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Bargain Hunters Beware: Stormy Seas May Be Ahead For This Cheap Share

At its current price of S$0.53, the China-based rig- and ship-builder Cosco Corporation (Singapore) Limited (SGX: F83) can be said to be cheap given that it’s selling for just 0.84 times its latest book value per share (total assets minus total liabilities) of S$0.63.

For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a price-to-book ratio of 1.32 at the moment.

But, bargain hunters who might be interested in the share may want to be aware that stormy seas may be ahead for Cosco.

What lies ahead

At the start of April this year, Cosco was even cheaper, being valued at only 0.8 times its net tangible assets. I had written an article about it, but also cautioned that investors might want to tread carefully with the company.

The reason for doing so was centered on three reeds: 1) In the three years from 2012 to 2014, Cosco’s leverage was high and growing; 2) it had produced negative operating cash flows in each year for the same three year period; and 3) one of Cosco’s customers had asked, at the start of April, for a nine month delay for the delivery of two jack-up rigs which are used to drill for oil.

On the third point, I also wrote in my earlier article that there was a possibility that more delays or even cancellation of orders could be in the cards for Chinese rig-builders. Here’s what I had quoted earlier from the Business Times:

“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.”

While one request for a delay may be an isolated incident, investors might want to start keeping a close eye on Cosco’s order book for its offshore marine segment given that the firm announced earlier today that another of its customers had requested for an extension to the delivery dates of two Platform Supply Vessels (PSVs) to 30 June 2016. The vessels were originally scheduled for delivery in early 2014.

Platform Supply Vessels are generally used to provide support services to offshore oil platforms. Given the dramatic decline in the price of oil which started late last year (oil prices are currently around 40% of where they were at their 2014-peak), it’s not unreasonable to think that Cosco’s customers in the oil & gas industry are feeling the pinch. This can be a dangerous situation for Cosco.

How more pain can develop

As I mentioned above, Cosco’s leverage was high and growing over the past few years. Its latest fiscal first-quarter earnings (for the three months ended 31 March 2015), released on 30 April 2015, revealed that the firm had taken on even more debt when compared to end-2014. You can see this in the chart below:

Cosco's balance sheet figures

Source: S&P Capital IQ

Requests from customers for delivery-delays can cause cash flow problems for Cosco and the more delays there are, the more severe the issues can be. Growing leverage and cash flow issues can make for a very combustible and painful mix.

To compound the problem, Cosco has generated negative operating cash flow in each year from 2012 to 2014 (something which I wrote about in my earlier article too). While there was a slight improvement in the first-quarter of 2015 – Cosco’s operating cash flow had improved from –S$546 million a year ago to –S$101 million – the inability to produce cash is still a big worrying sign.

A Fool’s take

In Cosco’s latest first-quarter earnings release, the firm also painted a difficult picture for its shipbuilding business:

“Due to new tonnage accumulation in the past years and overall weak macroeconomic conditions, any possible market recovery in the dry bulk shipping segment will be a slow process fraught with uncertainty. [Cosco] will continue to face pressure in ship building which may lead to excess shipyard capacity.”

Given what we’ve seen with Cosco at the moment – tough business conditions for both its ship-building and offshore marine segments; high leverage that’s still growing; and an inability to produce positive cash flows – bargain hunters who might be attracted to its low valuation might want to brace for the possibility that more pain could be in the horizon for the firm’s business as it navigates stormy waters.

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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.