Merrill Lynch -

Good 3Q07 numbers
Cosco Corporation reported 3Q07 numbers that were largely in line with expectations. Revenue surged 72.1% to S$547mn while net profit increased 36.7% to S$97.7mn.

Strongest quarter to date
Profitability of S$97.7mn represents the strongest quarter for Cosco since its inception. As management highlighted during its results, the group now makes over S$1mn per day as of the 3Q.

Order book continues to rise
Cosco has secured over US$6bn in orders thus far in 2007. Coming from an extremely low base in 2006, the growth of its order book is nothing short of phenomenal.

More room for growth
Cosco is optimistic that it can continue to secure orders as its shipyard capacity continues to expand. The group currently has a capacity of 1.73mn dwt, and this is expected to increase to 2.73mn dwt by the end of 2010, an increase of 58%.

Buy Cosco
We have upgraded our forecasts by 2-3% for 2007-09E to account for the potential for new contracts. Based on our estimates, Cosco will register a net profit CAGR of 51% over the next three years. Consequently, our price objective has been raised to S$10.10. Maintain Buy.Strongest quarter to date

 

Market Darling Doesn?t Disappoint

♦ 37% net profit growth in 3Q

Cosco Corporation (Cosco) posted impressive earnings numbers that will please the market. The company recorded net profit of S$97.7m in 3Q07, up 37% Y/Y and up 22% Q/Q. As usual, the business was driven by the shipyard business where revenues rose 77% to S$487.8m. The previous mainstay of ship repair is now augmented by more order book-based contributions, as shown by the shift in the revenue mix for this category to 65% of total sales. Margins for the marine services business also remained healthy, with gross margins improving to 30% from 26.5% in 2Q07. The dry bulk business also remained a steady performer, with revenues of some S$53.3m, and gross margins still sitting pretty at some 63%, buoyed by high freight rates for dry bulk shipping.

♦ Order book at US$6.4bn

We estimate that Cosco?s order book stands at some US$6.4bn, of which US$6.2bn were secured in the current year. We also estimate that Cosco has orders worth approximately US$900m on option. This puts the marine services business in good shape for the next three to five yearsas it progressively digests these contracts. However, we do not believe that Cosco?s yards are anywhere close to full capacity. We would anticipate Cosco announcing even more orders; we estimate that Cosco has sufficient capacity to take on a total order book worth some US$10bn. Furthermore, this is a target that can be easily scaled upwards, depending on Cosco?s own pace of yard expansion, particularly at Zhoushan. As for the dry bulk business, while there are currently market concerns that additional capacity onstream would depress freight rates, as indicated by the recent weakening of the Baltic Dry Index (BDI), Cosco?s dry bulk charters are long-term in nature, and will not see downward reversions in the near future.

 ♦ No forex issues

 On the hot-button topic of forex exposure, Cosco?s management took some pains to explain its own position. Firstly, there is a natural hedge that occurs as both sales and major material expenses such as steel and machinery are denominated in US dollars. The remainder is converted to renminbi, to take care of salaries and other operating costs. As for translation to Cosco?s financial reporting in Singapore dollars, Cosco undertakes to lock in the rates as and when the contract is first secured. Cosco was also quick to stress that it does not undertake speculative positions in the forex market. We believe that Cosco has sufficient controls in place to mitigate its foreign currency exposure.

 ♦ Maintain BUY to S$8.10 ? for now

 With year-to-date net profit of S$220.1m, Cosco is well on track to exceed our full-year earnings expectations of S$305.7m. However, we will not be adjusting our forecasts at this time, as the variation is not significant and builds in some level of conservatism. Overall, however, we remain positive aboutCosco?s prospects beyond our standard forward forecast for three years. Although we are not changing our forward three-year forecasts, we are maintaining our DCF-based target price of S$8.10, with the caveat that we may raise our valuation higher as and when we see further new orders. Maintain BUY.