Marine Sector Research Report

by DBS Group Research (25 June)

IRON cost pressure: The newswire reported that BHP Bilton and Rio Tinto and the Chinese steelmakers have settled on an annual price increase of 85-96 per cent for iron ores from Australia, confirming earlier rumours on similar magnitude of increase as Australian miners demand for a freight premium over iron ores from Brazil.

This two to three-month delay in settlement of annual price increase for Australian iron ores is significantly higher than the earlier 65-71 per cent price increase for Brazilian iron ores. This will inevitably drive up the cost structure for steel mills, and assert further pressure on newbuild prices for bulkers and containerships, given the higher cost structure.

China's surging appetite for iron-ore price has resulted in an annual price increase since 2004: 18.6 per cent y-o-y in 2004, 71.5 per cent in 2005, 19.0 per cent in 2006, 9.5 per cent in 2007, and 65-96 per cent in 2008, according to data from China Daily and DBS Vickers.

We reiterate our view that the Chinese yards have yet to feel the full impact of annual increase in prices for coking coal and iron ore YTD, as the usual time-lag in cost passed on by steel mills has been lengthened due to the government's clampdown on inflationary pressure in the economy and the expected strong resistance from customers to absorb a single sharp increase in steel prices.

Still, we believe that the Singapore Exchange-listed Chinese shipyards cannot avoid the inevitable but lagged steel price increase, and they will need to grapple with expected margin pressure on their 4-5 year backlog for orders that were secured at lower newbuild prices in 2006-07.

In our opinion, the negative effect of higher steel prices will set in for projects that start work after April 2008, after factoring in the lagged effect in steel price increase to customers, and taking into account the announced steel price increase YTD.

We recommend investors to switch or stay with Singapore-based yards, which are exposed to the still-positive offshore sector and face lesser cost pressure. Our picks include Sembcorp Marine, ASL Marine, and Jaya Holdings.

-Research Report by DBS Group Research (25 June)