Though the first nine months performance of GE Shipping was disappointing in light of weakness in world economy and the consequent impact on freight earnings, the company has reaped the benefit of an upturn in 4QFY03. While revenues have increased by 4%, higher realisation and capacity utilisation have led to a noticeable improvement in operating margins in the same period. The better than expected 4QFY03 numbers have improved FY03 performance as well.
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Just to highlight the recovery in freight rates in 4QFY03, consider the following facts. Firstly, GE Shipping is predominantly focused in the crude and product transportation segment with largely 'Aframax' type tanker mix (74% of the total capacity are tankers). Since the company has a large presence in this category, it benefits from any rise in crude production by the OPEC. This is because tanker rates are largely driven by OPEC's decision to hike/lower crude output, which in turn is determined by the industrial activity in key economies like US, Europe and Japan.
Whilst the world economy slowed down, crude prices remained firm throughout the year. This was on account of various factors like Venezualan strike, disruption in crude output in select African countries like Nigeria, spurt in fuel demand in the US during the winter and the Iraq war. However, in 4QFY03, OPEC hiked crude output to soften prices. Though there has been a significant flow of capacities in the tanker segment (in terms of tonnage), higher output benefits tanker players. As a result, crude carrier earnings gained by 10% and 6% as compared to the trend in 4QFY02 and 3QFY03 respectively. With 24% of tonnage capacity in the dry bulk segment, GE Shipping has also benefited to the spurt in freight rate arising from higher demand for steel. Average earnings for dry bulk carriers increased by 10% in 4QFY03 as compared to 3QFY03. Since the company's dry bulk fleet is largely in the spot market, it was able to take complete advantage of the improvement.
The result of the rise in earnings is reflected in the company's 4QFY03 results with topline increasing by 4%. This is contrary to the trend in 1QFY03, 2QFY03 and 3QFY03 where revenues fell by 36%, 16% and 17% respectively on a YoY basis. Since shipping companies operate with high fixed costs, any sharp rise in earnings tends to have a positive impact on margins (defined in financial terms as operating leverage). The improvement in margins in 4QFY03 for GE Shipping has to be viewed in this context. This has had a favorable impact on full year margins as well. Compared to 220 basis points fall in operating margins for 9mFY03, FY03 margins have increased marginally. Extraordinary income for FY03 includes profit from sale of ships to the tune of Rs 160 m and gain from sale of residual real estate to the extent of Rs 98 m. Excluding gains, net profit for FY03 is actually lower by 8%.
The stock currently trades at Rs 43 implying a P/E multiple of 3.8x FY03 earnings. Though the company expects tanker and dry bulk earnings to grow, we expect this to be short-term in nature. Cumulative tanker deliveries in FY03 and FY04 is estimated at around 27 and 15 m dead weight tonnage (dwt). To put things in perspective, this surmounts to 10% of existing tanker capacity. With such a large inflow combined with a weakening demand scenario, further rise in freight rates for the tanker market from the current levels seem stiff. In this context, we expect earnings growth of the company to continue to remain weak in FY04 as well.
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