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Stay away from Chinese shipbuilders - Irregularities Findings

According to a report by CIMB Securities:

Offshore Marine and Chinese Shipbuilders

What happened: News emerged on irregularities findings in 2009 financial statements of 17 Chinese SOEs including CNOOC. CHALCO, COSCO and China Unicom. 1.9bn RMB (US$292m) of assets and 2.63bn RMB (US$404m) of profits were found overstated while 3.43bn RMB (US$527m) of liabilities were falsely included. Some other profits, assets and liabilities were unaccounted.

What we think: Share prices for the Chinese shipbuilders (Cosco and YZJ) have already reacted negatively to the news with both stocks down 3% this morning. Cosco being an SOE, with repeated provisions made over the past year and lack of accounting treatment transparency could face further sell-down with this news. YZJ's >RMB10bn of financial assets may be seen as risky by investors given the reduced confidence in the 'accuracy' of Chinese financial statements.

What you should do: Stay away from Chinese shipbuilders for now given the negative sentiments. We maintain our NEUTRAL view on both stocks given the (i) execution risk in Cosco and (ii) concerns of chunky financial assets in YZJ and its earnings quality dilution. Downside risk however could be mitigated by some contract wins.

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