COSCO Corp

OCBC on 7 Aug 2012

COSCO Corp (COSCO)’s net profit attributable to shareholders decreased by 13% YoY to S$27.6m (2Q11: S$31.9m) such that 1H12 net profit formed 50% and 43% of ours and the street’s full year estimates. 2Q gross profit jumped 56% YoY to S$117.4m (2Q11: S$75.1m) due to higher contribution from ship repair, conversions and marine engineering, but the gains were offset by lower other income and higher net interest expense. In our view, a quick turnaround is unlikely. Without an established track record, COSCO may need to bid for jobs at low margins or with back-loaded payment schedules, resulting in higher balance-sheet risks. Furthermore, the group remains vulnerable to cost over-runs for its offshore contracts. Maintain SELL rating with unchanged S$0.84 fair value estimate.

2Q results within expectations
COSCO Corp (COSCO)’s net profit attributable to shareholders decreased by 13% YoY to S$27.6m (2Q11: S$31.9m) such that 1H12 net profit formed 50% and 43% of ours and the street’s full year estimates. Revenue was flat at S$975m (2Q11: $996m), but gross profit jumped 56% YoY to S$117.4m (2Q11: S$75.1m) due to higher contribution from ship repair, conversions and offshore engineering. However, the gains were offset by lower other income (2Q12: S$34.0m; 2Q11: S$61.4m) and higher net interest expense (2Q12: S$13.2m; 2Q11: S$4.2m).

Is the margin recovery sustainable?
Unlike previous quarters which saw provision of losses for certain contracts (due to cost overruns), COSCO recorded S$15.9m of write-backs in 2Q12. Excluding provisions and write-backs of expected losses on construction contracts, the group’s (adjusted) gross margin recovered to 10.4% for 2Q12 (2Q11: 8.3%). As quarterly margins are historically volatile due to variation of orders, this ‘margin recovery’ may not be sustainable. Management is also not optimistic. Shipbuilding margin is likely to remain under pressure due to low values of contracts secured in 2010, while the offshore segment is expected to incur higher execution costs going forward.

No quick turnaround
The group faces significant headwinds in its transition into an offshore yard. Without an established track record, the group may need to bid for jobs at low margins or with back-loaded payment schedules, resulting in higher balance-sheet risks. Furthermore, COSCO’s broad range of outstanding offshore jobs – many of which are new to the group – imply higher risks of cost over-runs. We adjusted our model slightly to incorporate the latest results and keep our SELL rating and S$0.84 fair value estimate (on 1.4x P/B) unchanged.