COSCO Corp net gearing continues to rise

2Q14 results within expectations
COSCO Corp reported a 29% YoY rise in revenue to S$1.15b and a 19% increase in net profit to S$14.3m in 2Q14, such that 1H14 net profit accounted for 58% and 52% of ours and the street’s estimates, respectively. We would not read too much into quarterly earnings, though, given the potential for huge swings in earnings due to the group’s current stage in the offshore learning curve – e.g. 1H13 net profit accounted for 70% of FY13’s full year earnings. A S$12.9m allowance was made in 2Q14 for inventory write-downs, but on a more positive note, there were no provisions made for construction contracts in the quarter.

Updates on deepwater drillship and Octabuoy
For the deepwater drillship contract that was terminated by Dalian Deepwater Development, arbitration in London is still ongoing and the company is unable to quantify the financial impact of the project. As for the Octabuoy hull and topside module, the contract has been terminated, and COSCO Nantong has the right to either complete or not complete the project as it deems fit, and to sell the project at a public or private sale.

Not upbeat about newbuilds in dry bulk
In the dry bulk shipping segment, management believes that the group may continue to face pressure in newbuilds. Due to new tonnage accumulation in the past years, any possible market recovery “will be a slow process with uncertainty”.

Net gearing continues to rise
As at 30 Jun 2014, the group’s order book stood at US$8.1b, with progressive deliveries up to 2016. However, margins are likely to remain low due and focus should remain on execution. Management continues to expect “difficult and challenging” business and operating conditions this year, which does not augur well for a company with a net gearing of 1.2x (vs. 0.5x in 2Q12 and 0.9x in 2Q13) and is still scaling the offshore learning curve. Maintain SELL with S$0.61 fair value estimate.