China COSCO Holdings (1919 HK):Containing the damage but de-rating continues

Valuation de-rating not yet complete. Since 2008, China COSCO’s (CCH) book value has declined 54% due a string of losses. To counter the trend, the company disposed assets in 2013; however, selling profitable assets to compensate for core business losses risks subverting future ROE. We expect the company to make another RMB5.6b loss in 2014F and think the share price deserves a de-rating together with its book value. We stand by our Underperform rating and HK$2.20 target price based on 1x 2014 P/B.

Profits, finally… With the help of a RMB4.3b net disposal gain, CCH managed a FY13 net profit of RMB235m, turning around the RMB10b loss in 2012. In 2013, the company’s container and bulk shipping achieved loss reductions from RMB1.5b to RMB988m and from RMB7.8b to RMB1.7b, respectively. Both segments turned a profit in 2H13.

…but not for long. On the assumption there will be no further asset disposals, 2014 is going to be a tough year for CCH. We expect container shipping losses to enlarge to RMB2b, with bulk shipping faring a little better by reducing its loss 8% to RMB1.6b.

Capacity expansion back on schedule. Part of the 2013 loss reduction in bulk shipping was achieved by retiring some of CCH’s loss-making bulk shipping capacity. Dry bulk shipping turnover declined 12% in 2013, following the 14% decline in 2012. On the container shipping side, while competitors have been upgrading to larger vessel sizes, CCH has resisted expanding its container fleet for years due to the loss-making bulk shipping business. In our view, the company needs to upgrade both its container and bulk fleet if it wishes to maintain any semblance of competitiveness. To this end, CCH has announced construction of eight dry bulk vessels (4 x 40k DWT and 4 x 180k DWT) at a cost of US$312m.

Financing pressure. CCH’s net debt-to-equity ratio increased from 31% in 2009 to 114% in 2013. By the end of 2013, CCH had RMB25b in long-term borrowing due in one year.

Upside risks to our call. (1) A sudden improvement in global trade would have a positive impact on company earnings. (2) Should iron ore price decline sharply, China might import more iron ore, which would drive up bulk shipping demand. (3) Slower or fewer-than-expected new vessel deliveries would likely lead to better-than-expected freight rates.