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Freight rates for domestic container shipping have been falling since April due to weak domestic demand. The Pan-Asia Shipping China Domestic Trade Container Freight Index (PDCI) fell 1.6% WoW and 16.5% YoY to 876 over June 22-28, 2024, approaching a five-year low. In contrast, freight rates for foreign trade are relatively strong at present, and some vessels that were used for domestic trade are now traveling on export routes.

In our view, freight rates for domestic container shipping will likely stabilize and rebound as transport capacity for domestic trade decreases and demand recovers in 2H24. Zhonggu Logistics ranks No.3 in the domestic trade market by shipping capacity. In addition, it has cost advantages, because it has many large vessels in its fleet. We are upbeat on its earnings growth amid rising freight rates.

Comments

Freight rates for foreign trade remained high; domestic freight rates will likely trend up; foreign trade business of Zhonggu Logistics will likely improve. Freight rates for foreign trade have been ramping up since April due to ships bypassing the Red Sea and increased demand from Europe and the US. There is a shortage of transport capacity for foreign trade, and some vessels in China have shifted from domestic routes to export routes. According to Alphaliner, the number of charters for Zhonggu Logistics’ vessels for foreign trade increased over April-June 2024, and these charters have longer contract terms and offer higher rents.

According to Clarksons, rents of 2,000TEU and 4,400TEU container ships in six-month contracts had increased 91% and 80% YoY as of July 5. In our view, the high freight rates for foreign trade will likely accelerate route changes of vessels, boding well for the improvement of freight rates for domestic trade. In addition, we expect Zhonggu Logistics to report higher earnings from its foreign trade business as its capacity for exports as a percentage of total shipping capacity increases. In our view, longer contract terms will also likely help the firm secure earnings in 2024 and 2025.

Keep an eye on upside potential of freight rates for domestic trade in the peak season. Peak season for domestic trade is approaching, and we expect freight rates to stabilize and rebound. The second and the third quarter are traditional slack seasons for domestic container shipping. At present, freight rates for domestic trade have dropped to a five-year low due to demand pressure in the slack season and decreasing transport capacity for domestic trade. We expect the freight rates to stabilize and rebound in the peak season in 4Q24.

The firm has ample cash on hand and attractive dividends; keep an eye on investment value. At end-March, the firm had Rmb10.3bn in cash on hand (including wealth management products and structured deposits) and Rmb3.7bn in net cash, and its current market cap is about Rmb16.9bn. We think it has investment value.

In addition, the firm's dividends are attractive. If the firm’s dividend payout rate is 70%, its dividend yields would be 7.2% and 7.8% in 2024 and 2025 (the firm's dividend payout ratio in 2022 and 2023 were 73.5% and 88.0%).

Given relatively low freight rates for domestic trade in 2Q24 (average PDCI is down 14.4% YoY), we think the firm’s earnings from domestic trade might come under pressure. We think its overall earnings in 2Q24 will likely be the same as the level in 2Q23, because we believe its stock price has priced in pessimistic expectations in the domestic market and its foreign trade business will likely generate more profit in 2Q24.

Financials and valuation

We raise our 2024 and 2025 earnings forecasts 6.0% and 6.6% to Rmb1.74bn and Rmb1.88bn, given rising income from foreign trade- related charters. According to corporate filings, the firm plans to sell two vessels for around US$112-120mn. It booked yields of Rmb431mn in June for vessels to be sold. However, it did not include the two vessels because the deal was not completed. The stock is trading at 9.8x 2024e and 9.1x 2025e P/E. Given falling risk appetite, we maintain an OUTPERFORM rating and our TP of Rmb11.5, implying 13.9x 2024e and 12.9x 2025e P/E, offering 41.8% upside.

Risks

Geopolitical conflicts; weaker domestic demand.