Shipbuilding (NEUTRAL):Shares to keep climbing?
Shipbuilding shares rebound, but further upside limited: Shares in domesticshipbuilders have leapt an average of 16% over the past two weeks, driven by: 1)anticipation of oil prices rebounding thanks to a delay to interest rate hikes in the US; 2)the likelihood of won depreciation benefitting earnings over the long term; and 3) bottomfishing following a period of prolonged share-price weakness. Investors are keen to knowwhether shares will keep rising. We do not believe they will.
Oil prices not high enough to stimulate offshore orders: Despite oil priceshaving rebounded 16% from an Aug 26 bottom, they are not yet high enough to stimulateoffshore orders. Indeed, oil prices are currently just 47% of the level they averaged over2011-2014, a period when oil firms were highly active in placing offshore structure orders.Also, international forecasting institutions (such as the EIA and global investment banks)have been cutting their oil price outlooks. In the drilling rig segment (which is the mostsensitive to oil prices among offshore structures), deliveries are still being delayed andorders cancelled. Meanwhile, new orders at major shipbuilders remain weak mainly dueto a dearth of offshore orders.
Won depreciation benefits to be negated by decline in shipbuilding prices:Currency depreciation implies that current orders (which determine future earnings) willbe more profitable, as won weakness should translate into higher shipbuilding prices forKorean shipbuilders. Indeed, while the global shipbuilding index has slipped 3.6% overthe past year, won-denominated shipbuilding prices have risen 10%. Nevertheless,investors can only expected won depreciation to lead to margin improvement if US dollardenominatedshipbuilding prices remain unchanged. Korean and Chinese players build69% of the world’s vessels, but shipbuilders in the two nations have seen their orderbacklogs thin considerably, leaving ship owners with stronger bargaining power. Thus, webelieve that depreciation of the won and yuan will eventually lead to a decline in USdollar-denominated shipbuilding prices.
Valuation: Although shipbuilders are trading at just 0.56x forward P/B, they did sufferunprecedented losses in 1H. We estimate a normalized ROE of around 6% for Koreanshipbuilders given that prices are unlikely to rise, and weak orders should hurt top linegrowth and increase the burden of fixed costs. In sum, we do not find shipbuildersparticularly attractive. For shipbuilding shares to rerate, the market needs to see at leastone of the following: 1) a recovery in the offshore market; 2) a decline in the burden offixed costs thanks to severe cost cutting; or 3) structural changes in the competitivelandscape led by M&As among top-tier shipbuilders