STX Pan Ocean @ 86.5 cts ( Shipping / Korea ) 10 comments
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1.Pressure on bulk shipping rates
STX Pan Ocean is the top bulk shipper in South Korea, and one of the world's leading companies in this field as well. In terms of stability it can be considered a shipping blue chip.
That is really not saying much when we consider the cyclicality of the shipping industry. Top shippers like NOL went deep into the red in bad years like 2002, illustrating how badly hit shippers can be by deteriorating global trade and consequently low freight rates. Although global trade is booming now, the good days of surging freight and charter rates for shippers and shipowners in 2003-04 are over: massive numbers of new ships, on order at shipyards since 2003, are coming onstream starting 2006 and shipping rates are starting to soften significantly: just watch the BDI (Baltic Dry Index) collapse from >5500 in late 2004 to ~3000 now.
Any investor worth his salt would be aware of the above macro trend. The issue for them would be whether to take advantage of low share prices for shipping companies to buy in now, due to the fact that many shippers are trading at near their NTA and at very low trailing PE valuations now. NOL, for example, at $2.95 last traded is only slightly above its NTA of $2.80 and at only 3 X trailing PE. Similarly, STX is trading at only about 1.3X NTA and 5-6X trailing PE.
The question is, are these low valuations meaningful? I have long maintained that low PEs are hardly relevant for cyclicals, and this is no exception. NTA is a more effective price support, albeit psychologically: imagine if a stream of new ships are due to come online, will the shippers be able to liquidate their fixed assets (ie. existing ships) at suggested NTA value even if they wanted to?
What becomes more important during an inflationary economic phase, which is what I see the global business cycle trending towards, is whether a business has the pricing power to maintain margins, and/or the economies of scale to trim average operating costs while growing revenues. The former reason is definitely not applicable to shipping: inflation significantly raises prices of key inputs such as bunker fuel and capital (through interest rates), while the easing shipping capacity supply situation (due to new ships coming onstream) means revenue rates per ton transported are likely to drop or at best, stabilise. The latter reason may be a reason for buying into shipping blue chips like NOL and STX; both are big shipping operations with substantial negotiating power. Yet I would rather buy NOL than STX: the former is into container liners which have seen rates plateau rather than collapse, suggesting underlying strength, while the latter's main business is in dry bulk transport which constitutes about 80-90% of total revenue. This kind of one-trick pony situation is unhealthy and STX has been trying to diversify out into other forms of shipping (oil/LNG/container) and recently logistics (bought a freight forwarder) but that is going to take time and money. That Oct 2005 purchase of a mere 20% stake in the freight forwarder cost US$160M; as at end Sep 2005 STX's cash resources were US$184M --> it doesn't have much more expansion capital now. You know what a need for capital often leads to: either more debt (amid a rising interest rate environment), or more placements (dilution of existing shareholders).
As a matter of fact, I often also put a risk discount for new IPOs, because IPO year earnings often turn out to be the best. STX, by virtue of its size, is likely to be more stable and hence that discount may be less. But don't forget the country discount. I have mentioned it in a post in another blog: PE valuations in different countries. Korea's market PE is below 10 times, for several reasons: firstly, political risk, in the form of North Korea; secondly, financial risk, as has been revealed by the chaebol collapse during the 1997 Asian currency crisis (although nowadays the debt situation is better). Why do you think STX, Korea's biggest shipper, chose to list in Singapore? To get a better IPO price, that's why. (Incidentally, STX had to IPO at a low price of $0.90 in July, way below its target of $1.27, due to lack of demand) In the event that tensions flare again in the Korean peninsula, all bets are off for the downside, especially for companies like STX whose businesses are inextricably linked to trade. Somehow, I don't think such country risk is factored into small investors' thinking, yet it is as real as any other commonly-considered business fundamentals.
Buy this stock only if you hanker after the dividend payout, which I expect to be ~S$0.10 or so (based on annualised 1H05 profits and dividend policy of at least 30% earnings payout). Remember, though, that the company is likely to be quite tight-fisted given its simultaneous need for capital to expand. And be ready to hold long-term (perhaps until the next shipping cycle)?