BT: Hock Lock Siew - The curious case of two shipbuilders

Business Times - 10 Nov 2010

Hock Lock Siew
The curious case of two shipbuilders

By LYNN KAN

DOES one march to the drumbeat of the market or heed the advice of research analysts when investing?

This dilemma is thrown into sharp relief when the two views diverge, as with the curious case of the two Chinese shipbuilders listed on the Singapore Exchange: Yangzijiang Shipbuilders and Cosco Corporation.

Consistently, Yangzijiang has been preferred by analysts covering both shipping companies. Yangzijiang has received higher target price (TP) guidances over Cosco. The 12-month analyst consensus TPs peg Yangzijiang at $2.14 over Cosco at $1.94.

However, those who look to the market behaviour would have to abandon these endorsements by analysts. Cosco has already exceeded these expectations. By yesterday, two market days after it announced a 137 per cent improvement in net profit of $55.1 million, Cosco shares have put on 22 cents to $2.16 - way past analysts' targets. Instead, YZJ is the laggard at $2.02.

The market has repeatedly taken Cosco's side, making it an expensive shipping stock compared to its peers. According to a report by DBS Vickers, Cosco's 2011 forward price-earnings are at 16.1 times versus YZJ's more modest 11.9 times.

The market could certainly be right right now, but analysts seem to be making convincing cases for Yangzijiang over Cosco in their reports.

For one thing, Yangzijiang - whose ambitions are to be an integrated shipping company - takes on new expertise through less risky acquisitions or joint venture undertakings. Case in point: It recently penned a memorandum of understanding with CSBC Corporation in Taiwan, which would likely see Yangzijiang learn from the large-capacity shipbuilder and allow it to venture into building larger ships than it is doing now. Cosco, on the other hand, has ventured into unfamiliar terrain such as offshore equipment building without such tie-ups. Though it delivered the Seven driller this year, the project led to a year's worth of delays and dented its profit margin severely in 2009.

Secondly, YZJ has had better margins because of better execution in the past. Yangzijiang maintained its shipbuilding margins at about 23-24 per cent this quarter and analysts are typically confident about its execution time.

Cosco has a rockier execution track record. It reported at its third-quarter briefing margins of 10 per cent for its bulk carrier segments. This isn't a cushy margin but is already an improvement from the time its margins were deeply compressed at 2.9 per cent.

Lastly, while Cosco's orders amounting to about $6.1 billion into 2012/2013 have recently pipped Yangzijiang's $5.3 billion, the quality of their order books differs greatly. Cosco is dogged by a delay/cancellation rate of about 50 per cent, compared with Yangzijiang's much healthier 9 per cent.

Yangzijiang also has helped reduce cancellations and delays from its clients because it helps clients liaise directly with banks to secure financing. Cosco doesn't have a similar mechanism, so risks of cancellations are much higher.

On paper, the case for Yangzijiang is a stronger one. But a glance at Cosco's skyrocketing price hits home a sobering fact: much of the good news from Yangzijiang is already priced in, while the rebound for Cosco isn't entirely.

What could explain the occurrence is what's slightly beyond the market's horizon: the risk of oversupply in the bulker market in 2011, which will trouble Cosco more than Yangzijiang next year.

Although Cosco's improving margins and larger order books are the causes of much exuberance, the company's shares might not fare so well in a few months because it's much more exposed to the building of bulk carriers than is Yangzijiang. According to a report by Credit Suisse released in July, Yangzijiang's order books are 64 per cent bulk carriers and 36 per cent containership. Cosco's order books are 93 per cent bulk carriers. Its most recent announcement last week of new order wins were also all bulk carriers, adding and not subtracting to its dependence on bulker newbuilds for revenue.

So, those scratching their heads over the Yangzijiang versus Cosco dilemma might want to bear in mind that there's more to a company's fortunes than current upward-trending price movements. Exuberance on a stock - especially in shipping - should include longer-term calculations, such as industry-wide systemic risks and sound business strategies.