Korea Shipbuilding:2Q16positive surprise –await order recovery in 2H16
2Q16 earnings surprises for both HHI and Mipo: Hyundai Heavy reported revenue ofKRW9.9trn and operating profit of KRW557bn for 2Q16. Despite the loss at the plantbusiness and one-off severance pay of KRW200bn, earnings surprised, mostly driven by:1) a better-than-expected earnings contribution from refinery (11.7% OPM as the refiningmargin improved by USD2 q-o-q); and 2) earnings turnarounds for the Shipbuilding (OPMat 4.6%) and non-shipbuilding divisions, including the Engine and Offshore (OPM at 13.4%resulting from change in orders) divisions. The Engine division reported an OPM of 24.2%in 2Q16 vs 18.7% in 1Q16, from higher after-service parts sales for its own Himsenengines. We think an increasing portion of after-service parts sales should continue todeliver an OPM above 15% going forward. The company guided for stronger new ordersin 2H16 as it thinks uncertainty should be resolved in late August after the final phase ofindustry restructuring in Korea.
Hyundai Mipo reported revenue of KRW1.06trn (-12.9% y-o-y) and operating profit ofKRW74.1bn in 2Q16, despite severance pay at KRW19.3bn. Slower sales were driven byless vessel construction and a lower contribution from the brokerage business, whilelower plate costs drove a margin improvement. The higher-margin LPGC portion rose to28% in 2Q16 (vs 21.3% in 1Q16); the company expects it to increase throughout 2016,saying it was becoming more confident about delivering a higher OPM. In new orders, thecompany is getting more inquiries on medium-range (MR) tankers as well as inquiries onsmall LNGC and targets USD2bn of new orders in 2016 (vs USD230m achieved YTD).
Estimate changes: For HHI, we raise our 2016e/17e operating profit by 62.6% and19.0%, respectively, to factor in better-than-expected shipbuilding earnings as a result ofcost-cutting and the turnaround in earnings for the non-shipbuilding divisions. Our TP(2017e SOTP valuation) at KRW150,000 is unchanged as we increase HHI’s net debt by4.2% to reflect weaker new orders overall in 2016. We retain our Buy rating.
Mipo remains our preferred play in the sector: With continuous earnings improvementand a new order recovery in 2H16, we think visibility should improve; we assume nofurther book value erosion in 2016e. We retain our KRW100,000 TP and Buy rating.