China Shipping Development (1138 HK):Not sinking but still bailing water

Maintain Underperform. China Shipping Development(CSD) reported a RMB2.2b loss. Revenue increased 3%while COGS rose 2% (fuel costs were down 9%, port chargesup 18%, and depreciation up 13%). We revise our 2014Fearnings forecast from RMB39m to RMB361m to includehigher government subsidies for vessel disposals during theyear. Excluding the subsidy, we believe CSD will make verylittle profit in 2014F.

Vessel residual value needs to be lowered. CSD changedits accounting vessel residual value from US$180/LDT toUS$470/LDT in March 2012 and then to US$420/LDT thisyear. Increased residual value led to a RMB235m vesseldisposal loss in 2013. The company plans to dispose ofanother 20 vessels in 2014F and has recognized a RMB422mprovision in 2013 for the potential loss. In our view, thecompany has to lower its vessel residual value to a morerealistic level lest the disposal loss becomes a burden post2014F. CSD’s current residual value of US$420/LDT is higherthan the market scrap price of around US$350/LDT. Vesselscrap price is driven by steel price, which has furtherdownside given the weak macro environment. 56 out of 133vessels owned by CSD are 20-plus years old and thereforesubject to disposal.

The interest coverage ratio is worrying. CSD reportedoperating cash flow of RMB1.4b in 2013, up from RMB891min 2012. Operating cash flow is considered an early sign of anearnings pickup for cyclical sectors. However, financing costsincreased 63% causing the EBITDA interest coverage ratio tofall to 0.94x, which is a concern.

COA low implementation rate but rates likely to increase.

Only 16% of coastal bulk COA contracts were implemented atannual contract rates in 2013; the rest were at spot rates. Weestimate 25% of 2014F COA contracts will be secured at theannual rate, which will increase about 20% fromRMB45/tonne, the rate last year, with the rest at spot rates.

Valuation. Our HK$4.10 target price is based on 0.5x 2014FP/B. Though CSD remains the cheapest bulk shipping stockunder our coverage, in our view its book value is vastlyoverstated and warrants a discount.

Risk. The upside risk is that iron ore prices continue todecline prompting China to import more iron ore fromAustralia and Brazil.