Don’t sink, float

Leading ship equipment maker IPOs in Shanghai

Don’t sink, float

Hard times at the shipyard

Like the Titanic, the Andrea Gail is famous for sinking. The sturdy fishing boat disappears into the deep during a “perfect storm”, as told by author Sebastian Junger. The film version starred George Clooney. He drowns rather handsomely, of course.

But talk of a perfect storm also seems to capture the financial hurricane conditions facing much of the world’s shipbuilding industry.

That begs the question: who would choose to buy stock in a company that is sailing into such tempestuous weather?

Certainly, it looks like China Shipbuilding Industry is offering a decidedly contrarian investment opportunity, through the IPO it is currently marketing in Shanghai. As the country’s biggest maker of ship equipment (such as engines and propellers), the firm’s fate is closely tied to the shipping sector’s health. “The ship-equipment industry is in the same boat as the shipbuilders, which are all suffering from falling orders,” Zhou Fengwu, an analyst at Orient Securities told the People’s Daily.

Still, China Shipbuilding was looking to raise Rmb14.7 billion ($2.2 billion) from its offering, which constitutes about 30% of the company’s enlarged share capital. It plans to use the proceeds to expand capacity and upgrade its engine technology.

The timing may raise one or two eyebrows. In the first nine months of the year Chinese shipyards received 70% less orders than in the corresponding period for 2008. In fact, the boss of Yangzijiang Shipyard told the South China Morning Post that he could earn more money from scrapping ships than building them. Ren Yuanlin – who runs the country’s sixth biggest vessel maker – estimates that profit on building new ships (at current prices) is practically zero, whereas scrapping old ones still carries a 20% margin.

In the meantime, shipbuilders scan the horizon hopefully for signs of new orders. But the news is grim indeed: analysts reckon that shipping lines could lose a combined $20 billion this year.

In WiC24, Tim Huxley, CEO of Wah Kwong Maritime and Marine, explained the reasons for the malaise. A collapse in global exports – thanks to the financial crisis – had put massive downward pressure on freight rates. But further, Huxley added: “The biggest problem that shipping has given itself in the past five years has been the massive expansion of shipbuilding capacity. There’s 103 million (deadweight) tonnes of new bulk carriers scheduled for delivery in 2010. Just compare that with 2007, when the figure was 25 million tonnes! Adding to the oversupply: there’s something like 120 large bulk carriers sitting off China – as these ships come back into the market that also increases supply.”

You don’t have to be Adam Smith to work out that an excess of new ships will continue to put pressure on freight rates – and thereby shippers’ profitability.

Which brings us back to why China Shipbuilding Industry is pushing for an IPO now.

Even though the data may not look good, Beijing nevertheless seems to have deemed shipbuilding to be one of its “strategic” industries.

The goal is to surpass South Korea as the world’s biggest shipbuilder by 2015. Another target is that 80% of shipping components should be locally made. Foremost, the plan is to pare back reliance on Japanese and Korean engines. As Zhou at Orient Securities forecasts: “In the mid and long-term, China Shipbuilding will benefit from the government’s push to develop the local industry.”

The company also has an ace up its sleeve: China’s rapidly expanding navy. Since 2006 its military orders have increased by a compound annual growth rate of 50.6%. The potential order pipeline leads the China Times to classify the firm as a “blue chip military stock”.

Others must agree. Whatever the industry outlook in general, the IPO priced at the top of its range on Wednesday.

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