The  China  scale  of  shipbuilding.  Shipbuilding  in  China  is  carried out on  a  much larger scale than in regional yards. The workshop itself stands on 15ha of land, which is actually bigger than some entire yards. As JES is building 47,500dwt-94,000dwt bulk carriers, the blocks are suitably large with each block the height of a low-rise building (Figures 1 and 2). However, due to the size of the yard and blocks, we were unable to see a clear layout of the yard and the process chain.

Operating  near  full  capacity.  JES has an estimated 2,000,000dwt annual capacity, and with 20 vessels under construction at the moment of up to 94,000dwt each, it is operating near full capacity. We saw blocks laid out alongside the main yard road ready for assembly to  form  the  hulls,  and  vessels  in  later-stage  completion  that  had  already  been  launched and now berthed along the 1,800m shoreline of the JES yard (Figures 3 and 4).

Largest  drydock  in  China.  Some  big  slipways.  JES  has  some  impressive  assets,  with the  most  prominent  being  its  drydock  of  480m  length  by  142m  width.  Straddling  this drydock  is  a  massive  gantry  crane  spanning  230m  capable  of  lifting  1,200  tonnes  which makes it one of the largest in the world (Figure 5). We climbed up one of the bulk carriers and peered into the one of the holds (Figure 6).  Not to be outdone, the slipways measure 265m x 61m and 285m x 38m (Figure 7) and other cranes fill the sky (Figure 8).

Depressed margins and delayed deliveries.  Even though the yard is operating near full capacity, 3Q12 gross margin was a mere 5% and the quarter would have been in the red if not  for  a  large  RM55m  forfeit  of  deposit  recognised  in  income.  We  also  noted  a  RM60m provision for 'liquidated and ascertained damages' which we understand to be related to penalties for late deliveries which potentially affect half the vessels under construction. We speculate  that  part  of  these  provisions  is  a  business-necessary  method  of  reducing  the price of the vessels to the customers, since newbuild market prices have fallen sharply.

From net cash to net debt. Another issue is cash flow. A year ago, JES was in a net cash position but with the slowdown in payments from customers, a large proportion of the cash has been consumed by working capital. We calculate net gearing to be 30% as of 3Q12.

Order  book,  future  margins,  vessel-price  concerns.  In  3Q11,  JES  reported  an  order book of US$1.2b. Since then, order flow has been anemic totaling US$116.7m. We believe the  present  order  book  to  be  close  to  US$600m  and  for  most  of  it  to  be  recognized  by 1H13.  As  fixed  costs  for  a  shipyard  can  be  rather  high,  this  situation  exerts  downward pressure on future margins and there is a possibility that JES is already operating at a loss today. This reduces JES' bargaining position with customers, and we are concerned that the  recent  Platform  Supply  Vessel  (PSV)  orders  might  have  been  received  at  low,  fixed-cost-covering margins.

Labour  dispute.  While  we  were  at  the  JES  yard,  we  witnessed  dozens  of  workers gathered outside a gate. The scene was peaceable, with hawkers still selling their wares to the assembled workers. Inside the yard, work  was halted with the workshop, drydock and slipways almost empty of workers. 

JES has stated that these workers are subcontractors' workforces, and that 'it is a common practice  that  they  defer  the  payments  to  its  workers  to  ensure  that  these  workers  do  not leave their job without notice given which will eventually affect the workforce planning in the yard.' We hope to see better labour relations in coming years.

Offshore  exodus.  With  the  commercial  vessel  market  in  the  doldrums,  JES  has  made  a move towards offshore oil & gas assets. It has formed an offshore team to spearhead the offshore expansion strategy, and also 'formed a joint venture with a Singapore entity with an experienced offshore team'.

In  addition  to  the  PSVs,  we  understand  that  JES  is  targeting  a  leap  up  the  value  chain towards  building  jackup  rigs.  We  are  not  surprised  '  their  neighbour  Yangzijiang  recently secured a jackup rig order plus another offshore contract. Margins in the offshore oil & gas space are much higher, potentially high enough to afford a learning curve and help tide the yards over this period of mass starvation.

The long march offshore. Before JES can reap the rewards of being in the offshore oil & gas  space,  it  has  a  series  of  immediate-term  hurdles  to  clear.  First,  it  has  to  work  off  the current order book, and to turn the operating cash flow back into the black. With much of its cash tied up in deposits and working capital, this may be the most difficult step.  Second, it has to resolve the present labour disputes, and also to build up a skilled offshore production team.  Third,  it  has  to  secure  sufficient  vessel  orders  (whether  commercial  or  offshore)  to keep  the  yard  afloat  while  it  scales  the  learning  curve.  Finally,  it  has  to  develop  a  track record of delivering high-quality offshore assets, and hopefully then to secure the holy grail of a large series of rig orders that will maximize the Chinese model of mass-production.

Valuations  at  a  low.  JES  is  currently  trading  at  a  P/B  of  0.4x,  which  indicates  that  the market may have already priced in potential losses due to the low order flow.  The trailing-12-month P/E is rather high at 15.3x, so it appears that the book value now supporting the share price at current levels.

Source: OSK