Thursday, January 17, 2008
Anniversary Look at the Shipping Companies - part ii
COSCO (1919)
COSCO has transformed into a dry bulk shipper. Its old business of container shipping and port operation (via COSCO Pacific) now contributes maybe only 15% to the bottom line. A better benchmark for comparison is China Shipping Development (1138).
Business wise the two differ slightly. CSD has 2/3 of its turnover from shipping crude oil and 1/3 from dry bulk (mostly coal). Its routes are 60% domestic and 40% international. COSCO on the other hand ships mostly iron ore (40%), coal (30%), and grain (10%) from overseas to China. COSCO's parent operates an oil tanker fleet which has yet to be injected into COSCO.
Oil and dry bulk shipping is more defensive than container shipping as China demand for resources is much more robust than consumer demand of the US and Europe whose economies are slowing down. Specifically all the infrastructure China has to build in the next few years will require a lot of steel and hence iron ore. Coal is mother of all energy and China doesn't have enough either and has become a net importer. Grain shortage is fast becoming a problem as well and so demand should also grow strong. Oil requires no explanation and so much for the broad picture.
CSD is trading at 15x 07 earnings (25x 06 earnings). I've included 06 p/e as well because looking at the freight index it seems 07 is an extraordinary year and no one is quite sure performance like that can be repeated. The index has dropped by more than 30% since peaking last October. Actually if you look at the movement of the Baltic dry index over the last few years, then the recent rise and fall of HSI is really nothing in comparison.
COSCO is trading at a lower 9x 07 proforma earnings. Apparently the market perceives demand for oil tankers will be stable even under economic downturn, and that CSD's less international exposure is safer. But a large premium in share price has done away much of the attraction so I'll pass. I also remember CSD once (I think in 2005) was trading at only 5x historical p/e and many researchers (including Quam) were suggesting a sell. Of course they were then embarrassed but my point is market can be very wrong, far more than you can imagine and you may not survive the interim loss.
COSCO's dry bulk fleet had earnings of more or less $6-8b in 2004-06. Then 2007 interim earnings shot up by nearly 100% to $6b and management last estimated only 2 days ago full year proforma earnings to be well over $18b (incl. container shipping and port operation). I assume non-dry-bulk business to contributed about $3-4b and hence dry bulk business should earn about $14b or more last year, as it's hard say what "well over" really means and I don't know if there's any non-recurring items.
Looking forward, what earnings should I use? 7b or 14b or somewhere in between? This gives a total group earnings ranging from $10b to $18b, or p/e of 8.6-15.5x against a capitalization of ~$155b. If I cut it in the middle then p/e is about 12x, still considerably cheaper than CSD historical p/e of 15x.
One concern is the age of the fleet as I read from the acquisition that dry bulk fleet worldwide is quite old due to lack of investment in the past and many ships are near retirement age. These ships are only hanging there because demand is so strong. If you look at this positively, then if demand does slow down these ships can retire and won't drag down earnings of everyone as much. If you look at this negatively, then replacement ships will carry much higher current cost and depreciation charge.
For COSCO, it owns ships for 40% of its capacity while charters for the remaining 60%. It seems a safe position to me, neither too aggressive nor conservative. If things turn really bad COSCO can always charter fewer ships.
I think the current price is tempting for speculation but only fair for investment.
Note: On a more difficult note, since merger accounting was used to account for the dry bulk fleet acquisition, there's no mark up of asset value and depreciation going forward will definitely be understated. So the p/e should be adjusted higher.
DISCLOSURE: I hold 316 and no 1919 at time of writing.
COSCO has transformed into a dry bulk shipper. Its old business of container shipping and port operation (via COSCO Pacific) now contributes maybe only 15% to the bottom line. A better benchmark for comparison is China Shipping Development (1138).
Business wise the two differ slightly. CSD has 2/3 of its turnover from shipping crude oil and 1/3 from dry bulk (mostly coal). Its routes are 60% domestic and 40% international. COSCO on the other hand ships mostly iron ore (40%), coal (30%), and grain (10%) from overseas to China. COSCO's parent operates an oil tanker fleet which has yet to be injected into COSCO.
Oil and dry bulk shipping is more defensive than container shipping as China demand for resources is much more robust than consumer demand of the US and Europe whose economies are slowing down. Specifically all the infrastructure China has to build in the next few years will require a lot of steel and hence iron ore. Coal is mother of all energy and China doesn't have enough either and has become a net importer. Grain shortage is fast becoming a problem as well and so demand should also grow strong. Oil requires no explanation and so much for the broad picture.
CSD is trading at 15x 07 earnings (25x 06 earnings). I've included 06 p/e as well because looking at the freight index it seems 07 is an extraordinary year and no one is quite sure performance like that can be repeated. The index has dropped by more than 30% since peaking last October. Actually if you look at the movement of the Baltic dry index over the last few years, then the recent rise and fall of HSI is really nothing in comparison.
COSCO is trading at a lower 9x 07 proforma earnings. Apparently the market perceives demand for oil tankers will be stable even under economic downturn, and that CSD's less international exposure is safer. But a large premium in share price has done away much of the attraction so I'll pass. I also remember CSD once (I think in 2005) was trading at only 5x historical p/e and many researchers (including Quam) were suggesting a sell. Of course they were then embarrassed but my point is market can be very wrong, far more than you can imagine and you may not survive the interim loss.
COSCO's dry bulk fleet had earnings of more or less $6-8b in 2004-06. Then 2007 interim earnings shot up by nearly 100% to $6b and management last estimated only 2 days ago full year proforma earnings to be well over $18b (incl. container shipping and port operation). I assume non-dry-bulk business to contributed about $3-4b and hence dry bulk business should earn about $14b or more last year, as it's hard say what "well over" really means and I don't know if there's any non-recurring items.
Looking forward, what earnings should I use? 7b or 14b or somewhere in between? This gives a total group earnings ranging from $10b to $18b, or p/e of 8.6-15.5x against a capitalization of ~$155b. If I cut it in the middle then p/e is about 12x, still considerably cheaper than CSD historical p/e of 15x.
One concern is the age of the fleet as I read from the acquisition that dry bulk fleet worldwide is quite old due to lack of investment in the past and many ships are near retirement age. These ships are only hanging there because demand is so strong. If you look at this positively, then if demand does slow down these ships can retire and won't drag down earnings of everyone as much. If you look at this negatively, then replacement ships will carry much higher current cost and depreciation charge.
For COSCO, it owns ships for 40% of its capacity while charters for the remaining 60%. It seems a safe position to me, neither too aggressive nor conservative. If things turn really bad COSCO can always charter fewer ships.
I think the current price is tempting for speculation but only fair for investment.
Note: On a more difficult note, since merger accounting was used to account for the dry bulk fleet acquisition, there's no mark up of asset value and depreciation going forward will definitely be understated. So the p/e should be adjusted higher.
DISCLOSURE: I hold 316 and no 1919 at time of writing.
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