NOL sinking with demand-supply mismatch

Reinitiate coverage with Hold. We resume coverage on Neptune Orient Lines (NOL) with a Hold rating and target price of $1.10, based on 0.8x FY12F P/BV. Softening demand and a glut of new vessels on order look set to challenge the shipping industry well into 1H12. Though current stock valuation is inexpensive, we think investors should ideally wait for more positive signs of moderating freight rate decline before taking the plunge.

A double whammy. NOL recorded a sharper-than-expected net loss of US$91m for 3Q11, which generally disappointed the market. Falling freight rates due to excess capacity on key routes and higher bunker fuel prices have combined to hurt container shipping lines. The group’s quarterly losses could further widen in the off-peak season in 4Q11.

Possible prolonged downturn. The prospects for an early recovery in the industry could be derailed if the global economic turmoil spreads and consumer demand in Europe and the US deteriorates. In the event of a prolonged downturn, we believe the Asian container shipping sector will simply be a story of market share gains to insulate against the difficult macro-environment. Against this backdrop, it is likely that NOL will report its second consecutive annual loss in FY12.

Equity-raising an overhang. NOL still has more than US$2.0b of vessel instalment payments until end-2013, which will be financed through a combination of bonds and committed ship financing. Based on our estimates, net gearing would creep up to almost 0.9x in FY12F, suggesting that raising of fresh funds cannot be ruled out, especially if credit markets should tighten or a new acquisition is made.

Poor outlook priced in. The stock has underperformed the Straits Times Index YTD, falling by 49% against a 13.3% decline in the index. We believe the weak outlook for the shipping industry with little expectation of earnings recovery in the near term is largely reflected in the share price.