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China Shipping Development (1138 HK) Summary

Core Content

China Shipping Development (1138 HK) has shown a significant recovery in its financial performance for the first half of 2014 (1H14). The company reported a net profit of CNY39.4 million, which is a sharp turnaround from a CNY922.7 million loss in 1H13. This improvement is attributed to better cost control, increased revenue, and the impact of seasonal demand.

The share price has increased by 25.8% over the past three months, with a target price of HKD6.75, representing a 24% increase from the current price of HKD5.46. The company's market capitalization is currently at HKD18.6 billion, with a free float of 53.6% and issued shares of 3,405 million.

Key Highlights

• Profit Recovery:

  • 1H14 net profit was CNY39.4m, ahead of the consensus forecast of a CNY7m loss.
  • Excluding the loss from vessel demolitions, the company achieved a net profit of CNY139m, driven by a 20.3% revenue increase and only a 0.6% cost increase.
  • The gross margin expanded by 17.1 percentage points (ppt) to 13.0%, the highest since 1Q11.

• Operational Improvements:

  • Overall traffic grew by 29.2% to 260.8 billion tonne-nautical miles, but average freight rates dropped by 6.9%.
  • Fuel efficiency improved, leading to a 5% drop in total fuel expenses.
  • The company recognized a gain of CNY24.2m from the waiver of other payables.

• Cost Management:

  • Cost of service increased only 0.6% YoY, and SG&A costs rose by 6.9%.
  • Other operating costs, such as port, sea crew, and lubricants, decreased YoY, showcasing strong cost discipline.

• Earnings Outlook:

  • The company expects 2H14 earnings to improve, particularly in 4Q14, due to the seasonal peak.
  • Management remains optimistic about FY14 earnings, with a guidance that it will remain profitable for 9M14.
  • The company raised its FY14-16 earnings forecasts by 13.3%, 8.9%, and 7.8%, respectively, to incorporate margin improvements and the contribution from the acquisition of Shanghai Beihai Shipping (SBH).

• Acquisition and Subsidies:

  • CSD acquired a 40% stake in SBH, which contributed CNY114.2m in 1H14.
  • Potential government subsidies from vessel scrapping are expected to further boost 2H14 earnings.

• Capital Structure and Financial Metrics:

  • Net debt/equity ratio is forecasted to remain high at 177.9% for FY14, but is expected to decline to 154% in FY16 as profitability improves.
  • Free cash flow is expected to increase significantly in FY15 and FY16, with a forecast of CNY1,163.8m and CNY3,213.5m, respectively.

Key Drivers of Earnings Growth

• Revenue Growth:
  • Oil shipment increased by 6.7%, iron ore shipment by 35.4%, and other dry bulk shipment by 226.4%.
• Cost Control:
  • Fuel, port, and wage costs declined YoY, contributing to the gross margin improvement.
• SBH Contribution:
  • The acquisition of SBH is expected to add to the company's profit in 2H14.
• LNG Shipping:
  • A long-term positive factor, with the company ordering three additional LNG vessels in July and exploring entry into LNG feeder services in China.

Valuation and Investment View

• P/B Ratio:
  • The current P/B ratio for FY14F is 0.68x, which is undemanding compared to a five-year average of 0.92x.
• Target Price:
  • The target price is HKD6.75, based on an unchanged 12-month forward P/B multiple of 0.8x.
• Investment Recommendation:
  • The analyst reiterates a BUY recommendation, citing strong earnings recovery and growth potential.

Outlook for FY15 and Beyond

• Earnings Growth:
  • The company expects a 384% growth in core earnings for FY15, driven by better margin performance and the contribution from SBH.
• LNG Shipping:
  • LNG transportation is expected to become a new medium-term earnings driver starting in FY16.
• Gearing:
  • Gearing is forecast to peak in FY14 at 177.9% but decline to 154% in FY16 as the company improves profitability and reduces capex.

Key Financial Metrics

Summary of Key Points

• Profit Recovery: 1H14 net profit improved significantly from 1H13, with a net profit of CNY39.4m.
• Gross Margin Expansion: Gross margin increased by 17.1ppt to 13.0%, with all segments except domestic iron ore transportation showing improvement.
• Cost Management: The company maintained cost control, with a minimal increase in service costs and a significant drop in fuel expenses.
• SBH Acquisition: The acquisition of SBH is expected to add to the company's earnings in 2H14.
• LNG Shipping: A long-term growth driver with the company ordering more LNG vessels and exploring new markets.
• Target Price: HKD6.75, with a 24% increase from the previous target.
• Investment View: BUY recommendation is reiterated due to the improved financial performance and growth potential.