• Yangzijiang Shipbuilding’s 4Q18 above expectations; boosted by forex gains and income from forfeited deposits. 
• Secured US$280m worth of new orders in 4Q18. 
• Korean yards merger to accelerate industry recovery; newbuild prices and margins set to improve. 
• Reiterate BUY; Target Price S$1.82. 

Reiterate BUY; Target Price S$1.82

• YANGZIJIANG SHIPBLDG HLDGS LTD (SGX:BS6)’s valuation remains undemanding at 0.9x P/BV, at 10% discount to global peers, notwithstanding its more attractive 11% ROE, 3.5% yield and solid balance sheet with 94 Scts net cash.
• Yangzijiang Shipbuilding is a prime beneficiary of a stronger USD and among the best proxies for exposure to a recovery in the shipping and shipbuilding sectors.

One of the World’s Best-managed and Profitable Shipyards

• Core shipbuilding revenue ahead is backed by its healthy order backlog of US$3.9bn (~2x revenue coverage) as at end-Dec 2018. Better returns from the investment segment provides upside to its recurring income stream.
• As the largest and most cost-efficient private shipbuilder in China, Yangzijiang Shipbuilding is well positioned to ride the sector consolidation and shipbuilding recovery. Its strategy to move up into the LNG/LPG vessel segment through a partnership with Mitsui strengthens the longer-term prospects of the company.

Where We Differ

• While market has placed much focus on Yangzijiang Shipbuilding’s order win momentum, we opine that this is less critical given that the yard is full for the next two years. We believe the key re-rating catalysts are Yangzijiang Shipbuildings successful strategic positioning to expand into the LNG carrier and tanker markets and overall shipping and shipbuilding recovery leading to margin improvements.

Valuation

• We value Yangzijiang Shipbuilding based on sum-of-parts (SOP) methodology. We arrive at a target price of S$1.82, after applying 9x FY19F PE on shipbuilding earnings, 1x P/BV for bulk carriers and 1x P/BV for investments.
• Our Target Price translates into 1.1x P/BV, which is in line with 0.5SD below its 10-year mean.

Key Risks to Our View

• USD depreciation and hike in steel cost. Revenue is denominated mainly in USD, and only half is naturally hedged. If the net exposure is unhedged, every 1% USD depreciation could lead to a 2% decline in earnings. Every 1% rise in steel costs, which accounts for about 20% of COGS, could result in 0.8% drop in earnings.

What's New - Another Strong Quarter

A strong 4Q18.

• Yangzijiang Shipbuilding’s reported headline PATMI of Rmb1.25bn in 4Q18, was double that of market expectations. This brought 2018 net profit to Rmb3.61bn (+23% y-o-y).
• Results were boosted by income from forfeiture of deposits of cancelled vessels (+Rmb377m), forex gains (+Rmb411m), reversal of impairment loss (+Rmb190m), partially offset by inventory write down (-Rmb211m), net allowance for foreseeable loss (-Rmb100m), and Venture Capital JV losses (- Rmb90m).
• We have revised up our FY19-20 by ~10% each year, factoring in the higher reversal from foreseeable losses and financial assets.
• Core shipbuilding margin (adjusting for provisions) remained decent at ~15% in 4Q18. While reported core shipbuilding gross margin contracted to 9% in 4Q18, adding back the increase of ~Rmb180m provisions, margins remained decent at ~15% vs 17-20% over the past 3 quarters.

Secured 8 new orders worth US$280m in 4Q18, comprising:

• Two 1,800 TEU containerships
• One 83.5k DWT combination carrier
• Three 82k DWT bulk carriers
• Two 208k DWT bulk carriers

Order wins for 2018 amounted to ~US$1.5bn, below the company’s internal target of US$1.8bn.

• We are not overly alarmed with the slowdown of orders in 2H18 (~US$500m in 2H18 vs US$1bn in 1H18). Historically, Yangzijiang Shipbuilding tends to be more selective on order taking when its yards are close to full, currently with a revenue coverage of > 2 years. As yard consolidation in Korea is taking shape, we expect this to accelerate industry recovery, leading to margin expansion for shipbuilding.
• Orderbook stood at US$3.9bn, a marginal decline from US$4bn a quarter ago. This implies revenue coverage of 2- years. Yangzijiang Shipbuilding is ranked No.1 in China and No.4 in the world based on outstanding order book.

Solid balance sheet.

• Including HTM investments, Yangzijiang Shipbuilding is in net cash, equivalent to 94 Scts per share or 60% of its NTA.
• Declared better than expected 5 Scts final dividend (vs 4.5 Scts in FY17); which represents 3.5% yield.

Briefing Takeaways

1. Shipping market especially dry bulk and container vessel markets have deteriorated during the past few months but seems to be bottoming out.
2. Yangzijiang Shipbuilding maintains its order win target of US$2bn for this year and expects order momentum to pick up towards 2H19.
3. Management expects stronger recovery of tankers relative to bulkers and containers. Yangzijiang Shipbuilding plans to build four Medium Range (MR) tankers in 2019 to optimise yard operations. While owners are not ready to place newbuild orders at this point, Yangzijiang Shipbuilding has received keen interest from clients to co-own the tankers.
4. LNG carrier orders - not reliant solely on Mitsui partnership. It has a collaboration with Mitsubishi. In addition, Yangzijiang Shipbuilding has recently acquired a design company to develop products for the non-Japanese market.
5. The closure of partner Mitsui’s main yard in Japan could channel some of their future orders to their JV yard.
6. Merger of DSME and HHI should be positive for Yangzijiang Shipbuilding. The merger of CSIC + CSSC would shrink capacity, and lead to lesser price competition.
7. Forex remains the unpredictable swing factor to earnings. Yangzijiang Shipbuilding has made further provisions of Rmb180m in 4Q18. Total provisions for foreseeable losses amounted to Rmb1.1bn, which will be reversed as vessels are delivered in 2019-2020. Assumptions - Rmb6.5/USD, steel cost Rmb4,800/5,300 per ton for 2019/2020 (+10% p.a. from current Rmb4,300), labour cost +10% p.a.

Source: DBS Research - 04 Mar 2019