Asia Container Shipping:Downside risk remains

Deutsche Bank Markets Research Asia China Transportation Industry Asia Container Shipping Date 15 February 2016 Recommendation Change Downside risk remains Adding China Cosco and K-Line to our conviction Sell list ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Sky Hong, CFA Research Analyst (+852) 2203 6131 sky.hong@db.com Joe Liew, CFA Research Analyst (+65) 6423 8507 joe.liew@db.com Key Changes Company Target Price Rating 1919.HK 4.10 to 1.10(HKD) Hold to Sell 2866.HK 2.60 to 1.50(HKD) - 9101.T 297.00 to 190.00(JPY) - 9104.T 330.00 to 150.00(JPY) Hold to Sell 9107.T 260.00 to 130.00(JPY) Hold to Sell 117930.KS 3,300.00 to 1,700.00(KRW) - 2603.TW 12.40 to 10.40(TWD) - 2609.TW 6.00 to 4.00(TWD) - 0316.HK 62.00 to 49.50(HKD) - 601919.SS 3.30 to 0.93(CNY) - 601866.SS 2.08 to 1.23(CNY) - Source: Deutsche Bank Top picks China Cosco Hldgs (1919.HK),HKD2.67 Sell Kawasaki Kisen (9107.T),¥182 Sell Hanjin Shipping (117930.KS),KRW2,840.00 Sell Source: Deutsche Bank The expectation of further RMB deprecation has started affecting demand negatively, and coupled with continued mega vessel deliveries and lack of supply discipline by lines, it suggests the current downcycle will be prolonged. Against this backdrop, to trigger bottom-fishing by investors, we believe sector P/B needs to fall further, possibly towards 0.5x as seen during the GFC, from the current 1.0x. We add China Cosco to our conviction Sell list as it looks expensive at 1.4x P/B and top-line weakness would outweigh merger synergies. We also downgrade MOL and K-Line to Sell from Hold. Demand prospect is getting cloudier on RMB move For the mid-to-long term, RMB deprecation is a positive for China’s exports. However, in the short run, any further weakness in the RMB will weaken demand as overseas importers have started delaying their orders. Moreover, the inventory-to-sales ratio for US retailers has hit 1.48x, the highest since the GFC, leaving sufficient room for inventory de-stocking. This negative currency effect is seen in the recent weak Asia-US container volume in an otherwise peak pre-CNY season. Our recent channel checks reveal that Chinese exporters also remain depressed on the export outlook. Thus, we cut our 2016/17E demand growth to 2.0/3.0% from 4.0/4.5% previously. Supply discipline is the only resort, but looks difficult to achieve Another 518k TEU of mega vessels will hit the water in 2016 (with 800k more in both 2017 and 2018), which will force Asia-Europe capacity to grow c.10% in 2016 (vs. est.2% demand growth). Liners’ supply discipline has also become increasingly difficult to achieve, given the widening cost gap. While the latest mergers (Coscon+CSCL; CMA CGM+NOL) should further consolidate market share, pricing competition typically intensifies post mergers, based on prior experiences. This is due to liners seeking to preserve market share while cargo owners seek to diversify their risks. Moreover, the existing alliances are set to break up post mergers, creating short-term instability for the industry. How deep and long will this downturn last? The sector has traded down to 1.0x P/B, vs. 2016E ROE of -19%, which still looks expensive. During the GFC, the sector troughed at 0.5x P/B vs. ROE of -20%. More importantly, investor interest has waned over the past several years as the sector’s oversupply was widely expected to persist. This explains why the sector’s P/B range has not only moved down but also contracted. We expect a prolonged downcycle; hence, value will only emerge when P/B is closer to the GFC trough of 0.5x. Conviction Sells: China Cosco, K-Line and Hanjin; key risks Post restructuring, China Cosco will become a pure container shipping line. We expect any related merger synergies to be offset by the recurring top-line weakness. At 1.4x P/B and loss-making, we view the stock to be overvalued in both absolute and relative terms (Maersk at 0.7x P/B and OOIL at 0.4x P/B). We also cut K-Line to Sell from Hold as its higher exposure to container shipping versus its Japanese peers points to larger downside risks to earnings. We maintain Sell on Hanjin and Yang Ming and downgrade MOL to Sell from Hold. Stronger-than-expected global trade is a key risk. In this report we cha