Time to Buy Beaten Down Korean Shipbuilding Companies?


When you’ve hit rock bottom, the only way is up.

The proverb could be aptly applied to the sunken shares of Korean shipbuilding companies, argues Nomura Jaehyung Choi.

We have been bearish on Korean shipbuilders since June 2014, mainly owing to: 1) extremely weak new order momentum amid falling oil prices; 2) large amounts of provisioning due to oil majors delaying / cancelling offshore projects; and 3) the ongoing restructuring process. However, we believe that all the negatives (potential delays / cancellations, book value reduction) are already priced into the shares, and we expect 2017F could be an inflection point in terms of new orders / backlog quality / ship prices / ROE improvement.

Choi notes the restructuring of Korean shipbuilding companies is proceeding well.

Some investors have concerns that Korean shipbuilders might lose current market leadership due to severe restructuring, similar to what happened to the Japanese yards in the 1980s. However, we believe the Korean shipbuilders’ restructuring strategies are correct, as they: 1) cut capacity (consolidation) / labour costs following a fall in revenue; and 2) are awaiting a market recovery, focusing on high-end vessels rather than surrendering business opportunities or diversifying their portfolios, as Japanese yards did in the 1980s.

New orders are also showing signs of a recovery, while ship prices are expected to moderately improve as tough new environmental rules are implemented on sulphur oxide (SOx) and ballast water treatment systems (BWTS), and as break-even prices (BEP) on offshore oil projects fall:

We see signs of a recovery in new orders, given: 1) a better supply-demand balance for all ship types; 2) environmental regulations (on SOx, BWTS and CO2) and a hike in steel plate prices could generate new demand; 3) there is a chance of speculative demand as prices for ship types are at historical lows (similar to the 2013 cycle); 4) stabilised oil prices at around USD40~50/bbl could see offshore orders resume, as the BEP for global oil majors’ deepwater projects falls to USD40-50/bbl; and 5) Korean shipbuilders have a competitive edge compared to other global yards for high-end vessels including LNGCs, VLCCs, and offshore, which are in the 2017F/18F pipeline.

Since ship prices peaked in 2014, they have fallen sequentially amid reduced backlogs for all ship types and shipowners’ increased bargaining power over shipbuilders. Catalysts for a rebound include: 1) steel price hikes; 2) environment regulations; and 3) rising backlogs.

Choi has upgraded Samsung Heavy Industries (010140.KR) from reduce to buy and Hyundai Heavy Industries (009540.KR) from neutral to buy. The two stocks are Choi’s top picks among Korean shipbuilders given their strong balance sheets and cash flows, as well as brisk new order growth.

Choi has a KRW16,500 a share target price on Samsung Heavy Industries, which implies 33% upside, and a KRW220,000 a share target price on Hyundai Heavy Industries, which implies 28% upside. Samsung Heavy Industries trades at 0.7 times book value, while Hyundai Heavy Industries trades at one times book value.

Source: Barron’s

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