COSCO - SELL: DMG

SELL: DMG & Partners Securities

Nov 01, 2008 The Business Times

ON a year-on-year comparison, Cosco Corporation's revenue surged 80.7 per cent to $987.7 million in Q3 2008 as order backlog for shipbuilding and marine engineering was recognised.
Revenue from this segment contributed 92.1 per cent (an increase of 87 per cent) or $909.9 million. Dry bulk shipping turnover grew 36 per cent to $72.5 million, lifted by more favourable charter rates renewed in the earlier part of the year. Though gross margin was lower at 23.4 per cent (compared to 37.9 per cent in Q3 2007) as a result of higher material costs and a shift in revenue contribution mix towards lower margin shipbuilding business, Cosco still managed to improve its bottom line by 16.5 per cent to $113.9 million.

But as compared to Q2 2008, Cosco's revenue declined 5.7 per cent. Turnover from ship building fell 10.7 per cent while marine engineering dropped 24.4 per cent, bringing the overall top-line contribution from ship repair, shipbuilding and marine engineering down by 6 per cent. Coupled with a lower gross profit margin of 23.4 per cent (a decline of 260 basis points), Cosco's profit after tax and minority interests fell by 11.5 per cent.

Only one of the first 10 dry bulk carriers would be delivered this year. The remaining nine carriers, which are currently being built in Zhoushan shipyard, would be delivered progressively in 2009. The management attributed the delay to several reasons:

1. Zhoushan shipyard was not operating at optimal capacity as the yard was undergoing expansion works concurrently.

2. Over-ambitious vessel delivery schedule, overlooking the fact that Cosco only ventured into the newbuilding business segment in 2007. Going forward, we remain concerned on the tight schedule and further possible delay in vessel deliveries as the management hinted that not all 40 vessels scheduled for delivery in FY 2009 have commenced construction work. A typical bulk carrier newbuild takes 12-15 months to build.

The Baltic Dry Index (BDI) plunged below 1,000 recently (This is a fraction of the 10,000 a year ago). While Cosco would not expect any material negative impact from this falling BDI in the short term as the current charter contracts had been locked in based on higher freight rates previously, we believe the protracted low BDI rates would impact Cosco's shipping contribution in FY 2009 significantly.

The management guided that Cosco's shipping business division would be loss making should its bulk carriers be chartered at the current spot rate.

Cosco has always been a relatively high-beta stock, and this is especially evident in today's volatile market environment. As we continue to take a cautious stance on our sector outlook pertaining to the shipping industry, we are lowering our price-to-book valuation parameter to 1.0 times (from 1.2 times previously), deriving a target price of $0.680 (from $0.860 previously). Maintain SELL.

Cosco Corporation
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DMG & Partners Securities
Oct 31 close: $0.775