Muted freight rates could impact revenues of shipping firms in the current year.
The decline in freight rates is certainly not good news for shipping companies and will keep their stock prices under pressure in the medium term. To begin with, the key Baltic Dry Index, which measures the cost of shipping commodities like iron ore, has fallen by half over the last month. However, its impact on Indian shipping companies is likely to be limited as, unlike the global shipping fleet of which nearly half is comprised of dry bulk carriers, the proportion in India of such carriers is about 16 per cent.
On the other hand, the rates on the tanker segment, which transports crude oil and its derivatives and constitute three quarters of the Indian shipping fleet, have been weak dropping 11-25 per cent over the last three months, and is a cause of worry. We look at the impact of the crash in dry bulk rates, demand for tankers and the outlook for Indian shipping companies.
| MIXED BAG | |||||
| FY12 estimates | EPS (Rs) | % chg | P/E (x) | EV/Ebitda (x) | ROCE (%) |
| Essar Shipping | 6.7 | 131.0 | 20.9 | 9.0 | 5.2 |
| GE Shipping | 46.8 | 37.6 | 6.4 | 5.3 | 7.5 |
| Mercator Lines | 5.0 | 284.0 | 9.8 | 3.3 | 6.4 |
| Shipping Corp | 7.3 | -14.0 | 22.1 | 11.2 | 5.4 |
| Varun Shipping* | --- | --- | --- | 8.2 | 3.5 |
| % change is y-o-y; * Loss making Source: Bloomberg, ICICI Securities | |||||
Dry bulk impact
Crisil Research believes private Indian shipping companies like GE Shipping, Mercator Lines and Essar Shipping have a majority of their ships on long-term contracts, which insulates them from spot rate fluctuations. Shipping Corporation of India (SCI), however, could be the worst hit as a higher proportion of its bulkers are exposed to the spot market.
The SCI scrip is down six per cent over the month, while stocks of other shipping companies are trading flat, or marginally in the red, over a one-month period. So, expect dry bulk rates to be weak on a supply overhang and weak Chinese demand.
Tankers: Mixed signals
Crude oil tanker freight rates, which dropped 11-25 per cent over the three-month period ended June, are likely to remain low in July on account of poor demand and a drop in crude oil shipments, according to ICICI Securities. Further, an oversupply of large carriers will mean tanker rates will be soft in the near term.
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On the other hand, the research firm believes the recovery in product carrier (represented by Baltic Clean Tanker index) rates is expected to continue in July. While crude oil prices remained range-bound in June and are currently trading at $76 a barrel, the demand outlook by the International Energy Agency is muted. It believes consumption would rise by a slower 1.6 per cent in 2011 (versus 2.1 per cent growth estimated in 2010) to 87.8 million barrels a day.
This is due to increasing end-use efficiency and gradual phasing out of economic stimulus in the developing world. ICICI Securities believes tanker rates would gradually improve over the current year with the phasing out of single-hull tankers, but the 10 per cent increase in the crude and product tanker fleet in 2010 will cap the gains.
GE Shipping
The company intends to add eight offshore vessels that will result in a more diversified vessel portfolio and stable revenue stream. The phasing out of single-hull carriers is expected to keep tanker rates stable in the medium term, believes Angel Securities. The trigger for the stock is the listing of its subsidiary, Greatship, in the current fiscal. A strong balance sheet, best return ratios among peers and attractive valuations make it a good bet.
Mercator Lines
While the dry bulk rates have crashed in the recent past (dry bulk carriers form 45 per cent of its fleet), long-term contracts on a majority of vessels should help the company to overcome freight-rate volatility. Analysts expect an improvement in profitability in 2011-12 on the back of an improvement in tanker rates and stable dry bulk business. While the stock is not expensive and should see a jump in earnings in 2011-12, only those investors with a two-year perspective should consider this scrip.
SCI
Though SCI’s revenues and margins are likely to improve as the company plans to replace a part of its old fleet (age is twice that of Indian peers), the weak freight rate environment and its exposure to the spot market are major concerns, according to analysts at ICICI Securities. Its Rs 8,000-crore expansion also means that net profit will shrink on higher depreciation and interest expenses. Given the freight outlook, expansion and high valuations, the stock is best avoided.
Varun Shipping
Higher expenses and poor revenue growth (due to weak freight rates for LPG carriers) meant the company posted losses for the two consecutive quarters ended March. Analysts do not expect it to turnaround any time soon, though the improvement in LPG freight rates (especially larger vessels) is a definite plus. The company is betting on the growth of LPG usage, especially in rural India, to boost demand and keep rates firm. Given the poor earnings visibility, investors need not take an exposure to this stock.