Monday, October 7, 2013

Yangzijiang : Wary of a False Dawn (MKE)

Yangzijiang Shipbuilding
Sell (from Hold)
Share price: SGD1.135
Target price: SGD0.98 (from SGD0.93)
Wary of a False Dawn

Sector recovery not convincing. There recent surge in BDI has fuelled rising anticipation for a recovery in the shipping market, and expectations for a return in shipbuilding orders. We do not see a broadbased recovery for Chinese shipbuilders yet as (1) rise in BDI was led mainly by rate hikes for capesize vessels, (2) container freight rates remain weak, and (3) yard overcapacity issue lingers. We fear that YZJ’s recent rise in share price may meet with downward pressure when shipping market recovery story disappoints. Downgrade to Sell, SOTP-based TP at SGD0.98.

Shipbuilding prices not likely to rise significantly yet. The new wave of shipbuilding orders is expected to be driven by structural switch to fuel-efficient vessels rather than the need for new capacity. Korean shipbuilders hold the lead for such vessels while competitiveness for Japanese shipbuilders have re-emerged with the lower Yen. Therefore we do not see shipbuilding prices picking up significantly. In comparison to 2008 peak, average price is at least 30% lower currently. Thus, while there may be some short-term spike in new orders, we still see margin contraction and EPS decline for YZJ’s core shipbuilding business for FY13-15F as higher margin contracts are depleted from orderbook.

YZJ is a still a standout yard. We have no doubt that YZJ stands out among the Chinese shipyards. This view was reinforced after our recent visit to its JNYS and Xinfu yards in Jiangsu, PRC. We witnessed vessel launch of Chinese shipyards’ first 10,000teu containership, which is being built by YZJ. This clearly demonstrates its superior expertise relative to many Chinese shipyards. It is building a total of 16 such units for Seaspan which includes an option for 9 more.

But lift in sector valuation level is fragile. We agree YZJ would be the best proxy to ride a shipbuilding recovery cycle, but we disagree that this is the turn. We think that the recent lift in valuation is fragile as it is not supported by future EPS growth with margin decline still in the cards. We argue that order win pickup is still not sufficient to drive EPS growth in the core shipbuilding business for FY13-15F as shipbuilding prices would remain capped.

Lift in valuation fragile, shipping market recovery story may disappoint
Recent surge may have overshot fundamentals. In our view, recent surge in share prices for shipbuilding counters may have overshot sector fundamentals. The lift in sector valuations is not supported by robust EPS growth. While we see slight improvement in near-term orderbook momentum from the sudden optimism, without a corresponding rise in shipbuilding prices, EPS decline and margin contractions are still in the cards.

Flush in capacity must first occur. We believe that a flush in excess capacity must first occur, otherwise a surge in orders now may result in revival of near-death shipyards, further capping shipbuilding price appreciation and delaying the recovery of the sector. This could be made worse if the shipping market recovery story fails to materialise as expected.

Valuations fragile, downgrade to Sell. As such, we think that current valuation level is fragile and see corrections ahead from profit taking and possible disappointment in the shipping market recovery story. We downgrade YZJ to SELL on grounds that the recent price surge is overdone. We value the stock at SGD0.98 based on our SOTP model. While we have raised order win expectations to USD1.9-2.4b for FY13- 15F from USD1.3-2.2b, we cut our FY13-15F net profits by 2-9% as our previous gross margin assumptions for its shipbuilding segment of 19- 24% may be too high. We now assume segmental gross margins to be 13-20% over this period.

Shipping market recovery not convincing
There is rising optimism for a recovery of the shipping market due to a recent surge in bulk shipping rates. We are cautious to infer that a broad-based recovery for the shipbuilding sector will be imminent, especially for the Chinese shipbuilding sector, due to the following reasons:

1) BDI rise led by mainly by capesize rates. The positive expectation was fueled by a sudden surge in BDI. This may have been driven by Chinese steel producers restocking their iron-ore inventory and importing cheaper and higher quality seaborne supplies from Australia over domestic supplies. Historically bulker rates have been volatile and had rose during this same period at least for the last 3 years prior in the led up to Chinese Golden Weak. Furthermore, the recent rise was mainly driven mainly by rate hikes for capesize vessels. We are skeptical about its sustainability without convincing signs of an economic recovery. China’s September PMI came in at 51.1, below market expectations which cast further doubts on a sustained economic rebound.

2) Container freight rates softening despite the surge in BDI. Despite the surge in BDI, when comparing over a longer time horizon, BDI level is still significantly below peak or even the more normalised levels of 2,000-6,000. Furthermore, BDI reflects the bulk shipping market and is not representative of the whole shipping
market. The container shipping market remains weak as evidenced by the fall in Shanghai Containerised Freight Index. While Maersk has raised their demand growth in 2014-2015 to 4-6% from 2-3%, the increased capacity expected to come in from shipyards still far exceeds the expected demand growth given thet 10-11% growth in capacity this year. This creates a huge supply-demand gap which we believed continue to cap rate increases.

3) Yard overcapacity unresolved. We still see structural weaknesses from the unresolved yard overcapacity issue in China which would take some time to flush out. According to the China Association for National Shipbuilding, there are about 1,650 shipyards in China of which half could shut down in the next few years. The State Council of China has initiated to accelerate the consolidation of the industry and restrict growth in capacities through a three-year plan through 2015. Until we see the
consolidation of these excess capacities, we do not expect to see significant improvement in prices.

A false surge will prolong downturn
Meanwhile, we concur with the view that a surge in ordering of new vessels now may not be positive for the industry. Without a corresponding uplift in global economy and shipping demand, this may further aggravate the vessel oversupply situation and delay shipbuilding sector recovery. According to Alphaliner, the imbalance that is created by the recent surge in orders for mega-ships will impede the recovery in the liner sector, with no sustainable recovery expected until 2015. We believe that for a healthy recovery for the Chinese shipbuilding sector, events need to unfold in the following order:

Flushing out of excess shipbuilding capacity -> Firm economic recovery drives shipping demand -> Ship owners place orders for new ships in anticipation of increase in demand -> Increased tightness in shipyard capacities -> rise in shipbuilding prices

Shipbuilding prices unlikely to show significant uptick
Current wave of ship demand driven by structural switch, not capacity needs. The new wave of ship orders would be driven by switch to fuel-efficient vessels rather than the need for new capacities. Korean shipbuilders hold the lead in this area. Increasingly, Japanese shipbuilders are becoming more competitive with the depreciating Yen. There are only a few Chinese yards who are capable of building such vessels, of which YZJ is one of them. Ship owners who can order such ships now are a select few who has a strong balance sheet and the competition to secure such orders are intense among the yards.

Recent orders for such vessels in the liner market consists of orders by
(1) United Arab Shipping Co for five 18,000teu and five 14,000teu vessels from Korea’s Hyundai Heavy,
(2) MSC for six 18,000teu from Korea’s Daewoo Shipyard,
(3) CMA CGM for three 16,000teu from Chinese shipyards, and
(4) Seaspan for ten 14,000teu from Korea and China under a long-term charter of Yang Ming.

Ship prices not likely to rise much yet until excess capacities are flushed. Because of reasons above, although we agree that ship prices have passed its bottom, we do not expect a significant rise in shipbuilding prices yet until the excess capacities are being flushed out. As the lower priced ships are recognised in shipbuilders’ revenue in the next few years, expect to see a trend of margin decline.

Fear of a replay of a false start as in FY10. We fear that the recent surge in orderbook and minor uptick in prices could be a replay of the false start in FY10 when the slight pickup in price and order win drove share price higher but disappointed subsequently. In comparison, average prices at current levels are even lower than that of FY10 and higher contract volume is needed to achieve a similar level of net profits.

But Yangzijiang is still the standout yard among
Chinese shipbuilders
First Chinese yard to launch 10,000teu container vessel. We recently visited YZJ’s JNYS and Xinfu yards in Jiangsu, PRC. We witnessed the vessel launch of its first 10,000teu containership, also the first such vessel to be launched by a Chinese shipyard. This clearly demonstrates YZJ’s superior expertise relative to many Chinese shipyards. It is building a total of 16 such units for Seaspan which still has outstanding options for 9 more such units. YZJ’s yards are generally filled with work going on all around in contrast to the empty dock scene in many other Chinese yards.

Superior margins due to discipline in order intake. YZJ also has superior margins in comparison to its peers. It has managed above 20% gross margins while many Chinese shipyards are achieving only single to low double-digit margins. This is due to its discipline in taking in only profitable orders and those with reasonable financing terms. Its proven execution track record also helps in gaining customer confidence.

But strong order win momentum recently should not be extrapolated. Order win momentum has been exceptionally strong recently. Out of YTD order win of USD2.1b, USD1.4b were announced in the last three months, most from exercising of options. We believe that this surge in ordering activities is temporary. In our view, some shipowners may fear that the prices would rise higher and are ordering before their options expire. We raise our order win expectations for FY13F/14F/15F from USD1.3b/1.7b/2.2b to USD2.3b/1.9b/2.4b. However, despite this increase, our estimates still show a range of 3- 23% YoY EPS declines over this period.

YZJ still has outstanding options of USD1.36b. YZJ has secured about USD2.1b in new contracts YTD. It has 28 options outstanding worth about USD1.36b, of which 11 options are for containerships worth USD0.85b and 17 options are for bulkcarriers worth USD0.51b.

HTM assets still a substantial portion of profits. Its HTM assets and micro-finance business still accounts for almost half of its total gross profits. Default risk has been low at less than 5%, according to YZJ and these has mostly been covered by the sale of collaterals. We still exercise some caution over this business, valuating it now at 10% discount to its book value.

Wait for more convincing recovery data points. YZJ would be the right stock to ride a shipbuilding recovery cycle. However, we are not convinced that this is the turn. We recommend investors to Sell into strength and wait for more convincing recovery data points. In our view, this would be (1) flushing out of excess shipyard capacity, (2) convincing macro economic growth driving trade and shipping recovery and (3) substantial rise in shipbuilding prices.

Source/Extract/Excerpts/来源/转贴/摘录: MKE-Research,
Publish date: 03/10/13

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