Marine Shipping Equity Research

Huatai Research

23 March 2017

Equity | Hong Kong Initiate on shipping: En route to OVERWEIGHT profitability, selective by segment Initiation

Lisa LIN +86 21 2897 2209 Prefer dry-bulk and container shipping to tankers Analyst [email protected] We launch coverage of China and Hong Kong shipping with OVERWEIGHT on Xiaofeng SHEN +86 21 2897 2088 both dry-bulk and container shipping, and NEUTRAL on tankers. The industry is Analyst [email protected] characterized by highly cyclical supply and demand: typically, strong demand lifts freight rates, boosting carriers’ earnings; then follows rapid growth in capacity, Stock recommendations prompting a downturn. We select stocks on the basis of segment exposure and TP operating model. In order of preference: 1) we like dry bulk shipping, for its real Company Code (HKD) Rating industry recovery; 2) we like container shipping, for an earnings upside Sinotrans Shpg 368 HK 2.33 BUY OOIL 316 HK 51.20 BUY opportunity; and 3) we are less keen on the tanker segment, largely on oil COSCO 1919 HK 3.46 HOLD Pacific Basin 2343 HK 1.82 HOLD production cut and heavy orderbook headwinds. We assume coverage of: Sinotrans Shipping (BUY), Orient Overseas (International) Limited (OOIL, BUY), Source: Huatai HK Research estimates Cosco Shipping Holdings (HOLD), and Pacific Basin Shipping (HOLD).

Dry bulk shipping: BUY Sinotrans Shipping; HOLD Pacific Basin We think the market has bottomed, and is trending upwards. A depressed 2016 saw the Baltic Dry Index (BDI) at its lowest level ever, but we expect a gradual recovery from 2017 onwards, driven by: 1) a healthy demand growth trend; 2) limited growth of vessel supply and a high scrapping rate; and 3) earnings uplift from improving freight rates. We rate Sinotrans Shipping BUY on its return to profit in 2017E and dividend payout upside in 2017E-2018E. We HOLD Pacific Basin on likely another net loss year in 2017E resulting from higher average vessel cost, despite rising freight rate. We forecast positive earnings for Pacific Basin will occur from 2018 onward.

Container shipping: BUY OOIL; HOLD on Cosco Shipping We hold an optimistic view on container shipping in 2017, when both freight rates and industry profitability look set to rebound. Industry consolidation and discipline on freight pricing have been triggered by the severe market condition last year, and we think co-operation and consolidation among lines will remain prominent trends, with a positive impact on capacity supply in the long term. We rate OOIL BUY on its strong earnings upside driven by rising freight rate and potential new business from the Ocean Alliance network. We have a positive results outlook on OOIL for 2017E-2019E. We HOLD Cosco Shipping, given our cautious view on its aggressive expansion and the higher cost of chartering vessels from its group company.

Tankers: Oil production cut and heavy orderbook headwinds Tanker shipping, our less liked segment, is facing short-term headwinds from oil production cut and heavy orderbook, in our view. We are also cautious on rising optimism on recovery of oil production in the US (the second-largest seaborne crude importer), which could lower global crude seaborne demand growth. Meanwhile, with 40.8mn DWT capacity (7% of existing fleet capacity) due for delivery in 2017, a rise in supply with little change in demand could make 2017 a downside year for tanker shipping.

Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 1 Please refer to end pages for analyst certification and required disclosures.

Hong Kong Marine Shipping

Content Investment summary ...... 3 Dry bulk shipping: recovery from 2017 onwards ...... 5 Favorable supply-demand balance into 2017 ...... 5 Supply ...... 5 Demolition ...... 6 Demand ...... 6 Balancing ...... 9 BDI rebounded, positive on industry earnings ...... 9 Container shipping: opportunity unfurls in 2017 ...... 11 Industry consolidation under way ...... 11 Realignment of global shipping alliances ...... 12 Supply-demand looks better in 2017 ...... 13 Deliveries ...... 13 Supply ...... 13 Scrapping ...... 14 Demand ...... 14 Freight rate heading into positive territory...... 15 Tanker shipping: unattractive on headwinds ...... 17 Pressure appears on VLCC earnings ...... 158

Companies Sinotrans Shipping (368 HK; TP HKD2.33; BUY) ...... 19 Orient Overseas International (316 HK; TP HKD51.20; BUY) ...... 24 Cosco Shipping Holdings (1919 HK; TP HKD3.46; HOLD) ...... 28 Pacific Basin Shipping Limited (2343 HK; TP HKD1.82; HOLD) ...... 32

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Investment summary Sinotrans shipping: We see 2017E as a profitable year for Sinotrans Shipping (Sinotrans), with dry bulk market recovery and rising freight rates supporting a net profit of USD15mn. Operating all major types of dry bulk vessel (Capesize, Panamax, Handymax and Handysize), Sinotrans should have diversified gains from the rising market. We think balance-sheet strength will support dividend payout surprise in 2016 (DPS of US¢0.51, even in a loss-making year), and likely upside in dividend payout for 2017E-2018E. We initiate coverage at BUY with a target price of HKD2.33, based on 0.67x PB (three-year historical average +2SD). We think a premium is deserved under the rising market and dividend payout upside.

Orient Overseas (International) Limited (OOIL): Our top pick in liners, Orient Overseas International (OOIL), is historically one of the most profitable in the region. Record-low freight rates and OOIL’s loss-making 2016 were caused by secular choppiness which has now subsided, in our view, and we forecast 2017E net profit of USD178mn driven by: 1) strong rate recovery on all main routes; and 2) potential revenue upside and expanded network coverage from joining the Ocean Alliance. We initiate coverage at BUY with a target price of HKD51.20, based 0.88x PB (five-year historical average +1SD). We view the current valuation of 0.77x PB as still attractive, given the rising market and its premium profitability comparing to its peers.

Cosco Shipping Holdings: We expect Cosco Shipping Holdings (Cosco) to return to profit in 2017E, supported by a freight rate recovery that began in 2H16 and will be sustained, in our view, by high rates of idling and scrapping continuing into 2017. We initiate coverage at HOLD with a target price of HKD3.46, based on 1.50x PB (three- year historical average +1SD). As a Chinese flag line and A+H listed company, Cosco has historically traded at a premium to peers, and we think the current valuation fair under the rising market and earnings upside, and taking into account our cautious view on Cosco’s aggressive expansion.

Pacific Basin Shipping: As a world-leading owner-operator of modern Handysize and Supramax dry bulk ships, Pacific Basin Shipping Limited (Pacific Basin) is one of the best operators of minor bulk shipping, achieving premium earnings through high utilization of quality vessels. However, given our cautious view on the pace of rate recovery in the smaller-vessel segment, Pacific Basin’s focus, we think rising freight rates will only be sufficient to narrow losses year on year in 2017E; we forecast an earnings turnaround in 2018E. Our target price of HKD1.82 is based on 0.92x PB (three-year historical average +1SD). We think the valuation is fair under the rising market and improving earnings, and initiate coverage at HOLD.

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Hong Kong Marine Shipping

Fig.1. Shipping sector: valuation comparison Market PE (X) PB (X) ROE (%) Dividend yield (%) Stock name Ticker Rating cap (USD mn) 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E

Shipping - H

Cosco Shipping 中远海控 1919 HK HOLD 4,775.8 (3.3) 42.7 18.6 1.6 1.6 1.4 (48.9) 3.7 7.8 0.0 0.0 0.0 Holdings - H Orient Overseas 东方海外 316 HK BUY 3,505.7 (16.0) 19.7 12.6 0.8 0.7 0.7 (4.9) 3.8 5.6 0.0 0.0 0.0 Intl Ltd Sinotrans 中外运航运 368 HK BUY 1,017.9 (4.4) 65.8 22.2 0.6 0.6 0.6 (12.8) 0.9 2.5 2.0 0.0 0.0 Shipping Pacific Basin 太平洋航运 2343 HK HOLD 946.5 (8.9) (45.3) 85.5 0.7 0.8 0.7 (8.3) (1.7) 0.9 0.0 0.0 0.0 Shipping Cosco Shipping 中远海能 1138 HK NR 2,482.0 6.9 9.7 10.7 0.6 0.6 0.6 8.4 6.1 5.4 4.4 3.4 3.3 Energy - H Shipping - A

Cosco Shipping 中远海控 601919 BUY 8,613.2 (6.0) 76.9 33.5 2.9 2.8 2.6 (48.9) 3.7 7.8 0.0 0.0 0.0 Holdings - A CH Cosco Shipping 中远海特 600428 BUY 2,193.0 386.7 149.3 137.0 1.6 1.6 1.6 0.4 1.1 1.2 0.1 0.0 0.0 Specialized CH Cosco Shipping 中远海能 600026 BUY 4,160.0 14.1 15.4 14.8 1.0 1.0 1.0 7.3 6.6 6.5 0.0 0.0 0.0 Energy - A CH China Merchants 招商轮船 601872 NR 4,052.7 16.4 21.7 20.5 1.8 1.7 na 13.9 8.4 na 2.3 1.5 na Energy CH Shipping - International Maersk 马士基 MAERS NR 36,482.9 38.8 21.8 15.9 1.1 1.1 1.1 2.7 5.1 6.9 2.5 2.0 2.2 航运 KB DC Evergreen Marine 长荣海运 2603 TT NR 1,622.3 (7.7) 326.7 (25.5) 1.0 1.0 1.0 (12.0) (3.4) (4.4) 0.0 0.2 0.1 Yang Ming 阳明海运 2609 TT NR 690.4 (1.5) (3.2) (4.4) 1.4 1.9 3.5 (74.4) (69.9) (22.3) na na 0.2 Marine Precious 珍宝航运 PSL TB NR 494.5 (6.5) (26.7) 550.0 1.3 1.3 1.4 (12.9) (6.0) (0.5) 0.0 0.0 0.6 Shipping

Source: Bloomberg, Huatai HK Research estimates

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Dry bulk shipping: recovery from 2017 onwards We expect a gradual recovery in the dry bulk shipping industry to begin in 2017, driven by: 1) a healthy demand growth trend; 2) limited growth in vessel supply; and 3) improving earnings for most of the dry-bulk segments, especially for Capesize vessels.

With a record-low BDI of 290 in 1Q16, 2016 was the worst year for the dry bulk shipping market ever. Toughness in the industry in the early months of 2016 was caused by an unexpected drop in global seaborne activity. By March this year, however, conditions had improved and we think the market has bottomed out and begun to move in an upward trend.

Favorable supply-demand balance into 2017 Supply In 2016, global dry bulk market supply grew by 2.2% yoy to a capacity of 794mn DWT. We forecast supply growth to slow down in 2017 to 1.8% yoy, based on limited new deliveries and a high scrapping rate assumption.

According to current fleet development, Capesize vessels account for about 39% of total market capacity, followed by Panamax (25%), Handymax (24%) and Handysize (12%). New delivery capacity in 2016 declined by 4% yoy, a further indication of contraction in vessel supply. In 2017, we forecast limited new deliveries of about 49mn TEU (+3% yoy), with a large portion of new capacity coming from Capesize (37% of total new deliveries) and Handymax (28%). A thin orderbook is also a theme we expect to continue in 2018 with only 19.7mn TEU of new deliveries projected (-59% yoy), which represents a record-low orderbook for delivery in a year. According to Clarksons, by end-February 2017, the industry orderbook was at 77mn TEU of capacity pending, representing about 10% of the existing fleet, which is at a decade-low level; and we view this as a leading indicator for contraction in supply growth.

Fig.2. Global dry bulk fleet capacity (mn DWT) (%) Fleet capacity Supply growth (rhs) 900 18 800 16 700 14 600 12 500 10 400 8 300 6 200 4 100 2 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E Source: Clarksons, Huatai HK Research estimates

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Fig.3. New deliveries by vessel type Fig.4. Market capacity by vessel type (2016)

(mn DWT) Capesize Panamax (yoy%) Handysize 60 Handymax Handysize 10 Handymax 12% Growth (rhs) 24% 0 50 (10) 40 (20)

30 (30)

(40) 20 Capesize (50) 39% 10 Panamax (60) 25% 0 (70) 2014 2015 2016 2017E 2018E 2019E Source: Clarksons, Huatai HK Research estimates Source: Clarksons, Huatai HK Research

Demolition A high scrapping rate continuing in 2017 and beyond is another catalyst that heralds limited supply growth, in our view, driven by: 1) regulatory requirement for fitting of ballast water treatment system (effective September 2017); and 2) International Maritime Organization (IMO) regulation on use of low-sulfur fuel in 2020. Ship owners may well prefer to scrap non-compliant vessels which bring in low earnings, rather than incur additional cost on scrubbers, and on ballast water treatment systems which typically cost around USD1mn to install. As such, we expect the high scrapping rate in the dry bulk market to continue, and forecast a firm scrapping rate of 4% throughout 2017.

Fig.5. Bulkcarrier demolition capacity and scrapping rate (mn DWT) (%) Total fleet demolition Scrapping rate (rhs) 40 6

35 5 30 4 25

20 3

15 2 10 1 5

0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Clarksons, Huatai HK Research

Demand There was improvement in demand growth in 2016 and we expect demand growth to remain healthy in 2017. The dry bulk demand growth originates from a rise in iron ore and coal trade, which account for 29% and 23%, respectively, of global dry bulk trade in 2016.

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Fig.6. Global dry bulk trade by product (2016) Others 38%

Iron ore 29% Grain 10%

Coal 23% Source: Clarksons, Huatai HK Research

China's iron ore and coal imports are the most important drivers of global dry bulk demand. As the largest iron ore importer, China accounted for 72% of global iron ore imports in 2016, followed by Japan (9%) and Korea (5%). The major iron ore exporting countries are Australia (56%), Brazil (26%) and South Africa (4%). The rise in Chinese domestic steel consumption will support demand for larger vessels (Capesize and Panamax) to carry iron ore. Vale’s new S11D project in Brazil has become the most cost effective iron ore mining project, and we see ramp-up of the project’s output as a long- term driver of demand for larger vessels.

Fig.7. Global iron ore import by region (2016) Fig.8. Global coal import by region (2016) Europe KoreaOthers China Japan 8% 5% 4% 18% 9% Taiwan India Malaysia 2% 18% 3% Taiwan 6%

Korea 11% Others 15%

Europe China Japan 14% 72% 15% Source: Clarksons, Huatai HK Research Source: Clarksons, Huatai HK Research

Fig.9. Global growth: dry bulk throughput vs GDP

(%) Global dry bulk throughput growth Global GDP growth 16 14 12 10 8 6 4 2 0 (2) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 (4) (6)

Source: Bloomberg, Huatai HK Research

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We expect China’s iron ore imports to continue growing at a steady pace into 2017, following on from the record-high import of over 1.02bn tonnes in 2016 (+7.5% yoy). According to the China customs service, China’s January import of iron ore was up 12% yoy to 92mn tonnes, a reflection of the country’s continued cuts to domestic iron ore output and ongoing inventory stockpiling at Chinese ports. At the start of March, iron ore inventory at major Chinese ports was reported at 119mn tonnes, an indicator of the continuing build-up. Based on our current projections, we expect a 4% yoy rise in Chinese seaborne iron ore imports to 1.07bn tonnes in 2017.

Fig.10. Chinese seaborne iron ore imports Fig.11. Major China ports: iron ore inventory (2014-now) (mn tonnes) (yoy%) (mn tonnes) 1,200 China iron ore imports Growth (rhs) 16 140

14 120 1,000 12 100 800 10 80 600 8 60 6 400 40 4 200 20 2 0 0 0 Jan-14 Jan-15 Jan-16 Jan-17 2011 2012 2013 2014 2015 2016 2017E Source: CEIC, Huatai HK Research estimates Source: CEIC, Huatai HK Research

Fig.12. China's iron ore price index: import vs domestic (2013-now) (RMB/tonne) 1,400 Import Domestic 1,200

1,000

800

600

400

200

0 2013 2014 2015 2016 2017 Source: CEIC, Huatai HK Research

Asian countries in aggregate accounted for 79% of global coal imports in 2016, and among them, the top four importers are: China (18%), India (18%), Japan (15%) and Korea (11%). The top exporters in 2016 were Indonesia (39%), Australia (25%) and Russia (11%). We expect coal demand to rise, mainly in developing Asia.

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Hong Kong Marine Shipping

Fig.13. China coal import growth (2015-now) (%) 80

60

40

20

0

(20)

(40)

(60) Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Source: CEIC, Huatai HK Research

Balancing We forecast a rebalancing in the dry bulk shipping market in 2017, with 1.8% supply growth and 2.0% demand growth globally. The improving demand is helping to ease over-capacity in dry bulk shipping, which we view as an important passage on the industry’s route to recovery.

Fig.14. Global dry bulk shipping: demand and supply growth (%) 18 Supply growth Demand growth 16 14 12 10 8 6 4 2 0 (2) 2010 2011 2012 2013 2014 2015 2016 2017E Source: Clarksons, Huatai HK Research estimates

BDI rebounded, positive on industry earnings The Baltic Dry Index (BDI) is the most important indicator of the global level of dry bulk freight and is calculated at a composite of dry bulk time charter averages. By end-2016, the index had risen by 231% from its record low in 1Q16, with the rebound mainly driven by robust iron ore import demand from China. We have seen the upside trend on the average industry charter rate continue into 2017. On 7 March, the BDI broke 1,000 points, which further indicates a strong rate rebound.

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Fig.15. Baltic Dry Index (2014-now) (x) 2,500

2,000

1,500

1,000

500

0 2014 2015 2016 2017 Source: Baltic Sea Exchange, Huatai HK Research

We have seen a strong rise in average time charter earnings across all types of vessel in recent weeks since February, after declines in January. The strong earnings rebound across all vessel types seems to indicate an upward trend in demand. By early March, Capesize average spot earnings increased by 295% compared to the same period last year; robust year-on-year earnings recovery also occurred for other vessel types: Panamax (178%), Handymax (127%) and Handysize (96%).

Fig.16. Capesize: spot time charter rate Fig.17. Panamax: spot time charter rate (USD'000/day) (USD'000/day) 25 2015 2016 2017 14 2015 2016 2017

12 20 10

15 8

10 6 4 5 2

0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Clarksons, Huatai HK Research Source: Clarksons, Huatai HK Research

Fig.18. Handymax: spot time charter rate Fig.19. Handysize: spot time charter rate (USD'000/day) (USD'000/day) 12 2015 2016 2017 9 2015 2016 2017 8 10 7 8 6 5 6 4 4 3 2 2 1 0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Clarksons, Huatai HK Research Source: Clarksons, Huatai HK Research

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Container shipping: opportunity unfurls in 2017 We hold a positive view on the prospects for the container shipping sector in 2017, as we see it continuing to pull away from its worst period in six years. We attribute the downturn to severe industry supply-demand imbalance, a lack of pricing discipline and global economic slowdown. Industry overcapacity put significant pressure on freight rates and hurt industry profitability. Indicating the difficulty in 2016, the industry index was at a record low in 1Q16, and for the first time in 30 years, a major player, Hanjin, declared bankruptcy.

For 2017, we think freight rates and industry profitability will rebound after last year’s nadir, and also expect the sector to benefit significantly from its restructuring and the new Ocean Alliance network, although there are risks remaining, related to US protectionism and economic recovery in the Euro zone.

Industry consolidation under way Major container carrier Hanjin Shipping’s demise last year has triggered two responses from shipping companies to deal with the industry’s poor condition, in our view: 1) consolidation, and 2) moves to promote discipline on freight pricing. Last year, CMA CGM completed its acquisition of Neptune Orient Lines (NOL); and Cosco and CSCL completed their merger. Furthermore, three M&A transactions have regulatory approval pending: 1) Hapag Lloyd and UASC merger; 2) Japan’s “Big-3” merger of NYK, MOL, and K Line; and 3) Maersk’s acquisition of Hamburg Sud. Assuming all the pending transactions are completed, Maersk will enhance its largest global container carrier position with an 18.2% global share by capacity, followed by MSC (13.5%) and CMA CGM (10.5%). Chinese flag carrier Cosco stands fourth with 7.5%.

Fig.20. Global top 16 carriers: market share by capacity (2016)

APM-Maersk 15.3 MSC 13.5 CMA CGM 10.5 COSCO 7.5 New Japan Co 6.6 Evergreen 4.7 Hapag-Lloyd 4.5 Hamburg Sud 2.9 OOCL 2.8 Yang Ming 2.7 UASC 2.6 MOL 2.5 NYK Line 2.4 Hyundai M.M. 2.2 Hanjin Shg 1.9 PIL 1.8 K Line 1.7 (%) 0 2 4 6 8 10 12 14 16 18 Source: Alphaliner, Huatai HK Research

The new Japan Big-3 line will start operating in 2018 if this transaction is completed successfully. Post merger, the carrier will accounts for 6.6% of global capacity and provide upside on transpacific route. Transpacific route accounts for the largest capacity portion of Japan’s Big-3 with 37%, 43% and 51%, respectively, for MOL, NYK and K Line. We think after the merger, capacity on Asia – US routes will be further consolidated and that overlapping capacity will be removed, providing an upside catalyst for a rise in shipping rates. Other players which have major capacity on the transpacific route (eg, Cosco, Evergreen, and OOCL) will also benefit from industry restructuring, in our view.

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Fig.21. Main carriers: capacity breakdown by route (Feb 2017)

APM - Maersk 15 22 5 MSC 5 30 2 CMA CGM 20 24 4 COSCO 24 28 20 Evergreen 34 29 12 OOCL 30 25 12 Yang Ming 27 34 11 MOL 37 21 8 NYK Line 43 23 7 K Line 51 27 6

0 20 40 60 80 100 (%)

Asia - N America Asia - Europe Intra-Asia Others

Source: Alphaliner, Huatai HK Research

We think more M&A will occur in the container sector as consolidation removes overlapping capacity, and surplus vessels are likely returned to shipowners when charters expire. As a result, we see the supply-demand imbalance turning more favorable for shipping lines and the downward pressure on shipping rates easing.

So far, consolidation has been done by Chinese, Japanese and Korean lines. In our view, the next focus of restructuring will be on the three independent Taiwanese operators Evergreen Marine, Yang Ming and Wan Hai. Evergreen and Yang Ming have a large proportion of capacity overlap on the Far East – North America route (34% and 27% of their total capacity deployed on this route, respectively), while Wan Hai is an intra-Asia player. We think consolidation would help Taiwanese lines reduce duplication and enlarge their total market share to compete with other national lines.

Realignment of global shipping alliances From 1 April, the shipping industry is slated to have three new alliances: 2M, Ocean Alliance and THE Alliance. This represents a realignment of four alliances formed in the past. The industry has turned to vessel sharing alliances as a way to reduce costs, and boost vessel utilization. The Far East – Europe and Far East – US routes are the busiest for container shipping, and account for 20% and 16% of global capacity deployment respectively. We also see demand in the intra-Asia market increasing (attracting 11% of global fleet capacity deployed).

Under the new alliance network, 2M and HMM will become the largest alliance by vessel capacity with around a 31% global market share, followed by Ocean Alliance (25%) and THE Alliance (14%). Since December 2016, 2M partners and HMM have engaged in strategic cooperation on East-West trade routes. The cooperation gives HMM access to the 2M network through a combination of slot exchanges and slot purchase. The new alliance network will offer customers faster transit times, competitive sailing frequencies and most extensive port coverage.

Overall, we think consolidation and co-operation among lines are likely to remain prominent trends and have a favorable impact on capacity supply in the long term.

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Fig.22. Global capacity by route (2016) Fig.23. Global capacity by alliance (from 1 April 2017) Idle Eur - N Am Others Intra- 6% 4% Oceania 30% Africa related Europe 4% related 4% 8% Others 2% Intra-FE 11% FE - Europe THE 20% Alliance 14% 2M+HMM 31% ME/ISC related 12% Lat Am related FE - N Am Ocean 16% 13% 25% Source: Alphaliner, Huatai HK Research Source: Alphaliner, Huatai HK Research

Fig.24. New shipping alliances (from 1 April 2017) Fig.25. Old shipping alliances (2016) 2M+HMM Ocean THE Alliance Unaligned 2M O3 CKYHE G6 Unaligned Maersk Cosco K-Line Zim Maersk CMA CGM Cosco (CKYHE) HMM Zim MSC Evergreen MOL Hamburg Sud MSC UASC K-Line MOL Hamburg Sud HMM CMA CGM NYK PIL Cosco (O3) Yang Ming Hapag Lloyd PIL OOCL Hapag Lloyd Wan Hai Evergreen NYK Wan Hai Yang Ming Hanjin Shg OOCL Matsor

Westwood

Source: Alphaliner, Huatai HK Research Source: : Alphaliner, Huatai HK Research

Supply-demand looks better in 2017 We expect a supply-demand outlook favorable to container shipping in 2017, driven by: 1) the opportunity presented by delayed deliveries, which will crimp supply growth; 2) high level of idling rate and scrapping rate continuing to ease overcapacity pressure; and 3) gradual improvement in the global economic environment.

Deliveries In 2016, there was only 0.9mn TEU of new deliveries, representing 4.5% of the existing fleet, and the lowest delivery rate in the past six years. According to Alphaliner, there will be around 1.4mn TEU of new vessels delivered in 2017 (+56% yoy), based on the orderbook as of February and delivery spillover from last year. However, we think actual new deliveries will be much lower than estimated above, as more new deliveries will be pushed back by negotiation between carriers and shipbuilders. Maersk, the world’s largest container carrier, announced it has pushed back 2017 delivery of nine ships by a year. We look for more announcements this year of delayed deliveries. Overall, we think any delays beyond current expectations will present the industry with an opportunity to improve both the supply-demand imbalance and overall market conditions in their favor.

Supply Following robust fleet expansion in recent years, global total container fleet capacity reached 20mn TEU in 2016. However, following growth of 8.6% yoy in 2015, 2016 saw the industry’s lowest fleet growth rate (+1.5% yoy) in six years (11% fleet growth in 2000-2009, and 6% in 2010-2016, on average).

We see the fundamentals of the supply side remaining positive, resulting from a slowdown in the pace of deliveries, high demolition, and a limited orderbook. We project 3.0% fleet growth in 2017, based on: 1) the current orderbook; 2) 3% forecast scrapping rate; and 3) 2017 deliveries delayed from 2016. So far this year, we see containership new orders limited to only five vessels, with a focus on smaller types. In January, the containership newbuilding price index declined by 2% mom to a historical low. Overall we think new orders placed in 2017 will be moderated.

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Scrapping In 2016, vessel scrapping amounted to 0.7mn TEU, an increase of 240% yoy. The trend has continued into 2017 with 27 vessels (0.1mn TEU) demolished in January. Of the scrapped capacity, 49% is “old Panama” vessels. The opening of the new Panama Canal has already led to deployment changes, and more “old Panama” vessels will be demolished in 2017. According to Clarksons, more than 50% of current Panama vessels will be demolished in the next five years and replaced by large vessels that can pass through the widened Panama Canal, thereby reducing shipping costs. Overall, we think demolition in 2017 will reached an historically high scrapping rate of 3%.

Fig.26. Global fleet capacity Fig.27. Demolition and scrapping rate (mn TEU) (%) ('000 TEU) (%) Gross fleet capacity Gross supply growth (rhs) 25 10 700 Demolition scrapping rate (rhs) 4 9 600 3 20 8 7 500 3

15 6 400 2 5 10 4 300 2 3 200 1 5 2 100 1 1 0 0 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017E2018E 2009 2010 2011 2012 2013 2014 2015 2016 Source: Alphaliner, Huatai HK Research estimates Source: Alphaliner, Huatai HK Research

However, our 3.0% fleet growth rate in 2017 does not include the impact from idling vessels, which means the actual operating capacity in the market (effective supply) would be lower than gross industry capacity. We estimate an idle rate at 7% of total fleet capacity in 2017 (2016: 6%). A higher idle rate estimate also supports our view that the industry is undergoing restructuring, and that global major players are focusing on industry profitability through avoiding overlapping fleet deployment and thereby easing downward pressure on freight rate. Moreover, we expect the scrapping rate to remain steady in 2017 at 3.0%.

Fig.28. Global containership idle capacity and scrapping rate (%) 8 Idle capacity Scrapping rate 7 7 6 6 4.9 5 5 4.1 4 3.6 2.8 2.8 3 3 3 3 2.3 2.2 2.3 2 2 1.7 2 1.4 1.1 0.8 1

0 2010 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E Source: Alphaliner, Huatai HK Research estimates

Demand In 2016, demand growth appeared to accelerate to 1.7% yoy, against 1.4% in 2015. We expect gradual improvement in main routes, while growth in intra-Asia trade is projected to accelerate further. We forecast 2.0% demand growth in 2017, a positive impact from a gradual improvement in the global economy compared to last year, which is in line with GDP growth guidance from the IMF. According to IMF data, 2016 global GDP was

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3.1% and the global economy will have gradual improvement to 3.4% in 2017. We think the improvement in global demand growth is driven by a return to growth in the European economy (Far East – Europe route), firm transpacific growth, and a gradual uptick in the China economy. According to Clarksons, European demand is projected to support 3.4% growth in main lines trade, and further growth is expected on East – West routes. Moreover, we think intra-Asia trade will continue to have robust growth driven by firm economic growth in emerging markets. IMF forecasts project emerging market GDP will reach 4.5% in 2017 versus 4.1% last year.

Fig.29. Global GDP growth (%) World Developed economies Emerging market economies China 8 6.9 6.7 7 6.5 6.0 6 4.8 5 4.5 4.1 4.1 4 3.4 3.6 3.2 3.1 3 2.1 1.9 2.0 2 1.6

1

0 2015 2016 2017E 2018E Source: IMF, Huatai HK Research estimates

Overall, we expect gradual demand improvement in 2017 along with moderate supply growth. Although further significant changes are needed to improve the market imbalance, and there are also risks from potential US protectionism that are not clear so far, we think the industry will take advantage of the delayed vessel deliveries and co- operation in 2017.

Fig.30. Global container supply and demand growth (%) 20 Gross supply growth Demand growth

15

10

5

0

(5)

(10) 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E Source: Alphaliner, Huatai HK Research estimates

Freight rate heading into positive territory Since 2H16, spot freight rates appear to have bottomed out on a range of main lines. Although the freight market is still far from robust, we think industry earnings are heading into positive territory.

By the end of 2016, the Shanghai Containerized Freight Index (SCFI) had risen around 138% since its record low in March 2016. The biggest improvements were on long haul routes, which had worse conditions that were caused by overcapacity and pricing indiscipline last year. Following Hanjin’s bankruptcy, we see accelerating industry consolidation and strong discipline on freight pricing, and expect average spot rates will remain well above last year’s.

23 March 2017 15

Hong Kong Marine Shipping

Fig.31. Shanghai Containerized Freight Index (SCFI) Fig.32. China Containerized Freight Index (CCFI) (USD/TEU) (USD/TEU) 2015 2016 2017 1,200 1,200 2015 2016 2017

1,000 1,100

800 1,000

600 900

400 800

200 700

0 600 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: SSE, Huatai HK Research Source: SSE, Huatai HK Research

For transpacific routes, nearly two-thirds of trade are under annual contracts that are repriced in May each year. By end-February, the spot rate for the Shanghai – US West route had increased by 64% yoy. We expect earnings on transpacific routes to gradually improve this year as rate charges will be reset in May and have around 50-100% upside compared to last year, in our view. Currently, annual contracts are still under negotiation.

For the Asia – Europe route, the charges are on an annual, semi-annual or quarterly basis and are reset in December each year. By end-February, the spot rate indicated a significant upside trend, rising by 258% yoy. Now the contract price has been reset, we expect substantial earnings improvements on this route.

Fig.33. Asia – US West freight rate Fig.34. Asia – Europe freight rate (USD/FEU) (USD/TEU) 2015 2016 2017 2,500 1,400 2015 2016 2017

1,200 2,000 1,000

1,500 800

1,000 600 400 500 200

0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: SSE, Huatai HK Research Source: SSE, Huatai HK Research

23 March 2017 16

Hong Kong Marine Shipping

Tanker shipping: unattractive on headwinds We think tanker shipping could be facing significant headwinds in the short term, due to the global oil production cut announced last year. Since then, the global oil price has risen strongly, and there is also optimism about recovery in US oil production, which would potentially lower crude seaborne trade demand growth.

Tanker shipping mainly comprises shipment of crude and refined oil, which are shipped from energy production countries to consumption countries. The main shipping routes are from the Middle East to: 1) the Far East, 2) the United States, and 3) Northwest Europe. Since 2008, oil shipping has been enjoying a strong earnings period, driven by a rise in oil production in the Middle East that led to a pick-up in seaborne oil transportation.

As the largest seaborne crude import country, China reported an average import in 2016 of 7.1mbpd, representing 16% yoy growth; however, we think this figure will ease to 7% yoy in 2017 (to around 7.6mbpd), resulting from high oil price. The US, the second largest import country, reported an average 4.6mbpd crude import in 2016, with 10% yoy growth. However, we think there will be a large import decline in 2017 due to rises in the US’s domestic production of both crude and shale gas.

Fig.35. Global seaborne crude imports (mn bpd) (yoy%) 40 Global crude imports Growth (rhs) 5 39 4 39 3 38 2 38 1 37 0 37 (1) 36 (2) 36 (3) 35 (4) 35 (5) 2012 2013 2014 2015 2016 2017E Source: Clarksons, Huatai HK Research estimates

Fig.36. Global crude imports by region (2016) Fig.37. Global crude exports by region (2016) North Latin America America Others North Sea 13% 9% Africa 12% 14% 5%

Europe 24%

Others 23% Middle East 46% Asia 54%

Source: Clarksons, Huatai HK Research Source: Clarksons, Huatai HK Research

Overall, the tanker market (both crude and product tankers) reported 6% yoy supply- side growth in 2016, and we project a slide to 4% in 2017. We see a headwind on the demand side due to oil production cut with rising oil price. We expect only 1% yoy seaborne demand growth in 2017.

23 March 2017 17

Hong Kong Marine Shipping

Fig.38. Tanker shipping supply-demand growth (%) Supply growth Demand growth 8

6

4

2

0

(2)

(4)

(6) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E Source: Clarksons, Huatai HK Research estimates

Pressure appears on VLCC earnings At this point in time, tanker shipping is the only one that has been profitable in the sector in the past two years, and has benefited from strong very large crude carrier (VLCC) earnings. However, given the declining in demand for crude imports, VLCC spot earnings decreased to around USD30,000/day in early 2017, representing a 42% yoy decline. VLCC supply growth is currently projected at 4.6% yoy in 2017 versus 8.4% yoy last year. We project VLCC demand growth will decline to 1.2% yoy versus last year’s 5.2% yoy.

Fig.39. Global VLCC capacity growth vs seaborne crude trade growth (%) VLCC capacity growth Global crude oil seaborne trade growth 9 8 7 6 5 4 3 2 1 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E Source: Clarksons, Huatai HK Research

Fig.40. VLCC: one-year time charter rate (2013-now) (USD'000/day) 60

50

40

30

20

10

0 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Source: Clarksons, Huatai HK Research

23 March 2017 18

Sinotrans Shipping ( 368 H K; T P H KD2.33; BU Y)

Sinotrans Shipping (368 HK) Equity Research

Huatai Research

23 March 2017

Equity | China | Marine Shipping Rising tide spells a return to profit, valuation attractive, BUY BUY | TP HKD2.33

Initiation

Lisa LIN +86 21 2897 2209 Initiate at BUY with target price of HKD2.33 Analyst [email protected] We see 2017E as a profitable year for Sinotrans Shipping (Sinotrans), with dry Xiaofeng SHEN +86 21 2897 2088 bulk market recovery and rising freight rates supporting a net profit of USD15mn. Analyst [email protected] Operating all major types of dry bulk vessel (Capesize, Panamax, Handymax and Handysize), Sinotrans should have diversified gains from the rising market. We Key data think balance-sheet strength will support dividend payout surprise in 2016 (DPS of US¢0.51, even in a loss-making year), and likely upside in dividend payout for Target price (HKD) 2.33 2017E-2018E. We initiate coverage at BUY with a target price of HKD2.33, based Closing price (HKD as of 21 Mar) 1.98 on 0.67x PB (three-year historical average +2SD). We think a premium is Upside +/- (%) 18 deserved under the rising market and dividend payout upside. Mkt cap (USDmn) 1,018 6m avg daily val (USDmn) 1.32 Industry tailwinds; return to profit in 2017 52wk price range (HKD) 1.98/1.11 We expect favorable supply-demand balance to boost dry bulk shipping rates. After two loss-making years, we expect an earnings upcycle at Sinotrans from BVPS (USD) 0.45 2017, and forecast net profit of USD15mn in 2017E (2016: net loss of USD230mn). In our view, Sinotrans will benefit from industry tailwinds, as well as Share performance sustainable earnings from its Intra-Asia container business and new LNG (HKD) (%) business via JV. 2.0 60 1.8 38 Strong balance sheet to support dividend payout upside 1.6 15 Unlike peers, Sinotrans has consistently maintained a strong balance sheet and kept sufficient funds available to chart its long term development. We like the 1.3 (8) company’s net cash positon and lower depreciation cost after recognizing an 1.1 (30) impairment loss in 2016. We view its strong balance sheet as ample protection Mar-16 Jul-16 Nov-16 Mar-17 from both any need for high leverage and even insolvency. DPS of US¢0.51 was Share price Rel. to HSI (rhs) a surprise for 2016, and we expect no less than a 30% dividend payout in 2017E. Source: FactSet

Valuation still attractive after recent share price gains Our TP of HKD2.33 is based on a 0.67x PB multiple, a premium to its three-year historical average, and implying 18% share price upside. We think a premium is deserved, given: 1) the rising dry bulk market; and 2) consistently strong balance sheet with sufficient net cash on hand.

Risks to our view Downside risks: 1) higher-than-expected supply growth; 2) lower-than-expected demand growth; and 3) a slump in dry bulk rate.

Financials

YE 31 Dec FY15 FY16 FY17E FY18E FY19E Revenue (USDmn) 1,000 841 963 1,082 1,184 yoy% (17.2) (15.8) 14.4 12.4 9.5 Net profit (USDmn) (66) (230) 15 46 65 yoy% nm nm nm 196.2 41.3 EPS (diluted, USD) (0.017) (0.058) 0.004 0.011 0.016 PE (x) (15.3) (4.4) 65.8 22.2 15.7 PB (x) 0.5 0.6 0.6 0.6 0.5 EV EBITDA (x) (36.1) (3.4) 16.0 10.8 9.1 Dividend yield (%) 0.0 2.0 0.0 0.0 0.0 Free cashflow yield (%) (15.4) (7.9) (11.5) 0.2 1.6 Source: Company data, Huatai HK Research estimates

Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 19 Please refer to end pages for analyst certification and required disclosures.

Sinotrans Shipping (368 HK)

Investment thesis We initiate coverage of Sinotrans Shipping at BUY with a target price of HKD2.33, based on a 0.67x PB multiple (three-year historical average +2SD). The target price implies 18% share price upside. Our positive view is mainly driven by: 1) dry bulk shipping recovery to lead to positive earnings in 2017E; 2) strong balance sheet with net cash on hand, versus industry average net debt/equity average of 70%; and 3) dividend payout upside surprise in 2016-2017E.

Fig.41. Company structure (2016)

China Merchants Group

Sinotrans & CSC Holdings Co Ltd. (PRC)

Sinotrans Shipping Limited (HK)

Dry Bulk Container LNG Ship Management Others

Source: Company data, Huatai HK Research

Fig.42. Fleet structure (2016) Owned vessels Chartered vessels Total

Dry bulk vessels No. of vessels DWT (‘000) No. of vessels DWT (‘000) No. of vessels DWT (‘000) Capesize 9 1,609 2 362 11 1,971 Panamax 11 908 28 2,215 39 3,123 Handymax 13 773 11 650 24 1,423 Handysize 4 128 0 na 4 128 Sub-total of bulk vessels 37 3,418 41 3,227 78 6,645 Container vessels (TEU) No. of vessels TEU No. of vessels TEU No. of vessels TEU <1,000 6 4,196 5 2,774 11 6,970 1,001-2,000 5 5,341 7 9,945 12 15,286 2,001-3,000 na na 2 5,472 2 5,472 >3,000 na na 1 4,300 1 4,300 Sub-total of container vessels 11 9,537 18 27,352 29 36,889 Total vessels 48 na 59 na 107 na

Source: Company data, Huatai HK Research

Industry tailwinds; return to profit in 2017 According to our latest dry bulk shipping model, supply-demand growth appears to be re-balancing, following the market’s worse year for six years in 2016. We think the market has bottomed out and is tending towards an upward trend. We forecast a turnaround in Sinotrans’s earnings, following two years of losses (2015-2016). Strong recent gains in dry bulk rates and vessel values support our view of earnings recovery. The Baltic Dry Index (BDI) broke the 1,000 mark in early March, while spot charter rates across all vessels types has been trending up strongly since February.

We forecast the BDI will once again average above 1,000 in 2017, providing a strong catalyst for earnings upside at the company. Historically, Sinotrans’s earnings have correlated closely with the BDI and we estimate its cash breakeven is equivalent to a

23 March 2017 20

Sinotrans Shipping (368 HK)

BDI level of 600-650, and that its operating breakeven (operating expenses plus depreciation) is equivalent to BDI of 800-850.

Fig.43. Company share price vs Baltic Dry Index

(HKD) 3 1,400 Share price Baltic Dry Index (rhs) 1,200

1,000 2 800

600 1 400

200

0 0 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Source: Bloomberg, Huatai HK Research

Strong balance sheet to support dividend payout upside A strong balance sheet helped Sinotrans weather the industry downturn over the past two years. By end-2016, the company reported total available funds (cash and bank deposits) at USD644mn with interest bearing liabilities at USD71mn only. Under current market conditions, with the industry’s losses so severe, balance sheets at most regional peers are more precarious. Sinotrans has proposed a final dividend of HK¢4 in 2016, which was unexpected by many investors, considering the company’s net loss in 2016. Management guides that a stable dividend policy will be considered, given Sinotrans’s healthy financial position.

Fig.44. Interest bearing liabilities vs cash and equivalents

(USDmn) 800 Debt Cash and bank balance 700

600

500

400

300

200

100

0 2014 2015 2016 2017E

Source: Company report, Huatai HK Research estimates

Valuation still attractive after recent share price gains Our TP of HKD2.33 is based on a 0.67x PB multiple, a premium to its three-year historical average, and implying 18% share price upside. We think the share deserves a premium, given our view the dry bulk market is recovering, and its historical undervalued at 0.44x PB average vs 1.0x PB industry average.

23 March 2017 21

Sinotrans Shipping (368 HK)

Fig.45. 1-year forward PB Fig.46. forward PB vs ROE (x) (x) (%) 0.8 5 0.8

0.7 0.7 0

0.6 +1SD=0.53x 0.6 (5) 0.5 (10) 0.5 Avg=0.44x 0.4 0.4 (15)

0.3 0.3 (20) 0.2 (25) 0.2 -1SD=0.35x 0.1 0.1 (30)

0.0 0.0 (35) Jan-14 Jan-15 Jan-16 Jan-17 Jan-14 Jan-15 Jan-16 Jan-17 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research

23 March 2017 22

Sinotrans Shipping (368 HK)

Full financials

Income statement Cash flow statement YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Revenue 1,000 841 963 1,082 1,184 EBITDA (24) (185) 61 91 111 Cost of goods sold (1,030) (889) (925) (1,002) (1,081) Financing costs 12 5 7 6 6 Gross profit (31) (47) 38 80 104 Chg in working capital 27 107 (19) (9) (5) Selling and distrib cost (36) (34) (39) (44) (48) Tax (8) (1) 1 2 3 Admin expenses 0 0 0 0 0 Other 12 91 (15) (7) (8) Others oper inc/exp (19) (164) 8 (1) (1) Operating cash flow 19 16 33 83 107 Operating profit (86) (246) 6 35 54 Capital expenditure (176) (96) (151) (81) (91) Financial cost-net 12 5 7 6 6 Other investing activ's 170 235 90 15 (15) Share of P&L of assoc 0 0 3 5 5 Investing cash flow (7) 139 (61) (66) (106) Others inc/exp 0 0 0 0 0 Increase in debt (6) (8) (3) (11) (2) Profit before tax (74) (241) 16 46 65 Increase in equity 0 0 0 0 0 Tax expense (8) (1) 1 2 3 Dividends paid (41) (20) (20) (20) (20) Minority interest/other 15 13 (1) (3) (4) Other financing activ's (8) 2 2 2 2 Net profit (66) (230) 15 46 65 Financing cash flow (55) (26) (22) (29) (21) Depr and amortization 62 60 55 56 57 Change in cash (43) 128 (49) (12) (19) EBITDA (24) (185) 61 91 111 Cash at start of year 202 155 283 235 223 EPS (USD basic) (0.017) (0.058) 0.004 0.011 0.016 Effect of forex rate chg (4) 0 0 0 0 Year-end cash 155 283 235 223 204

Balance sheet YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Inventories 16 18 17 19 20 Acc & bill receivable 301 157 185 207 227 Cash & cash equiv 508 644 595 584 564 Other current assets 26 36 40 40 41 Total current assets 852 855 837 850 852 Fixed assets 1,292 1,105 1,202 1,227 1,260 Intangible assets 1 3 2 2 2 Other long-term assets 208 111 48 62 107 Total long-term assets 1,501 1,219 1,251 1,291 1,369 Total assets 2,353 2,074 2,089 2,141 2,222 Performance Accounts payable 214 178 186 201 217 YE 31 Dec FY15 FY16 FY17E FY18E FY19E Short-terms loans 8 8 8 8 8 Growth (%) Other liabilities 4 22 23 25 27 Revenue (17.2) (15.8) 14.4 12.4 9.5 Total current liabs 225 209 217 234 252 Gross profit n/m n/m n/m 113.3 29.2 Long-term debt 71 63 60 49 47 Operating profit n/m n/m n/m 476.5 55.2 Other long-term liabs 0 6 0 0 0 Net profit n/m n/m n/m 196.2 41.3 Total long-term liabs 71 69 60 49 47 EPS n/m n/m n/m 196.2 41.3 Equity 1,878 1,878 1,878 1,878 1,878 Profitability ratios (%) Reserves/other items 157 (90) (74) (28) 36 Gross profit (3.1) (5.6) 3.9 7.4 8.8 Shareholder equity 2,035 1,788 1,804 1,850 1,915 EBITDA (2.4) (22.0) 6.3 8.4 9.4 Minority interest 22 8 8 8 8 Net profit (6.6) (27.3) 1.6 4.2 5.5 Total equity 2,057 1,796 1,812 1,858 1,923 ROE (3.2) (12.0) 0.9 2.5 3.4 BVPS (USD basic) 0.51 0.45 0.45 0.46 0.48 ROA (2.7) (10.4) 0.7 2.2 3.0

Solvency (x) Net gearing ratio (%) (20.9) (31.9) (29.1) (28.3) (26.5) Current ratio 3.8 4.1 3.9 3.6 3.4 Valuation Quick ratio 3.7 4.0 3.8 3.5 3.3 YE 31 Dec (x) FY15 FY16 FY17E FY18E FY19E Operating capability (days) PE (14.5) (4.2) 62.1 21.0 14.8 Total assets t/o ratio (x) 0.4 0.4 0.5 0.5 0.5 PB 0.5 0.5 0.5 0.5 0.5 Receivable 108 67 69 69 69 EV EBITDA (23.0) (2.1) 7.3 4.9 4.1 Payable 75 72 72 72 72 Dividend yield (%) 0.0 2.1 0.0 0.0 0.0 Inventory 6 7 7 7 7 FCF yield (%) (16.3) (8.4) (12.2) 0.2 1.7 Cash conversion cycle 39 2 3 3 3 Source: Company data, Huatai HK Research estimates

23 March 2017 23

Orient Overseas Internati onal ( 316 H K; T P H KD51.20; BUY)

Orient Overseas International (316 HK) Equity Research

Huatai Research

23 March 2017

Equity | Hong Kong | Marine Shipping Our top pick in liners; profitable with valuation attractive, BUY BUY | TP HKD51.20

Initiation

Lisa LIN +86 21 2897 2209 Initiate at BUY with a target price of HKD51.20 Analyst [email protected] Our top pick in liners, Orient Overseas International (OOIL), is historically one of Xiaofeng SHEN +86 21 2897 2088 the most profitable in the region. Record-low freight rates and OOIL’s loss-making Analyst [email protected] 2016 were caused by secular choppiness which has now subsided, in our view, and we forecast 2017E net profit of USD178mn driven by: 1) strong rate recovery Key data on all main routes; and 2) potential revenue upside and expanded network Target price (HKD) 51.20 coverage from joining the Ocean Alliance. We initiate coverage at BUY with a Closing price (HKD as of 21 Mar) 43.50 target price of HKD51.20, based 0.88x PB (five-year historical average +1SD). We view the current valuation of 0.77x PB as still attractive, given the rising Upside +/- (%) 18 market and its premium profitability comparing to its peers. Mkt cap (USDmn) 3,505 6m avg daily val (USDmn) 4.55 Strong rates to drive earnings; turnaround to profit in 2017 52wk price range (HKD) 46.50/26.00 Driven by rising spot rates, we expect an earnings turnaround at OOIL this year. BVPS (USD) 7.22 We see the biggest improvements coming on long-haul routes (Far East – North America and Far East – Europe), where OOIL has greatest exposure (30% and Share performance 25% capacity deployed, respectively). We forecast 8% yoy growth in average (HKD) (%) revenue per TEU, which supports our net profit estimate for OOIL of USD178mn 50 70 in 2017E. 44 45 38 20 Tailwinds from Ocean Alliance: on course for revenue upside 31 (5) OOIL’s desertion from the G6 to the Ocean Alliance positions the company among top-tier liners, in our view. As we see it, OOIL will benefit from Ocean 25 (30) Mar-16 Jul-16 Nov-16 Mar-17 alliance as: 1) it will be able to extend network coverage on Middle East routes, Share price where no capacity was deployed by G6; and 2) offering more destinations to Rel. to HSI (rhs) customers could bring in more business and add revenue upside. Source: FactSet

Peer-leading profitability: valuation attractive At a discount to industry average 1.0x PB, the stock’s 0.77x PB is still attractive, in our view, given the rising market and OOIL’s premium profitability. Our target price of HKD51.2 is based 0.88x PB (five-year historical average +1SD).

Risks to our view Downside risks: 1) US protectionism; 2) net capacity growth higher than expected; and 3) sluggish economic growth.

Financials YE 31 Dec FY15 FY16 FY17E FY18E FY19E Revenue (USDmn) 5,953 5,298 6,023 6,300 6,924 yoy% (8.7) (11.0) 13.7 4.6 9.9 Net profit (USDmn) 284 (219) 178 279 406 yoy% 4.9 nm nm 56.9 45.9 EPS (diluted, USD) 0.454 (0.350) 0.284 0.445 0.649 PE (x) 12.3 (16.0) 19.7 12.6 8.6 PB (x) 0.7 0.8 0.7 0.7 0.7 EV EBITDA (x) 283.8 (22.1) (83.4) (204.7) 196.0 Dividend yield (%) 2.0 0.0 0.0 0.0 0.0 Free cashflow yield (%) (9.6) (21.2) (11.2) (3.7) 1.1 Source: Company data, Huatai HK Research estimates

Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 24 Please refer to end pages for analyst certification and required disclosures.

Orient Overseas International (316 HK)

Investment thesis We initiate our coverage of Orient Overseas (International) Limited (OOIL) at BUY with a target price of HKD51.2 based on a 0.88x PB multiple (five-year historical average +1SD). Our positive view is mainly driven by: 1) strong rate recovery in the container shipping industry, which should lead to positive earnings from 2017 onwards; and 2) the benefits we expect OOIL’s membership of the Ocean alliance will bring (extended route coverage and potential revenue upside).

Fig.47. Revenue by route (2016) Fig.48. Capacity deployed by route (2016) Trans- Intra-FE Intra-Europe Asia-Europe Atlantic ANZ/Oceania 12% 1% 16% 11% related Idle 11% 4% Others 1% Europe-N Am 1% ME/ISC related 15% FE-N Am Trans-Pacific 30% Intra- 37% Asia/Australasia 36%

FE-Europe 25% Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research

Strong rates to drive earnings; turnaround to profit in 2017 Spot freight rates appear to have bottomed out on a range of main routes since the second half of 2016. Although the freight market is still far from robust, we think industry earnings are heading towards positive territory. We estimate 8% yoy on average growth in revenue per TEU in 2017E-2018E, which we forecast will drive positive earnings from 2017 onwards, with 3.78% ROE in 2017E, versus -4.85% ROE in 2016.

Fig.49. Average revenue per TEU (USD) 1,200

1,000

800

600

400

200

0 1H14 2H14 1H15 2H15 1H16 2H16 2017E 2018E Source: Company data, Huatai HK Research

Tailwinds from Ocean alliance: on course for revenue upside We like OOIL’s smart move over to the Ocean alliance, where it joins the third- fourth- and fifth-largest liners globally (by capacity). Along with 2M and THE alliance, the newly established Ocean alliance will be one of most powerful, giving OOIL access to a larger service network on the Transpacific and Middle East routes. We believe revenue upside could come from new business that arises from OOIL being able to offer more destinations to customers via the alliance network.

23 March 2017 25

Orient Overseas International (316 HK)

Fig.50. Weekly services by Ocean Alliance and G6

10 Ocean Alliance G6 9 8 7 6 5 4 3 2 1 0 Asia Europe Asia Europe Trans pacific Trans pacific US East Coast TransAtlantic Middle East Med PNW PSW Note: PNW - Pacific Northwest, PSW – Pacific Southwest Source: Company data, Huatai HK Research

Valuation attractive, trading below book value and industry average The stock is currently trading at 0.77x PB, which is below its book value and at a discount to the global industry average of 1.0x PB. Our target price of HKD51.2 is based on 0.88x PB (five-year historical +1SD). Given the current rising market condition, and OOIL’s firm ROE upside potential, we think the stock is being undervalued.

Fig.51. Rolling PB Fig.52. Rolling PB vs ROE (x) (x) (%)

1.2 1.2 10 5 1.0 1.0 +1SD=0.88 0 X 0.8 Avg=0.73x 0.8 (5) (10) 0.6 0.6 -1SD=0.59x (15) 0.4 0.4 (20) (25) 0.2 0.2 (30) 0.0 0.0 (35) Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research

23 March 2017 26

Orient Overseas International (316 HK)

Full financials

Income statement Cash flow statement YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Revenue 5,953 5,298 6,023 6,300 6,924 EBITDA 38 (499) (148) (60) 60 Cost of goods sold (5,262) (5,032) (5,541) (5,733) (6,231) Financing costs (64) (79) (58) (53) (50) Gross profit 691 265 482 567 692 Chg in working capital (61) (42) (197) (56) (137) Selling and distrib cost (357) (422) (271) (252) (242) Tax (23) (20) (15) (23) (33) Admin expenses 0 0 0 0 0 Other 569 709 837 874 912 Others oper inc/exp 20 19 20 20 20 Operating cash flow 458 68 420 682 751 Operating profit 353 (138) 231 335 470 Capital expenditure (796) (812) (812) (812) (712) Financial cost-net (64) (79) (58) (53) (50) Other investing activ's 522 864 107 314 328 Share of P&L of assoc 18 18 20 20 20 Investing cash flow (274) 52 (705) (498) (384) Others inc/exp 0 0 0 0 0 Increase in debt (80) (99) (426) (203) (231) Profit before tax 307 (200) 192 302 440 Increase in equity 0 0 0 0 0 Tax expense (23) (20) (15) (23) (33) Dividends paid (82) (12) 0 0 0 Minority interest/other 0 0 0 0 0 Other financing activ's (224) (130) 102 (147) (106) Net profit 284 (219) 178 279 406 Financing cash flow (386) (240) (324) (350) (337) Depr and amortization 319 368 386 403 418 Change in cash (202) (119) (609) (166) 30 EBITDA 38 (499) (148) (60) 60 Cash at start of year 1,943 1,738 1,625 1,016 850 EPS (USD basic) 0.454 (0.350) 0.284 0.445 0.649 Effect of forex rate chg (3) 7 0 0 0 Year-end cash 1,738 1,625 1,016 850 880

Balance sheet YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Inventories 72 84 121 126 137 Acc & bill receivable 499 474 495 518 569 Cash & cash equiv 2,016 1,627 1,017 851 881 Other current assets 329 381 212 194 206 Total current assets 2,917 2,566 1,846 1,688 1,793 Fixed assets 6,021 6,077 6,581 6,836 6,976 Intangible assets 56 60 66 70 74 Other long-term assets 738 702 775 775 775 Total long-term assets 6,815 6,839 7,422 7,681 7,825 Total assets 9,732 9,405 9,267 9,369 9,617 Performance Accounts payable 750 696 835 864 939 YE 31 Dec FY15 FY16 FY17E FY18E FY19E Short-terms loans 439 601 451 429 407 Growth (%) Other liabilities 20 15 17 17 19 Revenue (8.7) (11.0) 13.7 4.6 9.9 Total current liabs 1,209 1,313 1,303 1,310 1,365 Gross profit 7.0 (61.6) 81.5 17.7 22.1 Long-term debt 3,663 3,489 3,213 3,033 2,823 Operating profit 7.3 n/m n/m 45.1 40.3 Other long-term liabs 62 83 55 52 48 Net profit 4.9 n/m n/m 56.9 45.9 Total long-term liabs 3,725 3,572 3,268 3,084 2,871 EPS 4.9 n/m n/m 56.9 45.9 Equity 63 63 63 63 63 Profitability ratios (%) Reserves/other items 4,735 4,457 4,634 4,913 5,319 Gross profit 11.6 5.0 8.0 9.0 10.0 Shareholder equity 4,798 4,519 4,697 4,975 5,382 EBITDA 0.6 (9.4) (2.5) (1.0) 0.9 Minority interest 0 0 0 0 0 Net profit 4.8 (4.1) 2.9 4.4 5.9 Total equity 4,798 4,519 4,697 4,975 5,382 ROE 6.0 (4.7) 3.9 5.8 7.8 BVPS (USD basic) 7.67 7.22 7.51 7.95 8.60 ROA 2.9 (2.3) 1.9 3.0 4.3

Solvency (x) Net gearing ratio (%) 43.5 54.5 56.4 52.5 43.6 Current ratio 2.4 2.0 1.4 1.3 1.3 Valuation Quick ratio 2.4 1.9 1.3 1.2 1.2 YE 31 Dec (x) FY15 FY16 FY17E FY18E FY19E Operating capability (days) PE 12.3 (16.0) 19.7 12.6 8.6 Total assets t/o ratio (x) 0.6 0.6 0.6 0.7 0.7 PB 0.7 0.8 0.7 0.7 0.7 Receivable 30 32 30 30 30 EV EBITDA 283.8 (22.1) (83.4) (204.7) 196.0 Payable 51 50 54 54 54 Dividend yield (%) 2.0 0.0 0.0 0.0 0.0 Inventory 5 6 8 8 8 FCF yield (%) (9.6) (21.2) (11.2) (3.7) 1.1 Cash conversion cycle (16) (12) (17) (17) (17) Source: Company data, Huatai HK Research estimates

23 March 2017 27

Cosco Shi ppi ng Hol dings ( 1919 H K; T P H KD3.46; H OLD)

Cosco Shipping Holdings (1919 HK) Equity Research

Huatai Research

23 March 2017

Equity | China | Marine Shipping Positive outlook, valuation fair, initiate at HOLD HOLD | TP HKD3.46

Initiation

Lisa LIN +86 21 2897 2209 Initiate at HOLD with target price of HKD3.46 Analyst [email protected] We expect Cosco Shipping Holdings (Cosco) to return to profit in 2017E, Xiaofeng SHEN +86 21 2897 2088 supported by a freight rate recovery that began in 2H16 and will be sustained, in Analyst [email protected] our view, by high rates of idling and scrapping continuing into 2017. We initiate coverage at HOLD with a target price of HKD3.46, based on 1.50x PB (three-year Key data historical average +1SD). As a Chinese flag line and A+H listed company, Cosco has historically traded at a premium to peers, and we think the current valuation Target price (HKD) 3.46 fair under the rising market and earnings upside, and taking into account our Closing price (HKD as of 21 Mar) 3.63 cautious view on Cosco’s aggressive expansion. Upside +/- (%) (5) Mkt cap (USDmn) 4,775 Earnings upside driven by strong freight rate recovery 6m avg daily val (USDmn) 9.14 We think industry profitability is heading into a positive territory after its most 52wk price range (HKD) 3.93/2.58 challenging year in 2016. Spot freight rates appeared to have bottomed out on a BVPS (RMB) 2.78 range of main routes since 2H16. We expect strong earnings upside at Cosco in 2017, and forecast net profit of RMB771mn, a turnaround from a net loss of RMB9.9bn in 2016E. Share performance (HKD) (%) World’s fourth-largest liner, founding member of Ocean alliance 4.0 15 After asset restructuring with CSCL in 2016, Cosco became the fourth-largest 3.6 5 liner globally in capacity, and a founding member of Ocean alliance. We think 3.2 (5) membership of the alliance give Cosco the benefit of extended network coverage 2.8 (15) and more frequent line services, both of which could attract new business and 2.4 (25) customers. Mar-16 Jul-16 Nov-16 Mar-17 Share price Rel. to HSI (rhs) Trading at a premium to peers, valuation looks fair now Source: FactSet As a Chinese flag line and A+H listed company, Cosco has historically traded at a premium to its peers. We think rising freight rates are reflected in the recent stock hikes, and base our target price of HKD3.46 for Cosco on 1.50x PB (three-year historical average +1SD). We think our valuation is fair, given the rising market and earnings upsides.

Risks to our view Upside risks: 1) demand stronger than expected; and 2) further industry consolidation driving freight rate hikes. Downside risks: 1) US protectionism; and 2) sluggish economic growth.

Financials YE 31 Dec FY14 FY15 FY16E FY17E FY18E Revenue (RMBmn) 66,901 57,404 63,285 69,179 75,903 yoy% - (14.2) 10.2 9.3 9.7 Net profit (RMBmn) 363 283 (9,869) 771 1,769 yoy% - (21.8) nm nm 129.4 EPS (diluted, RMB) 0.035 0.028 (0.966) 0.076 0.173 PE (x) 90.9 116.2 (3.3) 42.7 18.6 PB (x) 1.4 1.2 1.6 1.6 1.5 EV EBITDA (x) 34.5 28.7 (524.4) 29.8 27.7 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 Free cashflow yield (%) (2.8) (1.6) (20.0) (12.7) (15.5) Source: Company data, Huatai HK Research estimates

Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 28 Please refer to end pages for analyst certification and required disclosures.

Cosco Shipping Holdings (1919 HK)

Investment thesis We initiate our coverage of Cosco Shipping Holdings at HOLD. Our target price of HKD3.46 is based on 1.50x PB (three-year historical average +1SD). Our positive view is mainly driven by strong freight rate recovery since 2H16 and we think the upside trend is sustainable, with support coming from high idling and scrapping rates continuing into 2017, in our view.

Fig.53. Company structure (2016)

China Cosco Shipping Corporation Limited

100%

Cosco Group 45.47%

Cosco Shipping Holdings （A+H） （601919 CH,1919 HK）

100% 46.72%

Cosco Shipping Holding（A+H） Cosco Shipping Ports （601919 CH,1919 HK） （Cosco Pacific，1199 HK）

Source: Company data, Huatai HK Research

Fig.54. Fleet structure (2016) Owned Chartered in Total No. of No. of No. of Fleet (TEU) Capacity vessels Capacity vessels Capacity vessels >15,000 - - 94,910 5 94,910 5 10,000-15,000 187,416 16 331,600 26 519,016 42 8,000-10,000 - - 350,743 39 350,743 39 6,000-8,000 - - 12,464 2 12,464 2 4,000-6,000 188,982 40 295,646 63 484,628 103 2,000-4,000 3,400 1 40,531 17 43,931 18 <2,000 15,324 12 88,215 80 103,539 92 Total 395,122 69 1,214,109 232 1,609,231 301

Source: Company data, Huatai HK Research

23 March 2017 29

Cosco Shipping Holdings (1919 HK)

Earnings upside driven by strong freight rates recovery Spot freight rates appear to have bottomed out on a range of main routes since the second half of 2016. Although the freight market is still far from robust, we think industry earnings are heading into positive territory. We forecast net profit of RMB771mn in 2017E, a turnaround from a net loss of RMB9.9bn in 2016E, and expect profitability to accelerate into 2018E.

Fig.55. Capacity by route (1H16) Fig.56. Revenue by route (1H16) Lat Am Sub-Saharan ANZ/Oceania China Other int'l related Africa related related Eur-N.Am 16% markets 8% 4% 4% 1% (incl. Atlantic ME/ISC Ocean) related Intra-Europe 8% 9% 1% Intra-Asia (incl. Idle Australia) 1% 21% Intra-FE FE-Europe 20% Trans-Pacific 28% 31%

Asia - Europe (Med) FE-N Am 24%

24% Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research

Trading at a premium to peers, valuation looks fair now As a Chinese flag line and A+H listed company, Cosco has historically traded at a premium to peers. We think recent stock hikes have priced in rising freight rates. We base our target price of HKD3.46 on 1.50x PB (three-year historical average +1SD). We think the valuation is fair under the rising marketing and earnings upcycle.

Fig.57. 1-year forward PB Fig.58. 12-month forward PB vs ROE

(x) (x) (%) 3.0 3.0 10 5 2.5 2.5 0 2.0 2.0 (5) +1SD=1.50x (10) 1.5 1.5 Avg=1.22x (15) 1.0 1.0 (20)

-1SD=0.95x (25) 0.5 0.5 (30) 0.0 0.0 (35) Jan-14 Jan-15 Jan-16 Jan-17 Jan-14 Jan-15 Jan-16 Jan-17

Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research

23 March 2017 30

Cosco Shipping Holdings (1919 HK)

Full financials

Income statement Cash flow statement YE 31 Dec (RMBmn) FY14 FY15 FY16E FY17E FY18E YE 31 Dec (RMBmn) FY14 FY15 FY16E FY17E FY18E Revenue 66,901 57,404 63,285 69,179 75,903 EBITDA 5,169 7,297 (273) 4,737 5,245 Cost of goods sold (62,877) (55,243) (65,102) (65,687) (71,081) Financing costs 1,901 2,842 2,263 1,030 1,357 Gross profit 4,024 2,161 (1,817) 3,491 4,822 Chg in working capital (693) (67) 580 (870) (114) Selling and distrib cost (4,308) (4,293) (3,130) (3,255) (3,500) Tax 1,044 (457) (478) (351) (590) Admin expenses 0 0 0 0 0 Other 3,785 4,399 (4,246) 473 701 Others oper inc/exp 1,327 5,369 350 1,000 1,300 Operating cash flow 6,037 6,717 (1,881) 282 1,354 Operating profit 1,043 3,237 (4,597) 1,236 2,621 Capital expenditure (6,958) (7,228) (4,698) (4,463) (6,471) Financial cost-net (1,901) (2,842) (2,263) (1,030) (1,357) Other investing activ's 6,323 457 11,239 5,700 3,786 Share of P&L of assoc 1,366 1,361 1,362 1,547 1,684 Investing cash flow (635) (6,770) 6,541 1,237 (2,685) Others inc/exp 0 0 0 0 0 Increase in debt (10,508) (5,067) (26,667) (2,231) 2,421 Profit before tax 507 1,756 (5,498) 1,753 2,949 Increase in equity (129) (11) 0 0 0 Tax expense 1,044 (457) (478) (351) (590) Dividends paid (333) (451) 0 0 0 Minority interest/other (1,188) (1,508) (754) (631) (590) Other financing activ's (2,891) (2,161) 21,789 1,060 (199) Net profit 363 283 (9,869) 771 1,769 Financing cash flow (13,860) (7,690) (4,878) (1,171) 2,222 Depr and amortization 4,115 4,048 2,834 2,777 2,916 Change in cash (8,458) (7,744) (218) 348 891 EBITDA 5,169 7,297 (273) 4,737 5,245 Cash at start of year 48,206 39,705 32,690 32,473 32,821 EPS (RMB basic) 0.035 0.028 (0.966) 0.076 0.173 Effect of forex rate chg (43) 729 0 0 0 Year-end cash 39,705 32,690 32,473 32,821 33,712

Balance sheet YE 31 Dec (RMBmn) FY14 FY15 FY16E FY17E FY18E Inventories 1,927 1,502 1,653 2,066 2,479 Acc & bill receivable 7,722 10,508 13,871 15,162 16,636 Cash & cash equiv 40,571 33,930 32,773 33,121 34,012 Other current assets 500 270 0 0 0 Total current assets 50,720 46,211 48,296 50,349 53,127 Fixed assets 82,509 88,370 2,103 2,143 2,205 Intangible assets 107 163 150 150 150 Other long-term assets 15,453 25,291 71,733 70,213 73,776 Total long-term assets 98,069 113,824 73,986 72,506 76,131 Total assets 148,788 160,035 122,281 122,855 129,258 Performance Accounts payable 15,377 17,836 21,403 21,596 23,369 YE 31 Dec FY14 FY15 FY16E FY17E FY18E Short-terms loans 18,886 11,171 12,588 12,400 11,960 Growth (%) Other liabilities 1,711 897 1,007 992 957 Revenue - (14.2) 10.2 9.3 9.7 Total current liabs 35,975 29,905 34,999 34,988 36,286 Gross profit - (46.3) n/m n/m 38.1 Long-term debt 68,057 75,293 47,210 45,167 48,029 Operating profit - 210.4 n/m n/m 112.0 Other long-term liabs 1,799 1,847 944 903 961 Net profit - (21.8) n/m n/m 129.4 Total long-term liabs 69,855 77,141 48,154 46,071 48,989 EPS - (21.8) n/m n/m 129.4 Equity 10,216 10,216 10,216 10,216 10,216 Profitability ratios (%) Reserves/other items 14,163 18,191 9,953 10,725 12,494 Gross profit 6.0 3.8 (2.9) 5.0 6.4 Shareholder equity 24,379 28,408 20,169 20,941 22,710 EBITDA 7.7 12.7 (0.4) 6.8 6.9 Minority interest 18,579 24,582 18,959 20,855 21,272 Net profit 0.5 0.5 (15.6) 1.1 2.3 Total equity 42,958 52,990 39,129 41,796 43,983 ROE - 1.1 (40.6) 3.8 8.1 BVPS (RMB basic) 2.39 2.78 1.97 2.05 2.22 ROA - 0.2 (7.0) 0.6 1.4

Solvency (x) Net gearing ratio (%) 107.9 99.1 69.1 58.5 59.1 Current ratio 1.4 1.5 1.4 1.4 1.5 Valuation Quick ratio 1.4 1.5 1.3 1.4 1.4 YE 31 Dec (x) FY14 FY15 FY16E FY17E FY18E Operating capability (days) PE 90.9 116.2 (3.3) 42.7 18.6 Total assets t/o ratio (x) 0.4 0.4 0.5 0.6 0.6 PB 1.4 1.2 1.6 1.6 1.5 Receivable 42 66 79 79 79 EV EBITDA 34.5 28.7 (524.4) 29.8 27.7 Payable 88 116 118 118 118 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 Inventory 11 10 9 11 13 FCF yield (%) (2.8) (1.6) (20.0) (12.7) (15.5) Cash conversion cycle (35) (41) (30) (28) (27) Source: Company data, Huatai HK Research estimates

23 March 2017 31

Paci fic Basi n Shi ppi ng Li mited (2343 HK; TP H KD 1.82; HOLD)

Pacific Basin Shipping Limited (2343 HK) Equity Research

Huatai Research

23 March 2017

Equity | Hong Kong | Marine Shipping Long passage to earnings turnaround in 2018E, HOLD HOLD | TP HKD1.82

Initiation

Lisa LIN +86 21 2897 2209 Initiate at HOLD with target price of HKD1.82 Analyst [email protected] As a world-leading owner-operator of modern Handysize and Supramax dry bulk Xiaofeng SHEN +86 21 2897 2088 ships, Pacific Basin Shipping Limited (Pacific Basin) is one of the best operators Analyst [email protected] of minor bulk shipping, achieving premium earnings through high utilization of quality vessels. However, given our cautious view on the pace of rate recovery in Key data the smaller-vessel segment, Pacific Basin’s focus, we think rising freight rates will Target price (HKD) 1.82 only be sufficient to narrow losses year on year in 2017E; we forecast an Closing price (HKD as of 21 Mar) 1.82 earnings turnaround in 2018E. Our target price of HKD1.82 is based on 0.92x PB (three-year historical average +1SD). We think the valuation is fair under the Upside +/- (%) 0 rising market and improving earnings, and initiate coverage at HOLD. Mkt cap (USDmn) 941 6m avg daily val (USDmn) 4.87 Industry recovery tailwinds; cautious on smaller-vessel segment 52wk price range (HKD) 1.91/0.72 Despite the strong rate rises recently in dry bulk shipping (BDI broke 1,000 points BVPS (USD) 0.32 in early March), we expect the industry recovery to be at too slow pace for Pacific Basin to return to profit in 2017. We forecast earnings improvement to a net loss Share performance of USD17mn in 2017E (2016: net loss of USD87mn), followed by a turnaround starting in 2018, when we expect net profit of USD9mn. However, we are cautious (HKD) (%) 2.0 120 on smaller vessels (Handymax and Handysize), Pacific Basin’s focal segment. We think there is downside risk on smaller-vessel freight rates driven by a large 1.7 85 number of orders becoming due for delivery this year. Once delivered vessels are 1.3 50 deployed, there will be limited room for rate rises, in our view. 1.0 15 0.6 (20) Post share price hike, valuation looks fair Mar-16 Jul-16 Nov-16 Mar-17 We think the stock’s 50% ytd hike reflects recovery in the dry bulk market and the Share price premium rates available under Pacific Basin’s cargo business model. The stock is Rel. to HSI (rhs) at a 30% premium to its three-year historical average PB. We base our target Source: FactSet

price of HKD1.82 on 0.92x PB (three-year historical average +1SD), and think the current valuation fair, with industry recovery and earnings improvement priced in.

Risks to our view Upside risks: 1) greater infrastructure investment globally; and 2) higher ship scrapping and limited new deliveries. Downside risks: 1) reduction in demand for dry bulk shipping; and 2) an increase in new ship ordering.

Financials YE 31 Dec FY15 FY16 FY17E FY18E FY19E Revenue (USDmn) 1,260 1,087 1,486 1,664 1,858 yoy% (26.7) (13.7) 36.6 12.0 11.6 Net profit (USDmn) (19) (87) (17) 9 73 yoy% nm nm nm nm 708.2 EPS (diluted, USD) (0.010) (0.026) (0.004) 0.002 0.018 PE (x) (24.2) (8.9) (55.4) 104.4 12.9 PB (x) 0.5 0.7 0.9 0.9 0.8 EV EBITDA (x) 20.2 58.7 28.7 21.1 13.8 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 Free cashflow yield (%) (10.7) (17.1) (6.9) 5.3 6.8 Source: Company data, Huatai HK Research estimates

Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 32 Please refer to end pages for analyst certification and required disclosures.

Pacific Basin Shipping Limited (2343 HK)

Investment thesis We initiate our coverage of Pacific Basin at HOLD with a target price of HKD1.82, based on a 0.92x PB multiple, sets at one standard deviation above its three-year historical PB. The share price is up by 50% ytd, reflecting recovery in the dry bulk market and the premium rates from the company’s cargo business model. We view the current valuation as fair.

A leading operator of pure modern Handysize and Supramax vessels As one of the world’s leading owners and operators of modern Handysize and Supramax dry bulk ships, Pacific Basin is one of the best operators in minor bulk shipping and is able to achieve premium earnings through the high utilization of quality vessels which combine minor bulk cargo trades. Among the world’s vessels that are less than 20 years old, Pacific Basin operates about 6% of the Handysize type and 3% of the Supramax type.

Fig.59. Market share by company: Handysize Fig.60. Market share by company: Supramax

Pacific Basin Pacific Basin 3% 6%

Others 67% Others Other Top- 76% 10 21% Other Top- 10 27%

Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research

Shipping rates rising, but not enough in Pacific Basin’s segments Despite the strong rate rise recently in the dry bulk segment, we expect the industry recovery to be at a pace too slow to return Pacific Basin to profit in 2017. We forecast earnings improvement, with a net loss of USD17mn in 2017E from a net loss of USD87mn in 2016, then a turnaround starting from 2018 with USD9mn net profit forecast in 2018E.

We see downside risks on shipping rate rise for Handysize vessels, the major focus of Pacific Basin’s business. We project a large number of vessel orders placed within small vessel type (Handysize) will be becoming due for delivery in 2017. Rate rises would likely be limited once new deliveries are deployed.

23 March 2017 33

Pacific Basin Shipping Limited (2343 HK)

Fig.61. Spot charter rates Fig.62. Five-year secondhand vessel prices (2011-now)

(USD'000) (USDmn) 18 Handymax Handysize 30 Handymax Handysize 16 25 14 12 20 10 15 8 6 10 4 5 2 0 0 2013 2014 2015 2016 2011 2012 2013 2014 2015 2016

Source: Clarksons, Huatai HK Research Source: Clarksons, Huatai HK Research

Post share price hike, valuation looks fair The stock’s 50% ytd hike reflects recovery in the dry bulk market and the premium rates available under Pacific Basin’s cargo business model, in our view. The stock is at a 30% premium to its three-year historical average PB. We base our target price of HKD1.82 on 0.92x PB (three-year historical average +1SD), and think the current valuation fair, with industry recovery and earnings improvement priced in.

Fig.63. 1-year forward PB Fig.64. 1-year forward PB vs ROE (x) (x) (%) 0.9 0.9 0 0.8 0.8 (5) 0.7 +1SD=0.68x 0.7 (10) 0.6 0.6 Avg=0.50x 0.5 0.5 (15)

0.4 -1SD=0.33x 0.4 (20) 0.3 0.3 (25) 0.2 0.2 (30) 0.1 0.1 0.0 0.0 (35) 2014 2014 2014 2015 2015 2015 2016 2016 2016 2017 Jan-14 Jan-15 Jan-16 Jan-17 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research

23 March 2017 34

Pacific Basin Shipping Limited (2343 HK)

Full financials

Income statement Cash flow statement YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Revenue 1,260 1,087 1,486 1,664 1,858 EBITDA 118 44 116 140 199 Cost of goods sold (1,264) (1,142) (1,471) (1,614) (1,746) Financing costs (40) (34) (35) (32) (28) Gross profit (4) (54) 15 50 111 Chg in working capital 10 29 (3) (3) (5) Selling and distrib cost 0 0 0 0 0 Tax (1) (1) (0) 0 1 Admin expenses (6) (6) (8) (9) (10) Other 12 11 (18) (15) (58) Others oper inc/exp 28 6 9 (1) (3) Operating cash flow 99 50 60 90 108 Operating profit 18 (54) 16 40 98 Capital expenditure (146) (181) (125) (40) (44) Financial cost-net (35) (31) (33) (31) (27) Other investing activ's 92 83 16 29 32 Share of P&L of assoc 0 0 0 0 0 Investing cash flow (55) (99) (109) (11) (12) Others inc/exp 0 0 0 0 0 Increase in debt (265) (210) 32 (138) (64) Profit before tax (17) (86) (17) 9 72 Increase in equity 0 0 0 0 0 Tax expense (1) (1) (0) 0 1 Dividends paid (12) 0 0 0 0 Minority interest/other 0 0 0 0 0 Other financing activ's 177 228 228 228 228 Net profit (19) (87) (17) 9 73 Financing cash flow (100) 18 260 90 164 Depr and amortization (100) (99) (100) (100) (100) Change in cash (57) (31) 212 169 260 EBITDA 118 44 116 140 199 Cash at start of year 257 200 169 142 188 EPS (USD basic) (0.010) (0.026) (0.004) 0.002 0.018 Effect of forex rate chg (0) (0) (0) (0) (0) Year-end cash 200 169 381 311 448

Balance sheet YE 31 Dec (USDmn) FY15 FY16 FY17E FY18E FY19E Inventories 51 62 76 84 91 Acc & bill receivable 87 81 111 124 138 Cash & cash equiv 358 269 142 188 234 Other current assets 0 9 7 8 10 Total current assets 497 421 336 404 472 Fixed assets 1,611 1,653 1,819 1,655 1,690 Intangible assets 28 25 23 34 17 Other long-term assets 10 7 17 5 7 Total long-term assets 1,649 1,686 1,858 1,695 1,714 Total assets 2,146 2,107 2,194 2,099 2,186 Performance Accounts payable 117 141 181 199 215 YE 31 Dec FY15 FY16 FY17E FY18E FY19E Short-terms loans 293 96 91 109 164 Growth (%) Other liabilities 46 24 54 60 65 Revenue (26.7) (13.7) 36.6 12.0 11.6 Total current liabs 456 261 326 368 443 Gross profit n/m n/m n/m 236.0 123.3 Long-term debt 633 744 781 625 506 Operating profit n/m n/m n/m 149.7 146.8 Other long-term liabs 86 62 63 64 61 Net profit n/m n/m n/m n/m 708.2 Total long-term liabs 719 806 844 689 567 EPS n/m n/m n/m n/m 708.1 Equity 194 40 40 50 110 Profitability ratios (%) Reserves/other items 776 1,001 984 993 1,066 Gross profit (0.3) (5.0) 1.0 3.0 6.0 Shareholder equity 971 1,041 1,024 1,043 1,176 EBITDA 9.4 4.1 7.8 8.4 10.7 Minority interest 0 0 0 0 0 Net profit (1.5) (8.0) (1.1) 0.5 3.9 Total equity 971 1,041 1,024 1,043 1,176 ROE (1.9) (8.6) (1.6) 0.9 6.6 BVPS (USD basic) 0.51 0.32 0.25 0.26 0.29 ROA (0.8) (4.1) (0.8) 0.4 3.4

Solvency (x) Net gearing ratio (%) 58.5 54.8 71.3 52.3 37.1 Current ratio 1.1 1.6 1.0 1.1 1.1 Valuation Quick ratio 1.0 1.4 0.8 0.9 0.9 YE 31 Dec (x) FY15 FY16 FY17E FY18E FY19E Operating capability (days) PE (24.2) (8.9) (55.4) 104.4 12.9 Total assets t/o ratio (x) 0.6 0.5 0.7 0.8 0.8 PB 0.5 0.7 0.9 0.9 0.8 Receivable 25 27 27 27 27 EV EBITDA 20.2 58.7 28.7 21.1 13.8 Payable 33 44 44 44 44 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 Inventory 14 20 19 19 19 FCF yield (%) (10.7) (17.1) (6.9) 5.3 6.8 Cash conversion cycle 6 2 1 1 1 Source: Company data, Huatai HK Research estimates

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