- Above  expectations.  Yangzijiang  Shipbuilding  (YZJ)'s 3Q13 net profit of CNY821m (-6% y-o-y, +1% q-o-q) beat our and consensus' estimates by  12%  and  32%  respectively  as  the  GPM  for  its  shipbuilding-related segment  remained  higher  than  expected  at  22.3%.  In  the  meantime, gross  profit  from  held-to-maturity  investments  and  micro-financing  rose 14% y-o-y, making up 32% of total gross profit.

- Improving  outlook.  Management  expects  the  shipbuilding  sector's outlook  to  remain  challenging  as  it  is  still  undergoing  a  consolidation. However, several positives are emerging: i) prices have risen by  5-10% from  six  months  ago;  ii)  payment  terms  have  improved  from  20:80  to 30:70 and 40:60; iii) weaker yards are forced to close due to zero orders or  the  inability  to  secure  working  capital  financing;  and  iv)  orders  are flowing to state-owned yards and top private yards, which benefits YZJ.

- Growing  orderbook  enhances  visibility.  The  company  has  a  net orderbook  of  USD3.87bn  (CNY23.6bn)  for  88  vessels.  YTD,  YZJ  has won  USD2.1bn  new  orders  for  52  vessels,  marking  its  strongest  order intake  since  2007.  The  company  has  29  options  worth  USD1.36bn  and management  expects  some  of  these  to  be  taken  up  by  end-FY13.  We have forecast USD2.6bn worth of new orders in FY13.

-  HTM investments set to remain high for a while longer. Management plans to maintain the current level of held-to-maturity (HTM) investments in  the  next  few  years.  As  such,  we  expect  HTM  investment  income  to stay high over FY14F-15F.

- Reiterate  BUY,  with  higher  SGD1.50  TP  (from  SGD1.45).  Our  SOP approach: i) values YZJ's shipbuilding unit at 12x FY14F P/E; ii) adjusts for  cash and  financial  assets, and  iii)  imputes  a  lower  debt and  amount due to customers. Our TP reflects a 9.9x FY14F P/E.

- High-priced  orders  at  the  tail-end  now.  Management  said  the  high-margin ship orderbook makes up a small portion of its current orders and expects all of the ships  to  be  delivered  by  1H14.  It  will begin  recognising more  mid- and  low-priced  orders  in  2014.  We  expect  gross  margins  for  its  shipbuilding-related segment to fall from 21.9% in FY13 to 15.9% in FY14 and 14.1% in FY15.

- Reopening Changbo  yard. Management plans to reopen the Changbo yard in 1Q14 to take in more orders.

- Taxes rise. YZJ was charged a 25% tax rate for its Jiangsu new yard, compared to 12.5% when the yard just commenced operations. The tax is also higher due to  the  withholding  tax  on  the  income  that  was  repatriated  from  YZJ's Chinese subsidiaries  to  the  Singapore  holding  company.  The  company  is  applying  for new high-technology enterprise status, which will allow it to enjoy a 15% tax rate - although the outcome remains uncertain.  

- Wage  inflation  likely  to  be  in  10%  range.  Despite  the  closure  of  yards  in China,  wages  remain  on  the  uptrend.  Management  expects  wages  to  rise  10% per annum over the next few years.

- Continues  to  diversify  away  from  core  shipbuilding  business.  In  9M13, shipbuilding contributed 66% of total gross profit. Management plans to grow its income  from  other  units  such  as  investment  and  microfinancing,  as  well  as  the property  division,  from  34%  to  50%  of  earnings  over  the  next  few  years.  The property division will start by developing the old yard in Jiangsu and may see  an earnings  contribution  in  2015.  Note,  however,  that  we  have  not  factored  in earnings from the property unit into our numbers.

- HTM  assets.  YZJ  is  repositioning  its  portfolio  to  invest  in  more  government-linked assets which have a longer tenure and lower interest rates. The effective rate  for  government-linked  assets  is  still above 10%.  Borrowers  are  primarily  in the real estate sector, followed by manufacturing, and trading while the collateral coverage  ratio  is  above  2x.  Default  rates  for  HTM  investments  are  <5%,  and these are mostly repaid from the sale of collaterals.

- Consensus  earnings  estimates  may  be  too  conservative.  Our  net  profit estimates for FY13-15F are 6/27/23% above consensus. We believe the street is too negative on margins and income from YZJ's HTM investments. Management is looking to keep HTM investments at this level for the near term.

Source: OSK