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THIS CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE'S REPUBLIC OF CHINA (THE "PRC") (EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAO)
A surprise rebound: With gross margins of negative 20% or worse, CSD’s international
tankers have been the single biggest drag on its earnings over the past three years. A modest
margin reversal to low single-digits in 1H14 wasn’t exciting since it wasn’t enough to catapult
tanker RoE out of the loss-making territory. But 4Q14 rally has taken rates to levels unseen
since 1H10. CSD, with almost half of its sales from tankers, would be a key beneficiary of this
turnaround. We expect tanker business gross margins to rise to mid-20s and 2015-16 RoE to
rise to 5-6% (13% above Street), levels unseen since 2010.
Weak supply growth meets rising demand: Ironically, it’s the bearish sentiment caused by
declining seaborne crude oil trade which set the sector up for the rate rally. Unlike the 80%
growth in dry bulk capacity, crude tanker supply grew by only 26% since 2008. At the same
time, a 30%+ fall in US crude imports since their peak in 2011 discouraged new orders and
kept a firm lid on tanker supply growth and its order-book. But just as supply growth got
whittled down to a trickle, a sharp fall in oil prices created a surge in demand – possibly, from
a mix of demand response and increase in offshore oil storage. In addition, lower oil prices
could create a powerful tailwind, if US crude imports start rising again.
Upgrade H-share to OW(V): The complex interaction of volatile demand and fragmented
supply makes forecasting of near-term shipping rates a near impossible task. However,
continued weak supply growth (3% in 2015) in tankers favours a return to a healthier rate and
margin performance in 2015, particularly if demand gets a boost from reversal in falling US
crude imports (due to a potential fall in onshore shale production). In our recent reports, we
also argue that a stock’s own historical trading range has been better guide in this sector than
“absolutist” valuation approaches. Thus, we switch to new TP based on a 2015 PB of 0.80x
(peak PB since 2011) from a EVA-based valuation. Our target multiple is the bull-case PB
managed by CSD historically for mid-single-digit RoE. We remain UW on the A-share due to
its steep valuations but raise its TP in-line with the increase in H-share.
China Shippg. Dev H (1138 HK)
Upgrade CSD-H to OW(V): Tankers turning around
Crude tankers have been the single biggest drag on CSD’s profits but fall in oil prices have triggered a freight rate rally
Just as tanker supply growth turned to a trickle, anaemic demand and rates are showing signs of a surprise reversal
Upgrade CSD-H to Overweight (V) from Underweight (V) with TP of HKD6.59 (HKD3.50 previously); reiterate Underweight on CSD-A with TP of RMB5.26 (RMB2.73 previously)
Industrials Marine Equity – China
Company report Restricted
Index^ HSCEIIndex level 12,207RIC 1138.HKBloomberg 1138 HK
Source: HSBC
Overweight (V) Target price (HKD) 6.59 Share price (HKD) 5.39 Forecast dividend yield (%) 2.6 Potential return (%) 24.8
Note: Potential return equals the percentage difference between the current share price and the target price, plus the forecast dividend yield
Dec 2013 a 2014 e 2015 e
HSBC EPS -0.46 0.10 0.35 HSBC PE 42.9 12.3
Performance 1M 3M 12M
Absolute (%) 9.8 10.0 -2.5 Relative^ (%) 4.3 -6.2 -17.8
Note: (V) = volatile (please see disclosure appendix)
Enterprise value (CNYm) 56,647Free float (%) 47Market cap (USDm) 4,114Market cap (HKDm) 31,911
Source: HSBC
7 January 2015
Shishir Singh* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4292 [email protected]
Mark Webb* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6574 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
Issuer of report: The Hongkong and Shanghai Banking Corporation Limited
Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
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Financials & valuation: 1138 HK
Financial statements
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Profit & loss summary (CNYm)
Revenue 11,344 13,429 14,237 14,788EBITDA 905 3,166 4,071 4,099Depreciation & amortisation -1,669 -1,841 -1,809 -1,698Operating profit/EBIT -764 1,325 2,262 2,401Net interest -931 -1,280 -1,412 -1,359PBT -2,229 452 1,421 1,613HSBC PBT -1,583 395 1,305 1,497Taxation 12 -52 -104 -153Net profit -2,234 332 1,249 1,392HSBC net profit -1,571 343 1,201 1,344
Cash flow summary (CNYm)
Cash flow from operations 480 1,510 2,608 2,656Capex -3,863 -6,905 -800 -800Cash flow from investment -4,145 -6,905 -800 -800Dividends 0 0 -375 -375Change in net debt 3,811 5,866 -1,808 -1,481FCF equity -4,343 -5,452 1,692 1,740
Balance sheet summary (CNYm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 47,468 51,210 50,201 49,303Current assets 5,072 5,794 5,963 6,090Cash & others 1,919 1,700 1,700 1,700Total assets 58,842 64,425 64,040 63,724Operating liabilities 3,027 2,743 3,223 3,336Gross debt 33,604 39,250 37,442 35,961Net debt 31,684 37,550 35,742 34,261Shareholders funds 21,227 21,505 22,380 23,364Invested capital 47,594 52,561 51,241 50,356
Ratio, growth and per share analysis
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Y-o-y % change
Revenue 2.6 18.4 6.0 3.9EBITDA 13.2 249.8 28.6 0.7Operating profit 70.6 6.2PBT 214.4 13.5HSBC EPS 249.9 11.9
Ratios (%)
Revenue/IC (x) 0.2 0.3 0.3 0.3ROIC -1.6 2.3 4.0 4.3ROE -7.0 1.6 5.5 5.9ROA -2.2 2.5 4.1 4.2EBITDA margin 8.0 23.6 28.6 27.7Operating profit margin -6.7 9.9 15.9 16.2EBITDA/net interest (x) 1.0 2.5 2.9 3.0Net debt/equity 142.6 167.4 152.9 140.3Net debt/EBITDA (x) 35.0 11.9 8.8 8.4CF from operations/net debt 1.5 4.0 7.3 7.8
Per share data (CNY)
EPS reported (fully diluted) -0.66 0.10 0.37 0.41HSBC EPS (fully diluted) -0.46 0.10 0.35 0.39DPS 0.00 0.00 0.11 0.12Book value 6.23 6.32 6.57 6.86
Overweight (V)
Key forecast drivers
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Coal Volume (bn ton miles) 72 76 81 81Tanker Volume (bn ton miles) 194 211 217 219Other Dry bulk Volume (bn ton 145 257 282 282Coal GPM (%) 0 4 14 16Tanker GPM (%) -7 17 26 25Other dry bulk GPM (%) 6 16 16 16
Valuation data
Year to 12/2013a 12/2014e 12/2015e 12/2016e
EV/sales 4.6 4.2 3.8 3.6EV/EBITDA 57.4 17.9 13.4 12.8EV/IC 1.1 1.1 1.1 1.0PE* 42.9 12.3 10.9P/Book value 0.7 0.7 0.7 0.6FCF yield (%) -21.4 -28.5 9.0 9.5Dividend yield (%) 0.0 0.0 2.5 2.8
Note: * = Based on HSBC EPS (fully diluted)
Price relative
Source: HSBC Note: price at close of 06 Jan 2015
2
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8
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2013 2014 2015 2016China Shipping Dev H Rel to HSCEI
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Financials & valuation: 600026 SH Underweight Financial statements
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Profit & loss summary (CNYm)
Revenue 11,344 13,429 14,237 14,788EBITDA 905 3,166 4,071 4,099Depreciation & amortisation -1,669 -1,841 -1,809 -1,698Operating profit/EBIT -764 1,325 2,262 2,401Net interest -931 -1,280 -1,412 -1,359PBT -1,757 259 880 1,042HSBC PBT -1,028 1,889 2,926 3,022Taxation 12 -52 -104 -153Net profit -1,762 139 708 821HSBC net profit -1,016 1,837 2,822 2,869
Cash flow summary (CNYm)
Cash flow from operations 480 1,510 2,608 2,656Capex -3,863 -6,905 -800 -800Cash flow from investment -4,145 -6,905 -800 -800Dividends 0 0 -375 -375Change in net debt 3,811 5,866 -1,808 -1,481FCF equity -4,343 -5,452 1,692 1,740
Balance sheet summary (CNYm)
Intangible fixed assets 0 0 0 0Tangible fixed assets 47,468 51,210 50,201 49,303Current assets 5,072 5,794 5,963 6,090Cash & others 1,919 1,700 1,700 1,700Total assets 58,842 64,425 64,040 63,724Operating liabilities 3,027 2,743 3,223 3,336Gross debt 33,604 39,250 37,442 35,961Net debt 31,684 37,550 35,742 34,261Shareholders funds 21,227 21,505 22,380 23,364Invested capital 47,594 52,561 51,241 50,356
Ratio, growth and per share analysis
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Y-o-y % change
Revenue 2.6 18.4 6.0 3.9EBITDA 13.2 249.8 28.6 0.7Operating profit 70.6 6.2PBT 240.1 18.4HSBC EPS -190.6 53.6 1.7
Ratios (%)
Revenue/IC (x) 0.2 0.3 0.3 0.3ROIC -1.6 2.3 4.0 4.3ROE -4.5 8.6 12.9 12.5ROA -1.3 2.0 3.2 3.2EBITDA margin 8.0 23.6 28.6 27.7Operating profit margin -6.7 9.9 15.9 16.2EBITDA/net interest (x) 1.0 2.5 2.9 3.0Net debt/equity 142.6 167.4 152.9 140.3Net debt/EBITDA (x) 35.0 11.9 8.8 8.4CF from operations/net debt 1.5 4.0 7.3 7.8
Per share data (CNY)
EPS Rep (fully diluted) -0.52 0.04 0.21 0.24HSBC EPS (fully diluted) -0.30 0.54 0.83 0.84DPS 0.00 0.00 0.11 0.12Book value 6.23 6.32 6.57 6.86
Key forecast drivers
Year to 12/2013a 12/2014e 12/2015e 12/2016e
Coal Volume (bn ton miles) 72 76 81 81Tanker Volume (bn ton miles) 194 211 217 219Other Dry bulk Volume (bn ton 145 257 282 282Coal GPM (%) 0 4 14 16Tanker GPM (%) -7 17 26 25Other dry bulk GPM (%) 6 16 16 16
Valuation data
Year to 12/2013a 12/2014e 12/2015e 12/2016e
EV/sales 4.5 4.2 3.8 3.5EV/EBITDA 56.5 17.6 13.2 12.6EV/IC 1.1 1.1 1.0 1.0PE* 16.9 11.0 10.8P/Book value 1.5 1.4 1.4 1.3FCF yield (%) -22.3 -29.8 9.4 9.9Dividend yield (%) 0.0 0.0 1.2 1.3
Note: * = Based on HSBC EPS (fully diluted)
Issuer information
Share price (CNY)9.11 Target price (CNY)5.26 -
42.3
Reuters (Equity) 600026.SS Bloomberg (Equity) 600026 CHMarket cap (USDm) 3,987 Market cap (CNYm) 24,799Free float (%) 47 Enterprise value (CNYm) 55855Country China Sector MarineAnalyst Shishir Singh Contact +852 2822 4292
Price relative
23456789101112
23456789
101112
2013 2014 2015 2016CHINA SHIPPING DEV A Rel to HSCEI
Source: HSBC Note: price at close of 06 Jan 2015
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China Shippg. Dev H (1138 HK) Marine 7 January 2015
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International tankers have been the biggest pain point for CSD
CSD’s tanker business accounts for little less than half of its revenue. It was a strong profit generator for
the group in 2009-11 and accounted for over a third of its gross profits during this period. But the tanker
business has been bleeding cash over the past three years, particularly on the international routes where
gross margins have fallen to as low as negative 20s (%) in the second halves of 2011, 2012 and 2013.
Banking on Tankers
Loss-making crude tankers have been the pain point for the
company during 2011-13 but signs of turnaround are visible
Weak demand kept supply growth and order-book in check over
past few years but demand trends appear to be reversing sharply
Raise 2015-16e RoE to 5-6% and CSD-H/CSD-A target prices to
HKD6.59/RMB5.26 based on 2015 PB of 0.80x; upgrade CSD-H
to OW(V) from UW(V); reiterate UW on CSD-A
Ex-1: CSD Tanker Business Revenue & Gross Margins (%)
1H11 2H11 1H12 2H12 1H13 2H13 1H14
Tanker Revenue (RMB bn) 3.3 2.9 2.8 2.8 2.6 2.7 2.8 Domestic 2.0 1.4 1.0 1.2 1.0 1.0 1.0 International 1.3 1.5 1.8 1.6 1.6 1.7 1.8 Gross Margin (%) 11.7 2.6 -4.7 -3.3 -4.4 -9.6 14.5 Domestic 30.8 31.5 14.3 26.2 17.0 21.3 33.2 International -17.3 -24.1 -15.5 -24.8 -17.7 -28.7 3.4
Source: Company
Ex-2: Segment-wise revenue (RMB m) Ex-3: Segment-wise gross profit (RMB m)
Source: Company, HSBC estimates Source: Company, HSBC estimates
3,509 3,887 2,700 2,698 2,750 3,018
6,099 6,2305,593 5,389 5,976 6,518
1,676 2,0402,761 3,257
4,703 4,859
02,0004,0006,0008,000
10,00012,00014,00016,000
2010a 2011a 2012a 2013a 2014e 2015e
Coal Oil Other Dry bulk
834 907
-139 -9 100 418
1,151462
-223 -381
1,043
1,626
368
130
172210
762
777
-1,000-500
0500
1,0001,5002,0002,5003,000
2010a 2011a 2012a 2013a 2014e 2015e
Coal Oil Other Dry bulk
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However, after posting its first positive operating margin in more than four years during the first half of
2014, the international tanker business is showing signs of a turnaround. Its prospects may brighten
further if the recent fall in oil prices displaces North American shale oil production by cheaper imports.
But a tanker turnaround is shaping up through VLCC fleet
More than 55% of the company’s tanker capacity is on very large crude carriers (VLCCs) which typically
carry crude from the Middle East to China. Almost all of the company’s international tanker business is
conducted on these vessels. Apart from 14 VLCCs, CSD also has seven mid-sized Aframax tankers (80-
120K DWT) used for short-haul international routes but most of its Panamax and Handysize tankers are
employed in domestic business along the eastern coast in China. Consequently, the outlook for
international tanker margins is driven by the rates for its VLCC fleet.
Benchmark VLCC spot rates for the Middle East Gulf to Japan route (known as TD3 in industry
parlance) have broken through their 2010 highs and we believe that the recent upward momentum would
sustain next year as rising demand meets modest supply growth. This is why 67% of gross profit increase
implied by our 2015 forecast comes from our projections for the company’s international tanker business.
Ex-4: CSD tanker capacity according to vessel type (Jun-14) Ex-5: VLCC earnings (USD/Day) have rebounded to 2010 highs
Source: Company Source: Company
Declining tanker demand so far kept the supply growth in check
2008 was a strong year for bulk shipping rates until the credit crisis hit. This was a period when demand
for bulkers as well as tankers outstripped supply and rates surged to over USD100,000/day in several sub-
sectors. Excess capacity was created in both sectors subsequently but both evolved differently since then.
Rising shale oil production in the US and declining crude oil imports meant a bearish outlook for crude
tanker demand which also kept its supply growth in check. At the same time, continued growth in China’s
dry bulk appetite sustained the build-out of the dry bulk fleet. Due to these diverging demand trends,
tanker supply grew only 26% since the end of 2008 but bulkers increased by 80% – a supply growth
differential of 54% in favour of bulkers. Even after accounting for higher dry bulk demand growth, the
tankers appear to be in far better shape than bulkers. According to Clarksons, dry bulk shipping demand
(ton-miles) grew by 32% between 2008 and 2014, while crude tanker demand grew by only 3% - a
demand growth differential of 29% in favour of bulkers as well. The data above suggests that supply-
demand mismatch is about 25 percentage point worse in bulkers than in tankers (54-29%).
Handysize19%
Panamax15%
Aframax10%
VLCC56%
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Supply growth between end of 2008 and Oct-2014
Source: Clarkson Research Services
VLCC Supply
mn DWT 2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e
New orders 32.7 6.1 17.7 2.2 6.6 14.9 9.7 15.0 12.0 5.0 Deliveries 12.8 16.4 16.6 19.1 15.3 9.5 7.6 9.3 16.2 13.5 Order Cancellations 1.3 -3.5 -2.9 -4.5 -5.1 -5.2 -0.1 0.0 0.0 0.0 Order book 77.6 63.7 62.0 40.7 26.8 27.0 29.0 34.7 30.5 22.0 Scrapping -0.8 -2.4 -3.5 -3.3 -2.7 -5.0 -3.0 -3.0 -3.1 -3.3 Losses/Removals -7.5 -5.5 -9.5 -3.4 -1.5 -1.2 -0.3 -0.3 -0.3 -0.3 Fleet 151.1 159.7 163.3 175.8 186.9 190.2 194.5 200.5 213.3 223.1 YoY% 5.7 2.3 7.6 6.3 1.8 2.3 3.1 6.4 4.6 Order book as % of fleet 51.3 39.9 38.0 23.1 14.3 14.2 14.9 17.3 14.3 9.8
Source: Clarkson Research Services, HSBC estimates
A closer look at the VLCC supply growth reveals that the sector has added only 2% pa to its capacity in
the past two years after it grew by 6-7% pa in 2011-12. As highlighted earlier, such tepid growth in tanker
supply was largely due to the influence of declining imports of crude oil by the US.
The fall in US imports due to growing onshore production of shale oil has only partly been offset by
growth in Asian imports during this period but the dismal demand environment has also helped shrink the
VLCC order-book to only 15% of the current fleet. This suggests that the supply growth is likely to
remain a modest 3-6% pa over the next 12-18 months.
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Bulkers Handysize Handymax Panamax Capesize Tankers VLCC SuezMax Aframax Panamax H'sizetankers
Seaborne crude oil imports
mm bpd 2008 2009 2010 2011 2012 2013 2014e
US 7.8 7.1 7.2 6.7 6.1 5.1 4.9 Others 0.8 0.8 0.8 0.7 0.7 0.6 0.5 North America 8.6 7.9 8.0 7.4 6.8 5.7 5.4 China 3.3 3.7 4.4 4.6 4.9 5.1 5.7 India 2.6 3.2 3.3 3.4 3.6 3.9 4.0 Japan 4.2 3.7 3.7 3.6 3.7 3.6 3.5 Asia 15.7 16.4 17.0 17.4 18.4 18.6 19.3 Europe 1.8 1.6 1.4 1.4 1.5 1.5 1.5 Others 12.1 10.6 11.1 11.0 11.5 11.0 10.7 Global imports 38.2 36.4 37.5 37.2 38.2 36.8 36.8 YoY % -0.5 -4.6 2.9 -0.9 2.7 -3.6 0.0 Source: Clarkson Research Services
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Oil price decline likely cleared the oversupply in VLCCs…
The recent rally in tanker rates has happened alongside a simultaneous sell-off in crude oil. It’s difficult to
argue that tanker demand has increased solely due to a demand response to lower prices since such an event
would probably take some time to happen than occur almost concurrently with the steep fall in crude prices.
A more plausible explanation for higher rates could be the increase of tankers for offshore or floating storage
of crude oil. We must point out that current floating storage costs of USD1.5-1.8/barrel (see table below) do
not allow a simple arbitrage based on the Brent forward curve since the front month contracts allow a spread
of only USD0.6-0.7/barrel, which isn’t enough to cover the storage costs. However, despite the apparent lack
of an arbitrage in floating storage, it’s difficult to rule out the possibility that higher tanker rates are being
caused by a pick-up in “speculative storage” instead of arbitrage.
Crude oil storage costs/month (USD/Barrel)
VLCC Rate (USD/Day) average for Dec-2014 74,172 Vessel Capacity (mn barrels) 2.0 Number of days 30 Vessel Cost (USD/Barrel) - (A) 1.11 Brent Crude Price (USD/Barrel) 60 Cargo value (USD mn) 120 Financing rate of interest p.a. (%) 10 Financing Cost - (B) 0.49 Floating Storage Cost (USD/Barrel/Month) – (A) + (B) 1.61
Source: HSBC estimates
Consensus and HSBC’s view on crude price indicates that the current price slump and ensuing supply
rationalization would cause the commodity price to rebound next year (HSBC Brent Crude forecast:
USD90/bbl). In our view, such a scenario could have incentivized some speculators/traders/producers to
hoard oil instead of selling into an over-supplied market at currently depressed prices. Clearly, a tanker’s
use for offshore storage makes sense for any market participant looking for a rebound in Brent crude to
over USD75/bbl (from under USD55/bbl. currently) within next year. The fact that the availability of
VLCCs for storage is rather limited relative to global crude oil trade of 37-38m barrels/day suggests that
such a trade does not even need wider acceptance by the market, and, consequently, is far more likely to
have contributed to the clearing up of surplus capacity despite the lack of arbitrage opportunity.
YoY% change in US crude oil production and imports
Source: EIA
-20.0
-15.0
-10.0
-5.0
0.0
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The limited availability of surplus tankers can be ascertained as follows. According to Clarksons, the VLCC
market is over-supplied by around 80-90 vessels from a global fleet of 631. These vessels could be tied up for
storage even as the rest of the fleet is employed in the usual trade. These VLCCs could store up to 160-180m
barrels but that amounts to only around five days of global seaborne trade of crude (2m bbl/vessel).
Rates to remain supported if US shale oil production declines The surge in domestic shale oil production has displaced North American crude imports over the past
three years. Seaborne crude oil imports by the US are on track to decline by c32% to an average of 4.5
million barrels per day in 2014 since their most recent peak of 6.7 mmbpd in 2011. Such a sharp decline
in demand from the biggest crude oil importer has had a debilitating impact on tanker rates, particularly in
the past three years. Needless to say, a reversal of this trend would be beneficial to tanker rates. OPEC’s
latest decision to not cut production despite rising supply from non-OPEC, most notably US shale oil, has
sent oil prices down by almost 50% within a short time. If oil prices do stay low, it is only reasonable to
expect supply rationalization from marginal producers in the US.
US Seaborne crude oil imports (million barrels per day)
Source: EIA; 2014 data is based on first nine months of the year
Some may argue that the demand destruction for VLCCs hasn’t been as acute and consequently, a
reversal in demand trends is unlikely to bring much relief either. While it’s true that the VLCC trade of
Arabian Gulf imports hasn’t been as badly hit as some short-haul trades of other vessel classes, we
believe that VLCC rates have indeed been negatively impacted by softness in other segments. A quick
look at tanker rates of other crude carriers – namely, Suezmax and Aframax – shows appreciable
correlation of 0.7-0.9 between the rates of different classes and lends credibility to this view.
0.00
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1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
US Seaborne crude imports US crude imports from Arabian Gulf
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Tanker TCE rates (USD/Day)
Source: Clarkson Research Services
We revise up our assumptions for tanker business CSD reports tanker rates in RMB/Ton-mile. Since this is not equivalent to the USD/day spot rates
reported by Baltic Exchange daily, we convert CSD’s rate to another one equivalent and comparable to
benchmark VLCC rates (VLCC benchmark route of TD3: Mid-east to Japan). Our new 2015 assumptions
for the tanker rates assume them to be near the highs last seen in 1H10.
HSBC’s forecast for CSD’s tanker rates relative to TD3-TCE rate (VLCC benchmark)
Source: Clarkson Research Services, HSBC estimates
The revision in our tanker forecasts result in 60% and 32% increase in our 2015e and 2016e EPS,
respectively. This implies a RoE of c6% in each of these years. We have also revised down our rate
assumption for the coal business in 2H14 since the rates have underperformed our expectations.
Consequently, our 2014 EPS estimate is lowered by 49%. Despite lower near-term earnings, we believe
that the market is more likely to focus on forthcoming improvement in the tanker business.
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0
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60,000
80,000
100,000
120,000
140,000
2H08
1H09
2H09
1H10
2H10
1H11
2H11
1H12
2H12
1H13
2H13
1H14
2H14
1H15
e
2H15
e
1H16
e
2H16
e
TD-3 TCE CSD TD3 Implied Rate
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We move away from an “absolutist” valuation methodology… Our previous target price of HKD3.50 for CSD H-shares was based on simplified economic profits
methodology, which assumed sustainable RoE of 7.4%, a levered cost of equity of 17.5% and book value
growth of 0%. This implied a target 2015 PB of 0.42x. In recent months, however, we have moved away
from an absolutist view on valuation for some of CSD’s bulk shipping peers as they proved to be overly
pessimistic in post-QE3 era of low rates (see our upgrade of Pacific Basin titled Recalibrating Valuations
published on 6 October 2014 for details). In this report, we shift our valuation of CSD to the same.
In our view, the stock’s own historical trading range is probably a better guide to its future performance
than a static parameter-driven valuation. Cyclical stocks such as the ones in the bulk shipping sector have
typically managed a higher valuation than would be warranted by their high leverage (net debt-to-equity
of over 160%) or depressed RoEs (<2%) since investors appear to pay a premium for their ability to
escape the long-term trend and generate wind-fall profits from time to time.
An alternative approach to valuation is to set the company’s target valuation at a price-to-book
commensurate to its RoE, as guided by its historical trading range.
New vs. Old estimates
Old 2014 2015 2016
Revenue 12,987 13,210 13,608 EBITDA 3,495 3,567 3,735 Operating Profit 1,654 1,758 2,037 PBT 781 924 1,243 Net Profit 645 785 1,055 EPS 0.19 0.23 0.31
New 2014 2015 2016
Revenue 13,429 14,237 14,788 EBITDA 3,166 4,071 4,099 Operating Profit 1,325 2,262 2,401 PBT 452 1,421 1,613 Net Profit 332 1,249 1,392 EPS 0.10 0.37 0.41
New Vs. Old (%) 2014 2015 2016
Revenue 3.4 7.8 8.7 EBITDA -9.4 14.1 9.8 Operating Profit -19.9 28.7 17.9 PBT -42.1 53.8 29.8 Net Profit -48.5 59.1 32.0 EPS -48.5 59.1 32.0
Source: HSBC estimates
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… set new TP at bull-case PB managed by CSD historically for mid-single digit RoE, upgrade H-share to OW(V) from UW(V)
A quick look at historical price-to-book suggests that the company has traded in two distinct ranges after the
credit crisis in 2008. Till the end of 1H11, the stock comfortably commanded a PB of over 1.0x for what
turned out to be the only mid-single digit RoE performance. This may lead some to argue that as the
company’s RoE heads back towards where it was in 2010, its valuations may do the same and rebound to
above book value (2010-1H11 average: 1.32x). However, investors must note that the consensus was grossly
over-estimating CSD’s future performance during this period. One-year forward RoE projected by consensus
during 2010 and 1H11 was consistently above 10% and this provided a clear uplift to its valuations. However,
this isn’t the case now when consensus (and us) are forecasting only a mid-single digit RoE.
Can CSD’s PB rise to levels last seen in 2010-11 as its RoE (excl. one-offs) rebounds to similar levels of mid-single digits?
Source: HSBC
CSD Price-to-Book (Trailing) between 2008 and 2014 CSD Price-to-Book (Trailing) between 2011 and 2014
Source: Thomson Reuters DataStream, HSBC Source: Thomson Reuters DataStream, HSBC
29.7
27.7
33.8
19.9
5.22.8
7.8 6.14.9
2.4
-5.1
0.6
-7.9-6.2
0.42.2 3.4
6.9
3.29x
4.31x
3.69x
1.80x1.22x
1.54x1.64x
1.44x1.09x
0.65x 0.61x 0.43x 0.47x 0.55x 0.61x 0.64x
1.05x
1.43x
0.00x
0.50x
1.00x
1.50x
2.00x
2.50x
3.00x
3.50x
4.00x
4.50x
5.00x
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
Jun-
07
Dec
-07
Jun-
08
Dec
-08
Jun-
09
Dec
-09
Jun-
10
Dec
-10
Jun-
11
Dec
-11
Jun-
12
Dec
-12
Jun-
13
Dec
-13
Jun-
14
Dec
-14
Jun-
15
Dec
-15
RoE Clean (%, LHS) Price-to-Book (RHS)
0.30
0.60
0.90
1.20
1.50
1.80
2.10
Dec
-08
Dec
-09
Dec
-10
Dec
-11
Dec
-12
Dec
-13
Dec
-14
0.20x
0.30x
0.40x
0.50x
0.60x
0.70x
0.80x
Dec
-11
Jun-
12
Dec
-12
Jun-
13
Dec
-13
Jun-
14
Dec
-14
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CSD: Consensus 12m forward RoE and PB (trailing) – consensus forecasted 12-m fwd RoE exceeding 10% prior to 1H11
Source: Thomson Reuters DataStream, HSBC
A scatter chart of 12m forward RoE and PB since 2009 shows that the company’s PB has not risen above
1.0x for consensus RoE forecasts of below 10%. In our view, despite the turn-around in tankers and coal
business, CSD’s RoE is unlikely to move beyond mid-single digits over the next three years.
Since 2009, market hasn’t awarded a PB of over 1x to CSD unless consensus 12-m forward RoE was over 10%
Source: Thomson Reuters DataStream, HSBC
Given our forecast of a RoE recovery to 5-6% in 2015-16 and CSD’s trading history, we believe that the
company can command the bull-case valuation it has historically commanded for such a valuation.
Consequently, we set our new target multiple at 2015 PB of 0.80x (the peak PB since 2011), which implies a
new TP of HKD6.59 (HKD3.50 previously) for CSD’s H-shares. There may be further upside to the stock if,
much like 2010, an over-enthusiastic consensus ramps up its forecasts to over 10% but, in our view, this is
likely to be temporary occurrence, if at all. Our target price for CSD A-shares moves to RMB5.26 (RMB2.73
previously), which is our H-share TP adjusted for HKD/RMB exchange rate of 1.254.
Under our research model the Neutral rating band for volatile stocks is 10ppt above and below the local
hurdle rate (9.5% for China), a potential return of -0.5% to 19.5%. Our H-share TP implies a potential
0.0x
0.2x
0.4x
0.6x
0.8x
1.0x
1.2x
1.4x
1.6x
1.8x
2.0x
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Dec
-09
Mar
-10
Jun-
10
Sep-
10
Dec
-10
Mar
-11
Jun-
11
Sep-
11
Dec
-11
Mar
-12
Jun-
12
Sep-
12
Dec
-12
Mar
-13
Jun-
13
Sep-
13
Dec
-13
Mar
-14
Jun-
14
Sep-
14
12m fwd consensus RoE % (LHS) PB (RHS)
0.0x
0.2x
0.4x
0.6x
0.8x
1.0x
1.2x
1.4x
1.6x
1.8x
2.0x
-2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0
Pric
e-to
-Boo
k (tr
ailin
g)
12-month forward Consensus RoE (%)
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return of 24.8% (including dividend yield of 2.6%), which is above this band; thus, we upgrade our rating
on China Shipping Development’s H-shares to Overweight (V) from Underweight (V).
Under our research model the Neutral rating band for non-volatile stocks is 5ppt above and below the
local hurdle rate (9.5% for China), a potential return of 4.5% to 14.5%. Our A-share TP implies a
potential return of negative 41.1% (including dividend yield of 1.2%), which is below this band; thus, we
reiterate our Underweight rating on China Shipping Development A-shares.
Potential return equals the percentage difference between the current share price and the target price,
including the forecast dividend yield when indicated.
Key upside risks: Continued slow-steaming despite higher rates and lower bunker prices, greater-than-
expected tightening in the domestic coal shipping market in China, supportive government policies for
the domestic shipping market, and higher-than-expected increase oil shipping demand.
Key downside risks: Sharp decline in Chinese commodity demand, sharp reversal in oil prices leading to
unwinding of offshore storage and/or preventing a potential increase in US crude oil imports.
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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Shishir Singh and Mark Webb
Important disclosures
Equities: Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below.
This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website.
HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.
Rating definitions for long-term investment opportunities
Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.
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*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities
As of 06 January 2015, the distribution of all ratings published is as follows: Overweight (Buy) 46% (29% of these provided with Investment Banking Services)
Neutral (Hold) 37% (28% of these provided with Investment Banking Services)
Underweight (Sell) 17% (21% of these provided with Investment Banking Services)
Share price and rating changes for long-term investment opportunities
China Shipping Dev H (1138.HK) Share Price performance HKD Vs HSBC
rating history
Recommendation & price target history
From To Date
N/A Neutral (V) 17 January 2012 Neutral (V) Underweight (V) 14 March 2012 Underweight (V) Overweight (V) 11 June 2012 Overweight (V) Underweight (V) 03 January 2013 Underweight (V) Neutral (V) 29 April 2013 Neutral (V) Underweight (V) 15 August 2013 Target Price Value Date
Price 1 5.00 17 January 2012 Price 2 4.60 16 March 2012 Price 3 4.10 22 August 2012 Price 4 4.70 27 November 2012 Price 5 4.20 03 January 2013 Price 6 4.00 20 March 2013 Price 7 3.60 29 April 2013 Price 8 3.30 19 August 2013 Price 9 4.40 28 January 2014 Price 10 3.80 19 March 2014 Price 11 3.70 31 August 2014 Price 12 3.50 30 October 2014
Source: HSBC
Source: HSBC
CHINA SHIPPING DEV A (600026.SS) Share Price performance CNY Vs HSBC
rating history
Recommendation & price target history
From To Date
N/A Underweight 30 November 2014 Target Price Value Date
Price 1 2.73 30 November 2014
Source: HSBC
Source: HSBC
2
7
12
17
22
27
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
Jan-
15
2
7
12
17
22
27
32
37
42
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
Jan-
15
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HSBC & Analyst disclosures Disclosure checklist
Company Ticker Recent price Price Date Disclosure
CHINA SHIPPING DEV A 600026.SS 9.48 05-Jan-2015 4, 6, 11CHINA SHIPPING DEV H 1138.HK 5.39 05-Jan-2015 4, 6, 11
Source: HSBC
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next
3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this
company. 4 As of 30 November 2014 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 November 2014, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 November 2014, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 30 November 2014, this company was a client of HSBC or had during the preceding 12 month period been a client
of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as
detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this
company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in
securities in respect of this company HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis.
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.
Whether, or in what time frame, an update of this analysis will be published is not determined in advance.
For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.
Additional disclosures 1 This report is dated as at 07 January 2015. 2 All market data included in this report are dated as at close 05 January 2015, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.
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Mark Webb Regional Head of Conglomerate and Transport Research +852 2996 6574 [email protected]
Parash Jain Analyst +852 2996 6717 [email protected]
Shishir Singh Analyst +852 2822 4292 [email protected]
Stephen Wan Analyst +852 2996 6566 [email protected]
Rajani Khetan Analyst +852 3941 0830 [email protected]
Aric Hui Associate +852 2822 3165 [email protected]
Conglomerate and Transport (Asia-Pacific)
