Yangzijiang - Staying on course

Yangzijiang Shipbuilding (YZJ) delivered record high NPAT of Rmb1.1bn (up 53.7%YoY) in H109 on revenue of Rmb4.6bn, up 32.4%YoY. Gross margin improved sequentially from 20.3% in Q1 to 24.4%% in Q2 due to falling raw material costs. Also, tight cost control yielded low operational expense at 2.1% of sales (6.9% in 2008).

The absence of new order inflow in H1 did not come as a surprise, and YZJ is focusing instead on securing the orderbook at hand. Its orderbook of 139 vessels worth US$6.1bn as at end-June will fill the production schedule till mid-2012, based on the current delivery schedule. Meanwhile, YZJ is also accommodating customers’ requests for late delivery of completed vessels and/or change in the vessel type.

As overcapacity for the shipping and shipbuilding industries is likely to worsen, we believe risks such as few new orders, order cancellation, and late payment etc will likely increase. Only established yards such as YZJ, with a track record in operation and financial strength, will survive the downturn, in our view.

We raise our 2009/10/11 EPS estimates by 11%/22%/27% from Rmb0.54/0.48/0.33 to Rmb0.59/0.57/0.46 on higher margin assumptions. We raise our target P/BV from 1.3x to 2.4x by applying a 30% premium (0% previously) over the regional peer average of 1.8x P/BV to reflect YZJ’s industry leading ROE. Our new price target of S$1.03 suggests 8.4x 2010E PE and 6.3x EV/EBITDA versus the peer average of 8.6x and 6.7x, respectively.

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Yangzijiang: Hardships building up

Yangzijiang’s FY08 earnings grew 82% yoy to RMB1.6bn on topline growth of 91% yoy. The bottomline fell short of our estimate by 5% due to provision of RMB200m. Although the Chinese government’s stimulus policy to support the shipbuilding sector should bring some light to the industry, the risks of order cancellation/delays and default risk amidst depressed freight rates and credit crunch remain high. We trim our estimates by 5% and 10% for FY09 and FY10 respectively, on account of higher order cancellation / delay and potential provisions. Maintain Fully Valued. TP reduced to S$0.32.

4Q08 gross margin shrunk by 10ppt qoq to 13% due to provisions of Rmb200m. In view of the deteriorating conditions for shipping industry, Yangzijiang increased its provision for potential cost variation to 8% of contract prices, from 0.5% previously. The cost variation is to account forunexpected additional cost such as doubtful debt, price discount to shipowners and cost over-run for projects under construction. The provision may be reverted upon completion of the projects if the actual total cost incurred is less than budgeted cost.

Cancellations/delays underway. Despite the Chinese government’s efforts to stimulate the shiipbuilding sector, the challenges of cancellation / delay and default risk amidst depressed freight rates and credit crunch will cap share price performance. Yangzijiang now expects to stretch its orderbook delivery over a longer period of 4.0 years, vs 3.5 years previously, as requests for order rescheduling are flowing in.

Maintain Fully Valued; TP reduced to S$0.32. We trim our estimates by 5% and 10% for FY09 and FY10 respectively, as we now expect order cancellation / delay of 25% vs 15% previously, as well as raise the provision levels in FY09-FY10. Our TP is reduced to S$0.32 based on 3x revised FY09 earnings. Although we like YZJ’s proven execution track record, we see downside risk to current share price in anticipation of negative newsflow hitting the industry. Maintain fully valued.