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G.E. Shipping: Research meeting extracts
Sep 12, 2005

We had recently met with the management of G.E. Shipping (GES) to gain first hand information of the demerger plan of the offshore business and what are the expectations from the future. Here are the key extracts of the meeting.

On the ‘crude’ reality
GES’ management is of the belief that not the high price of crude but the longevity of the prices remaining high is what can affect the global shipping industry. Also, in the shipping business, crude production and demand/consumption drivers have a greater affect then the prices. This is the reason that shipping capacity continues to remain in high demand despite the rise in crude prices. Also, as per the management, there is a certain amount of speculation involved in this spike in global crude prices and the same has been more impacted by ‘paper-trading’ from hedge fund positions.

The extent of speculation can be gauged from the fact that, during the second quarter of the current calender year 2005, the spike in crude prices was despite a 2% sequential fall in demand and a 1% rise in production.

View on China
The management believes that the ‘China fear’ of a hard landing has reduced since the past few months. Also, it has indicated that while there has been reduction in growth numbers (especially growth in oil and commodity consumption) coming out of the Chinese economy, the absolute amount has only increased over the past.

On asset prices
The management indicated that asset prices, both for new-building and second-hand ships, have fallen by 10%-18% in the first half of FY06 and expects them correct further in the second half. However, the correction is likely to be more prominent in single hull tankers than in the double hull category. Around 45% of GES’ tanker capacity is double hull compliant, with 60% being the global average. Also, it is not mandatory for the company to convert its single hulls into double hulls before 2008.

Plans in the LNG sector
Along with other players like Varun Shipping, Qatar Shipping and Essar Shipping, GES has evinced interest in transporting LNG for the Rs 20 bn Petronet LNG terminal at Kochi.

On global fleet
As per GES, the net fleet growth is expected to be around 6% in the current calender year with a gross addition of 10 mdwt. The current world tanker fleet stands at about 345 mdwt with another 90 m dwt likely to come in the next few years (as per the current order backlog). Around 5 mdwt of the current tonnage is likely to be scrapped in 2005, with 4 mdwt already scrapped in the first eight months of the year. The global dry bulk capacity stands at 335 mdwt.

On GES’ fleet
GES' current fleet of 75 vessels comprises 44 ships (an aggregate tonnage of over 2.9 m dwt) and 31 offshore vessels (17 Offshore Support Vessels, 2 Drilling Rigs, 1 Construction Barge, 11 Harbour Tugs). The company’s current new building order book comprises 5 MR Product Tankers (aggregating 0.2 m dwt) and 7 offshore support vessels with an aggregate committed capex of around US$ 250 m in the next two years. Out of this, while US$ 180 m is likely to be expended in the shipping business, the rest will come in the offshore segment that will soon be demerged into a separate company.

On offshore demerger
The management has indicated that traditionally, shipping companies globally have leveraged up to 1 time their networth (have a debt to equity ratio of 1:1). This is because of the volatile nature of the global shipping industry. Now, offshore companies can go for an aggressive leverage due to the stable nature of the business and the longer-term duration of contracts. In fact, the debt to equity ratio in this business can go to as much as 2:1 or 3:1. This demerger will, thus, enable the offshore business of GES to borrow more for furthering its expansion plans, which was earlier dependent on the larger shipping business. This, the management has indicated as one of the key rationale for the demerger.

Offshore business’ performance
  FY05 1QFY06
Revenues 3,500 720
Share in total revenues 16.0% 9.3%
NP 960 180
NPM 27.0% 25.0%
     

The process of demerger will take about 6-8 months (by March 2006) and the management had earlier indicated that there might be suspension in listing of GES’ stock for a week when the new shares are listed and share capital is reduced.

The NAV of the offshore business as at the end of June 2005 was RS 50 per share while the NAV of the shipping business was Rs 232 per share. The management has indicated spending

What to expect?
At the current price of Rs 207, GES’ stock is trading at a price to earnings multiple of 1.1 times our estimated FY07 book value. Considering that we have assigned a price to book value band of 0.8 to 1.1 times for the company, the stock thus looks fairly valued from the medium term perspective. Investors should, however, note that these valuations are of the combined entity, which includes both the shipping and the offshore businesses. This apart, considering the fact that the volatility is likely to increase for the core shipping business as and when the offshore business is demerged, investors need to practice caution.

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