Tea with Mike: Analysis of Yangzijiang, an S-chip (Part 2).

Now, let’s address the various concerns I have with regards to investing in YZJ:

1) Falling margins for shipbuilding

Most of the fat contracts secured during the boom years in 2007-2008 are over. One should not expect margins to be fat today but I doubt we will see a free-fall in margins. YZJ's latest quarter's margin is about 20% for its core shipbuilding segment which is low by historical standards but if we compare it with Chinese peers, it’s not bad at all. Management has mentioned they will not drastically lower prices to secure deals. Although I take their word with a pinch of salt, the numbers seem to bear this out too.

2) Operation and execution risk

One of the bigger deals undertaken by YZJ that is due for delivery is the 10,000 TEU container ship. One should closely monitor the delivery as any prolong delay or problems after delivery will be serious, and I would run with my money at double quick time

 

3) Another fraud in the making?

Yangzijiang, being another S-chip, does need close scrutiny. I cannot ascertain their numbers, but there are a few things I take comfort in. They have FCF in all but 2011, and this translate to dividends, so it’s not a complete paper exercise. Due to the fact that they are dealing with ships, it is extremely difficult to fake a deal, you can check if there is indeed a deal from the customer side (Yangzijiang’s customers are renowned, big companies with ready information on their website) There is also third party website that track shipbuilding orders and the sale of 2^nd hand vessels, so chances of a fabricated deal is very low, but there is no way to track margin. E.g. they can be making a loss from building a ship due to cost overrun, but under-report the COGS in the quarterly reports, and there is no way can be sure when it comes to such nitty gritty.

4) HTM investments

This is my biggest concern. Yangzijiang has 12 billion in HTM (held to maturity) investments.  Such investment has provided them with a steady stream of supplementary income, and ensures their financial strength, which is critical in the ship building industry. The HTM investment is literally loans to companies who otherwise are unable to get loans at better rates. So, if you like, Yangzijiang has a banking arm.

More than half of its HTM is charging interest rate of more than 12%, and about 1/6 of it HTM is above 18% when the PBoC benchmark rate is about 6% and effective interest rate of YZJ loans is only 4%. (From 2012 AR)

I am concerned about the strength of the companies that need to loan from YZJ at above 12%  which is also known as the shadow banking rate. However, impairment level till 2012 is less than 5%, and from their latest quarterly report, there is zero bad loans, loans are covered by collateral pledged by borrowers.

Another reason why I find the HTM risk easier to bear is fact that about 55% of the collaterals are properties or land, and YZJ has set up a property development arm to develop land at the old shipyard when they were asked to vacant the land for other development purposes, so it seems that the management does have a contingency plan. From the interview with NextInsight, most of these land and properties are in Jiangsu where it operates. Hence, they do not have any problem that comes from a lack of local knowledge.

Ship building and its related activities still contribute up to 90% of its revenue. So, even if there should be some inflated issues with HTM, which are assets and not liabilities, YZJ should still survive.

In conclusion, if you cannot trust the numbers of YZJ, you should not invest in it. If you trust the numbers, there are several good things going for it. Hope my analysis make sense.

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Read Part 1: here.