Yangzijiang Shipbuilding - CGS-CIMB Research 2018-06-05: Orders Could Surpass Expectations

Yangzijiang Shipbuilding - CGS-CIMB Research 2018-06-05: Orders Could Surpass Expectations YANGZIJIANG SHIPBLDG HLDGS LTD SGX:BS6

Yangzijiang Shipbuilding - Orders Could Surpass Expectations

  • Yangzijiang Shipbuilding (YZJ) is the second-worst performer on the FSSTI (-31% YTD), after Starhub. We think YZJ's share price has pessimistically priced in sharper drop in orders and margin erosion.
  • Upgrade to ADD. We see opportunity to accumulate, with limited downside. 
  • Potential catalysts are
    1. stronger-than-expected orders, and
    2. profit upgrade by consensus.
  • YZJ successfully clinched US$846m of orders YTD or 46% of our US$1.8bn FY18 target. Order book currently stands at US$4.1bn with delivery stretching till 2010.
  • It is trading at 0.6x CY18F P/BV or -1.5 s.d. of its 5-year mean, cheaper than the Singapore yards (above 1x P/BV) and it is profitable.

Why should it underperform the market?

  • Yangzijiang Shipbuilding’s YTD stock performance has been as bad as Starhub. We see this as unwarranted. Starhub’s share price performance could be due to its removal from MSCI Singapore and consecutive declining earnings outlook for FY18-20F in addition to the risk of lower dividends and threat from the entry of the fourth telco into Singapore.
  • Meanwhile, YZJ’s underperformance is due to management toning down its FY18 order book guidance (to be lower than 2017) in 1Q18 as well as recent broker downgrades on unprofitable shipbuilding contracts, in our view. We think
    1. its latest order wins,
    2. gross margin of c.9% for the new orders, and
    3. a stable Baltic Dry Index (BDI) could alleviate the above concerns.
  • Its strong net cash position could also support yield of c.4% in FY18F.

Shipbuilding still profitable

  • YZJ’s shipbuilding is still profitable, taking into account today’s exchange rates and steel costs. In 4Q17, the company had assumed Rmb and steel prices will continue to be on an upward trend, and had provided for Rmb1.2bn of construction losses based on US$/Rmb of 6.16 and steel costs of Rmb4,700- 4,800/tonne.
  • With the provisions, shipbuilding gross margin (GM) came in at 13% in 4Q17. The figure would have been 41% without the provisions because of the profit recognition of three large-size containerships -- 10,000 and 11,800 TEU (GM of > 25%). Seven of these vessels are to be delivered in 2018; we think this will support its overall shipbuilding margin in FY18F at 15% (our assumption). The division achieved 17% GM in 1Q18.

Rising shipbuilding prices

  • We think stable Baltic Dry Index (BDI) amidst rising ship prices would continue to encourage healthy demand for bulk carriers. 
  • Shipbuidling index has risen 14% from the low in 2016. The narrowing price gap between newbuild and secondhand vessels also makes it more worthwhile for owners to order new ships vs. purchasing ships from the secondary market. For instance, a capsize (180k DWT) newbuild costs c.US$45m to build vs. US$35m for a 5-year old vessel (2016: less than US$30m).

Orders could surpass 2017

  • In YZJ's latest two strong order years (2015 and 2017), orders were back-loaded in 2H. YTD orders of US$846m has surpassed 1H17's US$450m, suggesting a chance for 2018F to beat 2017’s performance. 
  • We keep our order forecasts of US$1.8bn for 2018F and US$1.5bn for 2019F for now.

HTM generating better returns

  • YZJ's 1Q18 Held To Maturity (HTM) investment stood at Rmb12bn with investment income of c.Rmb300m (FY17: Rmb1bn).
  • According to management, c.Rmb10bn of YZJ's current investment portfolio were low-risk, generating 8% returns. Management aims to gradually boost the yield from HTM from 2H18, up 25-50% to 10-12% by year-end.
  • We believe the higher returns from HTM investments is likely to sustain YZJ's earnings growth in FY19F, despite the lower margins from shipbuilding.

Upgrade from Hold to ADD

  • Yangzijiang Shipbuilding (YZJ) is trading below 1.5 s.d. of its 5-year mean. We think this is unwarranted given its order momentum and earnings growth trend ahead.
  • Our unchanged Target Price of S$1.27 is based on an SOP valuation. We peg 0.8x P/BV (-0.5 s.d. to 5-year mean) to its shipbuilding book and 1x P/BV to its HTM investments (ROE c. 10%). We believe our valuation method prices in weaker order momentum and margin pressure.
  • Re-rating catalysts could come from
    1. stronger-than-expected orders and
    2. upgrade to Bloomberg consensus profit forecasts on the back of higher shipbuilding margins and better returns from HTM.
  • Missing order target could be the downside risk.

LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2018-06-05
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