These are tough times for shipping companies as freight rates on the back of a weakening demand have crashed. The gloomy outlook has had an adverse impact on stock prices of shipping companies and the Rs 850 crore Varun Shipping is no exception; it has tanked 57 per cent since its January highs. However, India's largest LPG transportation company believes that its focus on offshore (upstream), crude tanker (midstream) and the distribution (product/LPG) businesses, which have steady demand, has helped it to escape the carnage that dry bulk and container ships have fallen prey to. The company's vice chairman and managing director, Yudhishthir Khatau, enumerates on the trends in the sector and plans chalked out to grow its business in an interview to Ram Prasad Sahu. Excerpts:
How has the downturn (dip in freight rates) impacted your business?
Basic activities of cooking (LPG), transportation (petroleum) and heating and cooling form a critical part of energy transportation requirement. These are areas you normally don’t cut back on. While the transportation requirements for the energy sector have gone down, there has not been the same sort of cut back that you have seen in the container and dry bulk sectors.
Our freight rates for crude tankers per day have averaged $35,000-40,000, for gas carriers it is around $25,000-30,000, while offshore assets give us about $50,000. In most sectors, we outperform the industry on the rates due to various reasons. For example, in the crude tanker sector, we have a modern fleet, in LPG our utilisation rates are better than the industry and in offshore we are more skewed towards the deepwater segment. For us, the topline drop in revenues would be limited to 5-10 per cent.
Why is Varun focussing on offshore operations?
We started offshore operations in 1984, but were operating in the shallow water exploration segment. We moved into deep water exploration two years ago. Earlier, offshore contributed about two per cent of our revenues, this fiscal it will probably constitute 20-25 per cent. We operate in this business because it is a high technology essential services space and tends to be more resilient in a downturn than other segments. Offshore continues to do well as there is still continued requirement for deepwater oil exploration. Oil majors who have entered into exploration exercise are reluctant to cut back as assets required for exploration are not easy to come by. When they have taken these assets and blocks, they have committed themselves and would like to complete the cycle.
Going forward, we would have greater volume coming from offshore, which gives us the best margins. Out of the total capex plan of $400 million for FY09, we have invested $100 million in acquiring assets and are looking at adding more vessels (two or three) before March 31, 2009. We believe that it is viable to venture into the sector with oil at $50-60 a barrel.
What would be the impact of Opec’s cut of 2.2 million barrels a day?
There will be an impact, but this cut will bring down production by less than 3 per cent of the global production and besides there are other (non-OPEC) countries that can bridge that gap. The second aspect is tonne miles. Though production has come down, tonne miles (miles a tonne of oil is transported) are going up.
This is because refining bases are no longer (as they were traditionally) in the ports of production (West Asia) or ports of consumption (Western world) but in third-party (India) countries. One of the reasons for the drop in consumption estimates was the spiralling cost of oil, but today it is at an economical price range, which will stimulate consumption. For example, in this quarter, freight rates on the Aframax (smaller crude oil carriers) are better than the average of last year whereas it should have come down due to the slowdown. Two reasons for this.
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One, the cost of capital has increased and also that people are worried about prices of oil falling. The same quantum of oil is being transported but vessels are moving down in size as lesser amount of working capital is required. Secondly, if you buy oil (as traders do) and sell it and lose money you would do so on a smaller parcel than a larger one. Thus, volumes remain the same but are being transported by smaller size ships creating more demand for them. Since we are oriented to the medium-sized vessels we are seeing benefits of that.
How has demand changed for LPG?
India consumes 10-11 million tonnes of LPG, but produces about 70 per cent with the balance being imported. So far, our analysis shows that there is no reduction in demand for LPG in India. With the Reliance facility coming on stream, more LPG will be produced. There might be a reduction in imports, but a greater amount of coastal movement along the Indian coast. About 50 per cent of the world’s LPG is used for cooking and we don’t see that going down due to economic slowdown. Freight rates for the LPG have been pretty resilient and the reduction has been limited to 5-10 per cent.
Why has LPG share to revenues come down to half from three quarters earlier?
We wanted to become a one-stop energy transportation company for our customers whose product base is diversified into upstream, midstream and downstream. While we started in the product tanker business in 1973, they had to be phased out due to mandatory requirements. We have been phasing out single hulls since 1990s and the last one was sold a few weeks ago.
This is the reason why in percentage terms, tanker volumes had gone down. Since LPG requires an immense amount of critical mass, this called for major investments, adding size which helped us become a major player in India (70 per cent market share in LPG transportation).
There are reports of contract cancellations in the industry. How is Varun coping up?
So far, we have not had any cancellations of contract nor do we have any ship on order. Fortunately for us all the ships have been delivered to us and they are on duty. We have capacity utilisation of 90 per cent. We are less affected by the downturn partly due to our planning. The first instance was our exiting of dry bulk business and consolidation in the energy sector. We believed that in the long run a company like Varun would be better served by being in the high technology energy transportation sector where the underlying cargo base (energy) is much stronger than the dry side.
The dry bulk had low technological barriers and low value addition, vis-à-vis crude. The second example is the scrapping of single hull vessels. Companies were buying single hull vessels till three years ago while the last single hull vessel we bought was in 1991 and have been phasing out ships since then with the last one being phased out recently.
Isn’t your debt in excess of Rs 2,000 crore and a debt-equity ratio just under 2.5 high?
Our debt-equity ratio is higher than some of our peers as we have been replacing our fleet and have been the fastest in expanding it. We have replaced all single hulls and after the replacement too our assets have increased substantially in size, nature and quality. We are getting adequate finance at these levels. While we are looking at conserving cash, growing the business in a sustainable manner and utilising opportunities (such as now), which at other times would have been costlier, is key for us.