Cosco Corporation -Red chip turning blue

􀂾 Story: Story: From a mere shiprepair group, Cosco Corp’s earnings
profile will be transformed with a new stream of contributions from
the fast growing shipbuilding and offshore business. By 2009, the
group’s earnings profile will be transformed with 40% coming from
shiprepair, 30% from shipbuilding and 30% from offshore
engineering. YTD, the group has secured new contracts worth
US$2.9bn, representing 4.4x shipyard sales in FY06. Ongoing yard
expansion will speed up delivery of this order book over FY07 to FY09,
leading to accelerated EPS CAGR of 40% till FY09.
􀂾 Point: Restructuring is far from over; the group could divest its
fleet of 12 bulk carriers and may be eyeing other shipyards as
acquisition targets to strengthen its position as a leading shipyard
group in China. The possibility of ‘A’ shares listing, if it comes about,
will provide the currency to finance potential acquisitions, which will
further drive it up the shipbuilding value chain.
􀂾 Relevance: We expect the current re-rating on the stock to
continue on the back of a) possibility of ‘A’ share listing; b) more M&A
drivers; c) contract wins for both offshore and shipbuilding; and d) a
strong set of 2Q results. The stock is trading at P/E of 21x(FY08F) and
16.4x(FY09F), undemanding vs industry peers in China trading at 33.5x
and 24.5x on FY08-09 earnings. We have raised our FY08 earnings by
4.2% on the back of higher contract win assumptions and introduced
FY09 earnings. Maintain BUY, target price raised to S$5.60 as we roll
forward our target valuation based on 25x FY09 shipyard earnings and
the market value of its shipping fleet.
Total new orders of US$2.9bn secured to-date for 2007, visibility
extends into FY09. The group hit an amazing start by securing US$2.9bn
worth of new projects, of which 60% is for shipbuilding and 40% for
offshore structures and engineering projects. The order book represents
4.4x its shipyard sales in FY06. With these contracts secured, earnings
visibility is extended till FY2010.
Forecast net earnings CAGR of 40% up till FY09. We have assumed that the
group will secure contracts worth US$330m in 2H07, and US$2bn each in
FY08 and FY09. We believe these assumptions are conservative, given that
it has had a strong headstart in 1H07. Earnings visibility is strong, with
85% of FY08 sales and 60% of FY09 sales already covered by its existing
order book.
Potential upside to earnings if it acquires 19% stake in Cosco Shipyard
Group from sister companies. The group aims to raise its effective stake
in Cosco Shipyard Group (CSG), the holding company which controls all
the shipyards within Cosco Corp’s stable. Currently, it owns 51% in CSG
and in the event it acquires the balance of 19% stake held by related
companies - Shanghai Ocean Shipping (8%), Cosco Guangzhou (8%) and
Tianjin Shipping (3%) - its effective interest will rise to 70%. The move
should be positive as we expect net earnings for Cosco Corp to rise by 10%
to 13%, assuming acquisition P/E ranging between 10x to 15x on FY07
earnings.

More restructuring on the cards
May divest bulk carriers. We think that the group is one step closer to unlocking the value of its fleet of 12
bulk carriers, riding on the rise in BDI and capital values of its bulk carriers. Within the Cosco group, the
recent listing of sister company, China Cosco in Shanghai last month could have paved the way to speed up
the possible divestment of Cosco Corp’s fleet of bulk carriers. China Cosco raised proceeds of
US$2bn(Rmb15 bn ) and it plans to spend up to Rmb6bn to invest in 12 new container vessels and
Rmb1.68bn to acquire a 51% stake in Cosco Logistics from its parent Cosco Group. China Cosco, which is
currently engaged only in container shipping, would have excess funds should it add on bulk shipping as
another business division. The Cosco Group owns 250 bulk carriers through several unlisted entities in
TianJin, Qingdao, Hong Kong, Xiamen. Cosco Corp is the only listed bulk carrier shipping company within
the group, with a fleet of 12 bulk carriers.
Unlocking value from its ships. We estimate the market value of Cosco Corp’s bulk carriers, averaging 5
years, is worth US$38m each or US$450m in total. Assuming a cash divestment, this will realise net
proceeds of US$310m, after offsetting loans of US$140m. Based on book value of US$180m, a potential
sale will realise capital gains of US$270m translating into S$0.18 per Cosco Corp share. The sale could yield
potential bonus dividend for the group, given that its business is cash generative with minimal gearing.
Creating a shipyard giant via acquisitions? In addition to its aggressive expansion plans to double capacity
to 2.7md wt by 2010, the group is likely to be eyeing acquisitions to strengthen its leadership position in
China. Riding on the back of China’s vision to be the global leader in shipbuilding by 2015, we believe
Cosco Corp may step up its acquisition efforts. We turn the spotlight on Nantong COSCO KHI Ship
Engineering Ltd (NACKS), which is a 50/50 joint venture between its parent COSCO group and Kawasaki
Heavy Industries, with a total investment of US$240m.
Nantong Cosco Kawasaki is the only shipyard within the group that is not under the umbrella of Cosco
Corp. NACKS is mainly engaged in building bulk carriers, oil tankers and Post-Panamax container vessels.
Since 1999, the group has delivered about 30 vessels. NACKS is located just next to Cosco Corp’s shiprepair
yard in Nantong. Phase 2 of NACK’s yard expansion plans will be completed by Mar 2008, (Rmb2bn)
comprising a new 500K dwt building dock and a 300Kdwt outfitting quay. On completion, this will raise its
shipbuilding capability by 1.5mdwt to >2mdwt, allowing it to build larger vessels such as 8000TEU
container ships, 5000 PCC Ship, VLCC tankers and 185Kdwt bulk carriers. NACKS, which ranked top 7 by
order book in China for shipbuilding, has a market share of 3% in China based on its order book of 897K
CGT, comprising 48% in bulk carriers, 22% in containerships and 30% in tankers. This is the only shipyard
owned by Cosco Group which has not been injected into Cosco Corp.
Multiple benefits in acquiring Nantong Cosco Kawasaki. Following Cosco Corp’s move into shipbuilding
this year, we believe there are multiple benefits if it acquires this company.
a) NACKS has a strong track record with 8 years of shipbuilding history, and has been climbing the value
chain over the past years to build VLCCs and containerships of up to 5400 TEU. In contrast, Cosco Corp is a
new kid on the block in shipbuilding, its capability limited to bulk carriers, and conversion of single hull to
double hull vessels. NACKS will provide a leg up in its ambition to climb the value chain in shipbuilding, to
build container ships and VLCCs.
b) NACKS, together with Cosco Corp enjoys a ‘natural feed’ of orders from its parent and sister companies.
Cosco Group is the largest shipping group in China with a fleet of >650 vessels comprising container ships,
tankers, bulk carriers, general cargo and specialized vessels. With Cosco shipping group on an expansion
trail, this should generate shipbuilding orders for 40 vessels per year, including replacement of aged
vessels.
c) The acquisition, depending on transacted price, is likely to be accretive, as Cosco Corp will benefit from
NACKS existing order book as well as ride on its expansion plan, which will be ready by Mar 2008.
Additional capacity from NACKS will take Cosco Corp’s shipbuilding capacity to 40 vessels per year by 2010,
with 30 from Cosco Zhoushan, and10 from NACKS.