SCI FPO

Investors with a long-term perspective of at least two-three years can consider applying at cut off in the follow-on public offer (FPO) of The Shipping Corporation of India (SCI), the country's largest shipper (35 per cent share) in terms of Indian flagged tonnage.



The company's diversified fleet (bulk carriers, crude and oil product tankers, and container vessels among others) caters to a wide gamut of chartering requirements, in domestic and international markets.

At the announced price band (Rs 135 to Rs 140), the stock seems reasonably priced from a valuation perspective. At the upper end, the stock is at a discount to its book value per share (Rs 160), and discounts the trailing twelve month earnings by around 9 times. Retail bidders will get a 5 per cent discount on the final price.

Long-term benefits

An attractive price point blunts, to some extent, risks from headwinds being faced by the shipping industry in the near-to-medium term. Major among these are an expected oversupply situation in global shipping fleet over the next couple of years (with large orders placed earlier coming on-stream), concerns about growth moderating in China (a big driver for bulk goods such as iron ore and coal) and nervousness about the state of economic recovery in the US (the biggest consumer of energy fuels).

Global shipping freight rates, though higher than the all-time lows seen earlier, have suffered some reversal after a tentative pick-up in the first half of this calendar. This is reflected in the weakness in the Baltic Dry Index and the Baltic Tanker Indices.

Given the prevalent demand-supply dynamics in global fleet and goods transported, SCI's ongoing aggressive expansion plans may weigh down the company's financial performance in the near to mid-term.

The company's 26 vessels on order (expected to be delivered between 2011 and 2013) and additional order for 20 vessels planned for FY-2011 will result in a sharp increase in its current fleet strength of 77. Going forward, SCI plans to invest USD 4 billion to double its tonnage capacity from 5.37 million dead weight tonnage (DWT) currently to around 10 million DWT over the next five years.

While there may be short-term pain with increased depreciation and interest pressures, SCI's move to become significantly larger by taking advantage of depressed asset prices currently may well pay off when the fortunes of the cyclical shipping industry turn for the better.

That said, several older orders placed by the company at higher rates could be a drag. In any case, the new arrivals will decrease the average age of SCI's fleet (15.47 years currently), which will help improve realisations and reduce operating expenses.

While the global macro-economic environment remains unpredictable, significant opportunities in the domestic market hedge risks for players such as SCI, with domestic cabotage law providing preference to Indian flagged vessels in coastal trade. Besides, with the prognosis of healthy growth in the Indian economy, the country's international trade is also likely to keep pace. In the April to September 2010 period, India's exports and imports have grown 21.4 per cent and 23.2 per cent over the previous year.

Among other drivers, the huge coal import requirements for the rapidly growing power sector, increasing imports of crude oil, and India fast emerging as a refining hub should provide good opportunities for diversified players such as SCI.

Also, the company's tie-ups with SAIL and Coal India should provide sizeable business opportunities. In addition, the prospects for SCI's container vessels and offshore vessels look good, with increased manufacturing and energy exploration activity in the country.

With the share of Indian merchant fleet in the country's overseas trade being only around 9.5 per cent (down from 31.5 per cent in 1999-2000), there seems to be good scope for effective deployment of SCI's expanded fleet. Besides, the continued phasing out of single-hull tankers globally should ease supply overhang pressure to some extent.

Financials reviving

Like most other shippers, SCI had a difficult fiscal 2010, with income from operations and net profit declining by 20 per cent and 60 per cent over the previous year to Rs 3,460 crore and Rs 387 crore.

Both its major segments — bulk carriers and tankers (around 68 per cent of income in FY10), and liner (around 21 per cent of income) saw a sharp decline in profits (around 30 per cent and 50 per cent respectively).

The current fiscal has been better, with freight rates having revived relative to the same period previous year. The first quarter profits rose almost 60 per cent to Rs 191 crore while recent September quarter profits rose seven-fold to Rs 251 crore. Significantly, the liner division which had been making losses turned in profits in the first half. Net margin which had declined sharply in 2010 has revived and is above 20 per cent in the current fiscal. Return on net worth also improved from 6 per cent last fiscal to 12.7 per cent (annualised) in the first half.

The company's good cash position (Rs 2,310 crore) and low leverage (0.55) should help fund-raising for expansion plans. Going forward, the company should be able to manage a good showing in the current fiscal, helped by a low base effect. The real benefits of the expansion programme may however be visible only a couple of years down the line.

Other Risks

Given that more than 90 per cent of SCI's income is denominated in foreign currency, sustained appreciation in the rupee could impact its performance.

Proposed changes in the Direct Tax Code on the tonnage tax scheme (a presumptive taxation scheme for shipping companies) could result in a higher tax incidence. Also, the company's plans to get into other businesses such as ship-building, probably with an eye to backward integration, may expose the company to higher risks.

Issue details

The SCI offer comprises of a fresh issue and offer for sale of 42.35 million equity shares each. At the upper end of the band, the fresh issue would raise around Rs 593 crore, a chunk of which would be spent towards vessel acquisition. Total issue proceeds would be around Rs 1,186 crore. The offer opens on November 30 and closes on December 3.