Here’s Why The Cheap-Looking Cosco Corporation (Singapore) Limited May Not Be a Bargain After All

Shares which are selling for lower than their net tangible assets are often thought of as potential bargains in the market.

On that basis, the China-based ship building and repair outfit Cosco Corporation (Singapore) Limited (SGX: F83) would qualify to be a bargain share too; at the moment, the company has tangible shareholder’s equity (another name for net tangible assets) of S$1.37 billion and a market capitalisation just north of S$1.11 billion.

But, a closer look beneath the hood suggests that bargain hunters may want to approach the share with caution.

Collapsing fundamentals

Over the past three years from 2012 to 2014, Cosco has seen its balance sheet deteriorate, judging from how its debt has grown significantly (some two-thirds higher!) while cash has remained relatively stagnant.

In addition, the ability to generate cash flow has been elusive for Cosco over the same period, seeing as how its operating cash flow has been negative throughout.

Cosco's financials

Source: S&P Capital IQ

Cosco’s growing leverage and recent inability to produce cash from its business does not exactly lend confidence to its future prospects. That’s especially so given the possibility of interest rates rising in the future. (On a related side-note, the phenomenon of rising rates has already taken hold in Singapore.)

Delaying customers

To add fuel to the fire, Cosco announced yesterday that a customer had asked to delay the delivery of two jack-up rigs by nine months.

These rigs are meant to drill for oil and it appears that the sharp decline in the price of oil that has occurred since the second half of 2014 has affected that particular customer of Cosco.

While this episode may just be an isolated incident, dark clouds do seem to be gathering on the horizon for Cosco. As The Business Times reported earlier today on the company’s Wednesday announcement:

“DBS Vickers analyst Ho Pei Hwa said [in a research note] that more contract deferments and cancellations are likely to hit Chinese offshore firms since most of their orders for newbuild rigs are from speculators who “do not have charter contracts on hand”.

“The speculators are now lowering their expectations in an attempt to dispose the rigs under construction. If attempts fail, we believe they may forgo the 5 per cent deposit and walk away from the contract. This will then trigger another round of asset deflation as the yards would be under tremendous pressure to recoup their construction cost,” she said.

A Fool’s take

None of all the above of is meant to say that Cosco would definitely be a poor investment from this point on – there are still many issues to consider before any investing decision can be made.

But given what we’ve seen with Cosco – its high and increasing leverage; its negative operating cash flows; and the phenomenon of customers starting to delay the deliveries of their orders – I’d like to reiterate that bargain hunters may want to proceed with caution with this superficially cheap share and be cognizant of the risks involved.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.