The return of the provisions
▊ After five consecutive quarters of provision writebacks, which offered hope that its operations might stabilise, Cosco once again reminded us that redemption is still a long way off. De-rating catalysts could come from persistent weak execution. At 55% of our FY13 core earnings, 9M was 66% below our expectation and 79% below consensus’s. The negative deviance stems from inventory writedown and the provision for contract losses. We cut our FY13 EPS by 21% to factor in the 3Q earnings miss and lower FY14-15 EPS by 9-11% on weaker margins. We maintain our Underperform rating, but raise our target price as we roll forward to 22x CY15 P/E (five-year mean).
Return of the provisions
Cosco recorded S$4.2m in core earnings for 3Q as it was hurt by provisions for contract losses and inventory writedown, which totalled S$49.7m. The group achieved gross profit margin of 7.4% for 3Q, bringing 9M gross margins to 9.5%. 3Q could have been uglier if it had not been for a one-off compensation of S$13.2m received from customers. As a result, we now lower FY14-15 EBIT margins by 0.4% pt (FY14: 5.7%, FY15: 6.3%).
Worse to come?
We believe that Cosco’s 4Q results could be uglier, owing to the reversal of profits for the cancellation of its drillship order. The cancellation is now under arbitration and the company is unable to quantify any financial impact. However, in line with the conservatism principle in accounting standards, we believe that we would see the impact in 4Q. Upside risk would come from a successful sale of the drillship. The unit is undergoing sea trials and Cosco shares that it has several enquiries for the vessel.
We recommend investors to sell the stock in view of the negative triggers in 4Q. We believe that the market has already priced in US$2bn of order intake. While the company may ‘buy’ contracts by lowering profitability, that would not buy it any favours from the market.
Publish date: 06/11/13