• Cost savings to continue into 2HFY14
• Downward pressure on freight rates
• Upgrade to HOLD on valuation grounds

Cost savings arising from operational efficiency

We recently met up with Neptune Orient Lines (NOL) and noted that operational efficiency continues to be the key focus going forward for its liner segment, mainly through its fleet renewal programme. The 34 fuelefficient new-build vessels acquired through the programme were all received by end 2QFY14. Overall, we expect fleet capacity to shrink by ~5% after the planned retirement of 34 chartered vessels are completed by FY15, with no plans to purchase any vessels within the next few years. With a leaner and more efficient fleet, we believe cost savings are likely derived from: 1) lower bunker costs which makes up ~20-25% of total costs to operate a vessel, 2) network reconfiguration (e.g. calling on more ports with the same larger vessel), and 3) leveraging on its G6 alliance for top-line growth (i.e. buying slots from its partners on routes its does not operate in) without increasing its fleet capacity. We expect to see similar level of cost savings for 2HFY14 as compared to 1HFY14 of US$195.0m.

Depressed freight rates likely to continue

IMF recently cut its global GDP growth forecast on 7-Oct to 3.3% for 2014 and 3.8% for 2015, against its Jul-14 forecasts of 3.4% for 2014 and 4.0% for 2015. The demand growth driver for the industry is dependent on the world GDP growth and we expect demand to soften on weaker outlook. Based on order book as at Sep-14, market watcher Alphaliner forecasted that the supply of cellular fleet will grow 5.8% in 2014 and 8.0% in 2015. Hence, with supply growth exceeding forecasted demand growth, we think downward pressure on freight rates is likely to sustain for at least until end-2015 as we expect overcapacity to continue to plague the industry.

Upgrade to HOLD on valuation grounds

We expect the effects of operational efficiency and capacity discipline to partly offset the effects of lower profitability from depressed freight rates in its liner segment. Hence, we reduce FY14F and FY15F losses by a slight 3.7% to US$268.7m and 2.4% to US$238.2m, respectively, and with the recent slide in its share price since our last update in Aug-14, we upgrade NOL to HOLD on valuation grounds with an unchanged fair value estimate of S$0.90 (still based on 0.97 FY14F P/B).

Source: OCBC Research - 10 Oct 2014