Pacific Basin Shipping (2343:HK) Fair value: HK$2.20
Pacific Basin Shipping (2343:HK) Rating: Outperform
22 May 2018, Hong Kong – We recently met up with Pacific Basin Shipping’s management team and here are our key takeaways. Overall, we forecast the global dry bulk shipping demand to grow 3.5% this year, ahead of our projected industry capacity growth of 2.9% which will help to support freight rate recovery and PacBasin’s earnings improvement. As the world’s largest Handysize operator, PacBasin’s share price has historically had a positive correlation with the Baltic Handysize Index. The key downside risk is the global dry bulk shipping sector has low barriers to entry and any spike in freight rates could drive an influx of investments into building new vessels again.
KEEPING HALF OF ITS CAPACITY EXPOSED TO THE SPOT MARKET
Pacific Basin Shipping (2343:HK) has secured cover for 44% of its 29,880 contracted revenue days in the Handysize segment from 2Q18 to 4Q18. This is higher than its 37% coverage for the same period a year ago. For the Supramax segment, PacBasin’s level of coverage of 66% (of its 12,270 contracted revenue days) this year is similar to last year’s level of 65%. This will provide PacBasin with sufficient exposure to leverage on improving freight rates in the spot market.
MORE FAVOURABLE FREIGHT RATES TO LIFT EARNINGS THIS YEAR
PacBasin’s average daily TCE earnings rose 25% and 40% y/y for the Handysize and Supramax segment respectively during 1Q18. The Handysize and Supramax rates it secured cover for the remaining 3 quarters of this year are also 14% higher than the same period last year at US$8,520/day and US$10,090/day respectively.
DAILY RATES CONTINUE TO OUTPERFORM MARKET
In 2017, PacBasin generated average daily TCE earnings of US$8,320/day and US$9,610/day net for the Handysize and Supramax segments, outperforming the BHSI and BSI indices by 15% and 8% respectively.
This outperformance has continued into 1Q18, where PacBasin’s Handysize and Supramax average daily TCE earnings of US$9,710/day and US$11,490/day net have outperformed the market by 16% and 10% respectively. PacBasin’s large and well-diversified cargo base, fleet of interchangeable ships as the world’s largest Handysize operator helps to maximize vessel utilisation and minimize ballast legs compared to sector peers.
Chart: Pacific Basin Shipping – Distribution of Dry Bulk Cargo Carried (1Q18)
FUTURE FLEET EXPANSION WILL BE VIA ACQUISITION OF VESSELS IN THE RESALE MARKET
All of Pacific Basin Shipping’s newbuild vessels have been delivered and it does not have anymore newbuilding capex going forward. Management is still open to expanding PacBasin’s vessel fleet further but this will be via the acquisition of young, high-quality, Japanese-built vessels in the secondary market.
This strategy makes sense in our view given the large 30% valuation gap between newbuild and 5-year old resale vessels currently and that it will not add to the global industry oversupply while gaining market share.
Management also reassured us that they will continue to focus on their core competency and not venture into investing in Capesize vessels or other shipping segments (such as tankers) having learnt from past lessons.
NOT KEEN ON INSTALLING SCRUBBERS FOR NOW
In view of the new IMO Low Sulphur Emissions Cap of 0.5% scheduled to be implemented from 1stJanuary 2020, management is not in favour of installing scrubbers given the uncertainty, environmental considerations and high costs involved. It would make more sense to utilize low sulphur fuel which is likely to drive the industry to scrap more older vessels and encourage slow-steaming which will help to reduce global shipping capacity.
IFRS 16 TO HAVE LIMITED FINANCIAL IMPACT
The adoption of IFRS 16 Leases accounting will have limited impact (of less than 5% based on our estimates) on Pacific Basin Shipping’s balance sheet.
MODERATE GLOBAL DRY BULK SHIPPING CAPACITY GROWTH WILL HELP SUPPORT EARNINGS RECOVERY
We forecast the global dry bulk shipping demand to grow 3.5% this year, ahead of our projected industry capacity growth of 2.9% which will help to support freight rate recovery and PacBasin’s earnings improvement. This underpins our Outperform rating and Fair value of HK$2.20 for Pacific Basin Shipping. As the world’s largest Handysize operator, PacBasin’s share price has historically had a positive correlation with the Baltic Handysize Index.Further improvement in spot market freight rates in the Handysize segment will be the most important positive catalyst for the stock.
Chart: Pacific Basin Shipping share price versus Baltic Handysize Index (2007 to 2018)
RESURGENCE OF NEWBUILD VESSEL ORDERS, HIGHER SAILING SPEEDS AND POTENTIAL EQUITY ISSUANCE ARE THE KEY DOWNSIDE RISKS
The key downside risk for the global dry bulk shipping sector is that it has lower barriers to entry compared to the other shipping segments and a sharp improvement in freight rates could drive an influx of investments into building new vessels. In addition, there could be potential dilution if PacBasin issues more shares to fund its vessel acquisitions and/or to strengthen its balance sheet.
Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.
Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report.
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