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GE Shipping: Turn of the cycle? - Views on News from Equitymaster
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GE Shipping: Turn of the cycle?
Jul 31, 2006

Introduction to results
Private sector shipping and offshore major, GE Shipping (GES) has announced a poor set of numbers for the first quarter of FY07, reporting a 4% YoY decline in revenues. Operating margins have, however, witnessed a strong 6% expansion, mainly on the back of lower repair & maintenance and direct operating expenses. Lower gains on sale of ships have had the most striking impact on the bottomline, which has declined by 22% YoY.

Financial performance snapshot
Rs m) 1QFY06 1QFY07 Change
Sales 5,764 5,529 -4.1%
Expenditure 2,979 2,524 -15.3%
Operating profit (EBDITA) 2,785 3,005 7.9%
Operating profit margin (%) 48.3% 54.4%  
Other income 218 291 33.2%
Interest 257 332 29.4%
Depreciation 767 846 10.2%
Profit before tax 1,979 2,118 7.0%
Extraordinary items 1,727 793 -54.1%
Tax 173 152 -12.1%
Profit after tax/(loss) 3,534 2,759 -21.9%
Net profit margin (%) 61.3% 49.9%  
No. of shares 190.3 190.3  
Diluted earnings per share (Rs)*   45.3  
P/E ratio (x)*   4.9  
* 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 74 vessels, including 40 ships (tonnage of 2.87 mdwt and average age of 12.6 years) and 34 offshore vessels. The company is predominantly focused in the crude and product transportation segment with largely 'Aframax' type tanker mix. The company also has presence in oil drilling rigs and marine construction through its offshore arm – Great Offshore – that will soon be demerged into a separate company.

What has driven performance in 1QFY07?

Shipping in rough waters: The shipping division, which had led GES’ growth in the past few quarters, faced tremendous pressure during 1QFY07, consequently showing a revenue decline of 22% YoY. Lower operating days and pressure on freight rates combined to inflict damage on the division’s performance. Shipping revenue days, at 3,612, were around 5% YoY lower than 3,783 days in 1QFY06. Also, average time charter yields (freight rates) declined across the range of vessels (see adjacent graph). The pressure was paramount in the dry bulk segment, where yields crashed by over 31% YoY. However, on a sequential basis, the maximum effect was seen in tanker yields, which declined by nearly 29% QoQ during 1QFY07.

As reported by Teekay Shipping, one of the major players in the tanker segment, pressure on tanker rates during the last few months has been a result of heavier than usual refinery maintenance in the US and Asia, planned maintenance at some of the oil fields in the North Sea, and production disruptions in Nigeria. However, GES’ management expects the situation to improve from here on, as recovery of refineries post the maintenance period and expected robust demand for gasoline and jet fuel shall lead to higher refining in the US, which will have a consequence in rise in imports. This shall consequently create a greater demand for tonnage. This effect has, in fact, already been seen in the initial part of 2QFY07 (July 2006), wherein rates of large vessels like VLCC and Aframax have more than doubled over rates prevailing in the beginning of May 2006.

Though the management expects tanker freights to remain healthy in the following quarters, we remain cautious in our view on the same, considering that much will depend on the demand and supply scenario prevailing in the tanker market. With supply outstripping demand in the recent past, consequently suppressing tanker freights, the future also warrants caution. In the dry bulk segment, the management expects rates to be firm, mainly due to continued growth in Asia thus leading to strong steel and energy demand.

Segment-wise performance…
  1QFY06 1QFY07 Change
Shipping      
Revenue 6,642 5,202 -21.7%
% share 86.2% 78.7%  
PBIT margin 55.0% 49.5%  
Offshore      
Revenue 716 1,159 61.8%
% share 9.3% 17.5%  
PBIT margin 29.4% 41.9%  
Others      
Revenue 351 252 -28.3%
% share 4.6% 3.8%  
PBIT margin 44.1% 96.1%  
Total      
Revenue 7,709 6,613 -14.2%
PBIT margin 52.1% 50.0%  

Offshore saves the skin: Carrying on from the strong performance recorded in 4QFY06, the offshore division performed superlatively during 1QFY07 as well, reporting revenue growth of 62% YoY. Apart from growth in the offshore fleet, the division’s superior performance during 1QFY07 should also be seen in light of a lower base in 1QFY06, when the rig ‘Kedarnath’ was undergoing repairs and was non-operational for a major part of the quarter. Poor weather conditions had also impacted performance of the offshore business during 1QFY06.

For FY07, the management expects utilisation to improve further on the back of increased exploration and production activities on the Indian coast. On the matter of demerger, the management has indicated that some issues still need to be resolved and the company is awaiting certain approvals. The effective date of the demerger will be announced post the approvals.

Lower R&M and direct operating costs aid margins: Led by lower repairs and maintenance costs and direct operating overheads, GES has reported a good 6% expansion in operating margins during 1QFY07. Based on segments, while PBIT margins of the shipping division declined to below 50%, from 55% in 1QFY06, the same for the offshore division expanded sharply to 42%, from less than 30% in 1QFY06.

Extraordinary impact on bottomline: Despite the growth in operating profits, led by improvement in operating margins, GES’ net profits declined sharply during 1QFY07. This was due mainly to lower gains on sale of ships (down 54% YoY) during the quarter. It must be remembered that, during 1QFY06, GES had recorded a large gain from sale of a VLCC (261,167 mdwt). Compared to that, the company sold a product tanker of 44,124 mdwt during 1QFY07. Excluding the extraordinary impact, GES’ bottomline has actually grown by 9% YoY during the quarter.

What to expect?
At the current price of Rs 224, the stock is trading at 1.2 times our estimated FY08 book value per share. We will be taking a re-look at our numbers considering the pressure expected on freight rates, a concern that we have been indicating for the past few quarters. We believe that prospects of the global shipping industry, going forward, shall be highly dependent on the levels of fleet addition and scrapping in the industry. As a matter of fact, the management estimates a net tanker fleet growth of 5% during FY07 (7% in FY06), on the back of relatively higher levels of scrapping. We shall update our subscribers with a view on the stock, post a research meeting with the management.

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