INDIAN SHIPPING SECTOR – THE TIDE HAS NOT TURNED! India Infoline Sector Studies Research Analyst Nishant Jadav 2685 0101 /Ext 210 India Infoline Limited 24, Nirlon Complex, Off Western Express Highway, Goregaon (E). Mumbai - 400 063. Tel : +91 022 2685 0505/0101; Fax +91 022 268505885 It's all about money, honey!
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INDIAN SHIPPING SECTOR – THE TIDE HAS NOT TURNED!
India Infoline Sector Studies
Research AnalystNishant Jadav
2685 0101 /Ext 210
India Infoline Limited24, Nirlon Complex, Off Western Express Highway,
In 2003 we saw the shipping stocks outperform the markets. India Infoline Shipping Index gavea return of 280% during the period April 1 2003 to December 31 2003, compared to 91.5% forBSE SENSEX for the corresponding period. The good news is that it’s not the end of high tideyet. We remain positive on the shipping sector as we expect a cyclical upswing for next 2 years.Freight rates for both dry and wet cargo are expected to remain firm. Capacity addition inshipping tonnage is taking place gradually but is not expected to outdo the demand growth fortonnage. Positive changes like tonnage tax introduction and increasing refining capacity in thecountry leading to increase in crude oil imports is adding to the upturn.
Stock RecommendationsCompany Recommendation ReasonGreat Eastern Shipping Company BUY One of the best picks in the industry, the
company is expanding fleet at a fast paceEssar Shipping Limited BUY A steady player focussed on logistics
solutions for marine transportShipping Corporation of IndiaLimited
BUY Being the largest in industry by tonnagecapacity, this company shows sign of growth
India Steamship Limited BUY Turnaround company with capacity additioninitiatives undertaken
Varun Shipping Limited BUY Stable earnings company with addition tofleet expected soon
Mercator Lines Limited BOOK PROFIT Rapid growth company with low quality fleet.Value already discounted in price
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Summary
Spurt in dry bulk ratesDry bulk rates have seen an upswing during the last one year. This was led mostly by increasingdemand for steel, iron ore and coal from China and coal demand from Japan and Europe. On thesupply front, the tonnage capacity was inadequate to service this demand leading to increase indry bulk rates.
As many Indian companies deploy their vessels overseas to take advantage of higher rates, thedomestic rates also underwent an upward revision due to inadequate supply and increaseddemand at the domestic front.
The Baltic Dry Index that used to move within 500 to 2000 points is currently above 4000points. We believe that such high level of rates will sustain for another one year at theminimum. This is because there is no major capacity addition in dry bulk tonnage and thedemand for tonnage is strong. According to industry sources, the total addition to tonnage in drybulk fleet will be just 11% in FY04.
The demand from China for steel and iron ore is expected to persist for at least the next oneyear. There is no major addition in tonnage this year. Shipyards have limited productioncapacities. There will not be any significant addition in tonnage in the short run as shipbuildingtakes around 18-24months. Further, increase in prices of iron and steel has made shipbuildingexpensive. Dry bulk rates are thus expected to remain firm in the short term for about a year.
Fleet Details
32%
6%43%
18%1%
LPG CC PC BC OSV
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Expected rise in Tanker ratesTanker rates are also expected to pick up steam for next six months. One key factor causing arate increase in the tanker segment was the winter demand for oil in US and EU. The impact ofwinter on oil demand generally varies with the severity of winter. This year with a severewinter, the tanker rates have remained firm.
Implementation of Tonnage TaxTonnage tax is a global practice of taxing shipping companies. It is calculated on a flat rate onthe Net Registered Tonnage (NRT) of the company after presuming a certain income on thesame. In India, shipping companies are taxed like any other company at the corporate tax rate of35%. After factoring the benefits available to shipping companies under section 33AC of theIncome Tax Act of India, the effective tax paid by Indian shipping companies is around 10-14%. This is still a high tax rate when compared to effective tonnage based tax of 1-2% paid bymost companies around the world.The government recently announced its intention to replace the existing corporate tax withtonnage tax taking the UK Tonnage Tax Act as the basis. It will bring taxes in line with globaltax levels without creating a need to change the tax structures and economic policies in othersectors.Tonnage tax will show a positive impact on net profits of the industry players as tax liabilitiesreduces. The net effect can however be quantified only after details of the policy are made clearby the government. Reduction in tax liability will leave additional funds in the hands ofcompanies for further expansion in the sector. International companies perceive tonnage taxmore convenient for operating in the country. This step is thus, expected to boost foreigninvestments in the sector. It will also boost the implementation of the Prime Minister’s SagarMela project worth Rs1000bn.Industry expects tonnage tax to be implemented effective from FY05 onwards with policyinitiative to be announced in the next Budget.
Attractive ValuationsMost shipping companies are trading at very low valuations. Our top pick in the sector is GreatEastern Shipping Company Limited. We had recommended a BUY on GE on November 272003. We MAINTAIN A BUY on the stock. Apart from GE, we have covered 5 othercompanies in this report. We recommend a BUY on Essar Shipping and SCI as they areattractively valued. We would however, recommend a SELL on Mercator Lines Limited as webelieve the company is aggregating low quality assets which will turn obsolete in the long term.
For the purpose of this study, we have covered the following companies
1. Shipping Corporation of India Limited2. Great Eastern Shipping Company Limited3. Essar Shipping Limited4. Varun Shipping Limited5. Mercator Lines Limited6. India Steamship Limited
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Given below is the comparison of the above companies based on their Q2FY04 performance. Ithas been compared with Shipping Corporation of India Limited, the industry leader in terms oftotal tonnage.
Rs mn ShippingCorporation
Of India
GEShipping
EssarShipping
VarunShipping
MercatorLines
Limited
IndiaSteamship
Operating Income 7,185 2,659 1,311 678 532 169Expenditure (5,504) (1,601) (790) (452) (379) (125)Operating Profit 1,682 1,059 522 226 153 44Other Income 62 278* 14 1 4 31Interest (88) (104) (146) (40) (20) (13)Depreciation (690) (461) (166) (131) (35) (16)Profit before Tax 965 772 224 55 101 45Tax (165) (12) (13) (4) (17) (15)Profit after Tax 801 760 211 51 84 31Net Profit 801 801 211 51 84 31Equity Capital 2,823 1,903 3,017 725 55 475EPS (Rs) (not annualized) 2.8 4.2 0.7 0.7 15.3 0.7OPM (%) 23.4 39.8 39.8 33.4 28.8 25.8Tonnage ** (MN DWT) 4.6 2.1 1.4 0.23 0.47 0.15* including gain on sale of ships and other assets** as on respective dates mentioned in the report
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The Shipping Industry
Shipping is a cyclical business and is affected by ship manufacturing activity around the world.When demand for tonnage increases, new ships are ordered to be made. Tariff rates increase bythe time ships are made, as it takes 18-24 months (subject to size and specifications) to buildships. As new ships start coming in, the rates reduce drastically due to the increased supply.
In India core sectors like iron ore, steel, coal, petroleum, chemicals, fertilizers etc rely on theshipping industry to transport majority of their raw materials and finished goods. India has acoastline of 7,516kms and majority of its trade with other countries is undertaken through watertransport. Performance of the economy bears a direct impact on the shipping business.
Shipping Tonnage
The Indian shipping tonnage increased from 0.19mnGRT in 1947 to 7.05mnGRT in 1999representing an annual growth rate of 7.2%. As on April 1 2003, the Indian Shipping tonnagestood at 6.18mnGRT. The average age of Indian fleet is 16.5 years - INSA.
Composition of Indian Fleet
Source: INSA
Concerns about quality of shipsIssues have been raised world over regarding quality standard of shipping fleet, after the“Prestige” oil spill. ‘Prestige’ was a single hull Aframax tanker carrying 70,000tons of heavy oilthat broke down in the Atlantic Ocean causing harm to environment and livelihood in thesurrounding area. EU has since then banned single hull tankers to pass through EU waters fromSeptember 2003 onwards. It has also ordered a phase-out of single hull tankers, to be replacedby double hull tankers by 2010. Governments and other organizations everywhere areemphasizing on phasing out of older and low quality fleet.
India too, does not have a very large composition of double hull tankers. Companies are in theprocess of replacing their existing single hull tankers with double hull tankers. Lack ofenforceable laws and low purchase costs of single hull tankers is however, luring Indian andother Asian companies to acquire these potentially harmful assets.
Classification of shipsOn the basis of the cargo carried, ships can be classified into liners and tramps. While linerscarry passengers and freight (containers), tramps carry dry bulk and wet bulk (tankers). Drybulk carriers are used to transport bulk goods such as grain, iron ore and coal. Tankers are usedto carry crude oil, petroleum products, chemicals, etc. Tankers can be further classified as oiltankers and product tankers.Offshore vessels are essentially tugs, supply vessels, and drill ships, etc, which transport menand materials to offshore oil installations.
Industry names for shipping vessels with approximate tonnage capacitiesCrude Oil Carriers CapacityPanamax 50,001-80,000 DWTAframax 80,001-120,000 DWTSuezmax 120,001-200,000 DWTVLCC (Very large cruse carrier) 200,001-350,000 DWTULCC (Ultra large crude carrier) 350,001 DWT and larger
Dry BulkHandy Size 10,000-30,000 DWTHandy Max 30,001-50,000 DWTPanamax 50,001-80,000 DWTCapesize 80,000 DWT and above
Product CarriersSmall 3,001-19,000 DWTHandy 19,001-25,000 DWTMedium Range 25,001-45,000 DWTLong Range One 45,001-70,000 DWTLong Range Two 70,001-100,000 DWT
Freight Passenger
Liner
Dry Bulk
Crude Carriers Product Tankers
Tankers
Tramps(carries fleet)
Shipping Fleet
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Payment termsCompanies charge freight rates depending on the nature of usage of their ships i.e. whether theships are taken on time charter or voyage charter.
Time charterTime charter means that a ship is taken on hire for a particular time-period say one year. Undera time charter, the ship owner is responsible for running expenses of the ship such asconsumables, maintenance, insurance etc but the charterer has to pay for expenses such as portdues, canal tools, bunkers etc. Freight rates are determined in the beginning and remain constantthroughout the charter period. The advantage is that, one is sheltered from adverse swings in thefreight rates. The ship owner gains if freight rates fall and vice versa. The general practice ofshipping companies in India is to keep a significant portion of their fleet under time charter.
Voyage charterAs against time charter, voyage charter means that a ship is hired for a particular voyage sayfrom Mumbai to Singapore. Here, the ship owner has to incur running expenses as well asexpenses like port dues, fuel cost, canal charges etc. In this case, the freight rates are decidedseparately for each voyage depending upon the general level of freight rates. The shippingcompanies here are exposed to greater risks, as they affect the movement of freight ratesimmediately. There could be some opportunities to earn higher rates if a particular type of shipis not available or a particular region faces a shortage of ships. In case of an increasing freightrate scenario, the company that has majority of its ships on voyage charter will thus benefitmore and it will tend to loose incase of a decreasing freight rate scenario.
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Factors affecting the performance of shipping companiesApart from freight rates, other cost items that impact the profitability of the industry are:
Dry-dockingDry-docking is one of the major expense items, which needs proper planning. As per industrynorms, every ship has to be dry-docked twice every five years. Moreover, the duration betweentwo dry-docks should not exceed three years. Dry-docking actually involves taking a ship out ofwater and undertaking repairs wherever necessary. A close inspection of the ship indicates thedamage occurred and need for repairs. Dry-docking is necessary to keep the ship in goodworking condition. However, dry-docking involves loss of working days for the ship resultingin loss of revenue apart from dry-dock expenses.Although dry-docking expenses depend upon the type of ships and extent of damage, undernormal conditions dry-docking of a Panamax would cost anything between Rs4-8mn. If the shipis a younger one, it should take 10 to 15 days of dry-docking. Again the number of days willdepend upon where the ship is being dry-docked. Normally, in Indian yards, the number of daystaken for dry-docking are more due to absence of modern facilities.
Bunker expensesAnother important cost for a shipping company is that of bunker or fuel which runs the ship.The current situation is quite favorable in this regard, as the fuel prices are quite low. However,when fuel prices are high they can significantly affect the margins of shipping companies.On an average, a Panamax consumes 25-30 ton of bunker per day. Bunker cost can be reducedby reducing the speed of the ship, thus reducing the consumption. However, this increases thetravel time for the ship and hence other costs. Hence a balance has to be struck between thebunker cost and other costs. Another way of reducing the bunker cost is to maintain the enginesin excellent condition by way of continuous overhauling. The latter also involves cost; hencestriking the balance is necessary.
Crew expensesIf a ship is compared with a factory then crew will be the factory workers and their salary wouldbe a major expense. In India, the government and the crew unions have certain norms regardingthe number of crew on a vessel. Foreign shipping companies follow international norms.
Profit or loss on sale of shipsFor acquisition of new ships or improving their cash flows or for getting rid of age old ships,shipping companies sell ships to realize profits or losses. Normally ships are sold dependingupon the company's expectations about future freight rates and ship prices. Profits from sale ofships account for a high proportion of profits to shipping companies.
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Company Coverage:
1. Shipping Corporation of India Limited
2. Great Eastern Shipping Company Limited
3. Essar Shipping Limited
4. Varun Shipping Limited
5. Mercator Lines Limited
6. India Steamship Limited
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The Great Eastern Shipping Corporation of India Limited
GE Shipping is among the top industry leaders in terms of total tonnage, sales and profitability.This year, the company has undergone vast capacity addition. The total tonnage of the companystood at 2.1mnDWT as on November 27 2003. The stock is available at a P/E of 9.2x FY04Eearnings. We had recommended at BUY on the stock at Rs.141.5 on November 27 2003. WeMAINTAIN BUY on the stock, as it is one of the best picks in the sector.
Investment Rationale
Spurt in dry bulk rates89% of the company’s dry bulk fleet is operating on spot contracts. This will enable thecompany to exploit the high dry bulk rates in the market. The company expects 100% capacityutilization in this segment on the back of high demand and firm rates. The revenue visibility ofthe dry bulk segment is expected by the company to be around Rs1552mn for the balance periodof FY04.
Expected rise in Tanker rates60% of the wet bulk fleet of GE Shipping is covered under time contract while the balance 40%remained uncovered which can take advantage of a spot rate increase.
Increased Refining ActivitiesAs domestic refining capacities in India increase, the requirement for ships to transport thecrude is also bound to increase. We believe the company is well poised to benefit from thisboom, as none of the other Indian shipping companies own a VLCC except GE Shipping.
Increasing Tonnage Capacity of the companyAt the start of FY04, GE Shipping had a total tonnage capacity of 1.32mndwt. Currently thetotal tonnage capacity of the company (including the delivery of 1 Aframax on November 152003) is 2.1mndwt (as on November 27, 2004). Thus it has added almost 64% more to its size inthe current year. This should be seen in light of the expected freight rate increase in the balancepart of the financial year.
Young FleetWith the delivery of newer vessels, the average fleet age of the company has reduced to around13.3 years (as on November 27, 2003). This will serve as an added advantage as younger fleetcan be employed more economically. At the same time, newer ships are scheduled to join thecompany’s fleet in the coming months.
Revenue from Off shore divisionA majority of GE Shipping’s revenues in the off shore division comes from the 2 drilling rigs ofthe company. Both the rigs are fully covered for H2FY04. The offshore support vessels, theconstruction barge and the harbor tugs are covered to the extent of 53%, 61% and 67% of theiroperating days respectively. For the balance period of FY 2003-04, the offshore division has arevenue visibility aggregating Rs1035mn.
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Company ProfileThe Great Eastern Shipping Company Ltd. (G E Shipping) is India's largest private sectorshipping and offshore services provider. The shipping division with an owned fleet of 35 cargo-carrying vessels operates in the dry bulk, crude oil, products and gas markets. The offshoredivision has a fleet of 30 vessels comprising off shore support vessels, tugs, drilling rigs & abarge (as on November 27 2003). The shipping division and the offshore division have beenawarded ISO 9001, 2000 version. With over 5 decades of operations, the company is todaypoised to meet the needs of a growing international clientele thereby creating value. GEShipping is strongly positioned in India and has international presence through its offices andsubsidiaries in London, Singapore & the United Arab Emirates.
An integrated and systems driven approach, strict adherence to quality and safety norms andapprovals from international oil majors have enabled GE Shipping establish a global client basereaffirming the company's credibility and reliability.
Fleet details (till November 27 2003)The company is focused on the transportation of energy products. The company has twodivision, shipping and offshore. The current fleet of the company stands at 65 vessels- 35 shipsand 30 offshore units.
Out of the 35 ships, the company has 9 dry bulk vessels and 26 tankers. In dry bulk segment,the company has 1 Panamax vessel, 3 Handymax, 3 Handysize and 2 Minibulk carriers. Out ofthe 26 tankers, the company has 16 Product Tankers (2 Panamax tankers, 8 Medium Range and6 General Purpose), 9 Crude Oil Carriers (1 VLCC, 1 Seuzmax and 7 Aframax) and 1 GasCarrier. Out of a total tonnage capacity of 2.16mndwt in shipping division, dry bulk segmentconstitutes around 15% (0.32mndwt) while 85% (1.84mndwt) is in the tanker segment.The offshore division of GE Shipping caters to oil field services. It owns 30 units, which arechartered out to operators like ONGC, Cairn and Hardy Exploration. The 30 units comprise of11 Tugs, 1 Barge, 2 Drilling Units, 8 Anchor Handling Tug Supply Vessels, 3 Anchor HandlingTugs, 2 Offshore Supply Vessels, 1 Diving Supply Vessel and 2 Platform Supply Vessels.
PANAMAX1
HANDYMAX3
HANDYSIZE3
MINIBULK2
DRY BULK9
PANAMAX2
MEDIUM RANGE8
GENERAL PURPOSE6
PRODUCT16
VLCC1
SEUZMAX1
AFRAMAX7
CRUDE9
GAS CARRIER1
TANKERS26
SHIPPING35
11 TUGS 1 BARGE
2 DRILLING UNITS 8 AHTSVs
3 AHTs 2 OSV
1 DSV 2 PSV
OFFSHORE30
FLEET65
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Focused play in shipping sectorGE Shipping had earlier entered into a variety of businesses including real estate, propertydevelopment, investment and commodities trading. However, it gradually reduced its interestsin those businesses in order to concentrate on its core competency – shipping.
ManagementThe company has recently restructured its management team and included younger people whoshall look after the day to day management of the company. Mr. Vijay Sheth and Mr. BharatSheth who currently manage the company have taken the positions of Mr. K.M.Sheth and Mr.Sudhir Mulji. The latter however, due to their vast experiences, continue to provide valuableguidance to their successors.
Organization Structure
Capital HistoryFrom To Paid-up Shares (No's) Face Value (Rs) Paid-up Capital (Rs
*OPM without including gain on sale of ships and other assets is 39.8% in Q2FY04.
Q2FY04• The company registered an increase in income from operations and sales (including gain on
sale of ships and other assets) of 7.2% to Rs2752mn in Q2FY04, as against Rs2568mn inQ2FY03. Other income increased by 287.3% to Rs186mn from Rs48mn for the sameperiod, due to dividend income and interest refund from Income Tax. The segmentalanalysis of the company revealed that, in Q2FY04, the shipping division contributed around67.78% to total revenues, offshore division contributed around 23% to total revenueswhereas others contributed around 9.22% to total revenues.
• The operating margin of the company stood at 41.8% in Q2FY04. It dipped by 200 basispoints from 43.8% in Q2FY03, mainly due to 36.6% increase in repairs and maintenanceexpenditure and other operating expenditure, which increased by 22.2% to Rs367.6mn inQ2FY04 from Rs300.7mn in Q2FY03.
• The net profit significantly increased by 41.2% to Rs801.2mn in Q2FY04 as againstRs567.3mn in Q2FY03.
H1FY04For the first H1FY04, the income from operations and sales of the company (including gain onsale of ships and other assets) stood at Rs5697mn, an increase of 18.1% when compared toRs4825mn in H1FY03. For H1FY04, the shipping division contributed around 68.1% to thetotal revenue and 60.7% to the PBIT, whereas the offshore division contributed around 24% tothe total revenue and 27.3% to the PBIT. The net profit rose by 104% and stood at Rs1763.5mn.
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OutlookThe company is well placed in both its divisions, shipping as well as offshore activities. In ascenario of increasing freight rates and low capacity, the company is adding more ships to itsfleet. A good proportion of its tonnage, which is uncovered, can take advantage of rising spotrates. Positive changes in the industry like the probable implementation of tonnage tax willimprove revenues further. The company has a well-diversified fleet of offshore vessels. Most ofthem are already deployed for a majority of the year. The stock is available at a P/E of 9.2xFY04E earnings.
Positive factors like corporate image restructuring, possible addition to tonnage, better assetutilization spell good times ahead for Essar Shipping. We recommend a BUY as the stock as itis available at an attractive P/E of 10x based on FY04E earnings.
Transformation from ‘transporter’ to ‘solutions provider’The company is changing its focus from being a transporter to a solutions provider in the seatransportation industry. ESL wants to control the full supply chain logistics of crude oiltransportation. The company believes that it is very important to provide clients optimizationsolutions in sea transportation in order to reduce their transportation costs. ESL calls thisconcept “rig to refinery and beyond”. It provides clients transportation facilities starting fromthe rig where the oil is generated to the refinery and transportation of the final product. Thisprocess includes large ships for sea travel, small ships doing lighterage operations, storagefacilities, etc. ESL manages to achieve this with optimum transportation cost and minimuminventory cost. ESL does not do just Port A to Port B shipping rather it covers the entire valuechain of sea transport. In their services, they study the oil refinery, its planned output, thecountry from where the crude will be imported, the most cost effective method of transportingthe crude oil, etc.
Increased refineries in the countryThe growth of ESL is expected to come from this segment going ahead. As more petroleumrefineries are being set up in India, it will lead to more import of crude oil and export of endproducts. The company plans to serve the value chain of oil exploration, production and export.The company also expects to provide profitable integrated coastal services to address non-pipeline transport requirements.
Double hull tankers as a plus pointThe company’s fleet of 6 double hull tankers should be seen as an added advantage consideringthe stringent EU norms and the growing awareness for quality fleet.
Reduced interest costThe company has plans to refinance US$30mn of its debt in order to take advantage of reducedinterest rates. This move will reduce the debt-financing burden of the company by almostUS$3mn. The benefits of this move are likely to be materialized partly in the coming monthsthis year and fully from FY05 onwards.
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Company BackgroundEssar Shipping Limited (ESL) is one of the world's leading integrated sea logistics companieswith an asset capitalization of US$1bn. ESL operates in two main segments, energytransportation (Energy Transportation Group) and coastal transportation (Integrated CoastalTransportation Group).
The Energy Transportation Group provides sea transportation management services to theglobal energy industry. While the Integrated Coastal Transport Group provides supply chainmanagement services for the sea transportation of bulk cargo and refined products.
ESL provides crude oil transportation and sea transportation management services to US,European and Indian oil majors. ESL has over 20 years of oil handling experience. Over the last10 years the company’s fleet has handled 900 million barrels of crude oil over 3.6m nauticalmiles. ESL's fleet handles a daily average of six billion barrels of crude, 475,000 barrels ofpetroleum products and 430,000 tons of dry cargo. ESL also provides sea transportation andsupply chain management services for the steel, power, cement and fertilizer companies inSoutheast Asia and India. Currently ESL is focused on getting a high geographical market sharein terms of energy transportation.
Fleet DetailsThe company has a diversified fleet of ships. It has a presence in bulk carriers, product carriersas well as crude carriers. Its fleet of 6 Suezmax tankers is one of the largest in the world. Thetotal fleet consists of 32ships with a capacity of 1.4mn DWT comprising 14% of Indianshipping fleet. The average age of the fleet is 14 years, as compared to world average of 19years. ESL uses a combination of time charter and voyage charters (spot) in its contracts. Thecompany is currently working with 94% asset utilization.
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Segment Type Units Capacity (DWT)Capesize 2 251,753Bulk carrierHandy max/size 4 145,153
Corporate StructureESL has 3 subsidiaries under it. Essar International Limited is ESL’s 100% owned subsidiarytaking care of international operations. It focuses on providing services to international clientslike Exxon Mobil, Chevron Texaco, etc. Vadinar Oil Terminal Limited is another 100%subsidiary of ESL that takes care of the company’s terminal business. ESL also holds 97% inEssar Sisco Ship Management Company (ESSMC). ESSMC is a shell company holdinginvestments in non-shipping business like investments in Essar Steel Limited and Essar OilLimited. ESL has separated the 3 companies in order to enable the investors to differentiate therevenues generated and the risk faced by each business.
Capital HistoryFrom To Paid-up Shares (No's) Reason Face Value (Rs) Paid-up Capital (Rs mn)
The company reported a 24.5% growth in topline to Rs1.3bn in Q2FY04.The operating marginsof the company have improved by more than 1000 basis points to 39.8% in Q2FY04. This ismainly because of reduction in fleet operating expenditure to 42.8% (as a percentage of sales) inQ2FY04 as compared to 50% in the same quarter last year. Growth in income from operationsand increase in operating margins is reflected in a rise of 196.3% in net profits to Rs211mn inQ2FY04 from Rs71.2mn in Q2FY03. This translates into an annualized EPS of Rs2.80.
In H1FY04 the company has posted 30.2% rise in net sales to Rs2.7bn and 392.6% rise in netprofit to Rs513.8mn. The EPS for H1FY04 stands at Rs3.40. The company has managed toconstantly de-leverage itself in the previous five years. The D/E ratio of the company hasreduced from 1.55 in FY00 to 0.46 in Q2FY04.
OutlookPositive factors like corporate image restructuring, possible addition to tonnage, better assetutilization spell good times ahead for Essar Shipping. We recommend a BUY as the stock as itis available at an attractive P/E of 10x based on FY04E earnings.
Projected Income StatementYear to (Rs mn) 03/02 03/03 03/04EFreight, charter hire 4802 4797 5277Income from Operations 4802 4797 5277Other income 112 106 109Profit/(loss) on sale of ships 49 58 116Total income 4962 4961 5502
Wages of floating staff (542) (559) (586)Repairs & maintenance - fleet (504) (192) (206)Other operating expenses (1593) (1896) (2322)Other expenses (239) (312) (350)Cost of sales (2878) (2959) (3114)PBIDT 2084 2003 2389Interest (566) (716) (625)PBDT 1518 1287 1763Depreciation (735) (669) (676)Profit before Tax 784 618 1087Provision for tax 939 15 (109)Profit after tax 1723 633 979Adjusted PAT 1723 633 979
SCI is the largest Indian shipping company controlling over 40% of shipping tonnage. Thecompany plans to take advantage of the industry upswing with aggressive growth plansirrespective of its divestment status. The stock is available at a P/E of 17.4 times FY04Eearnings of Rs11 per share. We believe the company is a good investment bet given its size andgrowth potential.
Investment Rationale
DivestmentAs per our expectation, divestment of 51% stake of Government of India holding in SCI willtake some time as government keeps busy with ONGC and GAIL divestment. We believe thatthe stock may be driven more by divestment triggers than fundamentals. With the divestmentscenario improving in the country, it makes financial sense to hold on to the stock.
Increase in fleet underwaySCI had consciously slow paced its capital acquisition programme in the past in light of thedivestment initiatives of the government. In its tenth 5-year plan the company had planned acapital expenditure of US$1.2bn (approximately Rs58bn). The company had not kept pace withthis target. The total investment in H1FY04 was around US$227mn (US$130mn for acquiring 2VLCCs and US$97mn for 2 Suezmax tankers).
It is expected that some of the restrictions, related to capital acquisition projects, imposed onSCI by the government will be relaxed soon. SCI is now looking forward to expanding its fleetat a rapid pace. The company is expecting delivery of the 2 Suezmax tankers (named m.t. DeshShakti and m.t. Desh Shanti) in February 2004 and May 2004 respectively. The tankers havebeen ordered with M/s. Daewoo Shipbuilding and Marine Engineering Company Limited, SouthKorea respectively.
Diversified FleetSCI, due to its sheer size, has a presence across all segments of the shipping business. Withincreasing demand of marine trade, the company has over the years, diversified into a largenumber of areas, and is today the only Indian shipping company operating Break-Bulk service,International Container service, Passenger service, Liquid/Dry Bulk transportation service etc.Presence across a large number of segments helps the company attain stability and avoidvolatility in earnings due to poor performance of a particular segment.
Proactive boardSCI’s board is making efforts to be more proactive and flexible like other private sectorshipping companies. It is planning to induct young professionals in the senior management as itsofficers reach super annuation. This move will help the public Sector Company to take less timeto decide on issues involving huge capital outlay.
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Company BackgroundThe Shipping Corporation of India was established by the amalgamation of Eastern ShippingCorporation and Western Shipping Corporation on 2nd October 1961. The companycommenced operations as a marginal Liner shipping company with just 19 vessels. Today, afterover four decades SCI has grown into a giant conglomerate having substantial interests in 12different segments of the shipping trade. SCI has a significant presence on the global maritimemap and is India’s largest shipping line that owns and operates about 40% of the Indian tonnageand has a presence in practically all areas of shipping business servicing both national andinternational trades.
Vessels on orderOwn Vessels Number DWT ShipyardCrude oil tanker 2 146,860 Daewoo Shipbuilding and Marine Engineering Co. Ltd.Crude oil tanker 2 300,000 Hyundai Heavy Industries Co. Ltd.LNG(in joint venture with JapaneseLines)
2 80,000 Daewoo Shipbuilding and Marine Engineering Co. Ltd.
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Organization structure
SCI is organized into 3 operating divisions (I above) supported by 2 service divisions (II & IIIabove). Each division headed at the corporate level by a full time Director forming a CorporateGroup. The Corporate Group works under the overall direction and control of the Chairman andthe Managing Director. The SCI board is headed by the Chairman and Managing Director, 5 fulltime directors of respective divisions and 7 part time directors (2 official and 5 non-official)nominated by Government of India.
OutlookThe stock is available at a P/E of 17.4 times FY04E earnings of Rs11 per share. The companyplans to take advantage of the industry upswing with aggressive growth plans irrespective of itsdivestment status. We believe the company is a good investment bet given its size and growthpotential.
SCI reported a 20% increase in sales to Rs7.18bn in Q2FY04 from Rs5.97bn in Q2FY03. Otherincome for the quarter increased by 9.9% to Rs62.4mn from Rs56.8mn. The operating profitmargin increased to 23.4% in Q2FY04 as against 12.3% in Q2FY03. The total expenditureincreased by 5.3% to Rs5.5bn from Rs5.2bn in Q2FY03. Operating profit for Q2FY04 increasedby 128% to Rs1.68bn from Rs0.73bn in Q2FY03. The company reported net profit of Rs801mnin Q2FY04, up by 4% from Rs770mn in Q2FY03.
For H1FY04 the total sales were Rs14.99bn, 33.9% higher than that in H1FY04. The net profitof the company stood at Rs2.3bn, which translates into a half-yearly annualized EPS of 16.3.The Company declared a special interim dividend of 170% (Rs17 per share) out of GeneralReserve on October 03, 2003.
VSL has a stable revenue stream with modest growth in top line. Majority of its fleet is on longterm contracts. Significant growth in earnings is can be expected if company undertakescapacity addition. The stock is trading at a P/E of 7.8 times FY04E EPS of Rs4.1
Strong hold in LPG carrier marketVSL is a market leader in terms of tonnage in LPG carriers transporting 61% of total LPGimports of India. There are only 2 players in India having LPG carriers excluding VSL – SCIand GE Shipping. LPG carriers are technologically superior and it takes a high degree of skill tomanage them. The availability of good LPG carriers in the world is limited. There are not manyoperators in this segment. The crew required for maintaining a LPG carrier has to be skilled andexperienced. These factors serve as entry barriers for most other companies while the companyis well placed with 4 LPG carriers. The company’s LPG carrier in the international marketcommands great credibility due to its efficient management. It has been in use for almost 100%of the days till date.
Vessels deployed on long term contractsMost of the company’s vessels are deployed on long term contracts. This strategy ensuressteady revenue stream for the company and reduces the risk of sudden movement in bulk rates.This however means that the company is not in a position to take advantage of the increasedfreights rates in the recent past.
Most vessels are medium size vesselsMost of the company’s vessels are medium sized. The company has 3 medium range productcarriers between 30,000-37,000DWT, 1 Handymax vessel in the bulk carrier category and 2small chemical carriers. The advantage of medium to small sized vessels is that they arerelatively less susceptible to rate fluctuations. This is one of the reasons why the company hasbeen able to perform satisfactorily even in worst times of the industry cycle.
Addition to fleet underwayVSL is planning to add 2 more vessels to its fleet. We expect the additions to be in the crudecarrier segment and the dry bulk segment. The reasons for this assumption are as follows: The company has a strong hold in the LPG market and thus should look at developing
presence in other areas of business The demand for crude carrier tonnage is on the rise due to increasing refining activity in the
country The demand for dry bulk tonnage is also rising due to low capacity additions and increased
transport of dry cargo.
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Company BackgroundVSL is one of the leading private sector companies in India owning and operating 12 vessels infour sectors viz. the LPG, petroleum products/easy chemicals, dry bulk and offshore sector.VSL was the first Indian company to commercially operate LPG carriers in India and as on dateowns 61 per cent of the total Indian LPG tonnage including the largest LPG carrier in India.Varun set up a subsidiary, viz. VSC International Pte Ltd in Singapore in 1995 which presentlyowns two offshore supply vessels.
Fleet DetailsThe company has a diversified mix of shipping vessels. The company earlier had two bulkcarriers out of which it sold one last year.
Segment Units CapacityLPG carriers* (LPG) 4 74520Chemical carrier (CC) 2 14648Product carrier (PC) 3 97241Handymax bulk carriers (BC) 1 42628Offshore supply vessels (OSV) 2 2172Total 12 231209* does not include dwt of LPG/C Maharshi Dattatreya
Capital HistoryFrom To Paid-up Equity Shares (No's) Reason Face Value (Rs) Paid-up Capital (RS mn)
The company recorded an increase in sales by 27% to Rs678mn in Q2FY04 as compared toRs534mn in the corresponding period in the previous year. Profit after tax for Q2FY04 was upby 391 per cent to Rs.51.08mn as compared to Rs.10.40mn for the corresponding quarter in theprevious year.
OutlookThe company's turnover for the year ended 31st March 2003 was Rs.2302.57mn and its netprofit was Rs.113.83 million. VSL has a stable revenue stream with stable growth rate in topline. Majority of its fleet is on long term contracts. Significant growth in earnings is expected ifcompany undertakes capacity addition. In our projections we have assumed that to takeadvantage of the upswing in the industry, the company will add a vessel to its tonnage beforeend of FY04. The stock is trading at a P/E of 7.8 times FY04E EPS of Rs4.1
Projected Income StatementYear to (Rs mn) 03/02 03/03 03/04EIncome from Operations 2,128 2,303 2,648Other income 9 15 15Profit on Sale of Ships 0 50 50Total income 2,137 2,367 2,713
Company bagged MRPL contract worth Rs1bn for 8 monthsThe company bagged a contact from Mangalore Refineries and Petrochemicals (MRPL) fortransporting crude oil from the Gulf coast to Mangalore. The contract is for a period of 8months from August 2003 to March 2004 and involves importing 4.2million tons of crude oilwithin that period. The company agreed to take the contract at a rate of about 5$ per tonne forcarrying 4-6 parcels per month.
Company bagged IOC contract worth Rs600mn for one yearAfter the MRPL contract, the company bagged another contract from the Indian Oil Corporation(IOC) for the coastal movement of crude imported by the latter. The contact, which is for aperiod of 1year starting from October 2003, has 2 provisions for extension for another sixmonths. The company has offered a time charter rate of UD$17,500/day for the contract.
Increasing FleetThe company has taken advantage of the limited availability of Aframax tankers for the Indianoil industry. In this financial year itself, the company acquired 4 Aframax tankers with a totalinvestment of Rs1.5bn, increasing its tonnage capacity 4 times to 470,948DWT.
Focused playerThe company works the concept of return on investment for its growth plans. The company hasalways utilized its resources in exploring the most profitable sector of the shipping industry. It isfor this very reason the company has shifted its attention from transportation of bulk cargo onthe coast to transportation of liquid cargo in the port area. This policy of the company has paiddividends, which is apparent from the performance of the company. The company also windedup its trading business contributing 2% of revenues as it was a non-core activity and profitmargins in that segment were very low.
Most ships on long tern contractsMost of the company’s tankers are on long term contracts. Out of the 9 tankers that thecompany current owns, 4 tankers are on a long-term charter with IOC and 3 on a long-termcharter outside the country. The latest 1986 build Aframax (the ninth tanker) scheduled to jointhe company very soon will also be fixed up on a long-term charter.
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Wet Bulk Dry Bulk
Lighterage Shipping
Business Divisions
Issues of Concern
Single hull shipsMost of the company’s ships are single hull ships. Single hull ships are considered as lowquality ships because they are more prone to environmental hazards. The Economic Union andrecently the United States also laid restrictions on the use of single hull ships. In the long run,most of these ships will become obsolete and will have to be replaced by double hull ships.
Lower asset utilization going aheadThe company’s strategy of acquiring old second hand single hull vessels has proved to bebeneficial in the short run. The company has managed to grab good orders based on its pricingadvantage. We however think that the company will face some trouble to achieve full utilizationof assets once the orders are completed.
Company BackgroundMercator Lines Limited (MLL) is a coastal shipping company specializing in tanker tonnagewith growing presence in the international market too. It was incorporated on November 24,1983, as a Private Limited Company and was converted into a Public Limited Company onApril 3, 1984. The carrying capacity of the company has grown from about 4000 DWT in 1994to over 370,949DWT till November 30 2003. The company acquired another Aframax tanker(1986 built 99,999M/tons DWT) on December 1, 2003 which is expected to join the company’sexisting fleet by end of the month. With this, the total tonnage of the company will add up to470948DWT by the end of 2003. On December 3, 2003 Credit Analysis & Research Limitedupgraded the rating of Secured Redeemable Non-Convertible Debentures (NCDs) issued byMercator Lines Limited from CARE AA- (Double A minus) to CARE AA (Double A).
Business Divisions
MLL has two divisions viz. Lighterage (dry and wet cargo)and Shipping (tanker division). Lighterage division involvestransporting cargo both, wet and dry, from large vessels tothe shore with the help of smaller vessels like barges. Thelighterage division operates primarily in the Mumbai Portand has a dominant market share of about 65% in the region.It handles bulk liquids like petroleum products, edible oilsand specialty chemicals. The shipping division is engaged inthe coastal and international movement of petroleumproducts and other liquid cargo.
The company registered 191% jump in top line in Q2FY04. The net profit of the companyshowed a rise of 847% to Rs84mn in Q2FY04 from Rs9mn in Q2FY03. For H1FY04, the topline recorded a rise of 142% in net sales to Rs738mn. The rise in revenues is due to the additionof 3 Aframax tankers to the fleet in that period.
OutlookThe company’s strategy of acquiring old second hand single hull vessels has proved to bebeneficial in the short run. The company has managed to grab good orders based on its pricingadvantage. We however think that the company will face some trouble to achieve full utilizationof assets once the orders are completed. The stock price has moved up a lot in the last fewmonths. We recommend that profits should be booked on the stock at these levels.
Projected Income StatementYear to (Rs mn) 03/02 03/03 03/04EIncome from Operations 531.9 612.1 2,242.8Other income 12.3 2.4 2.4Profit on Sale of Ships 18.0 10.1 0Total income 562.1 624.6 2,245.1
Assumptions:• MRPL order is worth Rs945mn as 4.2 million tons of crude oil will be transported at the rate
of 5$/tonne in a period of 8 months starting August 2003• Revenues from MRPL contract are expected to be generated evenly throughout the period
The IOC order is worth Rs575mn (approximately) as 2 Aframax tankers are deployed withIOC for the order at the rate of UD$17,500/day for a period of 12 months starting October2003.
• Revenues from IOC contract are expected to be generated evenly throughout the period• Conversion rate of Rs45:UD$1 is assumed for calculations
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India Steamship Company Limited
One of the smaller companies in the shipping industry, which is expected to benefit from theshipping cycle upswing, is India Steamship. After making losses for the last few years, thecompany is now on a turnaround. The stock is trading at a P/E of 6x FY04E earnings.
Acquisition of shipsOn April 1, 2003 the company acquired a 1987 built 89960dwt Aframax oil tanker at a cost ofUS$13.3mn. The acquisition was part financed through a foreign currency loan from ICICIBank. This acquisition has taken the company’s fleet tally to two tankers. This has enabled thecompany to turnaround its business by reporting a net profit of Rs56.8mn on a turnover ofRs393.7mn for the six-month period ended September 30, 2003.A fleet of atleast 2 Aframax tankers is generally required in order to bid for contracts of oilcompanies. The company is planning to acquire one more Aframax. According to industrysources, the company has already inspected 15 Aframax vessels and has short-listed a couple ofvessels. The company is expected to finalize the acquisition in a few days.
Cost containment and efficiency improvementCost containment and efficiency improvement measures are being pursued by the company likeheightened ship maintenance, VRS for excess manpower, retirement of interest bearing debts.
Planned diversificationThe company is planning to diversify in LPG- Ammonia Carrier for transportation of ammoniaimports and chemical tanker for transportation of Phosphoric acid imports which arerequirements of group companies. Thus the company might be able to get a captive customerfor its vessels.
ManagementThe company belongs to the Birla Group of companies, one of the oldest business houses in thecountry. Currently the company is lead under the superior management capabilities of ShriAshok Kak who is responsible for the turnaround of the company.Shri. Ashok Kak joined as the Managing Director on May 10, 2002 for a tenure of three years.Shri Ashok Kak is a senior executive with over 40 years of operating experience. Hisbackground includes multi-discipline /multi-functional assignments in diverse companies likeEssco-Hindustan Petroleum, Associated Cement Companies and Eastman Kodak, where he wasespecially challenged in the areas of new business development, profitability improvement andturnaround situations. Immediately prior to his joining India Steamship Company, he was self-employed for a number of years, based in the United States of America.Shri. Kak is an experience-based strategic thinker, with strong operating and marketing skills,international capabilities and hands-on experience in new business development, internationalcontracting and diversification. He is a key resource for the turnaround of the company.
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Company backgroundIndia Steamship Company Limited belongs to the K K Birla Group of companies. The companywas experiencing years of declining sales/profitability and sometime back, with the approval ofthe government of India, completed a scheme for one-time settlement of its outstanding debts.
FleetCurrently the company has a total capacity of 150,685dwt. The company plans to expand anddiversify into other vessels in the future.Type Name Capacity (DWT) Age DeploymentAframax Tanker Ratna Shalini 89960 16 GE Shipping Co. LimitedPanamax Tanker Ratna Abha 60725 21 A petroleum Co. in Middle-EastTotal 150685
Capital HistoryFrom To Paid-up Shares (No's) Reason Face Value (Rs) Paid-up Capital (Rs mn)
In Company registered a 158% increase in sales to Rs169mn in Q2FY04 as compared toRs65mn in Q2FY03. The operating margins of the company improved drastically form anegative 30% to positive 31%. The cost cutting measures of the company has started paying off.The company recorded profits of Rs31mn in Q2FY04. For the first half of FY04, the annualizedEPS of the company stood at Rs1.6.
OutlookIndia Steamship is expected to be a major beneficiary of the shipping cycle upswing. With goodmanagement, asset acquisitions and corporate restructuring, the company is well placed for aturnaround. The stock is trading at a P/E of 6x FY04E earnings.
Baltic Freight Index (BFI) [Base: 1985 = 1,000] is the barometer of freight rates for dry bulksegment. It is a weighted average of the actual freight rates of Panamax and Capesize vessels atany point of time on 11 specific routes, which represent important trade routes.
BunkersAll kinds of fuel consumed by the machinery on board a ship in order to operate.
CargoGoods, merchandise or commodities of any description, which may be carried aboard a vessel,in consideration of the freight, charged; does not include provisions and stores for use on board.
ContractAn agreement recognized and enforced by the law
Deadweight/Deadweight Tonnage (DWT)The lifting or carrying capacity of a ship when fully loaded. It includes cargo, bunkers, water,(potable, boiler, ballast), stores, passengers and crew.
DemurrageCompensation payable by the shipper or receiver or charterer to the carrier due to the excesstime taken for loading or unloading a vessel. Demurrage refers only to situations in which thecharterer or shipper or receiver (not the vessel's operator) is at fault.
FreightMoney charged by the carrier for transporting goods. The reward payable to the carrier for thecarriage and arrival of the goods in a merchantable condition, ready to be delivered to themerchant.
Gross Registered Tonnage (GRT)The volume of each vessel's enclosed area
Gross weightThe full weight of a shipment, including goods and packaging.
Net Registered Tonnage (NRT)The internal capacity of a vessel measured in units of 100 cubic feet less the space occupied byboilers, engines, shaft alleys, chain lockers, officer's and crew quarters and other spaces notavailable for carrying passengers or freight. Net registered tonnage is usually referred to asregistered tonnage or net tonnage.
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IIL Shipping Index
The IIL Shipping Index consists of 4 stocks, viz, SCI, Great Eastern Shipping Company, EssarShipping Limited and Varun Shipping Limited based on their relative market capitalization.Return in the Index is calculated taking April 1 2003 as the base.
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