Kuwait Financial Centre Markaz R E S E A R C H Markaz Research is available on Bloomberg Type MRKZ <Go> Thomson Financial Reuters Knowledge Zawya Investor Noozz M.R. Raghu CFA, FRM Head of Research +965 2224 8280 rmandagolathur@markaz.com Layla Al-Ammar Investment Analyst lammar@markaz.com +965 2224 8000 Ext: 1205 Kuwait Financial Centre Markaz P.O. Box 23444, Safat 13095, Kuwait Tel: +965 2224 8000 Fax: +965 2242 5828 www.markaz.com Qatar Shipping DSM Code: QSHS Reuters Code: QSHS.QA Bloomberg: QSHS QD Current Market Price: QAR 35 (As of 2 Dec 08) Stock Volatility Low Medium High Expected Return Low Medium High O n a YTD basis, Qatar Shipping (QSHIP) stock has declined 41.5% in-line with DSM 20 s decline of 37.9% over the same period. QSHIP s Q3 2008 net income declined 7% YoY to USD 23 mn, whereas the company s operating income increased 20% YoY to USD 28 mn in the quarter. Deep sea transportation generated USD 34 mn worth of revenue for QSHIP in H1 2008. The declining shipping rates cause concerns over the continued profitability of this segment in the short term. Recently, QSHIP has been directed by the Government of Qatar to merge with Qatar Navigation (QNAV). We expect the merger to provide QSHIP with enhanced footprint in the shipping and allied activities in Qatar. Additionally we expect the merged entity to benefit from consistently improving operating efficiency of QNAV and expected synergies. QSHIP s non-operating income, primarily income from investments has been highly volatile. Income from investments was a major driver for total income growth in 2007, whereas it was also responsible for lower total income growth in 2006. The share of construction services in total operating revenue for QSHIP increased to 57% in H1 2008 from 44% in 2007. Deep sea transportation contributed 20% to total operating revenue in H1 2008. The net margin in offshore support services has seen a significant improvement, reaching 51% in H1 2008 from 35% in 2007. This has helped QSHIP maintain its net margin from operating segments despite the decreasing share of high margin deep sea transportation segment. We expect QSHIP s net income to decline by 1% in 2008 owing to lower shipping rates and volatile investment income. Assuming the merger of QSHIP and QNAV to take effect from the beginning of 2009, we expect the merged entity s 2009 net income to grow by 20%, driven by QNAV. On a stand alone basis, we expect QSHIP s 2009 net income to grow at lower rate of 5%. Our fair value P/E of 6.6x for QSHIP being in line with the current P/E leads us to believe that the company is fairly valued. USD Mn 2004 2005 2006 2007 2008E 2009E Operating revenue 140 209 244 231 NA NA Operating income 52 51 69 94 NA NA Net profit 61 115 126 171 168 177+ 2004 2005 2006 2007 2008* 2009* P/E (LTM) 35.92x 25.39x 13.19x 10.59x 6.39x 5.98x P/B (LFI) 5.81x 1.64x 1.77x 1.40x 0.79x NA Market Cap 2,201 2,912 1,662 1,808 1,058 NA Shareholders' Equity 379 1,778 942 1,295 1,347 NA Stock Returns 83% 14% -43% 9% -41% NA Note: 2008 figures PE, P/B and M.Cap as on 2 December 08, Stock return is 2008 YTD return, Shareholders equity as on Sep 30, 2008. 2009 P/E is forward P/E calculated using the estimated EPS for 2009 + For the merged entity, we estimate 2009 net profit at USD 417 mn. For 2008, we estimate the pro forma net profit for QSHIP and QNAV combined at USD 347 mn. Source: QSHIP Financial Reports, Bloomberg, Reuters
Analyst Discussion Notes Earnings growth QSHIP s net income declined by 7% YoY to USD 23 mn in Q3 2008 on the back of losses from investments For Q3 2008, QSHIP s net income declined 7% YoY to USD 23 mn on account of loss from investments amounting to USD 1 mn compared to investment gains of USD 6 mn in Q3 2007 (Figure 1). However, the company s operating income increased 20% YoY to USD 28 mn owing to a 53% YoY rise in operating revenue to USD 102 mn. For 9M 2008, QSHIP posted a net income of USD 126 mn compared to a net income of USD 131 mn in 9M 2007. The decline in net income in 9M 2008 was attributable to higher gains on sale of vessels in 9M 2007. On the other hand, QSHIP s operating income registered a YoY increase of 32% in 9M 2008 to reach USD 83 mn. Figure 1: Net Income & YoY growth 100 75 50 25 0 78 57 55 48 39 36 28 28 25 23 6 Q1FY06 Q3FY06 Q1FY07 Q3FY07 Q1FY08 Q3FY08 Net Income (USD mn) YoY growth (RHS) 500% 300% 100% -100% Source: QSHIP Financial Reports Shipping revenues growth expected to be subdued Lower shipping rates expected to hamper growth in shipping revenue in the short term Deep sea transportation generated USD 34 mn worth of revenue for QSHIP in H1 2008. The company currently has a fleet of 20 ocean going vessels of which two are under construction. The company has nine LNG tankers, six LPG tankers (of which two would be delivered by Q1 2009), four clean petroleum product tankers and one crude oil tanker. Given the slowing demand for crude oil and the falling crude oil prices, the shipping rates have been coming down in the industry. The shipping rates for an Aframax (80-120 DWT vessel) have come down from the high of USD 64,391 per day 1 in July to USD 38,550 per day in November 2008 (Figure 2). Given the excess capacity expected in the market when previous build orders are completed, we expect the shipping rates to come down further in the near future. This is also clear from the low future rate of USD 33,802 for March 2009. The continuously declining shipping rates would force lower charter rates for QSHIP for any vessels whose earlier contracts are expected to expire over the next 6-12 months. Thus, we remain concerned about the profitability and revenue from deep sea transportation in 2009. On the other hand, the company is well placed within the shipping industry. The average age of the fleet for the company is just 3.5 years which implies a very young fleet given the average useful life of 25 years. The average age of the fleet 1 The rates are for a standard Aframax vessel for a journey from Kuwait to Singapore. (Source: Bloomberg) Kuwait Financial Centre Markaz 2
is expected to reduce further to 3.1 years with the delivery of two new vessels before Q1 2009 end. The company has also indicated that given the low prices of the vessels currently, it may look at expanding its fleet by purchasing more vessels. This would enable the company to have high-valued assets acquired at low prices when the economy revives. Additionally, QNAV, which is also engaged in shipping activities through its marine transport segment, has seen revenue from the segment growing consistently since 2003. QNAV s marine transport revenue increased to USD 32 mn in H1 2008 from USD 23 mn in H1 2007. The contribution of marine transport business in QNAV s total operating revenue has also increased to 19% in H1 2008 compared to 16% in 2005. QNAV s relative strength in the shipping business will help soften the impact of subdued revenue growth in shipping business for QSHIP. Figure 2: Aframax shipping rates 70,000 USD per day 50,000 30,000 10,000 Jan-07 May-07 Sep-07 Dec-07 Apr-08 Aug-08 Nov-08 Mar-09 Aframax Historical Shipping Rates Aframax Forward Shipping Rates Source: Bloomberg Merger with QNAV to strengthen operational performance With stable operating income growth and improving margins, QNAV to strengthen operational performance post merger QSHIP has registered a steady growth in its operating income since 2005, with the operating income reaching USD 83 mn in 9M 2008 compared USD 63 mn in 9M 2007 (Figure 3). QNAV has performed even better with the company s operating income increasing steadily at a CAGR of 32% over the 2003-9M2008 period. For 9M 2008, QNAV s operating income stood at USD 87 mn, a YoY growth of 50%. The merged entity will benefit from steady and growing operating income of both QSHIP and QTEL. The merger with QNAV will also provide QSHIP with enhanced footprint in the shipping and allied activities in Qatar. Apart from marine transport business, QNAV has a presence in shipping agency, ship repair and fabrication, offshore services and commercial services businesses. On the efficiency front, QNAV has posted continued operating margin enhancement since 2004, with the margin reaching 32% for 9M 2008 from 29% for 2007, and 21% for 2004. On the other hand, QSHIP s operating margin declined to 30% for 9M 2008 from 41% for 2007. We believe the improving efficiency at QNAV would help partially offset relatively lower operating efficiency at QSHIP. Additionally, we expect the operational synergies to flow in once the operational integration of QSHIP and QNAV in complete, which would further enhance operating margin for the merged entity. Kuwait Financial Centre Markaz 3
Figure 3: QSHIP and QNAV Operating performance R E S E A R C H 120 50% 80 52 51 51 69 65 94 83 83 87 25% 40 34 23 33 0 2003 2004 2005 2006 2007 9M 2008 QSHIP operating income QNAV operating income QSHIP operating margin QNAV operating margin 0% Source: Respective Company Financial Reports Non-operating income is highly volatile Highly volatile income from investments add to concerns over the non-operating income While the operating income for QSHIP is relatively stable, the company s income from other sources is highly volatile. QSHIP s income from investments is primarily responsible for volatality seen in the total income growth for the company (Figure 4). Income from investments was a major driver for total income growth of 35% YoY in 2007. On the other hand, investment losses amounting to USD 12 mn were responsible for QSHIP s total income growing at lower rate of 13% in 2006. Though the company has posted gains from investments for 9M 2008, it s investments have generated negative returns in Q2 2008 and Q3 2008. Since a substantial portion of QSHIP s investment portfolio is concentrated in quoted securities, we remain concerned about the income from investments in near future given the currrent market conditions. Figure 4: Total income break-up & YoY growth (USD mn) 240 160 80 0 2003 2004 2005 2006 2007 9M 2008 125% 100% 75% 50% 25% 0% -80 Operating income Interest income Gain on sale of vessels -25% Investment income/ (loss) Other income Total income YoY growth (RHS) Source: QSHIP Financial Reports Additionally, QNAV also generates a substantial portion of income (44% in 9M 2008) from non-operating sources, primarily investments income. Given the higher contribution of investments income in QSHIP s as well as QNAV s total income, we expect the merged company s total income to be sensitive to market fluctuations. Kuwait Financial Centre Markaz 4
Share of construction services is growing in the operating revenue of the company reaching 57% in H1 2008 Construction services driving operating revenue growth QSHIP s operating revenue reached USD 175 mn in H1 2008 compared to USD 112 mn in H1 2007. Since 2003, the segmental pattern of operating revenue has changed, with construction services contributing higher share to total operating revenue for the company (Figure 5). The share of construction services in total operating revenue for QSHIP has increased to 57% in H1 2008 from 44% in 2007. Deep sea transportation, which contributed more than two-third of QSHIP s total operating revenue in 2003, saw its contribution declining to 20% in H1 2008. The continuous decline in the revenue from deep sea transportation is due to the sale of ocean-going vessels by the company in Q1 2007 and Q2 2008. Figure 5: Operating revenue Segmental contribution 100% 75% 50% 25% 0% 2003 2004 2005 2006 2007 H1 2008 Deep sea transportation Offshore support services Construction services Source: QSHIP Financial Reports Offshore support services improving in profitability Improvement in offshore support services net margin helps QSHIP to maintain its net margin from operating segments The net margin in offshore support services has seen a significant improvement, reaching 51% in H1 2008 from 35% in 2007 (Figure 6). This has helped the company to maintain its net margin from operating segments despite the decreasing share of high margin deep sea transportation segment. Deep sea transportation had the net margin of 51% in H1 2008 and 57% in 2007. In comparison, the construction services segment operates at relatively lower net margins thereby affecting overall net margin for operating segments. However, the construction services net margins have improved recently, with the segment posting net margin of 16% in H1 2008 and 19% in 2007, compared to net margin of -21% in 2003. Figure 6: Operating segments net margins trend 75% 50% 25% 0% -25% 2003 2004 2005 2006 2007 H1 2008 Deep sea transportation Construction services Offshore support services Net margin for operating segments Source: QSHIP Financial Reports Kuwait Financial Centre Markaz 5
Valuation On a YTD basis, QSHIP stock has declined 41.5%, in-line with DSM 20 s decline of 37.9% (Figure 7). The LTM P/E of the company has declined from 10.6x at the end of 2007 to 6.4x currently on account of stock price decline. QSHIP has low liquidity with a turnover velocity of 15% in 2007 compared to an average of 32% for the Doha Stock Market. Our fair value P/E of 6.6x being in line with the current P/E leads us to believe that the company is fairly valued (Figure 8). The risk level of the stock is high as compared to the Qatari market as is shown in the Markaz Volatility Index (Figure 9). We expect QSHIP s net income to decline by 1% in 2008 owing to lower shipping rates and volatile investment income. Assuming the merger of QSHIP and QNAV to take effect from the beginning of 2009, we expect the merged entity s 2009 net income to grow by 20%, primarily driven by QNAV. On a stand alone basis, we expect QSHIP s 2009 net income to grow at lower rate of 5% due to lower shipping income and unstable investment income in the light of current financial market. With the continued strength on operational front, we expect QNAV to drive net income growth for the merged entity in 2009. Figure 7: Share price and Volume trend Figure 8: QSHIP P/E trend 160 100 Monthly Volume (RHS) DSM20 Rebased QSHIP Rebased 20 10 (mn shares) 16 12 8 QSHIP P/E LTM Fair Value P/E 6.60 40 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 0 4 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Source: Bloomberg Source: Bloomberg Figure 9: Markaz Volatility Index (November 2008) Source: Markaz Research Kuwait Financial Centre Markaz 6
Income statement (USD Mn) 2003 2004 2005 2006 2007 Operating revenue 106 140 209 244 231 Operating income 34 52 51 69 94 Investment gains/ (losses) 15 8 58 (12) 34 Net profit 52 61 115 126 171 Balance Sheet (USD Mn) 2003 2004 2005 2006 2007 Assets Loans to LNG Companies 85 103 113 119 126 Investments available for sale 104 173 1,222 429 808 Vessels, property and equipment 256 312 441 385 411 Total Assets 596 691 2,083 1,252 1,560 Liabilities and Equity Term loans 170 224 231 230 186 Total liabilities 252 312 306 311 265 Shareholders equity 344 379 1,778 942 1,295 Key Ratios 2003 2004 2005 2006 2007 ROA (%) 9.6% 9.5% 8.3% 7.6% 12.1% ROE (%) 15.7% 17.0% 10.6% 9.3% 15.3% Operating revenue growth (%) 47.6% 31.4% 49.6% 16.7% -5.5% Operating income growth (%) 153.3% 52.7% -2.5% 36.8% 35.9% Net profit growth (%) 132.0% 18.9% 87.2% 9.8% 35.5% P/E (LTM) 23.37x 35.92x 25.39x 13.19x 10.59x P/B (LFI) 3.50x 5.81x 1.64x 1.77x 1.40x DPS (USD) 0.26 0.30 0.00 1.11 1.12 EPS (USD) 0.54 0.65 1.04 1.15 1.55 Year end market price (QAR) 46.22 84.45 96.36 55.00 59.82 Book Value per share (QAR) 13.19 14.54 58.83 31.16 42.86 Annual Trading Volume (mn) 6 18 21 12 15 Annual Trading Value (USD mn) 118 584 765 237 256 Turnover Velocity 11% 34% 30% 10% 15% M Cap (USD mn) 1,205 2,201 2,912 1,662 1,808 Source: QSHIP Financial Reports, Bloomberg Kuwait Financial Centre Markaz 7
Markaz Research Process Markaz Expected Return & Risk Analyst Call On Projected Stock Return Markaz Volatility Index (MVX) Company in relation to Benchmark Identification of Positive/Negative Drivers to the stock price from its current level Business Analysis (Company broken down to various segments for in-depth analysis and identification of growth drivers) Management Meet (Optional, where ever interest is shown by both parties Markaz & Company Analyzed) Analyst Calls (Optional, where ever analyst tracking the company are available) Preliminary Model Building Journals providing forecasts on Industry (price of commodity forecasts/intere st rate forecasts/trend forecasts etc) Analyzing International & Macro economic trends impact the company Annual Report Screening Quantitative Simulations Indicative Growth Guidance Probable Extent of PE Expansion /PE Contraction Earnings Growth P/E Weight 25 50% Short Term Profile (Last four quarters average growth rate) Short Term Profile (Last 12 Month average PE) Weight 60% 10 25% Medium Term Profile (Last three years average growth rate) Medium Term Profile (Last 24 Month Average PE) 40% 25 50% Analyst Consensus estimates
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