Yangzijiang Shipbuilding (KimEng)

Event

Yangzijiang Shipbuilding (YZJ) saw its share price retreating by more than 6% this week after its peer, Cosco Corp, dropped a bombshell on investors when it announced much weaker-than-expected 2Q11 results. With Chinese shipbuilders facing lingering headwinds amid uncertain outlook in the bulk/containership market, YZJ is our preferred pick in the sector for its execution track record, cost leadership and undemanding valuation. Reiterate BUY.

Our View

YZJ is confident of achieving at least 30% YoY growth for 1H11 (results to be released on 11 August) in view of the timely delivery of its vessels. This puts it on track to meet our full-year earnings forecast. Nevertheless, it would imply earnings growth of just 6% YoY in 2Q11 (or net profit of RMB850m) given that the group has already reported a 62.8% increase in 1Q11.

Cosco was hit hard by rising steel and labour costs, particularly with regard to its shipbuilding division. This was exacerbated by other macro uncertainties such as the appreciating renminbi against the US dollar and rising interest rates in China. We do not think YZJ will be immune to this predicament even though it is acknowledged as one of the more efficient shipyards in China.

Having said that, we reckon YZJ should be able to keep its gross margins steady at around 23% in FY11 (compared to 22.5% a year ago) as it continues to recognise high-margin orders secured prior to the global financial crisis. In line with management’s guidance, we have also assumed lower margins going forward. We estimate that a 100bps decline in margin would cause net profit to contract by about 4.4%.

Action & Recommendation

Despite being a leading shipyard in China, YZJ’s stock currently trades at a steep discount of over 30% to its domestic peers. We believe its controversial RMB10b investment in financial assets is weighing on the share price. We are switching to the SOTP valuation methodology to better reflect the group’s dual earnings stream. We maintain our BUY recommendation but with the target price lowered to $1.80.