Investing in Shipbuilding: Should You Haul Wind, or Heave Down?
—-Stock Watch: A Deep Dive into Yangzijiang Shipping—-
The investment graveyard is filled with investors aiming to take a stab at the shipping industry: a close second dare I say to the airline industry which has similar economic characteristics – large initial capital requirements, high fixed, and variable costs and only slight distinguishable services and features between the industry players. But don’t be confused by the name, Yanzijiang’s core business is in the shipbuilding space (along with trade logistics, ship leasing and real estate as supplementary businesses). While it would have been an investor’s dream if in the ship manufacturing space a duopoly similar to the airline industry existed, I do feel there are a number of factors present currently that will lead this to provide adequate returns commensurate with risk for an investor.
Established in 1956 and listed on SGX (The Singapore Stock Exchange) since April 2007, Yangzijiang has seen explosive growth in the last decade culminating in the ability to possess an annual shipbuilding capacity of 6 million dead weight tonnes (DWT). It has climbed up the value chain of shipbuilding during this time too, providing its customers increasingly cost yet energy efficient ships, including the likes of 25 units of 10,000 TEU containerships (to Seaspan, the world leader in containership ownership and management) and a 400,000 DWT Very Large Ore Carrier – the largest in the world. Always thinking ahead, in September 2018, the company also entered into a 51:49 joint venture (“JV”) to build LNG carriers with Mitsui conglomerate – a substantially more complex piece of equipment with higher margins. This is reflected in the healthy improvement of financial metrics of the business showcasing a robust recovery since the GFC.
Of course, investors are not rewarded for how the company has performed in the past but what lies ahead in its future and that is where we need to take out our crystal ball. Firstly, given the volatile and cyclical nature of the sector it is in, given the long lead time required to deliver a ship, the order book number is ever important.
It currently has a substantial order book (#1 in China and #5 in the world) to adequately protect itself from any economic slowdown – USD$ 3.1 billion which will keep their shipyards running at full speed for at least the next 1.5 years.
While the numbers seem to be on a bit of a downtrend, it does not include some new orders announced since end June and management has clearly indicated the pipeline of getting confirmed orders is quite strong too – to the order of closing USD 1.5-2 bln by the end of the year.
Given the over supply of ships thereby leading to a crash in charter rates (ergo their stock prices) in the recent past, the entire industry across the supply chain vertical is undergoing some much-needed consolidation. A more measured approach by all the industry players should lead to evenly spread profits all around.
In addition, on the back of the company’s JV with Mitsui, and the rapidly growing LNG market, I do expect to see more orders of LNG vessels coming in due course. The company is being pro-active and expanding into the clean energy space and has additionally acquired a 55% stake in Odfjell Terminal (Jiangyin) (OTJ) from Norwegian tanker shipping company Odfjell.
Single digit margins on the more standardized containerships will also give way to double digit margins in the more complex machinery involved in LNG vessels too providing an additional boost to profitability.
Given its robust balance sheet (gross gearing of 17%) and cash on hand (CNY 4.1 Bln) as of end 2018, in addition to making strategic investments as highlighted above, Yangzijiang is taking advantage of the prior excess capacity in the shipyards space purchasing half complete ships from now defunct yards, completing them and selling them at a substantial profit in a short duration of time.
So, why now?
I will try to break down 2 catalysts I believe that will be strong tailwinds for the company’s stock price:
1. In Mid August the share price dove nearly 50% due to the news that Mr Ren (Chairman and controlling stakeholder with a nearly 21% ownership stake) was ‘assisting in a confidential investigation carried out by certain PRC governmental authorities.’ An investor familiar with HK/China stocks knows that it is an inherent risk and could be a code word for the said individual being investigated themselves.
But in the case of Yangzijiang, the Board came out stating that the former is indeed the case, and that the authorities – Beijings central commission discipline inspection (CCDI) are looking into the dealings of Mr Liu – a veteran of the shipbuilding industry in China. Mr Ren is not the subject matter of the investigation nor have any other directors been roped in to assist the investigation. The company has been aggressively buying back shares in the open market via their authorized buy back program to the amount of 25 million shares.
That being said, there are common dealings between Mr Ren and Mr Liu – the latter is chairing the chairing foundation that the former has setup that is solely funded by the dividends receiving from his 21% ownership in Yangzijiang’s shares. In addition, a number of the company’s yards are physically situated in the provinces that Mr Liu used to oversee.
2. IMO2020 – ask any person in the shipping industry and they will say this is the biggest game changer that will affect the industry come Jan 1, 2020 that they have seen over the last decade maybe even two. International Maritime Organisation (IMO) will implement a new regulation for a 0.50% global sulphur cap for marine fuels. Under the new global cap, ships will have to use marine fuels with a sulphur content of no more than 0.50% against the current limit of 3.50% in an effort to reduce the amount of sulphur oxide. This is leading to a revamp of supply chains across the spectrum on how to get the correct fuel at bunkering stations from refineries or retrofitting ships with Scrubbers (open loop/closed loop) to ‘clean’ the fuel.
For the purposes of this piece, the effect on shipyards is 2-fold: older ships (over 17-18 years of age) will be scrapped rather than taking on additional capital investment of installing scrubbers on them, leading to higher charter rates and hence capital coming back into the industry. In addition, shipyards receive a short-term boost to the topline as they are fully booked this and the next year to install scrubbers on the newer ships.
Currently trading at 95 SGD cents, yields a market capitalization of 3.8 billion SGD which equates to a P/B ratio of .64, P/E of 5.1, and an attractive dividend yield of just over 5% (payout ratio of under 30%) – I believe there is an adequate margin of safety.
In conclusion, while the overall shipping industry, including shipyards is a very volatile industry, as Howard Marks says, it is important to understand the cycles. After a very long lull in this sector the tide seems to be turning, sorry for the pun, and given the strong order book coupled with recent headline news of the company’s chairman being pulled in for an investigation, this provides a very opportune time to invest in Yangzijiang.
Full Disclosure: Had previously acquired shares at 90 cents mid-2018 and sold them at 1.40 start of 2019. Currently hold a position with average purchase at SGD 90 cents and looking to add to the position further.
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