- Undervalued Investment with a target price range of $1.64 – $1.94. This represents a margin of safety of 70 – 100%.
- Prudent, competent and transparent management.
- Improving balance sheet health despite industry consolidation.
- A steady performer with strong earning capabilities.
- High and consistent historical dividend
Yang Zi Jiang (YZJ) is the largest private shipbuilding in China. YZJ produces a broad range of commercial vessels such as container ships, bulk carriers, and Liquefied Natural Gas (LNG) vessels. Apart from the main shipbuilding business, YZJ is also engaged in its own financial investments and other shipbuilding related business such as ship logistic, chartering and design services.
Over the years, YZJ had diversified their product mix to provide for multiple streams of income. This is in line with what the management intention to achieve back in 2013 – a 40% revenue from other streams of income apart from shipbuilding activities. Overall, a diversified product mix provides for lower risk exposure especially in an industry downturn where the number of shipyards in PRC had declined from over 3000 since the peak of the industry to less than 300 back in 2014.
YZJ’s customer mix is mainly derived from the Asian continent. While PRC & Taiwan form a good proportion of the Asian Market, historically, it only accounts for RMB 4 Billion which translates to an average of roughly 30% of the YZJ’s total order book. Apart from Asia, a major part of YZJ’s order book is also derived from European countries.
While YZJ’s order book is extremely volatile in nature and depends largely on the market’s demand. We are able to infer two things:
1) Contribution from the Asia market is filling up the decline from the Europe Market.
2) Demand from America countries is on an on-off basis.
The potential catalyst of growth stems from the e-commerce industry, belt and road initiative and stricter international maritime organization rules and regulations on vessel emission standards.
Stricter environmental rules and regulations had resulted in an increase in the demand for LNG carriers. Because of this the group believes that there is a huge LNG carrier demand driven by international trade in LNG and had since expanded into catering for this segment. As such, we can expect a higher contribution from the LNG segment moving forward.
Belt and road initiative will contribute to the global economic growth. As the global economic growth improves, we can expect higher trade activities among countries and hence resulting in an increase in shipping activities. This will contribute to the recovery of the shipbuilding industry.
A trade war between the US & China. Amidst the potential 25% tariff imposed on steel which will directly affect the YZJ’s cost of goods sold, YZJ operations will also be affected by a lower demand for commodities and weaker global trade volume which is a key driver for the demand for the construction of ship vessels.
While the main attention is between US & China, it is vital to remember that other nations targeted by the announcement are also major trading partners with the USA – Canada, South Korea, Japan and Brazil. The direct impact on an all-out global trade war is one that should not be taken lightly as it affects not just raw materials but also finished goods.
The birth of a behemoth. With the State Council, China’s cabinet, recently given its preliminary approval to merge China State Shipbuilding Corp. (CSSC) with China Shipbuilding Industry Corp. (CSIC), YZJ is set to compete with a potential giant that commands a combined revenue of US$81 billion.
While the focus of the shipbuilder’s activities differs from YZJ’s focus in cargo and container vessels, the birth of a new giant nonetheless poses higher competition in the shipbuilding industry as it is able to command higher economic of scales.
YZJ is founded by Ren YuanLin, age 64, who is currently an executive chairman to the company. His Son, Ren LeTian is appointed as the CEO of the group on 2015 as part of succession planning strategy for the continuity of the business and is currently responsible for the group’s overall shipbuilding operations. With a succession plan in place, investors can rest assured that the group will be in safe hands when YuanLin steps down in the future.
In addition, most of the board of directors and executive officers have vast experience in the shipbuilding industry and most of them worked their way from the ground up, usually started as a technician or welder. As such, I believe the management are all competent individuals who are able to make decisions that are in the best interest of YZJ’s long-term sustainability.
A good example of the management’s competency and professionalism can be seen in their ability to identify macro-changes in the industry and shift their resources to prepare ahead of time.
Back in 2014, the company had forayed into Liquefied Natural Gas Carriers in anticipation that the global demand for a more environmental friendly vessel will increase due to the heightening of eco-friendly regulations. In 2015, YZJ immediately secured their first order for LNG carriers and in 2016, the proportion of LNG carriers had increased up to 5.6% of YZJ’s order book. This is only made possible by YZJ’s swift and decisive management and also the groups R&D capabilities.
While it is important to acknowledge the right decisions that the management had made, it is also important to understand how the management behaves when their decision had failed to deliver the results expected.
In 2011, the management had identified ship demolition, scrap metal trading and related logistics support elements as important elements for hedging against steel prices and diversifying their revenue streams. As such, in 2013 the management developed three other business segments:
- Shipping logistics and chartering
- Ship demolition, steel fabrication, and related trading business
- Property development
However, some of the segment turned out to be non-profitable and in 2014 the management decided to rationalize its group structure by hiving off non-profitable business – ship demolition and property development. In its FY2014 annual report, the management had provided clear and transparent information with respect to their decisions rather than covering it up or even worse, continuing its non-profitable business.
In my opinion, this is a clear sign of a manager who has the competency to realize their mistakes and the courage to not only admit that they were wrong but also provide an immediate rectification. This is exceptionally important as the industry is in its downturn since 2008 and any minor mistakes can prove to be fatal in the long run if not rectified.
Another example of competent managers can be seen from YZJ’s management decision to not actively pursue offshore engineering projects back in 2014. This came despite YZJ’s successful penetration into the offshore engineering sector back in 2012 and its current ability to break even on projects.
In the FY2014 Annual Report, the management explained their decision by the fact that:
- the company is a relatively new player that has yet to acquire any competitive advantages.
- severe drop in demand for oil rigs due to the plunge in oil prices.
- there is a limit in the demand for oil rigs globally relative to the group’s mainstay in ocean-going vessels
Based on the above, we can infer that the management understands the company strengths and weakness in relation to the industry or sector that they are operating in. Because of that, they are willing to forgo opportunities in areas that YZJ is weaker in and focus their attention on areas that YZJ has competitive advantages.
Based on the above information, it is evident that the major bulk of the senior management remuneration is derived from the profit sharing scheme rather than salaries and bonuses. This aligns the management and shareholders interest and management will only be rewarded when the company performs as opposed to high fixed salaries and bonuses.
While 90% of the industry players had exited the market since the peak of the industry back in 2008, YZJ had improved its liquidity, solvency and working capital over the years. YZJ’s total liabilities and borrowings had decreased while its net asset value and cash position had increased significantly over the years.
With a healthier balance sheet, YZJ is in a better position to compete with other shipbuilders when it comes to tendering for contracts. In addition, YZJ will also be able to secure bank borrowing easier and at a cheaper cost due to the improved health of its balance sheet.
This can be inferred from the following:
Current Ratio: Current Assets / Current Liabilities
Quick Ratio: (Current Assets – Inventories – Restricted Cash) / Current Liabilities
With respect to the spike in debt levels, it has been explained by the management as:
- 2013 borrowings: increased significantly as a fund deployment strategy to strengthen cash position through cash management activities that generate return exceeding our current borrowing cost
- 2011 borrowings: increased significantly due to higher working capital requirements
*** For the calculation of working capital, I’ve removed several current assets that are evidently not meant for working capital purposes. Entries excluded are: Hold-To-Maturity Financial Assets, Derivative Financial Instruments, Restricted Cash and Land/Developmental Properties
Based on the working capital analysis, we can conclude that YZJ’s working capital had since improved since 2013. Between 2008 and 2013, we see that YZJ’s working capital is consistently in the negative region and in 2013, they had to make use of bank borrowings to finance for their working capital.
While that may be a potential red flag, YZJ’s management had acknowledged the weakness and problem that their weak working capital may pose and had since improved to a desirable level. As such, moving forward, I do not foresee any short-term problems when it comes to YZJ’s working capital but I believe we should pay close attention to the future behaviour of YZJ’s working capital.
As the industry continues to be plagued with order cancellations and an annual double-digit decline in global value of contracts awarded, YZJ manages to secure and maintain a healthy and consistent order book of US$ 4 Billion for over 10 years. This had translated to a healthy top-line performance that grew at a compounded annual growth rate of 4.45% from 2008 to 2017.
While the gross profits had been decreasing at an annual rate of 5.46%, YZJ’s earning per share had only experienced a decline of 3.59% as a result of the management’s abilities to manage their selling, general and administrative expenses.
Despite the volatility experienced in the industry, YZJ’s 3-year average EPS has been very consistent, ranging around SG$0.15/share ±$0.02. Over the years, YZJ has also been providing a consistent 8-9% Return on Asset and a double-digit Return on Equity.
While the ROA had been consistent, the ROE had experienced a huge decline over the years. This can be explained by the following reasons:
- The decline in bottom-line performance
- Dilution / Expansion of Share Capital
- The rapid increase in retained earnings
Nonetheless, given the industry downturn, it is still commendable for YZJ to command a double-digit ROE and a consistent ROA over the past 10 years.
From the chart above, we can infer that YZJ provides for a stable and consistent dividend amounting to an average of SG$0.04/share. This reflects an average yield of roughly 5% as seen from the below graph. Traditionally, a company that provides for high dividend yield coupled with a low dividend payout ratio is usually a sign of an undervalued company.
By applying the conservative assumption for the salvage value of YZJ’s assets, we derive at a liquidation value of $1.34 per share which represents a total of 148% of a share price of $0.90 per share.
To be conservative, I estimate the fair value of YZJ base on the lower price range of $1.63 to $1.94 based on FY2017’s performance. This represents an ample margin of safety of 70-100%. With respect to the fair valuation of YZJ, I adopt a rather unorthodox method by deriving the price through backward calculations. To derive the valuation, I calculated based on the value of P/E and P/B that I’m comfortable with which amounts to roughly (15x P/E and 1.5x P/B). However, to account for variabilities within the calculation, I focus on deriving a total value of 22.5x based on the multiple of 15x P/E and 1.5x P/B hence allowing for fluctuations within the two variables.
Taking into account the competency and transparency of the management, the competitive advantage that YZJ possesses, a healthy balance sheet and a stable and consistent dividend payout ratio and yield. I conclude that an investment in YZJ will be one that promises safety of principal and satisfactory return moving forward. While we are unsure how the future events will affect YZJ’s business performance, we can be confident that YZJ will be of going concern.
I am vested in the counter since 09 July 2018.
This article is meant to be the opinion of the author and is for information purposes only. This article should not be seen as financial advice.
All the information presented above are extracted from YZJ’s annual financial statement unless otherwise stated.
This article is also published on my website here.