Stock Review: Essar Shipping

ESSAR Shipping Ports & Logistics (ESPL) had recently announced a restructuring of its operations. This would help in greater management focus on its respective business lines. Furthermore, the demerged entity may find it easier to raise funds for expansion.
As part of the plan, ESPL would demerge its operations in shipping, logistics and oil fields into a separate entity, Essar Shipping. Also, its existing port operations would be housed in an entity called Essar Ports, and it would also merge two wholly-owned investment subsidiaries with itself. The two entities, Essar Shipping and Essar Port, would be listed shortly.

The company's port operations contributed just 14% of ESPL's FY10 revenue of 3,000 crore. Prior to this announcement, as per analysts' estimates, the sum of the part valuation of ESPL (ports, shipping, logistics and oilfields services businesses) ranged between 110 and 120 per share, with the port business accounting for a significant majority of this valuation. Under the restructuring, ESPL shareholders will get one share of Essar Shipping for every three shares held. The stock has traded in a range of 96 and 104, post the announcement in mid-August. Analysts highlight that when a diversified company demerges businesses, the parent often witnesses increase in its valuation due the unlocking of benefits of diversification. However, this may not necessarily be the case for ESPL. This is because the stock of ESPL (excluding the restructuring process) trades at more than 25 times its trailing four-quarter earnings and an immediate upside looks limited in the short term.

The demerger will help ESPL rationalise its capital allocation exercise. For instance, in FY10, its port business attracted one-third of capex, but contributed less than 15% to topline. With the demerger, the company would be able to cater to varying capital requirements of its businesses without pulling down the performance of other segments. The port business is inherently capital intensive and this move by the company's management appears logical to meet different funding requirements of its businesses. This restructuring plan has also come at a time when the company is aggressively expanding its capacities across its different business segments. In its port business, Essar is planning to grow its capacity from currently 76 million tonnes per annum to 158 million tonnes by 2013. The company had earlier highlighted that this would involve a capex of nearly 8,200 crore. In its shipping business, the capacity will increase from 25 vessels to 37 in the next two years.