Neptune Orient Lines Ltd- A lot of negatives priced into current valuations (POEMS)

Hold (Downgraded)

Closing Price S$1.55

Target Price S$1.51 (-2.4%)

• Significant container deliveries over the next few years

• Expect NOL to gear up following a change of strategy

• Challenging outlook for the container industry due to falling freight rates

• Change of analyst

• Revised earnings forecasts

• Downgrade to Hold with target price of S$1.51

Significant orders in the industry

Orders placed by shipping lines indicated a preference for larger vessels. The sizeable orders coming on stream could lead to a potential overcapacity situation, if demand growth does not keep pace. NOL has the highest ratio of order to capacity among the major players. However, the practice of slow steaming could moderate the effective capacity growth.

Expect high CAPEX over next few years

NOL would be increasing their operating leverage by shifting their strategy from chartering 70% of its current capacity to owning most of them. 300k TEUs of capacity would be absorbed into NOL’s current fleet, which would be offset by expiring charters over the next few years. We estimate that NOL would require cash outlays of US$3bn over the next 4yrs to fund the new vessels coming on stream. Consequently, we expect NOL to gear up significantly to be in line with the industry average of 0.7X gross gearing in 3yrs time.

Economic Indicators point to moderation of volume growth

The US and Eurozone PMIs tends to lead volume growth on their respective routes by 3months. We interpret the US data as an indication of a slight decline in weekly volume growth, due to high base effects from the strong rebound a year ago. For Europe, we expect moderation of growth, following 5 consecutive quarterly y-y increases of 20%. The next few months would be vital to NOL’s profit outlook as the shipping industry enters the seasonal third quarter peak.

Recovery of Freight rates would be vital to the industry

Freight rates had been on the decline and the full year profitability of NOL could be under threat, if freight rates do not increase fast enough to offset the rising bunker prices. We opine that the direction of freight rate movements would be the key to the outlook of NOL’s share price.

Valuation

We value NOL based on a P/B value methodology, from the regression of our forward ROAE forecasts with its historical values. We derive our target price of S$1.51 based on 0.92X FY11/12e blended BVPS of US$1.34 and translating it at an exchange rate of 1.23SGD/USD. After incorporating dividend expectations of S$0.01, we expect total return of -1.8%. Hence, we downgrade our recommendation of NOL to a Hold.