As ChinaÆs largest dry-bulk shipping company in terms of the size of its self-owned fleet, the company is benefiting from the continued rise in dry-bulk freight rates that is driven primarily by ChinaÆs seemingly insatiable demand for commodities. SinotransÆ plan to aggressively expand its shipping capacity over the next few years should also support a significant improvement in earnings, syndicate analysts believe.
Aside from its fleet of 26 dry-bulk vessels that are used to transport goods such as iron ore, coal, grain and steel products, the company also owns and operates three very large crude-carriers (VLCC) and five container ships. These vessels are chartered out to shipping companies complete with a crew, either on long-term contracts or for one specific voyage.
It has also placed orders for 13 new vessels, comprising eight dry-bulk vessels, four container ships and one double-hull oil tanker that will be bought by its 50% owned MS Tanker subsidiary. These ships will be delivered between 2008 and 2011 and will be part of the companyÆs plan to increase its dry-bulk shipping capacity to 4 million-5 million dead-weight tonnes (DWT) in the next five years from 1.3 million DWT today. The already ordered vessels will boost its capacity to 2.15 million DWT.
It is also looking to increase the capacity of its oil tanker fleet to 1.2 million to 1.8 million DWT from 832,000 DWT today and of its container vessel fleet to at least 5,500 twenty-foot equivalent units (TEU) from the current 2,230 TEU, which will be met by the four ships on order as these have a combined capacity of about 3,400 TEU. The cost of the 13 new ships will be about $3.5 billion, which sources say it plans to finance primarily through bank loans.
Another key earnings driver, according to sources, is the fact that contracts for 45% of the companyÆs dry-bulk fleet are up for renewal within the next year, which should allow it to capture the surge in spot market rates over the past 12 months. The benchmark gauge of dry cargo freight rates is the Baltic Dry Index, which has soared from about 3,000 points a year ago to more than 9,000 points today.
ôThis means SinotransÆ profitability is expected to increase significantly in 2008,ö notes one syndicate analyst, who projects a 16% rise in net profit this year followed by a 115% gain in 2008.
The company posted a net profit of $119 million in 2006 on the back of $248 million of revenues. Sources say the company itself is expecting this yearÆs profit to be at least $126 million, based on a first-half profit of $57.6 million. As a listed company, Sinotrans plans to pay about 30% of its profit as dividends, they say.
The company is offering 1.4 billion new shares, or 35% of the total share capital, at a price between HK$7.18 and HK$8.18 apiece. The deal will have the usual 90:10 split between institutional and retail investors, but standard clawback triggers will apply and could increase the size of the retail portion to 50% of the total in case of strong demand.
There is also a 15% overallotment option, which may boost the total proceeds to as much as $1.68 billion if exercised in full. BOC International and UBS are joint bookrunners of the offering.
Sinotrans Shipping is a subsidiary of state-owned China National Foreign Trade Transportation (Group), also known as Sinotrans Group, which was formed in 1950 and ranks as ChinaÆs largest transportation and logistics services company. Consequently, the Sinotrans name has strong brand recognition in the industry and the group also has long-standing relationships with many of its customers and suppliers, as well as the shipbuilders û which is key for getting deliveries on time even during busy periods like the present when most ship owners are ramping up. The parent will hold 65% of Sinotrans at the time of listing.
To help ensure sufficient demand for the offering, the company has already signed up seven cornerstone investors who will jointly buy $175 million worth of shares. Depending on the final price, this will see them take between 11.9% and 13.6% of the deal, which is quite low compared with other Hong Kong IPOs of a similar size that tend to sell at least 15% and often more than 20% to cornerstone investors.
Interestingly, Sinotrans has attracted no less than three shipping- related entities to support its offering: an investment unit of the China Merchants Group that invests solely in shipping companies; China Shipping (Hong Kong) Holdings, which is involved in international transportation of bulk cargo and containers, chartering and agency businesses and the provision of various shipping-related services; and Cosco (Hong Kong), another dry-bulk cargo and shipping services company.
The other cornerstones are Lee Shau Kee, the Li Ka-shing Foundation, alternative investment firm Citadel Equity Fund and Ping An of China Asset Management (Hong Kong), which is the overseas investment management arm of Ping An Insurance. Each of the seven cornerstones will by $25 million worth of shares and has agreed to a six month lockup.
According to sources, the price range values Sinotrans at 12.4 to 14.1 times its projected 2008 earnings based on the blended syndicate estimates, which compares with an average 14.2 times for other diversified shipping companies globally. The average is dragged down slightly by KoreaÆs Korea Line Corp and Hanjin Shipping, however, while Hong Kong listed China Cosco Holdings and China Shipping Development currently trade at 20.3 times and 16.2 times respectively. The latter two have been pushed higher after announcing significant asset injections and share issuance plans that have appealed to investors.
However, as 75-80% of SinotransÆ earnings come from its dry-bulk segment, some investors are likely to prefer to compare it to this sector of the market, which currently trade at an average 2008 price-to-earnings multiple of 12.4 times. As of Friday, Hong Kong-listed Pacific Basin was quoted at 11.1 times, according to Bloomberg data.
The company is planning to use about 55% of the net proceeds from the IPO to expand its fleet, both through the commissioning of new vessels and the acquisition of second hand ones, in addition to the vessels that have already been ordered. Another 25% will be set aside for the potential acquisition of other shipping companies to help boost its market share, although at this stage the company has no specific targets in mind, sources say. The remaining 20% will be split evenly between the repayment of bank loans and other debt and working capital.
Fluctuations in freight rates is one of the main uncertainties for a shipping company, but with the demand for vessels continuing to exceed the supply for at least another year, the short-term outlook for the industry is very favourable, syndicate analysts argue. Among other potential concerns for investors to weigh into their decision on whether to invest or not is the possibility of a significant slowdown in the Chinese economy that could reduce the demand for commodities. On the oil side, the companyÆs existing three VLCC are all single-hull vessels û a type of ship that will be phased out by 2010 in favour of the more environmentally friendly double-hull carriers. If Sinotrans is unable to replace its current capacity by that time, it could see its revenues drop.
The IPO also comes as crude oil prices have just broken through $95 per barrel and is expected to continue above $100 in the not too distant future, highlighting the potential risk of higher bunker fuels. However, Sinotrans has to cover the fuel costs only for its oil tanker fleet, which accounted for no more than 13.3% of its total revenues in the six months to June and 17.9% in the full year 2006, suggesting this wouldnÆt have a major impact on its overall costs.
The oil tankers are hired out on a voyage charter basis, which means Sinotrans provides a ship to the charterer for one specific journey from the loading port to the discharging port and covers all the costs related to that voyage. In return, the charterer pays a freight rate based on the volume of cargo that is being moved.
The companyÆs dry-bulk and container vessels, on the other hand, are hired out on a time charter basis where the charterer pays for the fuel and other voyage-related costs such as ports charges, canal dues, agent fees and additional war risk insurance, as well as a per-day fee for chartering the ship. Sinotrans provides the crew and covers the operational costs. Its dry-bulk fleet generated 82.4% of the total revenues in the six months to June and 76.9% in 2006, while the container operations accounted for 3.8% and 4.6% in the same periods.
The deal comes at a busy time in the Hong Kong market as listing candidates are keen to take advantage of the ample liquidity in the market and the current strong demand for Chinese stocks among international investors.
Sinotrans IPO will go roughly head to head with a smaller offering from Value Partners, which will start formal marketing to institutions on Wednesday. The popular Hong Kong fund manager is seeking to raise at least $300 million with the help of JPMorgan and Morgan Stanley, according to sources. However, it seems it will likely avoid the competition from fellow shipping company North China Shipping, which was also expected to come to market this month but hasnÆt yet sought approval from the stock exchange listing committee. Sources say the North China Shipping will be looking to raise between $700 million and $800 million and has hired JPMorgan as the sole bookrunner.
Meanwhile, heavy truck manufacturer Sinotruk and refrigerant maker Dongyue Group will both start pre-marketing of their Hong Kong IPOs today. Sinotruck has enlisted China International Capital Corp and JPMorgan as bookrunners and is said to be targeting about $1 billion. According to local media, Dongyue is seeking up to $220 million with the help of Citi.
Sinotrans will close its order books on November 15, but isnÆt expected to price the deal until November 17. It is scheduled to start trading on November 23. The 3.5-day retail offering will be open between November 12 and 15.
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