Sunday, November 24, 2013

Shipbuilding Industry Weathers The Same Storm, Reaps Different Fortunes

22 NOVEMBER 2013
Shipbuilding Industry Weathers The Same Storm, Reaps Different Fortunes
By Shane Goh

Since the global financial crisis, the shipbuilding industry has sailed through choppy waters. Even China’s largest private shipbuilder, China Rongsheng Heavy Industries Group, was forced to seek government assistance after a slump in vessel orders, losses in the first half of 2013 and FY12 as well as burning through its cash reserves.

Amid sluggish global trade, the ship transportation industry faced a low demand for vessels while due to an increased production at Chinese shipyards led to an oversupply of ships. Facing both demand and supply pressures, freight rates declined for ship liners as seen by the fall in the Baltic Dry Index, an assessment of the price of moving major raw materials by sea, from its high of 11,793 points set in May 2008 to 1,500 points as of 18 November 2013.

Consequently, lower orders have been placed for ships which inevitably resulted in a squeeze of margins experienced by shipbuilders.

For the two China-based shipbuilders listed on the Singapore Exchange (SGX), whose businesses largely involve constructing vessels that are used for global trades, Yangzijiang Shipbuilding (Holdings) has managed to sustain both its turnover and margins while COSCO Corporation (S) faced downward pressures on its margins.

For the other three, notwithstanding the overall optimistic outlook of the offshore oil exploration and production industry, divergence in gross profit margins has been witnessed over the past few quarters with Nam Cheong maintaining a range of 18 percent to 27 percent while Vard Holdings languishes.

Oil Prices
Based on the November 2013 edition of the Monthly Oil Market Report published by the Organisation of the Petroleum Exporting Countries (OPEC), world oil demand in 2014 is expected to increase by 1.2 percent, from 89.8 million barrels a day in 2013 to 90.8 million barrels daily, with China leading the way. The rise in consumption would impact oil prices favourably.

As demand is only one side of the coin, the supply factor has to be taken into consideration as well. In the same report, total non-OPEC oil supply in 2014 is forecast to hit 55.3 million barrels a day, up 2.2 percent from 2013’s estimate of 54.1 million barrels daily while total OPEC crude oil production hit 31.5 million barrels a day in September 2013.

Notably, for the first time in nearly 20 years, the US is producing more crude oil than it imports. Although it will not turn the country self-sufficient overnight, a reduced need on external sources of oil may lower prices as the US consumes the lion share of oil in the world. Nonetheless, as oil prices and demand surges, companies within the industry have been investing more time and resources into the exploration and mining of the asset.

Offshore Orders Surge
Based on information from Riglogix Data, the expected increase in offshore exploration and production activities has led to a jump in rig demand with 169 new rigs expected to be delivered between 2013 and 2015. This inflow of new rigs is anticipated to boost demand growth for offshore support vessels (OSV) which are necessary to support operations.

The increased activities by oil majors have benefitted local players such as Nam Cheong with order wins of 20 vessels worth approximately US$430 million for the year as of 12 November 2013. As of 30 September 2013, Nam Cheong’s order book, comprising a mix of OSVs for shallow and deep water operations that are due for deliveries beyond 2014, stood at RM1.7 billion, up from RM1.3 billion in December 2012.

Not confined to a single firm, Vard Holdings witnessed a similar growth as it saw its biggest annual order in six years, having won US$2 billion worth of contracts in the first nine months of 2013, 45 percent more than a year earlier.

Depressing Margins
However, higher revenues may not necessarily translate into a healthy bottom line growth as margins across the board have taken a hit. Among the three SGX-listed firms that derive more than half of their turnover from shipbuilding, catering to the oil and gas industry, Nam Cheong stands out with its recent upturn in both revenue and gross profits.

Gross Profit Margin Comparison

Gross Profit Margin Comparison
Sources: Respective Companies’ Financial Statements * EBITDA Was Used To Calculate Vard’s Gross Profit Margin

In its latest fiscal quarter, Nam Cheong’s top line has more than doubled from a year ago, underpinned by the progressive recognition of revenue derived from platform support vessels. Intriguingly, Nam Cheong has managed to sustain a gross profit margin of 25.6 percent despite the higher turnover.

The same story may not be said for its peers though. ASL Marine’s gross profit margin tumbled from 24.8 percent in 1Q13 to 16.2 percent in 1Q14 as increased competition in the industry, depressed ship pricing as well as rising labour costs weighed on profits.

Vard faced a harsher reduction from 13.5 percent in gross profit margin last year to 4.4 percent in its recent quarter as a result of cost overruns in its Brazilian yards. Sub-par work completed by its suppliers fell short of expectations and caused production delays.

The Leader
According to an independent market research report by Pareto Securities Asia, Nam Cheong is the largest shipbuilder of OSVs in Malaysia and the second largest player east of the Suez Canal. An integral component of Nam Cheong’s high margins, relative to its competitors, is its build-to-stock model.

This business model, which accounts for 70 percent of Nam Cheong’s shipbuilding segment, predicts and constructs future orders and sells the vessels at a premium due to the short time to delivery. Naturally, Nam Cheong runs the risk of possessing unsold inventory. It mitigates the risk by building vessels catered to the small and medium OSVs segment, which is the largest market among OSVs. Based on its track record, every single one of Nam Cheong’s vessels won jobs in the past five years.

Taking a leaf from Nam Cheong’s books, ASL Marine has recently begun its own build-to-stock shipbuilding programme, valued at $85 million, for five offshore vessels as it seeks to address the healthy demand for OSVs and combat increasingly stiff competition in the offshore shipbuilding sector.

Share Prices And Analysts’ Ratings
Source: FactSet, Figures Accurate As Of 19 November 2013
With rising oil prices and weakening margins, the outlook on the shipbuilding segment supporting the oil and gas industry is unclear. However, it appears that pre-empting demand down the road is a winner in commanding a higher margin as analysts pour favour on Nam Cheong with seven reports issuing a buy rating on the shipbuilder with a potential 33.3 percent upside in its share price.

Publish date: 22/11/13

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