ABG Shipyard

Valuations of the ABG Shipyard stock have moved up sooner than expected, owing to the rally it witnessed in the last six months on pick-up in orders and expectations of restoration in capital subsidy. The stock has gained 47 per cent from our ‘buy' recommendation in June 2010, thus capturing much of the potential we saw in the medium term.



Investors can take this opportunity to book profits in the stock and reduce their holdings. The conflicting signals emerging from the global shipbuilding industry, besides domestic issues such as meagre disbursal of capital subsidy and higher input costs, are causes for concern.

At the current market price of Rs 366, the stock trades at 9 times its estimated FY-12 earnings, at a premium to Bharati Shipyard and at par with Asian peers.

Global cues

ABG had a good September quarter with a 38 per cent growth in sales to Rs 555 crore and 33 per cent expansion in earnings to Rs 61 crore. Revenue booked on an order for a rig (from associate company) that was already under construction supported sales growth. While EBITDA margins at 25 per cent remained steady on a sequential basis, it is lower than the 28 per cent margins managed a year ago. This, despite ABG Shipyard's execution now being tilted in favour of rig orders, which typically enjoy superior margins. The lower margins appear to suggest that there could be pricing pressure. Reports also suggest that new vessel prices are still a good 20-30 per cent lower than their July 2008 peaks.

ABG Shipyard has managed export orders for rigs and vessels in the recently ended quarter taking its order backlog to over Rs 10,000 crore. The company has also so far not faced any cancellations. However, given that India is not among the favoured destinations for placing orders currently (India's share in global order inflows has declined from 1.5 per cent in 2007 to 0.1 per cent now), the recent orders won by ABG Shipyard could have come at the cost of compromising to an extent on profit margins. We do not expect profit margins to expand in the medium term.

Aside of pricing, higher cost of inputs such as steel can also weigh on profit margins. Though input costs marginally declined in the September quarter, it was a result of the company stocking up steel at lower prices. With execution proceeding at a good pace, it may not be long before higher the company feels the impact of higher steel prices.

Added to this, data from Rigzone (a database for the oil and gas industry) also indicate that global offshore rig utilisation has marginally declined to 75 per cent now, from 81 per cent six months ago. Any sustained decline in rig utilisation could result in postponement of orders already placed or affect future orders for shipbuilders especially in India, as Indian builders specialise in offshore rigs unlike their Asian peers who are more focussed on the dry bulk segment.

On the domestic front, limited disbursement of capital subsidy by the government has raised concerns on cash flows for shipbuilders. ABG Shipyard, for instance, has realised only a tenth of the Rs 520 crore of subsidy it has booked, even as Bharati Shipyard realised nothing.

ABG Shipyard though, received some relief through proceeds from sale of Great Offshore stock which it utilised to reduce debt. Decline in debt-equity ratio from a little over three times in March 2010 to 1.8 now, provides some relief on debt servicing and cash flows.

Triggers

Any renewal in the capital subsidy scheme may prove to be a short-term catalyst for the stock. The more critical factor to watch out for would be sustained inflow in orders. After an almost dry year in 2010, the company managed to bag a few orders in the last quarter of that year. A sustained revival in order inflows would be crucial for the sector to command higher valuations.