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China Shipping Development Co. Ltd. (1138.HK) - Recover gradually

Wednesday, September 23, 2009

4923

China Shipping Development Co. Ltd.(1138)

Recommendation on 23 September 2009
Recommendation	Hold
Price on Recommendation Date	$10.320
Target Price	$10.700

Weekly Special - 9618 JD.com

Overview

Interim result of China Shipping Development (“CSD” or “the group”) is in line with consensus. Both freight rate and shipping volume shrank as a result of economic contraction. Revenue and EPS in 1H09 for the group dropped 54.8% and 80.7% respectively. No interim dividend was declared.

Domestic coal and international oil shipment will recover

As we expected in the previous report, domestic oil shipment business outperformed others in 1H09. Nevertheless, we believe the other 2 major business segments, domestic coal and international oil shipment will recover in 2H09 while performance of domestic oil shipment will remain solid.

High orderbook may not harm CSD too severely

CSD has a very high orderbook. However, we think the situation may not be as worse as the investment community think. On the other hand, the rising borrowing and gearing ratio are our major concerns.

Target price HK$ 10.7

We value CSD at 1.53x 10PB. 12 months target price is HK$ 10.7. Maintain “Hold”.

1H09: The toughest period in recent years

Same as its peers in dry bulk shipping industry, CSD was adversely affected by economic downturn in 1H09. Both freight rate and shipping volume slumped, result in a sharp decline in revenue (-54.8%) and net profit (-80.7%) compared with 1H08.

Domestic coal shipment, the biggest revenue contributor in the previous year was the loser in 1H09, as a result of lower thermal power production and substitution of domestic coal by cheaper international coal. On the contrary, oil shipment, especially domestic oil shipment has a more robust performance by the help of long-term contracts with oil giants in China.

Overall, domestic coal, domestic oil and international oil shipment each accounts for 30% of the group's total revenue in 1H09.

Segment analysis

Coal shipment: Seesaw between domestic and imported coal

China's demand for coal declined as the need of thermal power reduced. However, as thousand of small coal mines in Shanxi province closed down since 2H08, domestic coal supply dropped for a short period of time. Domestic coal price was higher than imported price due to relatively constrained supply and thereby customers used imported coal to substitute domestic coal. As a result, CSD's domestic coal shipment business has been affected.

The situation has been changed recently. Coal supply in Shanxi province rebounded since May09. Besides, China coal import declined in recent months after hitting record high 16.07 million tonnes in Jun09. International coal price is rising rapidly and approaching domestic price. These signs reveal that the cost advantage of consuming international coal diminished. Demand for domestic coal and hence coastal coal shipment services will therefore increase in our view.

Domestic oil: Remain stable

As we mentioned in the last report published on 24/4/09, domestic oil shipment would outperform other segment as freight rates are fixed and bunker cost should drop significantly. This is exactly the case we saw in 1H09. Domestic oil shipment is on the spotlight in CSD's interim result.

Foreseeing that CSD will try to keep long-term relationship with China oil giants, we expect the group can maintain its market share in coastal oil shipment (currently 60%). Domestic oil shipment will remain core business for the group in next few years, however, sound growth is unlikely to be seen as long-term contracts also restrain upside potential in this segment.

International oil shipment: Both volume and ASP will recover

Benefited from the building up of national strategic oil reserve and hence increase of imported crude oil in China, volume of international oil shipment soared despite freight rate declined drastically.

As the pace of China crude oil import quickened (Jun: +14%, Jul: +42%, Aug: +18%) in recent months, we believe the international oil shipment volume will continue to rise. On the other hand, even though freight rate for tankers is still sluggish, we see signs of rebound. For example, since oil demand tumbled in 4Q08, many tankers were used as short-term floating oil storage tanks so as to avoid idleness of vessels. The trend has been reversed since Apr09, which reveal that demand for oil shipment is picking up.

New vessels delivery: Is it really a big concern?

CSD's orderbook is very high compared with peers. While orderbook for tankers and bulk carriers in the industry are approximately 33% and 64% respectively as of total fleet, CSD's orderbook are 74% and 153% for tankers and bulk carriers respectively. However, it may not be a big concern for the group in our view.

Tankers: Not white elephant

2H09-2010 is the peak period of tankers delivery. 7 VLCC, which will be mainly used in international oil shipment business, represents around 70% of the orderbook. As the shipment of imported crude oil will be the growth engine of the group, we believe shipping volume will increase accordingly and idleness of vessels can be avoided.

Bulk carriers: Vessels delivery match future demand

Unlike tankers, the peak period of bulk carriers` delivery for CSD is 2011-2012 while the peak period for the whole industry is 2009-2010. The dry bulk market should improve markedly in 2011. New supply will match new demand. In addition, average age for bulk carriers is over 20 years, which provide much room for the group to obsolete old vessels. Indeed, total capacity of bulk carriers was reduced in 1H09 (vessels delivered of 57,000dwt vs. vessels disposal of 79,000dwt).

Major concern: Gearing ratio is expected to rise

Capital expenditure for CSD is huge and clearly operating cash flow of the group is not sufficient to fulfill its commitment. We expect CSD will issue notes and increase its bank borrowing in the future. As a result, gearing ratio of the group may surge. Indeed the gearing ratio already rose from 23.7% at the end of 2008 to 30.7% as at the end of 1H09.

Valuation

We believe the trough is over but performance for different segments will vary, while domestic coal and international oil will recover modestly and domestic oil segment nearly remains unchanged. EPS for 2010 and 2011 are RMB0.73 and RMB0.95 respectively according to our estimation. We value CSD at 1.53x 10PB, which is 1 s.d. higher than the last 12 months average so as to reflect its gradual improved outlook, which translate to 12.77x 10PE. TP is HK$10.7. Maintain “Hold”.

Risks

We consider the following are downside risks to our relatively sanguine view: 1) Price gap between domestic and international coal widen again, which encourage the use of imported coal to replace domestic coal and 2) The pace of crude oil import may slow down in China as crude price is no longer cheap.

Financial Forecast

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