Adverse currency movement and a meltdown in steel prices have taken the wind out of ship-breakers' sails, stalling an otherwise bustling yard of Alang in Gujarat, Crisil Rating today said.
"The rupee had depreciated about 9 per cent in the 12 months to September 30, 2015 -- touching 66 per dollar from 61 seen in October 2014 -- adding to the woes of an industry already reeling under close to Rs 1,200 crore of cumulative forex losses in the last three fiscals," the rating agency said.
"This was flagged in our April 2014 report titled, Shipbreakers weather Rs 700 crore forex loss, yet continue to sail unhedged," the rating agency said.
"It's pertinent to note that forex and inventory losses would have been staggering had ship-breaking activity continued at the pace seen in 2013. Promoters with deep pockets have so far managed to sail in these choppy waters," the report said.
"The worry is that if steel prices don't rise and the rupee remains volatile, the world's largest graveyard for ships could turn one for ship-breakers, too."
It said ship-breakers buy condemned vessels based on letter of credit (LC) in foreign currency, which typically has a maturity -- 'usance' period -- of 6 months. As a business practice, ship-breakers do not hedge foreign currency exposure since it further depresses their already low operating margin of 4-5 per cent.
"In the 12 months to September 30, 2015, the value of LCs opened by 59 CRISIL-rated ship-breakers, accounting for around half of the industry size, is estimated at Rs 1,600 crore. ... Assuming that payout on maturity was done at an average exchange rate of 65, industry-wide forex loss would be some Rs 100 crore as on September 30, 2015, which will hurt profitability this fiscal," it added.
Compounding the problem, the 12-month period saw domestic steel demand muted, resulting in a 23 per cent decline in average realisation on scrap steel (a major output of ship-breakers and a key raw material in secondary steel making) from Rs 26,504 per metric tonne in October 2014 to Rs 20,398 in September 2015, the report said.
The price of scrap steel, which was declining between 2 per cent and 4 per cent on a monthly basis, plunged nearly 20 per cent after China devalued the yuan in August 2015, it added.
The ship-breaking industry operates on a short cash cycle. While a ship is dismantled over six months or so, sale of scrap takes place every month.
"But given the sharp decline in the price of scrap steel since August, the industry, despite its operating discipline, is estimated to have taken a knock of Rs 120 crore," it said.
These headwinds have reduced the average number of ships dismantled to less than 10 a month from nearly four times in 2013, when the activity had touched a 5-year peak, it said.
To shorten their operating cycle further and contain the impact of volatile currency and steel prices, ship-breakers have been buying smaller vessels.
