2017 Shipbuilding Outlook

Transcription

1 217 Outlook l November 15, Shipbuilding Outlook Bumpy road to recovery Analyst Ki-jong Sung kijong.sung@miraeasset.com Junior Analyst Ho-seung Lee hoseung.lee@miraeasset.com

2 Contents [Summary] 3 I. 216 review 5 II. 217 outlook 7 III. Outlook by vessel 26 IV. Offshore plant market 34 V. Orders and earnings outlook 41 VI. Investment strategies and valuation 42 [Top picks and stocks to watch] Hyundai Heavy Industries (954) 44 Hyundai Mipo Dockyard (162) 46 Samsung Heavy Industries (114) 48 Hanjin Heavy Industries & Construction (9723) 5

3 [Summary] Will shipbuilders overcome fear in 217? Worst-ever situation; Future to hinge on choices 197s Middle East instability - Replacement Increased VLCC demand demand (first time in 3 years) - Increase in world trade volume, new orders Economic boom - New orders grow as much as 2.5-fold Higher oil prices - Offshore generation Lower oil prices - Economic slump - Restructuring 217: Realignment, recovery 2H17 198s Shipbuilding/shipping slump Source: Clarkson, Bloomberg, 29 Global financial crisis Present Worries over long slump Voluntary capacity reductions; Shipbuilders competing for survival Shipbuilding Outlook

4 [Summary] Industry realignment Weak 1H, strong 2H Following industry realignment, recovery in 2H is likely on speculative demand. (mn CGT) New orders (L) HHI (R) (1/1/5=1) 12 HMD (R) Lower oil price 1,4 1st Offshore slump restructuring Offshore boom cycle 2nd restructuring -> M&A 1 1,2 Shipbuilding recovery; Industry 1, 8 restructuring Source: Clarkson, Shipbuilding Outlook

5 I. 216 review: Plunge in orders ignites fears Orders are as weak as they were in 29 Plunge in orders: Cumulative orders as of 3Q16 plunged 72% YoY to 8.74mn CGT. Order backlogs contracted to one year. Shipbuilders are making massive restructuring plans in a struggle to survive. Quarterly newbuilding orders by vessel type and price index 216 orders breakdown by vessel type (mn CGT) 2 16 Tanker (L) LPG carrier (L) LNG carrier (L) Containership (L) Bulk carrier (L) Newbuilding price index (R) (index) 2 18 Bulk carrier 18% Other 46% Containers hip 14% Tanker 14% LNG carrier 6% LPG carrier 2% Source: Clarkson, 1 Source: Clarkson, Shipbuilding Outlook

6 I. 216 review: Capacity cuts, personnel restructuring Shipbuilders making restructuring efforts Massive restructuring due to plunge in orders Only nine shipbuilders survive (vs. 26 in 28). Korea s three largest players are undergoing restructuring for the first time in 4 years, laying off more than 3% of their employees. Capacity is estimated to have fallen 5% from previous peak levels. Order backlogs amount to just one year. New orders and outlook of big three Korean shipbuilders Korean shipbuilding capacity: Still in overcapacity (US$bn) 7 Shipbuilding Offshore (mn CGT) F 17F Source: Clarkson, F Source: Korea Offshore & Shipbuilding Association, Shipbuilding Outlook

7 II. 217 outlook: Bumpy road to recovery Unprecedented slump in 216; Order growth to pick up in 217 During , shipbuilders for the first time saw orders decline for three consecutive years. Order growth is likely to recover in 217 (on a low base of comparison). Considering order cycle of three to four years (based on newbuilding price growth), ship prices are projected to pick up in 2H17. Orders to stay weak through 1H17 Short-term cycle of four-five years Order growth and outlook: Historic-low level in 216 (%) 2 15 Newbuilding price growth and outlook (mn CGT) (%) 12 New orders (L) 3 Newbuilding price growth (R) F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

8 II. 217 outlook: Bumpy road to recovery Global economy to be strong in 1H but weaken in 2H 217 global economic growth is estimated at 3% (IMF forecast: 3.4%). Expect an increase in US fiscal spending after the presidential election, delays to QE program by the ECB, Chinese economic measures, etc. The economy is likely to recover on a weakened USD after a likely rate hike in December, a rise in oil prices and global economic coordination, and an increase in fiscal spending in emerging nations Unstable demand might pose a burden to the recovery. Global economic growth and outlook Key macro factors in 217 (%) Interest rates Weak USD 3 2 Fiscal spending Oil prices 1 Policy coordination Emerging markets F 18F 2F Source: Thomson Reuters, Source: Shipbuilding Outlook

9 II. 217 outlook: Bumpy road to recovery Economic recovery unlikely to be smooth 217 world seaborne trade growth is forecast at 3%. Average trade growth during was roughly 3.2%; Average delivery growth was -2.1%. Deliveries are anticipated to plummet in on decline in orders for last three years and industry restructuring. World seaborne trade growth and outlook (mn tonnes) (%) 12, World trade volume (L) 12 YoY growth (R) 1 1, 8 8, 6 Global fleet growth and outlook (mn DWT) (%) 1,8 Containership (L) 12 LNG carrier (L) 1,5 LPG carrier (L) Bulk carrier (L) 1 Tanker (L) 1,2 YoY growth (R) 8 6, , 6 4 2, F F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

10 II. 217 outlook: Bumpy road to recovery Volatility of materials prices to ease Materials prices to stabilize Prices are likely to recover, but only modestly. Oil prices are projected to rise to US$6/bbl in 217, but are likely to be volatile. Stabilized materials and oil prices should help ship prices stabilize. Iron ore and heavy plate prices WTI price exceeded US$5/bbl after OPEC s cut agreement (RMB/tonne) 7, 6, Steel plate (L) Iron ore (R) (index) 25 2 (US$/bbl) WTI Brent 5, 1 4, , 1 6 2, 4 1, Source: Bloomberg, Source: Bloomberg, Shipbuilding Outlook

11 II. 217 outlook: Bumpy road to recovery No. of shipbuilders: To decline 7% Capacity: To decline 5% As of 216, the number of global shipbuilders declined 57% from the 29 level. The number is expected to fall further in 217 (by more than 7% overall). Global shipbuilding capacity is anticipated to decline 5% from the previous peak. Capacity is likely to decline 45-5% in 217 following additional restructuring and industry realignment efforts. (no.) 1, Source: Clarkson, Shipbuilding Outlook

12 II. 217 outlook: Bumpy road to recovery Supply glut to ease starting in global trade growth of 4% + demolition rate of 2.7% Fleet growth of 3.4% Oversupply to ease by 2% annually on average over the next six years The merchant vessel market is projected to fluctuate starting in 217, affected by the easing of oversupply and speculative ordering. Global vessel demolition and outlook Orders/capacity and outlook (mn DWT) (%) 7 Demolitions (L) 6 Demolition rate (R) 6 5 (years) 4 New orders relative to capacity Order backlog relative to capacity F F 18F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

13 [1] Tougher environmental restrictions Global environmental regulations to strengthen Market to change over medium to long term Ships that were built starting in 216 are subject to Tier III NOx emission limits and CO2 limits. At the 7th session of MEPC, it was decided to enforce SOx emission cut globally in 22 (3.5%.5%). [Short-term] 1) Installation of scrubbers; 2) Adoption of high-priced diesel engines (able to be fueled by low-sulfur fuel) [Long-term] 3) Adoption of environmentally friendly fuels (e.g., LNG); 4) Development of non-ballast ships Environmental regulations to strengthen Likely to affect the market over the medium to long term (ship demolitions to accelerate starting in 219). Timeline of IMO-imposed restrictions SOx emission limits in emission control areas (ECA) 1.5% m/m 1.% m/m.1% m/m SOx SOx emission limits in non-eca 4.5% m/m 3.5% m/m.5% m/m ~ ~ NOx Tier Ⅰ Tier Ⅱ Tier Ⅲ 17./kWh 14.4g/kWh 3.4/kWh Source: IMO, related data, Shipbuilding Outlook

14 [1] Tougher environmental restrictions Opening of the BWTS market Timeline of BWTS-related restrictions Ratification process In September 216, IMO ratified that vessels will be required to install ballast water treatment systems (BWTS) starting in October 217. BWTS market Fleet of roughly 6, units x W7mn BWTS costs per unit = approximately W42tr High expenses related to installing BWTS in old vessels Demolitions to increase, with demolitions of smaller vessels in particular likely to expand. Grace period is likely to be five years; installations could take one to six years after ratification. BWTS-related restrictions should change the market over the medium to long term. IMO Preparing for ratification Grace period BWTS required (only IMO-approved BWTS) Installation process (during grace period, installation can be delayed until the next inspection) BWTS unnecessary Grace period + inspection (5 years) BWTS required ~ ~ Installation of BWTS (grace period) USCG Preparing for ratification Grace period BWTS required (only USCG-approved BWTS) Grace period extension possible Timing of implementation is the same as that of IMO. However, due to the strict testing process, approval is difficult to obtain Preemptive acquisition of approval should enable firms to occupy the market Source: IMO, USCG, related data, Shipbuilding Outlook

15 [2] Restructuring/realignment: Insufficient Another crisis for the industry is possible if government continues complacent approach Industry restructuring efforts & new business plans There are no detailed measures for industry realignment; Efforts are merely focused on cutting capacity and personnel. With an increasing number of shipbuilders going bankrupt, R&D efforts will do little or nothing to boost the industry. The government aims to complete industry realignment by 22, with a new order target of W11tr Only a few shipbuilders would benefit. These plans seem overly complacent It is urgent to devise plans to improve competitiveness. Another crisis is possible if government continues its complacent approach. New business areas that the government will support Restructuring - No. of docks: Down by 23%(31 24) - Personnel: Down by 32% (62, 42,) - Emergency plans have just been completed. Acquiring new technology New business - HHI: Expanding into shipbuilding-it convergence services - SHI: Specialized in LNG value chain products - DSMI: New-generation vessels, defense exports Expanding vessel repair business Establishing offshore engineering companies Source: MOCIE, Source: Shipbuilding Outlook

16 [2] Restructuring/realignment: Company approach HHI SHI DSME Headcount (as of 2Q16) Self-rescue plan 26,299 Lay off 3, workers 12,355 Lay off 5,2 workers by end-218 (1,5 early retirements in 216) 12,699 Lay off 1,2 workers in production and 1,3 in management (by 22) Production facilities (current) 11 dry docks 22 jib cranes, 8 goliath cranes 3 dry docks, 5 floating docks, 5 goliath cranes, 2 floating cranes 2 dry docks, 3 floating docks, 2 goliaths, 3 jibs, 3 towers Self-rescue plan Successively suspend operation of 3 docks (marine docks) Discontinue operation of 2 floating cranes and 1 or 2 floating docks Sell 2 floating docks (building capacity to be cut by 3%) Balance sheet (as of 2Q16) Tangible assets: W19tr Short-term investments: W4.6tr Total debt: W32.6tr Interest-bearing debt: W17.9tr Debt ratio: 182% Tangible assets: W6.6tr Short-term investments: W.9tr Total debt: W12.7tr Interest-bearing debt: W5.1tr Debt ratio: 263% Cash assets: W1.3tr Tangible assets: W5.7tr Total debt: W18.1tr Interest-bearing debt: W6.1tr (capital impairment) Disposable assets Self-rescue plan [book value] Entire stakes in HI I&S, Hi Asset Management, and KCC (W165bn) HMC -.56% [W188.4bn] HMM % [W51.8bn] imarketkorea % (W5bn) Additional plans X Rights issue Prepared to sell two floating docks Debt-to-equity swap W3.5tr cost cuts (W1tr in labor, W1.6tr in capacity, and W.8tr in other) Source: Related data, Shipbuilding Outlook

17 [2] Restructuring/realignment: More action needed Unbilled receivablesto-revenue trend Unbilled receivables-to-revenue ratio has fallen to below 15% (including outstanding payments for drilling facilities). Offshore production facilities are 7% complete on average. Drilling facility projects are also in the final stages. That said, payment recovery after delivery remains uncertain. HHI (Wtr) Unbilled receivables (L) (%) 8 Unbilled receivables to revenue (R) SHI (Wtr) (%) 7 Unbilled receivables (L) 3 Unbilled receivables to revenue (R) DSME (Wtr) Unbilled receivables (L) (%) 1 Unbilled receivables to revenue (R) Source: Respective companies' data, Shipbuilding Outlook

18 [2] Restructuring/realignment: Korea s strengths Seeking growth through changes to product mix Bulk carriers, with highest localization rate and lowest margins, should be avoided. Mega-sized containership and tanker markets, Korea s traditional areas of strength, are maturing. Gas carriers are a growing market, led by Korea s big three. Offshore plants are in the early stages, with growth likely to continue in the next 1-2 years. Localization rate is now only 2%; Profitability should grow as localization rate rises. Product cycle by localization rate and design capability Competitive strength as implied by localization rates Type Introductory stage Growth stage Mature stage Decline stage Product Drillship, Semi-rig Fixed platform Oil-FPSO, LNG- FPSO LNGC FSRU LFS Containership Tanker Bulk carrier Localization rate 2% 5% 8% 1% Type Bulk carrier 2% 5% 8% 1% VLCC 2% 5% 8% 1% Containership 2% 5% 8% 1% Localization equipment Basic Detailed Steel plate + bulk Procure from outside Partially autonomous Autonomous Source: DSME, + Generalpurpose devices (valve, pressure vessel) + Core equipment (pump) + All equipment Autonomous Autonomous Autonomous Autonomous Autonomous Partially outsourced Wholly outsourced Wholly outsourced Wholly outsourced Design capabilities Production Shipbuilding Offshore LNGC/FSRU 2% 5% 8% 1% Drilling equipment Production equipment (FPSO) Source: DSME, 2% 5% 8% 1% 2% 5% 8% 1% Shipbuilding Outlook

19 [2] Restructuring/realignment: China s shakeup China plans to restructure some of the 71 shipyards on its white list China s government-led restructuring is picking up pace Unsustainable shipbuilders will be either shut down or sold. The industry is likely to realign towards four state-owned holding groups: CSSC, CSIC, COSCO and CSC. Number of shipyards is expected to decline from 644 in 29 to around 7 (Clarkson data). China plans to push for restructuring (through M&As) on companies on its white list (at least a 1% cut). Like Korea, China will likely focus on high-margin ships. Viable Chinese shipyards included in white list Viable Chinese shipyards included in white list (no.) Private shipbuilders 44 4 CSC 2 3 COSCO 7 2 CSIC CSSC 1 1st white list 2nd white list 3rd white list Source: China Shipbuilding Industry Association, Source: China Shipbuilding Industry Association, Shipbuilding Outlook

20 [2] Restructuring/realignment: China s shakeup Leading shipbuilding groups struggling with plunging orders and earnings CSSC (China State Shipbuilding Company) CSSC Holdings is China s largest shipbuilding group and owns 1 shipyards, including Shanghai Waigaoqiao Shipbuilding and Guangzhou Shipbuilding. CSIC Holdings is China s second largest shipbuilding group and has seven shipyards, including Dalian Shipyard. CSIC (China Shipbuilding Industry Company) (CGT mn) 6 Others Shanghai SY Hudong Shanghai Waigaoqiao Jiangnan Guangzhou (CGT mn) 3 Other Wuchang Tianjin Shanhaiguan Dalian Chongqing Bohai Beihai CSSC s earnings trend (RMBbn) (%) 12 Revenue (L) OP margin (R) CSIC s earnings trend (RMBbn) (%) 25 Revenue (L) OP margin (R) Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16-9 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16-2 Source: Clarkson, Bloomberg, Source: Clarkson, Bloomberg, Shipbuilding Outlook

21 [2] Restructuring/realignment: Lessons from Japan Cutting capacity and jobs will not solve everything, and may in fact undercut competitiveness Japan s capacity restructuring Japan controlled more than 55% of the global market in the 197s. The Japanese government implemented two rounds of massive restructuring in the 198s. Indiscriminate layoffs led to talent and technology drains, resulting in market share losses. Japan s market has become increasingly concentrated, with only 11 shipbuilders winning orders in 216. The industry s reliance on the government s currency policy has also increased. Japan s market share and deliveries Before first round (Mar. 198) After first round (198~1987) After second round (Mar. 1988) No. of shipyards No. of groups (%) (mn CGT) 4 Deliveries (R) 12 M/S (L) No. of docks/fleet Capacity 9.6mn CGT 6.3mn CGT (-37%) 4.6mn CGT (-24%) Capacity and workforce reductions led to technology and talent outflow Focus on automation and bulk carriers eroded JapanÊs competitiveness, causing market share losses Source: Source: Clarkson, Shipbuilding Outlook

22 [2] Restructuring/realignment: Lessons from aircraft industry The global aircraft industry has become a two-horse race The civil aircraft market has become a two-horse race between Boeing and Airbus. The industry went through a wave of consolidation from 1995 to 1999 to overcome structural challenges. The industry, though mature (CAGR is only 5%), has an ROE of over 4%. The industry serves as a successful example of restructuring. Structural changes of the aerospace industry Airbus s earnings trends (EURbn) (%) 7 Revenue (L) 4 ROE (R) F -1 Source: Source: Bloomberg, Shipbuilding Outlook

23 [2] Restructuring/realignment: Scenarios Scenario 1. A merger between SHI and DSME would put financial pressure on SEC and complicate employment issues, but improve cost competitiveness. A merger between SHI and DSME is the most straightforward scenario, but faces many hurdles. The merger would require additional financial government funds and SEC s investment. If either side insists on being spared, it is unlikely the deal will go through (SEC has a greater burden). Private capital should also be explored in order to ease the financial burden on the government and SEC, as both shipbuilders have too much debt. It makes sense to reduce the number of players to two (HHI and the combined entity) and cut capacity by more than 3% compared to the premerger level. Merger of SHI- DSME Government SEC Creditors & private capital A two-player game would reduce capacity and ease competition Source: Shipbuilding Outlook

24 [2] Restructuring/realignment: Scenarios Scenario 2. Creating two separate firms, one specializing in offshore and the other in merchant vessels, would lessen SEC s burden and be better from an employment perspective. SHI Merchant vessel JV (Merger of SHI-DSME) DSME Spin-off of offshore unit Government 5% 25% stake Offshore plant firm [Offshore plant EPCI] Drilling: Drillships, semi-submersibles, etc. Production: FPSO, FLNG, etc. Spin-off of offshore unit Private capital 25% Offshore Two players (HHI and spun-off firm) Merchant vessel Two players (HHI and merchant vessel JV) Source: Shipbuilding Outlook

25 [2] Restructuring/realignment: Scenarios Scenario 3. Combining offshore units of the big three into a JV specializing in offshore engineering would require government funds but help ensure competitiveness and job stability. SHI Merchant vessel JV (Merger of SHI-DSME) DSME Spin-off of offshore unit Production of key modules Spin-off of offshore unit HHI Offshore plant engineering firm Investments and order placements by KOGAS and KNOC Production of key modules Foster company specializing in bulk carriers and standard modules Source: Shipbuilding Outlook

26 III. Outlook by vessel: Tanker market recovery faces challenges Demand for crude oil and ethylene is on the rise Crude oil demand is rising modestly, driving up actual demand for crude carriers. Demolitions are expected to increase on a fall in VLCC demand. Expectations for market recovery are low, given sluggish second-hand vessel transactions. Ethylene demand is rising modestly. Actual demand for petrochemical product carriers is likely to climb modestly. Crude oil demand Ethylene demand (mn bbl/day) (%) 12 Oil demand (L) 5 YoY growth (R) (mn tonnes) (%) 2 Ethylene demand (L) 1 YoY growth (R) F F -4 Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

27 III. Outlook by vessel: Tanker market recovery faces challenges Rising expectations for orders from Iran and India Ship financing is essential Freight rates and second-hand vessel transactions are falling. Speculative orders are falling amid a lack of confidence in economic recovery. Crude carrier demand from new customers, including Iran and India, is expected to expand Ship financing services are necessary to receive orders. Shipbuilders must find ways to secure ship financing. Tanker orders and newbuilding price Tanker freight rate and oil price (index) 25 New orders (R) Newbuilding price (L) (mn CGT) 3 (US$/day) 4, Tanker frieght rate (L) WTI price (R) (US$/bbl) , , , F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

28 III. Outlook by vessel: Containership freight rate recovery is key Freight rate recovery is important Newbuilding prices have climbed on NOx Tier III regulations. Massive orders were placed in 215 ahead of introduction of stricter environmental standards, exacerbating supply/demand To dampen recovery in newbuilding orders. In 217, cargo traffic growth will likely remain flat YoY, reaching 3.6% YoY. Wait-and-see attitude is prevalent due to the global economic slowdown. Recovery in shipping rates is key to a market turnaround. Container trade volume & growth HRCI & CCFI (mn TEU) Containership cargo traffic (L) (%) 2 YoY growth (R) 15 (index) 2,5 HR index (L) CCFI index (R) (index) , 1, ,5 1,3 8 1, F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

29 III. Outlook by vessel: Containership freight rate recovery is key Mega-sized containership orders to recover Containership demolitions have surged Demolition rate is expected to remain around 2% in 217. In 217, newbuilding orders will likely see high YoY growth due to a low base of comparison stemming from weak orders in F orders: 65, TEU (+125% YoY) Containership orders and price trend Containership demolitions and demolition rate (index) New orders (R) Newbuilding price (L) (mn TEU) 4 (' TEU) (%) 5 Demolitions (L) 4 Demolition rate (R) F F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

30 III. Outlook by vessel: For bulk carriers, note iron ore pickup Aside from iron ore, commodities prices are showing no sign of a rebound Demand for commodities is unlikely to recover anytime soon due to the global economic slump. Iron ore demand and prices have picked up, driving up expectations for an economic recovery. However, iron ore demand is unlikely to continue to rise, given high global economic uncertainties. With the exception of iron ore, commodities are showing no sign of a rebound in prices and demand. Bulk carrier cargo traffic and growth Iron ore demand and price (mn tonnes) Other (L) Aluminium (L) (%) 5, Grain (L) Coal (L) 14 Iron ore (L) YoY growth (R) 12 (mn tonnes) 3 Iron ore imports (L) Iron ore price (R) (index) 25 4, , , , F Source: Clarkson, Source: Bloomberg, Shipbuilding Outlook

31 III. Outlook by vessel: For bulk carriers, note iron ore pickup Supply/demand conditions to improve on higher demolitions and lower deliveries Even Chinese state-owned shipping lines cannot afford to place orders to local shipbuilders. In 217, demolitions will likely remain high, at around 3%. Oversupply is easing markedly on the plunge in deliveries. Bulk carrier orders are projected to climb 35% YoY to 4mn CGT in 217. Bulk carrier orders and price trend Bulk carrier demolitions and demolition rate (mn CGT) 4 New order (L) Newbuilding price index (R) (index) 26 (mn DWT) 4 Demolitions (L) Bulker freight rate (R) (US$/day) 5, , 2 3, , , F F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

32 III. Outlook by vessel: For gas carriers, note natural gas demand Rising natural gas demand amid stricter environmental standards Natural gas demand has been rising steadily on stricter environmental standards. Global natural gas demand is expected to grow at a CAGR of around 4%. Demand for gas carriers has diversified to include offshore bunkering stations FSRUs for LNG bunkering to increase. Demand for LNDG and LPG carriers is on the rise. Orders by gas carrier type LNG and LPG demand (vessels) 12 LPG carrier Ice class LNG carrier (mn tonnes) 3 LPG trade volume LNG trade volume 1 FSRU LNGC demand for shale gas 25 8 LNGC demand for LNG FPSO shuttle Normal LNGC demand F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

33 III. Outlook by vessel: Gas carrier freight rate decline to be limited Demolitions to increase on falling freight rates LNG carrier freight rate has fallen to historic low. Demolitions are expected to increase on falling freight rates and higher demand for new vessels. Freight rates are unlikely to recover soon due to fleet growth, but the decline in rates should be limited in light of rising natural gas demand. LNG and LPG carrier freight rates LNG carrier fleet and demolitions (US$/day) 5, LPG carrier freight rate (L) LNG carrier freight rate (R) (US$/day) 15, (mn CBM) 7 LNG fleet (L) LNG demolitions (R) (units) 6 4, 12, , 9, 4 3 2, 6, , 3, F F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

34 IV. Offshore plant market: Showing signs of recovery Likely to emerge from three-year slump The offshore plant market was in the doldrums over the past three years. In particular, there was a lack of orders and deliveries of offshore drilling facilities. However, oil rig count has been picking up recently on the recovery in oil prices. The offshore plant market is likely to emerge from the three-year slump, aided by the resumption of orders in 2H16. Global orders for offshore drilling facilities Global oil rig count and oil price trends (units) 4 Drillship Semi-submersible rig (US$/bbl) 16 WTI (L) Oil rig count (R) (no.) 1,8 1, ,2-7% F 17F Source: Clarkson, Source: Baker Hughes, Shipbuilding Outlook

35 IV. Offshore plant market: Showing signs of recovery Large oil companies have recorded operating losses Large oil companies have been doing massive restructuring due to operating losses. Revenue is also expected to decrease on weak oil prices and lower investments. Offshore plant-related investments have also plunged. With oil prices hovering below $5/bbl, oil companies have focused on cost reduction Laid the foundation to resume offshore plant investments Oil price and large oil companies operating profits Brent crude price and offshore plant investments (US$bn) Total (L) BP (L) Shell (L) Exxon Mobil (L) Brent crude (R) (US$/bbl) (US$bn) Offore investment (L) Brent oil price (R) (US$/bbl) F 17F 3 Source: Bloomberg, Source: Bloomberg, Shipbuilding Outlook

36 IV. Offshore plant market: Showing signs of recovery Oil prices to rise gradually in 217 Oil prices are expected to rise at a modest pace. The EIA expects oil supply/demand conditions to stabilize in 217. We expect oil prices to recover gradually on the stabilization of supply/demand in 217 Brent crude to rise to $6/bbl. But oil prices are likely to be volatile, hinging on 1) competition for oil market hegemony between OPEC and the US and 2) Russia s willingness to cut production. EIA: Oil supply/demand conditions to improve in 217 Oil price trend and forecast (mn bbl/day) 3 Jan Feb Mar Apr (US$/bbl) 12 Bloomberg (Mean) Bloomberg (Low) Bloomberg (High) Miraeasset Daewoo forecast /16 5/16 9/16 1/17 5/17 9/17 Source: EIA, 1Q12 4Q12 3Q13 2Q14 1Q15 4Q15 3Q16 2Q17F Source: Bloomberg, Shipbuilding Outlook

37 IV. Offshore plant market: Showing signs of recovery Large oil companies are likely to invest in new production facilities Utilization of offshore drilling facilities down to 7% No need for new facilities. Utilization of offshore production facilities stands at around 9% Additional facilities needed Demand for offshore production facilities is increasing steadily. Likelihood of large oil companies investing in new production facilities has increased. Utilization of offshore drilling facilities Utilization of offshore production facilities Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

38 IV. Offshore plant market: Showing signs of recovery Efforts to cut oil production cost to less than $5/bbl Daily charter rates of drilling facilities have fallen by up to 4%. Restructuring efforts: Reductions in human resources and facilities. Shipbuilders, engineering companies, and ship owners have been making concerted efforts to cut production costs. Breakdown of offshore facility investments Daily charter rates of large-sized drilling facilities (US$/day) 6, Large-sized drillship (L) Large-sized semisub (L) Large-sized jackup-rig (R) (US$/day) 2, Subsea 27% Drilling equipment 35% 5, 17, 4, 14, Production equipment 38% 3, , Source: Source: Bloomberg, Shipbuilding Outlook

39 IV. Offshore plant market: Showing signs of recovery Standardization modularization, domestic production, and industry reorganization Offshore standards Process standardization Collaboration and standardization between shipbuilders (production) and engineering firms (design). KR and shipbuilders are striving to set optimal standards and cut component costs. Modularization and further domestic production of components are necessary to cut costs Efforts to cut costs and delivery period are underway. Deregulation Need to ease regulations on shipbuilders. We believe the Korean shipbuilding market should be reorganized into two players. Shipbuilding regulatory standards Ship owners Shipbuilders Capex Opex Man-hours Components - Cut shipbuilding man-hours and component costs - Reduce costs related to managers dispatched to shipbuilders via shortened project periods - Lower training costs via standardization - Lower maintenance/storage costs thanks to standardized spare parts - Reduce man-hours via standardized design - Finalize design sooner via simplification and reduced reworking - Minimize obsolete components by increasing compatibility among projects - Reduce space necessary to store components - Lower component production cost and shorten delivery period Ship ownersê standards Oil field standards (NORSOK, API, etc.) Engineering firmsê standards The number of standards that shipbuilders are required to follow increases exponentially Standards shipbuilders must observe Source: Shipbuilders, media reports, Source: Shipbuilders, media reports, Shipbuilding Outlook

40 IV. Offshore plant market: Showing signs of recovery Modest recovery in oil prices Offshore orders will likely resume, as oil prices are projected to recover steadily. Clarkson has a fairly positive view of the market. Drillship orders are anticipated to start to recover in 218 as deliveries resume. FPSO orders are forecast to improve beginning in 217; Relatively solid FLNG orders are expected. Drillship order trend and outlook FPSO order trend and outlook (units) (units) F 17F 18F 19F 2F 21F 22F 23F 24F F 17F 18F 19F 2F 21F 22F 23F 24F Source: Clarkson, Source: Clarkson, Shipbuilding Outlook

41 V. Orders and earnings outlook Order backlog and earnings to contract in 217 but start to recover in 2H17 and 2H18, respectively Order backlog has shrunk (to around one year) this year, but is projected to recover in 2H17, aided by speculative demand. The three-year-long downtrend in order backlog will take a toll on 217 earnings. Operating results should keep weakening through 1H18, and start to recover in 2H. Global production capacity is projected to be cut in half through further restructuring in 217; Survivors will likely benefit in 2H17. Order and revenue trend and outlook Avg. revenue and OP margin of top-three Korean shipbuilders (Wtr) 6 Order backlog (R) SHI (L) HHI (L) DSME (L) (US$bn) 7 (Wtr) (%) 1 Revenue (L) OP margin (R) F 17F F 17F -1 Source: Respective companies' data, Source: Respective companies' data, Shipbuilding Outlook

42 VI. Investment strategies and valuation: Overweight Focus on survivors of industry restructuring & realignment Revenue is projected to weaken in 217, but financial positions should remain stable thanks to major business restructuring. All shipbuilders are being affected by low order streams. We expect further restructuring/reorganization in 217; Focus on highly competitive builders with a stable financial position. Investment recommendation: HHI>HMD>HHIC>SHI Korean major shipbuilder s free cash flow P/B-ROE comparison for global peer group (216F) (Wtr) 12 DSME SHI HHI (P/B, x) CSSC 2. CSIC SHI Mitsubishi Mitsui HHI Keppel HMD F 17F Source: Respective companies' data, HHIC Source: Bloomberg, Shipbuilding Outlook

43 VI. Investment strategies and valuations: Overweight Retain Overweight; Short-term correction to present a buying opportunity Govt. plans to strengthen industry competitiveness seem insufficient and ineffective Korean shipbuilding stocks are likely to correct in the short term. Govt. support will not be enough to help struggling companies to regain competitiveness, as industrywide recession is projected to continue for a while. Further restructuring is expected, and the industry will eventually be realigned as govt. support runs out. Then competitive, financially strong shipbuilders will look attractive to investors. - Govt. plans insufficient and ineffective Investment points - Earnings to contract and additional restructuring likely due to lack of orders Competitiveness to weaken - Order backlog to start to rise in 2H - Industry to be reshaped by survivors. - Likely survivors: HHI and HMD Promising stocks - HHI (954/Buy/TP W175,) : The final winner - HMD (162/Buy/TP W94,): A war within its own boundaries - SHI (114/Trading Buy/TP W11,): Rising above competition - HHIC (9723/Trading Buy/TP W4,5): A hidden beneficiary Source: Shipbuilding Outlook

44 Hyundai Heavy Industries (954) The final winner Investment points The likely winner of the worst-ever shipbuilding recession. Relatively stable financial position, and additional assets available for sale. Operating results and cash flow have stabilized on the back of a diversified business portfolio and proactive restructuring. P/B of 1.x seems fair. Maintain Buy with TP of W175,. Risk factors Earnings are set to fall beginning in 2H17, as merchant ship and offshore order backlogs have shrunk (to around one year). Continued government support for rivals. 19 Hyundai Heavy Industries KOSPI Shipbuilding Outlook

45 Hyundai Heavy Industries (954) Shipbuilding Outlook

46 Hyundai Mipo Dockyard (162) A war within its own boundaries Investment points Small- and medium-sized shipbuilders are restructuring their businesses to improve deteriorating financial health. HMD boasts world-class competitiveness in productivity and product quality. HMD stands out among smaller shipbuilders due to its superior competitive edge and stable financial position. Although its order backlog is small, short delivery time (less than nine months) allows the firm to be more competitive than its larger counterparts. Retain Buy with TP of W94,; 217F P/B of 1.x seems fair. Risk factors Earnings are set to fall in 217, as order backlog has shrunk to around one year. Further business restructuring is likely in 217, given slow order stream in Hyundai Mipo Dockyard 15 KOSPI Shipbuilding Outlook

47 Hyundai Mipo Dockyard (162) Shipbuilding Outlook

48 Samsung Heavy Industries (114) Rising above competition Investment points Operating results have stabilized thanks to restructuring and productive growth. Financial health has improved after large-scale capital increase (stronger financials than competitors). SHI s major self-rescue plans and capital increase have paved the way for financial support (refund guarantee issuance, etc.). Designation as a preferred bidder for the Mozambique offshore plant project should partially offset low merchant ship orders. Cost cut efforts have continued. Upgrade from Hold to Trading Buy; Present TP of W11,. Risk factors Earnings are set to fall in 217, as order backlog has shrunk to around one year. Drillship orders may be cancelled. Overhang risk (due to capital increase). 13 Samsung Heavy Industries KOSPI Shipbuilding Outlook

49 Samsung Heavy Industries (114) Shipbuilding Outlook

50 Hanjin Heavy Industries & Construction (9723) A hidden beneficiary Investment points The government will invest W7.5tr over the next two years in the defense industry, placing orders for military vessels, patrol boats, etc. HHIC is expecting to receive exclusive orders for small-sized patrol boats (no competition in this category) Around W2tr over two years. The firm will shut down its merchant ship business in Yeong-do, and instead will develop the real estate. The firm is selling off its real estate assets in consultation with creditors. Upgrade from Hold to Trading Buy; Present TP of W4,5. Risk factors Delays to real estate disposal due to economic downturn. A high debt ratio (excessive borrowings). 12 Hanjin Heavy I&C KOSPI Shipbuilding Outlook

51 Hanjin Heavy Industries & Construction (9723) Shipbuilding Outlook

52 Compliance Shipbuilding Outlook

53 Compliance Shipbuilding Outlook

54 Compliance Shipbuilding Outlook