Expect  core  2014  earnings  of  CNY2.5bn,  reported  earnings  to  maintain  at CNY3bn  with stable dividend outlook.  On the slightly lower expected revenue in FY14  and  the  lower  margins,  we  expect  core  income  (including  HTM  earnings)  to come in at CNY2.5bn. However, there is a one-off CNY720m gain on the disposal of the old yard, which will be booked this year. Hence, reported earn ings should be in the  range  of  CNY3.2bn.  YZJ's  earnings  are  stabilizing,  and  management  has  also guided for dividend stability.

YZJ's HTM assets cannot be likened  to  China's trust funds.  We note three very critical differences between the two investment classes. First, the YZJ's HTM assets are basically loans from one company to another, whereas the trust products are akin to  mutual funds.  By not having to go through an intermediary, YZJ has better control of  the  actual  risks  and  rewards  involved.  Secondly,  its  loans  are  heavily collateralized,  requiring  2-3x  of  the  loan  value  in  shares,  undeveloped  land,  or insurance company guarantees. This results in a much higher margin of safety ( and trading off some of the returns;  YZJ's 12% average interest rate is considered low in China  for  borrowings  of  this  nature).  Third,  the  borrowers  on  the  trust  products  in China tend to be small-medium enterprises. YZJ's borrowers tend to be large (often listed) companies, which  materially reduces the risk profile of YZJ's HTM  borrowers. As  such,  we  think  that  current  market  fears  over  YZJ's  investment  portfolio  are misplaced and that a clearer understanding should make way for a rerating.

First jack-up rig expected to be profitable.  YZJ's first jackup rig is on schedule. Management does not expect to record any losses on this rig.  We believe that  the company  is currently recognizing zero margins  on this project, and  we are optimistic on the likelihood of a positive release of provisions upon delivery.

Two  mid-water  semi-submersible  rigs  ordered.  YZJ  reported  that  it  has  won orders for  two  mid-water  (300m-3000m operating  depths) semi-submersible drilling rigs worth USD0.825bn in total. Management said that these rigs can also be used in deepwater  operations  after  upgrading  the  topside  equipment.  Furthermore,  since there are only about 10 yards in the world building mid -water assets (Chinese and Singaporean  yards  are  focused  on  shallow  waters,  Korean  yards  on  deepwater),there  is  a  supply  gap  in  this  spac e.  There  are  options  for  two  more  rigs  to  be exercised within a year. YZJ will only announce the contracts as firm when it receives a deposit, which we expect to be in March.

Expect higher utilisation and efficiency in  all of  its  yards.  The higher volume of offshore work should allow YZJ to realise higher utilisation and efficiency gains at  its Taicang  yard,  which  will  lend  support  to  margins.  Further  economies  of  scale  are possible  if  the  two  semisubmersible  rig  options  are  exercised.  YZJ's  commercial shipbuilding should also see higher  efficiency  due  to  its  much larger  orderbook on hand  today.  Together,  these  will  mitigate  (but  not  completely  eliminate)  the  fall  in margins  arising  from  the  lower  contract  prices  of  vessels  ordered  in  the  last  three years.

Seaspan options likely to be exercised.  Management expressed confidence that the  Seaspan  (SSW US, NR)  orders will be exercised, given:  i) customer satisfaction on the successful sea trial of the first unit, and ii) its attractive pricing. We believe that this second batch of eight vessels (vs seven in the first batch) will be converted to firm  contracts  in  the  next  two  months.  Unit  prices  are  likely  to  be  in  the  range  of USD90m  -  down from  USD100m for the first batch  -  but we note that  the prices of materials and equipment have also come down.

Potential  tax  writeback  in  2014.  The  tax  expense  in  4Q13  was  higher  than expected due to the termination of a  tax incentive. However, as YZJ  is  now applying for "high-technology company" status.  As the company is now building a jack-up rig and has even won orders for semi-submersible rigs (one of the very few such orders in China), we expect YZJ to receive approval for this status in May 2014.  This should result in a one-time writeback of taxes and for street upgrades on lower  expected tax expenses.  We  are  still  assuming  an  overall  29%  tax  rate,  preferring  to  err  on  the conservative side.

YZJ's yards full up to 2015; so can cherry-pick contracts. With the surprise win of USD2.9bn  of  orders  in  FY13  (compared  with  forecasts  of  USD2.0bn),  YZJ's  yard slots have filled up much faster than expected.  The company  is now in  a  position to cherry-pick contracts for nearer-term delivery, after factoring in the options likely to be exercised.  Management  elaborated  that  contracts  won  over  and  above  these  may result  in  some  vessel  deliveries  being  pushed  back  to  later  years.  Therefore,  we expect any orders from this year onwards to be at healthy margins.

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Company Profile
Yangzijiang is a leading non-state owned shipbuilder in China with expertise in containerships and bulk cargo carriers.

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Source: OSK-DMG