3QFY2011 Update: Buy The Great Eastern Shipping Co.; Target Rs. 360-Angel Broking

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The Great Eastern Shipping Co. – 3QFY2011 Result Update

Angel Broking maintains a Buy on The Great Eastern Shipping Co. with a Target Price of Rs. 360.

Gesco reported subdued 3QFY2011 results due to lower tonnage and

average time charter yields (TCYs). Management reported a decline in NAV at

`362/share for 3QFY2011 (`382/share in 2QFY2011), as second-hand asset

prices fell considerably. Management also guided that in the absence of a pricearbitrage,

tankers (4–5% of the world’s fleet) earlier used for oil storage have

returned to the active fleet, plagued by over supply. Gesco shelved plans of listing

GIL, in light of prevailing market conditions. We maintain Buy on the stock.

Weakness persists in the shipping sector; offshore chugs on: Gesco’s consolidated

revenue (excl. gain on sale of vessels) declined by 21.3% yoy and 11.9% qoq to

`556cr. The shipping segment’s revenue declined by 26.9% yoy `434cr due to

lower revenue days (down 12.7% yoy) and avg. TCY for product tankers (down

19% yoy) and dry bulk carriers (down 4% yoy). The offshore segment’s revenue

grew by 4.0% yoy to `210cr, driven by increased operating days (7.4% yoy).

On yoy basis, EBIT margins for the shipping and offshore segments improved by

559bp and 2,422bp respectively. Consequently, consolidated EBITDA margin

stood at 36.4% (up 817bp yoy but down 469bp qoq). Gesco reported gain of

`55cr from the sale of vessels vis-à-vis nil in 3QFY2010 and `26cr in

2QFY2011. Moreover, the company reported marginal forex gains vis-à-vis

loss of `37cr in 3QFY2010 and `32cr in 2QFY2011. Consequently, reported

PAT increased by 24.5% yoy, but declined by 30.3% qoq, to `117cr.

Outlook and valuation: We have revised our earnings estimates downwards by

14.7% and 26.1% for FY2011E and FY2012E, respectively, to factor an

over-supply scenario in the tanker and dry bulk carrier segments, which would

constrain utilisation levels and TCYs in the near future. We expect healthy

performance from the offshore segment (~33% share in the top line) with

addition of 8 vessels to the current fleet of 18 and value the business at 5.0x

(unchanged) FY2012E EV/EBITDA, in line with global peers. At the CMP of 290,

the stock trades at 5.8x P/E and 0.7x P/B on FY2012E. We maintain Buy with a

revised Target Price of `360 (earlier `396).

Weak market dynamics weigh on the shipping business

For 3QFY2011, Gesco’s owned tonnage (incl. inchartered) declined by 12.3% yoy,

coupled with revenue days falling by 12.6% yoy on account of phase-out of older

single-hull vessels. The average TCY declined by steep 19.8% yoy for product

tankers (53% of the tanker fleet), while that for crude carriers marginally increased

by 1.2% yoy. As per management, on account of an absence of price-arbitrage,

tankers earlier used for crude storage (4–5% of the global fleet) are expected to

return to the active fleet. Besides, management expects the global fleet to witness

gross addition of ~12% in CY2011, with scrapping and slippages resulting in net

additions to be at ~8%, which could keep TCYs subdued.

Gesco maintained the spot-time mix for total fleet at ~50:50. Six product tankers

are expected to come up for renegotiation by FY2011-end. Going forward,

management has guided that revenue visibility for the balance part of FY2011 is

around `207cr. Crude tankers, product carriers (incl. gas carrier) and bulk carriers

are covered to the extent of around 74%, 83% and 62% of their operating days,

respectively.

Update on asset purchase and sales

During the quarter, Gesco sold three tankers as part of International Maritime

Organisation’s mandatory single-hull tanker phase-out by CY2010 and took

delivery of a second-hand general purpose tanker. Management has guided that

the remaining two single-hull tankers can technically trade up to CY2013–14 and

would be scrapped in case of their being commercially unviable.

Greatship (India) Ltd. (GIL), Gesco’s offshore subsidiary, took delivery of a

PSV/ROV during the quarter and through its subsidiary contracted to construct

three PSV/ROVs for delivery between 4QFY2012 and 1HFY2013. The current

owned and/or operated fleet of Gesco and its subsidiaries stands at 27 tankers,

five dry bulk carriers, four PSVs, seven AHTSVs, three MPSSVs, two ROVSVs and

two jack-up rigs.

Well-capitalised balance sheet

Gesco’s consolidated net debt-to-equity stood at 0.26x as of December 2010.

Management has planned capex of US $573mn (US $260mn already paid) in the

shipping segment, resulting in addition of 1.3mn dwt (three VLCCs, two

supramaxes and three Kamsarmax dry bulk carriers) to the fleet by FY2013E.

Moreover, with withdrawal of the GIL IPO DRHP, Gesco has plans to infuse further

investments vis-à-vis `1,116cr done so far. The planned capex for the offshore

segment is of US $362mn over the next two years (US $125mn already paid).

GIL and its subsidiaries have an order book of eight vessels – two MSVs, four

ROVSVs and two AHTSVs.

Investment arguments

Bottoming out of tanker freight rates holds key

The International Energy Agency (IEA) has revised its global oil demand forecast

and expects CY2011 demand to increase to 88.8mb/d from 87.4mb/d in 2010,

on stronger demand from OECD North America and non-OECD Asia. Moreover,

sustained higher oil prices and reduction in vessel supply on account of mandatory

scrapping of single-hull tankers could help charter rates to sustain at current levels.

Gesco will be a key beneficiary of higher tanker freight rates as it derives around

46% of its consolidated revenue from the tanker segment.

Relatively younger fleet

Under MARPOL requirements, Gesco has gradually reduced its fleet of single-hull

tankers by phasing them out over the past 24 months. This has substantially

improved the company’s asset quality, with a young fleet of 25 double-hull crude

and product tankers. The average age of Gesco’s fleet (32 vessels) is around 10.4

years, which is relatively young, given that most vessels have a life of 25 years.

Moreover, offshore assets such as platform supply vessels and anchor-handling

tugs are relatively young, which enable the company to earn better spot and

charter rates.

Trading at attractive valuation

Gesco’s shipping business has witnessed three consecutive quarters of decline in

the top line and the bottom line, reflecting impact of industry headwinds. We revise

our earnings estimates downwards by 14.7% and 26.1% for FY2011E and

FY2012E, respectively, to factor an over-supply scenario in the tanker and dry bulk

carrier segments, which would constrain utilisation levels and TCYs in the near

future. We have valued the shipping business on NAV basis, which fetches

`276/share (10% discount to NAV). We expect healthy performance from the

offshore segment (~33% share in the top line) to sustain, with addition of 8 vessels

to the current fleet of 18 vessels and value the business at 5.0x (unchanged)

FY2012E EV/EBITDA, in line with global peers which fetches `84/share . Based on

our target price of `360, the implied EV/EBITDA, P/BV and P/E multiples work out

to 7.8x, 0.8x and 7.2x, respectively, for FY2012E. Thus, on account of trading at a

significant discount to its global peers, we recommend Buy on the stock with a

Target Price of `360.