Yangzijiang Shipbuilding - DBS Research 2018-03-02: Proxy To Shipping Recovery

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YANGZIJIANG SHIPBLDG HLDGS LTD BS6.SI

Yangzijiang Shipbuilding - Proxy To Shipping Recovery

• FY17 earnings broadly in line; impressive ex-provision shipbuilding margin of 40% in 4Q17 but weak USD.
• and high steel cost could be a drag going forward
• Secured new contract wins of US$523m.
• Declared 4.5 Scts final dividend, or 3% yield. Reiterate BUY; TP$1.82.

Reiterate BUY; Target Price S$1.82. 

• As the largest and most cost-efficient private shipbuilder in China, Yangzijiang Shipbuilding (Yangzijiang) is well-positioned to ride the anticipated shipping and shipbuilding recovery. It has a solid balance sheet, sitting on net cash of 78 Scts per share (includes Held-to-Maturity investments), representing ~55% of NTA. 
• Our SOP-based Target Price of S$1.82 translates to 1.3x P/B, which is approx. 0.4SD below historical mean (1.9x) since listing in 2007. Valuation is undemanding at 1.2x P/B, against 9% ROE and 3% yield.

Proxy to shipping recovery. 

• The shipping supply growth could outstrip demand growth in 2018-2019 particularly for dry bulks and tankers. The global orderbook-to-fleet ratio has dropped to ~10% from the peak of ~55% 10-years ago, implying low single digit supply growth in the next two years. 
• Profitability improvement of shipping companies should drive demand for newbuild vessels and higher new-build prices.

Lower margins mitigated by preferential tax rate and writebacks.

• Core shipbuilding revenue was backed by its healthy order backlog of US$4.7bn as at end Dec-2017, which translates to revenue coverage of more than 2x. 
• While shipbuilding margins are expected to moderate from the average of 25-27% in 2016-2017 to 14-16% in 2018-2019, the drop could be mitigated by a lower tax rate, recognition of old yard relocation fees (Rmb158m) and write-back/disposal gains from terminated vessels.

Where We Differ:

• We have been more bullish on sector recovery and believe Yangzijiang deserves to re-rate catalysed by order wins and newbuild price increases eventually.

Valuation

• We value Yangzijiang based on sum-of-parts (SOP) methodology to better reflect the valuations of the various segments. 
• We arrive at a target price of S$1.82, after applying 14x FY18F price earnings (PE) on shipbuilding earnings, 1.5x price-to-book value (P/B) for bulk carriers and 1.3x P/B for investments.

Key Risks to Our View

• USD depreciation and hike in steel cost. Revenue is denominated mainly in USD, and only half is naturally hedged.
• If the net exposure is unhedged, every 1% USD depreciation could lead to a 2% decline in earnings. Every 1% rise in steel costs, which accounts for about 20% of COGS, could result in a 0.8% drop in earnings.

WHAT’S NEW - FY17 results above consensus’ expectations, in line with ours 

Results review: 

FY17 headline profit broadly in line. 

• Yangzijiang’s headline PATMI grew 67% y-o-y to Rmb2.93m in FY17, in line with our above-consensus-estimate.
• Shipbuilding margin would have been spectacularly high at 40% (vs reported 13%) in 4Q17 excluding Rmb1.2bn provisions. Reported core shipbuilding gross margin was down 13ppts y-o-y and 2ppts q-o-q to 13% in 4Q17.
• However, this was due largely to c.Rmb1.2bn provisions for expected cost overruns in anticipation of weaker USD and higher steel cost. Otherwise, shipbuilding margins would have been spectacular at almost 40%. We believe the high margin was attributable to the delivery of first three (out of total orders of 12 units) of 11.8k TEU mega containerships to PIL, which were on prudent profit recognition terms during the construction phase.
• On full year basis, shipbuilding margin would have been slightly higher y-o-y at 27% (vs reported 17%) in FY17, vs 25% in FY16 Provisions out of prudence. We understand the provisions were derived on assumptions of exchange rate at 6.15 Rmb/USD and steel cost at Rmb4,800 per ton. This appears rather conservative to us. Our economist expects Rmb/USD to average around 6.8 and 6.6 in 2018-2019 respectively, and steel cost has moderated to Rmb4,300-4,400 level from the recent high of Rmb4,800 in Dec-2017.

Solid balance sheet. 

• Including HTM investments, Yangzijiang is in net cash, equivalent to 78 Scts per share or 55% of its NTA. This bodes well for M&A activities.

Secured 15 new orders worth c.US$523m in Nov-Dec 2017.

• Yangzijiang secured 15 new orders worth US$523m in total since 3Q17 results announcement in early-Nov, comprising: 
  1. Four units of 82,000DWT bulk carriers 
  2. Seven units of 208,000DWT bulk carriers
  3. Four units of 2,400TEU containerships 
• The new contracts lifted wins for FY17 to US$2.1bn, ahead of management’s guidance of US$1.5bn.

Some contract terminations. 

• In 2017, contracts for 9 vessels were terminated, including 1 unit of 10k TEU containership, 4 units of 36.5k DWT bulk carriers, 1 unit of 82k DWT bulk carrier, 2 units of 84k VLGC and a jack-up rig. Downpayments collected from customers were forfeited.
• Vessels for six of the terminated contracts have been constructed, of which new buyers have been found for the 5 commercial vessels, and it is actively seeking the best resale price for the jack-up rig (value marked down to US$110m).
• Orderbook inched up to US$4.7bn, from US$4.3bn a quarter ago, implying revenue coverage of more than 2-years.
• Yangzijiang is ranked No.1 in China and No.3 in the world based on outstanding order book.
• Declared final dividend of 4.5 Scts (higher than 4 Scts last year), translating to 3% yield.

Earnings revisions. 

• We have fine-tuned our FY18/19 forecasts, factoring in the recognition of forfeited deposits of terminated units, partially offset by lower shipbuilding margins of 2-4ppts. The net impact is a 1-5% uplift to FY18- 19 earnings.

Outlook

Stronger newbuild demand but prices remain subdued. 

• In 2017, world contracting totaled 24m CGT and 77m DWT, representing 83% and 137% y-o-y increase respectively.
• Newbuild prices showed some signs of increase (~3%) towards 2H17 largely to reflect rising costs. Management believes that real sector recovery should be evident by a rebound in newbuild prices that would lead to profitability improvement, which might take a while given the still abundant yard capacity.

Target US$1.8bn new orders for 2018. 

• Management has set a conservative new order win target of US$1.8bn for 2018, which is lower than 2017’s US$2.1bn actual wins, considering the group’s revenue coverage has already exceeded 2x and there is lack of visibility on forex and steel prices at this juncture. 
• In addition, newbuild prices remain relatively low given the keen competition from Korean peers and SOE Chinese shipyards, which have benefited from government aid.
• Nevertheless, if market conditions improve, i.e. higher newbuild prices and better clarity on forex/steel price, we believe Yangzijiang could outperform on its order wins guidance. 
• Recall that last year, Yangzijiang beat its guidance of US$1.5bn set in early 2017.

Some measures to enhance return. 

• Given the pressure from forex uncertainty and higher steel costs, management is proactively looking for avenues to enhance returns.
• Management sees opportunities to take over incomplete vessels from bankrupt yards, which would yield better profit margins than newbuild contracts. Management may also look to raise its investment business, tapping on mixed ownership restructuring and trend towards environmental related business.

Pei Hwa HO DBS Vickers | http://www.dbsvickers.com/ 2018-03-02

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.820 Same 1.820