Fair value S$1.23
1Q12 results in line
Yangzijiang Shipbuilding (YZJ) reported a 12% YoY rise in revenue to RMB3.7b and a 7% increase in net profit to RMB1.0b in 1Q12, accounting for 24.0% and 27.9% of our full year estimates respectively. Bottom-line was also within the street’s expectations, representing 28.4% of Bloomberg’s mean full year estimate. Gross margin in the shipyard segment decreased slightly from 27.1% in 1Q11 to 26.4% in 1Q12, partly due to revenue recognition from the lower-margin ship demolishing business of about RMB123.5m. With no meaningful new orders in the quarter, the group’s order book fell to US$4.5b as at 31 Mar 2012 vs. US$4.7b in Dec 2011 and US$5.3b in Dec 2010.
New orders the main share price driver
We look back at what transpired in the last few years, and find that new ship building orders has generally been the main driver of the stock price. This in turn depends on global economic events such as fear of a Eurozone collapse, as certain key customers of YZJ are from Europe. We are forecasting
US$2.5b new orders for this year, which we believe has largely been priced in at current share price levels.
Poorer risk-reward ratio; newbuild outlook still dim
We note that about 70% of our FY12 new order estimate of US$2.5b depends largely on the 18 orders from Seaspan, resulting in a high concentration risk. Though the share price may see a positive kneejerk reaction when the orders turn effective, we believe that the riskreward ratio is currently biased against investors, unless the general shipbuilding market turns for the better. According to management, newbuild prices are still trending lower. Though the group is diversifying into the offshore industry, YZJ still has to undergo a learning curve before there can be earnings contribution. We lower our peg to 7.5x core FY12F earnings, in line with YZJ’s historical average, and as such our fair value estimate drops to S$1.23. Downgrade to HOLD.
What drives the share price?
Given difficult industry conditions which have resulted in yard consolidation in China, YZJ has turned in laudable results thanks to its competent management. However, this is not sufficient to drive the stock price higher. We look back at what transpired in the last few years, and find that new shipbuilding orders have generally been the main driver of the stock price. This in turn depends on global economic events such as fear of a Eurozone collapse, as certain key customers of YZJ are from Europe. We plot the amount of new orders secured by the group each year against the share price, and find a similar pattern between the two. This relationship is stronger than the acquisition announcements by the group (recall that YZJ has been active in acquiring companies in the past few years with its spare cash), as well as earnings surprises per quarter.
Tracking the share price and new order trend
From Exhibit 3, we see that YZJ secured US$4.97b new orders in 2007, which saw its share price peak around S$2.74 before falling in 2008 due to a dearth in new contracts. Though 2009 also saw few new orders, the share price rose mainly due to the global rebound in share prices from Mar 2009, and continued its ascent in 2010 due to a return of new orders and increasing confidence of a global economic recovery. However the shipbuilding outlook turned increasingly bleak in 2011 again with slower orders, and management sought to diversify its income streams by investing more heavily in held-to-maturity assets and develop its microfinancing business. With fewer orders and fears of a hard landing in China, the group’s share price fell again, till it rallied in the beginning of this year along with other offshore and marine stocks. Coincidentally, we are also expecting more new orders this year compared to FY11.
Expect orders to come in 2H12 to reach US$2.5b target that has been priced in
We are forecasting new orders of US$2.5b this year vs. the group’s US$1.2b new order intake for FY11, mainly due to the increasing likelihood that the remaining 18 newbuild containership orders by Seaspan turns effective. YZJ has clinched new orders of about US$206m YTD, and we estimate that the Seaspan orders would bump up the order book by around US$1.8b more. With the focus now on securing new orders to keep the yards busy due to the poor outlook of the shipbuilding market, we believe that going forward management would be less picky with jobs in terms of margins.
Update on shipbreaking and offshore operations
The shipbreaking business contributed RMB123.5m in revenue in 1Q12, but we estimate net profit was minimal due to low margins of less than 5%. This figure is likely to improve next year and the normalized margin should be around the 10-20% range. The group is mainly demolishing local vessels now, with no overseas orders. Meanwhile, as for the group’s budding offshore operations, we expect more clarity in Jun when more permits are granted and jack-up rigs can be constructed.
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