Yangzijiang Shipbuilding: Riding The Upcycle Of The Shipbuilding Industry

seekingalpha08-21

The shipbuilding industry is currently experiencing a robust multi-year upcycle, fueled by COVID-19, tightening environmental regulations, and geopolitical crises.With a full order book extending to ...

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Stewart SuttonCompany Background Yangzijiang (OTCPK:YSHLF) is China’s largest private shipbuilding company. The company has three giant dry docks and three large and medium-sized slipways, with an annual shipbuilding production capacity of 6 million DWT. Yangzijiang is an industry leader in building high-end container ships, and as its technology improves, it has also begun to enter LNG shipbuilding in recent years with 2 orders on hand. Yangzijiang has a very lean cost structure and continues to record healthy profit margins even during industry downturns. The New Upcycle For Shipbuilding Began Post Covid-19 In 2Q24, nearly all Asian shipyards reported explosive earnings growth, exceeding expectations by a large margin, including Yangzijiang (see chart 7), Hyundai Heavy, Samsung Heavy and Chinese State-owned CSSC. This marked the first quarter for listed shipyards to begin booking high margin orders received post Covid. This new upcycle originated from the second year of the Covid breakout, when severe labor shortages in port operations led to significant port congestion in US West Coast ports. The lockdown of Yantian port in China and a 6-day blockade of the Suez Canal by a stranded Evergreen ship further exacerbated shipping inefficiencies. Container freight rates soared, as did profits of shipping companies. Post Covid, leading shipping companies, such as Cosco Shipping, accumulated a large pile of cash (see Chart 1) due to their sky-high profits between 2020-2022. The strong balance sheets of major shippers have laid a solid foundation for the shipbuilding upcycle. Chart 1: Shippers accumulated a large pile of cash post Covid Source: Seeking AlphaShortages Of Ships Extended To All Major Ship Types Since 2022 In early 2022, Russia's invasion of Ukraine resulted in severe sanctions by Western Countries on its energy exports. This significantly impacted the shipping of crude oil, oil products and LNG. Many Russian tankers were re-directed from Europe to Asia, such as India and China, resulting in much longer shipping distances. Also, due to a significant reduction in pipeline gas imports from Russia, European countries turned to the US and the Middle East for LNG imports, creating a strong demand for new LNG ships. In January 2023, new environmental rules, EEXI and CII from the IMO became mandatory, requiring ships to measure their energy efficiency and report carbon intensity indicators. Industry experts believe the rule will lead shippers to reduce sailing speed (a.k.a. slow steaming) to reduce energy consumption. The breakout of the Red Sea Crisis throughout 2024 led to a significant disruption in shipping operations, and severe port congestions in Singapore, a major Asia-Europe hub port. This has caused another round of ship shortages and as expected freight rates surged since April 2024. Chart 2: Loss of capacity due to Covid and other events Source: Sea IntelligenceNew Ship Orders Have Exceeded Delivery For Three Years in A Row Based on the aforementioned events, all major ship types have witnessed a strong increase in orders almost simultaneously. The last time, a similar situation occurred was during the period of 2005-2007 known as the shipping Supercycle. The surge in ship orders has quickly depleted dry dock facilities, leading to a strong increase in order backlog. Chart 3: New ship order recovered post-Covid. It was initially driven by dry bulk and containers. After sanctions on Russia, tanker and gas orders also increased. Source: BRS Annual Review 2024Chart 4: New Orders have exceeded delivery for 3 years in a row Source: BRS Annual Review 2024Shipyard Supply Was Constrained While the shipping industry has enjoyed 3 years of strong profitability, it suffered a prolonged downcycle for nearly a decade. Post global financial crisis, there was a structural slowdown in China's export and infrastructure investment, significantly weighing on shipping demand for containers, dry bulk and crude oil. Many shipyards, particularly newly established ones during the Supercycle, saw sharp declines in orders since 2011 and have exited the market. Incumbent shipyards also struggled and had little incentive to expand their capacities. Current shipyard capacity was less than half of its capacity in 2007 and has not seen meaningful growth post-Covid. Therefore, when shippers were competing for limited yard capacity, we saw a surge in new build prices for ships, and ballooning order backlogs. Currently, all top-tier shipyards were fully booked until 2027, according to Clarkson. Chart 5: Yard capacity has fallen by more than 50% from its peak. Source: BRS Annual Review 2024Chart 6: New ship price index is approaching the highs seen in 2007. Source: ClarksonStrong 1H24 Results Indicated High Margin Orders Are Materializing Yangzijiang reported a strong set of 1H results, with revenue up 15% yoy, and its net profit surged by 77% yoy. This was driven by mix improvement as some of the high-margin orders received post Covid were delivered. Chart 7: Yangzijiang 1H24 Results   Source: Singapore Stock ExchangeForward-looking guidance from 1H24 is even more encouraging. The Book to Bill ratio is 4.6x in 1H24 (calculated as US$8.5 billion in new orders received in 1H24 divided by revenue of Rmb13 billion). The company mentioned in its earnings release that \"during the period under review, Yangzijiang Shipbuilding secured a total of 79 new orders worth USD8.5 billion. These new order-wins brought the Group’s total outstanding orderbook to a record-high amount of USD20.2 billion for 224 vessels, providing earnings visibility up to mid-2028.\" Low Valuation Leaves More Room For Re-rate Yangzijiang has a low valuation, as the company has remained profitable even during industry downturns. Singapore-based broker, DBS, estimated that Yangzijiang has at least a 5ppt cost advantage (as a percentage of revenue) against its Korean and Chinese peers. Hence, while Korean and Chinese shipyards have returned from loss to profit in 1H24, their P/E ratios look quite high. On the other hand, Yangzijiang’s P/E ratio was relatively low, as it continues to make a profit. We believe the shipbuilding industry will remain profitable in the coming 3-4 years, with current highly profitable orders. Consequently, more investors will begin to adopt the P/E ratio as their preferred metric for evaluating shipyard stocks. This trend will make Yangzijiang look more favorable to its peers, with its lower P/E and higher profit margin. Chart 8: Despite strong shares performance YTD, P/E remained low. Source: Seeking AlphaRisks There are two geopolitical risks to consider for Yangzijiang. Firstly, potential US sanctions on Chinese shipyards. The US has long been concerned about China's rising shipbuilding capacity. In 1H24, China won nearly 75% of global new ship orders, beating Korea and Japan by a wide margin. In May, the US Trade Representative's Office initiated Section 301 investigations of Chinese shipyards, which may result in additional surcharges for Chinese-made ships at US ports. While the impact is limited, in our view, as shipping companies can quickly adjust their fleets to fit the new rule. Additionally, the labor group calling for 301 investigations, requires a hypothetical charge of $1mn for a 20,000 TEU containership, which, if applied, won't meaningfully increase shipping costs. The second factor to consider is when the Suez Canal will return to normal. If Israel and Palestine can reach an agreement that is acceptable to the Houthis, the Red Sea Crisis will end. This will improve shipping efficiency, but negatively impact freight rates. However, given that shipyards already have a very full order book, and will only pick high-margin deals from the market, hence their strong margin trend will persist. Conclusion The shipbuilding industry is one of the few industrial sectors where demand can exceed supply. On top of that, this favorable condition is expected to remain for the next 2-3 years at least, providing high visibility on earnings growth. Yangzijiang Shipbuilding is a high-quality name with significant cost advantages and low P/E valuation, making it one of the key beneficiaries of this shipbuilding upcycle.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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