abc Global Research “Things change quickly in this business, Coco… As long as you have a seat at the table, you have a chance. The greatest value in shipping is option value” – The Shipping Man Time to reassess: We have been underweight on Pacific Basin since end-2012 as we saw at least two years of earnings disappointment at the time. The earnings compression was worse than we thought but is about to pass. We are still 33-40% below consensus on 2015-16e EPS and believe the Street’s optimism doesn’t factor in the ease of supply creation in the sector. On the positive side, however, we beliepve a volatile path to mid-single-digit RoE is intact since the worst of supply growth is over. A PB of 0.8x also appears to be attractive relative to the stock’s historical valuation. Resilience of valuations: Our target prices in the past two years have been in the range of a 0.5-0.6x PB, which we deemed appropriate for a low-single-digit RoE firm with a cost of equity of c.8%. But the stock has held onto its typical post-crisis PB range of 0.8-1.1x despite much weaker fundamentals. One of the reasons why this has happened could be the stock’s good record of return generation when acquired at a PB of less than 0.67x. Market-wide multiple expansion could be another reason – our analysis shows a clear uplift in multiples even in stocks with no earnings improvement. The value of volatility: There could be one more reason for the higher valuations. Investors possibly appreciate the value that an unanticipated surge in freight rates can create. It’s not just the possibility of windfall profits but also of beefy stock returns. Much like the freight rate spike in 4Q13, short-term rallies masquerade as a recovery and are even priced like a one. This volatility adds an option to bulk equities – it’s an option which prices the known unknowns and known unknowns are rather frequent in bulk markets. Raise TP to HKD4.93 (from HKD3.0) at a PB of 1.0x; upgrade to OW from UW: The complex nature of demand and supply and the inability to forecast near-term rates crystallize investor focus on valuations. Multiple expansion and a consistent post-crisis trading range have raised the PB floor to 0.8x. Investors can argue that a target PB of 1.0x looks excessive for a single-digit RoE company. But, we believe this is true only till one discovers that volatility has a value too. We think the current low rates will trigger slow-steaming and yet another rate spike as well as a rerating towards the top of the trading band of 0.8-1.1x. Pacific Basin (2343 HK) Upgrade to OW: Recalibrating valuations We have been right on earnings for the last two years… …but wrong on valuation, so we are changing our approach Upgrade to Overweight from Underweight with TP of HKD4.93 (from HKD3.0), implying a 2015e PB of 1.0x Industrials Marine Equity – Hong Kong Company report Index^ HANG SENG INDEX Index level 22,933 RIC 2343.HK Bloomberg 2343 HK Source: HSBC Overweight Target price (HKD) 4.93 Share price (HKD) 3.98 Forecast dividend yield (%) 2.0 Potential return (%) 25.9 Note: Potential return equals the percentage difference between the current share price and the target price, plus the forecast dividend yield Dec 2013 a 2014 e 2015 e HSBC EPS 0.00 -0.01 0.03 HSBC PE 18.8 Performance 1M 3M 12M Absolute (%) -16.2 -17.1 -24.2 Relative^ (%) -7.5 -14.9 -23.3 Enterprise value (USDm) 1575 Free float (%) 98 Market cap (USDm) 993 Market cap (HKDm) 7,709 Source: HSBC 6 October 2014 Shishir Singh* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4292 [email protected]Mark Webb* Head of Conglomerate and Transport Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6574 [email protected]View HSBC Global Research at: http://www.research.hsbc.com *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Issuer of report: The Hongkong and Shanghai Banking Corporation Limited Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms p art of i t
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abcGlobal Research
“Things change quickly in this business, Coco… As long as you have a seat at the table,
you have a chance. The greatest value in shipping is option value” – The Shipping Man
Time to reassess: We have been underweight on Pacific Basin since end-2012 as we saw at
least two years of earnings disappointment at the time. The earnings compression was worse
than we thought but is about to pass. We are still 33-40% below consensus on 2015-16e EPS
and believe the Street’s optimism doesn’t factor in the ease of supply creation in the sector. On
the positive side, however, we beliepve a volatile path to mid-single-digit RoE is intact since
the worst of supply growth is over. A PB of 0.8x also appears to be attractive relative to the
stock’s historical valuation.
Resilience of valuations: Our target prices in the past two years have been in the range of
a 0.5-0.6x PB, which we deemed appropriate for a low-single-digit RoE firm with a cost
of equity of c.8%. But the stock has held onto its typical post-crisis PB range of 0.8-1.1x
despite much weaker fundamentals. One of the reasons why this has happened could be
the stock’s good record of return generation when acquired at a PB of less than 0.67x.
Market-wide multiple expansion could be another reason – our analysis shows a clear
uplift in multiples even in stocks with no earnings improvement.
The value of volatility: There could be one more reason for the higher valuations.
Investors possibly appreciate the value that an unanticipated surge in freight rates can
create. It’s not just the possibility of windfall profits but also of beefy stock returns. Much
like the freight rate spike in 4Q13, short-term rallies masquerade as a recovery and are even
priced like a one. This volatility adds an option to bulk equities – it’s an option which
prices the known unknowns and known unknowns are rather frequent in bulk markets.
Raise TP to HKD4.93 (from HKD3.0) at a PB of 1.0x; upgrade to OW from UW: The
complex nature of demand and supply and the inability to forecast near-term rates crystallize
investor focus on valuations. Multiple expansion and a consistent post-crisis trading range have
raised the PB floor to 0.8x. Investors can argue that a target PB of 1.0x looks excessive for a
single-digit RoE company. But, we believe this is true only till one discovers that volatility has
a value too. We think the current low rates will trigger slow-steaming and yet another rate
spike as well as a rerating towards the top of the trading band of 0.8-1.1x.
Pacific Basin (2343 HK)
Upgrade to OW: Recalibrating valuations
We have been right on earnings for the last two years…
…but wrong on valuation, so we are changing our approach
Upgrade to Overweight from Underweight with TP of HKD4.93 (from HKD3.0), implying a 2015e PB of 1.0x
Industrials Marine Equity – Hong Kong
Company report
Index^ HANG SENG INDEXIndex level 22,933RIC 2343.HKBloomberg 2343 HK
Enterprise value (USDm) 1575Free float (%) 98Market cap (USDm) 993Market cap (HKDm) 7,709
Source: HSBC
6 October 2014
Shishir Singh* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4292 [email protected]
Mark Webb* Head of Conglomerate and Transport Research, Asia Pacific The Hongkong and Shanghai Banking Corporation Limited +852 2996 6574 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations
Issuer of report: The Hongkong and Shanghai Banking Corporation Limited
Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
Depending upon how bad or good a year has been, the 6-month forward returns would be positive if the valuation of Pacific Basin stock at the time of buying the stock was in the price-to-book range of 0.67x-1.00x
Valuations have gravitated up without fundamental support It’s rather surprising to see the resilience in Pacific Basin stock despite a history of earnings disappointment
and sharp cuts to consensus earnings this year. Shouldn’t valuations have broken down and out of the typical
PB range of 0.8-1.1x? The fundamentals of the company over last two years have indeed been a lot worse
than at any time in the past, but valuations remain well-supported. Have valuations been gravitating up
despite similar or even poorer fundamentals? More importantly, have valuations become richer even in
sectors like shipping which have shown little or no improvement in earnings?
To answer these questions, we selected a sample set from global stocks where RoE was already below 10% in
2010 and fell further to under 5% in the next three years (2011-13). We screened them further for financial
leverage and selected only the ones which have a net debt-to-EBITDA of over 2x. On the whole, 330 stocks
fit our criteria and we placed the annual average price-to-book of each of them into separate buckets. The
results show a clear move towards lower valuations in 2011 after a relatively strong 2010.
The chart below shows the distribution of the companies in our sample set according to their valuation in
any given year. Notice how the valuation distribution became skewed substantially to the left in 2011
(thick red line) from 2010 (thick black line). 2011, however, proved to be the low point and the
distribution of valuations has continued to move to the right since then. This comes out even more clearly
Valuations shrunk in 2011 after a robust 2010 but are now back at similar levels even though fundamentals remain depressed
Source: Bloomberg, HSBC
Pacific Basin earnings have been disappointing too often… HSBC vs consensus estimates
Fleet value-based approach is more of an art than science
Another way to look at valuations is through the value of company’s fleet, as indicated by current sale
and purchase market. Based on Clarksons data on asset values, we estimate the company’s dry bulk fleet
has a value of close to USD1.8bn. The towage fleet is valued at a book value of HKD0.55/share or
USD137m, taking the total enterprise value to USD1.9bn including the yet-to-be-delivered newbuildings. Pacific Basin fleet value (Sep 2014) at current asset prices excluding any contribution from chartered fleet
Dry Bulk Fleet Value (Aug-2014) USDm USD/Vsl
Handymax (Owned) 350 23.3 Handymax New Buildings (Owned) 163 27.2 Handysize (Owned) 900 14.1 Handysize Newbuildings (Owned) 367 28.2 Total 1,779 Less: Current Net Debt (all allocated to dry bulk) -655 Less: Current Capex Commitments -410 Current Market Value (USD m) – Dry Bulk Fleet 714 Current MV/share (HKD) - Dry bulk 2.87 Current MV/share (HKD) – Towage – at book value 0.55 Fleet Value/Share (HKD) 3.41
Source: Clarksons, HSBC estimates
We reduce the company’s net debt of USD655m and its capex commitments of USD410m to arrive at a
market value for its fleet of HKD3.41/share. Although these estimates suggest that the company’s equity
is trading at a substantial premium to its fleet value, we must caution that two factors are debatable: 1) Is
the secondary market value a reliable assessment? 2) Should there be a value of the chartered fleet?
Our fleet value estimate implies a price of USD14m for each of the 64 Handysize vessels owned by
the company (average age at eight years). This may look too low considering that a five-year old
Handysize is valued at USD19m and a new one is priced north of USD25m, however, the data from
Clarksons suggests a steep depreciation curve for the Handysize vessels in particular (say, relative to
Handymax). The presence of modern substitutes could be one of the reasons for the depressed value
of older Handysizes since Handymax vessels have grown rapidly in the last few years. However, we
have always pointed out that asset values are not the most reliable indicator particularly because they
are assessed by a far more illiquid and inefficient market compared to the equity market. A valuation
of merely USD1m/Handysize vessel more could add another HKD0.25/share and, if a slow recovery
takes hold as we think, history suggests that there would be upside to current asset values.
Charter rate less charter costs (USD/day) Second-hand Handysize asset values (USDm)
Source: Company, HSBC estimates Source: Clarksons
-5,000
0
5,000
10,000
15,000
20,000
2H06
1H07
2H07
1H08
2H08
1H09
2H09
1H10
2H10
1H11
2H11
1H12
2H12
1H13
2H13
1H14
2H14
1H15
2H15
1H16
2H16
1H17
2H17
Handymax Handysize
0.0
10.0
20.0
30.0
40.0
50.0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
10 Yr Handysize 5 Yr Handysize
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Yet another value contribution can possibly be argued for the contributions of chartered fleet. The
chartered fleet would account for more than 60% of revenue days in 2014e and while it has found it
difficult to earn a profit in volatile markets of the last three years, it’s worth remembering that the
situation can normalize if markets start trending up in a slow but sustained manner. On our forecasts
of charter spread (charter rate – charter cost) of USD500-600/day, the business would generate
USD25-30m of net profit annually over the next two years. At a conservative PE of 5x, such
chartered fleet earnings would add HKD0.50-0.60/share to the company’s valuation.
Pacific Basin fair value/share (HKD) based on its fleet valuation in slow recovery (including contribution from chartered fleet)
Source: Company, Clarksons, HSBC estimates
The chart above highlights our fleet-based valuation and its challenges. It offers a fairly wide value range
from HKD3.41/share to HKD4.53/share, implying a price-to-book of 0.73x-0.94x. The equity market’s
view is likely to vary depending on the trajectory of asset prices as well as its view on the stage of the
cycle and company’s ability to make money on its chartered fleet.
Apart from factoring in weaker-than-expected first half results, we have made only made marginal
changes to our estimates and continue to forecast a RoE recovery over the next two years.
Under our research model, the Neutral band for non-volatile stocks equals the local hurdle rate (average
cost of equity) set by our Global Equity Strategy team (8.5% for Hong Kong), plus or minus 5ppt. This
translates into a potential return of 3.5-13.5% for stocks meriting a Neutral rating. Our target price of
HKD4.93 (including the forecast dividend yield of 2%), implies a potential return of 25.9%, which is
above the Neutral band; we therefore upgrade the stock to Overweight from Underweight. Potential return
equals the percentage difference between the current share price and the target price, including the
forecast dividend yield.
Upside catalysts include slow-steaming persisting or higher minor bulk demand materializing. Downside
risks include shrinking demand for Handysize ships.
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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Shishir Singh and Mark Webb
Important disclosures
Equities: Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below.
This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website.
HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.
Rating definitions for long-term investment opportunities
Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.
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*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities
As of 03 October 2014, the distribution of all ratings published is as follows: Overweight (Buy) 45% (30% of these provided with Investment Banking Services)
Neutral (Hold) 37% (30% of these provided with Investment Banking Services)
Underweight (Sell) 18% (20% of these provided with Investment Banking Services)
Share price and rating changes for long-term investment opportunities
Pacific Basin Shipping (2343.HK) Share Price performance HKD Vs HSBC
rating history
Recommendation & price target history
From To Date
N/A Neutral 18 October 2011 Neutral Overweight 05 December 2011 Overweight Neutral 01 March 2012 Neutral Underweight 10 April 2012 Underweight Overweight (V) 11 June 2012 Overweight (V) Neutral (V) 01 August 2012 Neutral (V) Underweight (V) 11 December 2012 Underweight (V) Underweight 28 February 2013 Target Price Value Date
Price 1 4.06 18 October 2011 Price 2 4.12 01 March 2012 Price 3 4.12 19 June 2012 Price 4 3.56 01 August 2012 Price 5 3.00 17 February 2013 Price 6 3.20 28 January 2014 Price 7 3.30 26 March 2014 Price 8 3.00 08 July 2014
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next
3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this
company. 4 As of 31 August 2014 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 August 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 August 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 31 August 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as
detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this
company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in
securities in respect of this company HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis.
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.
Whether, or in what time frame, an update of this analysis will be published is not determined in advance.
For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.
Additional disclosures 1 This report is dated as at 06 October 2014. 2 All market data included in this report are dated as at close 03 October 2014, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.
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Disclaimer * Legal entities as at 30 May 2014 ‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking Corporation Limited, Hong Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Bank Canada, Toronto; HSBC Bank, Paris Branch; HSBC France; ‘DE’ HSBC Trinkaus & Burkhardt AG, Düsseldorf; 000 HSBC Bank (RR), Moscow; ‘IN’ HSBC Securities and Capital Markets (India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities Egypt SAE, Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv; ‘US’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC México, SA, Institución de Banca Múltiple, Grupo Financiero HSBC; HSBC Bank Brasil SA – Banco Múltiplo; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR; The Hongkong and Shanghai Banking Corporation Limited, Bangkok Branch
Issuer of report
The Hongkong and Shanghai Banking Corporation Limited Level 19, 1 Queen’s Road Central