Cosco - Outlook still murky

No surprises. Cosco’s full year results did not present with any surprises, as management had earlier guided in December 2008 that profit for the year would be lower than FY07. Revenue for the year increased 53.7% yoy to S$3,476m. Full year earnings fell 12.3% yoy to S$302.6m. The profit guidance announcement issued earlier had also stated that lower profits would have been due to provisions made for doubtful debts and higher costs relating to shipbuilding and offshore marine contracts. Provisions for doubtful debts and expected losses, and inventory write downs amounted to S$171.2m, in aggregate. First and final dividend of S$0.04/sh, and special dividend of S$0.03/sh was proposed, bringing total dividend to S$0.07/sh.

Margins hit by higher operating costs and large provisions. The impact of steel prices on profitability was stark in FY08, as it was reflected in the severe margin deterioration. Gross margin fell from 27.0% in FY07 to 18.1% in FY08. EBIT margin took an even larger hit, falling from 22.5% in FY07 to 13.2% in FY08, due largely to the aforesaid provisions and write-downs. As the Company had previously amassed steel on the expectation of further escalating prices, it has, in the last quarter, written down its stockpile to calendar-year-end prices. As such, we believe that FY09 should see an improvement in margins.

Dry bulk shipping contracts will expire in 2009. Of its fleet of 12 bulk carriers, three are currently on spot charter, while the rest will see contracts expire in 2009 – four in 1H09 and five in 2H09. Renegotiations and contract terms for the nine will be dependent on prevailing rates, and vessels will be put on spot charter if prevailing rates are unfavorable.

Outlook for FY09 still murky. Though we believe that Cosco is improving on its execution, the supply of new vessels to come into the market and rapidity of demand deterioration, coupled with a continuing lackluster macro outlook augments an already challenging operating environment for Cosco. Lack of clarity in information dissemination is also a point of concern for us, as we are unable to decipher the viability and profitability of existing contracts. We keep our HOLD call and target price of S$0.67.

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