DBSV: COSCO Q310 - Upside surprise

From DBSV.

Cosco : Upside surprise!

• 147% rise in 3Q earnings blew estimates, 9M10 accounts for 88% of consensus’ full year forecast • Fuelled by improved shipbuilding margins, tax savings and lower operating costs

• FY10F raised 10%; street to upgrade earnings and TPs

• BUY the powerful recovery play; TP S$2.35

3Q10 is a confidence booster.
3Q net earnings rose 147% yoy to S$55.1m on higher sales from all divisions except conversions, strong margin recovery from shipbuilding, and cost savings from preferential tax rate and tightened cost management.

Shipbuilding margins leaped further.
Adding back the cost overrun provision of S$27.6m for heavy lifts, bottomline would have been stronger at over S$70m, raises overall margins by 2.8ppt. In particular, gross margin for bulk carriers is estimated to have lifted to c10% from 6-8% in 2Q. We believe this is owing to efficiency gains, cuts in staff headcount and lower steel cost. We expect margin improvement to be sustainable, as projects delivered next year are based on higher shipbuilding prices secured in 2007 vs lower cost of steel.

Street to play catch up.
9M10 net profit of S$155m beats our already highest estimate on the street, accounting for 81% and 88% of our and consensus’ full year estimates. We believe the street will react positively on this set of strong results and bring about FY11 earnings upgrades closer to our 25%-above-consensus forecasts. We are leaving our FY11 numbers intact, but tweaked FY10 estimate upwards by 10% to reflect the lower tax rate and operating costs.

Target order wins met.
Cosco has won US$1.8bn new orders YTD, hitting our FY10 assumption. Current order book of US$6.1bn will sustain workflow till 1Q13. Going into 2011, offshore orders should take centre-stage with expected order wins of US$2.15bn in anticipation of 2-3 turnkey projects including SEVAN drilling rigs and FPSOs.

Earnings turnaround play.
We expect sequential improvement in shipbuilding earnings over the next few quarters to underpin share price performance. There is ample room for growth as Cosco maximizes the utilization of its seven shipyards. Maintain BUY. Our TP of $2.35 is based on blended fair values based on SOTP (S$2.13) and P/BV (S$2.59). Key risks to our forecast lie in RMB appreciation, rising steel cost, weak shipping rates and project execution.