• Gross margin only 4.9% in 3Q
• S$10.6m of provisions
• In an unenviable position

3Q14 results in line

COSCO Corp reported a 17% YoY rise in revenue to S$1.16b and a 69% increase in net profit to S$7.1m in 3Q14, such that 9M14 net profit accounted for 76% and 69% of ours and the street’s estimates, respectively. On a YoY basis, profit was higher due to lower provisions on construction contracts (S$10.6m in 3Q14 vs S$33.9m in 3Q13); a less aggressive depreciation policy also aided bottom-line. However, gross profit margin dropped significantly from 7.4% in 3Q13 to 4.9% in 3Q14 with the execution of lower margin contracts.

Three offshore projects already cancelled or at risk of cancellation

COSCO recently announced that delivery for the Sevan 650 drilling unit has been extended to up to 36 months from Oct 2014; 2Q14 was the original delivery date. For the deepwater drillship contract (~US$630m) that was terminated by Dalian Deepwater Development, arbitration in London is still ongoing and the company is unable to quantify the financial impact of the project. As for the Octabuoy hull and topside module (~US$240m), the contract has been terminated, and COSCO Nantong has the right to either complete or not complete the project as it deems fit, and to sell the project at a public or private sale.

Weak execution and deteriorating balance sheet in a slowing market

As at 30 Sep 2014, the group’s order book stood at US$8.9b, with progressive deliveries up to 2016. However, as the group continues to execute projects that were secured in recent years “at low contract values” due to the weak shipping market, it expects operating margins on these new shipbuilding projects to face downward pressure despite improving gains in efficiency and productivity. This does not augur well for a company with a net gearing of 1.3x (vs. 0.6x in 3Q12 and 1.0x in 3Q13) and is still scaling the offshore learning curve. Given COSCO’s weak execution abilities, relatively poorer quality clientele, and deteriorating balance sheet amidst a slowing offshore market, we lower our P/B from 1.0x to 0.8x, resulting in a lower fair value estimate of S$0.50. Maintain SELL.

Source: OCBC Research - 4 Nov 2014