Cochin Shipyard: A reasonable play on the defence segment

A healthy order book and improving profitability and returns ratios make the pricing attractive

The question that many investors have with respect to the Cochin Shipyard initial public offering is its timing. Justifiably, not much is in favour of the shipping or shipbuilding industry right now. However, the disconnect between the company’s name and its operations may offer comfort to investors. In fact, with growing defence spending and the sector becoming modernised indigenously, Cochin Shipyard’s initial public offering (IPO) may evoke the right amount of interest. From commencing operations as a ship repairer, Cochin Shipyard has radically transformed itself into a commercial shipyard to undertake repair work for the Navy’s aircraft carriers, making it an attractive IPO.

Business operations

Incorporated in 1972 as a government owned company, Cochin Shipyard has emerged as the largest public sector shipyard in India in terms of dock capacity. It has two docks for shipbuilding with a capacity of 110,000 deadweight tonnage and ship repair with capacity of 125,000 DWT. It is the only profitable shipyard in India. Cochin Shipyard has built and delivered vessels across the board, including bulk carriers, tankers, platform supply vessels, anchor handling tug supply vessels, barges, bollard pull tugs, passenger vessels and fast patrol vessels.  As for commercial contracts, Cochin Shipyard has refitted all types of ships, including oil exploration and life extension for the Navy, Coast Guard, Shipping Corporation of India, ONGC and port trusts. That apart, Cochin Shipyard has exported nearly 50 ships and vessels to countries, including the US, Germany, the Netherlands, Cyprus and Saudi Arabia. With proven capabilities in ship repairing and after executing over 2,000 projects, Cochin Shipyard commands a 39 per cent market share in the country’s ship-repairing industry.

Currently, Cochin Shipyard’s order book at Rs 3,000 crore provides revenue comfort for 18 months. The company is building India's first indigenous aircraft carrier, its most notable order. With this, its order book is clearly in favour of the defence sector (80 per cent) and more towards shipbuilding contracts.

Financials

Over the past 10 years, when the shipbuilding and repair industry was going through a rough patch, Cochin Shipyard’s revenues and net profit expanded 11 per cent and 19 per cent, respectively, on a compounded basis. This indicates the company is not affected by traditional industry downturns. Operating profit margins, too, have improved from 8 per cent in 2006-07 to 18.4 per cent in 2016-17. With net cash of about Rs 2,000 crore, debt is not a burden for Cochin Shipyard as with most private players. Consequently, return ratios have been consistently healthy.

Valuations and IPO details

Priced at Rs 424-432, the issue is valued at about 18 times 2016-17 earnings. Given the limited scope for peer comparison, the valuation appears reasonable when compared to the Sensex asking rate of 22 times 2016-17 earnings. Analysts at Motilal Oswal, IIFL, ICICI Securities and Quant Broking feel the valuation is reasonable.

More importantly, after a dearth of IPOs with a larger portion for fresh issuance, Cochin Shipyard is as an exception. Of the Rs 1,468 crore the company plans to raise through the IPO at the upper end of the price band, 10 per cent is an offer for sale by the government, fetching it about Rs 489 crore. The rest (Rs 979 crore) is fresh issuance. This will be deployed in setting up a stepped-up dry dock facility and an international ship repairing facility. Construction of the stepped-up dock will begin in January 2018 and is likely to be completed in 30 months. The international ship repairing facility may help Cochin Shipyard expand its ship-repair revenue by 60-70 per cent post completion.

Risks

Cochin Shipyard’s key clients are the Navy and Coast Guard, which accounted for 73 per cent of its revenue on September 30, 2016. However, there is no long-term agreement or contractual commitment between Cochin Shipyard and its clients. Therefore, repeat orders are based on a strong relationship and execution record. Likewise, as with any sector, the dominance of foreign players,  particularly those in South Korea, Japan and China, is a key threat to Cochin Shipyard.