Weakening of freight rates is a short-term phenomenon that will impact the shipping sector. But, healthy demand and supply bottlenecks will ensure stable growth for companies in this sector.
A slowdown in consumption due to a weakening global economy has resulted in a drop in demand for shipping services. This, coupled with fears of a supply overhang, has led to a steep decline in freight rates for tankers which transport crude and oil products as well as cargo carriers that deliver iron ore and coal.
The Baltic Dry Index and Baltic Dirty Tanker Index which measure cost of shipping dry commodities and crude have dipped 40 per cent apiece over their respective highs in May and July this year.
The impact of this is visible on the stock prices of shipping companies which have tanked between 19-42 per cent since May versus a 15 per cent decline in the Sensex.
Though things have looked better since July except for Bharati Shipyard and Shipping Corporation which have given negative returns, most companies have however returned far less than Sensex’s 12.5 per cent.
While the drop in American consumption of petroleum products has caused a blip in the demand for oil and thus hiring rates for tankers, the slowdown in construction activity in China and factory closures before the start of Olympics reduced the demand for commodities and bulk vessels.
Though the situation does not look too appetising, what are the implications of the current trends on the fortunes of shipping companies and ship builders?
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We look at the various segments including tankers, dry bulk, containers and specialised ships to ascertain the short- to -medium term movement of freight rates, supply of ships and growth prospects for Indian shipping companies and ship builders.
| FY10 ESTIMATES | ||||
| Rs crore | Sales | EBIDTA | Net profit | P/E |
| GE Shipping | 4080 | 1877 | 1428 | 3.3 |
| Mercator Lines | 2457 | 1106 | 663 | 3.2 |
| Varun Shipping | 1050 | 630 | 210 | 4.7 |
| Great Offshore | 1200 | 540 | 350 | 6.3 |
| ABG Shipyard | 2200 | 583 | 307 | 6.4 |
| Bharati Shipyard | 1300 | 325 | 159 | 5.8 |
Demand and Freight rates
Tanker freight rates
Tankers with over 36 per cent of world’s seaborne trade are the largest segment of the shipping business. The tanker market has been going through choppy waters in the recent past.
The decline in tanker rates should however be seen in light of the unusual increase in rates in Q2 (typically a lean period) driven by higher oil cargo movement between Atlantic and Pacific basins (and partly due to conversion of vessels to dry bulk/Offshore carriers).
Analysts estimate that the demand for tankers will remain subdued and this will lead to softening of charter rates over the short term. Some upward movement, however, might be witnessed due to seasonal variations.
Says S S Kulkarni, secretary general, Indian National Shipowners Association, “Weather patterns, especially weather disturbances (during September and October) and the severity of winter among other things, will decide the course of freight rates for tankers over the next two quarters.”
While last year the weather was calm and the winter was less severe causing tanker rates to drop, this year, with Tropical Storm Gustav expected to hit the US gulf coast by Thursday, freight rates could spike.
Three years ago, Hurricanes Katrina and Rita destroyed more than 100 platforms and led to a temporary shut down of 92 percent of oil output and 83 percent of natural gas production in that area. Freight rates, which are currently hovering at around $50,000 per day (YTD average $70,000 per day), should firm up once old freighters are scrapped.
“This is likely to happen if bunker rates (fuel costs to run a shipping line) remains at the current levels as it becomes unviable to run these vessels at these levels,” says Manish Sharma, associate director, KPMG Advisory Services.
Tanker demand
The demand for tankers is primarily driven by the demand for oil. Analysts estimate that in developed countries that form the Organisation for Economic Co-operation and Development, consumption of oil is expected to drop by 1.2 per cent to 48 million barrels per day in 2009.
| OIL DEMAND | ||
| Mn bbl/day | 2008 | 2009 |
| OECD | 48.6 | 48.0 |
| Asia | 17.5 | 18.1 |
| Total | 86.9 | 87.8 |
| % increase | 0.929 | 1.036 |
Despite weakening of demand in OECD countries, the International Energy Agency believes that going ahead the demand-supply situation will be tight because of supply constraints (OPEC production at record highs), refinery limitations (maintenance issues) and demand growth in emerging markets.
Analysts believe that the consumption growth in the Asian region (India and China) which is expected to jump by 3.4 per cent to 18.1 million barrels per day in 2009 is expected to compensate for the OECD dip.
Coupled with increased exploration activity and large refinery capacities in West Asia, Africa and South Asia (57 per cent of the 9.8 mbd of refinery capacity to added by 2012) and the fact that demand centres (Western Europe/the US) are located away from the crude and refining source, is likely to keep tanker charter rates robust going ahead.
The anticipated shortfall in refining capacity in developed markets is also the reason for increased orders for Very Large and Ultra Large Crude Carriers (VLCCs/ULCCs) that can carry 2 million barrels over long distances.
India, too, is expected to contribute to the increased flow of tanker traffic as the increase in refinery capacity could see a more balanced movement with exports getting a larger share than is the case now.
Dry bulk carriers
Charter rates and demand
After touching a historical high on the Baltic Dry Index in May 2008 to 11,793, freight rates have dropped over the last two months on the back of a slowdown in Chinese demand. Since iron and coal comprise half of the dry bulk cargo, demand for these commodities directly impacts the freight rates and orders for ships.
China is a key player as the country’s steel makers account for 43 per cent of global imports of iron ore and a major chunk of coal trade. However, due to its policy of shutting down polluting industries (due to Olympics), there was a cut in Chinese production. Coal imports to China fell 32 per cent y-o-y in May 2008 and 36 per cent from May to June due to the government clampdown.
The sharp dip was also caused by the increase in supply of vessels and conversion of single tankers into dry bulk carriers to adhere to the International Maritime Organisation’s regulations on phasing out single hull carriers by 2010.
In addition, according to Sharma, in Capesize (largest of the dry bulk carriers with a capacity of 80,000 deadweight tonne (dwt) or more), there are over 90 ships which are 25 years or older and so will need to be replaced by new ships.
However, this is also the segment which has got the highest order book to existing fleet ratio across all types of carriers at 98 per cent. The reason for this rush of orders is because unlike tanker markets, where unattractive rental rates are forcing owners to slow down ships to save fuel, rental income from Capesize carriers is strong. Will the rush of orders and delivery over the next few years lead to a decline in rates?
Says Sharma, “There might be a correction in the short term, but new trade routes between India and South Africa and China and Brazil could push demand for commodities and trade in this sector.”
Also slippages will mean that freight rates will hold steady. Some research firms have a bearish outlook on this segment.
According to a recent Bloomberg report, Goldman Sachs expects the Baltic Dry Index to average 40 per cent lower next year and sink another 47 per cent in 2010 on fears of a global economic slowdown. However, the rates in the dry bulk trade, which have been volatile since the last few months will be become clear over the next two quarters.
Containers/Offshore vessels
Containers
While average freight rates for the first seven months of 2008 is marginally up, they have been moving down y-o-y and show a decline for July. While smaller vessels (1,000 TEUs) used in short hauls are going for about $12,000 a day, larger vessels (4,500 TEUs) are available for $36,500 a day, marginally down from rates a year ago.
Unlike other carriers, containerships have to contend with higher proportion of empties, where they have to travel a leg of the trade without cargo. Since delivery dates are committed, there is little that shipowners can do to ensure full cargo at all times.
Weak freight rates, of late, is due the demand slowdown in the US which reflects in the lower transpacific shipment volumes and the excess new capacity of container ships to be added. To the existing capacity of 12 lakh TEUs, over 6.7 lakh TEUs are to be added over the next four years with the largest chunk to be added in 2009 and 2010. Slackening demand coupled with higher bunker (ship fuel) costs and empties make it difficult for shipping companies to make money.
Kulkarni, however, believes that the dip in demand could be compensated by containerisation volumes as more break bulk (like steel/rubber packed in bundles, pallets or bins) are shipped in containers.
He believes that countries such as India where only 40-45 per cent of break bulk goes in the form of containerised cargo compared to double the number in the developed world could push the container volumes going ahead. Unlike the tanker and dry bulk segment a slowdown, higher bunker costs and supply of capacity will hit the container ship segment the hardest.
Offshore
With crude prices ruling at $115-120 to a barrel and increasing exploration activity the demand for chartering offshore supply vessels is moving up. With the 1,760 platform supply vessels (PSVs) globally operating at 100 per cent capacity, day rates for deepwater drilling rigs are inching up towards $700,000.
Demand for offshore vessels can also be gauged from the fact over 900 chartering requests were received for the 120-odd Indian offshore vessels for FY08. Analysts believe that despite global orders for 265 new vessels, strong demand for oil will help absorb the additional capacity.
Conclusion
The opening up of new trade routes, likelihood of demand picking up in China, scrapping of old carriers and slippages in supply of vessels mean that freight rates and demand for ships across most segments should pick up in the next two quarters and remain strong at least till FY10 when higher capacity and new vessels would temper the freight rates.
While FY 2010 estimates for Indian shipping companies peg their PE multiples in the range from 3.5 to 6.6 times, for the two listed shipbuilding companies Bharati Shipyard and ABG it is 4.1 and 6.5 times respectively.
In this light, there are select Indian companies some of which such as Mercator lines are diversifying into dredging and offshore to derisk their businesses, which would stand out. In addition, with a majority of vessels on long-term charter rates there is revenue visibility with a marginal impact due to the dip in spot rates. For shipbuilding companies, the high order-book to sales ratios (7.6 times FY08 sales for Bharati Shipyard) is comforting.
Great Eastern Shipping
India’s largest shipping company in the private sector, Great Eastern (GE) Shipping has a fleet of 41 vessels with over 70 per cent being tankers. The company plans to invest $162 million in the current fiscal to acquire two long range product tankers. It plans to pump in a further $433 million to acquire nine dry bulk and a product tanker between FY10-12.
With a majority of its fleet in the tanker segment, the company is affected by the spikes in tanker freight rates. About 55 per cent of its fleet is contracted out on spot rates.
In Q1 FY09, despite a 15 per cent decline in revenue days, the company managed to increase revenues by 10 per cent y-o-y on the back of high tanker and high bulk freight rates. Despite higher repair and maintenance expenses and increase in bunker cost, higher yields helped improve EBIDTA margins to 54.6 per cent from just under 50 per cent a year ago.
Its offshore services subsidiary, Greatship India, which has a fleet of five vessels plans to double its strength in the current fiscal at a cost of $104 million. Its $725 million investment over the next three fiscals, which includes a 350 feet jack up rig, is expected to increase its fleet size to 19. While the volatility in spot prices is expected to impact GE’s revenues, the strong demand for offshore vessels should boost revenues of its subsidiary.
Great Offshore
Great Offshore is well placed to take advantage of higher crude oil prices and the resultant increase in the offshore investment and hiring rates for vessels in the domestic and global markets.
The company operates 41 different types of vessels including rigs, platform support vessels (PSV), anchor handling tug supply vessels (AHTSV) and multi support vessels (MSV). It recently (28 August 2008) acquired a high-end modern AHTSV and placed orders for a jack-up rig and a MSV, which are expected by May 2009.
During the last two years, the company’s revenue growth has been at 39 per cent; Rs 745.9 crore in FY08. With additional fleet, analysts expect the company to generate additional revenues of about Rs 300-350 crore in FY10 on the basis of prevailing rates.
And, as the company forays to into deep water drilling segment through the inorganic route, the same should translate into higher growth.
Mercator Lines
Mercator Lines has a $450 million capex plan, which will add a rig, two dredgers, one VLCC and two carriers to its 28 unit (3 million dwt) fleet over the next two years. The diversification into dredging, the offshore segment and coal mining should also help derisk its business and enhance revenues.
Further, the company would have stable revenues as 70 per cent of its fleet is on long-term charter rates. It will thus, take a marginal hit due to the dip in the spot freight rates. While demand for tankers and dry bulk cargo carriers should remain strong going ahead, the company’s prospects in the offshore and dredging businesses also look bright.
The company has contracted out its four dredgers and makes gross margins of $18,000 per day (charter rate is about $25,000 per day) on them.
On the offshore business side, the company is expected to benefit with half of India’s 57 blocks under NELP VII expected to be offshore based. With a rig expected to join its fleet in March 2009, it should also benefit from the 60 per cent operating margins with rig rates of about $100,000 per day.
The company’s coal mines in Mozambique and Indonesia are also expected to add significantly to its kitty going ahead. Its long-term contracts and diversification should help it rake in 25 per cent growth in revenues over the next two years.
| VISIBLE GROWTH | ||
| Rs crore | ABG Shipyard | Bharati Shipyard |
| Order book | 9500 | 4870 |
| Sales FY08 | 967 | 699 |
| Order/sales (x) | 9.8 | 6.9 |
| Mcap | 1844 | 821 |
Varun Shipping
Varun Shipping is a leading player in the LPG transporting segment, with about 70 per cent share of all PSU controlled LPG cargo entering India. The company should benefit from the country’s growing energy demand and its dependence on the imports. While this will ensure volume growth, freight rates are expected to remain firm due to shortage of vessels.
The company operates majority of its fleet in the hydrocarbon sector. This includes 12 LPG carriers, three double-hull Aframax crude tankers, one product tanker and five AHTSV.
This is also a reason, that the company is less affected with the recent decline in the dry cargo/tanker rates. Importantly, the company is now focusing on the offshore segment, where the demand and the realisations are relatively high. It is increasing fleet in this segment and has recently taken delivery of a specialised AHTS used for deep sea oil exploration activity.
As a result of these efforts, revenue from offshore has gone up from mere 3.55 per cent (Rs 23.9 crore) in FY07 to 19.46 per cent (Rs 165.5 crore) in FY08. The company is expecting this to rise further to 25 per cent in FY09.
ABG Shipyard
ABG Shipyard, the largest private shipyard, has been the key beneficiary of the higher demand for support vessels (SV) or ships used in oil exploration and other activities. Its current order book of Rs 8,985 crore, which is almost 8.1 times its FY08 revenue, provides revenue visibility for the next four to five years.
While the growth in order book has largely been driven by demand from the oil and gas sector, the company has also benefited from demand for small and specialised vessels such as cost guard, pollution control and short sea trade vessels used in different activities by corporate and government agencies, which accounts for over 25 per cent of its order book.
The critical part is the expansion of capacities, which will help in timely execution of existing orders and to tap the upcoming opportunities in the sector.
ABG is expanding its capacities through organic and inorganic initiatives. It acquired Vipul Shipyard to expand its Surat facility, which is expected to be operational by FY09 and will result in an increase of about 40 per cent in capacity to 44 vessels.
The company’s Dahej facility will be fully commissioned by the end of FY2010, which will have capacity to produce four off-shore rigs and ships up to 1,20,000 dwt. Notably, the company is setting up its biggest shipyard on a 300 acre land in South Gujarat at an investment of Rs 1,200 crore.
However, this facility will become operational in about three years and will build only 6-8 large vessels (annual revenue potential of around Rs 2,000 crore). In ship repairing, which is a growing and high margin business, ABG is in the process of acquiring Western India Shipyard Company (WIS).
In FY08, WIS reported revenues of Rs 43.66 crore and net loss of Rs 28.73 crore. WIS currently has capabilities to repair vessels up to 60,000 dwt. Post restructuring and integration with ABG, prospects for WIS also look good. Overall, the prospects look good and the strong order book and expansion plans should see ABG grow at 35-40 per cent annually over the next three years.
Bharati Shipyard
Bharati Shipyard, the second largest private shipyard in the domestic shipbuilding industry, manufactures different kind of ships such as cargo and tankers with focus on offshore vessels, which account for 70 per cent of its order book.
Increasing E&P expenditure along and ageing of offshore vessels augur well for Bharati. The company’s foray into manufacture of off-shore rigs will reap benefits in the longer term. It is currently manufacturing one off shore rig for Great Offshore.
In the near term, the company’s order book of Rs 4,870 crore (seven times its FY08 revenues) provides good visibility; revenues should grow at 35-40 per cent annually for the next three years.
Its ongoing two greenfield projects at Dabhol and Mangalore with total investment of Rs 1,050 crore are expected to be completed by FY11.
The company believes, post commissioning of these facilities, it would be able to generate business which would be about 5-6 times its current turnover at 100 per cent capacity utilisation.
These capacities will help increase revenues and also facilitate faster execution of orders. In light of these developments, Bharati should show healthy growth.
| Shipbuilding capacity The current order book at the end of May 2008 is about 523.3 million dead weight tonnage or cargo weight. This is more than 50 per cent of the current capacity and is expected to be delivered over the next 4 years. The reason for such a high percentage? Higher freight rates. Says Revati Kasture, head, Industry Research, CARE Research, "The shipping freight rates remained buoyant in 2004, 2005, 2006 resulting in an ordering spree among the shipping companies." |
If a major part of this comes onstream there will be a large overcapacity at a time when growth numbers are muted. However, Citibank research report on yard capacity in key centres such as Korea and China shows that slippages in delivery due to shortage of slots (capacity) at the shipyards will mean that shipbuilders will fall short by 17-18 per cent and 35-37 per cent in 2008 and 2009 deliveries keeping the demand supply situation tight.
China has overcommitted and orders were cancelled as they could not scale up capacity to meet the influx of fresh orders. Additional yard supply is coming in from China, Vietnam, India and Korea in that order.
Says Sharma, "In addition to the lack of capacity at shipyards, reasons for the slippage are the shortage of components.” Despite the talk of a slowdown and excess capacity, the ship building sector industry could see two years of robust growth backed by strong charter rates and overflowing order books.
While the shipbuilding industry is dominated by Korea, China and Japan accounting for 87 per cent of supply, Indian ship builders such as Bharati Shipyard and ABG Shipyard could pose a threat over the next decade on the back of a engineering talent pool, cheap labour and tying up of their component supply chain.