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Chinese shipping and port names boast ‘attractive valuations’, profits helped by rate hikes and Asean agreement

Blue-chip shipping and port names in China are currently at attractive valuations, writes UOB Kay Hian Research analyst Roy Chen.

Despite some slowdown in volume growth amid near-term economic headwinds, Chen expects the port segment’s profitability to be largely stable due to recent rate hikes and notes that China’s integration within RCEP is a medium-term positive.

The Regional Comprehensive Economic Partnership (RCEP) is a free trade agreement (FTA) between the 10 Asean member states and its five FTA partners: Australia, China, Japan, New Zealand and Republic of Korea.

“As for the container shipping segment, we expect sea freight rates to remain subdued in the medium term and forecast two years of sharp profit declines for the segment in 2023-2024,” writes Chen in a Nov 22 note.

UOBKH is initiating coverage on the China shipping and port sector with a “market weight” rating, and Chen prefers the port segment, at “overweight”, over the container shipping segment, at “market weight”. Both segments are inexpensive, in his view.

The port segment is a largely stable industry, with profitability helped by rate hikes, says Chen.

“We expect Chinese port/terminal operators’ profitability to be largely stable, thanks to the industry-wide rate hikes (of high single-digit to double-digits) in late-2021 and early-2022. We note that port services in China are still underpriced today and there is ample scope for further hikes in the medium- to long-term, which will support the profit margins of port operations,” he writes.

This is despite flattish volume growth in 2022-2023 amid economic headwinds. “Given the uncertain economic outlook in the near term, we have conservatively projected largely flat or slight lower organic throughput for port/terminal operators in 2022-2023,” says Chen.

The port sector in China boasts strong fundamentals, he adds. “Port/terminal development/investment has high entry barriers and ports usually have their own captive markets and hence face limited competition. Two other favourable trends for Chinese port investments include the segment’s ongoing consolidation, and improving productivity and cost efficiency from service automation.”

The integration with RCEP is a medium-term positive, says Chen. In 7M2022, China’s trade value with RCEP countries, collectively forming 32% of China’s foreign trade value, soared 18.8% y-o-y, boosting China’s overall foreign trade growth by 5.6 percentage points (ppt).

“We expect the deepening trading relationships with the RCEP partners to continue bolstering China’s port volume growth going forward,” writes Chen, with the Hong Kong-listed COSCO Shipping Ports as his preferred pick.

Container shipping segment
High sea freight rates are coming to an end, says Chen, and spot rates are normalising fast.

Chen sees a subdued medium-term rate outlook due to overcapacity. “New vessel deliveries are expected to hit record levels of 2.34 million and 2.83 million TEUs (9.0% and 10.8% of the industry’s existing operating capacity) in 2023 and 2024 respectively. While vessel retirement and compliance with new energy efficiency and emission standards would take away some of the existing capacity, we expect the market to still take over three years to fully digest the surplus capacity.”

Profitability within the segment is expected to peak in 2022, then decline sharply in 2023-2024, according to Chen.

“The record profits in 2022 are due to high contract rates locked in in early-2022. With most of these high-rate contracts expiring in 2023, we expect container shipping players to see two consecutive years of sharp profit declines with their profitability returning to normalised levels in 2024,” he writes.

That said, the segment is well-capitalised to navigate the downcycle, adds Chen. “Thanks to the supernormal levels of profits in the 2020-2022 upcycle, most container shipping companies have strong balance sheets today. The strong balance sheets — some with considerable net cash positions — allow container shipping firms to navigate the downcycle while eyeing M&A opportunities.”
Source: The Edge Singapore

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