Yangzijiang Shipbuilding - Banker in sailor’s suit (CIMB)

There is a difference between building ships and making loans. We believe YZJ should focus on its core shipbuilding expertise. Its micro-financing business and large exposure to financial assets have investors worried right now.

We keep our Underperform rating despite assurance from the company regarding its investments in micro-financing/financial assets and profit guidance.

What happened

Following a series of corporate failures in Wenzhou, YZJ issued a statement this morning to reassure investors that it is not affected by and does not foresee any negative impact on its financial performance from its micro-financing investments. YZJ has two micro-financing investments: Jiangsu Runyuan (51% stake) and Wuxi Runyuan (31.5% stake).

Concerning these investments, we note that first, they are small and account for less than 3% of its NTA. Second, these short-term loans (repayable within a year) have been extended to rural, small-to-mid technology enterprises and individuals. Third, interest rates charged are within the Chinese banking system’s authorised bands. Finally, provisions have been made for such investments for unforeseeable losses, although no indications of bad debts as of now.

YZJ also added that investments in financial assets, held to maturity, are secured against collaterals with debt coverage at less than 2x. There has been no default on such investments since 2008.

Business is normal for its core shipbuilding operations and YZJ is on schedule deliver 65 vessels in FY11. It is also confident of earnings growth of not less than 30% in its 9M11 results (9 Nov).

What we think

The micro-financing business is small at about 2% of YZJ’s 2Q11 earnings. We are more worried about its Rmb10bn investments in financial assets, as their magnitude dilutes the quality of its core shipbuilding earnings. Interest income from these investments accounted for 35% of its 2Q11 net profit.

What you should do

We believe investors are better off investing in pure shipbuilders or banks, rather than a hybrid business like YZJ’s.