ABG Shipyard

Investors with a two-three-year perspective can consider limited exposure to the stock of ABG Shipyard. Lull in order flows, slower execution pace and liquidity issues, as a result of severe cash crunch faced by shipowners globally led to Indian shipyards being de-rated from an average price-earnings multiple of 12-18 times to less than five times.

However, with an order backlog of 5.2 times FY-10 sales and nil order cancellations in the worst of times, ABG Shipyard has also shown more indications of pick-up in execution pace and order flows compared with other players.

A superior order mix, quicker revival in earnings and additional rig facilities to cater to the offshore market make this stock a superior option in the Indian context. However, given that shipbuilding as a sector is not fully out of the woods, ABG Shipyard may at best be a dark horse play. Investors with some risk appetite can consider exposure to the stock.

At the current market price of Rs 250, the stock trades at about 5.5 times its estimated per share earnings for FY-11. This does not factor in any revenue potential from its subsidiary, Western India Shipyard, a loss-making ship repair entity that ABG acquired under a scheme of arrangement. However, ship-repair business could fetch lucrative operating margins of 25-30 per cent.

Indian edge

While lower order cancellations and improved execution pace are likely to provide relief for shipbuilders worldwide, orders may take time to pick up as revival across the globe remains painfully slow.

However, Indian shipyard players stand differentiated for three reasons: They hold a more diversified order book across segments compared with their South Korean and Chinese counterparts. Indian players most often gain repeat orders, thereby reducing risks of cancellations.

With improved capacities, Indian players would be better placed to take orders for larger-sized vessels that may provide better profit margins.

Chinese and South Korean shipbuilders — leaders in shipyards — have been concentrating on dry and wet bulk carriers and containership segments. Globally, a majority of sea-borne trade happens in the dry bulk carrier segment. However, as demand for dry bulk commodities such as coal and iron-ore is largely perceived to be driven by China, the outlook for this segment remains muted.

Interestingly, according to a CARE Research Report on the Global Shipbuilding Industry, Indian shipbuilders have diversified by constructing offshore and specialised vessels.

When viewed in terms of volume (dead weight tonnes), dry bulk account for 82 per cent of Indian players' order composition as a result of the larger size of dry bulk vessels.

However, in terms of number of vessels, offshore and specialised vessels account for a good 52 per cent of Indian players' order book as against 35 per cent of dry bulk.

In contrast, offshore and specialised vessels accounted for just 9 per cent (in terms of number of vessels) of China's order book and 5 per cent of Korea's orders.

It is, perhaps, this diversified profile that has provided some cushion to Indian players. ABG, for instance, witnessed a 37 per cent growth in revenues annually over the last two years, while net profits expanded by 14 per cent over the same period.

Offshore opportunity

Offshore vessels could also be an area that holds prospects over the long term. According to reports, close to 50 per cent of offshore vessels are over 25 years of age and need replacement.

Recent incidence of oil spill puts forth the need to have double hulls to reduce the impact of such accidents on the marine ecology.

Indian shipyards specialise in the construction of offshore vessels. For instance, ABG shipyard has a rig facility in its existing yard to cater to the increasing demand in this space. Besides, Indian shipyards have also been promised orders (for both public and private companies) by Defence, partly to combat recessionary times. Companies such as Larsen & Toubro have already been recipients of such orders.

Why ABG?

ABG Shipyard, Bharati Shipyard and Pipavav Shipyard are the three major players in the shipbuilding industry in India, aside of L&T's Greenfield project.

ABG tops the list in terms of volume of order book (86 as against 42 for Bharati).

While Pipavav holds larger capacity, the company has already faced order cancellations and is re-negotiating terms for a number of other orders, thus adding uncertainty on the revenue front.

The Bharati Shipyard stock has traditionally suffered a discount to ABG as a result of its high gearing.

While the company's recent stake in Great Offshore has brought with it business opportunities (and debt) in the offshore segment, its inability to bag orders in the mainstream business in recent times is a cause for worry.

The company is also reported to have taken a German customer to court after the latter cancelled an order.

ABG, on the other hand, has managed to get orders for cement carriers recently, thus bringing some relief on the order flow front.

Besides, the company has ramped up execution pace significantly, suggesting that clients have not been requesting for postponement of delivery.

The company delivered 17 vessels in FY-10 as against just six in FY-09. This increased execution also means that cash flows from clients would flow in at a faster pace.

For the full year ended FY-10, ABG's sales grew 28 per cent to Rs 1,807 crore while net profits expanded 22 per cent to Rs 208 crore.

However, for the March quarter, operating profit margins, excluding subsidies, fell sharply by 5 percentage points to 13.5 per cent over the previous quarter, suggesting that raw material costs are beginning to hurt once again.

As shipbuilders tend to have adequate stock of raw materials such as steel, there may not be too much volatility in input costs for a few quarters.

With debt of Rs 2,500 crore, ABG's debt-equity ratio has become more risky at 2.5 times. However, this appears to be largely a result of slower execution pace, which means longer periods of guarantees and higher working capital cycle.

With execution pace picking up, this may be expected to decline. Fund flows from clients such as Essar (financial closure being over) may help tide over immediate concerns.

via bL