KE Report dated 4 Aug

TP 1.8 

Yangzijiang Shipbuilding - Company Update Still the fairest of all

Yangzijiang Shipbuilding (YZJ) saw its share price retreating by more than 6% this week after its peer, Cosco Corp, dropped a bombshell on investors when it announced much weaker‐ than‐ expected 2Q11 results.

Notwithstanding the lingering headwinds faced by the Chinese shipbuilders, YZJ is our preferred pick in the sector for its execution track record, leadership position in cost management as well as, undemanding valuation. Reiterate BUY with a lower target price of $1.80.

YZJ is confident of achieving at least 30% YoY growth for 1H11 (to be released on 11 August) in view of the timely delivery of its vessels. This puts it on track to meet our full‐ year earnings forecast. Nevertheless, it would imply earnings growth of just 6% YoY in 2Q11 (or net profit of RMB850m) given that the group has already reported a 62.8% increase in 1Q11.

Cosco was hit hard by rising steel and labour costs, particularly with egard to its shipbuilding division. This was exacerbated by other macro uncertainties such as the appreciating renminbi against the US dollar and rising interest rates in China. We do not think YZJ will be immune to this predicament even though it is acknowledged as one of the more efficient shipyards in China.

We reckon YZJ should still be able to keep its gross margins steady at around 23% in FY11 (compared to 22.5% a year ago) as it continues to  recognise high‐ margin orders secured prior to the global financial crisis. However, due to the lower‐ priced new contracts, we have assumed slimmer margins going forward. We estimate that a 100bps decline in margin would cause net profit to contract by some 4.4%.

Government goodies to offset higher cost

Yangzijiang announced yesterday that it has secured RMB139.5m worth of government incentives (RMB20.8m) and tax subsidies (RMB118.7m) granted by the Jiangsu municipal government. While this represents only 4% of our FY11F earnings forecast, we believe the handout will help to offset some of the rising operating costs being borne by the group. According to management, the tax incentive scheme will be valid till 2013.

Last month, YZJ also issued an statement to clarify several investor concerns: 1) it has no immediate plan to issue convertible bond 2) there has been increasing diversification in its order book towards Asian ship owners while existing longterm European customers have strong financial standing and payment track record 3) it has renewed its share purchase mandate in April this year and will consider share buybacks to protect minority interests. 

To better differentiate the contribution of its core earnings from income generated from held‐ to‐ maturity investments, we apply a SOTP valuation using:

(i) 13x FY12 PER for the shipbuilding business, in line with its bigger peers in the region,

(ii) NPV of interest income from FY11‐ 13F.

Our new target price of $1.80 implied an undemanding PER of 11x. Maintain BUY.