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GE Shipping: Great expectations, but…

Apr 29, 2005

Performance Summary
G.E. Shipping (GES), India's largest private sector shipping company, has reported yet another quarter and year of robust performance. For FY05, while topline has grown by 52% YoY, profits are up 72% YoY. What is more, operating margins have expanded by a strong 390 basis points during the fiscal. Performance for the fourth quarter has been equally robust.

Financial performance: A snapshot
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Sales 4,620 5,552 20.2% 13,519 20,492 51.6%
Expenditure 2,141 2,587 20.8% 6,864 9,602 39.9%
Operating profit (EBDIT) 2,480 2,965 19.6% 6,656 10,890 63.6%
Operating profit margin (%) 53.7% 53.4%   49.2% 53.1%  
Other income 191 160 -16.2% 658 453 -31.2%
Interest 145 224 53.9% 470 829 76.5%
Depreciation 605 736 21.5% 2,012 2,850 41.6%
Profit before tax 1,920 2,166 12.8% 4,832 7,664 58.6%
Extraordinary items (26) (70) 123 170 38.5%
Tax 47 (421)   244 (254)  
Profit after tax/(loss) 1,848 2,517 36.2% 4,711 8,088 71.7%
Net profit margin (%) 40.0% 45.3%   34.8% 39.5%  
No. of shares 190.3 190.3   190.3 190.3  
Diluted earnings per share* (Rs) 38.8 52.9   24.8 42.5  
P/E ratio (x)         3.9  
(* annualised)            

About the company
GES is the largest private sector shipping company in India (owns almost 15% of the Indian shipping capacity). Currently, the company has a fleet of 73 vessels, including 42 ships (tonnage of 3.02 mdwt (million dead weight tonnes) and 31 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 FY05?
Shipping leads the charge: The shipping business of GES led the company's topline growth in FY05 with a YoY growth of 66% in revenues. The segment now contributes to around 79% of GES total revenues, up from 71% at the end of FY04. Buoyant demand for crude and the consequent strong demand for shipping capacity has led to freight rates remaining strong throughout the year. And this has contributed to the shipping business' strong growth. The performance of the division was equally strong in 4QFY05 and revenues here grew by 26% YoY. Apart from the strong freight rates, this was made possible by a 22% rise in shipping tonnage and 8% increase in revenues days for the company.

As a matter of fact, global oil demand has increased from 82.1 million barrels per day (mbpd) in 4QFY04 to 84.5 mbpd in 4QFY05, a YoY growth of 2.9%. On a QoQ basis, the growth in oil demand was 1.6%. China and North America accounted for a majority of the YoY demand in oil, and this has led to a sharp increase in the time charter yield for crude carriers (see table below) for GES.

Rising yields (TCY*/day)…
(US$) 4QFY04 4QFY05 Change
Crude carriers 31,400 37,866 20.6%
Product carriers 14,100 18,977 34.6%
Dry bulk carriers 19,300 23,899 23.8%
*Time Charter Yield = US$/day x Number of operating days

The dry bulk segment has also played an important role in the strong growth of GES' topline in this quarter and fiscal. During 4QFY05, a strong 6.5% YoY growth in global steel production and increase in coal trade contributed to the growth in the dry bulk market. Also, increased iron ore movement, especially on account of imports by China has led to buoyant dry bulk rates in the quarter. The performance of the offshore business (16% of revenues) was not in line with that seen by the shipping division. Revenues for the segment grew by a sedate 8% during the fiscal.

Operating leverage aids margin expansion: Lower than proportionate (relative to the topline) growth on the expenditure front has led to GES reporting margin expansion in both the quarter and the fiscal. Particularly, while staff expenses declined from 10.4% of sales in FY04 to 9.9% in FY05, repairs and maintenance costs moved down 120 basis points to 9.8% during the fiscal. Based on segments, while the shipping division has reported a 680 basis points improvement in its PBIT margins in FY05, those for the offshore division have declined by 360 basis points. Investors should note that shipping business benefits largely from the operating leverage. It has a high fixed cost component in its total cost and whenever there is a spurt in the topline (either due to rise in revenues days or robust freight rates or both), profits grow at a faster rate, which is what is reflected from the strong rise in margins in this quarter.

Margin expansion, tonnage tax benefits aid bottomline: Apart from the effects of a robust topline growth and expansion in margins, tax write-back due to benefits from the tonnage tax regime has helped GES report a strong growth in net profits for both 4QFY05 and FY05. The growth would have been higher but for the decline in other income component for both the periods.

What to expect?
At the current price of Rs 164, the stock is trading at a price to earnings multiple of 3.9 times FY05 earnings. The company board has declared a final dividend of Rs 3 per share (dividend yield of 1.9%). This takes the total dividend for FY05 to Rs 9 per share.

GES has outperformed our revenue and profit guidance by 5% and 12% respectively and the stock currently trades at a price to earnings multiple of 3.5 times our expected FY07 earnings. Also, the current market price implies a price to book value of 0.9 times our estimated FY07 book value per share for the company. We believe that at these valuations, the stock is fairly valued from a 2-year perspective.

GES has benefited in the FY05 from the buoyancy in global freight rates and strong growth in trade of commodities and crude. As per the management's pronouncement in the first half of the fiscal, the freight rates were likely to be volatile in the second half. And the fact is that they were very volatile on account of the Hurricane Ivan that knocked off around 500,000 bpd of US production. Also, low US oil inventory and a severe than expected winter added to the volatility. Considering these facts, the performance of GES is excellent.

For the future, we believe sustainability in growth is still an issue. Higher crude prices could impact the global economic growth momentum, which in turn could slowdown oil demand. Another factor to watch out for is the performance of the Chinese economy. If China were to slowdown, on the margin, there could be oversupply of fleet in select regions of the shipping market. As a result, freight rates are vulnerable. Also, as GES' management had indicated to us, any ‘shock' in form of the US economy slowdown might have a negative impact on the shipping industry's and GES' performance in the future. Having said that, there is likely to be stability on the offshore side of the business, which would act as a cushion in case the shipping cycle weakens significantly in the future.

We shall update our research report on the company after a meeting with the management.

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