Neptune Orient Line

MACQUARIE EQUITIES RESEARCH on 20 Aug 2012

FOLLOWING our discussion with Neptune Orient (NOL) after Q2 results, we downgrade the stock from "neutral" to "underperform" to reflect a reduction in our profit expectations due to persistent capacity over-supply in 2013.

While we cut our 2012 and 2013 earnings, we raise our 2014 forecasts to account for NOL's cost cutting efforts.

We believe there are more downside risks to freight rates, and the market is placing too much faith in carriers' ability to hold down supply. Cracks are appearing on supply discipline with Evergreen and Hanjin adding a new loop in the Asia-Europe lane in August despite a very weak peak season.

Container supply growth will accelerate from 7.3 per cent in 2012 to 7.8 per cent in 2013. The high portion (63 per cent) of large container ships (8,000TEUs+) for 2013 delivery is a key concern for us as these new ships are designed primarily for the key Asia-Europe trade lane, where demand is weakening.

Despite the weak outlook, we believe NOL may emerge from the downturn in better shape. Currently NOL only owns 37 per cent of its fleet, which is low versus the sector and resulted in a weaker-than-sector margin for the past two years. The company has ordered 32 new ships to replace older chartered-in vessels. This will reduce NOL's operating lease payment (14 per cent of OPEX) in 2013 and 2014 and also the operating cost of vessels.

NOL initiated two cost reduction programmes in 1H12, aiming to take out US$500 million in operating expense and US$70 million in staff costs. This is a positive start as management has recognised NOL's high cost base and is taking steps to address this.

We cut NOL's 2012 earnings from a net profit of US$34 million to a loss of US$226 million and 2013 earnings to US$55 million to account for the 1H loss of US$370 million and a weaker 2013 outlook.

We also bring down NOL's TP from S$1.08 to S$0.95, implying a FY12E PB of 0.8x.

We believe over-supply in 2013 will put pressure on freight rates and see no reason to own the stock at 1.0x FY12 PB. However, we think investors should revisit NOL in H2 2013, as we get more evidence of NOL's success in cutting costs and on an improved supply-demand balance in 2014.

UNDERPERFORM