Cosco Corporation Ltd: Offshore is the key

- Excluding provisions, net profit was in line.
- Shipbuilding margin held up well at 10%; offshore income rose 113% y-o-y, set on growth trend.
- A flurry of offshore contracts underway, raising the bar for Cosco.
- Maintain BUY; TP adjusted lower to S$2.86 as FY11-12F EPS revised down by 13-15%.

1Q11 results affected by provisions. 1Q11reported net earnings of S$37m (+17% y-o-y) came in below ours (S$60m) and market expectations; the variance caused by a S$20m provision for lower priced – lower margin shipbuilding contracts in anticipation of higher-than-expected steel and equipment cost, and forex. Shipping fared worse than expected; revenue halved to S$17m as average charter rates fell to US$15.5k per day vs US$28k per day in 1Q10. In addition, minority interest was higher than expected on higher contributions from Qidong, a new yard in which the group holds only a 50% stake.

Look beyond the 1Q's bottomline. Core operating statistics were actually in line; gross margin for shipbuilding held up well at 10%(including provisions) with efficiency improvements offsetting rising production costs, and offshore is gaining traction as revenue doubled y-o-y. We expect net profit to rebound in the coming quarters as 1Q is the seasonally weakest quarter and earnings tend to be lumpy, swung by deliveries, provisions/impairments and reversal of provisions/impairments. 1Q1 1 accounted for 12.5% of our forecasts vs 12.9% (1Q10) for 2010.

Offshore contracts lining up. Firm contracts for Sevan's two cylindrical rigs worth US$1.05bn will be inked soon with Sevan Drilling's successful listing on 3rd May. In addition, Cosco is reportedly close to securing two jackups (US$350m) from KS Energy. Besides, it is likely to win 2 FPSO contracts from Sevan and topside jobs from existing customers. These almost-in-the-bag orders should bring Cosco's order wins to US$3.0bn, beating our expectation of US2.5bn.

Offshore provides the sparkle! Disappointing results could lead to near term weakness on the stock, but we maintain our optimism on Cosco's long-term outlook, where it is emerging as a leading offshore yard in China, supported by expansion in existing yards and potential parental injection. Offshore contribution will grow, currently accounting for 35% of its gross order book of US$5.9b. Maintain BUY. Our TP is revised down to S$2.86 with 15%/13% cut in FY11/12F earnings to account for lower 1Q11 performance, lower shipping profits and higher MI.

Source