Great Eastern Shipping Company

 

 

Great Eastern Shipping Company (GESCO) is into two businesses: shipping and offshore. In 2005, it decided to demerge the offshore business into a separate company, Great Offshore Limited, with an independent board. Moreover, it is planning to list its wholly owned subsidiary, Greatship (India) Limited (GIL).

 

Sectoral overview

Shipping is a global business where performance is closely linked to the state of the global economy. According to Fitch ratings, the outlook for the Indian shipping industry is negative in 2010. The sector is closely linked to trends in global trade. A weak demand scenario has led to increased competition and low freight rates. Assets acquired in the last two to three years (at peak prices) are now producing low yields - at times below break-even point. Companies with long-term contracts have been shielded to some extent from the sharp decline. However, these contracts generally have a tenure of one year, and it is likely that charter rates will see some reduction upon renewal. The industry is plagued by excess capacity across various sectors - tankers, bulk carriers and container ships - and declining freight or charter rates. Fitch expects rates to remain low in 2010.

 

World oil demand in 2010 is expected to be 86.6 million barrels per day, which is about 2 per cent higher than in 2009, as per the International Energy Agency. Specifically, demand from non-OECD nations, especially from fast-growing nations like India and China, is expected to improve the demand for tankers. In the medium to long term, significant refinery expansion in the Middle East and Asia will lead to higher tanker demand due to increase in the ton-mile situation. But on the supply side, despite scrapping and slippages, strong fleet expansion is expected to keep fleet utilisation under pressure.

 

The company

The promoters of GESCO are the Mulji (Sheth) Brothers and the Bhiwandiwalla family. With a net income of Rs 3,092 crore as on March 2009, GESCO is India's largest private-sector shipping company. The shipping business involves transportation of crude oil, petroleum products, gas and dry bulk commodities. The offshore business provides services to oil companies in carrying out offshore exploration and production (E&P) activities. Currently, the company has 37 vessels comprising 31 tankers with average age of 10.9 years and six dry bulk carriers with average age of 13.6 years.

 

Strengths

Robust long-term performance: The company's profit after tax has grown at a five-year compounded annual growth rate (CAGR) of 24 per cent, and sales at a five year-CAGR of 16 per cent. Healthy quarterly result: In Q4FY10, the company's consolidated net profit grew 24.1 per cent year-on-year (y-o-y) and jumped nearly 65.0 per cent quarter-on-quarter. Consolidated revenue fell 1.0 per cent y-o-y. However, it improved sequentially by 8.6 per cent (q-o-q basis). GESCO posted a healthy growth in the fourth quarter on account of firm rates in crude and bulk segment and strong revenue growth in the offshore segment which stood at 126.1 per cent y-o-y during the period.

As for margins, operating profit margin (OPM) stood at 41.2 per cent, an increase of 2,414 basis points (bps) y-o-y and 1,294 bps q-o-q during the March quarter. Net profit margin stood at 20.3 per cent, rising 411 bps y-o-y and 695 bps q-o-q during the period. GESCO has a healthy balance sheet with high cash balance of Rs 2,218 crore as on March 2009 which translates into a significant cash per share of Rs 165.  The company has a very good client base. With such a high cash balance it is in a comfortable position to service its debts.

 

Growing offshore book: A well-capitalised balance sheet and a growing offshore book are expected be a strong annuity for the company.

 

Weaknesses

Being a prominent player in the shipping industry, the company is exposed to economic risk, volatility and foreign exchange risk. Further, any decline in oil demand could negatively impact tanker freight rates. Although the current order book for tankers and dry bulk remains high, excess supply of fleet may affect vessel rates adversely. The actual supply of fleet in the shipping industry is likely to be lower due to order book delays and cancellation as well as fleet scrapping. Moreover, the continuing upward movement in dry bulk rates is largely dependent on China's sustained raw material consumption. If China does not sustain its pace of consumption, dry bulk freight rates may be hit.

 

Desai believes that since the management is conservative , profitability is capped to a certain extent in a rising freight-rate scenario as the management locks around 50 per cent of vessels in time charter, i.e., on contract basis.

 

Growth opportunities

Committed capex plans. GESCO currently has a total capex commitment of USD 577 million, which translates to approximately Rs 2,712 crore at current exchange rates. This will result in addition of three tankers and five dry bulk carriers.

 

Earnings expectations. The company is expected to deliver a robust performance in the coming years. We expect 45.0 per cent CAGR in bottom line to Rs 1,079 crore and 18.0 per cent CAGR in revenue to Rs 3,980 crore over FY10-12E. This will be driven by addition of vessels and higher freight rates.

 

GIL IPO to unlock value. The company intends to list its 100 per cent subsidiary, GIL, by the end of FY2011 through fresh equity issuance. This will unlock the potential value of the offshore business, which globally trades at a higher multiple than the shipping business due to better stability and high earnings visibility.

 

Valuations

The company's debt to equity ratio on a consolidated basis is reasonable at 0.93. It has displayed consistent growth in earnings per share (EPS) for the last ten years; however, EPS dropped nearly 71 per cent compared to the previous year and stood at Rs 25.99 in FY10.

 

At a market price of Rs 289.70, the stock is trading at a 12-month trailing price-to-earnings ratio (PE) of 20.62 (as on May 28, 2010). This is much higher than the five-year median PE which is 5.6.

 

Should you buy?

The company has displayed consistent growth in the past. The stock is trading at a significant discount to its global peers. Moreover, operating cash flow has seen consistent growth which has enabled the company to maintain its dividend-paying track record. The company has managed to deliver an admirable performance despite a volatile freight-rate environment. If the world economy and international trades improves, the company's performance will improve.

 

Given the decline in EPS in FY10 results, the stock price should correct. Buy when the PE ratio gets closer to its five-year median.