COSCO Corporation (Singapore) Limited — How did its order book rise so much?

COSCO Corporation (Singapore) Ltd maintains a cautious outlook for the rest of the year.

The shipbuilder warns that sliding crude oil prices have forced major oil companies to cut budgets for deep water rigs.

Moreover, a number of deep water rigs delivered this year are already struggling to get leased.

As a result, new orders in the offshore space have declined.

Also, there are challenges in the offshore space that are specific to COSCO Corp.

As it moves up the value chain, it is likely to face technical challenges that would impact its efficiency and profitability.

However, the company says it is determined to build its expertise to cater to a broader customer base in the long term.

In the dry bulk shipping space, it feels the new tonnage accumulated over the past few years means the recovery will be a “slow process with uncertainty”.

The company just announced earnings for Q3 FY2014:

Revenue: +17 per cent to S$1.16 billion (RM3 billion)
Profit: +69 per cent to S$7.2 million
Forex gain/(loss): S$5.1 million vs (S$0.2 million)
Cash flow from operations: (S$227.5 million) vs (S$316.3 million)
Dividend: Nil
Order book: US$8.9 billion (RM29. 7 billion) with deliveries up to 2016

Shipyard revenue was by far the biggest revenue generator. It increased by 17.2 per cent to S$1.1 billion while dry bulk shipping and other business revenue increased by 11.2 per cent to S$13.4 million.

Interest on borrowings was higher by 12 per cent.

However, the depreciation charged during Q3 was 19 per cent less than that in the same quarter last year.

During the quarter, it made a S$10.6 million allowance for expected losses on construction contracts, against an allowance of S$33.9 million last year.

It also made a S$1.6 million allowance for impairment of receivables and a S$1.6 million allowance for inventory write-down.

Analyst Low Pei Han at OCBC Research finds Q3 earnings to be in line with estimates — but that didn’t stop her maintaining a SELL rating.

COSCO Corp’s nine months’ profit of S$60.7 million accounts for about 76 per cent of the broker’s full-year target.

The broker adds the drop in gross profit margin to 4.9 per cent in Q3 from 7.4 per cent a year ago was due to execution of lower-margin contracts.

It also points out that three offshore projects of the company have already been cancelled, or are at risk of being cancelled.

These three projects are: Sevan 650 drilling unit (worth about US$525 million) which has been deferred for up to three years; Dalian deepwater drilling contract (worth about US$630 million) for which the arbitration is still going on in London; and Octabuoy hull and topside module (worth about US$240 million) which will likely be cancelled in the near future.

The broker reiterates COSCO Corp’s outlook statement in which it highlighted further erosion of its operating margins as it continues to execute orders won in recent years due to the weak shipping market.

Despite improved efficiency and productivity at its shipbuilding operations, OCBC Research warns a further erosion of operating margins doesn’t augur well for a company which has a net gearing of 1.3 times against just 0.6 times a couple of years ago.

The broker cites COSCO Corp’s “weak execution abilities, relatively poorer quality clientele, and deteriorating balance sheet amidst a slowing offshore market”, as key reasons for lowering its price-to-book-value estimate to 0.8x from 1x earlier.

As a result, OCBC Research maintains a SELL rating on the stock with a fair value estimate of S$0.50.

In the words of analyst Ho Pei Hwa at DBS Group Research, COSCO Corp reported “a disappointing set of results” as its Q3 net profit fell to a “miserable” S$7.1 million.

The third consecutive quarter of margin decline is worrying, adds the broker.

According to the broker, COSCO Corp’s “hefty” gross order book of US$8.9 billion is a “double-edged sword” as the shipbuilding orders are of low value while the offshore segment continues to see a “steep learning curve”.

The broker is also worried that the shipbuilder might not be able to sell the cancelled drillship units due to “weak market sentiment and abundant supply of new drilling rigs”.

The broker also reveals that the 4th Sevan cylindrical rig unit is near completion and it faces the risk of cancellation as the customer has failed to secure a charter contract for the rig and COSCO Corp might be held responsible for the delay in delivery.

DBS Group Research reiterates FULLY VALUED rating on the stock with a target price of S$0.62, having potential downside risks.

Investor Central. We keep your investments honest.

1. On what basis did the management revise the useful lives of its assets?

According to page 8 of its Q3 earnings report, COSCO Corp revised the estimated useful lives of certain assets within leasehold land and buildings, plant and machinery and docks and quays, after conducting a review on January 1.

As a result, the company has increased the estimated useful life of its assets which has the consequence of reducing the depreciation expense in its earnings report.

Therefore, its profit before tax for Q3 has increased by S$9.3 million whereas the profit before tax for the first nine months has increased by S$27.5 million due to the lower depreciation charge.

It is noteworthy that in the absence of the lower depreciation charged so far in 2014, COSCO Corp would have recorded a 24 per cent drop in pre-tax profit for the first nine months, compared with the 20 per cent rise it actually did.

Had it charged the depreciation at the same rate as in the previous year, it would have recorded pre-tax loss in Q3 instead of a profit figure.

The net book value of its property, plant and equipment as at September 30 was also higher by about S$27.5 million.

According to page 90 of its 2013 annual report, COSCO Corp estimated the following useful lives of its assets for 2013:

Buildings on freehold land: 50 years, leasehold land and buildings: 10 to 50 years, office renovations, furniture, fixtures and equipment: 3 to 5 years, plant, machinery and equipment: 3 to 10 years, motor vehicles: 5 to 10 years, motor vessels: 20 years and docks and quays: 30 years.

In the absence of clarity, we wonder which of the above estimates were tweaked in the review on January 1.

Also, on what basis did the management decide to stretch the useful lives of the assets?

2. How much more is it willing to borrow?

COSCO Corp had a cash balance of S$1.8 billion on September 30, which was down from S$2.03 billion on December 31.

At the same time, its trade and other receivables have increased from S$2.91 billion on December 31 to S$4.74 billion on September 30.

The company’s total debt stood at S$4.66 billion on September 30 compared with S$3.78 billion on December 31.

Its net debt to equity ratio has shot up to 1.29 times on September 30 from 0.8 times on December 31.

In all likelihood, COSCO Corp’s profitability will decline further as it executes more of low value contracts and climbs up the learning curve in the offshore segment.

Therefore any reasonable investor would wonder how it plans to serve its debt obligations in the coming quarters.

Moreover, how else does it plan to raise funds to finance its working capital?

Just like it has done so far this year, will it borrow more to meet its working capital needs?

In that case, how much more would it be?

3. How did its order book rise so much?

On page 11 of its Q3 earnings report, COSCO Corp claimed to have an order book of US$8.9 billion on September 30, with progressive deliveries up to 2016.

According to page 10 of its FY2013 earnings report, COSCO Corp’s order book was US$7.8 billion on December 31.

Going by this measure, its order book has grown by a net US$1.1 billion in the first nine months.

Looking through the announcements, it has won a combined US$1.58 billion worth of orders in the first nine months of the year for two livestock carriers worth US$57 million, two platform supply vessels worth US$60 million, two platform supply vessels and four emergency vessels worth US$100 million, one jack-up rig worth US$184 million, four platform supply vessels worth US$120 million, one accommodation barge and seven bulk carriers worth US$300 million, four subsea supply vessels worth US$470 million, two bulk carriers worth US$56 million, one floating accommodation and one module carrier worth US$230 million.

On the other hand, COSCO Corp recorded a S$3.23 billion (about US$2.58 billion) revenue from shipyard operations in the first nine months, against deliveries of seven bulk carriers, two livestock carriers, one tender rig, two pipelay heavy lift vessel, two wind turbine installation vessel, one tender barge, one float-over launch barge and one jack-up rig (refer pages 9/10 of its Q1, Q2 and Q3 earnings reports, and a wind turbine vessel delivery announcement on April 4).

Therefore that leaves us wondering why its order book increased by US$1.1 billion in the first nine months even as it delivered S$3.23 billion (about US$2.58 billion) worth of orders and won only US$1.58 billion worth of new orders during the period.

4. How is its order book calculated?

According to page 91 of its 2013 annual report, COSCO Corp recognises revenue on “percentage-to-completion method”.

However, the annual report doesn’t disclose the basis on which its order book is calculated.

We wonder if the portion of the value of its orders which has been booked as revenue is simultaneously reduced from its order book.

In other words, what is the net order book of COSCO Corp?

In its Q3 earnings report, the company also said that its order book has progressive deliveries up to 2016.

However, its recent order-win announcements indicate deliveries extending into the first half of 2017.

To clear the confusion, can we please have a vessel-wise break-up of the order book?

5. What took it three years to inform the shareholders about the default on Octabuoy hull and topside module’s order?

On July 22, COSCO Corp announced that ATP Oil & Gas (UK) Limited would terminate the vessel-building contract for Octabuoy hull and the topside module.

ATP Oil & Gas (the buyer) placed the US$131.8 million order in April 2008.

The buyer made a deposit of US$3 million at the time.

In October 2009, the terms of the contract were amended.

Now, the buyer agreed to pay the remaining US$99 million consideration for the vessel at the time of delivery in 2011, instead of paying it in instalments as agreed in April 2008.

That means the buyer had paid about US$32.8 million to COSCO Corp by October 2009.

In May 2011, the buyer placed another order for an Octabuoy Topside module worth US$114 million, to be delivered in Q3 2013.

But on July 22, COSCO Corp announced that both contracts would be terminated.

In that announcement, it also said that it has completed construction work of about 96 per cent of the hull and about 47.96 per cent of the topside module project.

Apparently, the Octabuoy hull was not delivered, as agreed, at the end of 2011.

We wonder what took COSCO Corp almost three years before it announced the delay to its shareholders on July 22.

Or did it disclose the delay on an earlier occasion too?

In that case, can you please point out the date of such a disclosure?

6. Why didn’t it initiate the legal proceedings earlier against the buyer?

Moving on, why did COSCO Corp not initiate legal proceedings against the buyer if it failed to take the delivery of the vessel in 2011?

We already know that the buyer still owes US$99 million on the Octabuoy hull contract.

However, we don’t know how much of the US$114 million the buyer still owes for the topside module contract.

As per the proposal approved under the legal proceedings against the buyer in the UK, COSCO Corp says it shall be entitled to retain any instalments paid by the buyer.

Also, COSCO Corp shall have ‘full right and power’ to complete and/or sell the vessel at a public or private sale.

So, how much money has the buyer already paid towards the contracts?

Secondly, has COSCO Corp found a new buyer for the vessel? And how much would it lose/gain in that process?

7. Is Octabuoy hull and the topside module still a part of its order book?

Technically, the Octabuoy hull and topside module is no longer committed for sale to a specific buyer.

Therefore, is it still included in the US$8.9 billion order book of COSCO Corp?

Similarly, is the Dalian deepwater drilling contract worth US$630 million still a part of its order book?

8. Why wasn’t Sevan Developer delivered on time in Q2?

In May 2011, Sevan Drilling ASA’s subsidiaries Sevan Drilling Rig V Pte Ltd and Sevan Drilling Rig VI Pte Ltd placed orders with COSCO Corp to build two drilling rigs for US$1.05 billion, with deliveries agreed in Q4 2013 and Q2 2014.

In Q3 last year, COSCO Corp delivered a drilling rig named Sevan Louisiana to Sevan Drilling ASA on October 23.

However, no vessel was delivered to Sevan Drilling ASA or Sevan Drilling Rig VI Pte Ltd in Q2 earlier this year.

A few months later, on October 17, COSCO Corp announced the deferment of the delivery of the drilling rig named Sevan Developer to Sevan Drilling Rig VI Pte Ltd for a year, along with options, exercisable at six months, to extend the delivery date up to a total of three years from October 15.

COSCO Corp didn’t disclose the reasons for which the drilling rig could not be delivered during Q2.

Was COSCO Corp not able to finish the work on time? Or did Sevan Drilling ASA decline to take delivery?

Now that COSCO Corp has given options to Sevan Drilling ASA to extend the delivery date up to three years and meanwhile continue to market Sevan Developer as a part of its fleet, any reasonable investor would wonder what made COSCO Corp sweeten the deal for Sevan Drilling ASA.

Would Sevan Drilling ASA pay a penalty for not taking delivery as per the contract?

On that note, how much of the US$525 million consideration has Sevan Drilling ASA already paid?

And if COSCO Corp didn’t breach the contract, why did it not pursue legal remedy against Sevan Drilling ASA for the default?

These are some of the questions that are not answered in the announcements of COSCO Corp.

At least, we couldn’t spot the answers there.
Source: Malay Mail, Investor Central