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Tuesday, June 07, 2005

Cosco @ 1.89 ( Ship repair / China ) 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.High valuation for bulk shipping and ship repair operations, suggesting earnings has to catch up

2.Execution risk on offshore engineering business

3.Insider selling

Cosco has become the premier representative China stock on the SGX since the collapse of CAO, and its valuation has hardly been affected despite the fallout dragging many other PRC-linked stocks to single-digit historical PEs. Instead it is now trading at almost 17 times forward PE, and that is if we can believe GK Goh's (a vested party) forecast 2005 earnings in its latest report.

The story of Cosco these 2-3 years has been one of restructuring, where it has successfully consolidated its parent company's shipyard operations under its wing. In fact, according to its 1Q05 statement, revenue from ship repair now accounts for ~80% of total, with the balance coming from shipping. The market is buying into its past success in restructuring and hoping that its strong state-linked parentage might lead to further profitable acquisitions, and also that the China ship-repair market is seen as having strong future competitiveness and potential.

This is all very reasonable but look at the valuation. Consider the two parts of its operation separately in terms of PE. For bulk shipping, let's be generous and peg it to a heavyweight like Noble, trading at 7 times. Consider GK Goh's projection that 2005 earnings will comprise 35% shipping contribution and 65% ship repair, and also the abovementioned 17 times forward PE being traded for the entire group. This means that the ship repair operations are valued at 22 times forward PE! This is comparable to Sembcorp Marine which has a much larger revenue base, has an unbelievable order book and is a big player in the hot global offshore rig construction market. Anyway, Sembcorp Marine has been trading at about 15 times PE historically, and itself in my opinion is now at the upper end of its band.

Cosco's latest 1Q05 results also indicate earnings projections might be too frothy; 1Q net profit ex-extraordinary items is about S$24M, versus full-year projection of ~S$125M. Group current assets are actually lower than current liabilities. Add to this the fact that the shipping market is getting soft: Cosco Shipping recently forecast falling profits (reported in a BT article).

This means high hopes are being placed on Cosco's ship repair business, and perhaps also its offshore engineering business (but it just completed its FIRST FPSO repair/conversion!). Are these hopes excessive given the share price? I'm certainly not putting my money either way.

By the way, the insiders (Cosco directors) have been selling recently. Check the SGX website before it is too late (now these share transaction annoucements are cleared away in 1-2 months' time).

(1) GK Goh's latest analyst report




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