Cosco Corporation (S) Ltd-Sailing through rough waters (POEMS)

Hold (Maintained)

Closing Price S$1.025

Target Price S$0.91(-11.22%)

• We see slight improvement in operating conditions, particularly in shipping and steel costs.

• However, negative sentiments and weak fundamentals will likely cap further upside.

• Maintain Hold recommendation with a revised target price of $0.91.

2Q11 Results flashback

Cosco Corp reported 2Q11 PATMI of $32 mil. (-53.4 % Y-o-Y) respectively. PATMI fell sharply mainly due to 1) lower profits from dry bulk shipping 2) lower margins from marine engineering projects and 3) higher tax expenses due to deferred tax benefit adjustments. Since the release of 2Q11 results, Cosco’s share price has greatly underperformed the market.

Slight improvement in operating conditions

Cosco does not hedge the prices of its steel raw material costs with derivative contracts. As a result, it has incurred losses on construction contracts in the past few quarters as steel prices soared. However, we observed that steel prices have softened in the past few weeks due to concerns over the health of the global economy and fall in Chinese demand. This should provide some relief on cost pressures for Cosco.

Negative sentiments and weak fundamentals to cap further upside

Cosco’s disappointing results in 2Q11 has caused investors to become more wary of its ability to execute its record offshore orderbook profitably. In addition, it faces the danger of order cancellations for both its marine engineering and dry bulk ship building projects if macroeconomic conditions were to deteriorate further. We believe these factors will continue to overshadow any improvements in its operating conditions (lower steel prices, higher BDI) or future offshore wins, capping further upside for the stock.

Valuation:

We arrive at our revised target price of $0.91 after lowering our P/E assignment for Cosco to 14x FY12e EPS (from 15x previously) to reflect weaker sentiments in the shipbuilding sector. We also cut our EPS forecast for 2011e and 2012e to 7.2 cents and 6.6 cents respectively as we lower our expectations of future offshore order wins and margins for Cosco shipyard operations (stemming from poor execution and lower value of ship building contracts secured post-crisis). Maintain HOLD with revised target price of S$0.91.