Event
Cosco posted weaker-than-expected 2Q11 earnings, with net profit diving 53% YoY to $31.9m. Despite turnover staying firm, earnings were eroded by higher costs which resulted in lower margins, as well as a $12m tax adjustment. With execution and order outlook looking weak once more, we cut our forecasts and downgrade Cosco to HOLD with the target price lowered to $1.80.
Our View
Sequentially, 2Q11 net profit was even lower than 1Q’s already weak quarter. Gross margins declined from 11.1% to 7.5%, indicating that the improvement in execution has derailed. This was exacerbated by higher costs across the board. The shipyard business saw repair margins drop to single digits. Repair margins have also been affected by price competition, while shipbuilding was most keenly hit by higher steel and labour costs. For offshore, margins shrank due to higher R&D costs in conjunction with a steeper learning curve for new vessel types which have led to cost overruns.
Bulk shipping was hurt by weaker rates, with the business just barely profitable. Finally, income tax rose by 74%, or a tax rate of 33%, above its normalised rate of between 16% and 20%. This is due to the one-off impact of a $12m deferred tax adjustment. This is expected to adjust back to the normal level for the full year.
Management sees the overall market as difficult, and Cosco may struggle to secure new shipbuilding orders. It is also unlikely to be significantly profitable yet for its offshore segment, given that it is a relatively new entrant with no competitive niche.
Action & Recommendation
We cut our FY11 and FY12 forecasts by 30% and 23%, respectively, on lower margins despite turnover remaining healthy on its US$7.0b orderbook. Our price target is lowered to $1.80 from $2.43, based on a PBR of 3.5x and FY12F PER of 18x. Downgrade to HOLD.
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