Shaky waters still ahead for NOL

Weaker rates in May. Neptune Orient Lines' (NOL) recently announced that its container shipping operating performance for the period between 7 May and 3 Jun saw container shipping volumes increase 7% YoY on the back of higher volumes carried on the Intra-Asia and Asia-Europe trade lanes but fell more than 1% MoM on seasonality factors. On an YTD basis, volume increased by 9%. Average revenue per Forty-foot Equivalent Unit (FEU) continued to fall due to lower rates on the Asia-Europe trade lane (-7.6%) while YTD average revenue per FEU fell 1% YoY.

Weak rates to remain despite peak-season surcharges. We maintain our assertion that rates will remain weak in 2H11 as 2Q11 comes to a close, particularly in the Asia-Europe trade lane, given the fierce competition amongst carriers and poorer utilization levels. Furthermore, the annual Transpacific rate negotiations have reportedly failed to yield the desired rate increases despite the implementation of peak-season surcharges as carriers continue to undercut fees in a bid to revive utilization levels, which have suffered in part due to the ordering boom of 2007/2008. We believe that even with the growth in volume demand during the peak-season, it will be insufficient to offset the drag caused by the growth in excess capacity.

NOL's fleet expansion a positive; oversupply threat remains. NOL had recently confirmed orders for 12 new container vessels with Korean shipyards, 10 of which will be its largest and most efficient vessels (14,000-TEU), for delivery in 2013/2014. An upgrade of 10 vessels from 8,400-TEU to 9,200-TEU was also included in the agreement. We view the expansion plan as a positive for NOL as it seeks to take advantage of the current low cost environment for ship building to improve its cost competitiveness with reductions in its average costs over time, and to keep pace with competitors like Maersk and OOIL, which had recently made orders for similar vessels. However, unless global economic recovery can keep up with the expected increase in vessels in 2012/2013, we feel that the container shipping industry will relive similar problems where rates continue to remain depressed.

Near-term weakness to persist; maintain HOLD. Given the continued weakness in freight rates, we reiterate our view that prospects for NOL in FY11 are not as rosy. We forecast lower revenue for 2Q11 (-1.5% MoM) and adjust freight rate growth lower by another 3% on the back of increased competition during the peak season as carriers attempt to boost utilization levels. We maintain our HOLD rating but reduce our fair value estimate from S$1.95 to S$1.63, based on the 5-year historical P/B average of 1.0x.