Yangzijiang - Pure shipbuilder in a prolonged downturn

In line with Nomura’s negative macro view on the merchant shipping and shipbuilding sector, we suggest that investors should avoid pureplay shipbuilders since the oversupply in both bulk and container ships (particularly in the mid-sized segment), following the past three years of strong new-building orders, is likely to lead to prolonged weakness in the commercial new-building orders.

Also, while the privately owned Chinese shipbuilder has managed to keep cancellations at bay, with no announcements made as of yet, we believe these risks remain. Management stated the group has secured significant upfront payments, which will likely deter cancellations, although for those customers who are hard put to secure financing, the decision to cancel the project may be the only option, in our view.

The group has highlighted it is one of a few shipbuilders in China which is eligible for the shipbuilding stimulus scheme, and that the group will actively work with banks to help its customers apply for financing. However, we believe the stimulus measures, for which there are still very few details, are more likely to favour the stateowned yards, and could turn out to be too little, too late or not relevant for some shipowner customers, particularly the overseas shipowners, which make up the bulk of Yangzijiang’s customers.

YZJ’s order backlog stands at US$6.7bn as of 1Q09, with 149 vessels scheduled for delivery into 2011-12, according to management. In FY08, the group delivered 27 vessels, amounting to 850,000 deadweight tonne (DWT), which makes it one of China’s top 10 most productive yards.

The group expects to deliver 41, 45 and 50 vessels in FY09, FY10 and FY11, respectively, from its US$6.7bn backlog, which we believe should be achievable based on its execution track record but only if there are no cancellations or delivery postponements. Its US$6.7bn orderbook comprises 76 containerships (1.73mn CGT at US$4.3bn) and 73 bulk carriers (1.03mn CGT at US$2.4bn), according to the group’s management.

With a sound shipbuilding history going as far back as the mid-1950s when it started as a state-owned shipyard, YZJ has built up a reputable business and claims strong client relationships with its major customers, which include Canadry (Italy), Carisbrooke Shipping (UK), Cosco (China), D’amato (Italy), Formasa Taiwan, Guangdong Yudean (China), Hansa Shipping of Germany, IMS Shipping (Italy), Reederei B. Rickmers, Peter Dohle Sciffahrts KG and Seaspan of Canada.
While we have raised our FY09F and FY10F earnings by 17.3% and 8.8%, respectively, to account for the group’s 1Q09 results, we still expect the group’s earnings to show a decline from FY08, given the continued drought in new shipbuilding orders.

We maintain our REDUCE rating on YZJ, with a price target at S$0.48 (from S$0.37) based on our upward earnings revision for FY09-10F on the back of strong 1Q09 results. Our price target is based on a discounted cashflow valuation, with a WACC of 12%, which is the same as that used for Cosco Corp. YZJ is trading on FY09F and FY10F PE of 10.4x and 11.5x, respectively, which is ahead of its Korean counterparts. Given our bearish view on shipbuilding as a whole, we believe YZJ’s valuations are not at a significant discount to warrant a Neutral rating, and retain our REDUCE rating. While we appreciate that management has raised dividends, the yields remain relatively less attractive vs the Singapore yards, although we highlight that FY09F and FY10F average ROE remains creditable at 20% and 15%, respectively.

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