S$050 to S$0.75 as a result of the increase in PE estimate from 6x FY09 to 9x in-line with global rise in valuations of shipbuilding stocks. We think Yangzijiang deserves to trade at a premium to Cosco Corp’s shipbuilding business, which we have valued at 8x FY09, thanks to its efficiency and track record. The stock continues to look attractive relative to its historical PE. Maintain O-PF.

Yangzijiang: Excellent execution priced

Shipbuilding industry is not expected to turnaround soon. Unlike consumer and manufacturing industries, where recovery could be expected by 2H09, the new orders for newbuilds are not expected to flow in materially till 2011, in view of the huge order backlog and bleak shipping outlook. YTD, there were only two orders of handymax vessels placed. In fact, there could wellbe more cancellation of contracts, which has virtually gained momentum in April. We believe shipbuilders’ earnings are likely to peak this year. The cancellations and deferments as well as price cut for existing orders would be a drag on shipbuilders’ revenue stream and profitability in 2010. We have built in 25% cancellations / deferments of Yangzijiang’s current order book of US$6.7bn and assumed new order wins of US$50m a year in 2009-2010.

Trading at unjustifiable premium over Korean peers. Yangzijiang’s share price soared c.80% after it posted record 1Q results. It is now trading at a notable premium of >20% over the Korean shipbuilders. This appears overdone to us given Korean yards’ larger market capitalization and stronger execution. This should suggest limited upside to share price in the near term. In addition, the anticipated correction of BDI in coming weeks should impose additional downward pressure on Yangzijiang’s share price as well, in view of its high correlation with BDI (0.68).

Downgrade to FULLY VALUED. We advise investors to take profit. We are leaving our earning forecasts intact. However, our TP is raised to S$0.68, on a higher multiple of 6.5x 09PE vs 5x previously, which is in line with the average valuation for Korea and HK-listed peers. This translates to 2.0x P/Bv, in line with the historical average P/Bv for Korea shipbuilders.

Yang Zi Jiang Shipbuilding - Not yet dawn

We revise our earnings forecasts for Yangzijiang Shipbuilding (YZJ) on the back of improved margin due to larger vessels under construction in 2009. We maintain Underperform but increase our target price to S$0.38 from S$0.28.

Holding up better than peers: YZJ’s profitability is holding up relatively well compared with its Chinese peers, with 1Q09 EPS up 17% YoY. We think the key driver is larger vessels under construction. The average vessel size under construction rose from 14,360cgt/vessel in 2008 to 20,575cgt in 2009, up 43%. The expanded vessel size improves production scale and margin. We think the larger vessels will help YZJ to maintain a high margin this year; however, we expect the average vessel size under construction to pull back to 15,567cgt in 2010.

Revision of current contracts: YZJ has seen 6–12 month delays in delivery and revision of vessel prices for current contracts. The company denies cancellations so far. We estimate a six-month delivery delay would decrease the company’s margin by about 2% and a price renegotiation range of 15–20%. Our commodity team’s recent visits to steel plate companies indicated that some ship plate plants are seeing delays of up to two years.

Decreasing utilisation: Having expanded in 2007, YZJ’s new capacity is scheduled to be fully deployed by 2012. However, without new orders, the company’s capacity utilisation will shrink to below 50% after 2010, in our view. We believe the decreasing utilisation will put pressure on the yard’s margin.

We raise our EPS forecast for 2009 by 23%, leave our 2010 EPS forecast unchanged and cut our 2011 EPS forecast by 7%. We increase our target price to S$0.38 from S$0.28. 12-month price target: S$0.38 based on a Price to Book methodology. Catalyst: No new orders and more revision of the current backlog.

We maintain our Underperform recommendation, but increase our target price to S$0.38 from S$0.28. We think current cancellations or revision of the previous contracts will impact YZJ’s earnings starting in 2010. We maintain our negative view on the shipbuilding industry. We believe the recent rally of the shipbuilding company shares is not supported by a fundamental recovery of the industry.

Yangzijiang - Margins holding up well

Yangzijiang reported a stronger than anticipated set of 1Q09 results. Net profits of Rmb483m were up 30% yoy and 47% of our full-year estimate thanks to stronger than expected margins. We are upgrading our FY09 net profit estimate by 39% to reflect the higher than anticipated results. Yangzijiang delivered 6 vessels in 1Q09 (8 so far this year) and is on schedule to deliver all 40 vessel scheduled for delivery in 2009. The new yard is running at 50% capacity and is on track to reach 90% by 2010.

Yangzijiang’s gross margins held up better than expected. The margins came in at 20% vs. our full year estimate of 13% thanks to the recognition of higher value vessels (company is making close to 40% margins on those) andthe lower than anticipated steel prices. To reflect this difference, we have upgraded our full-year 2009 gross margin estimate to 16%. We still expect the company to be impacted by the 8% provisions on potential cost variations, especially once it delivers these higher value vessels.

Yangzijiang has not seen a single of its 149 vessel order book (US$6.7 billion) cancelled. The company is working hard to avoid any cancellations by helping customers find funding, providing delivery delays or order modifications and even providing rebates. As a result our 35% order cancellation is too aggressive and we reduce it to 20%. At the same time we are increasing our working capital requirements to reflect the delays and rebates offered.

To reflect the better than anticipated margins and lower order cancellations, we increased our FY09 net profit estimate by 39% and our FY10 estimate by 106%. This leads us to upgrade our 6x PE target price from S$0.36/share to S$0.50/share. With 11% upside to our new TP, we are upgrading our rec from a SELL to an O-PF. We expect Yangzijiang to outperform the other shipbuilders although the news surrounding the sector will remain negative.

Yangzijiang 扬子江 牛气十足

去年全球船业不景气，扬子江船业(Yangzijiang Shipbuilding)却牛气十足。

该公司昨天公布全年业绩显示，去年按期交付27艘船，营业额比2007年增长91％，报人民币73亿5910万元(下同，合16亿1920万新元)，净利则大幅攀升82％，报15亿7976万元(3亿4700万新元)。

其中，第四季净利增长25％，报3亿9508万元。每股盈利45.13分，每股净有形资产值1.18元。公司宣布每股派发年终免税股息新币1.8分。

公司董事长任元林受访时表示，尽管今年的新订单会大大减少，目前公司手持的订单额仍高达69亿美元(105亿新元)，可供扬子江船业生产三年半到四年。公司目前也拥有净现金人民币30亿6000万元，这在当前全球遭遇金融海啸的特殊时期，为公司换来了更多的主动，因而他对接下来的业务“并不担心”。

任元林说，公司在过去价格平稳时，提前承接了大批订单。其中，由他们自己开发制造的9万2000吨中国扬子江型散装船，同目前的巴拿马型散装船相比，油耗不增，船员不增，运量却增长了25％，且由自己定价。一家意大利船东，一口气就订下22艘。

任元林说：“可以这样说，目前在中国非国有企业中，扬子江船业已成为同业中的标杆、排头兵和佼佼者。”

公司实行保守稳健的经营策略，凡客户订单除先付20％的预付金外，还有20％的银行担保，加上客户都是经过挑选的大公司，因而撤单的情况几乎没有发生。

中国政府日前出台的船舶工业振兴规划，已将扬子江船业列入重点支持企业。任元林说，江苏全省上百家民营造船企业中，只有三家被列入名单。

据世界最大的船只经纪商克拉克森公司(Clarkson)统计，扬子江船业在去年的全球造船产能方面名列第26位，产量列21位；在中国则分别为第6位和第8位。　

任元林说，扬子江新厂今年产量将翻番，整个集团的产量将增长50％，预计全年业务仍将保持强劲增长势头。

S-Shares Results Review Summary and Outlook

In summary, two-thirds of the S-share companies under review saw their earnings rose for 2008, although most of the growth came during the first half of 2008.

Discretionary consumer companies saw significant demand slowdown in the second half of 2008, which became even more apparent in the 4th quarter. Companies either faced a slowing of revenue growth (like China Hongxing) or had to sacrifice lower margins (Hongguo and China Sports) to maintain sales growth via product discounts or by keeping ASPs low.

Meanwhile, the earnings outlook for discretionary consumer companies is fairly muted. We expect companies to continue spending on A&P to maintain their brand visibility, whilst also likely to embark on discounts either directly or indirectly to consumers to induce spending, which would pressure margins.

Consumer staple companies like Pacific Andes, China Fish, and Celestial NutriFoods were less affected. While companies under this segment also saw a slowdown in second half of 2008, impact was less significant. We still saw a 7% and 19% growth for China Fishery and Celestial NutriFoods respectively. Raffles Education continued to deliver robust growth largely on operating efficiency.

Going forward, we believe the impact of a slowdown in consumer sentiment will impact more on branded staple food like Celestial NutriFoods.

Shipyards like Cosco and Yangzijiang were hit by provisions. In view of the deteriorating conditions for shipping industry, the shipyards have prudently made higher provisions for doubtful debts and cost overrun in 4Q08. In line with its profit guidance, Cosco plunged into losses of S$24m in 4Q08, due mainly to provisions for inventory write-downs, doubtful debts and cost overrun at its shipbuilding division. Yangzijiang’s FY08 earnings fell short of our estimate by 5%, blames on a provision of RMB200m. Stripping this out, its bottomline would have come in 5% above our expectation.

Yangzijiang - 2008 profit in line with UBSe and consensus

YZJ reported NPAT of Rmb1,580m (+82%YoY) and revenue of Rmb7,359m (+91%YoY) for 2008. Both are largely in line with UBS estimates (-5% and 3% above consensus, respectively). Note YZJ’s GM fell to 18.5% in 08 from 23.0% in 07, mainly due to the margin contraction to 12.7% in Q408 (19.9% in Q407), as it raised provision for potential cost variation to 8% of contract price from 0.5%.

YZJ’s mgmt guided the company would stick to its original delivery schedule of 40 vessel in 2009, though it could provide 3-6mo berthing time upon receiving the full payment and if required by ship owners. YZJ has not yet encountered order cancellation, and will proactively co-work with its customers to avoid or reduce such risk down the road.

The recently announced industry revitalization plan by China govt would benefit two large state-owned shipbuilding giant, CSSC and CISC, as well as some selected names such as YZJ, one of three private yards in Jiangsu named. With 27 vessels of 850k DWT delivered in 08, YZJ was ranked 6th in China with an orderbook of 155 vessels of US$6.9bn. However, it is difficult to quantify the policy benefits, as most are guideline only as of now.

We will review our forecast following the results. We maintain our Buy rating and 12-month price target of S$1.30, based on 2.5x 2009E book value.

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).