• Yangzijiang Shipbuilding’s 3Q19 net profit slightly below; shipbuilding margins normalising.
• Order flow is trending up as IMO2020 approaches.
• Potential return of Chairman will remove key overhang.
• Trading below cash; Reiterate BUY; Target Price adjusted to S$1.68 following earnings revisions.

Reiterate BUY; Target Price Trimmed to S$1.68, Following Earnings Revisions

• Yangzijiang Shipbuilding (SGX:BS6) is currently trading below its net cash position of ~S$1 per share, which is unwarranted, and largely due to the uncertainty over the investigations surrounding the Chairman as well as other concerns such as macro slowdown and decline in shipbuilding margins.
• Valuation is compelling at 0.6x P/BV against 10% ROE and 5% dividend yield.
• The expected uptrend in contract flows and potential return of the Chairman could lift the stock closer to S$1.50, a level prior to the negative news relating to the Chairman.

One of the World’s Best Managed and Profitable Shipyards

• Core shipbuilding revenue ahead is backed by its healthy order backlog of US$3.2bn (~1.5x revenue coverage) as at end-Sep 2019. Investment segment provides stable recurring income.
• As the largest and most cost-efficient private shipbuilder in China, Yangzijiang Shipbuilding is well positioned to ride on the sector consolidation and shipbuilding recovery. The company’s strategy to move up into the LNG/LPG vessel segment strengthens its longer-term prospects.

3Q19 Results Slightly Below; Catalysts Emerging

3Q19 headline profit slightly below.

• Yangzijiang Shipbuilding’s headline earnings slid 10% y-o-y to Rmb702m in 3Q19, slightly below our expectations of ~Rmb750-800m. Quarterly performance tends to be lumpy, swung by forex, allowance / reversal of allowances for cost overruns, and project margins. 9M19 net earnings of Rmb2,463m made up ~74% of our full year projection.
• Adjusting for the effect of reversals/provisions for expected losses, core shipbuilding margin moderated to 8.7% (adjusted for net reversal of provisions for onerous contracts of Rmb155m ) vs 10.1% in 2Q19 (adjusted for net reversal of provisions for onerous contracts of Rmb254m) and 14.6% in 3Q18 (adjusted for net provisions of Rmb152m).
• As of end Sep-2019, provision for onerous contracts and warranty provisions stood at Rmb674m (from Rmb829m a quarter ago) and Rmb354m (from Rmb346m a quarter ago) respectively.

Order momentum is picking up.

• YTD, Yangzijiang Shipbuilding has clinched ~US$700m in new orders, forming 35-47% of its annual target of US$1.5-2.0bn. Overall newbuild ordering has been slow this year especially in 1H as shipowners adopted a wait-and-see approach amid economic uncertainties and ahead of IMO 2020 implementation.
• Nevertheless, order win momentum seems to be improving with more clarity on implementation of IMO 2020. This should eventually kick start the vessel replacement cycle especially for small-to-mid size vessels.
• Orderbook rises a notch to US$3.2bn, from US$3.1bn a quarter ago, as order wins gathered momentum in 3Q19. This implies revenue coverage of 1.5 years, and hopefully the stronger order flow ahead will lift coverage back to the ideal range of 2-2.5 years.

Trading below net cash.

• Including debt investments, Yangzijiang Shipbuilding is in net cash, equivalent to S$1.0 per share or 65% of its S$1.55 NTA per share.

Earnings revisions.

• We have lowered our FY19 net profit by 6%, largely attributable to the push back of recognition of old yard relocation fees from government and gains on vessel disposal totaled Rmb248m to 2021.
• We have also cut our FY20 forecasts by 10% factoring lower shipbuilding margins by ~2ppt.

Key Takeaways From Briefing

Strive to meet annual order target.

• Management remains committed on the US$1.5-2bn p.a. order win target. While it might be rather challenging to conclude another US$800m worth of orders over the next 1.5 months, stronger flow of contracts will certainly be a positive signal and re-rating catalyst.

JV yard with Japanese partner Mitsui has commenced operations

• JV yard with Japanese partner Mitsui has commenced operations in Aug-19 and contributed a small profit of S$3.4m at associate line in 3Q19. The JV yard, named Yamic, is currently constructing six units of 82k dwt bulk carriers for the Japanese market. Partner Mitsui has transferred nine Japanese yard managers to the JV yard.
• The main goal of Yamic is to build LNG carriers, to tap the booming LNG demand. Based on the current development, some meaningful orders could materialise in 2020. Management shared positive feedback from Japanese shipowners, who are impressed with the quality of the yard which seems to be as good as the Japanese yards.

Upside to dividend payout?

• In view of the China slowdown, out of prudence, management is scaling back debt investments. As a result, cash on hand has risen to Rmb9.2bn or approx. 46 Scts per share as of end Sep-2019.
• Management stressed its commitment to reward shareholders with stable dividends. Hence, we believe company will likely maintain 5 scts dividend payout despite expectations that earnings will decline during FY19-20F, but a higher payout can’t be ruled out as well given its cash hoard.

Chairman’s return?

• Management reassured investors that Chairman’s assistance in investigations does not relate to the shipyard business and his absence is not affecting Yangzijiang Shipbuilding’s day-to-day operations and contract wins outlook etc. Local bankers remain very supportive as well.
• In response to investors’ concern over Chairman, the CEO is hopeful on the Chairman’s return to assume his duties soon. This will be a strong catalyst that will remove the key overhang and re-rate the share price, in our view.

Valuation

• Our target price of S$1.68 is based on sum-of-parts, pegged to 8x FY20F PE shipbuilding earnings, 1x P/BV for bulk carriers and 1x P/BV for investments. This translates into 1x P/BV, which is 0.5SD below its 10-year mean (1.4x).

Where We Differ

• We believe critical catalysts are Yangzijiang Shipbuilding’s successful strategy to expand into the LNG carrier and tanker markets, and overall recovery in the shipping and shipbuilding segments leading to margin improvements.

Source: DBS Research - 15 Nov 2019