Neptune Orient Lines (DBSVickers)

HOLD; S$1.53, Price Target: S$2.10

NOL to order 12 new ships for delivery in 2013-14

NOL to expand owned fleet further. Close on the heels of its recently announced S$300m 4.40% notes issue, NOL Group announced the signing of LOIs for 12 new ships with Korean shipyards due for delivery in 2013-14. The new order would include i) ten 14,000 TEU vessels to be constructed at Hyundai Samho Heavy Industries, and ii) two 9,200 TEU vessels to be constructed by Daewoo Shipbuilding & Marine Engineering Co. (DSME). NOL would also be upgrading its existing order with DSME for ten 8,400 TEU ships to 9,200 TEU capacity, in line with the specs for the new 2-ship order at DSME. Taken together with its existing orders placed in 2007 and 2010, NOL will be adding about 350,000 TEUs in gross capacity over 2012-14. Given that about 150,000 TEU capacity ships come off charter during that period and will be replaced by the owned ships, net increase in capacity by 2014 will be around 200,000 TEUs or 35% from current levels. The owned-to-chartered fleet composition will also change from current 30:70 to about 50:50 by end-2014, in line with management’s targets.

The total consideration for new vessels and upgrades is around US$1.54bn. We estimate the 14,000 vessels to cost around US$130m each, the 9,200 TEU vessels to cost around US$100m and the upgrades to cost around US$5m each. The price looks fair to us and seems to be at a slight discount to OOCL's orders with Samsung in March'11 for six 13,000 vessels for US$138m each and Hamburg Sud's orders for six 9,700 TEU ships for US$118m each (as reported by Clarkson). The recent notes issue should help finance pre-delivery payments, while bank lending for the remainder can be arranged at a later stage. NOL has already secured bank-lending amounting to about 78% of value of its last batch of orders. Net gearing for the Group is, however, projected to increase from current levels of around 0.2x to 0.5x by end-FY12 and even higher, going forward, as more of the owned ships are delivered.

Indicative of change in strategy? The 14,000 TEU ships are the biggest that NOL has ordered to date, and is suitable for deployment on the Asia-Europe trade. The bigger players on the Asia-Europe trade like Maersk, MSC, CMA-CGM and CSCL have already deployed or ordered ships of this size/ class, and NOL would find it hard to compete effectively on this route without the cost advantages obtained from running these bigger and more efficient ships. The more aggressive intent to protect market share on Asia-Europe routes, where NOL has traditionally not been seen as a strong player, could be a sign of change in strategy as NOL has seen some recent changes in top management, including changes in Group CEO and the President of the container shipping division (APL). The smaller 9,200 TEU ships will however, be deployed on the Transpacific route, where NOL already has a premium position. We believe it is still very early days to call changes in the Group's longterm strategy, though.

Clouds building up in the horizon. While there is no immediate impact on earnings from these new orders, we view the industry-wide phenomenon of placing new orders to gain market share in the 2013-14 period with caution, as even the long-term demand-supply dynamics now begin to look increasingly fragile. In the near term, carriers continue to struggle with weakening freight rates across trade lanes, and there is no sign yet of a peak-season driven demand recovery. 2Q11 will likely be another loss-making quarter for NOL, as well as the industry at large, and whether 3Q11 will be strong enough to recover the losses will remain to be seen. As such, we maintain our HOLD call on the stock for now but see potential downside risks to our earnings assumptions for FY11/12.