A Steady Hum at South Korea's Shipyards

The good times are likely to continue for shipbuilders Hyundai, Samsung, and Daewoo well into the next decade, though Chinese rivals loom

Don't try to tell South Korea's ultra-prosperous shipbuilders their days are numbered as competition intensifies with China. Executives at the country's major shipping yards see their order books for mega-ships bulging well into next decade.

"Sure the Chinese will challenge our leadership in the future," says General Manager Kim Boo Kyung at Samsung Heavy Industries, the world's second largest builder of ships. "But that won't happen until 2020 or beyond."

While plenty of South Korean industries have a bad case of China jitters, it isn't so when it comes to the sprawling cargo ships that carry around the world's major tradable goods. The Koreans rule: They built 41% of all ships delivered last year, and the country is home to 6 of the world's top 10 shipyards.

In the most sophisticated freighter category—liquefied natural gas carriers—four out of five are built by Korean companies. Korea is also home to the three biggest industry players: market leader Hyundai Heavy Industries (HYHZF), followed by Samsung Heavy (SMSHF), and Daewoo Shipbuilding & Marine Engineering.

Reason for Concern

To pull away from shipyards in China, which aims to eclipse Korea as the largest shipbuilding country by 2015, Korean companies are focusing on such high-value-added vessels as LNG carriers, ultra-large ships, and oil-exploring drill ships. The Koreans are also seeking more innovative ship-manufacturing processes to boost productivity (see BusinessWeek.com, 5/12/06, "Korea's Shipbuilding Industry Sails Ahead").

There is some reason for concern, however. By one key metric, the Chinese have overtaken the Koreans this year. British Clarkson Research Service, which closely tracks the industry, said in a recent report that Chinese yards signed 56.6% of the total number of new contracts in the first quarter of 2007, with the Koreans accounting for just 26.1%. Korean newspapers called it an early warning signal that the country's shipyards will face a fate similar to that of domestic textile manufacturers and assembly-heavy electronics makers that have either relocated to China or closed shops.

Managers at Korean yards brush aside the argument. The demand for new orders this year has been largely focused on bulk carriers for delivery by 2009, and the Korean shipbuilders are fully booked with work until the first half of 2010. "The bulk carrier market is certainly hot, but we don't have the room to accommodate the needs," says Kim.

Cyclical Industry

The plentiful backlog of orders underlines an extraordinary stretch of shipping demand since the last industry slump back in 2002. At the end of March, Korean shipbuilders were sitting on orders for 1,186 vessels totaling 75.8 million gross tons and worth more than $100 billion, according to the Korean Shipbuilders' Assn.

That will keep the major players in high-speed mode for about 3 1/2 years. "We are in a cyclical industry, and this boom can't last forever," points out Kwon Oh Yoon, a senior manager at the association. "But there's no sign in the horizon the buoyant mood will sour any time soon."

Not surprisingly, Korean shipyards are raking in some serious profits. Until late last year, they had suffered from lackluster profitability because of the combination of a sharp rise in steel sheet prices in recent years and the low contract prices they accepted until the latter half of 2004. Given a three-year lag time between when contracts are signed and when earnings are booked with the delivery of ships, the yards are beginning to reap rewards in earnest from lucrative contracts dating from late 2004.

Red-Hot Activity

The biggest beneficiary will be Hyundai Heavy, the undisputed global leader.

After almost quadrupling its net profit to $771 million in 2006, Hyundai Heavy is expected to more than double profit this year, figures brokerage Korea Investment & Securities.

That's because shipbuilding prices almost doubled from a low in mid-2002 to early 2005 and have since stayed strong. Hyundai Heavy stock has jumped some 126% so far this year, making it the best performing blue chip on the Seoul Stock Exchange.

Share gains of Samsung and Daewoo have been less impressive, although they have risen by 59% and 39%, respectively, in 2007. One reason was their greater emphasis on specialized LNG carriers, whose contract prices have climbed less dramatically than those of tankers, containers, and bulk carriers. "Although my top pick is Hyundai Heavy, all the big three will likely post double-digit profit margins by the end of next year," says Song Jae Hak, shipbuilding analyst at Woori Investment & Securities.

Industry watchers say the ongoing red-hot shipbuilding activity has been triggered by China's seemingly nonstop economic and trade growth. "The emergence of China as the factory of the world has changed the paradigm of shipping patterns, thereby fueling fresh shipbuilding needs," says Cho Yong Jun, head of research at Shin Young Securities in Seoul.

House of Cards

A big upsurge in global commerce with the mainland led to the development earlier this decade of ultra-large container ships several football fields in length. Shipping lines raced to build oversized ships, capable of stacking between 8,000 and 12,000 containers, to service ever-growing seaborne trade between Asia and the U.S. Now, many industry officials believe the race to build bigger fleets by shipping lines won't be likely to end unless China scales down its industrial ambitions (see BusinessWeek.com, 4/23/07, "Why Taming the China Dragon is Tricky").

Take the latest frenzy to build bulk carriers. China's determination to own huge steel plants for fast industrialization created a sudden upswing in coal demands to power the mills. That made China a net coal importer from an exporter in the past, forcing Japan and South Korea, which used to import coal from China for generating electricity, to switch their coal source to Australia.

The switch not only meant longer hauls, requiring a greater number of shipping days, but also congestion at Australia's coal-handling New Castle port. That holds up scores of ships waiting to be loaded, thereby contributing to the shortage of ships carrying dry bulk cargoes. To worsen the situation, the recent imposition of duty on export of iron ore from India prompted China to divert its iron ore imports from India to Brazil, again engaging more bulk carriers on longer hauls.

Rise in Freight Charges

The upshot: Ocean freight for dry bulk cargoes skyrocketed. Short-period daily hire rates for 75,000-ton-class vessels in the Pacific have hit a historic high of $46,900 per day in May, up 30% since the beginning of this year and up more than 100% from a year earlier. The Baltic Exchange Dry Index, the best indicator of bulk cargo shipping prices, has topped 6,600 in May from below 1,500 in mid-2002.

The stunning rise in freight charges is spurring bulk carrier operators to join the race to secure more vessels. Clarkson notes this pushed the price of a new, 170,000-ton-class bulk carrier to $79 million in March, up from $76.5 million in February and $71 million in January. Shipping lines are also starting to place orders for large container ships for delivery in 2010 because they are worried that docks and berths at major shipyards would be completely taken over for building bulk carriers unless they hurry.

"It looks like a case of déjà vu," says a recent Clarkson report. Last year, when there was a boom in the large tanker building market, container ship owners rushed back to shipyards to secure berths for 2009 delivery because of dangers of losing a new supply of containers for that year. "Last year the driver of the shipbuilding market was the tankers, and this year it is bulk carriers," says Cho at Shin Young.

The competition to sign shipbuilding contracts early certainly won't increase the bargaining power of shipping lines. But it is music to ears of the Korean shipyards that dominate in building mega-vessels.

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