November 23, 2011

Neptune Orient Lines (NOL SP)

COMPANY INSIGHTS

Target price
Current price Bloomberg code

S$1.50 (+46%)
S$1.03
NOL SP

Transforming its business base

NOLs re-fleeting should really move the cost needle

Timothy Ross Analyst timothy.ross@samsungfn.com +852 3411 3770 Davin Chunpong Wu Analyst davin.wu@samsungfn.com +852 3411 3781

Source: Company data

We initiate coverage of Neptune Orient Lines (NOL) with a BUY rating and S$1.50 target price, based on 1x P/B. We believe NOL will be one of the names most positively affected by the short-term change in sentiment towards the liner sector, which we expect to begin early next year as capacity exits the system, due to its liquidity, profile, and link to the Singaporean government. At the top line, NOL has increased its exposure to the growing intra-Asian trade lanes, although it still generates more than 50% of revenue from Transpacific routes. Thus, the company should benefit from any pop in rates resulting from upcoming capacity constraints, for which we see mounting evidence. Longer term, we estimate that its fleet replacement program and the capacity flexibility that it retains over the next three years (through the ability to redeliver many of its chartered-in vessels) should drive its unit cost base down by around 15%. Supplementing the anticipated return to profitability of its liner business, NOLs logistics operations should expand the 15% share of group revenue that it currently contributes and enjoy margin expansion as 2011s growthrelated investments in the business platform bear fruit.
SUMMARY FINANCIAL DATA 12-09 6,516 -741 -0.36 nm -5.7 -28.2 nm 1.08 -9.6 0.00 21.36 12-10 9,422 447 0.17 nm 8.9 15.3 8.5 1.36 5.7 2.30 11.70 12-11E 9,380 -313 -0.12 nm 0.6 -9.9 nm 0.70 69.8 0.00 59.42 12-12E 10,054 -64 -0.02 79.6 3.3 -2.2 nm 0.72 13.6 0.00 86.66 12-13E 11,470 584 0.23 nm 9.7 18.6 3.5 0.59 3.8 4.55 65.71

SAMSUNG vs THE STREET

Reemerging even stronger

No. of I/B/E/S estimates Target price vs I/B/E/S mean Estimates up/down (4 weeks) 1yr fwd EPS vs I/B/E/S mean Estimates up/down (4 weeks) I/B/E/S recommendation 22 +68% 0/13 -1% 1/13 Uprf (3.70)

NOLs combination of business base, balance sheet strength, and state sponsorship should ensure its survival in the current industry downturn. We believe, however, that strategic initiatives in its business mix and fleet replacement will see it strengthen its market position as normality returns. Our earnings estimates are broadly in line with the markets this year and next, but we expect a more robust rebound in 2013 as its transformation pays off. Shipping companies are not long-term buys and holds, but we view the current price as an opportunity to build a position at a low entry price.

Revenue (US$ m) Net profit (adj) (US$ m) EPS (adj) (US$) EPS (adj) growth (%) EBITDA margin (%) ROE (%) P/E (adj) (x) P/B (x) EV/EBITDA (x) Dividend yield (%) Net debt to equity (%)

Source: Company data, Samsung Securities estimates

This report has been prepared by Samsung Securities (Asia) Limited. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 11

Neptune Orient Lines

THE PITCH
RETURN FORECAST

Neptune Orient Lines (NOL) ticks all the boxes that we are looking for: an intra-Asian service skew, a conservatively managed balance sheet, sound corporate governance, and a commitment to lowering its cost base. We believe that it will emerge from the current industry downturn in better shape and could play a part in industry consolidation. We initiate coverage of NOL at BUY and S$1.50 target price.

FUNDAMENTALS
VALUATION 12-11E nm 0.7 69.8 0.00 -9.9 12-12E nm 0.7 13.6 0.00 -2.2 12-13E 3.5 0.6 3.8 4.55 18.6

Cost-base reduction: We see unit costs (opex/TEU) falling 15% over the
next three years as new vessels with more compelling operational economics enter the fleet. Primarily these last are driven by scale economies and more fuel-efficient engines.

P/E (adj) (x) P/B (x) EV/EBITDA (x) Dividend yield (%) ROE (%)

Extending its competitive advantage: Access to capital at low financing

costs is a crucial advantage that NOL has on account of its current scale, past performance, and prevailing GLC-sponsorship. This allows the company to reshape its fleet at much lower capital and operational costs/slot at a time when its smaller competitors are expected to be creditconstrained.

SAMSUNG vs THE STREET Samsung Target Price EPS 12-11E EPS 12-12E EPS 12-13E Buy/Hold/Sell AT A GLANCE Business summary NOL is a major container shipping company, operating a fleet of about 600,000 TEUs with an order book that could see this grow by 50% to 2014. It also features a growing logistics business and nine shared and captive container terminals in the US and Asia. Sector Transportation NOL SP Bloomberg code Market cap Shares out (float) 52-week high/low ADT (3M) Price performance Neptune Orient Lines Straits Times Index 1M -5% +0% US$2,675m 2.58bn (32%) S$2.38/1.00 US$12.54m 6M 12M -45% -14% -53% -15% S$1.50 US$-0.12 US$-0.02 US$0.23 Buy Street S$0.89 US$-0.09 US$-0.03 US$0.05 Uprf (3.70)

Deleveraging: Debt is expected to top out at about US$5bn in 2012, in line

with the timing of peak deliveries. Net debt-to-total capital will hit about 66% in 2011, but should fall rapidly for the following two years, allowing dividend payments to resume.

Robust logistics contributions continue: Double-digit revenue growth is

anticipated at the logistics division, along with margin expansion over the next 12 months. While we consider that this will be insufficient to offset the liner divisions losses, we believe the logistics business is an important creator of value for NOL stakeholders. VALUATION

Reversion to the mean expected by 2013: Our profit forecasts suggest

that NOL should trade in excess of book value by 2013 and at book value over the next 12 months.

Break-up value takes this even higher: Were the business to be

disaggregated and sold, we believe that its value/share would be even greater than P/B suggests. We initiate coverage on NOL with a 12-month target price of S$1.50. BEAR VIEWS & BLUE SKIES

In our bear case, the wheels fall off global trade, there is no slippage in
delivery, and industry participants continue to operate all capacity at below breakeven rates. Assuming the same sets of margins and trough P/B as we saw three years ago, we could see as much as 43% downside in the stock from here, with a bearish target price of S$0.60.

A more benign outlook assumes that industry participants adopt capacity

restraint voluntarily and on a more sustainable basis than the short-term trade that we are suggesting will occur. This would imply that NOLs blended rates rise to about US$1,382/TEU, which would still remain short of 2010s US$1,394 average and well short of historical peak levels in the mid-US$1,500s. This could see NOLs EBIT margins recover to around 6% in 2012, and the sorts of P/B multiples emerge that NOL traded at in 20052006, or around 1.4x equivalent to a target price of S$1.95.

THREE NUMBERS THAT MATTER

Turn in transpacific freight rates

Dec 2011

Intra-Asian freight rates

Mid-Feb 2012

1Q12 idle capacity

1Q12

>US$1,600/FEU
Sustaining this level would mean a better rate environment into 1Q12 than the previous two quarters. About 50% of NOLs revenue is derived from trades to the Americas.

<10% YOY reduction

Asian trades have been NOLs fastest-growing segment, but rate declines have limited revenue growth. We expect this to have moderated in 4Q11.

Up to 10% of fleet
Our thesis is built on all carriers taking capacity out faster than expectedNOL should be no exception as the weak first quarter provides the catalyst.

November 23, 2011

Neptune Orient Lines (NOL SP)

Figure 1: Summary Financials
12-08 Profit & loss (US$ m) Revenue Gross profit EBITDA EBIT Net interest income / (expense) Net other pre-tax income Pre-tax profit Income tax Minority interests Net other post-tax income Net profit, FD Normalised net profit, FD EPS (as reported, FD) (US$) EPS (normalised, FD) (US$) EPS growth (%) DPS (US$) Balance sheet (US$ m) Net tangible fixed assets Net intangible assets Net working capital Inventories Accounts receivable Accounts payable Net other NWC assets Invested Capital Net other assets Capital employed Net debt / (cash) Total equity BVPS (US$) Cash flow (US$ m) Operating cash flow Net capex Free cash flow (FCF) Divestments / (investments) Other investing cash flows Dividends paid Share issuance / (buyback) Other financing cash flows Increase / (decrease) in cash FCF per share (US$) DuPont analysis Revenue growth (%) a) Tax burden (x) b) Interest burden (x) c) Depreciation burden (x) d) EBITDA margin (%) e) Asset turnover (x) f) Financial leverage (x) g) ROCE (%) (c x d x e) ROE (%) (a x b x f x g) Valuation & key indicators P/E (x) (norm, FD) P/B (x) FCF / EV (%) Dividend yield (%) EV/EBITDA (x) EV/Capital employed (x) Net debt to equity (%) Net interest cover (x) Source: Company data, Samsung Securities estimates 9,285 493 493 230 -22 -71 137 -49 -5 0 83 153 0.06 0.10 -70.8 0.06 12-09 6,516 -373 -373 -659 -52 11 -700 -39 -2 0 -741 -741 -0.36 -0.36 nm 0.00 12-10 9,422 834 834 557 -56 29 530 -66 -3 0 461 447 0.18 0.17 nm 0.03 12-11E 9,380 54 54 -226 -50 11 -265 -40 2 0 -303 -313 -0.12 -0.12 nm 0.00 12-12E 10,054 331 331 -34 -51 12 -73 7 2 0 -64 -64 -0.02 -0.02 79.6 0.00 12-13E 11,470 1,113 1,113 694 -61 14 647 -65 2 0 584 584 0.23 0.23 nm 0.04

3,652 0 2,530 159 721 -163 1,812 6,181 4,492 1,689 815 2,461 1.67

3,518 0 2,508 197 738 -242 1,815 6,027 3,793 2,233 607 2,797 1.08

3,706 0 3,020 244 1,082 -1,174 2,869 6,726 3,842 2,884 382 3,222 1.25

4,609 0 3,400 375 1,219 -1,285 3,091 8,010 6,808 1,201 1,759 2,917 1.13

5,445 0 3,388 302 1,207 -1,359 3,238 8,832 8,446 387 2,510 2,853 1.10

5,676 0 3,696 344 1,376 -1,455 3,431 9,372 8,179 1,194 2,287 3,438 1.33

499 -830 -380 0 -15 -151 1 418 -75 -0.26

-551 -62 -640 0 -11 -39 958 -391 -96 -0.31

693 -445 222 0 -5 0 1 400 644 0.09

-191 -1,184 -1,383 0 0 -2 0 754 -623 -0.54

449 -1,200 -751 0 0 0 0 793 42 -0.29

873 -650 223 0 0 0 0 67 290 0.09

13.8 0.61 0.60 0.47 5.3 1.78 2.04 4.4 3.2

-29.8 1.06 1.06 1.77 -5.7 1.21 2.05 -12.2 -28.2

44.6 0.87 0.95 0.67 8.9 1.60 1.96 9.4 15.3

-0.4 1.14 1.17 -4.21 0.6 1.39 2.19 -3.4 -9.9

7.2 0.87 2.17 -0.10 3.3 1.36 2.57 -0.5 -2.2

14.1 0.90 0.93 0.62 9.7 1.40 2.60 8.5 18.6

16.23 0.42 -20.12 3.37 3.83 1.12 32.56 10.54

nm 1.08 -17.82 0.00 -9.61 1.61 21.36 nm

8.51 1.36 4.69 2.30 5.68 1.64 11.70 9.95

nm 0.70 -36.82 0.00 69.79 3.13 59.42 nm

nm 0.72 -16.71 0.00 13.58 11.63 86.66 nm

3.49 0.59 5.23 4.55 3.83 3.57 65.71 11.36

November 23, 2011

Neptune Orient Lines (NOL SP)

Business Fundamentals

Future-proofing the cost base

In our view, NOL has one of the more appealing sets of fundamentals of any of our coverage universe. The company is leveraging its combination of sponsor strength, business mix, financial stewardship, and competitive positioning to improve its cost structureaiming to emerge from the current industry downturn in an even more dominant position. Balance sheet and access to capital We believe that access to capital will be one of the defining features of the next two years in the liner industry. With most trade lanes generating losses and order books requiring significant progress payments, relationships with external capital providers and the cost of this capital should create a key competitive advantage. On account of its own strong balance sheet and its relationship with Singaporean sovereign wealth fund, Temasek, we consider that NOL will be able to finance its growth profile and should be able to do this at advantageous rates (only Taiwanese carriers currently pay less over Libor than NOL to finance vessel acquisitions).
Figure 2: NOLs fleet development 1,000 900 800 700 600 500 400 300 200 100 2004 2006 2008 Fleet size (TEU, 000s) 2010 30% 25% 20% 15% 10% 5% 1,000 0% -5% -10% 2012 2014 Fleet growth (YoY % ch (1,000) 2006 2008 2010 2012E 2014E Net debt, US$m (Left) Figure 3: NOLs balance sheet structure 6,000 5,000 4,000 3,000 2,000 70% 60% 50% 40% 30% 20% 10% 0% -10% Net debt: total capital (Right)

Source: Company data, Samsung Securities estimates

Source: Company data, Samsung Securities estimates

Net debt-to-total capital is expected to peak at around 66% next year as net debt hits about US$5bn. This reflects the companys investment in fleet expansion, which will see operated slots almost double in the five years between 2009 and 2014, assuming lease capacity is rolled over as it comes off hire. NOL now charters in about 70% of its vessels, but is moving towards a greater proportion of self-owned vesselsparticularly amongst the larger-sized varietiesin an effort to lower costs and increase efficiency.

November 23, 2011

Neptune Orient Lines (NOL SP)

We estimate that the company can return up to 40% of its fleet to its financial owners between now and 2014, permitting significant fleet flexibility and capacity to replace expensive chartered in tonnage with cheaper balance-sheet financed newbuilds. New vessel deliveries, debt, and net debt-to-total capital are all expected to peak in 2012, before declining sharply over the next two years. Cost-base transformation The change in fleet structure is the key to a permanent shift in NOLs cost base. Its order book is concentrated around the larger vessels that offer significant cost advantages already touched on in our note. Employing these vessels at a lower ownership cost than the leased-in capacity that they will either replace or supplement is key to the 15% reduction in NOLs unit operating costs over the next three years.
Figure 4: NOL EBIT (US$m) vs. margin (%) 2,000 1,500 15% 10% Figure 5: NOL operating cost/TEU (US$) 1,700 1,600 1,500 1,400 1,300 1,200 (500) (1,000) 2006 2008 2010 2012E 2014E -10% 1,100 -15% 1,000 2006 2008 2010 2012E 2014E

1,000
500 -

5%
0% -5%

EBIT, US$m (Left)

EBIT Margin % (Right)

Source: Company data, Samsung Securities estimates

Source: Company data, Samsung Securities estimates

This cost reduction is key to NOLs margin recovery from negative territory this year and to break even similar to levels last seen in 2006 by 2013. Without NOLs track record and financial firepower to order and operate these classes of tonnage, its competitive position would be expected to erode, as any real control of its revenue line (as is the case for the rest of the industry) would prove to be illusory. Forecast assumptions Our earnings targets are built around what we view as very modest assumptions with respect to changes in bunker price, with most of the gains made in efficiency, lower rental costs, and reduced SG&A per box. On the revenue side, we expect load factors to remain in the low 90s and that some rate stability returns to transpacific and intra-Asian routes over the next two years, primarily as a consequence of capacity reduction on the former and sustained demand growth in the latter trades. Transpacific volumes will likely dip in line with Americas continued-muted recovery, but volume growth is anticipated elsewhere and aggregate load factors should get back to near-record levels by 2014. We do expect further weakness in European rates in 2012 as the influence of the larger vessel deliveries likely that year is felt, with little upside for the subsequent two years.

November 23, 2011

Neptune Orient Lines (NOL SP)

Figure 6: NOLs key revenue drivers Volumes by route (TEU, 000s) Americas Europe Asia / Middle East Rates (US$/TEU) Americas Europe Asia / Middle East Load factor (%) Bunker price (US$/ton) 1,707 1,248 850 97% 309 1,668 1,424 939 97% 358 1,933 1,564 984 90% 528 1,592 1,095 710 90% 354 1,888 1,571 816 94% 464 1,898 1,299 717 93% 646 1,936 1,234 717 92% 630 1,955 1,234 738 94% 600 1,975 1,234 775 96% 600 2006 1,790 1,068 1,336 2007 2,028 1,120 1,568 2008 2,048 1,178 1,704 2009 1,830 954 1,794 2010 2,216 1,184 2,262 2011E 2,087 1,291 2,695 2012E 2,191 1,355 3,180 2013E 2,520 1,491 3,657 2014E 2,898 1,640 4,096

Source: Company data, Samsung Securities estimates

Logistics business a diamond in the rough Having struggled through the 2008 downturn (more on its lack of perceived fashionability as an asset-intensive operator than on its lack of profitability), the logistics business is now becoming an area of growth for NOL.
Figure 7: NOL logistics earnings profile 100 90 80 70 60 50 40 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0%

EBIT (US$m)
Source: Company data, Samsung Securities estimates

EBIT Margin (%)

This improvement has been built around the success of its largely land-based warehousing and intermodal businesses in the US, where retail and auto verticals have experienced significant top-line growth. Margins in 2011 are expected to have been muted by expansion-related expenses (such as IT) that are necessary to allow the business to scale up as revenue expands. We anticipate that EBIT margins will rise to above 5% over the next three years on a top-line CAGR of >8% through to 2014.

November 23, 2011

Neptune Orient Lines (NOL SP)

Valuation

Rising returns should push multiples higher

With positive earnings unlikely to be reported this year and next, we are compelled to look at asset-based valuation methodologies, with price-to-book chief amongst these. At its current 0.8x, NOL is trading at almost one standard deviation below its longterm mean forward P/B of just over 1x. While above the 0.35x P/B recorded in Mar 2009, it is almost a full multiple down from its Jan 2011 highs.
Figure 8: NOLs rolling P/B trading range 3.0x 2.5x 2.0x + 1 SD 1.5x Mean Figure 9: NOLs rolling P/B vs ROE 3.0x 2.5x 2.0x 100% 80% 60% 40%

1.5x
1.0x -1 SD 0.5x 0.0x 1996 1999 2002 2005 2008 2011 1996 1999 2002 2005 2008 2011 2014 Rolling PB (Left) ROE (Right)

20%
0% -20%

1.0x
0.5x 0.0x

-40% -60%

Source: Company data, Bloomberg, Samsung Securities estimates

Source: Company data, Bloomberg, Samsung Securities estimates

As with most highly operationally geared, capital-intensive businesses, there is a strong coincident relationship between valuations and returns, with the latter generally leading the former. We expect NOLs ROE to rally from the current years -9.4% to over 20% in 2013. Looking at history, this suggests that NOL should trade at a P/B of around 1x, equivalent to a target price of S$1.40. A figure of this magnitude is corroborated by a break-up analysis valuing the company at S$1.63/share. This assumes all chartered fleet is returned, owned vessels are divested at prevailing market values, along with containers and the logistics business, and that net balance sheet debt is repaid. The terminal assets are also taken into account, although 90% of its throughput is NOL- or alliance partner-based, so their value is likely at the lower end of the comparable company spectrum. We have also adjusted the resulting valuation for a 20% haircut to represent the potential bid-offer spread required to divest such a portfolio of assets at any one time.

November 23, 2011

Neptune Orient Lines (NOL SP)

Figure 10: NOL break-up valuation Asset Owned fleet Owned containers Terminals Logistics operations less: Net debt Equity value Adjusted equity value Equity value/share US$m US$m US$m US$m US$m US$m US$m S$ Value 3,340 938 900 750 -1,759 4,169 3,335 1.63 Comment Average age of 6.3 years and US$/TEU of US$8,150 670k boxes, average age of 5 years,10-year useful life, new box cost of US$2,800 2009A EBITDA adjusted for subsequent liner sales & multiple of 12x 2012E NPAT of US$75m, P/E of 10x Year-end estimate for 2011

A 20% haircut for liquidity impact 2.583bn shares outstanding; 1.26 SG$:US$

Source: Clarksons, company data, Samsung Securities estimates

We have used a simple average of the two approaches to derive our target price of S$1.50.

November 23, 2011

Neptune Orient Lines (NOL SP)

Bear Views & Blue Skies

Favourable risk-reward balance

All of the companies in the sector have similar key drivers. Bear views centre on all the capacity that is ordered showing up on time, coupled with a slump in consumption and a further leg-up in the price of bunker fuel (although these last two drivers would typically move together). A bull case would emerge if even more supply than anticipated is idled, scrapped or cancelled, with rates ramping up as a consequence. Bear caseearly 2009, dj vu all over againtarget price at S$0.60 The wheels fall off global trade, there is no slippage in delivery, and industry participants continue to operate all capacity at below breakeven rates. We saw this three years ago and there is no reason to suggest that pessimistic scenarios would not be repriced into the stock if these factors were to play out against a backdrop of global economic downturn. Assuming the same sets of margins and trough P/Bs, we could see as much as 43% downside in the stock from here, with a bearish target price of S$0.60. Blue skies casereality bitestarget price at S$1.95 While our central view is based on some form of industry discipline being forced upon the liner segments participants, a more benign outlook assumes that they adopt these measures voluntarily and on a more sustainable basis than the short-term trade that we are suggesting will occur. This would imply that NOLs blended rates rise to about US$1,382/TEU, which would still remain short of 2010s US$1,394 average and well short of historical peak levels in the mid-US$1,500s. This could see industry EBIT margins recover to around 8% in 2012, NOLs to be a couple of percentage points lower, and the sorts of P/B multiples would emerge at which NOL traded in 2005-2006, or around 1.4x, equivalent to a bullish target price of S$1.95.

November 23, 2011

Neptune Orient Lines (NOL SP)

AppendixCompany background
Leading player in transpacific and ASEAN markets Neptune Orient Lines (NOL) is the worlds seventh-largest liner company and is the largest in its Singapore home market. NOL operates a container shipping and logistics business through its key brandsAPL and APL Logistics. APL operates a fleet of 145 vessels (598,577 TEU), of which, 98 vessels (or ~70% of TEU total capacity) are chartered-in. It is a leading player in the transpacific market, with a 9% market share in 2010 and which accounts for more than half of its revenue. In recent years, APL has been expanding its presence in the intra-Asian markets, which now account for 40% of its container volumes.
Figure 11: Revenue breakdown by trade routes (2011E) Figure 12: Volume breakdown by trade lane (2011E)

Intra-Asia 23% Intra-Asia 40% Transpacific 53% Asia-Europe 24%

Transpacific 39%

Asia-Europe 21%

Source: Company data, Samsung Securities estimates

Source: Company data, Samsung Securities estimates

Listed on the Singapore Stock Exchange in 1981, NOL is controlled by Temasek Holdingsthe investment arm of the Singapore government, which owns a 67% stake in the company. Ng Yat Chung has taken over the role of Group President and CEO; before joining NOL, Mr Ng served as a senior executive in Temasek and has been the Chief of the Defense Force for Singapore.
Figure 13: Global top-ten container shipping lines Rank 1 2 3 4 5 6 7 8 9 10 Operator APM-Maersk Mediterranean Shg Co CMA CGM Group COSCO Container L. Hapag-Lloyd Evergreen Line APL CSCL Hanjin Shipping MOL TEU 2,472,899 2,029,758 1,350,232 650,867 622,490 608,056 582,560 509,798 489,381 435,565 Ships 647 472 403 147 143 166 143 146 103 103

Source: Alphaliner

10

November 23, 2011

Neptune Orient Lines (NOL SP)

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Analyst certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of such analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research report. The analyst(s) principally responsible for the preparation of this research report receives compensation based on determination by research management and senior management (not including investment banking), based on the overall revenues, including investment banking revenues of Samsung Securities Co., Ltd. and its related entities and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. Samsung Securities Ratings Structure Samsung Securities uses the following investment ratings Company BUY BUY HOLD SELL SELL

Expected to increase in value by 30% or more within 12 months and is highly attractive within sector Expected to increase in value by 10% or more within 12 months Expected to increase/decrease in value by less than 10% within 12 months Expected to decrease in value by 10% or more within 12 months Expected to decrease in value by 30% or more within 12 months

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