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Mercator Lines: Research meet - Views on News from Equitymaster
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Mercator Lines: Research meet
Sep 17, 2008

We recently met the management of Mercator lines to understand the Indian shipping industry in general and the company in particular. Following are the extracts from the meeting. Shipping Industry
Ships

Ships are highly liquid assets. They can be bought and sold at a short notice and within a narrow range of the prevailing international prices. Hence the normal operations of a shipping company includes buying and selling of ships to exploit ship prices.

Most ships are financed by 10% to 20% equity and the balance in debt. Hence the debt equity ratio of a shipping company rises sharply when it acquires ships. Given the liquid nature of shipping assets, shipping companies can bear a high debt equity ratio. The tenor of debt is typically 8 years. Companies payback around 80% of the debt by that time and keep about 20 to 30%, which they refinance.

Deployment of ships: Types of charters
Customers hire Vessels in 3 ways – Voyage charter, Time charter and Bareboat charter. In voyage charter, the customer takes the vessel for a specific voyage of say 1 month. Under a voyage charter, the shipping company bears the bunker (fuel) cost and port dues. A customer who needs to ship cargo frequently hires a vessel under a time charter. The period of time charter can last from 5 years for bulk carriers to 1 year for tankers. During this period, the customer conducts multiple voyages. Under a time charter, the customer meets the bunker cost and port dues. A customer might also opt for leasing a ship on a bareboat basis. Under a bareboat charter, he bears all the ship operating expenses in addition to the bunker cost and port dues.

Company’s costs under the 3 types of charters

Particulars Bareboat Time Charter Voyage Charter
Topline - - 100
Bunker - - 40
Port dues - -
TCY* - 60 60
Ship opex - 10 10
EBITDA 50 50 50
*Time Charter Yield or Net freight

The Benchmark rates:Time Charter Yield
While the topline is a function of time under a time charter, it is a function of the quantity of cargo under a voyage charter. The net freight from a vessel is expressed as Time Charter Yield (TCY). TCY is expressed on a per day basis for both types of charters. TCY rates for different types of vessels can be compared with international benchmarks.

Management nimbleness
The management of shipping companies need to be nimble. Firstly, they need to take quick decisions in buying and selling ships and exploit price movement in shipping assets. Secondly, they need to deploy the vessels in such a manner as to make acquisitions viable. For example, shipping companies try to arrange back-to-back time charters for a new ship so that the earnings from the charters equals the debt raised for acquiring the ship (i.e 80 % of the ship’s purchase price).

Mercator lines
Business segments

The company is the 2nd largest (in terms of tonnage) private shipping company in India. It operates 12 bulk carriers, 13 tankers and 4 dredgers. It has also ventured into oilrigs and coal mining.

Acquisition policy
The company prefers acquiring existing ships instead of placing orders with shipyards for two reasons. First, it avoids the risk of delayed delivery, given the order book size of shipyards the world over. Second, it avoids the unproductive blockage of capital for 3 to 4 years. It may be noted that Mercator does have to pay a premium for buying existing ships.

Spot rates vs. Time charter
Mercator deploys roughly 70% of its fleet under a time charter basis and 30% on a voyage charter basis. For bulk carriers, about 80% are under time charter basis while for tankers it is about 50%. Time charter rates are generally lower than spot rates. The company prefers time charters in order to lock in favorable rates in advance. However, most shipping companies deploy very large crude carriers (VLCCs) on a spot basis in a bid to capture upswings in TCYs (tends to be very volatile for VLCCs).

Future plans
Mercator has diversified into the dredging segment to counter the cyclicality of the cargo business. With a life of around 20 years, dredgers are required in ports throughout the year. They require an investment of US$ 80 m per unit and have a payback period of 4 to 5 years. The company also plans to get into oilrigs business with its first oilrig coming on stream in March 09.

The company has already incurred a capex to the tune of US$500 m during the current fiscal. The capex is towards 1 VLCC, 1 dredger and 2 Singapore-based vessels. Due to element of debt financing, the company’s debt equity ratio will go up in FY09 from the level of 0.8 in FY08.

  • Also read - A look at the shipping industry – I

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