• Cost savings cushion revenue decrease
• Rate increases unsustainable
• HOLD on valuation grounds

Cost savings cushion revenue decrease

Neptune Orient Lines' (NOL) FY13 revenue came in within our expectations while PATMI loss was lower than expected. Group’s core EBIT narrowed 9% to a net loss of US$167m. Core EBIT for liner shrank 8% to US$231m loss despite revenue decreasing 9%. This is largely due to cost of sales decreasing 8% from operational cost efficiencies and lower bunker prices. While additional cost savings are expected in 2014 from the eight newbuilds and operational efficiency improvements, the impact could still be easily negated by suppressed freight rates. In the logistics business, core EBIT decreased 4% to S$64m while revenue increased 2% to US$1.59b. The decline in core EBIT is mainly because of its contract logistics suffering a fall in core EBIT from US$36m in FY12 to US$22m in FY13, which is in turn caused by an extended automotive plant shutdown in North America and slow sector recovery.

Rate increases unsustainable with demand-supply imbalance

While there is some optimism for the container shipping industry over agreed general rate increase (GRI) by transpacific container shippers in Jan-14, we think this is uncalled for. Looking back at the recent two years, attempts at GRI have only seen temporary successes. Without the fundamental issue of overcapacity tackled, we think container shippers are unlikely to stick to the GRI for long though it makes everyone worse off. According to Alphaliner forecasts, there will be a 2 ppt gap in 2014, resulting from projected supply and demand growth of 6.6% and 4.6% respectively. Management’s guidance is slightly more optimistic at 1 ppt gap with supply and demand growth of 5.5% and 4.5% respectively.

HOLD on valuation grounds

In our FY14 forecasts, NOL’s ROE is still unattractive to shareholders at 3.0% and will thus trade at a discount. We derive a fair value of S$0.97 (previous: S$0.95) based on a forward PBR of 0.93x, which is at 1.5 s.d. below its historical two-year average. We upgrade to HOLD on valuation grounds.

Source: OCBC Research - 21 Feb 2014