Global Economics

Korea's Shipbuilding Industry Sails Ahead


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Life is good, in fact downright glorious, right now for Korea's white-hot shipbuilding industry. Demand for next-generation super container ships, which span several football fields in length, shows no signs of abating, while the prices for these sea-going monsters is going off the charts. Japan's shipbuilding industry is a much-diminished force, and the competitive threat from Chinese rivals is still a ways off.

For now, Korean companies such as Hyundai Heavy Industries, Daewoo Shipbuilding & Marine Engineering, and Samsung Heavy Industries dominate the market for mega-container ships, huge tankers, and most advanced carriers of liquefied natural gas.

Hyundai, Daewoo, and Samsung are the three biggest ship builders in the world, and they have taken in so much business of late that their backlog of ship orders will keep them busy over the next three years. "With all our nine dry docks fully booked well into 2009, we are focusing on more profitable contracts," says Hyundai Heavy spokesman Lee Kwang Ho. Not surprisingly, investors have become enamored with Korean shipping stocks.

FUTURE PROFITS. Hyundai Heavy's share price has doubled to $116 in the past year, and analyst Cho Young Jun, who follows the industry for Shin Young Securities in Seoul, says there's still room for the stock to gain another 50% by the end of this year at the world's No. 1 shipbuilding company. Why? Ship prices have doubled since they hit bottom in 2002 and "Korean shipyards have their profits locked in until 2009," says Cho.

He predicts that Hyundai Heavy's net earnings will triple to $642 million this year from $197 million last year. And he expects the company's profits to top $2 billion in 2008.

Hyundai's earnings jumped nearly fivefold in 2005, but the company's profit margin was only 1.7% on sales of $11.07 billion. The disappointing performance was due in large part to the weak market conditions in 2002. (There is usually a three-year lag time between the period contracts are signed and then ships are completed and fully booked as earnings.) On the flip side, the sky-high prices for shipbuilding contracts now being awarded will certainly translate into a profit windfall later in the decade.

HUNT FOR OIL. The industry boom is tied largely to three factors. Tougher environmental requirements by the International Maritime Organization are calling for the phase-out of single-hull tankers in 2010, and many ship owners want to build vessels before the new rules come into force. Double-hull ships, which will eventually become the industry standard, are less likely to spill cargo, particularly oil, when involved in collisions.

Another driver behind demand is China's hyper-growth economy and a big upswing in global commerce with the mainland that is increasing seaborne trade between Asia and the U.S. With so much global trade transported at sea, shipping lines are crying out for the creation of outsized ships capable of stacking up to 10,000 containers on their decks.

Then there's a surge the oil demand from developing countries such as China and India that has sent oil prices into the stratosphere. This not only requires more tankers, but also has prompted a rise in the use of liquid natural gas (LNG). That, in turn, is sparking demand for LNG carriers. The global hunt for oil is also leading to an increase in the need for new offshore oil production facilities, which Korean yards also build.

The Koreans have become the biggest beneficiaries of all of this, thanks to the decline of Japan's shipbuilding prowess. The biggest problem facing Japanese shipyards is that they cannot recruit enough young engineers, particularly those capable of designing new ships. A survey by Korean shipbuilders shows that nearly half of maritime engineering students graduating from 11 Korean universities and colleges in recent years have been employed at local dockyards. In Japan, only 20% of the newly minted engineers have ended up working at Japanese yards.

STAYING ON TOP? As a result, Japanese shipbuilders have lacked the flexibility needed to cater to the shift to ever-bigger freighters. "This forced the Japanese to focus on building pre-formatted ships, allowing the Koreans to dominate in more lucrative segments," points out Credit Suisse (CSR) shipbuilding analyst Lee Sok Je. An April report by London-based market researcher Clarkson showed Korean yards accounted for 71.3% of the new orders last year for LNG carriers, 64.3% of mega container ships, and 42.4% of very large tankers.

However, the Chinese are potential threats. Armed with cheaper labor, Chinese yards have already snatched contracts for bulk carriers and smaller tankers. Yet Korean execs in the industry say a big gap in productivity, quality control, and punctual delivery will keep the Chinese away from big-buck projects in the foreseeable future. "We are ahead of China by about 10 years," says Samsung Heavy chief executive Kim Jing Wan, who heads the Korea Shipbuilders' Association. "Korea will remain the top shipbuilding country for the next two decades."

One reason is the more enlightened and efficient ship-manufacturing processes employed by the Koreans. When constructing a ship, the Koreans fashion key segments of the vessel into modular blocks that include most piping work and other interior facilities before transporting them to a dry dock for assembly. This approach has dramatically reduced shipbuilding time and has improved productivity.

SMOOTH SAILING. "That's essential to maximize the use of the dry dock," points out Hyundai's Lee. "We build an average of 9.4 ships a year in a dry dock, while a typical Chinese yard builds only three." Of course the Chinese will eventually catch up. And the current boom can't last forever in the notoriously cyclical shipping industry. A slowdown in the global economy could quickly reverse the trend.

For now, there's no sign on the horizon that things are cooling off. New orders for a total of 136 vessels worth $12 billion were placed with Korean yards in the first quarter of this year, up by a third from a year earlier, according to government figures. Whatever happens in the months to come, the good life at the Korean yards will continue at least until 2009.


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