Severe losses ahead for NOL in FY11

NOL underperformed the market by 27% over the past year on concerns over free falling freight rates, overcapacity in the container shipping industry and more recently, a weakening economic outlook. However, we believe that current valuations for the stock had already priced in a recession scenario (even though we may not necessarily be in one) and could see limited downside, unless the global economy dips into a prolonged downturn.

While the stock price is still some way off the doomsday valuation troughs of 0.3-0.4X BVPS, we believe that accumulating the stock on the dip could prove to be a good strategy as we may not reach trough valuations hit during GFC. NOL could also be a surprising outperformer to the index should the broader market de-rate to recession valuations, which the stock already did.

A recession looming?
If US & Euro area slips into a full fledged recession, global trade volumes would collapse and the ongoing oversupply in the container shipping industry could lead to significant losses for container shipping lines like NOL. While we had factored in full year losses for the company with the current lackluster freight rates, a decline in trade volumes during recessions would have downside risks to our forecasts. In particular, our FY12E numbers are built on the premise that major demand centres in US & the Euro area does not enter a deep and prolonged recession. Latest PMI figures showed that the US and China remains in expansion territory, while the Eurozone contracted in Aug and Sep for the first time since the GFC.

More pain ahead in the near term
We revised our earnings forecasts southwards and expect more severe losses in FY11E and
expect only marginal profits for FY12E. Our downwards revision for FY11E is due to lower than expected freight rates for P7 to P8, which we had earlier expected to reflect uplifts from surcharges. FY12E is lowered on downward revisions to our volume assumptions on weaker
economic outlook and trade flow expectations.

Valuation
We value NOL based on a P/B value methodology, from the regression of our forward ROAE
forecasts with its historical values. We derive our target price of S$1.40 based on 0.92X FY11/12e blended BVPS of US$1.15 and translating it at an exchange rate of 1.32SGD/USD. We do not expect any dividend to be paid out over the next 12months based on our forecast of a full year loss for NOL. Hence, we see upside of 31% to our target price and upgrade our recommendation to Buy.