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Shiploads of Fortunes

ABG Shipyard is expected to be a major beneficiary of the robust domestic & international shipbuilding industry

ABG Shipyard formerly known as Magdalla Shipyard Private Ltd, is the flagship company of the ABG Group. The company is into shipbuilding and ship-repair activities. It has the distinction of being the largest private sector shipbuilding yard in India.

ABG Shipyard's state-of-the-art manufacturing facilities in Surat, is spread across 32.54 acres. This shipyard has the capacity to construct 23 ships on a modular basis. The yard has been certified by DNV - one of the world's leading registrars for certification as ISO 9001:2000 compliant.

The company is expanding its manufacturing facility in Surat and setting up a new shipyard in Dahej as well. The new facility in Dahej will have the capacity to build eight large vessels a year, ranging from Handymax and Panamax to Aframax.

These expansion plans have been financed through a mix of initial public offer proceeds, debt and private placement of equity. ABG raised Rs 157 crore through its maiden public offer, a majority of which would be utilized to fund the Dahej shipyard.

Investment Rationale
Diversified Product Portfolio
Shipbuilding sector is directly related to the fortunes of the shipping industry, which is cyclical by nature. Hence, to de-risk this factor, ABG has diversified its vessel offerings by catering to the oil and gas sector, short sea trade and the coast guard. The company has built support and utility vessels for oil and gas companies, and pollution control and interceptor vessels for the coast guard. These vessels are always in demand and provide a cushion to the company whereby it is not severely affected by the volatility in the shipping cycle.

Demand for Off-shore Vehicles
Of late, oil prices have touched record highs and that has led to a dramatic rise in the level of exploration activities with several oilrigs being set up. Normally, a single oilrig requires about 15 off-shore vehicles (OSV), which is an investment of around Rs 300 crore per rig, considering an average cost of Rs 18 crore to 20 crore for one OSV. In such a situation, the demand for OSVs is expected to be very strong. OSVs contribute about 30 per cent of ABG's order book. Recently, ABG bagged an order worth US$480 million from Essar Oilfields Limited, Mauritius to build tow self-elevating rigs as well.

Extension of Subsidy
Governments across the globe provide assistance to their domestic shipbuilding industry in the form of subsidy. Some countries like China provide assistance in the form of zero per cent interest and tax benefits. Such assistances have helped Asian companies out price their Indian peers in global biddings in the past. However, in 2002, the Indian government started a subsidy scheme under which it provides a 30 per cent subsidy for all export orders and domestic orders for ships greater than 80 meters. Such subsidy income, which constitutes about 16 per cent of ABG's shipbuilding revenues, will boost its earnings and enable it to compete with its international peers.

High Replacement Demand
The International Maritime Organisation has issued a directive to phase out all single-hull tankers by 2010 to reduce oil pollution in the oceans. This regulation will accelerate the demand for double-hull tankers. Furthermore, the average age of an Indian fleet is about 16 years. This factor will add to the replacement demand since 60 per cent of the current Indian fleet would need to be replaced within five years. ABG, which is expanding its capacity, would be optimally placed to capitalize on this buoyant demand.

Risks & Concerns
Discontinuation of Subsidy
Subsidy accounts for nearly 16 per cent of ABG's shipbuilding revenues and 13 per cent of the total revenue. Shipping Ministry of India is to provide subsidies worth Rs 400 crore to two major private shipyards, ABG and Bharti, but only ABG has received any amount from the ministry, and that too only Rs 20 crore. While the industry players are confident about receiving the subsidy, the wait may be longer. Furthermore, there are talks about the subsidy being cut down to 20 per cent.

Competition from Domestic, International Players
Domestic competitors include state-owned shipyards like Cochin Shipyard and private sector players, Bharti Shipyard are strong competitors. The company also has to compete against Chinese and South Korean companies. The competition can affect ABG's pricing and impact margins.

Order Cancellations
The shipbuilding sector has borne the brunt of the global trade and economic slowdown in the form of fewer new shipbuilding orders along with the cancellation of existing orders. However, the management of ABG has indicated that they have not witnessed any cancellations till now. Furthermore, ABG receives 20 per of the order amount as a non-refundable advance, which reduces the chances of an order being cancelled.

Valuations
ABG trades at 3.5x FY09E earnings and 2.2x FY10E earnings. Concerns of global economic growth slowing down and the credit crunch have led to decline in stock prices of shipbuilding companies. ABG's order book in excess of 10x FY08 revenues provides sustained revenue visibility, but concerns of current global trade slowdown and the renewal of subsidy by the Government of India prevail. ABG is at a 30 per cent discount to global average at 4.21x CY09E earnings. The target price would be at Rs 160, which means an upside of 38 per cent from current level.



Financials
  FY 06  FY 07  FY 08
Net Sales (Rs cr) 541.74 704.36 977.26
PAT (Rs cr)* 72.38 104.11 152.17
EPS (Rs) 19.77 22.84 31.55
RONW (%) 27.43 21.57 24.92
ROCE (%) 54.4 39.28 43.52
FY ending March 31 each year
*Net of non-recurring transactions

Source: ICICI Direct