IPO Analysis - Pipavav Shipyard

Long journey on premium cruise

Currently in a cyclical downturn, the uptrend does not seem to be on the horizon for the ship-building industry

Pipavav Shipyard is setting up a modern shipyard at a cost of Rs 2995.18 crore on the west coast of the country adjacent to Pipavav Port in Amreli district of Gujarat. Originally promoted by SKIL Infrastructure and Grevek Investments in 1997 as Pipavav Ship Dismantling and Engineering, the present name was acquired in April 2005 to reflect the change in its main business to shipbuilding and ship-repair. Punj Lloyd joined as co-promoters in September 2007. It will hold a 19.43% stake in the post-issue equity capital. The other original promoters, SKIL Infra and Grevek, will own about 18.27% and 1.85%, respectively, of the post-issue capital.

On completion of the construction of a shipyard, Pipavav Shipyard will have the capability to construct and repair a wide range of vessels up to 4,00,000 dead weight tonnage (DWT) including very large crude carriers (VLCCs) and large naval and coast-guard Vessels.

Pipavav Shipyard comprises two sites: a special economic zone (SEZ) unit located on about 95 hectares and an export-oriented unit (EoU) on about 103.92 hectares aggregating nearly 198.92 hectares. A block-making unit and part of the fabrication facility comprises the SEZ unit located in a SEZ owned by E Complex, a wholly owned subsidiary of the company. The shipyard site consisting of the dry dock is part of the EoU, which is 4.5 km from the SEZ unit. An internal road constructed by Pipavav Shipyard links the block-assembly area and the dock site.

Two Goliath cranes, with lifting capacity of 600 tonnes, will service the dry dock, with 662 metres of length and 65 metres. Currently, it is the largest dry dock in India and can accommodate two-and-a-half Panamax vessel or one VLCC or four small vessels at a time for construction.

A major part of construction of the shipyard is complete, barring installation of two Goliath cranes. Construction of the first of the two Goliath cranes will be completed end September 2009 and the second by October 2009. Work on the shipyard will be over by October 2009. Having completed the construction and installation of equipment at modular fabrication and other allied facilities, Pipavav Shipyard has commenced commercial operations with the building of modules of ships from 1 April 2009. The company is targeting to deliver the first Panamax vessel on April 2010 with subsequent deliveries expected to occur at intervals ranging from one to three months thereafter.

Due to the changed market composition, Pipavav Shipyard decided to put up a dedicated facility to cater to offshore business including development of an offshore yard, dredging in the sea face in front of offshore yard for load-out, construction of workshops, building of internal roads and installation of equipment. Construction of the exclusive offshore yard will complete in all respect by March 2010. Through the offshore yard, the company aims to offer products and services such as offshore platforms, rigs, jackets and vessels (excluding sub-sea pipelines) for oil and gas companies.

As it does not have prior experience in shipbuilding, Pipavav Shipyard has executed cooperation agreements with various companies that have substantial experience in this business. For instance, it has tied up with KOMAC, a Korean ship designing and consulting firm, to provide ship designs, drawings, plans and documents; procurement support for supply of non-Indian-sourced shipbuilding materials, shipboard machineries and equipment; production management services related to the start-up and initial operation of Pipavav Shipyard; and technical support services for the construction of the Panamax bulk carriers. It has entered into agreements with PILS Company of South Korea, a procurement and logistics firm, to assist it with the procurement of certain component parts for production, and has executed a technical assistance agreement with SembCorp, a company operating shipyards and offshore construction and fabrication facilities in Singapore. For building offshore supply vessels(OSVs), the company has roped in Jurong Shipyard of Singapore as technical collaborator.

Pipavav Shipyard proposes to utilise the proceeds of the issue to fund the construction of facilities for shipbuilding, ship repair and offshore yard (Rs 179.27 crore), as margin for working capital (Rs 244.04 crore), and for general corporate purpose.

Strengths

Has firm orders from Golden Ocean (of Bermuda) and AVGI (of Greece) for construction of 10 Panamax bulk carriers of 74,500 DWT each. The aggregate value of the orders is Rs 1788 crore (or US$ 373.52 million), with the delivery starting April 2010 and ending by May 2012. Has also received notification of award of contract for construction of 12 OSVs from ONGC. The order value is Rs 535 crore. Thus, the order book excluding the contract under renegotiation (eight Panamax vessels) and arbitration (four Panamax vessels) stood at Rs 2323 crore. Renegotiating with clients Golden Ocean and AVGI to construct two and six Panamax vessels, respectively. The client will get an option to take delivery or terminate the contract by paying option fee.

Punj Lloyd, as a co-promoter, to conduct all its offshore business (excluding construction and fabrication of sub-sea pipeline) in India through the company or as a consortium partner with the company. This will facilitate pre-quality and successful bagging of orders in niche offshore product segments.

Employs modular process of shipbuilding, enabling it to simultaneously fabricate various parts of ship. Moreover, the longest dry dock and huge Goliath cranes give an edge in launching the vessel by drastically cutting down the dry-docking time of a vessel. Has installed high capacity machines such as a 1,600-tonne steel plate press that will facilitate processing thicker steel plates used in submarines. Has access to skilled manpower at globally competitive cost. Modern shipbuilding facility backed by skilled manpower will facilitate quality offerings at globally competitive prices.

Tax benefits under SEZ and EOU as modular fabrication unit is located in a SEZ and the shipyard in an EOU. However, the notification issued by the Union government in March 2009 stipulated capping total benefits accruing to shipyards located in SEZs from the subsidy plus any other benefits and incentives from the Central government at 30% instead of the earlier policy of shipyards getting 30% subsidy in addition to any other available benefits and incentives.

Weaknesses

The global shipbuilding industry has been going through a cyclical downturn since the second half of calendar year (CY) 2008. After a boom in order intake, there have been hardly any major new orders for commercial vessels in the past year. Few orders were booked at very low prices by public-sector yards in China. Instead, the sector is witnessing order cancellations and rescheduling of delivery dates. The slump in orders are due to soft freight rates and fall in prices and rise in availability of second-hand vessels. According to statistics released by the Japan Ship Exporters' Association (JSEA), backlogs held by the Japanese builders dwindled to 60.16 million gross registered tonnage (GRT) end July 2009 from 70.94 million GRT in September 2008. While the long-term prospects of the shipbuilding industry is good, no one is ready to hazard a guess on the bounce-back, which depends on pick-up in freight rates and scrapping of older vessels. . If the market does not pick up till 2011, then the situation could worsen as most of the current order backlog of the existing yards will get over by then, and competition will intensify for new orders, further affecting realisation.

Two major players such as South Korea and Japan, with reputation for quality, might shift their focus to hitherto ignored niche OSVs due to the downturn in the shipbuilding industry. As a result, competition is set to intensify for the Indian shipbuilding industry primarily comprising small players.

Currently, major firm orders are for building commercial ships and not naval and coast-guard vessels. However, small inroads have been made in OSVs by bagging an order for 12 OSVs from ONGC. Commercial shipbuilding is cyclical and it is currently going through a rough patch, with no major orders in the last 12 months. Cancellation of orders or deferment of delivery has become common. Being not an exception to the general trend in the industry, is currently involved in arbitration with one of its clients, Setaf, which had singed contract for four Panamax vessels. The arbitration is over whether the client has the right to cancel the order. Similarly, also renegotiating with Ocean Green and AVGI for a total of eight Panamax vessels. Naval contracts are less cyclical to commercial shipbuilding.

Lacks experience and prequalification for large ticket orders, especially in the offshore market.

Foreign direct investment (FDI) in any company in the defence sector is capped at 26% of the equity capital and requires prior approval of the Foreign Investment Promotion Board. Pre issue aggregate foreign investment stands at 28.62%. Post issue it will come down to 24.96%. May be required to comply with the FDI guidelines to qualify for naval contracts. Failure could affect prospects in the lucrative naval and coast-guard orders.

Currently does not have in-house capability to make basic design for shipbuilding. It bought basic design from KOMAC for Panamax vessels and does the process design engineering in-house.

Current firm order book after considering the delivery schedule of vessels will result in only 56% capacity utilization of the fabrication and dry dock. Thus, optimum utilisation depends on bagging fresh orders, especially orders with shorter delivery schedule.

Any spurt in material/steel cost will affect profitability as prices of orders are fixed.

Shipbuilding orders taken after 14 August 2007 are not eligible for the shipbuilding subsidy of 30%. This has put Indian ship builders at a cost disadvantage as major shipbuilding nations across the world are providing incentives to their shipbuilding industry. Though the order book of 22 Panamax vessels (including orders renegotiated and in arbitration) is eligible for shipbuilding subsidy, replacement orders (fresh order in place of cancelled order) are not eligible for subsidy.

After changing its business from ship dismantling to ship building in 2002-03, has gone through the corporate debt restructuring (CDR) for loans taken to finance construction of ship-dismantling facility. As it has paid the lenders, currently not subject to the CDR scheme. However, rescheduled part of its long-term debts (principal) including loan from HUDCO and IL&FS amounted to Rs 77.46 crore end March 2009 .

Poor corporate governance track record of promoters and directors is a concern. Trading in Horizon Infrastructure, in which promoters and directors Nikhil Gandhi, Bhavesh Gandhi are also directors, has been suspended by the NSE due to non-compliance with the technical and procedural requirements of the listing agreement with the NSE. Following satisfactory redressal, the NSE ended the suspension. Trading was allowed from 25 January 2008. However, Sebi is currently conducting a preliminary investigation into the price movement and transaction post lifting of suspension. Moreover, there are criminal and legal proceedings against certain directors, promoters and promoter group entities.

Part of the equity shares held by the promoters, SKIL and Grevek Investments and Finance, and pledged with certain lenders prior to the filing of the red herring prospectus, has been temporarily released so as to comply with the requirement of Sebi, with specific understanding between promoters, company and lenders. These will be re-pledged on 31 October 2009 in favour of lenders unless the promoters have repaid all amounts due and outstanding.

Foreign institutional investors, who will hold 24.96% of the post-issue equity, are not bound by the lock-in period and are free to sell most of their stake post listing. This may affect the share price of the company on listing.

Valuation

Since the shipyard is still under construction and commercial operation commenced only on 1 April 2009, cost related to the project has been treated as project development expense pending capitalisation in the fiscal ended March 2009. Hence, the profit and loss account is not representative of the operations.

The order book at Rs 2323 crore (excluding orders under renegotiation and arbitration) is relatively small compared with domestic peers who boast of strong order books, with a diversified mix. Pipavav Shipyard's order book including contract under renegotiation but excluding under arbitration was about Rs 3769.9 crore. The order book of Bharati Shipyard was Rs 5065.5 crore with pending execution at over Rs 3106.49 crore end June 2009 and that of ABG Shipyard was at Rs 12474 crore end May 2009.

Post-IPO, the market cap of Pipavav Shipyard will stand at Rs 3994.79 crore (at the upper price band) and Rs 3661.89 (at the lower price band) compared with ABG Shipyard's current market cap of Rs 1283.18 crore and that of Bharati Shipyard's Rs 559.12 crore. The enterprise value to order book excluding contracts under renegotiation and arbitration at offer price of Rs 55-60 is 2.1-2.2. In comparison, the enterprise value to order book of ABG Shipyard stands at 0.2.

Pipavav Shipyard, with the largest and a modern shipbuilding facility in India, will be ideally placed to capitalise on the uptrend in the shipbuilding industry as and when it comes. However, as of now, it looks like the uptrend in the shipbuilding industry will take a long time to come.