The author is an analyst of NH Investment & Securities. He can be reached at [email protected] — Ed.
Pan Ocean’s 4Q19 results missed consensus, weighed upon by IMO regulations and tepid market conditions. In light of Covid-19 effects, the bulk carrier market will likely remain sluggish in 1Q20. While the possibility of further deterioration looks limited, recovery is likely to prove slow. We lower our TP on Pan Ocean to W5,600.
Market conditions abnormal; slow rebound anticipated
While adhering to a Buy rating on Pan Ocean, we lower our TP from W6,500 to W5,600 on revisions to 2020 earnings forecasts. We downwardly adjust 2020E OP by 20% from our previous estimate, as we expect sluggish raw material demand and difficulties related to bulk carrier operations to continue through 2Q20. Our TP was calculated by multiplying a target P/B of 1.0x to 2020E BPS of W5,626. Pan Ocean’s shares are currently trading at a 2020E P/B of 0.7x.
Going forward, bulk freight rates (rather than earnings) are to be more important in determining Pan Ocean’s share price direction. Recently, the Baltic Dry Index (BDI) has risen slightly, climbing to 535p on Feb. 28 after dipping to a 2020 low of 411p on Feb. 11. While small- and mid-sized freight rates have rebounded as of late, the capesize (large vessel) freight index is continuing to fall. Although demand for grain (key cargo for small- and mid-sized vessels) has improved on the back of grain harvest seasonality, demand for iron ore (major bulk cargo for large-sized vessels) has remained sluggish. With China’s iron ore inventories down only 0.3% YTD in 2020, it is tough to expect an inventory build-up cycle. In order for iron ore trade volume to recover meaningfully, a rebound in Chinese steel demand and product prices looks necessary.
Viewing current bulk freight rates as being abnormally low (due to a combination of sluggish demand and extreme weather conditions in major iron ore producing countries), we believe that expectations for an uptrend remain valid, even though any recovery is likely to prove slow.
▶ 4Q19 review: Earnings slightly miss consensus, due to sluggish market conditions and IMO regulations
Pan Ocean recorded 4Q19 sales of W618.7bn (-5.2% y-y) and OP of W51.2bn (-2.3% y-y; OPM of 8.3%), with both figures arriving slightly short of consensus. On the non-operating side, a loss of W4.9bn was reflected on the sale of one vessel. We largely attribute the decline in sales to: 1) a drop in vessel utilization rate ahead of the implementation of new IMO regulations; 2) a decrease in cargo volume due to a weakening in China’s coal imports; and 3) a reduction in the number of operating vessels. We believe that Pan Ocean’s 1Q20 earnings will represent a bottom in terms of 2020 quarterly results.