Yangzijiang Shipbuilding - UOB Kay Hian 2017-08-10: 2Q17 Earnings Beat Forecasts But Share Price Rise Is A Bridge Too Far; Downgrade To HOLD

Yangzijiang Shipbuilding (YZJSGD SP) - UOB Kay Hian 2017-08-10: 2Q17 Earnings Beat Forecasts But Share Price Rise Is A Bridge Too Far; Downgrade To HOLD YANGZIJIANG SHIPBLDG HLDGS LTD BS6.SI

Yangzijiang Shipbuilding (YZJSGD SP) - 2Q17 Earnings Beat Forecasts But Share Price Rise Is A Bridge Too Far; Downgrade To HOLD

  • Yangzijiang reported a better-than-expected 2Q17 net profit of Rmb720m and core net profit of Rmb591m. 
  • Shipbuilding revenue rose on higher activity but margins were pressured by low contract prices. The shipbuilding industry is still in overcapacity and it remains to be seen if the recovery can be sustained. Valuations look stretched.
  • Downgrade to HOLD with a higher target price of S$1.42. Entry price: S$1.14.



RESULTS


Core net profit of Rmb591m; exceeded expectations. 

  • Yangzijiang Shipbuilding (YZJ) reported 2Q17 headline net profit of Rmb720m (+73% yoy, +8% qoq) on the back of higher revenue of Rmb3,791m (+27% yoy, -19% qoq) and an 89% yoy decline in interest expense. Excluding one-off impact from fair value gains, disposal gains, forex losses and impairments on financial assets, core net profit was Rmb591m. 
  • Results exceeded expectations as 1H17 core net profit of Rmb1,225m formed 61% of our full-year estimate.

Shipbuilding: Higher revenue but lower gross margin of 20%. 

  • Revenue for the shipbuilding segment was Rmb3,443m (+26% yoy) in 2Q17, attributed to higher shipbuilding activities and trading revenue. 
  • Gross margin for the overall shipbuilding business was 14% (-2.2ppt yoy, -1.6ppt qoq). This was due to lower gross margins for the core shipbuilding business (2Q17: 20%, 2Q16: 24%) on lower contract prices for its vessels and a higher proportion of earnings from the trading business, which had a low gross margin of ~1%.

Investment income jumped 32% yoy, margins stable. 

  • The segment saw earnings rise to Rmb331m (+32% yoy, +63% qoq). This was driven by higher income from its held-tomaturity (HTM) portfolio, which saw earnings rise 34% yoy. 
  • Income from micro-finance continued to decline, falling 14% yoy. Margins for these segments remained largely stable at 95% (HTM) and 99% (micro-finance). The HTM portfolio size was Rmb10.6b (-9% yoy, +0.2% qoq).

Remained in net cash. 

  • YZJ maintained net cash of Rmb302m in 2Q17 although this decreased from the Rmb1.2b net cash in 1Q17. 
  • Current borrowings rose from Rmb1,351m to Rmb5,196m, which YZJ will seek refinancing at lower interest rates.

Secured US$133m in new orders for 2Q17, reported another US$381m in Jul 17.

  • YZJ has secured 33 new shipbuilding contracts ytd, worth US$832m. This compares against its full-year contract win of US$820m secured in 2016.

Disposed of two vessels, suffered one shipbuilding order termination. 

  • Two 92,500dwt dry bulk carriers were disposed at a profit on the second-hand market in Jul 17. The group also had one shipbuilding contract for an 82,000dwt vessel cancelled in 2Q17, bring ytd cancellations to 5 vessels.


STOCK IMPACT


Outlook improves, not an outright recovery. 

  • The shipbuilding industry continues to have excess capacity although the situation has improved significantly from 2009. The number of shipbuilders has declined 57% from 2009 to 2016, and is expected to fall further to 70% by 2017. 
  • Coupled with an improvement in charter rates and second- hand prices, this is currently spurring new orders. However, it remains uncertain if the recovery is sustainable, given the historical inclination of ship owners to exacerbate the supply situation at the hint of an upturn in each cycle.

Order target of US$1.5b remains unchanged. 

  • New orders continue to remain challenging, and despite the improvement in contract wins, YZJ was hesitant to raise its order wins target of US$1.5b for 2017. Management declined to give guidance on the contract wins outlook for next year, saying they prefer to deal with one calendar quarter at a time.


EARNINGS REVISION/RISK


Raise 2017-19 earnings by 22-26%. 

  • We kept our contract wins assumption unchanged at US$1b but have adjusted the revenue recognition period. Our shipbuilding margins have also been lifted to 21% (from 18%). This accounts for the conflux of declining steel prices and a depreciating renminbi against the US dollar (more revenue after translation).
  • Our revised 2017-19F net profit are Rmb2,429m, Rmb2,347m and Rmb2,628m respectively.


VALUATION/RECOMMENDATION


Downgrade to HOLD but raise target price to S$1.42. 

  • We nudge our 1-year forward P/B multiple to 1.1x (from 1.0x), raising our target price to S$1.42. 
  • Our P/B multiple represents the long-term mean since 2011, and translates to an implied 1-year forward 9.8x PE based on the P/B-ROE relationship, which is well above its historical forward PE of 8.1x. 
  • Much of the YZJ's current share price run-up since 1Q17 can be attributed to the recent rally in the Straits Times Index (STI) and YZJ being a constituent stock. With the index unlikely to pull back in the near term, share price is not likely to pull back sharply as well.
  • Headline earnings may be improving but the outlook remains challenging, so current valuations look stretched. 
  • Downgrade to HOLD. We recommend taking some profit from this level.




Foo Zhiwei UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-10
UOB Kay Hian SGX Stock Analyst Report HOLD Downgrade BUY 1.42 Up 1.26



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