Synopsis

China Shipbuilding Defense is a large backbone shipbuilding enterprise under the China Shipbuilding Industry Group and the country's core military manufacturing enterprise. Its predecessor was Guangzhou Shipbuilding International Co., Ltd. The company was listed in Shanghai and Hong Kong in 1993, and is the first A+H listed shipbuilding company in China. The name was changed to China Shipbuilding Defense in 2015, and the actual controller is the State Finance Committee of the State Council. China Shipbuilding Defense is a large-scale comprehensive marine and defense equipment enterprise group integrating four major marine equipment: marine defense equipment, marine transportation equipment, marine development equipment, and marine technology application equipment. The Group's main business includes ship repair, power operations, mechanical and electrical equipment, and marine engineering. It has one of the world's most advanced technologies in the field of liquid cargo ships, branch line containers, and special ship construction. Its main products include defense equipment products represented by military ships, maritime police equipment, public service ships, etc., marine marine products represented by branch line containers, dredgers, offshore engineering platforms, wind power installation platforms, etc., and marine application products represented by energy equipment, high-end steel structures, construction machinery, environmental protection equipment, and industrial networking platforms.

Its two major holding subsidiaries are Guangzhou Shipbuilding International and China Shipbuilding Huangpu Wenchang. Guangzhou Shipbuilding International is the largest and most modern integrated shipbuilding enterprise in South China under the China Shipbuilding Industry Group. As the world's first shipbuilding company to build advanced semi-submersible ships, nearly one-third of the world's semi-submersible ships are built by Guangzhou Shipbuilding International, contributing to China's strength for global infrastructure construction and maritime trade. Huangpu Wenchongze was founded in 1851. It has 171 years of construction history and more than 130 years of military engineering history. The development process spans three centuries. It is the main construction base for domestic military ships, special engineering vessels, and marine engineering. It is the largest and strongest production base for dredging engineering vessels and branch line containers in China.

industry background

The shipping industry has a clear periodicity, which is mainly affected by factors such as the development of world economic trade, cyclical fluctuations in the shipping market, and international crude oil prices and raw material prices. A typical ship cycle can be divided into 4 steps: recovery, prosperity, decline, and Xiaotiao. Currently, the shipping industry has experienced the Xiaotiao Stairway due to the COVID-19 pandemic, and is currently showing a weak recovery trend. The China Shipbuilding Industry Association announced the China Shipbuilding Capacity Utilization Monitoring Index (CCI) for the second quarter of 2023, which reached 798 points. This is the first time in nearly ten years that the index is close to 800 points, up 14% year on year and 3.4% month on month. Currently, the production guarantee factor for global shipyards is 2.89 years, up 0.34 years from 2022, while the production guarantee factor for Chinese shipyards is 3.46 years, up 0.73 years from 2022. In other words, the capacity utilization rate of Chinese shipyards is at an advanced level in the world. In 2023, China's shipbuilding completion capacity was 42.23 million heavy tons, an increase of 11.8% year on year; the number of new orders received was 71.2 million heavy tons, an increase of 56.4% year on year; by the end of 2023, the number of handheld orders was 13.939 million heavy tons, an increase of 32.0% year on year. For the first time, all indicators showed a 2-digit increase. In the first half of 2023, China's shipbuilding completion volume, new orders, and hand-held orders accounted for 49.6%, 72.6%, and 53.2% of the world's total by load weight, to revise the total inventory classification of 47.3%, 67.2%, and 46.8%, all ranking first in the world. China's shipbuilding industry ranked first in the world for 14 consecutive years. China became the only country in the world to achieve full growth in the three major indicators in 2023. Furthermore, since the life span of a ship is generally 18 to 22 years. Currently, the aging of ships around the world is becoming increasingly severe. It is estimated that by 2026, more than 25.2% of the world's ships will be over 20 years old. Under difficult circumstances, China's new ship construction prices are rising steadily. According to data from the Shipping Research Organization Clarkson, China's new shipbuilding price index rose from 773 points at the end of 2020 to 1060 at the end of October 2023. The price index for new shipbuilding has been rising all the way up, approaching the peak level of the previous ship cycle. Under the sluggish economy, the shipping industry continued to lose money for many years. In recent years, backward production capacity has gradually cleared up. As a pioneer in the shipping industry, China Shipbuilding Defense is expected to take the lead in leading the weekly recovery of the shipping industry.

advantage

With a large number of new ship orders and new shipbuilding prices rising steadily, I am optimistic that the late-stage performance will materialize. After 10 years of silence, the upward cycle of new shipbuilding has begun. High-value orders received by China Shipbuilding Defense since the second half of 2021 have been delivered continuously since 2022, which has led to a marked increase in performance. In 2022, China Shipbuilding Defense completed the delivery of 32 ships, totaling 62.75 million heavy tons, and realized revenue of 12.795 billion yuan (yuan, same below), an increase of 9.63% over the previous year; realized net profit of 688 million yuan, an increase of 767.13% over the previous year. It is worth noting that in the first half of 2023, the global offshore operations market was active, but due to factors such as tight production resources and high financing costs in the shipbuilding industry, demand for new construction fell short of the same period last year. China Shipbuilding Defense turned against the market. In the first half of 2023, China Shipbuilding Defense completed the delivery of 19 ships, totaling 487,600 heavy tons, and realized revenue of 5.982 billion yuan, an increase of 40.06% over the previous year; this resulted in net profit of 0.13 billion yuan, a year-on-year decrease of 33.09%. In the first half of 2023, China Shipbuilding Defense's total contract price was about 56.11 billion yuan, of which the total price of the in-hand shipbuilding order contract was about 53.66 billion yuan, including 116 ship products and 2 offshore equipment, totaling 30289 million tons; the total contract price for non-shipbuilding products such as offshore wind power equipment and ship repairs was about 2.45 billion yuan.

According to data from Clarkson of the Shipping Research Organization, since 2023, shipyards have quickly sold the remaining ship delivery space in 2025, and new shipbuilding prices have continued to rise. As of the end of June 2023, the price index for new shipbuilding was 171, 5% higher than in early 2023 and 34% higher than in early 2021, reaching the highest level since January 2009.

In the first half of 2023, China Shipbuilding Defense undertook 20 new shipbuilding orders of type 7, achieving a new order of 7.326 billion yuan, an increase of 132.94% over the previous year. The company was fed up with shipbuilding orders, and the delivery period was scheduled as far as 2027.

It is worth noting that due to the relatively long process of ship manufacturing, it usually takes 2 years from signing a new order to final completion, and revenue is usually confirmed after complete delivery. As a result, the implementation of shipyard performance is delayed, usually 2 to 3 years after the release of new contracts. China Shipbuilding Defense holds sufficient orders and new shipbuilding prices are rising steadily, and we are optimistic that the Group's late results will be fulfilled.

The shipping industry is related to national defense forces, concentrating production capacity on leading companies. The shipping industry is an important industry related to the development of the national economy and national defense and security. It is an essential component of the Chinese manufacturing industry. More than 90% of China's foreign trade goods are completed by sea, and the shipping industry is a strategic channel for China to integrate into economic globalization. Furthermore, the shipping industry is an important military force for the country and plays an important role in maintaining the country's economic security and national defense security. For example, ships are an important force in the country's military transportation and are useful for strengthening national defense construction. In times of emergency, strong shipping power is the foundation for securing the transportation of the country's citizens and strategic goods. China's national defense spending rose to 1.36 trillion yuan in 2021, an increase of 6.9% over the previous year. China's national defense spending in 2022 is estimated at 1.45 trillion yuan, up 7% year on year. In 2023, China's national defense spending climbed to 1.58 trillion yuan, up 7.2% year on year. Too many unstable political factors on the periphery drive national defense development spending to increase year by year, and the demand for equipment upgrades is beneficial to the long-term development of military industry stocks. China Shipbuilding Defense is a scarce military and national defense concept stock in Hong Kong stocks. In addition, the shipping industry is still recovering at the bottom of the cycle. It has a certain safety margin, and is optimistic about the space for it to develop higher in the later stages.

In the context of the global shipbuilding industry's continued production capacity, China's shipbuilding industry ranked first in the world for 14 consecutive years, and shipbuilding orders continued to shift to China. The shipbuilding industry has been in Xiaotiao for a long time, gradually phasing out backward production capacity, and gradually concentrating on new orders and high-end ship orders. Currently, the leading enterprise in the Chinese shipbuilding industry is China Shipping Group Co., Ltd., with companies in the second tier including Yangtze River Shipbuilding, New Era Shipbuilding, Dalian COSCO Shipping Kawasaki, etc., and the third tier is local shipbuilding enterprises and private shipbuilding enterprises. According to data from the China Shipbuilding Industry Association, in the first three quarters of 2023, the top 10 companies accounted for 64.3% of the country's shipbuilding completion volume, the top 10 companies accounted for 62.5% of the country's new orders, and the top 10 companies accounted for 61.2% of the country's handheld orders. A large number of orders are concentrated among leading companies. China Shipbuilding Defense has benefited from the parent company's head effect, and it is expected that it will be the first to benefit as the industry recovers.

Outnumbered

The supply and demand cycle of the shipping industry is affected by macro factors

Demand in the shipping industry is mainly affected by macroeconomics, including factors such as macro policies, GDP growth, trade, exchange rates, interest rates, inflation, raw materials and commodity prices, and industrial chain supply chains. For example, in 2022, the shipbuilding business, which accounts for 61.59% of revenue, recorded revenue of 7.880 billion yuan, a year-on-year decrease of 14.28%, gross profit margin of 7.62%, and a year-on-year decrease of 1.60%. The main reason for the decline in revenue was due to the expansion of demand in the repair and modification market, China Shipping Defense gradually expanded the scale of repair and modification operations, and the share of shipbuilding business declined accordingly; the main reason for the decline in gross profit was that the products that were completed and delivered were mainly carried out when steel prices were low and exchange rates were high in the previous period, while export orders were mainly priced in US dollars, which led to a lower overall gross margin of products. Furthermore, due to the Group's implementation of order-based production and the long construction cycle, price fluctuations in raw materials such as steel and rising labor costs, or leading to a passive increase in the cost of the Group's products under construction, it is more difficult to control the increase and decrease costs, which has a certain impact on the Group's business performance. For example, shipbuilding prices will lock in the price of related materials at the time of signing, and later increases in steel prices will significantly affect shipbuilding companies' costs, thereby dragging down the group's performance.

The geopolitical crisis raises the risk of shipowners breaking their contract

Geopolitical disruptions continue, hampering the recovery of shipping. The Suez Canal, which opened in 1869, carries about 12% of global trade, making it one of the busiest canals in the world. As Houthi attacks continued, the Red Sea crisis worsened, further affecting shipping trade, causing half of the ships to avoid the Red Sea and Suez Canal routes, taking a detour to the Cape of Good Hope, and causing the transportation capacity of millions of containers to be impacted. If ships use the Cape of Good Hope route, the travel time between eastern Asia and western Europe will increase by about 25 to 35 percent. Freight costs have risen, shipping schedules have been extended, and delivery dates have been delayed, and the momentum of a weak recovery in shipping has once again been hit. In this context, shipowners may experience financial difficulties and financial constraints, leading to delays in ship payment, delays in confirming delivery, contract amendments, and even cancellations, causing China Shipbuilding Defense to have a risk of breaking the order.

Investment Recommendations

Optimistic about China Shipbuilding Defense's position as a pioneer in the shipping industry, it first gave China Shipbuilding Defense a “better than the market” rating, with a target price of HK$12. The Group is expected to achieve net profit from 2023 to 2025, divided into 53 million yuan, 500 million yuan, and 800 million yuan, an increase of -92%, 843%, and 60% over the previous year; it is proposed to buy at a low price and hold for a long time.