YangZiJiang - Buy by DBS (13 Oct 09)

Sturdy earnings
• Expect Yangzijiang to beat consensus and our forecasts for 2H09 and 2010 on lower steel costs.
• Upgrade 2009-2010 net profits by 11%-17% as we cut steel costs by 10%-11%.
• Raise target price to S$1.36, implied a 40% upside; Reiterate BUY on superior execution.

Lower steel costs. We re-examined our assumption for steel costs, the largest unhedged cost component (>20% of COGS) for shipbuilders. Based on recent price trend, steel costs in 2H09-1H10 will likely be lower than our expectation. Steel prices have hovered at low levels of RMB3000–4000/ton YTD and are not expected to pick up significantly in the near term, based on our industry checks.

Upgrade earnings. We have lowered our full year steel cost assumption from RMB4500-5000/ton to RMB4000-4500/ton in FY09-FY10 forecast periods. These have lifted our gross margins by 2ppt to 23.5% in FY09 and 22% in FY10, leading to upward revision in net profit forecasts for FY09 and FY10 by 11% and 17% respectively. The marginal declines in net profit forecasts in FY10- FY11 are due to cessation of tax holiday for new yard and margin normalisation.

Scope for consensus upgrades post 3Q results. On the back of favorable steel prices and on track delivery, Yangzijiang is expected to report a stellar 3Q09 results similar to 2Q09, when release on 3rd Nov. We project 3Q09 to record net profit of RMB550-600m on revenue of c. RMB2.4bn. With this, 9M09 bottomline could make up 80%-85% of consensus forecasts, which will likely call for a series of earnings upgrades by the streets.

Maintain BUY; Target price raised to S$1.36. Our target price is raised to S$1.36 following the earning revisions, still pegged to 11x FY10 EPS. This is in line with the average PE of regional peers. Superior execution track record. We continue to favor Yangzijiang for its solid execution and consistent earnings delivery. The shipbuilding track records of SGX-listed shipyards have generally been patchy, ranging from estimated losses to positive 23% gross margin. Yangzijiang has stood above its peers by achieving consistent and better 19-23% gross profit margin and 78% net profit CAGR in the 2004-08 periods; through its superior raw materials and forex hedging strategies and better order book quality.