20161206-三星证券-The_worst_has_passed_39页_1mb

Sector Update Summary: Shipbuilding (OVERWEIGHT)

Core Content

This report provides an analysis of the Korean shipbuilding sector, highlighting the positive outlook for 2017 despite the challenges faced in 2016. The sector is upgraded from NEUTRAL to OVERWEIGHT, based on the belief that the worst is behind and that recovery is on the horizon. The report focuses on three major players: Hyundai Heavy Industries (HHI), Hyundai Mipo Dockyard (HMD), and Samsung Heavy Industries (SHI), with specific target prices and performance expectations.

Main Points

1. Positive Outlook for Shipbuilding Sector in 2017

• Korean shipbuilding stocks have rallied 63% this year.
• Concerns about oil prices and declining sales are considered unfounded.
• Shipbuilders are expected to outperform the market in 2017.
• HHI is highlighted as the most positive due to its large market share (64% of the sector's market cap) and its potential to benefit from industry restructuring and momentum from spinoffs and listings of non-shipbuilding units.

2. Oil Prices Stabilizing

• Oil prices have rebounded 89% since their February 2016 lows, reaching USD49/bbl.
• Prices are less volatile than before, which is favorable for both oil majors and shipbuilders.
• OPEC's decision to cut output signals a shift in policy and suggests prices will not fall below USD30/bbl in the long term.
• The breakeven price for offshore projects has dropped to USD55/bbl, making them more viable as prices stabilize.

3. Demand for Offshore Structures to Rebound

• Offshore structure orders have been absent for over a year and a half due to price uncertainty.
• With oil prices rebounding, demand for offshore structures is expected to increase.
• Korean shipbuilders are likely to benefit from this as they are the world leaders in offshore construction.
• The market's expectations are at rock bottom, and even one or two offshore orders could trigger a rally in shipbuilding shares.

4. Industry Restructuring and Capacity Reduction

• Korea is more responsible for global overcapacity than China and Japan.
• The big three (HHI, SHI, DSME) are restructuring by reducing fixed costs, cutting workforce, and selling non-core assets.
• Workforce reductions are expected to be significant, with HHI, SHI, and DSME reducing their staff by 1,500, 1,392, and 3,000 respectively in 2015-2016.
• These cuts are seen as reductions in construction capacity, as skilled labor is crucial for production.

5. Financial Challenges and Recovery Prospects

• Shipbuilders are expected to see a 30% revenue drop in 2017 due to weak orders.
• However, with stabilized oil prices and industry restructuring, the financial outlook is improving.
• Oil majors are expected to recover profits in 2017, which will support the demand for offshore structures and shipbuilding.

6. Investment Strategy: Buy on Weakness

• The report recommends buying shipbuilding stocks on weakness, as valuations are at historical lows.
• The recovery in demand and prices, combined with restructuring efforts, should lead to improved performance in 2017-2018.

Key Information

• HHI: Target price KRW190,000 (26.7% upside)
• HMD: Target price KRW78,000 (22.6% upside)
• SHI: Target price KRW10,000 (13.8% upside)
• Order Backlog: Expected to contribute significantly to 2017 sales, with some projects unlikely to contribute due to delivery timelines.
• Workforce Reductions: HHI, SHI, and DSME have all implemented early retirement and salary cuts, reducing their workforce by 17.5% from 2014 levels.
• Global Vessel Construction Capacity: Expected to fall 40% from its previous peak by 2017.
• Oil Price Forecasts: EIA and Bloomberg predict a 16.5% to 21.3% increase in 2017 oil prices, with less volatility expected.
• Offshore Market Recovery: Expected to normalize in 2017 as oil majors regain confidence in long-term prices.

Conclusion

The Korean shipbuilding sector is poised for recovery in 2017, driven by stabilizing oil prices, reduced global overcapacity, and industry restructuring. The report recommends upgrading the sector to OVERWEIGHT and buying on weakness as valuations are at historical lows. The big three shipbuilders are expected to benefit significantly from the anticipated rebound in offshore structure orders and improved financial conditions.