Asiamoney Top 10: transportation (includes Orient Overseas and Thai Thoresen profiles)

Asiamoney magazine, May 2008 – Top 10 column

 Intro

Dry bulk shipping operators completely dominate the top 10 for the transport industry – our monthly study of the Asian companies with the highest return on equity within particular market sectors. Airlines, airports and toll roads are nowhere, and even within the shipping industry there is barely a place for container operators. It’s all about dry bulk.

Bulk carriers are those ships that carry unpackaged commodities such as coal, ore or cereals. Part of the reason for their success today is because they are exposed to the resources cycle: more coal or iron ore being mined in places like Australia and demanded in places like China obviously requires more dry bulkers to carry it all.

One problem with ROE, though, is that it’s historical: the dominance of dry bulk carriers in our list reflects the fantastic environment of 2007, when the Baltic Dry Index – the established benchmark for the spot dry bulk shipping freight rate – climbed 122%. Towards the end of the year it started falling and by the middle of January was down 37% from its peak, and, although it has since rebounded, it appears to reflect a tougher market ahead.

Analysts say one reason for the sharp fall in the BDI was the market waiting for iron ore negotiations to be concluded, setting firm prices for what China, in particular, will pay for ore. This reflects just how much this sector is affected by the price and demand for the commodities they carry. Credit Suisse’s shipping research team rates a Chinese slowdown as the single biggest risk to its otherwise bullish view on the Asian dry bulk shipping sector. “A significant slowdown in China’s economy would lead to declining commodities demand,” says the broker. “This would impact upon shipping companies with vessel oversupply potentially leading to a sharp decline in freight rates.”

The price negotiations were a short term issue, though. A bigger concern is the extraordinary quantity of new ships on order. As the managing director of Thoresen Thai Agencies, Chandchutha Chandratat, explains on page xx, between 2009 and 2010 the size of the world dry bulk shipping fleet will expand by more than 25%, such is the volume of new vessels being delivered. In fact, Credit Suisse calculates that the dry bulk vessel order book now stands at 57% of the entire existing fleet. Many of the ships they replace will be scrapped, but not all, and this huge increase in supply cannot help but have an impact on freight rates.

A potential US recession won’t help, though it’s not the end of the world: dry bulk demand is driven by emerging economies (which have a more pressing need for raw materials). Credit Suisse calculates that trade flows to developed countries accounted for a still substantial 46% of major bulk demand in 2006, but points out that they only accounted for 21% of growth in major bulk demand from 2001 to 2007.

That’s not, though, the case for container shipping, which is driven by the developed world, which has more of a demand for finished goods. Here, the picture looks rather stark. “The sector is leveraged to the slowdown in developed economies, and 2008 could see oversupply due to weaker demand,” says Sam Lee at Credit Suisse. The only container shipping name in our list is the one at the very top: OOIL.

And where are airlines on our list? Only a budget carrier, AirAsia, makes the grade. Macquarie Research notes that both Singapore Airlines and China Eastern Airlines showed evidence of a slowdown in traffic growth and demand in their March operating statistics. SIA’s passenger load factor fell for three months in a row, but as Macquarie says, “the real headline is the 8.1 percentage point fall in passenger load factor on the North American routes.” It seems a slowing US economy is already having an impact in Asia. “We think that most of the poor operating data for the downward leg of this cycle are still to come,” Macquarie says.

Still, plenty of airlines are doing perfectly well: apart from AirAsia, double digit return on equity figures were logged by Malaysian Airlines, SIA, Cathay Pacific, Air China and Asiana, with Thai Airways just short. China Southern, China Eastern, China Airlines and Korean Airlines are the laggards. But spare a thought for Pakistan Airlines: its ROE came out of the Bloomberg machine at minus 375.2%. Room for improvement there, it would appear.

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1. Orient Overseas, Hong Kong: 73.8%

Orient Overseas (International) is a Hong Kong listed company active in container transport and logistics services, ports, and property development. Orient Overseas Container Line, its wholly owned subsidiary, is one of the largest transportation, logistics and terminal companies in the world. Property development focuses on China. Sold its terminals division for US$1.99 billion last year; even with that removed, net profit was US$553.7 million, up 29.3% on 2006.

2. Pacific Basin, Hong Kong: 69.8%

One of several dry bulk shipping groups on this list, again listed in Hong Kong. Operates a fleet of Handysize (shallow draft with onboard cranes) and Handymax vessels, which range in size from 25,000 to 60,000 deadweight tonnes. Specialises in the transport of minor bulk commodities, and handled 29.1 million tonnes in 2007, with coke and coal the biggest component. Young fleet, six years old on average.

3. Korea Line, 53.5%

Korean shipping group focusing on the transportation of energy and resources. Runs dry bulk shipping and LNG services through 28 vessels; runs a dedicated carrier service for Kepco, Posco and Kogas.

4. Thoresen Thai Agencies, Thailand, 37.7%

Another dry bulk group, this time based in Thailand. Also has an offshore services arm as well as some smaller service businesses. Listed its offshore services business, Mermaid Maritime, in Singapore last year; also achieved the rare feat of getting a convertible bond away in the early throes of the subprime credit crunch. See profile.

5. AirAsia, Malaysia: 35.5%

The only airline on our list is a Malaysia-based budget airline launched in 2001. Now flies to 45 destinations and has joint ventures in Thailand and Indonesia, with a fleet of 28 aircraft. Along the way has attracted funding from groups including Crescent Venture Partners; listed on Bursa Malaysia in November 2004; and signed a 130 aircraft commitment with Airbus.

6. HHI, Korea: 34.8%

Hyundai Heavy Industries is active in a range of industrial segments, but makes our list for its still-significant shipbuilding business, which is where HHI started in 1972. By 1974 it had turned a beach into the world’s largest shipyard; it has since become the leading world shipbuilder by deadweight tonnes. Separated from the Hyundai Group in February 2002. On January 1 it had a backlog of a staggering 471 ships, weighing 40.83 million tonnes; it will deliver 134 this year alone, more than one every three days.

7. Jaya Holdings, Singapore, 34.7%

Singapore-listed shipbuilder specialising in fleet owning and chartering, and shipyard operations. Specialises in small and medium offshore support vessels, such as tugs and other utility vessels, both as a builder and for chartering of its existing fleet for the offshore oil and gas, marine construction and mining industries. Has shipyards in Singapore, Batam and China.

8. Sinotrans Shipping, China/Hong Kong: 33.9%

One of China’s largest shipping companies. Owns a fleet of vessels and is active in dry bulk and container vessel time chartering and crude oil shipping services. Revenues climbed 22.1% to US$302.2 million in 2007, mainly thanks to dry bulk shipping.

9. Maybulk, Malaysia, 33.5%

One of Malaysia’s largest shipping enterprises, and one of very few active in international shipping through its own fleet. Owns dry bulk carriers and product tankers; also active in ship management and operates a container depot.

10. Precious Shipping, Thailand: 31.9%

Dry cargo shipping group listed in Thailand. Specialises in the tramp freight market – that is, one without a fixed itinerary or ports of call – and within that, small ships. Has 44 ships, unusual in this fragmented section of the market, and has 12 more on order between 2010 and 2013. Net profit in 2007 was Bt 4.156 billion, up from Bt3.715 billion in 2006.

ONES TO WATCH

Just outside the top 10 is Malaysian Airlines, one of the more remarkable turnaround stories of recent times. It was approaching bankruptcy in 2005, but under a new CEO and with the assistance of state-run Khazanah, it hit record profits in 2007. Its third quarter net profit, at RMB364 million, was up 52% year on year – and meant it had achieved the highest full-year profits in the airline’s 60 year history with only nine months of the year gone.

Another Malaysian stock, PLUS Expressways, is also just outside our list with an ROE of 25.3%. It runs tollways in Malaysia; traffic volumes were up 7.7% in the first two months of the year. Macquarie rates it outperform. “Given the stable and defensive nature of PLUS’ business, and the attractive dividend yield, we view it as an attractive investment in these times of high volatility,” says analyst Sunaina Dhanuka.

The highest ranked Taiwanese company is Sincere Navigation, ranked 12^th on ROE with 27.6%. Like so many on our list it’s a dry bulk operator. Credit Suisse rates it outperform.

PROFILE: ORIENT OVERSEAS

Our top ten is full of shipping companies, but almost all of them are in the dry bulk area, carrying commodities like coal or grain that won’t go into containers. Container shipping lines are conspicuously absent, with one exception – and it’s the name at the very top.

Orient Overseas International Limited (OOIL) , better known to most through its wholly owned container shipping subsidiary OOCL, is part of the fabric of Hong Kong’s recent history, and not just because of the profusion of ships that can be seen in Hong Kong’s waters carrying the OOCL logo. It was built by the Tung family: Tung Chee Hwa had to step down from running the company in order to become chief executive of Hong Kong Special Administrative Region for the handover of sovereignty from the UK to China in 1997. It was even the owner of the Queen Elizabeth when it sank in Victoria Harbour in 1972 amid efforts to convert it into a floating university campus.

Today, OO is in good shape. After the US$1.99 billion sale of its terminals division last year, it holds a net cash position – handy in a credit crunch – and achieved a 29.3% year on year increase in net profit, to US$553.7 million, in 2007 even discounting that sale.

Its impressive return on equity figures have a number of drivers behind them. Partly, it’s because of an excellent track record of picking the right time to buy new vessels, building the fleet when shipbuilding is cheaper. The resulting fleet is the youngest among OO’s peer group, with an average age of 5.2 years, which brings advantages in terms of reliability and operating efficiency. Owning the fleet is helpful too, given the effort the company puts into preventative maintenance: according to Stanley Shen, investor relations spokesman at OOIL, the total combined downtime from OO’s owned vessels for 2007 was just 256 hours, compared to over 3000 vessels for chartered vessels. “They [the ships the company owns] are hardly ever out of service and even when they are, it’s for a very short time,” he says. A new vessel was being delivered in the week of Asiamoney’s interview and a further 20 are on order between now and 2011, which will bring the proportion of ownership up and the average age still further down. And finally, there’s the IT system, which does not use a mainframe computer but instead works on client servers. This has been another source of efficiency gains: the company’s volumes have doubled in the last four years despite an only 5% addition to headcount.

That’s the good news. But the container shipping industry does face some challenges ahead. “One obvious issue in the short term is the oil price,” says Ken Cambie, chief financial officer. “The average price of bunker [shipping fuel oil] was about US$357 a tonne last year; in the first four months of this year the average would have been about $475, so almost $120 up on where it was last year.” This is obviously not a challenge unique to OO, and Cambie says this year is seeing “a united industry front in terms of recovering bunker costs through surcharges,” particularly on North American routes.

Then there’s the US outlook. Here, Cambie says problems were evident as long ago as 2005, when the US housing market started to slow, and says OO noticed a slowing of exports to the US throughout 2006 and 2007. “The industry has reacted in a very rational manner, with new capacity being added elsewhere to intra-Asia and Asia-Europe trade,” he says. “The profit on North America trade wasn’t that great in 2007 and the industry’s managed that already.” Still, exports from the US are doing well, driven by a weak US dollar, and trade routes that do not involve the US are seeing improving volume. For OO last year Asia-Europe volume grew 14%, and overall revenue by nearly 46% following an improvement on rates.

It is generally said that dry bulk shipping is more exposed to emerging markets, and container shipping more to developed markets. However, bulk shipping tends to be more volatile. Shen points out another major point of difference between the two models: bulk carriers go between a port of load and a port of discharge, carrying one commodity from one seller to one buyer. “On any one container vessel you might have 5000 customers, and you need to serve them all consistently,” he says. “It’s more like an airline. You need a well-oiled organisation to do this day in day out.” And this range of customers, while tricky to manage, is a defence against volatility.

Aside from shipping, the OO group has a property business, centred in China and with a particular focus on greater Shanghai. Having seen the terminals division sold, it is tempting to assume that the property business will go the same way in time. “I wouldn’t like to say we are going to spin it off, but what we are planning to do is get it to a state where the value of it can be better recognised,” says Cambie. The company has eight big projects underway in order to create a business with a continuous stream both of development and revenues. That has a couple of advantages: it’s a consistent earnings base to help counterbalance the more cyclical shipping industry; it makes it easier for analysts to value; and it creates the chance to sell it in future if the company wants or needs to. The cash from the terminals sale has proven very useful here, since one cannot borrow to purchase vacant land in China.

The company’s net cash position is really a one-off consequence of the terminals sale, but in the long term the gearing is likely to remain conservative: Cambie says he is comfortable with net debt to equity of up to one to one. In the meantime the cash balance may be helpful if other operators run into trouble and want to sell ships. “If it’s a more protracted global slowdown, holding quite large amounts of cash is helpful,” says Cambie. “It does figure in the back of our minds.”

PROFILE: THORESEN THAI AGENCIES

 Thoresen Thai Agencies has built a thriving business in dry bulk shipping and offshore services – one of Thailand’s only shipping businesses of note. It has been enjoying a great run. But can it keep it up?

Today, TTA looks in good shape. Its fourth quarter profit, at Bt1.159 billion, was a 34.5% increase on the previous quarter, driven by high utilisation and strong rates for freight. TTA is a market leader for bulk liner services between Asia and the Middle East, arguably the two most vibrant markets in the world: a good place to be. Its fully-loaded break-even on its shipping business – including everything from repair and maintenance to administration and depreciation – is US$7,000 per vessel per day; today it’s earning more than US$17,000. “I’d say 70% plus of our revenues for this financial year are already locked in,” says Chandchutha Chandratat, managing director.

But there are storm clouds ahead. “There are a number of headwinds emerging in 2009 and 2010,” says Chandchutha. “Various analysts agree on that, it’s just a question of the degree.”

One such analyst, Fearnleys, calculates that 127 million deadweight tonnes of new dry bulk vessels are expected to be delivered into the global market in 2009 and 2010 alone. To put that into perspective, the global fleet today is 395 million DWT. In other words, the fleet is going to expand by more than a quarter in just two years.

The demand side of the equation is robust, but surely not that robust. “Since this decade began it has been a boom for dry bulk shipping,” says Chandchutha. “On average it has grown by 6% a year. Our general belief is, with Asia still going strong, it should be able to trend at that kind of level through 2010. But with the huge amount of supply coming into the fleet, every analyst you read is projecting declining freight rates, probably in the latter half of 2009.” And being a leader on a particularly lucrative route is not the advantage it seems – since ships, obviously, are very portable. “That gives us consistent cargo volume, but what it does not do is insulate us from market pressures. If a lot of ships are trading the Pacific, there’s no reason those vessels cannot take up cargo right on our liner route. With potentially more open vessels in our trading area, we will of course get hit on price.”

The huge gap between TTA’s breakeven and its current freight margins will clearly insulate it, and it has another advantage: it is more diversified than some of its peers. In particular, it has built up in offshore services in recent years, which embraces a range of vessels from diving to firefighting but is particularly linked to the fortunes of oil and gas exploration. “We have made a very concerted effort over the past two years to diversify our business,” Chandchutha says. Its offshore services businesses are housed within a business called Mermaid Maritime. “When I joined three years ago, it was nothing in terms of revenues and profits.” Much has been done since then: Bt2.1 billion of equity was injected, assets were bought, people hired, and the resulting business was listed on the Singapore Stock Exchange last year. The result is a business with, hopefully, a different cycle to that of dry bulk shipping. “Even if oil prices fall quite a bit from existing levels, there will still be a very high level of production and exploration spending in the next five years,” he says. “So maybe in 2010, for example, shipping falls but we’ve got oil and gas picking up.” Since the IPO, Mermaid has ordered a new $136 million drilling rig, to be developed in late 2009, and some diving support vessels for delivery the following year (this alongside the nine ships on order for the dry bulk side).

Additionally, a shipping services business covers areas including ship brokerage to ship agency companies.

In the capital markets, it’s hard to fault TTA’s timing. The Singapore listing came before stock markets turned bearish, and additionally it managed to get a convertible bond away just as sub-prime started to bite, in September 2007. It raised US$169.8 million in a deal lead managed by Macquarie and Merrill Lynch – the only convertible launched out of Thailand in the whole year, and the second since the financial crisis of 1997. It took an unusual structure, with no put, and an amortising tenor with one third maturing at the end of each of years three, four and five. It featured a cash settlement option allowing TTA to redeem bonds for cash instead of stock in order to manage dilution. “And we issued the bond last year without any credit protection, which would be almost impossible today,” says Chandchutha. Its timing has been impeccable so far; will it remain so through tougher years ahead?