17 June 2013 Asia Pacific/Japan Equity Research Transportation (Marine Transportation (Japan)) / OVERWEIGHT Japanese shipping sector Research Analysts INITIATION Davin Wu 852 2101 6917 [email protected] Shipping profits rise as yen sinks Timothy Ross Figure 1: Japan shipping P/B vs. ROE* 65 6212 3337 [email protected] 3.5x 30% Stock Rating TP Upside 25% 3.0x MOL OP 490 39% 20% 2.5x NYK OP 340 39% K-Line UP 180 -1% 15% 2.0x 10% 1.5x 5% 0% 1.0x -5% 0.5x -10% 0.0x -15% 2009 2007 2008 2010 2011 2012 2013 2014 PB (left) ROE (Right) Source: Company data, Credit Suisse estimates *Average of MOL, NYK and K-Line ■ Rising returns to lift valuations: Despite a strong rally, the shipping sector is trading at one standard deviation (STD) below its long-term mean P/B and 27% below its economic value. We believe a recovery in the dry bulk market driven by scrapping and yen weakness should support higher valuations. We see the fleet market value as a more appropriate valuation base, as we expect fluctuations in the yen to cause fleet value to deviate from book values. We base our target prices on a combination of ROE–P/B and economic values of business portfolios. ■ Long USD, short JPY: The Japanese shipping companies generate much more USD revenues than costs, having net long USD positions. We expect the yen’s depreciation to magnify a dry bulk market recovery; every ¥1 depreciation against the USD should lift the sector’s profit by 4.4% and stock valuations by 1.3%. A weak yen would also help reduce the sector’s leverage and improve its ability to service yen-denominated debt with USD receipts. ■ Buy MOL: We identify six catalysts for the sector: (1) sustained depreciation of the yen; (2) improving Japanese export data; (3) upward revisions to company profit guidance; (4) accelerating iron ore shipment to China due to a larger price discount for imported ore; (5) rebounding dry bulk shipping rates; and (6) resulting improvement in earnings. Our top pick is MOL (9104, OUTPERFORM, TP ¥490), followed by NYK (9101, OUTPERFORM, TP ¥340). MOL is most leveraged to currency movements and a dry bulk recovery. We expect its earnings improvement to be the most pronounced among all of the shipping companies we cover in Asia. We rate Kawasaki Kisen (K-Line; 9107, TP ¥180) UNDERPERFORM because of its high exposure to falling long-haul container shipping rates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. 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CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 17 June 2013 Focus charts and table Figure 2: Shipping group revenue by segment Figure 3: Proportion of capesize trading in spot market 100% 4% 35% 10% 11% 12% 90% 17% 0% 27% 30% 35% 80% 44% 30% 70% 45% 38% 25% 60% 25% 82% 23% 50% 100%100%100%100%100%100% 89% 55% 40% 83% 20% 30% 46% 51% 15% 20% 45% 42% 10% 10% 18% 14% 10% 10% 0% NYK NOL CSD MOL 5% OOIL CSCL Hanjin K-Line Maersk COSCO Wan HaiWan Sinotrans PacBasin Evergreen 0% Bulk Liners Others MOL NYK K-Line Source: Company data, Credit Suisse estimates *post-hedging Source: Company data, Credit Suisse estimates Figure 4: Capesize supply–demand growth Figure 5: Earnings estimates at different FX rates US$/day YoY JPY mn 100,000 25.0% 90,000 90,000 80,000 80,000 20.0% 70,000 70,000 60,000 60,000 15.0% 50,000 50,000 40,000 10.0% 40,000 30,000 30,000 20,000 5.0% 20,000 10,000 10,000 - 0.0% - MOL K-Line NYK 2013 2014 2015 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Capesize earnings (left) Demand Supply At JPY100/USD (base case) At JPY120/USD Source: Company data, Credit Suisse estimates Source: Credit Suisse estimates Figure 6: Price to adjusted NAV Figure 7: CS estimates vs. consensus and co. guidance 60% FY03/2014 FY03/2014 FY03/2014 47% CS Consensus Co Guidance 40% NPAT NPAT NPAT CS CS Rating ¥ mn ¥ mn ¥ mn vs. consensus vs. guidance 17% 18% 20% 12% 7% MOL OP 57,898 37,989 50,000 52.4% 15.8% 2% 0% K-Line UP 8,500 15,869 13,000 -46.4% -34.6% -6% NYK OP 32,635 30,618 27,000 6.6% 20.9% -20% -17% -25% Total 99,033 84,476 90,000 17.2% 10.0% -40% -39% -37% -60% -51% NYK NOL CSD MOL EMC OOIL CSCL K-Line COSCO Wan Wan Hai PacBasin Sinotrans Source: Company data, Credit Suisse estimates Source: Company data, Bloomberg, Credit Suisse estimates Japanese shipping sector 2 17 June 2013 Shipping profits rise as yen sinks Bulk is leading the recovery Capesize dry bulk vessels and liner units are key swing factors affecting Japanese Scrapping activities so far shippers’ profitability. After experiencing last year the weakest dry bulk market since 1986, on track to hit our estimate we believe that the annual average capesize rate is set to rebound by 35% in FY3/14E, for the year driven by a high level of scrapping and a rebound in iron ore shipments. With China’s A 22% price discount for imported iron ore price now 22% cheaper than the domestic equivalent, we expect iron ore import iron ore relative to shipments to China to regain momentum in 2H 2013. The yen’s depreciation should domestic equivalent means magnify revenue growth. We believe MOL and NYK, oriented as they are toward the dry that China’s ore imports are bulk segment, are likely to see a sharp rebound in their core earnings this year. set to regain momentum Long USD, short JPY Buying Japanese shipping companies is equivalent to buying a USD asset that generates Japanese shipping more USD revenues than costs. With the Bank of Japan (BoJ) committed to a quantitative companies generate far easing policy to boost the economy, associated yen weakness should boost shippers’ more USD revenues than revenues and asset valuations. We estimate that every ¥1 depreciation against the USD costs; a weak JPY is should lift the sector’s profit by 4.4% and valuation by 1.3%. The stocks’ liquidity and positive for their earnings financial leverage should also improve significantly. Positive earnings surprise MOL and NYK’s profit projections were based on JPY/USD assumptions of ¥90–95 and an Upcoming earnings of NYK average bunker price of US$650/t, but the yen is trading at between ¥95–100/US$, and and MOL are likely to beat the bunker price is currently US$600/t. We believe the companies will need to revise up guidance, which is based on profit guidance this summer. Our net profit estimates for MOL and NYK are 18% higher conservative macro than company projections and 29% higher than the Bloomberg consensus. K-Line will assumptions likely see profitability weaken as container shipping spot rates drop sharply. We believe the 20% FY3/14 earnings growth the company projects and the 49% growth consensus outlook are unlikely to materialize. K-Line derives almost half of its revenue from the liner business. Our expectation of sustained weakness in the long-haul market is based on the company’s earnings recovery being far less robust than the market anticipates. Relief of balance sheet pressures The Japanese shippers have far more debt denominated in JPY than other currencies. Weak JPY means greater Japan’s quantitative easing policy and the associated JPY depreciation should improve ability to service JPY debt the companies’ ability to use USD earnings to service their JPY debt. We expect their with US earnings. EBITDA/interest ratio to rise to 9.4x from 6.3x in FY3/14. A sharp fall in the JPY loan interest rate and expectations of currency depreciation should drive the shippers’ preference towards more JPY debt, mitigating their requirement for fresh equity. A stronger cash balance due to the strength of USD should reduce their net debt levels. MOL our top pick; K-Line rated UNDERPERFORM Despite a strong rally, the sector is trading at 0.6x P/B, one STD below its long-term mean MOL is most leveraged to P/B of 1.25x and 18% below adjusted book value based on vessel market values. Rising favorable currency ROE and appreciating vessel prices should drive valuation multiple expansion. We rate movements and a dry bulk MOL and NYK both OUTPERFORM, with 39% and 39% potential upside, respectively. recovery; K-Line’s earnings MOL is most leveraged to favorable currency movements and an anticipated recovery in are negatively affected by the dry bulk segment. We rate K-Line UNDERPERFORM, with 1% potential downside, as falling container rates we expect weak earnings growth due to its high exposure to the liner business, which is impacted by fiercer competition as a result of weakening industry discipline. Our TPs for all stocks are based on the average of an ROE–P/B valuation and economic net asset values. The former should capture earnings momentum, while the latter reflects changes in asset values.