Updated: Aug 1
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YZJ is a leading Chinese private shipbuilder that is trading at near rock-bottom valuations of 0.22x EV/EBITDA and 0.62x P/B.
Over the past few months, the company has purchased over 70m shares (1.79% of total no. of shares outstanding). This amount is only overshadowed by the ~228m shares purchased during the GFC.
Event risks such as corporate succession and MSCI Singapore Index removal seems overblown as the business continued to secure elevated levels of orders in 2020.
Improved industry dynamics through rising demand and shrinking supply could pave the way for newbuilding price expansion.
YZJ has proved to be resilient even during downcycles and has been a consistent dividend paymaster. Current yield stands at 4.4%.
DCF-backed fair value estimate of $1.26, representing possible upside of 23.3%.
Yangzijiang Shipbuilding (YZJ) is a global top-10 shipbuilder, commanding a 4% worldwide market share by order book in 2019. Based in Jiangsu Province, China, the group has four shipyards and produces a broad range of commercial vessels including large containerships, bulk carriers and LNG carriers, serving orders from a well-established global customer network.
The company is currently trading at multi-year low valuations of 0.22x NTM EV/EBITDA and 0.62x P/B. The market's pessimistic view of the company could be due to the following reasons over the past couple of years:
Involvement of ex-chairman Ren Yuanlin in a Chinese governmental probe
Fears over a slowdown in the shipbuilding industry owing to COVID-19
Overhang from removal from the MSCI Singapore Index
However, I believe some of these concerns are overblown and the negatives are largely priced in. Given YZJ's steady track record of generating profits during downcycles and laser-focused execution in terms of order wins over the past year, I believe this presents a favourable risk-reward proposition.
What could the market be missing out?
1. Decade-high levels of share repurchases with strong historical signaling effect
Over the past year, YZJ's management has put its massive cash hoard to work by purchasing over 70m shares (1.79% of total number of shares outstanding) at an average price of $0.95, spending over $66.7m in the process. It is noteworthy that this is only the fifth time in YZJ's 13-year listing history that it is conducting share buybacks, with the number of shares being repurchased only being eclipsed by the ~228m shares purchased during the global financial crisis in 2008.
YZJ's management has been prudent with capital allocation decisions and have only deployed capital to repurchase shares during times of pronounced event risks when the company's fundamentals remain unaffected. These include market events like the GFC (2008), US-China trade war (2018) and when the ex-chairman was involved in a governmental probe (2019).
An analysis of previous buyback activity showed that these buybacks were largely positive on market sentiment, with the stock price rallying 28.4% - 144.8% within a year of the final buyback date each time. This points to management's acute awareness of the company's intrinsic value, which translated to a superior market timing track record.
At its present price of $1.02, the stock is up ~7.3% from the average buyback price of $0.95. History does not repeat itself, but it often rhymes.
2. Event risks could be overblown
Ever since the news broke that ex-chairman Ren Yuanlin was involved in a Chinese governmental probe in Aug '19, stock price performance has been lacklustre as the market dealt with the overhang. In fact, YZJ's stock price is still ~33% down from its July '19 high of $1.52. I believe this is unwarranted given that Ren Yuanlin was not the subject of the probe and merely assisting with investigations. Moreover, Ren returned in Dec '19 from his leave of absence and stepped down from the chairman role in Apr '20, making way for his son, CEO Ren Letian, to take over the reins.
With corporate governance no longer being the primary issue, the key question to answer was whether Ren Letian had the leadership ability to steer the company out of troubled waters. To answer this question, a key metric to monitor would be new order wins, of which YZJ had maintained US$2b in guidance for FY2020.
Amidst the challenging macro backdrop of COVID-19, Ren Letian was able to lead YZJ to clinch a respectable US$1.8b worth of orders, coming close to guidance and representing a three-year high. In doing so, I believe that the younger Ren has proved his salt as a suitable steward for the company.
Meanwhile, in an unrelated report, MSCI announced the deletion of YZJ alongside Jardine C&C from the MSCI Singapore Index. The index rebalancing occurred after ComfortDelgro, SATS, Sembcorp Industries and SPH were removed from the same index months earlier. This caused temporary selling pressure on YZJ's stock as index funds liquidated their positions around the 30 Nov '20 deadline. I do not see this as a big concern as fundamentals remain intact, with YZJ forging on with new orders throughout the sell-down.
3. Improving industry dynamics
Looking at YZJ's new order wins over the past decade or so in isolation would paint a picture of a business in structural stagnation. However, juxtaposing YZJ's order wins with global figures indicate its performance was largely in line with the industry.
Moreover, recent developments suggest that the global shipbuilding industry could be reaching an inflection point. Freight rates, as measured by the BDI and CCFI have been on a steady uptrend as Chinese exports stage a recovery.
Meanwhile, global supply is tightening, with the total number of active shipbuilding facilities falling ~60% from a cycle-peak of 684 to 281 in 2019.
These could bode well for newbuilding prices which have been consolidating for close to a decade. According to Barry Ragliano Salles, the catalysts for higher prices could come in the form of 1) demand/supply imbalances; 2) further consolidation of the global shipbuilding industry; 3) the replacement of ships delivered between 2005 and 2010 (1,360 - 2,485 ships per year) as well as 4) the need to replace non-eco and non-economic vessels which do not meet stricter regulatory requirements.
All these data points line up nicely in the context of the longer-term shipbuilding cycle, which tends to last ~30 years. Looking at Hedgeye's chart, the current cycle seems to be entering into a trough and we could witness a cyclical upswing in newbuilding orders in the coming years if these positive dynamics remain in play.
4. Consistent operating track record with sustainable dividends
At its core, YZJ's business is fundamentally sound and has demonstrated the ability to operate profitably across the full shipbuilding cycle. It also has a solid balance sheet with net cash of Rmb 4.4b or $0.23 per share.
Furthermore, YZJ has a solid track record of never missing a dividend payout throughout its listing history. Payout ratio also has never exceeded 30%, indicating that payouts should be sustainable at current levels. Moreover, YZJ's current ~4.4% yield seems decent after taking into account the opportunity cost of investing in other yield instruments, which generally offer meagre returns in this low-interest-rate environment.
In my back-of-the-envelope valuation model, I aimed to figure out the steady-state FCFF that YZJ can reasonably generate in perpetuity. After the cycle peak in 2008, EBIT, depreciation and capex have largely remained rangebound, with changes in working capital being the swing factor for FCFF calculations as YZJ expands and contracts its debt investment book.
YZJ's 10-year median (2009 - 2019) FCFF of Rmb 1.43b would capture its performance throughout the shipbuilding downcycle. Using this FCFF figure in perpetuity, I obtained a DCF-backed fair value estimate of $1.26 (23.3% upside). This implies an FY21E P/B of 0.71x, which does not seem unreasonable statistically.
If the global shipbuilding industry is indeed entering a trough in the current cycle, my estimates should prove conservative if one believes that YZJ can keep up with the industry's performance.
WACC of 10% - higher than Damodaran China sector averages for Banks (~5%) and Shipbuilding & Marine (~6.5%)
Terminal growth rate of 0%
Steady-state FCFF pegged to 10-year median
Furthermore, the market only seems to be pricing in its cash and debt investments and completely ignoring its primary shipbuilding business. This could act as a downside cushion for stock prices, especially when management is also conducting aggressive buybacks at these levels.
The street is largely bullish on the stock with 5 Buys, 2 Outperforms, 1 Hold and 1 Sell. Consensus average TP stands at $1.23.
1. Rising newbuilding prices
Rising newbuilding prices would be positive for new contract sizes and would boost YZJ's order book. This is already playing out as shipyards contend with cost-side pressures due to rising steel plate prices.
2. New order wins
Similarly, new order wins would be positive for replenishing YZJ's order book, providing visibility on future revenues.
3. Renewed share buyback mandate
YZJ's recent buyback activity is positive as it is accretive to ROE and EPS. Sustained share repurchases would be beneficial for long-term investors.
1. Rising raw material prices
Steel is an essential raw material in shipbuilding, estimated by DBS Group Research to constitute 20% of COGS. Furthermore, the research house asserts that every 1% uptick in steel costs would result in a 0.8% dip in earnings. With that being said, I am of the opinion that the effect of rising raw material prices could be offset by a corresponding increase in newbuilding prices.
2. FX risks
YZJ's transacts heavily in USD and its bottom line would be negatively impacted by a weakening USD. Incidentally, the USD has seen a steady decline against the CNY since 2020 in light of loose monetary policy. Thus, it would not be surprising to see YZJ recording a sizeable FX loss in FY2020. However, it is worth noting that YZJ has shown a tendency to hedge against currency risk and had currency hedges covering ~US$450m of contracts heading into FY2020. Hence, should the management view FX risks to be substantial moving forward, I believe that they would take the appropriate actions to hedge them out after what could be a kitchen sink year.
I first got interested in YZJ when I noticed their substantial and consistent buybacks back in Sep '20. This made sense given that YZJ was trading at (and is still trading at) near rock-bottom valuations. With corporate succession and index removal concerns out of the way, I am turning towards improving industry dynamics as demonstrated by rising demand and shrinking supply. I am also on the lookout for any signs of a cyclical upswing in the longer-term ship replacement cycle, which could be round the corner.
The points mentioned above give me good reason to believe that YZJ has considerable asymmetric upside. This was also enough to convince me to initiate a tracking position due to the actionability and time-sensitive nature of the idea. It doesn't hurt that I would be getting a decent yield while waiting for catalysts to materialise.
Till then, I will continue to validate my thesis and update the post with any new information.
Thanks for reading,
Disclaimer: I am long Yangzijiang Shipbuilding at an average price of $0.94. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such.
Cover photo source: Chris Pagan on Unsplash
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