China's Shipbuilding Industry: Capital Strategies for Prosperity
In mid-October, Songfa Co., Ltd., which had been suspended from trading for several days due to a significant asset restructuring, unveiled its plan for an asset swap aimed at acquiring 100% of Hengli Heavy Industries. This bold move marks a significant shift for the company from manufacturing daily-use ceramic products to a more prominent role in the shipbuilding industry as a private entity. The reality behind this transition is that both Songfa and Hengli Heavy Industries are under the control of the same couple, Chen Jianhua and Fan Hongwei, leading to perceptions that this maneuver is a strategic move by Hengli Group to strengthen its footprint in the shipbuilding sector.
While global economic development remains fraught with uncertainties, the shipbuilding industry, especially in China, has shown signs of flourishing, drawing heavyweight capital investments. This ongoing transformation has positioned mergers and acquisitions as a vital tool within this context, with companies like Songfa, previously considered less successful, now poised to play crucial roles in this evolving landscape.
Recent trends in the industry illustrate a robust influx of new orders among both established and emerging Chinese shipbuilders. Founded in July 2022, Hengli Heavy Industries quickly gained traction by purchasing assets from STX (Dalian) Shipbuilding Co., Ltd. and 12 other affiliated companies. The company managed to launch its first vessel—a 61,000-ton bulk carrier—in March 2023 and met its delivery targets a full year ahead of schedule. According to Clarkson Research, Hengli Heavy Industries secured an impressive 1.82 million CGT in new orders as of 2024, with bulk carriers comprising the largest segment of its order backlog at 43%, followed by container ships at around 29%, placing it roughly fifteenth globally in terms of overall order volume.
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One of the most prominent private shipbuilders, Yangzijiang Shipbuilding, reported a new order tally hitting 2.86 million CGT so far in 2024, primarily consisting of container vessels, which made up an impressive 60% of its order types. In contrast, state-owned enterprises like China Shipbuilding Industry Corporation and China Shipbuilding Industry Corporation (CSIC) are securing vast contracts, with China Shipbuilding's Jiangnan Shipyard and Waigaoqiao Shipbuilding alone holding 12.69 million CGT in orders.
The compelling performance in terms of order volume has facilitated a new lucrative landscape for dealing in renminbi, as seen in a recent deal wherein Hudong Zhonghua, a subsidiary of China Shipbuilding, announced the construction of six large 13,600 TEU container ships for Canada's Seaspan, emphasizing the contracts would utilize renminbi for payment—a rarity among foreign shipowners making substantial orders directly within Chinese yards. Given that 93.5% of new orders received by Chinese shipbuilders in the first half of 2024 came from foreign owners, this adjustment towards renminbi could mitigate exchange rate and interest rate risks for these companies.
However, the matter of balancing orders and production capacity continues to pose challenges. The shipbuilding industry is not conducive to operating on a thin profit margin, as many heavy industries have encountered issues from overextending capacity. Despite an abundance of new contracts, the long manufacturing cycle inherent in shipbuilding requires firms to secure interim financing to cover raw material and labor costs until the vessels are delivered and payment is received, raising overall financial pressures.
Huangdong Zhonghua's projected revenue for 2024 sits at around 23 billion RMB, with an ideally modest net profit margin of about 4%. This is comparable to China Shipbuilding, which also exhibits a similar net income ratio, while China State Shipbuilding Corporation's (CSIC) straightforward profit margin is even lower at around 2.44%. Unfortunately, these figures have been impacted by historical low-price contracts. The industry's struggle to balance the influx of orders with production capacity continues as it appears that shipbuilders who are ‘order-rich’ may benefit from exploring new strategic avenues.
The significance of financial structuring is paramount in this sector, where the cost of financing could mean success or failure. Shipbuilders are heavily reliant on bank loans due to the nature of order fulfillment, and fluctuating interest rates can significantly impact the sector's viability. This has been evident in the contrasting trajectories of the South Korean shipbuilding industry as they grappled with increased interest rates, leading to a relative decline when compared to their Chinese counterparts, whose loan rates remain over 40% lower than those in South Korea.
With several capable financial institutions backing shipbuilding processes in China, the capabilities of domestic financing organizations have increasingly filled the gap of traditional bank loans. China Export-Import Bank, boasting a mortgage loan portfolio of $18.5 billion, ranks as the world's second-largest ship financing institution, while China Minmetals Corporation holds over $18 billion in marine assets, firmly establishing its stance as a major player in the international ship leasing and financing market.
Equity financing avenues also present a solution to liquidity issues faced by shipbuilders. The consolidation between China Shipbuilding Industry Corporation and its state-owned counterpart, CSIC, in 2019 has set a precedent for successful capital operations leading to improved profitability metrics over the sector's norms. In 2023, another noteworthy transaction by Waigaoqiao Shipbuilding converting debt into equity, allowed the firm to offset substantial impairment losses while ensuring access to anticipated future cash flows.
Leveraging the assets of Hengli Heavy Industries, which evolved from STX Dalian Shipbuilding through a series of strategic maneuvers, offers substantial rejuvenation prospects. Songfa’s ambitious plan of divesting and forming partnerships not only simplifies transactional costs but also alleviates cash constraints further supported by strategic investments amidst established relationships within the industry. The future beckons further financial capabilities for this shipbuilder long overlooked due to its closure a decade prior.
As both new entrants and established players plow into the bustling shipbuilding economy, concerns over capital manipulations divorced from reality loom large. Nevertheless, the favorable dynamics of the shipbuilding market warrant prudent repositioning among trilateral relationships in asset management to ensure optimization of resources. The development potential, paired with a looming global demand for modern vessels, offers promising opportunities for major financial investments in the field.
Projections indicate that global ship investment requirements will reach an astronomical $2.3 trillion between 2024 and 2034, with new shipbuilding needs constituting approximately $1.7 trillion. Though uncertainty clouds the global economic framework, the aging vessels in the international fleet suggest a growing window for shipbuilders to fulfill new demand as the average age of vessels stands at 13.7 years, with nearly 42% exceeding two decades.
Despite external pressures, there exists an inherent challenge for producers to strike a balance amid rising order quantities and tight production capabilities, underpinning a push for both volume and price elevation within the market. Many shipyards have faced bankruptcy following the 2008 financial crisis, reducing the number of operational yards drastically, and leading to a consolidation in the industry.
Current metrics illustrate China’s undeniable lead within this domain, with not only extensive order volumes, active yard numbers, and a necessity for modernization reflecting ratios of 55.1%, 74.7%, and 61.4%, respectively, of the global total. As they strive to expand on this momentum, international competitiveness elevates, inviting existing firms to innovate operational frameworks.
Given the established standing of Hengli Group’s diversified portfolio, the entrance into shipbuilding represents not merely an expansion of activities but provides synergistic advantages to their existing oil, coal, and finished goods transportation businesses—the timing appears ripe for such moves practically devoid of hazards compared to a decade earlier amidst massive industrial upheavals.
Having achieved remarkable innovations in advanced marine products, including aircraft carriers and large LNG vessels, it continues to erode South Korea's competitive advantage, as evidenced by shifts in market share in recent years. As domestic rates offered by Chinese shipyards remain below their competitors, dismantling traditional biases toward South Korean standards only serves to enhance China’s growing presence in this sector.
All the while, established leaders in China’s maritime industry must navigate the dual challenges of mitigating cutthroat competition and enhancing their global stance by further consolidating the marketplace through mergers or strategic acquisitions. History illustrates that economies like Japan and Korea thrived on supportive government policies and robust supply chains, insights that China’s leaders are beginning to emulate with keen effectiveness.