NOL Near-Term Earnings Weakness

Assume coverage with HOLD, TP: SGD1.25. Following a change of analyst, we assume coverage of NOL with a TP of SGD1.25 based on 1.1X FY13-14E BVPS (long-term average: 1.2X). Fundamentally, we believe that the container shipping industry is near its cyclical trough and expect better times ahead as the supply overhang improves over the next few years. However, we remain cautious in our recommendation as the prospect of a third consecutive year of losses (on our estimates) will likely weigh on sentiment towards the stock. Furthermore, we believe consensus expectations of a profitable FY13 will be missed.

Consensus remains too bullish. After adjusting for the one-off gain on the disposal of a building, we forecast a third consecutive year of losses in FY13, to the tune of USD182m. We believe that consensus numbers may not have fully reflected the weak rate environment this year and expect earnings downgrades to trickle through. We expect losses to widen sequentially in 2Q13E, to approximately USD160m.

NOL trading below book

• NOL – Upgrade to BUY with TP of S$1.45.

NOL underperformed peers in FY12 and is still trading below book, and looks set for a re-rating in FY13

Potential for re-rating is emerging for the container shipping sector. Improved industry discipline and liners’ renewed focus on profitability should lead to better freight rates and earnings in FY13, compared to FY12. This will help offset concerns arising from continued demand-supply imbalance, whereby container trade demand growth of 5% will trail containership supply growth of about 8% in FY13.

With market sentiment improving as well, we should expect re-rating for this cyclical sector. Cyclical plays like container shipping will be early movers in a global recovery. We prefer liners with more exposure to the US and Intra-Asian routes.

Rates on the Asia- Europe route will be most

NOL turning the crimson tide

Target price: SGD1.35


Expect 3Q2012 back in black. We expect NOL to record its first quarterly net profit when it reports results on 25 Oct, after posting six consecutive quarters of losses. We believe this will be a positive catalyst for the beaten-down stock and will mark a defining quarter in NOL’s recovery out of the container shipping slump. We expect NOL to benefit from 3Q’s freight rate recovery to post a net profit in the region of USD50m, building on its liner operating profit posted in 2Q2012. We maintain our BUY recommendation on NOL as a proxy to the global economic recovery, and maintain our Target Price at SGD1.35, pegged to 1.2x 2013 P/BV.

Watching its freight. NOL’s average revenue / FEU would be a key metric to watch, as it represents its market strength relative to the China Containerised Freight Index (CCFI). NOL’s average freight is better correlated to movements of a one-month lag of the CCFI, and the increase of ~10% QoQ reported for 3Q2012 forms our basis of the improved freight forecasts for NOL. 3Q usually represents a seasonal peak in freight rates as holiday-season shipments move into full swing.

Further upside could emerge from HQ sale. We also estimate that the impending sale of the NOL Building could net NOL one-time gains of USD100-200m. While we prefer to exclude this from our forecasts for now, the potential upside of 4-9% to NOL’s NAV could provide a further jolt to NOL’s share price. The timing could be right for NOL to reap gains from a non-core asset and use the cash proceeds to strengthen its balance sheet.

NOL - Lower fuel prices Higher freight rates

Bunker fuel prices are finally down
Bloomberg’s 380 Centistoke Bunker Fuel Spot Price Singapore Index (BUNKSI38 Index) is currently trading at 9% below the average bunker fuel prices in 2Q12, which is in turn 11% lower QoQ than in 1Q12. After staying stubbornly high for about a year, bunker fuel prices have finally come off along with the fall in crude oil prices, providing the beleaguered container shipping sector a much needed relief.

Higher freight rates should spell turnaround
Moving in the opposite direction, the Shanghai (Export) Containerised Freight Index (SCFI) in 2Q12 averaged 31% higher QoQ, after a 21% gain in 1Q12. Shipping consultants Drewry this week said shipping liners’ successful rate hikes in major global trade lanes meant most liners are now profitable. And the successful rate hikes are the result of shipping liners’ collective discipline in managing container shipping capacity. For the rest of 2012, capacity management remains the key to shipping liners’ profitability. While eastbound transpacific shipping demand remains strong, the outlook for Asia-Europe routes is still bleak and is unlikely to see a strong peak shipping season this year.

Better allocation of capital and cost savings
Neptune Orient Lines (NOL) this week said it intends to sell

NOL perpetual securities are treated as equity, instead of debt

Fair value S$1.38
52-wk range (S$) 0.98 - 2.01

Details of the perpetual capital securities issue
Neptune Orient Lines (NOL) announced it has mandated four banks as joint lead managers in its issuance of S$-denominated perpetual capital securities. The size, pricing and distribution rate of this issue have not been finalised and will only be available after its currently ongoing meetings with investors. NOL has the option to call the perpetual securities in full and at par at the end of five years and every distribution date thereafter. The issue will have semi-annual distributions and, after a 10-year period, the distribution rate will see a step up of 1.5% p.a. NOL also has the discretion to defer distributions to perpetual security-holders. However, if NOL falls into arrear in the distributions to perpetual security-holders, it will be restricted from distributing dividends to ordinary shareholders. In addition, deferred distributions are cumulative and bear interest at the distribution rate. NOL said the proceeds of this issue will be primarily applied to its working capital needs.

Financial implications
The high 1.5% step up in the distribution rate after

NOL near record high bunker prices

Asia-Europe rate hikes were successful
After shipping liners announced rate hikes in the range of US$700- 800/TEU to Asia-Europe shipping routes, the Shanghai (Export) Containerised Freight Index (SCFI) jumped 19% higher WoW in the week ended 2 Mar 2012. This comes after the index edged 3% higher the week before. However, embedded within the comprehensive SCFI were two shipping routes that saw remarkable jumps. Over a twoweek period, Shanghai to Europe and Shanghai to Mediterranean rose 99% and 93% respectively, clearly showing shipping liners have been successfully in getting most, if not all, of the US$700-800/TEU (20- foot equivalent unit) rate hike that they previously sought.

NOL 4Q11 revenue fell 13% YoY to US$2.4b,

Fair value of S1.15


Nightmare Of A Quarter
• Size of 4Q11 net loss surprised street
• 1Q12 seems equally challenging
• Full rate hike is unlikely

NOL high fuel prices – profitability hurt

Neptune Orient Lines: Fair value of S$1.02



●Recent rate hikes may not be sustainable
●Intra-Asia freight rates remained flat
●Near record-high bunker fuel prices

Weak demand and oversupply – are rate hikes sustainable?

KimEng on NOL

target price of $1.10

Volume growth decelerates... Neptune Orient Lines (NOL) yesterday released its Period 11 operating data for the four weeks from 22 October 2011 to 18 November 2011. Container shipping volumes rose by a slower-than-expected 2% YoY, aided by higher volumes carried on the Intra-Asia trade lane. Weekly volumes marked a 7% MoM contraction, a further sign of slowing demand.

. …but rates appear to be stabilising. On the flip side, the average revenue per FEU (forty-foot equivalent unit) fell by 14% YoY but remains flat MoM to about US$2,400/FEU. Management attributed the drop to lower freight rates in the major trade lanes, particularly the long haul routes. On a YTD basis, container shipping volumes increased by 8% while average revenue per FEU fell by 10% YoY.

Expect weak 4Q11 results. We maintain our full-year net loss forecast of US$286m in FY11F (9M11 net loss was US$158m), which would imply a widening of 4Q net loss to US$128m. We do not think this should come as a major surprise to the market. According to some liners, the current depressed rates fail to even cover basic operating costs, let alone the stubbornly high bunker prices.

Seeking interim rate relief. The Transpacific Stabilization Agreement is proposing to raise Asia-US rates by a minimum of US$400/FEU from 1 January next year. Certain carriers such as Maersk Line and Hanjin Shipping also have plans to increase rates on the Asia-Europe route by US$200/TEU. In our view, the success of the intended rate restoration remains to be seen given the huge overcapacity in the industry.

Too early to pull the trigger. NOL’s share price has been relatively firm in recent times on positive newsflow of capacity rationalisation by leading carriers, but we think it is still too early to buy into the stock as the total number of idled ships currently (about 3% of global fleet) is hardly enough to offset the supply glut. Maintain Hold and target price of $1.10, based on 0.8x FY12F P/BV.

Gloomy outlook in container shipping

OCBC - fair value of $1.02

Neptune Orient Lines: Rough waters

NOL's container shipping operating performance in Period 9. Neptune Orient Lines (NOL) this week announced its container shipping operating performance for Period 9 (four weeks from 27 Aug 2011 to 23 Sep 2011). Period 9 volumes increased 5.4% YoY to 229,300 forty-foot equivalent unit (FEU) but average revenue per FEU (ARPF) fell to US$2,501/FEU, which represents a 19.4% YoY or a 2.3% MoM drop. Year-to-date, volumes are up 7.7% to 2.16m FEU but ARPF fell 8.5% to US$2,799.

Container shipping demand is soft. Major retailers are usually able to predict their shipping requirement for the upcoming festive sales by this time of the year. But this year, shipping customers are holding back on shipments due to uncertain economic conditions and little concern of finding shipping capacity. Although this could result in last-minute orders later this year, NOL management acknowledged that container shipping may lose out to air freight if orders come in too late. In another sign of the market's tentativeness, the Transpacific Stabilisation Agreement (TSA), a group of 15 container shipping lines, have delayed announcing targets for next year's rates on Asia-U.S. trade lanes. This is a result of inconsistent economic indicators and customers unwilling to commit to orders.

Coupled with overcapacity, container shipping is seeing freight rates falling. According to The Baltic and International Maritime Council (BIMCO), container shipping capacity has increased 6.5% YTD, as 483,000 FEU of capacity were delivered. The latest deliveries have resulted in total container shipping capacity of more than 7.5m FEU. Meanwhile, scrapping of vessels has only seen 15,258 FEU taken off the supply line, especially since the global fleet is rather young. For the whole of 2011, container shipping capacity is expected to outpace demand growth by 2ppt. The increase in container shipping capacity this year has depressed freight rates. And since shipping demand has failed to take off, shipping lines around the world will have to lay up vessels in the near future so as to limit container shipping capacity.

Retain fair value of $1.02 and upgrade to HOLD. Given the gloomy outlook in container shipping, we retain our lower-than-consensus fair value estimate of NOL at $1.02 per share. NOL's share price has continued falling since our last report and is now only 9% away from our fair value estimate. Thus, we upgrade NOL to HOLD. (Eric Teo)