South Korean shipbuilders weather financial storm

19 June 2009

Although South Korea’s shipbuilders have had a quieter start to the year than usual, partly because of a fall-off in export activity from the Middle East, optimism remains high.

South Korea’s industrial hubs at Ulsan, Busan and Geoje are home to some of the largest shipbuilding yards in the world. But despite having a 40 per cent share of the global market, they face a potentially difficult period of consolidation.

New business has all but dried up after five years of record orders, as the country’s dry docks struggle to maintain the booming order books of the past few years. While shipyards remain busy working on contracts won in 2006 and 2007, order backlogs have shrunk dramatically as demand for new vessels declines.

Korean shipbuilders have led the world in the construction of liquefied natural gas (LNG) carriers and oil tankers, with seven South Korean shipbuilding firms ranked in the world’s top 10. Korea overtook Japan as the largest shipbuilding country in the world in 2000, while China has subsequently taken the number two spot.

Liquidity problems

However, Korea’s three largest shipbuilders – Hyundai Heavy Industries (HHI), Samsung Heavy Industries (SHI) and Daewoo Shipbuilding & Marine Engineering (DSME) – with one-fifth of global orders, have taken just one new shipbuilding order between them this year.

HHI, the world’s largest shipbuilder, has slashed its order target for 2009 by 23 per cent to $21bn  compared with 2008, while SHI has gone even further, telling investors its order book will drop by one third to $10bn this year.

“There has been an impact from the financial slowdown on shipbuilding,” says Young Shin, senior vice-president for international sales and marketing at HHI. “But I am positive it will recover.”

Despite the problems securing new orders, the Korean Shipbuilders’ Association takes a bullish view of the market, predicting a 26 per cent rise in total exports to $54.4bn in 2009 because of a long backlog of orders. However, liquidity is likely to remain a problem.

Given the long-term nature of the business, the impact of the malaise spreading through the market over the past nine months may not be reflected in shipbuilders’ profit and loss accounts until early 2011.

“When the current orders are delivered throughout 2010, we will start to see a big drop in the sorts of earnings figures the main shipbuilders record,” says one Seoul-based industrial analyst.

“Their backlogs are worth tens of billions of dollars, but once they are worked through, you are looking at a big gap in their balance sheets.”

The shipbuilding industry is acting now to avoid further pain in the next decade. HHI, SHI and DSME are all tapping the debt market to raise funds for the first time in six years.

The government is also helping. The state-run Export-Import Bank of Korea (Kexim) and Korea Export Insurance Corporation (KEIC) were instructed by government ministries in April to give loans and guarantees to help shipowners pay for contracts and place new orders.

“The government decided to push for progressive restructuring plans and provide more liquidity because the global credit crisis has practically dried up orders for new ships worldwide,” said a government statement on 30 April. “Domestic shipyards won only one order in the first quarter.”

Kexim, the country’s top project financing bank, says that was only made possible after it successfully raised $2bn in January from the sale of global bonds.

“Since the end of last year, we have suffered from the severe scale of the crisis and it has been very difficult to meet the already committed projects,” says Jae-ho Koh, senior deputy director for project finance at Kexim. “Fortunately, we successfully issued global bonds, although the cost was very high. We have enough liquidity to cover important projects.”

Acquisition programmes

Other major shipbuilders likely to consider tapping loans are Hyundai Mipo Dockyard, Hyundai Samho Heavy Industries, Hanjin Heavy Industries & Construction and STX Shipbuilding.

Shipbuilding companies’ current difficulties represent a considerable change from the booming market earlier this decade, led by a string of orders from Qatar as it increased its LNG capacity.

Qatar Gas Transport Company (Nakilat), which supplies vessels to both Qatargas and RasGas, has acquired 45 LNG tankers from South Korean shipbuilders over the past few years in one of the biggest ship acquisition programmes ever. All are being deployed on transporting North field gas from Ras Laffan to distant markets such as Europe and the US.

SHI won orders for 18 of the 45 carriers, and in February hosted a naming ceremony with Qatargas for an $11bn order placed in 2006, to provide four 266,000-cubic-metre LNG carriers.

Wontae Park, general manager of investor relations  at SHI, says it has delivered the ships on schedule despite a large backlog of work, including orders for the Yemen LNG project.

“Delivering these carriers to Qatar is something to be proud of, particularly given their unique size,” says Park.

Qatar and South Korea have pushed tanker capacities to a new scale by introducing a new breed of larger LNG carrier ship, the Q-Flex, with a capacity of 210,000 cubic metres, and the 266,000-cubic-metre Q-Max, which is almost twice the capacity of a regular tanker.

Yet Park admits the industry faces a period of rationalisation. “We are quiet at the moment and activity from the Middle East has slowed,” he says. “We are still consistent on the oil tanker side, but the LNG market has slowed.

Weakening demand

With Qatar and Yemen both increasing production this year on their signature LNG projects, little demand for further shipbuilding orders is expected within the next few years.

The crude market is expected to remain steady if unspectacular. Iran continues to fuel strong growth in shipbuilding orders, while powerhouses such as Saudi Arabia and the UAE pause key oil field developments because of faltering global demand for their products.

Shipbuilders also face issues familiar to other sectors: uneven raw materials prices and the fluctuating currency. Posco, South Korea’s largest steelmaker, recently cut prices because of weakening demand, while Dongkuk Steel Mill Company, the country’s third-largest steel maker, dropped its plate steel price by 11 per cent. While this should be good news for shipbuilders such as SHI, volatility has made it difficult to forecast their costs over the lifespan of a project. As recently as September 2008, Dongkuk was charging $1,100 a tonne for steel plates, but this has now plummeted.

“The steel price is changing from quarter to quarter,” says Park. “Every company must deal with this factor, but it is a problem.”

Exchange rates also require careful financial management. The Korean won has risen 20 per cent against the dollar over the past three months after being battered in 2008, which has hit Korean exports. Analysts now expect Korean exports in May 2009 to fall by nearly 25 per cent compared with May 2008, which will be the seventh consecutive month of international sales declines.

The economic downturn has also hit some of Korea’s other strong export industries, such as its domestic car manufacturing sector.

Global car sales by Korea’s five car manufacturers in April 2009 fell by 15.3 per cent from the previous April to 418,506 vehicles.

Although no figures are yet available for 2009, the Middle East increased its automobile imports from Korea by 26.6 per cent in 2008 and truck imports by 48.9 per cent, providing a solid foundation for future growth.

The option of Korea setting up a car manufacturing plant in the Middle East has always seemed a long shot. But the opening of the UAE’s first vehicle assembly plant, in June 2009, may yet change attitudes in Seoul as the Middle East looks to create jobs for its young, growing populations.

In 2008, Japanese truck manufacturer Isuzu was reported by the Saudi and Japanese press to be considering local production of its trucks in Saudi Arabia, based on its strong sales there.

Korea’s Kia Motors has also previously entered into a joint venture with local Iranian manufacturer Saipa, while in 2008 it signed a deal with Saudi Arabia’s Al-Jabr Group for a distribution deal covering the kingdom.

Consumer market

Other traditional export areas including construction machinery are also holding up well. According to Korea Trade-Investment Trade Agency (Kotra), sales of equipment increased by 62 per cent to $701m in 2008.

“It was a volatile year for construction machinery,” says the Seoul-based investment bank industrial analyst. “When oil prices were high, there were strong budget allocations from governments in the region to order but that, of course, fell away in the latter part of last year.”

Consumer electronic firms are also struggling, with Samsung and LG Electronics forced to make large cost savings this year to remain competitive. Despite that, the region is a strong consumer of electrical items, with Samsung currently holding about one-third of the Middle East television market.

LG hopes to boost growth this year partly through increased sales of air-conditioning systems in the Middle East, despite an expectation that its global sales will fall by up to 30 per cent. It aims to break the $6bn mark in sales of home appliance goods from the Middle East and Africa region by 2010, up from $4bn in 2008, with strong growth forecast from the plasma television and mobile handset markets.

“In certain consumer industries, the Middle East is still a hot spot for companies like Samsung and LG,” says the industrial analyst. “There is still plenty of room to expand.”

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