We reiterate our NEUTRAL call on the Shipping & Ports sector. The shipping sector continues to experience a down-cycle with the Baltic Dry Index slumping to new lows in Feb-16, while the performance of the petroleum segment appears foggy due to volatile demand evident from weaker MoM rates in Feb-16. Meanwhile, local port operators are also bracing for tougher times with the slowdown in global economy, but, they still possess the advantage of cheaper tariff’s as compared to regional peers, with near-term earnings supported by the tariff hike. Due to the lack of stimulating catalyst in sight, we maintain our neutral stance on the sector. Our preferred pick for the sector is MISC (OP; TP: RM10.64) with the charter renewal of five Puteri class carriers and five newbuild contracts.

4Q15 results mostly above. BIPORT and MISC’s earnings were ahead of our estimates due to lower effective tax rates (24% vs. 30% forecasted), and better-than-expected charter rates in the petroleum division, respectively. There were no surprises for WPRTS which came in well within consensus and our expectations. As a result, we upped FY16E earnings for; (i) BIPORT (+4.4%) on lower tax rates, (ii) MISC (+13%) on stronger petroleum charter rates, while (iii) WSPRTS was upgraded (+2.1%) on lower tax rate guidance despite a slower growth outlook.

Ports growth rates declining. WPRTS saw throughput volume growth declining marginally to 8.1% to 9.05m TEUs in FY15 (from 12% to 8.37m TEUs in FY14). Going forward, we expect lower but positive volume growth, (est. 4.1% from 5-10% in FY15) taking into consideration; (i) uncertainties of the formation of shipping alliances, (ii) global economic slowdown (that could hamper demand for both imports and exports), putting downward pressure on ports throughput volume, as well as (iii) volatility in Ringgit in light of challenges in FY16. However, the slower growth impact for WSPRTS is mitigated as: (i) local port operators enjoy cost advantages as compared to the regional peers, (ii) effects of tariff hike will be fully reflected in FY16, (ii) it is further supported by the expansion plan to boost the handling capacity, and (iii) lower effective tax rate for WSPRTS (at 15%) from the ITA which was renewed for three years from FY15-17. Note that NCB has been taken private by its major shareholder MMCCORP through a mandatory general offer (MGO) during mid-Oct 2015 at RM2.1b.

Petroleum charter rate outlook murky. Petroleum charter rates were up in 4Q15 (+60% QoQ), but we do not expect this to sustain in the long run as 1Q and 4Q are generally stronger quarters, due to the winter season. Additionally, we are seeing lower MoM Spot rates for VLCC as at Feb-16 (-32.4%), suggesting that CY16 rates may not see strong growth rates similar to CY15, especially with new buildings entering the global fleet. At this point, we believe that the MoM weakness is too premature of an indication on charter rate outlook, but we will continue to monitor the key determinants closely, such as; (i) oil demand, (ii) the effects of the seasonal cold snap, and (iii) strategy of owners to sell up or sell down the market. All in, we are not overly bullish on the petroleum charter rate outlook in 2Q-3Q16 and expect rates to remain range bound for now.

LNG Charter rates on the downtrend, to last until CY18. This segment saw a slight uptick in 4Q15 (+4.9% QOQ for Spot rates), during the winter season. However, the outlook remains gloomy for LNG rates as there is still an oversupply of vessels, evident from weaker YoY data (-51% YoY for Spot rates). Additionally, supply is expected to increase further in CY16 from new Australian and US plants production, with cargo deliveries already fully contracted, while demand growth is lacklustre.

Baltic Dry Index making new lows in Feb-16 due to fleet oversupply. The Baltic Dry Index which is often seen as a leading indicator dipped to a 26-year record low (since Jan 1990) of 290 in Feb 2016, breaking below its FY15 low of 471 in Dec-15. However, rates are slowly picking up from the Feb-16 low to 406 (as at our cut-off date of 25th March 2016). The weakness is believed to be an effect of oversupply of fleets (i.e. handysize and supramax), which have been faster than the demand for dry bulk commodities, which is a result of slow import demand from China.

Lowering USD exchange rate assumptions to RM4.10 (from RM4.20). In line with our in house view, we are lowering our Ringgit to USD assumptions for all stocks under our coverage. As such, we lower MISC’s earnings by 2.2-2.3% to RM3.3-3.6b in FY16-17E. However, do note that MISC’s earnings and cost are secured in USD, which is the groups functional currency, thus, forex rates do not have a significant impact on the group’s earnings, but it is a mere standard for reporting. We make no changes to our call and TP for MISC (OP; TP: RM10.64) which is based on 1.25x PBV FY16E, on par with +1SD over the 5-year mean.

Ports implied PER marginally above historical average due to earnings stability. At our current TPs, BIPORT and WPRTS implied Fwd. FY16E PER of 24.0x and 22.6x are slightly above its *5-year historical average at +0.5SD. However, MISC’s shipping business warrants cheaper implied Fwd. FY16E PER of 14.2x (-0.2SD below its 5-year historical average), likely due to earnings risks from volatile segments. However, despite MISC’s implied PER being below average, the stock still warrants an OUTPERFORM call at current levels based on our PBV valuation method (1.25x PBV FY16E valuations) and TP of RM10.64. As for current PERs, both port operators traded above 20x and up to 27x PER over the last one year while MISC was traded range bound between 10.5x-13.8x. *Note that WPRTS historical average only consists of 2.5 years as IPO was in Oct-13.

Reiterate NEUTRAL on the Shipping & Ports sector. The outlook for the shipping sector is not exciting at this juncture as it is experiencing a down-cycle with the Baltic Dry Index slumping to new lows, while the previous bright spot which was petroleum charter rates, may not see strong growth in CY16 as initially expected. Meanwhile, local port operators are also bracing for tougher times with the slowdown in global economy, but they hold the advantage of cheaper tariff as compared to regional peers with near-term earnings supported by the tariff hike. With no stimulating catalyst in sight, we maintain our neutral stance on the sector. Our preferred pick for the sector is MISC (OP; TP: RM10.64) with the charter renewal of five Puteri class carriers and five newbuild contracts; the first two new LNG vessels are expected to be delivered in 2H16 and we expect the new delivery to drive earnings growth in FY16.

Source: Kenanga Research - 6 Apr 2016