The Great Eastern Shipping Company

The continuing lacklustre run of the Baltic Indices (indicative of global shipping freight rates) over the past few months has resulted in many shipping stocks exhibiting weakness on the bourses. The Great Eastern Shipping Company (GESCO), India's largest private sector shipping company, too has not been immune to this.

The scrip gave up some of the gains seen in the last calendar and has lost almost 14 per cent since mid-November. Its current price of Rs 321, however, presents a good buying opportunity for investors willing to wait out for at least one to two years, by which time the cyclical industry's dynamics are likely to turn favourable.



Meanwhile, the inherent strengths of GESCO, which include a strong balance sheet, a young fleet and an increasing presence in the high-potential offshore business should see it tide over the present turbulence in the industry. Besides, at the current levels, valuations seem attractive, with the stock trading at a 16 per cent discount to the company's net asset value (Rs 382), and its trailing twelve month PE (around eight times) being at a discount to global shipping peers. Also, the company has consistently maintained a reasonable dividend yield of between 3 per cent and 6 per cent, even in difficult years. In the near-term, value unlocking through the proposed listing of the subsidiary which houses the offshore business, may provide a positive trigger for the stock.

Short-term pain

The global fleet oversupply situation of 2010 (when a chunk of orders placed in pre-recession boom period came on-stream) is likely to spill over into a good part of 2011 or even into early 2012. This is expected to keep freight rates depressed in 2011, despite continued increase in shipping trade volumes (both in the dry bulk and tanker shipping categories in which GESCO operates) flowing from an expected revival in the global economy. Consequently, growth metrics of shippers such as GESCO may be uninspiring in the near term, and margins may be under pressure. However, from a longer term perspective, once the oversupply situation runs its course (with few deliveries expected in 2012), the scales are expected to tilt back towards demand-supply equilibrium, which should provide good support to freight rates. In the interim, high level of slippages, cancellations, scrapping of older ships, and the continued phasing out of remaining single-hull tankers will also help to some extent.

By the time the cycle turns, GESCO would have expanded its fleet strength considerably in both its shipping and offshore businesses, helping it capitalise on an improved business situation. The company, which had earlier placed orders for five bulk carriers, three crude tankers, and eight offshore vessels is expected to take most of the deliveries in 2011 and 2012.

This will increase the existing fleet of 32 (27 tankers and 5 bulk carriers) in the shipping business by around 25 per cent, and add 1.31 million dead weight tonnage (dwt) to the present capacity of 2.49 dwt. Also, the fleet strength in the high-potential offshore business (which has provided good support to the company in the present difficult shipping conditions) will increase from the present 17 to 25. The new entrants will reduce the average age of the company's fleet (9.4 years currently in the shipping business), help improve realisations by commanding better rates (especially with the increased focus on modern safety equipment), and reduce downtime and operating costs.

The offshore hedge

The higher-margin offshore business of GESCO has been increasing its share in the company's business pie. This segment, comprising 15 operating vessels and two rigs, provides logistics, subsea and drilling services to oil companies engaged in offshore exploration and production activities. From around 20 per cent in the first half of FY 2010, the offshore segment accounted for almost 33 per cent of consolidated revenues in the corresponding period of 2011.

With segment profits more than doubling and margins in excess of 40 per cent, the offshore segment effectively shielded GESCO's bottom-line in H1-2011 despite the pressure on the top-line arising from a weak shipping business environment. Consequently, while the company's sales in the first half declined by around 8 per cent over the previous year to Rs 1,275 crore, profits grew by around 31 per cent to Rs 343 crore. Operating and net margins stood at 42 per cent and 27 per cent, significantly up from the previous year.

This helped the company stage a turnaround of sorts from the dismal performance (akin to most other shippers) in FY-2010, when consolidated sales and profits declined by 25 per cent and 64 per cent to Rs 2,856 crore and Rs 513 crore respectively.

Going forward, the offshore business could increase its share and continue to make up for the weakness in the shipping business in the near-term. An ascending trend in crude oil prices, which incentivises offshore exploration activities, should bode well for the prospects of GESCO's offshore segment. In this context, the planned public offering of the offshore business subsidiary Greatship (India) Limited may provide a positive trigger for GESCO's stock.

Balance-sheet strength

Consolidated debt at Rs 5,096 crore, as on September 30, is around 0.85 times the equity base. With almost all debt being dollar denominated, the cost of borrowing is low at around 5.5-6 per cent. Considering the strong cash position of Rs 1,619 crore, net debt-to-equity is less than 0.6, providing GESCO headroom to fund its fleet expansion.

Out of the current committed capex of $573 million (around Rs 2,500 crore) in the shipping business, $234 million (Rs 1,600 crore) has already been paid. Fleet expansion in the offshore segment could be part-funded from out of the proceeds of the Greatship IPO.

As on October 30 last year, the revenue visibility for the balance of FY-11, from charters already fixed was to the extent of Rs 336 crore.

The major risk to our recommendation is deterioration in global economic conditions, which could keep freight rates languishing.