Cosco Research Report

by JP Morgan (5 Aug)

Q2 2008 results in line: Cosco posted H1 2008 net profit of $213 million (+74 per cent y-o-y), driven largely by its strong order backlog of $7.4 billion. Q2 2008 profit after tax and minority interests (Patmi) was $129 million (+60 per cent y-o-y, +53 per cent q-o-q). However, management has not provided any profit breakdown for the three divisions.

Steel price concern remains: Cosco experienced about a 28 per cent increase in steel prices YTD. It secured the steel requirement for the 10 dry bulk carriers for FY2008 delivery and 20 of the 40 for FY2009 at about 6,200 yuan (S$1,246) per ton.

Cosco hopes to secure the remaining steel requirements for the next 20 dry bulk carriers for FY2009 at slightly below 7,000 yuan per ton, which will still surpass the extra 20 per cent steel price buffer.

Given the continued tight supply and cost push pressures facing steel mills, we do not expect prices to weaken substantially despite the recent global slowdown.

Changes to earnings estimate: As confirmed by management, current steel prices have eroded their 20 per cent built-in steel price increase buffer. Based on the steel price trend over the past 12 months and management guidance of 6,200 yuan per ton for its existing steel inventory and potentially 7,000 yuan per ton for H2 2009 requirements, the newbuilding net profit assumption is likely to be between 5.8 and 7 per cent.

We reduce our margin assumption for the dry bulk carriers from 10 per cent to 6 per cent, and hence decrease our Patmi estimates for FY2009 by 9 per cent and for FY2010 by 12 per cent.

The lack of earnings transparency adds another layer of uncertainty, given the lack of visibility already on steel price inputs. We also do not see any major price catalysts in terms of contract momentum, as management is taking a more cautious approach towards filling their orderbook, although the six options from Sevan are widely known.

Key risks to our price target include a decline in steel prices and a substantial acceleration in the orderbook.

-Research Report by JP Morgan (5 Aug)