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GE Shipping: Facing rough weather? - Views on News from Equitymaster
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GE Shipping: Facing rough weather?
Jan 30, 2006

Performance Summary
G.E. Shipping (GES), India’s largest private sector shipping company, has announced poor results for third quarter ended December 2005, with revenues and net profits declining by 4% YoY and 36% YoY respectively. The performance for the nine-month period has, however, been decent, thanks to the strong performance reported during the first half of the fiscal. Operating margins have, however, contracted for both the periods under consideration, mainly due to a sharp increase in direct operating expenses.

Financial performance: A snapshot
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 5,938 5,719 -3.7% 14,940 16,440 10.0%
Expenditure 2,462 3,193 29.7% 7,015 8,761 24.9%
Operating profit (EBDIT) 3,476 2,527 -27.3% 7,925 7,680 -3.1%
Operating profit margin (%) 58.5% 44.2%   53.0% 46.7%  
Other income 130 126 -3.1% 293 548 86.9%
Interest 210 317 51.0% 605 849 40.3%
Depreciation 684 797 16.4% 2,114 2,354 11.3%
Profit before tax 2,711 1,539 -43.2% 5,499 5,025 -8.6%
Extraordinary items 260 365 40.5% 240 2,438 915.8%
Tax 96 52 -45.8% 167 302 80.5%
Profit after tax/(loss) 2,875 1,852 -35.6% 5,571 7,161 28.5%
Net profit margin (%) 48.4% 32.4%   37.3% 43.6%  
No. of shares 190.3 190.3   190.3 190.3  
Diluted earnings per share* (Rs)         50.8  
P/E ratio* (x)         4.7  
* On a trailing 12-months basis            

About the company
GES is the largest private sector shipping company in India. Currently, the company has a fleet of 72 vessels, including 40 ships (tonnage of 2.8 mdwt (million dead weight tonnes) and 32 offshore vessels. The company is predominantly focused in the crude and product transportation segment with largely 'Aframax' type tanker mix (around 85% of the total capacity are tankers). The company has also diversified into oil drilling rigs, marine construction and air logistics.

What has driven performance in 3QFY06?
Shipping saves day: Compared to the growth of 66% YoY in 2QFY06, revenues from the shipping business grew by just 18% YoY during 3QFY06. But this was enough to tide over the lackluster performance of the offshore division, which reported a revenue decline of 9% during the quarter, thus adding to the topline pressure for GES. Decline in shipping business growth was on the back of lower realisations (freight rates) during 3QFY06, which, though higher than those reported in 2QFY06, were almost 35%-40% lower than the rates in 3QFY05. Weakness was seen both in the tanker and dry bulk segments, and was mainly perpetuated by increased supply of tonnage into the market.

Pressure on time charter yields
(US$/day) 3QFY05 3QFY06 Change
Crude carriers 40,592 28,490 -29.8%
Product carriers 17,102 19,896 16.3%
Dry bulk carriers 22,196 14,617 -34.1%
The sequential rise in freight rates during 3QFY06 was on the back of seasonal factors, which had earlier seen the rates weaken in 1QFY06. During 3QFY06, hurricane-related refinery outages in the US Gulf led to an increase in oil movements over longer distances and a recovery in rates across all tanker segments. However, a 4 mdwt sequential rise in the world tanker fleet and 0.7 mbpd (million barrels per day) decline in non-OPEC production pared the gains from the rise in freight rates during the quarter. The pace of new-building orders, however, reduced towards the latter part of the quarter, the benefits of which might be seen in 4QFY06. At the end of December 2005, the tanker orderbook (87.6 mdwt) represented 25% of the existing world tanker fleet (349 mdwt). As a matter of fact, global oil demand has increased from 81.9 mbpd in 2QFY05 to 82.5 mbpd in 3QFY06, a QoQ growth of 0.7%.

Segment-wise performance…
  3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Revenue 5,129 6,039 17.8% 12,223 17,093 39.8%
% share 81.0% 85.2%   79.0% 84.2%  
PBIT margin 52.5% 30.4%   43.7% 42.2%  
Revenue 946 864 -8.7% 2,593 2,358 -9.0%
% share 14.9% 12.2%   16.7% 11.6%  
PBIT margin 41.7% 30.3%   39.4% 31.0%  
Revenue 258 183 -29.0% 665 850 27.8%
% share 4.1% 2.6%   4.3% 4.2%  
PBIT margin 45.0% 92.7%   28.4% 60.4%  
Revenue 6,332 7,086 11.9% 15,481 20,302 31.1%
PBIT margin 50.6% 32.0%   42.3% 41.7%  
* Includes segmental other income            
* Includes segmental other income

Oversupply in the fleet market also took its toll on the dry bulk segment of the company. Incidentally, this was despite a strong Chinese iron ore demand. Indicative of this, the Baltic Exchange Dry Index declined by almost 30%, from 2,944 in October 2005 to 2,057 in January 2006.

Pressure on GES’ offshore division was on the back of reduced utilisation of the company’s vessels due to some technical glitches and poor weather conditions. The Court of Bombay has approved the Scheme of Arrangement for de-merger of the offshore business a separate company called Great Offshore, which shall help unlock value from the potentially strong and relatively stable offshore business.

Higher operating expenses dent margins: A 9.8% rise in direct operating expenditure (as % of sales) was the chief perpetrator behind the margin contraction for GES during 3QFY06. Repairs and maintenance and staff costs also had major role to play in the pressure on margins.

Cost break-up
(Rs m) 3QFY05 % of sales 3QFY06 % of sales
Staff 485 8.2% 569 9.9%
Repairs & maintenance 542 9.1% 833 14.6%
Direct operating 835 14.1% 1,366 23.9%
Other 558 9.4% 435 7.6%

Based on segments, while the shipping division reported a 22.1% contraction in PBIT margins during 3QFY06, offshore PBIT margins declined by 11.4%. As has been indicated in the past, shipping is a high operating leverage industry and has a high fixed cost component. As such, whenever there is a spurt/decline in the topline, the effect straight follows to the bottomline. Thus, while operating leverage is very beneficial during times of upturn, during bad times, the company is hit hard due to necessity to keep paying high fixed costs.

It flows to the bottomline: Decline in revenues and contraction in operating margins had its effect on the bottomline of GES, which declined by 36% YoY during 3QFY06. For the none-month period, a high extraordinary income of Rs 3.3 bn as gains on sale of ships in the first half, helped the bottomline record a 29% YoY growth. During the quarter, GES sold three Handysize dry bulk carriers and a double hull product carrier.

What to expect?
At the current price of Rs 243, the stock is trading at 0.9 times our estimated FY08 book value. The company board has declared a second interim dividend of Rs 2.5 per share (dividend yield of 1.0%). Considering the poor third quarter performance of GES, we shall have to take a re-look at our projections for the company.

Our fears regarding the sustainability in robust growth that the shipping industry reported during the past three years have come true. This was amply seen from the volatile freight rates and the consequent impact on GES during 3QFY06. While it is difficult to predict any business, more so the highly volatile shipping business, on a QoQ basis we believe that GES’ performance in the coming quarters will be highly dependent on the scale of tonnage addition and scrapping of the world tanker fleet. We also remain cautious on China and US growth, which have been the main factors behind the strong growth of the shipping industry during 2003 to 2005. Having said that, the offshore business, till it is de-merged into Great Offshore, shall provide some stability to the overall performance of GES.

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