Mainland shipyards are expected to tap capital markets in the next two years to fund the mainland's ambition to become the world's largest shipbuilder.

While industry experts worry about overcapacity after 2010, order volumes are rising and margins on new ships are recovering, thanks to the mainland's booming trade, driving some Asian shipbuilders' shares up by more than 600 per cent this year.

Big shipbuilders such as Guangzhou Shipyard International Co Ltd and IPO candidate China State Shipbuilding Corp (CSSC) are expected to see bumper profits in 2007 and beyond, as domestic demand enables the mainland to displace industry heavyweights South Korea and Japan.

"There is strong investor interest in the market for mainland shipyards due to the industry boom and a scarcity of listed companies," said Michael Chan, an analyst at Macquarie Research.

Guangzhou Shipyard International is the lone listed player in a country that is home to more than 3,000 shipbuilders, around three-quarters of which are unqualified.

"I expect more mainland shipyards to tap the market, though we've not heard of many candidates yet," Chan said.

Major yards around the world are fully booked through 2009, but some shipbuilders such as Japan's Kawasaki Heavy Industries Ltd have warned of possible overcapacity as yards expand in order to capture growth.

Analysts, though, expect major mainland shipbuilders to see steady top-line growth as the global shipbuilding industry relocates in order to tap China's cheap labour. Strong local demand and the mainland's price advantage will drive order growth.

A ship ordered today will take three years to deliver.

"Ship orders are likely to be stable in the next six months but there will be a big question mark after that," said Hyejin Koo, an analyst with Lehman Brothers in Seoul.

The mainland, which lists shipbuilding as one of its top development priorities, will spend billions of dollars over the next half decade to fund the construction of three modern shipbuilding bases near Dalian, Shanghai and Guangzhou.

"The government's contribution will be minimal and the money will be raised in the market by companies and funded by bank loans," said Zhang Guangqin, president of the China Association of National Shipbuilding Industry.

China is the world's third-largest shipbuilding nation and had 18 per cent of the global market in 2005, lagging South Korea and Japan which accounted for a combined share of more than 60 per cent. But Beijing aims to become the largest shipbuilder by 2015, with output of 24 million deadweight tons (dwt) a year, or 35 per cent of the world's total.

CSSC, the world's No.3 shipbuilder and the parent body of Guangzhou Shipyard, is expected to raise US$800 million in a Hong Kong initial public offering next year.

It is spending US$2 billion initially to set up the Changxing Shipbuilding Base in Shanghai and Longxue Shipbuilding Base in the southern city of Guangzhou.

The group's annual capacity is expected to rise to 14 million dwt by 2015 when the bases are completed. It built 5.13 million dwt of ships last year.

Another State-owned group, China Shipbuilding Industry Corp, is building yards in northern China and plans to more than treble its annual capacity to 14 million dwt in 2015.

The heat is on

Investor interest has been returning to the sector. Shares in South Korea's Hyundai Heavy Industries (HHI), the world market leader, have gained 72 per cent this year, even after dropping 5.7 per cent on Monday amid fears that the price of newly built vessels could drop 20-30 per cent.

"China's fast-growing shipbuilding industry is a source of opportunity rather than a threat to HHI," said Lehman's Koo. "Since China's capability to build propulsion engines is limited, we expect to see HHI's shipment of marine engines to the mainland increase as shipbuilding capacity builds up," she added.

Shares in Guangzhou Shipyard, the world's fourth-largest handy-size tanker maker, have surged seven-fold this year - in line with its increase in third-quarter net profit to 110 million yuan (US$14 million).

The stock trades at 28 times projected earnings, while Asian rivals trade in a range of 11 to 50 times.

"This is good timing," Zhang said, referring to the current market boom for the development of shipyards in the country.

But the industry faces challenges, including a shortage both of talent and imported parts, higher raw material costs and a rising yuan exchange rate, said Li Li, a director at the Export-Import Bank of China.

Less than half the components in Chinese-made ships are made in China much lower than the 85 per cent local sourcing at South Korean yards and 95 per cent in Japan.

Under the mainland's industry blueprint, annual output will hit 17 million dwt by 2010, with more than 60 per cent of components to be produced locally by then.