Yangzijiang Research Report

by DBS GROUP (13 Aug)

MARGIN pressure more apparent: Yangzijiang's Q2 2008 net profit surged 132 per cent y-o-y to 338.2 million yuan (S$69.3 million) on 249 per cent higher sales, as margins disappointed. Gross margin fell 13.5 percentage points (ppt) y-o-y and 3.8 ppt q-o-q to 17.2 per cent, compared with our expectation of 20 per cent.

The negative impact of rising steel prices and the rising yuan against the US dollar has apparently hit Yangzijiang's gross margin earlier than expected, as it executed on projects that were secured in 2006 at much lower contract prices.

As a recap, while we have argued in earlier reports that margins for individual projects commencing April will be hit, the negative impact on the group's margins may only be more apparent in H2 2008.

Yangzijiang's gross margins should remain under pressure in H2 2008, as both steel prices and the currency continue to be significantly higher versus late Q4 2007. Indeed, we expect the prices for new steel plates supply for projects commencing in July 2008 to be about 10 per cent higher than those in Q2 2008.

But this could be mitigated by: contribution from two high-margin vessels with improved efficiency; the deployment of larger and higher-margin vessels, eg 92.5k bulkers; and the execution of better-priced contracts signed in 2007.

Still, we cut our gross margin assumptions for FY2008 and FY2009, and earnings estimates by 6 per cent and 10 per cent to 1.409 billion yuan and 1.701 billion yuan respectively.

While we believe Yangzijiang is pro-active in currency hedging and adopting margin enhancement measures, the execution of its record high order backlog remains a concern. Reduced TP based on a lower PE multiple of eight times (versus 14 times previously) on revised FY2009 forecast earnings.

This is in line with the de-rating of China-listed shipyards, where prices fell recently due to concerns of rising steel prices and currency, as well as order cancellations.

-Research Report by DBS GROUP (13 Aug)