Thursday, 28 August 2014

Neptune Orient Lines

WE have raised our rating from Underperform to Outperform for Neptune Orient Lines (NOL) as we observe the liner shipping sector displaying the same characteristics as it did in the last four months of 2012, during which time sector stock prices rallied 14 per cent.
  • We see port congestion in major ports (especially for large vessels) and potential box shortages constraining supply, combining with demand that is surprisingly on the upside, as being conducive to rate increases ahead of expectations.
  • We have lifted our earnings estimates for NOL from a loss of S$12 million to NPAT (net profit after tax) of S$15 million in 2014 and lift our estimate for 2015 38 per cent to S$105 million on better volume and rate expectations in Q314 and their flow through to the following year.
  • We have also lifted our target price for NOL from S$0.90 to S$1.15 as a consequence of the earnings improvement, but also because we think both asset values are rising and multiples are likely to expand. Our new TP is based on a target P/B of 1.1 times.
Capacity drives rates, rates drive stock prices, and we see capacity coming down at the same time as demand is rising, laying the foundations for a very firm Q3 peak season.
Demand growth averaged 7 per cent in Q214 among the liner companies we cover and had risen robustly in figures to June (EU box volumes +7 per cent YTD, US imports up 2 per cent, Asian exports +6 per cent). The factors driving demand (employment, housing starts and inventory levels) look set to maintain demand growth momentum in H214.
While vessel deliveries continue apace, congestion levels, especially in ports handling large vessels, have exceeded these. Congestion in some of Asia's feeder ports is also playing to this theme. Meanwhile, operators are identifying box shortages as another potential supply-side constraint.
Combined with better demand, we see a robust Q3 peak in both volume and rate terms, with earnings expected to exceed Q312, given the effects of large vessel and alliance efficiencies together with lower bunker prices.
Liner stocks gained 14 per cent from early September 2012 to end-December 2012 and we feel that they are well placed to repeat that gain as 2014 closes.
NOL's earnings are expected to hit consistently positive territory starting from Q314, as improved Transpacific spot rates benefit it, as will increases in some of its short sea markets.
As a large proportion of its rates are contract-based, NOL's earnings lift is not expected until next year when Transpacific rates re-set, but meanwhile, we anticipate that it will trade back to the 1.1 times P/B levels that characterised Q3/Q412, and which remain still at a discount to the company's post GFC mean of 1.2 times.
When marked to market, desk-top valuations show NOL at a slight premium to the market value of its assets. However, the youth of its fleet and its logistics business' potential value (as much as US$1.1 billion) suggest that this is really a discount.

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