Description

Overview

Jinhui Shipping & Transportation (“JIN”) is a dry-bulk ship owner and charterer based in Hong Kong. JIN is benefiting from a super-cycle in shipping and we believe it is currently trading at just 1.5-2x 2004 (and possibly 2005) earnings. The stock has run-up recently as this cycle has begun to hit; however, investors are just beginning to recognize the magnitude of the impact on earnings that this will have.

Background

Shipping is as fundamental a supply/demand business as you will find. On the demand side, China has been the principal driver as it has significantly increased imports of raw materials such as iron ore, scrap, and coal. Furthermore, as China’s demand for these raw materials has outpaced its neighbors’ ability to deliver them, China has been purchasing raw materials from further locations across the globe. This has had a two-fold impact on shipping. First – there is more material that needs to be shipped, and second, the shipping distances are longer. Dry bulk demand is forecasted to grow 6-7% in 2004.

On the supply-side, the soft bulk-shipping market of recent years and the hangover from the 1994 Asian financial crisis has limited investment. There simply are not enough ships available to meet demand. Asian port congestion has further compounded this, and has effectively reduced shipping supply by ~6-7%. Eventually, port capacity will be built-out, but there is not a near-term solution to this beyond marginal improvements in port logistics/processes.

It is relatively easy to see the new supply of dry-bulk ships that are coming into the market over the next few years, and it is very limited (4-5% growth before accounting for any scrapping of old ships). It takes 12-18 months to build a new large dry bulk ship, and yards are booked out through 2006 – largely with container and tanker orders.

The combination of these factors has led to a dramatic rise in shipping rates. The Baltic Dry Index (Bloomberg: BDIY) has risen from 2,000-2,500 over the first 9 months of 2003 to ~5,400 currently. (The BDI is the aggregate index that measures the cost of transporting dry cargo.) As we move into the spring grain season, it is likely that rates will be maintained. In fact, JIN management believes rates will continue to move higher. Some believe that what is occurring now in China is analogous to post WWII Europe/Japan or the industrialization of the U.S. We believe we will see super-cycle prices for 2004/2005, before returning down to a more normalized level as supply begins to enter the marketplace in 2006 and 2007.

Company Description

JIN owns 10 dry-bulk ships with an average age of 7 years, and has long-term charters on 12 additional ships that roll-off between 2005 and 2010 (1 in 2005, 2 in 2006, and the balance between 2007-10). JIN was fortunate/astute to lock up these charters at low long-term rates and will now benefit significantly from them.

JIN is a tramp shipper, and takes voyages contract-to-contract vs. liners, which travel fixed routes. Tramp shippers are especially benefiting from the tight market, as they can take bids for wherever demand is greatest. JIN has 3 Handymax, 10 SuperHM, 8 Panamax, and 1 Capesize ship. Its fleet is skewed towards the large size, and thus benefits from long cycle goods such as iron ore vs. short-cycle goods such as grain.

JIN trades on the Oslo exchange under JIN NO, but reports on a quarterly basis in USD. Jinui Holdings (137 HK) owns 51% of JIN, and is 58% owned by the founding Ng family. Jinhui Holding’s largest asset is its stake in JIN. The company was founded in 1987, Jinhui Holdings has been publicly traded since 1991, and JIN was carved out as a public company in 1994.

Earnings model

In late 2003, even as shipping rates increased, the majority of JIN’s ships were on long-term contracts that locked in lower rates. Thus, JIN only saw a limited pick-up in profitability. JIN entered 2004 with ~65-70% of its ships off of long-term contracts, and thus exposed to short-term/spot pricing. By 2H of 2004, this ratio increases to 90%.

The simplest way to understand the economics of the business is to look at it on a unit basis. In 2003, a Panamax ship that costs $7k to operate might have yielded $10k/day. At current spot rates, a Panamax can fetch $50k – but the operating cost is essentially unchanged. Operating profit is increased from $3k/day to $43k/day. Run for 355 days, this translates to an annual profit increase from $1.1MM to $15.3MM.

When we extend this model to JIN’s fleet of 22 ships and account for the two ships that are on long-term contracts (and thus unable to benefit from today’s spot rates) we get to ~$330MM USD revenue, translating to EPS of $2.25, or 15.75kr. At 19.1kr ($2.73), the stock currently trades for 1.2x these earnings. Note: these earnings are taxed – but the effective tax rate for JIN (and many other shippers) is only ~3%.

In actuality, we believe that management will lock-in long-term (1-2 yr) rates for a large percentage of its fleet later this year, as ship demand continues to rise during the grain-season this spring. In doing this, management will “take some money off the table”, and provide visibility to its earnings through 2005. These contracts will be done at a discount to spot-rates, so we expect that actual EPS in 2004 will be in the range of $1.40-1.80 or 9.80-12.60kr. This puts JIN at ~1.5-2x earnings that should remain at similar levels in 2005.

Valuation

Comparable dry-bulk shipping companies, such as Precious Shipping (PSL) and Thoresen Thai (TTA), trade at significantly higher multiples (6-7x 2004). Larger bulk shippers such as China Shipping and U-Ming Marine trade for multiples in the range of 10-15x. We believe JIN should trade for at least 5x 2004 earnings, or in excess of 50-65kr.

Another data point we like to look at is Enterprise Value/tonnage. This provides a sense of the earnings capacity of bulk shippers irregardless of their contracting decisions. On this metric, JIN is also valued at dramatically below market. With 517k owned tons and applying a 35% discount to the 867k tons on LT charters, JIN has 1,081k tons. With an Enterprise Value (including net debt of $76MM) of $345MM, JIN trades for $319/ton. Compare to PSL, JIN’s cheapest comp, which has a ratio of $752/ton. The average age of 7 yrs for JIN’s owned ships also compares favorably with PSL’s of 16.

This metric also provides a good measure that can be compared to what ships are currently being sold at. JIN just purchased a 55k ton ship for delivery in 2005 for $35MM (note: this ship was purchased from a group that had a claim on the ship – shipbuilders are not able to take new orders for 2005 delivery.) Thus, this ship was purchased for $636/ton – a significant premium to JIN’s EV/ton ratio. Given that the Ng family owns ~30% of JIN, and is highly incented to make value-creating deals, this purchase speaks volumes about their view of the market.

Finally, management has indicated that they intend to return a significant percentage of earnings to shareholders through special dividends this year (mid-year and EOY). We believe this will further highlight the value of this investment.

Catalyst

1. Company will generate massive earnings beginning in Q1
2. Management will be visiting the U.S. after Q1
3. Company plans to pay special dividends this year (~June and EOY), distributing a significant percentage of excess earnings to shareholders
4. Major investment banks/research houses are beginning to focus on shipping opportunities
5. Growing awareness by investors that the company can generate cumulative earnings of $3+ through 2005 and is trading at $2.73