[Into the Stocks] Korea Shipbuilding & Offshore Engineering Confirms the Bottom... A Turnaround Full of Hopes

[Asia Economy Reporter Lee Seon-ae] Korea Shipbuilding & Offshore Engineering, which posted an earnings shock in Q2. The stock price, which soared to 163,500 KRW on May 11 this year, has not been able to break through 130,000 KRW decisively. Investors watching this feel conflicted, but the securities industry unanimously agrees that now is an opportunity to 'increase weighting.' The bottom of the earnings has been confirmed, so only upward movement remains. If you expect a performance turnaround in the second half, now is the time for focused buying.

◆The anticipated earnings shock= According to the financial investment industry on the 23rd, Korea Shipbuilding & Offshore Engineering's Q2 consolidated sales were 3.7973 trillion KRW (-3.3% YoY, +3.1% QoQ), with an operating margin of -23.6%. Sales decreased due to production stoppages caused by a major accident at Hyundai Heavy Industries and the completion of production processes in the offshore sector, but increased compared to the previous quarter due to a rise in shipbuilding volume including special vessels. The main cause of the operating loss was the recognition of one-time expenses totaling 1.1188 trillion KRW in the shipbuilding and engine machinery sectors, reflecting the anticipated sharp rise in steel prices in Q2 results through construction loss provisions. Kim Hong-gyun, a researcher at DB Financial Investment, explained, "Korea Shipbuilding & Offshore Engineering's Q2 results recorded an earnings shock due to the recognition of one-time expenses conservatively reflecting the anticipated sharp rise in steel prices across the entire order backlog."

Han Young-soo, a researcher at Samsung Securities, also said, "Korea Shipbuilding & Offshore Engineering's Q2 consolidated operating loss was 897.3 billion KRW. If you remove the 910 billion KRW provision and the impact of production stoppages due to Hyundai Heavy Industries' safety accident, the actual Q2 operating profit is judged to be slightly positive," adding, "The reason for the large loss is that Korea Shipbuilding & Offshore Engineering applied more conservative assumptions regarding the price of steel plates than expected, so future profits and losses may be better compared to competitors."

◆Stable order backlog= The part that the securities industry focuses on is the stable order backlog. The shipbuilding industry has seen a decline in supply due to the exit of shipyards amid worsening market conditions over the past decade. With the recent surge in ship orders, surviving shipyards have secured stable order volumes. For the time being, the possibility of new entrants from the supply side is slim, creating an environment where cost increases such as sharp rises in steel prices can be passed on through new ship prices.

Korea Shipbuilding & Offshore Engineering's three shipbuilding companies focused on order achievements in the first half. Hyundai Heavy Industries secured 55 vessels, Hyundai Samho Heavy Industries 33 vessels, and Hyundai Mipo Dockyard 70 vessels, achieving 89% of the merchant ship order target. If a few more vessels scheduled for delivery in 2024 are ordered, the new order target for this year can be achieved early. In fact, after the rise in new ship prices, with full-scale order activities, securing the delivery schedule planned at the beginning of the year alone is expected to exceed the order target by more than 30% in terms of amount.

Um Kyung-ah, a researcher at Shin Young Securities, said, "The shipbuilding industry, which has filled about 2 to 2.5 years of order backlog based on delivery, has limited possibility to forcibly lower future order prices," adding, "Among these, the input costs of orders to be built from the second half of 2021 to the first half of 2022 have been conservatively estimated, making a performance turnaround possible after the second half."

◆Opportunity to increase weighting= The securities industry is raising their voices to use this as an opportunity to increase weighting. Kim Hong-gyun, a researcher at DB Financial Investment, maintained a target price of 180,000 KRW and said, "From a supply-demand perspective, ship supply capacity is limited while demand is expanding, and increased cost burdens in shipbuilding raise entry barriers," emphasizing, "Under a visible supplier-dominant market, the differentiation of the top shipyard will stand out, so the temporary earnings shock should be used as an opportunity to increase weighting."

The recovery phase of the shipbuilding industry's long-term cycle (long-term boom) is also a driving force for increasing weighting. Han Young-soo, a researcher at Samsung Securities, said, "The existing strategy to use adjustments caused by major Q3 events (Q2 earnings slump, temporary slowdown in order momentum due to shipyards' price increase demands, concerns about stock supply and demand) as buying opportunities remains valid," adding, "This is because the long-term cycle of the shipbuilding sector is improving, and the rise in steel plate prices will eventually be passed on to ship prices." He also predicted that preference for Hyundai Heavy Industries Group would continue, due to its better financial condition compared to competitors, investment capacity for eco-friendly ship development, and advanced technology.

Shin Young Securities recommended an overweight investment opinion on the shipbuilding sector, naming Korea Shipbuilding & Offshore Engineering as the top pick and Hyundai Mipo Dockyard as the second pick. Um Kyung-ah, a researcher at Shin Young Securities, said, "Shipbuilding is an industry that has repeatedly expanded capacity since the 2000s, so it is important to select companies that maintain competitiveness amid smooth restructuring," adding, "The restructuring phase of large shipbuilders is still ongoing, and the final stage is expected to be the absorption of Daewoo Shipbuilding & Marine Engineering into Hyundai Heavy Industries Group. The benefits of proactive restructuring will be concentrated on Korea Shipbuilding & Offshore Engineering." She continued, "Since May, the price adjustment has removed valuation burdens, and considering the increase in new orders, price rises, and a performance turnaround in the second half due to the big bath in the first half, it is judged to be an active buying period." Shin Young Securities set a target price of 210,000 KRW for Korea Shipbuilding & Offshore Engineering.

◆Holding company weakness... valuation is discounted= Within the Hyundai Heavy Industries Group stocks, Korea Shipbuilding & Offshore Engineering inevitably becomes more of a holding company as its subsidiaries' listings approach. This is an undeniable weakness.

However, the fact that there is sufficient upside potential even when approached as a holding company compensates for this weakness. Currently, Korea Shipbuilding & Offshore Engineering's valuation is attractive even from the perspective of a holding company. Hyundai Mipo Dockyard, a currently listed subsidiary, is trading at a premium within the sector, and assuming the same premium is applied to subsidiaries planned for future listing, the subsidiary listings could rather highlight valuation attractiveness.

Han Young-soo, a researcher at Samsung Securities, said, "Generally, the listing of unlisted subsidiaries lowers the discount rate applied to the equity value," adding, "Reflecting the capital impairment in Q2, the target price is lowered by 5% to 168,000 KRW (applying 2021 price-to-book ratio (PBR) of 1.2x = sector target PBR 1.23x × Hyundai Heavy Industries Group premium 17% × holding company discount 20%), but there is still about 30% upside potential."

Kim Hyun, a researcher at Meritz Securities, said, "The IPO of Hyundai Heavy Industries, a subsidiary expected to be a future leader (100% stake), is expected by the end of Q3, but the stock price discount factor as an intermediate holding company has already been priced in," adding, "Maintaining a target PBR of 1.0x, the current price level allows stable trading, with a fair price of 147,000 KRW."

This content was produced with the assistance of AI translation services.