Cosco Corp

Kim Eng on 14 Sept 2012

Rich valuations unjustified, reiterate SELL. With persistent weak outlook in the shipbuilding market, Cosco’s richer valuation relative to peers is simply unjustified. Why should a yard faced with tough domestic competition in China, faltering shipbuilding orders and weak offshore margins, trade at a higher valuation than established Singapore and Korean rig-building yards? We reiterate our SELL call and 1.3x P/BV target price of SGD0.73.

Things could get worse before they get better. Order cancellations could become more prevalent. Fellow shipbuilder Yangzijiang already had eight bulk carrier orders cancelled in 2Q12, mainly due to customer funding difficulties. This could prompt another round of sector-wide de-rating. Due to its strong PRC government links however, Cosco is unlikely to go bust. In the long run, it should emerge stronger from the current industry downturn.

Recovery seen only from 2014. However, we expect the shipping market to recover only from 2014 if ship supply tightens. One sign would be if the current global orderbook-to-fleet ratio falls further towards the 10% level. Currently, it stands at 17.9%, from a peak of above 50% in 2008. Another sign could be more orders for bigger and fuel-efficient ships, as shipping lines combat high bunker prices and prepare for low-emission requirements. AP Maersk-Moller has led the trend with orders placed for 18,000 TEU fuel-efficient containerships.

Offshore orders only help it stay afloat. Orders are not at a complete stop. Cosco recently announced a USD200m harsh environment accommodation semi-sub contract, bringing YTD orders to USD1.55b. However, the majority are offshore orders and Cosco has yet to demonstrate satisfactory profitability on these projects. Nevertheless, they do help to fill yard capacity and support fixed costs, which is the key surviving strategy for many Chinese shipyards currently.

Maintain SELL. While we are positive on the offshore sector, Cosco is not ready to ride this wave. We cut FY13F-14F net profits by 6-8% on lower margin assumptions. We reiterate our SELL rating with target price of SGD0.73 based on 1.3x P/BV. At 19.0x/18.4x FY12F/13F PERs, Cosco is trading at an unjustified premium above peers.