Morningstar | Cosco's Results Hit by Lower Freight Rates With Narrowing 3Q Loss; Fair Value Estimate Intact
No-moat rated Cosco Shipping Energy Transportation’s cumulative nine-month 2018 net loss of CNY 268 million was below our forecast due to slower-than-expected recovery in freight rates. That said, we have recently seen recovery in tanker freight rates going into the seasonally strong fourth quarter. As such, we keep our fair value estimate at HKD 3.42. We believe Cosco's share price is still overvalued as we think it is still early to expect a sustained recovery in freight rates post the peak season.Cosco’s shipping capacity increased by 18% year over year in the first nine months due to delivery of new builds, with shipping volume rising 31% year over year. However, the firm was loss-making, mainly due to falling freight rates, as seen in the 40%-50% drop in tanker rates (time charter equivalent, or TCE) for major crude oil shipping routes during the same period. Coupled with rising operating costs (higher fuel oil prices), Cosco’s gross margin fell to 10.3% from 25.4% a year ago.
While third-quarter operating data has not been detailed, preventing a deeper analysis, we do see a silver lining in the results. In particular, third-quarter net loss narrowed to CNY 53 million from CNY 131 million in the previous quarter, as improving supply (increasing demolition of aged vessels) and demand (entering into peak season) conditions have pushed freight rates higher, albeit still below the average breakeven point. On a positive note, average daily TCE of very large crude carriers, or VLCCs, has increased significantly in October and surpassed the average USD 20,000 breakeven rate, currently at around USD 41,180. As a result, we anticipate Cosco to turn profitable in the fourth quarter. In the longer term, we also expect the firm’s earnings to be less volatile on the back of increasing contribution from the stable LNG shipping business. With more LNG vessels scheduled to be delivered by end-2020, Cosco should continue to see robust earnings growth from this segment.
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