Morningstar | CSET to see strong earnings improvement after restructuring; still no moat.
As one of China’s leading shipping conglomerates, Cosco Shipping Energy Transportation, or CSET, is now the world’s largest oil tanker company by shipping capacity. The company’s profitability improved significantly after a restructuring deal where the company disposed of its dry bulk shipping business, given the surging tanker freight rates and the low bunker prices. That said, the high cyclicality, low product differentiation, and weak pricing power of oil tankers lead us to assign a no-moat rating to CSET’s business, as the firm is unlikely to generate satisfactory returns for shareholders in the long run. Prior to restructuring, CSET delivered very weak earnings and achieved an average return on invested capital of 2.0% from 2010 to 2014, significantly lower than its weighted average cost of capital. This is because of the overcapacity issue in the dry bulk shipping sector and the volatile freight rates in the oil tanker sector. Because of the slowdown in the Chinese economy, global dry bulk shipping demand plunged. This, coupled with the massive new capacity built during the 2006-07 shipping boom, led to a significant overcapacity issue, finally weighing on freight rates. Sluggish freight and high bunker cost weighed on the returns of CSET's tanker unit from 2011 to 2013, as reflected by the average gross margin of negative 1.2%. From 2014, global tanker companies saw a strong earnings turnaround: The steep oil price decline spurred oil shipping demand and drove down bunker cost. CSET’s oil tanker unit saw its gross margin surge to 35% in first-half 2015 from negative 7% in 2013. However, the strong shipping demand and surging freight enticed tanker companies to expand capacity. With new capacity coming on line in the next few years, we believe the tanker capacity supply will gradually catch up with demand. Thus, we see the high returns of CSET’s tanker business as unsustainable.
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