• Heading into 2020, the two key catalysts for Yangzijiang Shipbuilding's share price outperformance is the return of the company’s chairman and new-order wins, in our view. We believe that both should occur in the next 3-4 months and thus re-iterate our BUY rating and target price of S$1.46.
• Yangzijiang Shipbuilding’s current P/B of 0.63x remains inexpensive given that it is a 25% discount to its 5-year historical mean of 0.84x.

What’s New

Operationally solid.

• While there is no definitive timeline for the return of YANGZIJIANG SHIPBUILDING (SGX:BS6)’s chairman, we point out that the company remains operationally solid with gross-profit margin in 3Q19 expanding 0.8pp y-o-y to 19.5%, while core shipbuilding margin remained robust at 14%. At present, we maintain our 2020 and 2021 gross margin estimates at 17.5% and 17% respectively.
• Yangzijiang Shipbuilding’s CEO (and the chairman’s son) has many years’ experience in the shipbuilding industry and has been a steady hand since he was appointed CEO in March 15.

New shipbuilding orders for Yangzijiang Shipbuilding have mildly disappointed in 2019.

• However, we remain confident that in the near to medium term, the International Maritime Organisation (IMO) 2020 regulations will lead to new orders for the company. We point out that there are 184 LNG-fuelled ships currently on order, which is more than the 170 vessels in operation globally, as the impending IMO regulations encourage shipowners to take on the upfront costs of investing in cleaner-fuel vessels vs installing scrubbers.
• While scrubbers cost less, evolving IMO and country regulations may render some scrubber technology obsolete in the near term. Thus, we believe that there is meaningful upside for Yangzijiang Shipbuilding if the shipbuilding industry continues its move towards clean-fuel vessels, as more countries globally enact Emission Control Areas (ECAs).

A spare Rmb4.2b sitting in the bank.

• As at end-3Q19, Yangzijiang Shipbuilding had net cash of Rmb4.2b, part of which we believe could be used to pay a special dividend. (Yangzijiang Shipbuilding Dividend History)
• During its 3Q19 results briefing, Yangzijiang Shipbuilding had stated that it would look to scale back some capex in 2020; thus use of funds will likely decline y-o-y. In addition, it appears that the company will continue to scale back on its debt investments by Rmb1b-2b during the current quarter.
• In 2020, Yangzijiang Shipbuilding may also engage in M&A; however the company is more likely to use its own stock as payment given that it has bought back 23m shares in 2019. Taken as a whole, Yangzijiang Shipbuilding’s use of funds will not be onerous in 2020 and thus a special dividend could be paid out, in our view.

Stock Impact

What is IMO 2020?

• The IMO will enforce a new 0.5% global sulphur cap on fuel content starting from 1 Jan 20 – this is a material decrease from the present 3.5% limit. The global fuel sulphur cap is part of the IMO’s response to heightened environmental concerns. Thus, the shipping industry will have to deal with both the upcoming 0.5% sulphur cap, and also the existing 0.1% sulphur cap in designated ECAs.
• While shipowners can continue using high-sulphur fuel oil (HSFO), they will have to install on-bard scrubbers to clean their vessel’s emissions. The other alternative would be to use LNG-powered vessels.

Globally we have seen a better supply/demand balance in shipping-capacity growth in recent years due to more prudent orders.

• Thus, the shipping industry will likely be able to cope with any slowdown in global economic growth in 2020 due to US-China trade tensions or Brexit impacts. As an example, global bulk carrier orders as a percentage of total deadweight tons have come down across Capesize, Panamax, Handymax and Handysize vessels. However, we note that in 2020 and 2021, new orders will less likely be predicated on global trade outlook but rather the need to adhere to ever more stringent emission requirements.
• In addition, we believe that a better supply/demand balance in global shipping capacity could encourage shipowners to order cleaner fuel vessels compared to a state of oversupply.

The impact of IMO regulations on fuel demand will be material

• The impact of IMO regulations on fuel demand will be material, and in the medium term is likely to make shipowners change the dynamics of their fleet.
• According to Wood Mackenzie, demand for very low sulphur fuel oil (ie 0.1% sulphur content) will increase significantly from 2020 onwards, while distillate demand is also forecast to materially grow.
• Interestingly, LNG is not expected to play a major role in the shipping industry. In our view, these developments will have positive ramifications on Yangzijiang Shipbuilding in the medium to longer term as a ‘shake out’ in the shipping industry develops.

Earnings Revision / Risk

• None.

Valuation / Recommendation

• We re-iterate our BUY recommendation on Yangzijiang Shipbuilding and price target of S$1.46/share which is in historical P/B of 84x.
• Yangzijiang Shipbuilding’s P/B has rebounded from its trough of 0.52x recorded in late-Aug 19 and is now at 0.63x, which is still a 25% discount to its 5-year average. We note that this is also a discount to its regional shipbuilding peers in Korea which trade at an average of 0.7x P/B and have an average net debt/equity of over 52%, vs Yangzijiang Shipbuilding which is in a net cash position.

Share Price Catalyst

• New ship-building order announcements.
• News that the chairman is no longer assisting in the Chinese authorities’ investigations.

Source: UOB Kay Hian Research - 11 Dec 2019