ICICI Securities Limited

Transcription

1 Initiating Coverage Rating Matrix RATING : Sell TARGET : 63 TARGET PERIOD : 12 Months POTENTIAL UPSIDE : - 20% YoY Growth (%) FY10 FY11E FY12E FY13E Total Revenue EBITDA Net Profit Stock Data Bloomberg Code PIPV.IN Reuters Code PIPA.BO Face Value (Rs.) 10 Promoters Holding 45 Market Cap (Rs Cr) week H/L 120/58 Sensex Average Volumes Comparative Return Matrix (%) 1M 3M 6M 12M Pipavav Shipyard ABG Shipyard Bharati Shipyard Price Movement Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 NIFTY (LHS) Analyst s Name Bharat Chhoda bharat.chhoda@icicisecurities.com Jehangir Master jehangir.master@icicisecurities.com Pipavav Shipyard Ltd (RHS) March 31, 2011 World class facilities but execution yet to gather pace Pipavav Shipyard (Pipavav) is one of the largest shipbuilding yards in the world, capable of constructing vessels up to dwt. Superior infrastructure, modular construction technology, strategic tie-ups and a strong and diversified order book of ~ 6300 crore is expected to result in CAGR of 48.8% over FY10-FY13. However, concerns such as challenges on the execution side and rich valuation compared to established global shipyards make the riskreward ratio unfavourable in the medium term. World class infrastructure set-up with modular construction technology Pipavav operates one of the largest shipyard facilities in the world capable of constructing vessels up to dwt. The facilities include shipbuilding, ship repair and fabrication complex. Pipavav has adopted modular construction technology used by the best shipyards i.e. Samsung and Hyundai, which would enable the company to reduce the construction time of vessels. Execution remains a key concern There was a delay of ~15 months in the construction of the shipyard and the facility became fully operational only in December 2010 with the installation of Goliath cranes. The delay in construction of the shipyard has, in turn, led to significant delay in the delivery schedule of vessels. Although Pipavav has a strong and diversified order book valued at 6300 crore, the first deliveries of panamax and offshore vessels is likely only from Q2FY12 onwards i.e. delay of ~18 and ~3 months respectively. Valuation Pipavav Shipyard Ltd (PIPSHI) 79 At the CMP of 79, Pipavav is trading at 19.5xFY13E EPS of 4.1 and 2.5xFY13E P/BV of 31.7 i.e. 65.5% & 32.2% higher respectively than the best and established global shipyards. Although Pipavav is in a growth phase, significant premium over global shipyards would not be justified until execution improves. We have valued the stock at 2.0xFY13E P/BV and are initiating coverage with SELL rating and a price target of 63. Exhibit 1: Key Financials ( crore) FY09 FY10 FY11E FY12E FY13E Net Sales EBITDA EBITDA Margin (%) % 18.5% 24.6% PAT EPS P/E (x) P/BV (x) EV/EBITDA (x) RONW (%) ROCE (%)

2 Company Background Shareholding pattern (Q3FY11) Shareholder % Holding Promoter 45.0 FII 8.5 DII 12.0 Others 34.5 Promoter & Institutional holding trend (%) Pipavav is promoted by the SKIL Group and was incorporated as Pipavav Ship Dismantling and Engineering Ltd on October 17, The SKIL group has a long operational history and has been instrumental in setting up key infrastructure projects such as Pipavav Port, which was later acquired by the AP Moller-Maersk Group. In 2005 the name was changed to Pipavav Shipyard Limited. The shipyard is located about 130 km from Bhavnagar in Gujarat and is spread over an aggregate area of 491 acres, comprising an SEZ unit spread over 235 acres and an EOU spread over 257 acres with dry dock of 662 metre in length and 65 metre in width. % Q4FY10 Q1FY11 Q2FY11 Q3FY11 It operates the largest shipyard facility at a single location in India and is also among the largest in the world with the capability of constructing vessels up to dwt. It can construct dry bulk vessels, tankers, offshore vessels and defence vessels. Pipavav commenced commercial operations in April The shipyard was constructed at a total cost of ~ 3000 crore, which was financed through ~ 1200 crore of promoter equity, ~ 500 crore raised through IPO and ~ 1300 crore of debt. Promoters Institutional Increase in promoter stake SKIL Infrastructure, the promoter of Pipavav, increased its stake in the company from 24.6% in Q4FY10 to 45.0% in Q3FY11. The stake was increased after SKIL Infrastructure acquired the stake of Punj Lloyd and followed it up with an open offer. In addition, SKIL Infrastructure has been allotted convertible share warrants at 99.1, which would be converted into equity shares at a similar rate. Post conversion, the stake of the promoters is expected to rise to 47.0% Exhibit 2: Institutional holding in Pipavav Key Institutional Investors % Holding IL & FS 5.4 Smallcap World Fund 5.1 New York Life Investment Management India Fund 2.8 Sembcorp Marine Ltd. 2.6 EXIM Bank 2.6 IDBI Bank Ltd. 2.2 IL & FS Financial Services Ltd 1.7 LIC Source: BSE, ICICIdirect.com Research 1.5 Page 2

3 Investment Rationale Pipavav operates one of the largest shipyards in the world capable of constructing vessels up to dwt. The facilities include shipbuilding, ship repair and offshore fabrication complex. Pipavav uses modular construction technology which would enable Pipavav to reduce the construction and delivery time of vessels. Pipavav also has an order book comprising defence, offshore and dry bulk vessels valued at 6300 crore, which provides good earnings visibility. With the pick up in execution, we expect Pipavav to report a CAGR growth of 48.8% over FY10-FY13. Despite superior infrastructure set-up, execution remains a key concern for the shipyard. There was a delay of ~ 15 months in the construction of the shipyard and the facility became fully operational only in December A delay in the installation of Goliath cranes has led to a significant delay in the delivery schedule of vessels. Delivery of the first Panamax vessel is likely only from Q2FY12 onwards i.e. delay of ~ 18 months and execution remains a key concern for the shipyard. At the CMP of 79 Pipavav is trading at 19.5xFY13E EPS of 4.05 and 2.5xFY13E P/BV of 31.7 i.e. significantly higher than even the best and established global shipyards. Although Pipavav is in a growth phase, the significant premium over global shipyards would not be justified until execution improves. We have valued the stock at 2.0x FY13E P/BV and are initiating coverage with a SELL rating and a price target of 63. Exhibit 3: Comparative valuation (P/BV) 1.65 Samsung Pipavav ABG FY12E P/BV Exhibit 4: Comparative valuation (EV/EBITDA) Samsung Pipavav ABG FY12E EV/EBITDA Page 3

4 Pipavav is one of the largest shipyards in the world, which is capable of constructing vessels up to dwt along with the latest construction technology Single location facility and modular construction technology would provide economies of scale Largest single location shipyard facility in India Pipavav operates the largest shipyard facility at a single location in India and is also among the largest in the world. The dry dock is 662 metre in length and 65 metre in width and is capable of constructing vessels up to dwt. Pipavav is spread over an aggregate area of 491 acres, comprising an SEZ unit spread over 235 acres and an EOU spread over 257 acres. The facilities include shipbuilding, ship repair and offshore fabrication complex. It also has the capability to construct offshore platforms, SBMs, rigs, jackets, vessels, etc. for upstream oil & gas sector companies both in India and abroad. It has also installed two Goliath cranes, each with a lifting capacity of 600 tonnes to facilitate modular construction of vessels. ABG Shipyard and Bharati Shipyard, the two largest shipyards in India operate through multiple locations as against Pipavav which operates from a single location. As fabrication and dry dock facilities are located at a single location it offers economies of scale to Pipavav over other domestic yards. Exhibit 5: Capability comparison Hyundai Heavy Pipavav ABG Bharati Cochin Dry Dock Length (metres) Width (metres) Commercial Vessels (max vessel size) Dry Bulk Carrier dwt dwt dwt dwt dwt Crude Tanker dwt dwt dwt dwt dwt Product Tanker dwt dwt dwt dwt dwt Offshore Vessels Rig x AHTS/PSV Dredgers x Defence/Coast Guard Submarine x x x Frigate x x x Coastal Patrol Vessels Speed Boat Ship Repair Pipavav has adopted the modular construction technology, which is currently used by Korean and Chinese shipyard which allows speedier and cost efficient construction of vessels Modular construction Provides edge along with faster turnaround Pipavav has employed modular process of building ships, which breaks down a complete ship into internal parts and then simultaneously fabricates various parts of the ship in fabrication workshops. This method allows Pipavav to build several ships simultaneously. Construction of blocks, which includes steel stacking, treatment, cutting, forming, blasting, painting, welding and sub assembly of panels followed by assembly of blocks and outfitting is carried out at the fabrication complex. When ready, the blocks are moved to the dry dock for pre-erection of mega giga-blocks of ~600 tonnes each followed by lowering them on the dock floor for final assembly and vessel launching. This method ensures that the dry dock is occupied by new build vessel for the minimum possible time thereby reducing the construction time of vessels. Page 4

5 Indian shipyards, except Pipavav, lack world class infrastructure facilities which is an added advantage for Pipavav India has a number of shipyards but both PSU as well as private shipyards operate on a slightly dated construction technology as against the modular shipbuilding technology adopted by Pipavav. Further, both public and private sector shipyards do not have the size to construct or repair large sized vessels. This forces Indian shipping companies to place orders with foreign shipyards for larger sized vessels. Strong and diversified order book provides good earnings visibility Pipavav has a strong order book comprising defence, offshore and dry bulk vessels which provide good earnings visibility. It also has the second largest order book amongst Indian shipbuilding companies with a gross order book of 6330 crore and net order book of 5326 crore. Pipavav is expected to generate a turnover of 1598 crore in FY12 and is likely to overtake Bharati Shipyard to emerge as the second largest shipbuilding company in India in terms of revenue. Pipavav has a gross order book of 6330 crore and a net order book of 5326 crore which provides good earnings visibility Exhibit 6: Order book composition client wise Client Vessel Type Quantity Order Value Defence Indian Navy Offshore Patrol Vessels crore Offshore ONGC Offshore Support Vessels crore Dry Bulk AVGI Panamax Vessels 12 Golden Ocean Panamax Vessels 5 Setaf Panamax Vessels 4 Total 3150 crore 6330 crore Pipavav has the second largest order book size after ABG Shipyard and would overtake Bharati Shipyard in FY12 in terms of revenue Exhibit 7: Peer revenue and net order book Pipavav Bharati ABG Revenue FY12E Net order book* * Net order book denotes order book pending execution as on FY11E Page 5

6 Further, 43% of the order book comprises defence vessels and the company intends to focus on the defence sector to drive its future growth. Dry bulk vessels constitute almost 50% of the order book of Pipavav while defence orders constitute the second largest segment (43%) of the order book followed by offshore, which constitutes (7%) of the order book Exhibit 8: Order book composition by vessel type Offshore 7.6% Defence 42.7% Dry Bulk 49.8% Order book Break-up Strong contender for defence orders Government of India has indicated its preference to promote indigenisation of defence requirements. However, domestic shipyards do not have the capability and expertise to cater to the requirement and Pipavav can step in to fill the void Government of India intends to indigenise defence production to a large extent. This would translate into increased participation of domestic shipyards in the manufacture of naval vessels. PSU shipyards such as Mazgaon Docks, Cochin Shipyard and Hindustan Shipyard are the frontrunners in procuring orders for construction of naval vessels as they have the expertise and have also constructed naval vessels in the past. However, the delivery track record has not been good with significant delays in construction. Further, the yards are not modernised and lack latest equipment and infrastructure for timely construction of modern defence vessels. Private shipyards have stepped in to fill the void and even defence authorities have shown their preference towards private shipyards. Among private shipyards, Pipavav is best placed due to its size, technology and strategic partnerships with SAAB and Rosoboron. Recently, Pipavav also bagged a warship production license from the Government of India. The license empowers Pipavav to build five warships per year and Pipavav has bid for construction of submarines, destroyers, frigates, LPD, corvettes and aircraft carriers. Pipavav has also been declared the lowest bidder for supply of naval offshore patrol vessels for the Indian Navy worth ~ 2700 crore. The ship repair contract with Transocean would be beneficial in the long run Pipavav has entered into a MoU with Transocean for repairs of their offshore vessels deployed in the Indian subcontinent. Although the repair work has not commenced, it offers a major opportunity for Pipavav as it would make its entry into the high margin ship repair business. Page 6

7 Strategic tie-up with companies such as Sembcorp Marine, KOMAC, SAAB Dynamics, Rosoboron and Northrop would be of immense help in securing new build orders, especially defence. Key technical tie-ups/arrangements Pipavav has entered into tie-up with some of the best technology providers. Their expertise and vast experience would enable Pipavav to scale up its operations without many glitches and also enable the shipyard to bid for high end and technically advanced orders for defence vessels. Sembcorp Marine - Singapore Sembcorp Marine is a leading global marine engineering and shipyard group, specialising in a full spectrum of integrated solutions in ship repair, shipbuilding, ship conversion, rig building, topsides fabrication and offshore engineering. Sembcorp has been advising Pipavav on yard layout and manufacturing processes. KOMAC Korea Korea Maritime Consultants Co Ltd was established in 1969 as Korea s first and only private organisation of naval architects and marine engineers. KOMAC has designed more than 1,200 different classes and type of ships. Pipavav has a technical services agreement with KOMAC to source designs as well as assist in procurement of equipment and materials for commercial shipbuilding. SAAB Dynamics AB, Wallenberg Group Sweden SAAB is a global leader for products, services and solutions from military defence to civil security. Pipavav has entered into an MoU with SAAB Dynamics AB and the tie-up would offer access to cutting edge technology for building naval vessels. Rosoboron Export - Russian Pipavav has entered into a protocol with Rosoboron Export, which is a Russian government arm for defence cooperation with foreign governments. This protocol is for building four additional stealth frigates under Russian collaboration at Pipavav. The Russians have delivered three stealth frigates while balance four are under construction at a Russian yard and an additional four are expected to be built in India. The protocol would help Pipavav to develop state-of-the-art technology to build frontline warships on a cost effective and time bound basis. The protocol covers mid life updates, dry docking, repairs and modernisation of submarines of Russian origin in use by the Indian Navy. Northrop Grumman - US Northrop Grumman is one of the largest defence companies globally and has expertise in defence systems, airspace management systems, navigation systems, precision weapons and marine systems. Pipavav has signed an MoU with Northrop Grumman, which would give access to technology and expertise possessed by Northrop. Page 7

8 Industry outlook Commercial shipbuilding business Freight rates likely to remain under pressure Despite a recovery in demand of commercial vessels, freight rates continue to remain under pressure due to the excess supply of new build vessels joining the existing fleet of vessels. In addition, the order backlog of new build vessels is also significant. Exhibit 9: Dry bulk freight rates The last two years have been very volatile for the dry bulk market as the Baltic Dry Index touched an all-time high of in May 2008 and, thereafter, corrected by ~ 95% in the next six months to 663 in December 2008 Since then, the BDI has largely remained range bound and is likely to report a similar trend, going ahead, due to large supply of new build vessels Index Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 BDI BCI BPI Source: ICICIdirect.com Research The recovery in tanker freight rates is expected to be gradual Exhibit 10: Tanker freight rates Index Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Baltic clean tanker index Baltic dirty tanker index Source: ICICIdirect.com Research New build orders show revival but recovery expected to take longer New build orders reported a revival in the second half of CY10, but we believe that commercial shipbuilding business would take longer to recover from the current downturn on account of the large new build order backlog. Exhibit 11: Large order backlog to result in muted new build orders Present Fleet Order book Vessels mln DWT Vessels mln DWT % of DWT Dry Bulk Tanker LPG Containers Source: ICICIdirect.com Research Page 8

9 Rise in new build orders was observed in the second half of CY10 with dry bulk vessel orders reporting the highest activity Exhibit 12: Revival observed in new build orders but recovery still distant Dry Bulk Tankers Containers LPG/LNG Others Total Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Source:ICICIdirect.com Research Offshore shipbuilding business Sustained rise in crude oil demand along with firm prices Crude oil demand is likely to remain strong on account of consumption growth from China and India leading to firm crude oil prices. Crude oil demand and prices have reported remarkable strength over the last one year Exhibit 13: Crude oil demand and supply forecast Q1CY11E Q2CY11E Q3CY11E Q4CY11E Q1CY12E Q2CY12E Q3CY12E Q4CY12E Supply OPEC Non-OPEC Total Supply Demand OECD Non-OECD Total Demand Source: Bloomberg Exhibit 14: Crude oil prices trend $/barrel Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Source: ICICIdirect.com Research, Bloomberg Page 9

10 Offshore shipbuilding business offers good potential With the recovery in crude oil prices, offshore drilling/exploration is expected to pick up pace resulting in new build orders Strength in crude oil prices is likely to result in a rise in exploration/drilling spend. This would lead to demand for offshore drilling vessels such as jack-up rigs and support vessels such as AHTS and PSVs. Hence, we believe that offshore shipbuilding business would continue to show strength. Defence shipbuilding business Domestic shipyards could benefit from defence orders, which could provide regular and substantial business High value and potential to provide steady business Private domestic shipyards have in the past couple of years bagged small sized orders for coastal patrol vessels and speed boats. This has also opened up opportunities for private domestic shipyards to build larger sized defence vessels. The defence sector has the potential to provide regular business to and can also provide an effective hedge from the volatility of the commercial shipbuilding business. Ship repair business The ship repair business offers good growth potential as currently there are very few ship repair facilities in India Growing opportunity for specialised players The ship repair business in India offers good potential as there are few ship repair facilities in India. The shipbuilding business globally is passing through a downturn with a slowdown in new build orders. However, ship repair is an evergreen industry as irrespective of market conditions, ship repair activities continue on account of regular dry docking requirements. Further, stringent International Maritime Organisation (IMO) regulations mandate that vessels need to be sent for dry docking every 2.5 years and a special survey has to be carried out once in five years. There is no specialised ship repair yard in India except Western India Shipyard. Indian shipping companies send their shipping vessels to yards in Singapore, Dubai and Sri Lanka to carry out ship repairs and Indian vessel owners would prefer to get their vessels repaired in India if specialised repair facilities are offered. Page 10

11 Risks and concerns Company Specific Delay of 15 months in construction of shipyard facility There has been considerable delay in the commissioning of the shipyard. As per the DRHP filed by the company at the time of the IPO, the shipyard was expected to get completed by October 2009 but got completed only in December 2010 i.e. delay of ~ 15 months. The main reason for the delay was the non-availability of key personnel for the installation of Goliath cranes. There has been a delay of ~ 15 months in construction of shipyard facility Exhibit 15: Delay in shipyard construction Original completion date Fabrication yard, dry dock and installation of Goliath cranes Offshore yard Oct-09 Mar-10 Actual completion date Delay of 15 months Source: Company, DRHP, ICICIdirect.com Research, Dec-10 Considerable delay in delivery of vessels Goliath cranes need to be operational to lower and assemble the ship modules. The delay in their installation has resulted in delay in the delivery schedule of vessels. Currently, two Panamax vessels are being assembled in dry dock (area circled in chart below) and each are 50% assembled. The assembly of the complete vessel would require at least another three months after which painting, fitting, launching and sea trials would be carried out before the final delivery of the vessels. Hence, we believe the final delivery of the first two vessels would require at least another six months and delivery is likely only from Q2FY12 onwards i.e. a delay of at least 18 months. A delay of at least 18 months is likely in the delivery of the first Panamax vessel while a delay of at least three months is likely in the delivery of the first offshore support vessel Exhibit 16: Current status of shipbuilding activity at the shipyard Contract signing Raw material and equipment procurement Fabrication and modular assembly Vessel Assembly Painting and Fitting Launching Sea Trials Delivery Source: Company, DRHP, ICICIdirect.com Research Page 11

12 With the delay in the delivery of the first vessel, subsequent deliveries are also likely to get delayed Exhibit 17: Original delivery schedule and current status of vessel construction Original delivery schedule Dry bulk vessels Delivery date of first panamax vessel Apr-10 Subsequent deliveries Every three months Offshore Delivery date of first offshore support vessel Final delivery of 12 offshore vessels Jun-11 Dec-11 Expected delivery schedule Dry bulk vessels Delivery date of first panamax vessel Delay of 18 months Offshore Delivery date of first offshore support vessel Delay of 3 months Source: Company, DRHP, ICICIdirect.com Research Sep-11 Sep-11 Delay in payment by clients Construction of Panamax as well as offshore vessels is running behind schedule. Further, a delay in the initial deliveries would derail the delivery schedule of the remaining vessels leading to considerable slippages. This in turn, would lead to delay in payments from the clients and could also lead to invocation of performance guarantee. Revision in dry bulk order book contract value The initial dry bulk order book size of Pipavav was 22 Panamax vessels with contract value of ~ US$819 million. However, Pipavav was in discussions with its clients with regards to amendment/cancellation of its firm order book. After negotiations, the order book size has been reduced to 21 Panamax vessels and the contract value has been finally re-negotiated at ~ US$700 million. The original dry bulk order book value has been re negotiated to 700 crore from the earlier 819 crore Exhibit 18: Original order book size vs. revised order book size Panamax Vessels mn $ Original order book 10 vessels 373 Original order book 2 vessels 71 Original order book 6 vessels 231 Original order book 4 vessels vessels 819 Revised order book 21 vessels 700 Source: Company, DRHP, ICICIdirect.com Research Order cancellation could be a major setback for Pipavav Order cancellation Pipavav is currently executing orders worth 6330 crore for its various clients. Till date, there has been a cancellation of just one Panamax bulk carrier. We do not expect any more cancellations, going ahead. However, any unfavourable development could be a major setback for the shipyard Page 12

13 Pipavav is banking on defence orders to drive growth but if the company fails to bag defence orders it could lead to under utilisation in the long-term Non allotment of defence orders Pipavav has constructed a modern and state of the art yard, which is capable of catering to defence requirements of high-end modern and sophisticated defence vessels. It has also bid for defence orders and expects to bag them on account of its infrastructure capabilities. However, if the orders do not materialise it could lead to under utilisation of yard capacity, going ahead, as we expect sluggishness in the commercial shipbuilding business. Rise in steel prices may further dampen new build orders Steel prices, which constitute a major portion of the total vessel cost, have been steadily rising over the last two years. After touching a low of US$370 per tonne in June 2009, prices have since increased to US$900 per tonne and are approaching peak prices of US$1080 per tonne in June The rise in steel prices would lead to a direct rise in new build asset prices, which is a serious concern for shipbuilding sector. During 2008, high steel prices resulted in a rise in new build prices but it did not lead to drop in demand for new vessel orders as freight rates remained firm. However, the current environment is very different as freight rates are barely above operating costs for most ship owners. In such a scenario, even a small increase in asset prices could lead to a significant demand contraction and lead to a decline in new build orders that have just started to gain traction. Steel prices, which are a major cost component, have increased in the last two years. This would lead to a rise in new build prices which is likely to further dampen the demand for new build vessels Exhibit 19: US HRC prices trend US $/tonne Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Availability and retention of skilled manpower a concern Availability and retention of key skilled manpower could be a problem in the initial stages for the shipyard Availability of skilled manpower is also a key concern but the company has made considerable efforts to develop the basic infrastructure facilities such as housing at the shipyard site. Pledge of shares by promoter The promoters have pledged their entire holding in Pipavav. Implementation of new tax provisions would result in higher tax outgo although it can be set off in later years Implementation of new tax provisions to result in higher tax outgo Under the new tax provisions, even companies located in SEZs are required to pay MAT while they were earlier exempt. Page 13

14 Industry specific A slowdown in the US and Europe and moderation of growth in China could lead to sluggish demand for commodities, resulting in a drop in demand for commercial vessels Sluggish demand for merchant vessels The global economy, especially of developed countries, has managed to emerge out of the recession on account of exceptional measures such as quantitative easing and stimulus support by the respective governments. However, any slowdown in economic recovery in the US and Europe could lead to a decline in demand for crude oil as developed countries are the main demand drivers. Similarly, China is the main demand driver of dry bulk commodities such as iron ore and coal. China is making efforts to moderate its growth, which is likely to result in an easing in demand for commodities. The above factors could lead to a decline in demand for commercial vessels. Exceptionally large supply of new build vessels are expected to enter the market over the next two years. This would result in reduced new build orders Large supply of new vessels to cap new build orders Exceptionally large supply of new build vessels are expected to join the global shipping fleet over the next two years. Currently, 40.9% of the existing dry bulk fleet is on order while 22.0% crude oil tanker fleet is on order. Despite a modest rise in demand for vessels, exceptionally large supply of vessels is likely to result in depressed levels of freight rates. This, in turn, would result in very few new build orders for shipyards. Exhibit 20: Large supply pipeline Present Fleet Order book Vessels mln DWT Vessels mln DWT % of DWT Dry Bulk Tanker LPG Containers Source: ICICIdirect.com Research Shortage of liquidity and risk aversion by financial institutions could lead to a lack of debt funding options for new shipbuilding Risk aversion by financial institutions may lead to funding options drying up Global financial institutions are risk averse in funding new vessel purchases as the shipping industry is currently passing through a downturn. Further, depressed freight rates have also affected the viability for new proposals. As shipping is a capital intensive as well as highly leveraged industry, the lack of debt funding would result in a decline in new build orders for the next couple of years. Decline in vessel scrapping may lead to further pressure on freight rates Drop in vessel scrapping Scrapping of vessels continued unabated throughout 2009 as depressed freight rates and high scrap metal prices forced many ship owners to scrap their vessels before the end of their useful life. However, if scrapping activity slows down it could result in higher available tonnage leading to pressure on freight rates. Decline in crude oil prices is likely to result in a slowdown in exploration activities, thereby adversely affecting the demand for diving support vessels Decline in crude oil prices Crude oil prices have stayed above $70/barrel over the last one year. Firmness in crude oil prices has led to a rise in exploration and drilling spend necessitating demand for diving support vessels and services. However, conversely, a decline in crude oil prices below $70/barrel could lead to a slowdown in exploration and drilling activities, thereby adversely affecting the offshore shipbuilding business. Page 14

15 Non revival of subsidy scheme would make it difficult for domestic shipyards to compete with global players Non revival of subsidy scheme The Shipping Ministry has proposed the revival of the erstwhile subsidy scheme, which had lapsed in The proposal is pending for the last three years and various options are being explored to revive the scheme. However, non renewal of the scheme could be a major setback as it would make it difficult for domestic shipyards to compete with global shipyards especially in the current downturn. Aggressive pricing by Korean and Chinese shipyards to bag new orders could hurt the interests of Indian shipyards Aggressive pricing by Chinese and Korean shipyards A major factor contributing to the rise in order book size of Indian shipyards was the order backlog with global shipyards, which resulted in a delivery time of vessels in excess of four years. This prompted shipping companies to place orders with Indian shipyards, which offered to provide delivery of vessels with a lesser lead time. Hence, Indian shipyards benefited from the spill over of orders from the Japanese and Korean shipyards. As new build orders have slowed down considerably in the last two years, Japanese and Korean shipyards have spare capacity. Hence, we believe they would offer aggressive pricing to bag new build orders to enhance their capacity utilisation levels. Even the recent data suggests that majority of the new build orders in the last one year have been bagged by Korean shipyards such as Hyundai and Samsung and the trend is likely to continue in the medium term as well. Further, in the absence of a subsidy scheme, Indian shipyards would lack the competitive price advantage earlier enjoyed by them. Page 15

16 Financials Revenue growth at 48.8% CAGR for FY10-FY13 as execution gathers speed Pipavav has an order book of 6330 crore comprising 21 Panamax bulk carriers, 12 offshore support vessels and five offshore patrol vessels. The company has completed the capex and the dry dock and the Goliath cranes are fully operational. We expect the revenue booking to rise substantially in FY12 as execution gathers pace with the shipyard expected to report 48.8% CAGR growth over FY10-FY13. We expect revenues from shipbuilding to grow by 123% to 1244 crore along with a similar rise in subsidy booking to 187 crore while we have factored in a decline in trade sales to 168 crore over the same period. Revenues for FY12 are expected to rise by 81% to 1599 crore and rise further by 30% to 2074 crore in FY13. The EBITDA margin is likely to improve from 18.5% in FY12 to 24.6% in FY13. Pipavav is expected to report a PAT of 126 crore in FY12 and 270 crore in FY13. Revenues are expected to rise as execution gathers pace. Pipavav is expected to report positive PAT from FY12 onwards Exhibit 21: Revenue/EBITDA/PAT projections cr FY10 FY11E FY12E FY13E -500 Revenue EBITDA Net profit The core shipbuilding business is expected to rise by 123% to 1244 crore in FY12 and 37% to 1701 crore in FY13 as executions gathers pace. Exhibit 22: Shipbuilding and subsidy projections cr FY11E FY12E FY13E Shipbuilding Subsidy Page 16

17 Debt levels to ease as execution picks up Debt levels are expected to drop from 1340 crore in FY11 to 760 crore in FY13. This would also result in a decline in the debt-equity ratio to a modest The debt equity level is expected to drop as execution gathers pace. The debt-equity ratio is expected to drop to a modest 0.36 in FY13 Exhibit 23: Debt/equity ratio trend cr FY10 FY11E FY12E FY13E Debt Debt-Equity Debt equity ratio Pipavav has one of the best debt equity ratios in the industry. Pipavav had a debt equity ratio of 0.8 in FY10 as compared to a debt equity ratio of 2.6 for ABG Shipyard and 2.8 for Bharati Shipyard. The debt-equity ratio for Pipavav is expected to drop further to a very modest 0.6 in FY12. This provides sufficient room to Pipavav to raise further debt if required to carry out any additional capex. Exhibit 24: Best debt-equity ratio in the industry Pipavav has a very conservative debt-equity ratio as compared to ABG Shipyard and Bharati Shipyard FY10 FY11E FY12E Pipavav ABG Bharati, Page 17

18 Subsidies: Dry bulk order book eligible for subsidy Pipavav has till date booked subsidies of 157 crore. However, it has not received any subsidy from the government as subsidies are payable only on delivery of vessels and Pipavav would commence delivery from Q2FY12 onwards. Pipavav is expected to receive subsidies worth 945 crore with respect to its commercial vessel order book, which amounts to 3150 crore. Timely payment of subsidies would further improve the cash position of the company and also facilitate faster execution of its order book. Exhibit 25: Estimates of subsidy likely to be booked Almost 50% of the order book of Pipavav i.e crore that consists of dry bulk Panamax vessels is eligible for subsidy and the total subsidy amount is 945 crore FY10 FY11E FY12E FY13E FY14E FY15E FY16E Subsidy, Capex completed: Free cash flow to improve as debt comes down Pipavav has completed the capex spend and its shipyard complex is fully operational with fabrication yard, dry dock and Goliath cranes installed. It will not need to incur any more capex unless it plans to convert its existing wet dock into a dry dock, which would require additional capex spend of ~ 900 crore. As execution gathers pace, we expect an increase in stage wise payment from clients resulting in rise in cash flow. Page 18

19 Valuation Pipavav has set up world class infrastructure facilities, which are not comparable with any other domestic shipyard such as ABG Shipyard, Bharati Shipyard or Cochin Shipyard. Hence, it would command a higher multiple compared to domestic shipyards and more in line with international shipyards that have a similar infrastructure facility. At CMP of 79 Pipavav is trading at 19.5xFY13E EPS of 4.1 and 2.5xFY13E P/BV of 31.7 i.e. i.e. 65% and 32% higher than even the best and established global shipyards. Although Pipavav is in a growth phase, the significant premium over global shipyards would not be justified until execution improves. We have valued the stock at 2.0x FY13E P/BV and are initiating coverage with a SELL rating and a price target of 63. Exhibit 26: Valuation Parameters Valuation based on Global average Target multiple Target price ( ) PE multiple (x) Price to book value (x) Average target price ( ) 63 Current market price ( ) 79 Upside (%) Source: ICICIdirect.com Research (20.3) Page 19

20 Exhibit 27: Global peer valuation P/BV (x) P/E (x) EV/EBITDA (x) ROE (%) Company Country CY10E CY11E CY12E CY10E CY11E CY12E CY10E CY11E CY12E CY10E CY11E CY12E Shipbuilding Daewoo Shipbuilding* South Korea Hyundai Heavy Industries* South Korea Keppel Corp. Ltd* Singapore Samsung Heavy Industries* South Korea Sembcorp Marine* Singapore ABG Shipyard# India Bharati Shipyard# India Pipavav Shipyard# India *consensus # With regards to ABG, Bharati and Pipavav, three year data represents FY10, FY11 and FY12 (financial year ending in March) Exhibit 28: Domestic peer valuation ABG Shipyard Sales ( Crore) EPS ( ) PE (x) EV/EBITDA (x) RoNW (%) RoCE (%) Idirect Code ABGSHI CMP ( ) 351 FY Target ( ) 302 FY11E MCap 1787 % Upside -14 FY12E Bharati Shipyard Sales ( Crore) EPS ( ) PE (x) EV/EBITDA (x) RoNW (%) RoCE (%) Idirect Code BHASHI CMP ( ) 146 FY Target ( ) 172 FY11E MCap 426 % Upside 18 FY12E Pipavav Shipyard Sales ( Crore) EPS ( ) PE (x) EV/EBITDA (x) RoNW (%) RoCE (%) Idirect Code PIPSHI CMP ( ) 79 FY Target ( ) 63 FY11E MCap 5260 % Upside -20 FY12E Page 20

21 Exhibit 29:Profit and loss account ( Crore) FY09 FY10 FY11E FY12E FY13E Sales Growth (%) Op. Expenditure EBITDA Growth (%) Other Income Depreciation EBIT Interest PBT Tax Extraordinary Item Rep. PAT before MI Minority interest (MI) Rep. PAT after MI Adj. Net Profit Growth (%) Exhibit 30:Balance sheet ( Crore) FY09 FY10 FY11E FY12E FY13E Equity Capital Share Warrants Reserves & Surplus Shareholder's Fund Secured Loans Unsecured Loans Deferred Tax Liability Source of Funds Gross Block Less: Acc. Depreciation Net Block Capital WIP Net Fixed Assets Investments Inventory Trade Receivables Cash Other Current Assets Loans & Advances/Others Total Current Asset Current Liab. & Prov Net Current Asset Application of funds Page 21

22 Exhibit 31:Cash flow statement ( Crore) FY10 FY11E FY12E FY13E Net Profit Before Tax Depreciation Direct Tax Paid CF before change in WC Increase in Current Liabilities Increase in Current Assets CF from operations Pur. of Fix Assets Income from Inv CF from Investing Inc./(Dec.) in Debt Inc./(Dec.) in Equity Capital CF from Financing Opening Cash balance Closing Cash balance Exhibit 32: YoY Growth (%) FY09 FY10 FY11E FY12E FY13E Net sales EBITDA Adj. net profit Cash EPS Net worth Exhibit 33: Key ratios Cost ratios (%) FY09 FY10 FY11E FY12E FY13E Consumption of Raw Materials Manufacturing Expenses Employee Cost Administrative, Selling and other Expenses Profitability ratios (%) EBITDA Margin PAT Margin Per share data ( ) Revenue per share EV per share Book Value Cash per share EPS Cash EPS DPS Page 22

23 Exhibit 34: Key ratios Return ratios % FY09 FY10 FY11E FY12E FY13E RoNW ROCE ROIC Financial health ratio Operating CF ( Cr) FCF ( Cr) Cap. Emp. ( Cr) Debt to equity (x) Debt to cap. emp. (x) Interest Coverage (x) Debt to EBITDA (x) DuPont ratio analysis PAT/PBT PBT/EBIT EBIT/Net sales Net Sales/ Tot. Asset Total Asset/ NW Exhibit 35: Turnover ratios FY09 FY10 FY11E FY12E FY13E Working cap./sales ratio Inventory turnover in days Debtor turnover in days Creditor turnover in days Current Ratio Exhibit 36: FCF calculation ( Crore) FY10 FY11E FY12E FY13E EBITDA Less: Tax NOPLAT Capex Change in working cap FCF Exhibit 37: Valuation ratios (x times) FY09 FY10 FY11E FY12E FY13E PE (x) EV/EBITDA (x) EV/Sales (x) Dividend Yield (%) Price/BV (x) Page 23

24 Annexure Exhibit 38:Pipavav fabrication yard Exhibit 39: Shipbuilding process flow chart Source: ICICIdirect.com Research Page 24

25 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Add, Reduce and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: 20% or more; Buy: Between 10% and 20%; Add: Up to 10%; Reduce: Up to -10% Sell: -10% or more; ANALYST CERTIFICATION Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (East) Mumbai research@icicidirect.com We /I, Bharat Chhoda MBA and Jehangir Master ACA, research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc. Disclosures: ICICI Securities Limited (ICICI Securities) and its affiliates are a full-service, integrated investment banking, investment management and brokerage and financing group. We along with affiliates are leading underwriter of securities and participate in virtually all securities trading markets in India. We and our affiliates have investment banking and other business relationship with a significant percentage of companies covered by our Investment Research Department. Our research professionals provide important input into our investment banking and other business selection processes. ICICI Securities generally prohibits its analysts, persons reporting to analysts and their dependent family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities. While we would endeavour to update the information herein on reasonable basis, ICICI Securities, its subsidiaries and associated companies, their directors and employees ( ICICI Securities and affiliates ) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securities from doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securities policies, in circumstances where ICICI Securities is acting in an advisory capacity to this company, or in certain other circumstances. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate the investment risks. The value and return of investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to see Risk Disclosure Document to understand the risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to change without notice. ICICI Securities and its affiliates might have managed or co-managed a public offering for the subject company in the preceding twelve months. ICICI Securities and affiliates might have received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. ICICI Securities and affiliates expect to receive compensation from the companies mentioned in the report within a period of three months following the date of publication of the research report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. It is confirmed that Bharat Chhoda MBA and Jehangir Master ACA, research analysts and the authors of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Our research professionals are paid in part based on the profitability of ICICI Securities, which include earnings from Investment Banking and other business. ICICI Securities or its subsidiaries collectively do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. It is confirmed that Bharat Chhoda MBA, and Jehangir Master ACA, research analysts and the authors of this report or any of their family members does not serve as an officer, director or advisory board member of the companies mentioned in the report. ICICI Securities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. ICICI Securities and affiliates may act upon or make use of information contained in the report prior to the publication thereof. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject ICICI Securities and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. Page 25