shipbuilding sector icici dec10

8/4/2019 Shipbuilding Sector ICICI Dec10

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Please refer to important disclosures at the end of this report

Shipbuilding

Cruising to recoveryReason for report: Initiating coverage

Equity ResearchDecember 6, 2010

BSE Sensex: 19967

ABG Shipyard BUY

Pipavav Shipyard SELL

Sanket [email protected] 22 6637 7159

Indian shipyards may be in for a revival as the offshore segment, which is their

core strength, is seeing significant growth led by key demand triggers. Globally,

after turbulence in 09, shipyards have scripted an exciting recovery in 10 when

new orders are touching ~60mnGT and fundamentals have improved dramatically.

However, this recovery is fragile as merchant shipbuilding is still caught in

undercurrents, but poses little risk to Indian shipyards as most of them are

offshore centric. With good historical record in offshore supply vehicles (OSVs),

increased ability to make sophisticated ships, lower labour costs and robust

clientele, Indian shipyards are well poised to exploit the growth opportunity. We

initiate coverage on ABG Shipyard which has a strong offshore focus with

BUY and Pipavav with stronger focus on merchant shipbuilding with SELL.

Offshore On the up led by 6x rise in new orders over 10-14E. Globally,

favourable demand drivers rise in oil prices, pick-up in demand from the US &

Europe, rising upstream E&P expenditures and age profile of the fleet are

manifesting for the offshore segment, which is the core strength of most Indian

shipyards. The shipyards may also witness some immediate triggers such as: i)

orders from Shipping Corporation of India (SCI), ii) continued subsidy, iii) new

defence contracts and iv) rig & tanker orders. Hence, pent-up demand, especially in

offshore, is set to translate into new orders.

Merchant Amidst undercurrents, but Indian shipyards may steer clear.

Shipping capacity is set to grow faster than trade, thus decreasing utilisation, which

will impact freight rate. Cancellations may increase, especially in dry bulk, whereinshipbuilding is faced with Hobsons choice slippages/cancellations mean revenue

loss and if that does not happen, new orders will be delayed. We do not expect this

imbalance to clear till 13, when the first genuine stable orderbook cycle will start. But

Indian shipyards may steer clear on: i) low exposure to large dry bulk ships, ii) strong

clientele and iii) focus on defence & offshore.

Stock picking to be the key. Given that the improving scenario in the offshore

industry is counterpoised against emerging concerns in merchant shipbuilding, stock

picking is the key. In our view, ABG Shipyard, led by its offshore track record, strong

clientele in the dry bulk segment and high revenue visibility till FY14, is a safer bet.

While Pipavav has excellent execution capabilities and its increasing focus on the

defence sector is a big positive, nevertheless it is significantly dependent on revival

in merchant shipbuilding. With the emergence of Pipavav, we believe investors now

have a choice to take exposure to high-risk merchant shipbuilding or to play on

offshore dynamics.

ABG & Pipavav Initiate with BUY & SELL respectively. Our FCFE target price

values: i) ABG at ~Rs579/share (~Rs120/share for subsidy payments, CoE 14%,

terminal year FY22 and terminal growth 4%); we initiate with BUY and ii) Pipavav at

~Rs64/share (14% cost of equity, terminal year FY22 and terminal growth 4%); we

initiate with SELL.

INDIA


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Shipbuilding, December 6, 2010 ICICISecurities

2

TABLE OF CONTENT

Investment argument.......................................................................................................3Indian shipyards more offshore centric .......................................................................3wherein favourable demand drivers are manifesting ..................................................3Pent-up demand to boost offshore orderbooks...........................................................4even as merchant shipbuilding takes time to cast anchor...........................................4Indian shipyards may see immediate triggers ................................................................5Stock picking to be the key .............................................................................................6

Global shipyard Calm waters ahead?.........................................................................7After turbulence, some stability sighted.......................................................................7as industry fundamentals have perked up in 10 .....................................................7but merchant shipbuilding still caught in undercurrents ..............................................9Offshore Demand drivers exist ..................................................................................13

Key differentiators Indian shipyards & global peers ..............................................19Extension of subsidy will provide strong boost .............................................................19Government participation still high in the sector ...........................................................20Indian shipyards, recent entrants in building merchant ships.......................................22Increased dependence on offshore will continue..........................................................22Indian shipyards strength Customisation of ships.....................................................22

Index of Tables and Charts...........................................................................................24

COMPANIES

ABG Shipyard ................................................................................................................ 25

Pipavav Shipyard ........................................................................................................... 41

Note: Prices and Sensex as on December 3, 2010


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Chart 1: Increasing oil price and E&P expenditure

(60)

(40)

(20)

0

20

40

60

80

100

120

2007 2008 2009 2010E

(%)

BP Royal Dutch/Shell

Exxon Mobil Conoco Philps

0

20

40

60

80

100

120

140

160

(US$/bbl)

Oil Prices(RHS)

Source: Bloomberg, Company data, I-Sec Research

Pent-up demand to boost offshore orderbooks

Backed by exciting industry dynamics and significant replacement demand, we believe

it is only a matter of time before new orders for OSVs will rise globally. The only trigger

which is still to play out is day rates for OSVs and rigs, which have started improving

with increase in utilisation led by spike in oil demand.

Table 2: Growth drivers take off

2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018EGrowth in oil demand (%) 2 3 3 2 2 2 2 2New ships required 143 218 225 155 158 161 164 167Scrapping 308 308 308 308 308 308 308 308Increase in demand 451 526 533 463 466 469 472 475Deliveries 310 178 411 502 600 600 600 475Overall shortfall in system 166 514 636 597 462 331 203 203Day rates for offshore Good Great Great Great Good Good Good Good

All units in nos: Source: Industry, I-Sec Research

even as merchant shipbuilding takes time to cast anchor

Merchant ship building will take time to recover from the excesses in 07-08. This is

especially true for dry bulk, wherein current orderbooks are expected to be >45% of

the fleet. In India, shipyards (except Pipavav) have focused mostly on offshore

shipbuilding. As per our base case, which assumes ~5% trade growth in 11E (dry bulk

trade growth likely to be ~12% in 10E), new orders will start only in FY14. In fact, in

11E-13E, we expect only ~30mndwt of orders to be placed. However, this will be

followed by a sudden spurt of orders in 14-15 in our view, which will normalise

(capacity utilisation ~89%) post 16.

Upstream E&P

expenditures have

increased ~27-34%

for major companies.

They will continue to

increase in the longterm as more and

more oil will come

from fields that are

yet to be developed


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5

Table 3: How will the dry bulk cycle play out?

2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E

General economic situation Boom Volatile Growth?Dry bulk trade (bn te) 2.8 3.0 3.1 3.0 3.4 3.6 3.7 3.9 4.1 4.3 4.5Converted into shipdemand (mn dwt) 322 351 369 368 406 426 447 470 493 518 544Increase in demand 29 18 -1 38 20 21 22 23 25 26

Actual available

Fleet (mn dwt) 363 386 411 438 486 522 525 529 550 582 611Net increase in fleet size 22 26 27 48 36 3 4 21 32 29

Capacity utilisation 89 91 90 84 84 82 85 89 90 89 89Baltic Dry Index Good Great Great Low Low Low Decent Good Great Good GoodNew order contracting 50 148 105 30 70 30 80 62 41

Source: Industry, I-Sec Research

Our bull case assumes trade growth to continue at ~10%, normalising to ~5% post

16E. Based on bull-case assumptions, 11-13 will see a spurt in orders, to be

delivered in 13-16 before normalising in 17.

Chart 2: New orders Bull versus base case Table 4: Assumptions

0

10

20

30

40

50

60

70

80

90

2011E 2012E 2013E 2014E 2015E 2016E 2017E

(mndwt)

Base Case Bull Case

Base case Bull case

Growth in dry bulk trade (%) 5 10-5Planned delivery from current orderbook(mn dwt) 363 363Cancellations from existing orderbook(mn dwt) 165 116

New orders 11-13 30 140

Ship capacity utilisation (%) 89 89

Source: Industry, Bloomberg, I-Sec Research Source: I-Sec Research

Indian shipyards may see immediate triggers

Long-term growth prospects apart, Indian shipyards may see immediate triggers such

as new orders from SCI, stake purchase by SCI and revival of the subsidy scheme.

SCIs ~Rs135bn boost will give concrete revenue visibility

SCI (with ~79 ships & 5.1mndwt capacity) is planning to invest ~Rs135bn to acquire

>60 ships in the next few years. While it has already placed orders for ~29 vessels, it

is yet to place for the rest. In the past, SCI has not placed significant orders with Indian

private shipyards, and thus we have not considered this in our valuations.

However, the Government has recently come out with a notification, which excludes

the clause of past experience for Indian private shipyards while bidding for Indian

contracts. This indicates the Governments intent to attract higher private participation

in SCIs shipbuilding orders. And if Indian shipyards win even 10% of the contract, it

will provide concrete revenue visibility to the sector and give it a boost.


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Chart 3: Percentage of SCI ships older than 20 years

0

20

40

60

80

100

120

Tankers Bulkers Offshore

(%)

Source: SCI

SCI stake purchase plans will provide a benchmark

SCI also plans to buy a minority stake in an Indian shipyard, which could providebenchmark to valuations.

Revival of the subsidy scheme

The Government has extended 30% subsidy for export orders till August 07. The

scheme may be extended in one form or the other for orders beyond 07. This will give

a major boost to the sector, even if the actual payments are erratic and non-timely.

Given the lack of clarity, we have not factored in continued subsidy in our estimates.

Stock picking to be the key

Given that the improving scenario in the offshore industry is counterpoised againstemerging concerns in merchant shipbuilding, we believe stock picking is the key. We

initiate coverage on ABG Shipyard with BUY as we prefer: i) its strong background in

offshore, ii) sufficient revenue visibility till FY14 and iii) strong clientele that can

withstand even the pressures of merchant shipping. We initiate coverage on Piavav

Shipyard with SELL owing to: i) low revenue visibility, ii) high dependence on

merchant ship building and iii) less experience.


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Global shipyard Calm waters ahead?

After turbulence, some stability sighted

Undoubtedly, the global shipyard industry has been treading water since 09.

Excesses in 04-08 have been haunting the industry in the form of

slippages/cancellations (~40% in dry bulk) and high orderbooks (+25% for tankers and

~46% for dry bulk).

Global trade, however, has recovered smartly. WTO estimates value growth in 10 to

be ~13% versus decline in 09. Freight indexes have recovered from their lows in 09

Shipyards have started getting new orders, although not as much as 08 levels, but

better than 09 levels and more importantly, ahead of expectations. Credit is easily

available to shipping companies and orders for new ships at cheap rates have spiked.

Chart 4: Macro indicators for merchant shippinghave improved percentage change

Chart 5: Some companies have raised ~US$3bn tofund asset acquisitions

(80) (30) 20 70

Container Ships

VLCC

Capesize

Baltic Dry

Tanker Rates

Sea Born Trade

GDP

(%)

2009 vs 2008 2010 vs 2009

0

100

200

300

400

500

600

700

800

900

India

Taiwan

Malaysia

Thailand

Ja

pan

Middle

E

aat

(US$mn)

Source: Industry, Bloomberg, I-Sec Research Source: Industry, I-Sec Research

as industry fundamentals have perked up in 10

If we do not look at 08 and 09, standalone 10 has been a good year for the industry,

with key growth drivers manifesting well. In fact, it does not appear that 09 was

arguably the worst period for the industry.


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Chart 6: GDP growth likely to be +4%... Chart 7: while sea trade could touch ~6%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

(%)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

(%)

Source: Industry, Bloomberg, I-Sec Research, IMF Source: I-Sec Research

Chart 8: Baltic Dry sluggish, but similar to 03

levels

Chart 9: and only tanker rates are sluggish

0

1000

2000

3000

4000

5000

6000

7000

8000

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

0

5

10

15

20

25

30

35

40

45

50

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

('000US$/day)

Source: Industry, Bloomberg, I-Sec Research Source: Industry, Bloomberg, I-Sec Research

Chart 10: Oil prices and demand high Chart 11: New orders could easily cross ~60mnGT

70

72

74

76

78

80

82

84

86

88

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

(mn

bbd)

0

10

20

30

40

50

60

70

80

90

(US$/bbl)

Oil Demand Oil Prices (RHS)

0

20

40

60

80100

120

140

160

180

200

1999

2000

2001

2002

2003

2004

2005

2006

2007

2010E

(mn

GT)

Source: Industry, Bloomberg, British Petroleum, I-Sec Research Source: Industry, I-Sec Research


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but merchant shipbuilding still caught in undercurrents

The current scenario in merchant shipbuilding justifies existing concerns orderbook

growth for Indian shipyards is unlikely to come from merchant shipping. In fact, we

believe merchant shipping is set to witness further lows before it perks up.

Demand not a concern, supply isWe do not believe that demand is a concern oil trade, although impacted by low

demand from the US and Europe, is increasing gradually, while dry bulk trade has

rebounded, growing ~8-12% YoY versus (3)% last year. Thus, demand for shipping

exists. Our concern is that shipping capacity will increase at a faster pace. The global

trade boom and GDP growth through 03-08, along with International Maritime

Organisation regulations and replacement demand, led to a huge spike in orderbook

of shipyards globally in 04-08.

Chart 12: Dry bulk trade has rebounded Chart 13: Oil trade improving gradually withimproving demand from Europe and US

-4%

-2%

0%

2%

4%

6%

8%

10%

2006 2007 2008 2009 2010E

10

12

14

16

18

20

22

2006 2007 2008 2009 2010E

(mnbbd)

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%US Europe Oil Trade (RHS)

Source: UNCTAD, BP, Industry, I-Sec Research Source: UNCTAD, BP, Industry, I-Sec Research

Chart 14: Led by GDP & world trade growth, new order CAGR at 25% in 1999-07

0

20

40

60

80

100

120

140

160

180

200

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010E

(m

nGT)

-4

0

4

8

12

16

(%

YoY)

New Orders (LHS) World GDP Sea Trade

~25% CAGR


Consistent growth in

sea trade and GDP,

IMO regulations and

age profile led to new

orders growing at ~25%CAGR in 1999-07


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As this orderbook will be delivered in the next 2-3 years, shipping capacity will grow

faster than trade, thus decreasing capacity utilisation even from the current levels,

which may impact freight rates, thus impacting shipping companies even more. This

entire cycle will delay the inflow of new orders, hurting shipbuilding.

Chart 15: Since, world trade, deliveries and freightrates correlated

Chart 16: as the deliveries rise, current ratesmay come under pressure

Economy

Trade

Freight Order Backlog

DeliveryFleet

Scrap

Demand for shipping spaceSupply of shipping

space

Economy

Trade


DeliveryFleet

ScrapEconomy

Trade


DeliveryFleet

Scrap

Demand for shipping spaceSupply of shipping

space

0

2

4

6

8

10

12

14

16

18

2010E 2011E 2012E 2013E

growth(%)

80

85

90

95

100

105

110

(Index)

Gross Fleet

World trade

Freight Rates (RHS)

Source: Industry, I-Sec Research Source: I-Sec Research

Biggest risk from dry bulk, where even 20% scrapping may not help

To illustrate, global orderbook for dry bulk ships is ~46% of the current fleet size and

~17% of the current fleet is >25 years old. Even if 20% of the fleet retires in the next

three years, net increase in fleet size will still be 26% at 8% CAGR. Even in case of

slippages and the time period extending to five years, the fleet size will grow at ~5%CAGR. Since the fleet utilisation is already low, global dry bulk trade will have to grow

at a significant pace or freight rates are unlikely to improve. This will be difficult given

the historical track record.

Table 5: Fleet retirement may not be helpful

Service(000 nos)

dwt(mn)

Orderbook(dwt)(mn)

Orderbook(% of fleet)

Fleetretirement

(%)

Net fleetgrowth

(three-yearCAGR) Prospects

Tankers 6.7 449 114 25 10 4.9 Demand from the US and Europe isstill low ~7.5% of the fleet is singlehull. Actual fleet retirement couldeasily be in excess of 10%

Crude oil 2.1 320 90 28Oil product &others

4.6 129 25 19

Bulk carriers 8.2 513 236 46 20 8.0 Trade is unlikely to grow at this rate.We expect cancellations/delays andscrapping to increase in 11

Dry bulk 7.0 468 200 43Ore 0.1 30 33 110Others 1.1 15.5 3 18Others 10.2 281 61 22 NA

Source: Bloomberg, Industry, I-Sec Research; fleet as of October 10

As the orderbook will

be delivered in the next

few years, trade growth

may not be enough to

maintain freight rates at

even current levels

The orderbook for

dry bulk is more than

sufficient to meet

trade increases andfleet retirement


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11

and slippages and cancellations in dry bulk fleet will extract a price

A lot will depend on slippages and cancellations (currently ~40-50%), but shipbuilding

is faced with Hobsons choice slippages and cancellations mean loss of revenues

and if that does not happen, new orders will be delayed. In any case, we do not expect

a sharp revival in orderbook cycle in the dry bulk category, at least till FY14.

We expect a shake up in dry bulk fleet in 11-12 and revival in 13

We believe 11-12 will be the most crucial year for shipping and thus for shipyards. In

11, even if 50% of the expected deliveries do not happen, the fleet size will increase

10% which can not be met by trade growth. This will increase demand-supply

imbalance, creating even more pressure on freight rates, thus increasing

cancellations. We do not expect this imbalance to clear till 13, when the first genuine

stable orderbook cycle will start.

Chart 17: Shake up in dry bulk fleet imminent in 11-12

300

350

400

450

500

550

600

650

2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E

(mndwt)

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%Demand Supply Capacity Utilisation (RHS)

Source: Company data

Handymax and Handysized Silver lining does exist

For Indian shipyards, risks are lower because they construct smaller-sized Handymax

(also called Supramax) and Handysized bulk ships, which are used for transportation

at the regional level. Thus, their rates are dependent on regional growth something

which was witnessed in Asia Pacific where iron ore trade, and going forward, coal

trade will support the shipping industry. In our view, chances of cancellations for

smaller ships seem to be the least in the overall dry bulk segment.

In 11-12, dry bulk

fleet is unlikely to

increase owing to

cancellations and

scraping. As trade

keeps on increasing,

capacity utilisation

will increase leading

to rush of orders in

13, before

normalising beyond

15 to 05 levels


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Chart 18: In 09 and 10, Chinas iron ore importssupported Asia Pacific trade

Chart 19: Coal trade could boost growth in thefuture

0

10

20

30

40

50

60

70

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

(mnte)

0

50

100

150

200

250

2007

2008

2009

2010E

2011E

2012E

2013E

2014E

2015E

(mnte)

0

100

200

300

400

500

600

700

800

900

1,000

(mnte)

India Imports

World Imports (RHS)

India's coal import to

rise by 22% CAGR

Source: Bloomberg, I-Sec Research Source: CEA, I-Sec Research

Chart 20: Baltic Handysize & Supramax indexes more stable than Baltic Dry

40

60

80

100

120

140

160

180

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Oct-10

Oct-10

Handysize Supramax Baltic Dry

Source: Bloomberg, I-Sec Research

What if trade continues to grow at 10%?

After the decline of ~4%, dry bulk trade is expected to grow ~8-12% in 10E, mainly on

the back of increasing commodities trade from China, Africa and Asia Pacific. Thus,

our bull-case scenario has factored in 10% growth till 12E, after which growth may

gradually normalise to 5%. This scenario is plausible if the US and European

economies recover, Indias demand for coal starts increasing and China continues to

be the iron ore giant.

In such a case, after the lull in 09-10, new orders may increase suddenly, which will

normalise only after 15 when trade growth starts coming down to ~5%.

Chinas iron ore

imports stabilised

Handy and Supra

indexes after the

great fall in 08-09.

With steel production

in China declining in

the past four months,

iron ore imports may

decline, but coal

imports will pick up

led by demand fromIndia


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Chart 21: Trade growth of 10% implies continued contracting of new orders

300

350

400

450

500

550

600

650

700

750

2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E

(mndwt)

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%Demand Supply Capacity Utilisation (RHS)


Table 6: Orderbook will continue to grow

11E 12E 13E 14E 15E 16E 17E 18E 19E 20E

World trade (mnte) 3,720 4,055 4,379 4,686 4,967 5,215 5,476 5,750 6,038 6,339New orders (mn dwt) 25 54 61 41 44 46 48 50 52 54

Source: Company data

Offshore Demand drivers exist

Oil demand rising in spite of a subdued US and Europe

Oil prices have been rising gradually over the past year as demand from emerging

economies has not slowed down. According to IEA, Q3CY10 saw a demand and

supply of ~88mnbbd and ~87mnbbd respectively higher than pre-crash levels in

spite of the fact that US and Europe demand, which accounts for 40%+ of global

demand, is still subdued. This lends greater credence to the current rally.

Chart 22: Increasing global demand has gradually increased oil prices

84

85

86

87

88

2007 2008 2009 3Q2010

(mnbbd)

0

20

40

60

80

100

120

140

160

(US$/bbl)

World Demand World Supply Oil Price (RHS)

Source: Bloomberg, IEA, I-Sec Research

If trade keeps on

growing at ~10%,

capacity utilisation

and thus, freight

rates are unlikely to

come down. We maysee spurt in order

booking in 12-13,

after which orders

will normalise

Since 09, oil prices

have increased

steadily owing to

higher demand from

developing countries

such as China, and

liquidity. This rally

could be more

sustainable as the

US and Europe have

only shown subduedsigns of recovery


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14

Chart 23:..even though US & European demand isstill subdued versus pre-08 levels

Chart 24: when they contributed ~41% to globaldemand

14

15

16

17

18

19

20

21

2007

2008

2009

Q12010

Q22010

Q32010

(mnbbd)

US Europe

Europe

18%Others

46%

US

23%

India

4%

China

9%

Source: Bloomberg, IEA, I-Sec Research Source: IEA, BP, I-Sec Research

E&P expenditures have started increasing and will continue to rise inthe long term

After a decline in 09, major oil companies have increased upstream E&P expenditure

in conjunction with rising oil prices. As per our analysis of the quarterly performance,

all major oil companies (except Conoco Phillips) have increased their upstream E&P

expenditure 27-34%. Various reports suggest that E&P expenditures will continue to

rise in the long term as new fields will have to be developed to support even the

current production levels.

Chart 25: Increasing dependence on new fields

100

80

60

40

20

0

1990 1995 2000 2005 2010 2015 2020 2025 2030 2 035

Unconventional oil

Natural gas liquids

Crude oil: fields yet to be found

Crude oil: fields yet to be developed

Crude oil: currently producing fields

mb/d ~40-

50mnbdwill comefrom newoil fields

100

80

60

40

20

0

1990 1995 2000 2005 2010 2015 2020 2025 2030 2 035

Unconventional oil

Natural gas liquids




Unconventional oil

Natural gas liquids




mb/d ~40-

50mnbdwill comefrom newoil fields

Source: IEA, I-Sec Research


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15

Chart 26: means that E&P expenses willcontinue to rise

Chart 27: E&P expenses linked to oil prices

0

50

100

150

200

250

300

350

400

2004

2005

2006

2007

2008

2009

2010E

2011E

2012E

2013E

Capex&Opex(U

S$bn)

Africa Asia

Australiasia Eastern Europe & FSULatin America Middle East

North America Western Europe

0

100,000

200,000

300,000

400,000

500,000

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

(US$mn)

0

25

50

75

100

125

(US$/bbl)

Source: Industry, I-Sec Research Source: Industry, I-Sec Research

Daily rates have started inching up

In conjunction with the gradual increase in oil prices, rig rates, numbers of operational

rigs and day rates for Anchor Handling Tug & Supply (AHTS) ships have moved up

from the lows in 09. We believe it is only a matter of time before utilisation and daily

rates improve further owing to stability in oil prices, increasing demand and growing

E&P expenditure.

Chart 28: AHTS rates have started inching up with increasing oil price

Oil Prices vs AHTS Prices

0

50

100

150

200

250

300

350

400

450

500

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Oil Prices Index AHTS Prices Index

Source: Industry, BP, I-Sec Research

Table 7: and so have the rig rates

Type of rig Estimated rates Current 6 mnths ago 1 year agoHigh Spec Jack-ups 150 130 120 120Old Jack-ups 80-100 70-90 80 705G Harsh 500 450 525 5255G International 450-500 400 450 510


AHTS day rates

generally move in

line with oil prices.

They have juststarted recovering

after the fall in 09


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16

Chart 29: Number of operational rigs has also increased since 09

1,500

2,000

2,500

3,000

3,500

4,000

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

Aug-10

Oct-10

(Nos)

Source: Bloomberg

Age profile of support fleet adds to the demand

Moreover, ~44% of the offshore fleet is more than 25 years old a result of the 09 erawhen sudden decrease in oil prices led to a postponement of new orders. Thus, if the

current trend in oil prices continues for some more time, we may see a revival in the

order cycle of the offshore business.

Chart 30: About 44% of the offshore fleet is >25 years old

>25 years

>20 years

>15 years

>10 years

44%


H2CY11 may see revival in new orders in support vessels

In spite of the strong demand factors coming into play, we do not see a major upsurge

in global offshore orderbook, till at least end-FY11. The reason is obvious fall of oilprices created an excess capacity in 09, which will get cleared first before any

increase in day rate. Once day rates increase and companies show more confidence

on the rise in oil price and demand, a revival will ensue in new orders. This may take a

year and we expect orderbook of support vessels to revive in the second half of CY11

based on scrapping of old ships, stronger signs of revival in the US and Europe and

stability in oil price. However, as regards rigs, it may take some time as orders, which

have already been placed, will get delivered in the next 2-3 years.

As oil prices fell in

08-09, many rigs

were shut down.

However, with

increasing oil prices,

the number ofoperational rigs has

started rising again


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Chart 31: OSV order cycle to revive as early as 11

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

2010E

2011E

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

2020E

(nos

)

0

100

200

300

400

500

600

700

(nos

)

Fleet Size New Orders (RHS)


Chart 32: Imbalance between demand and supply to stabilise post 17

0

100

200

300

400

500

600

700

201

0E

201

1E

201

2E

201

3E

201

4E

201

5E

201

6E

201

7E

201

8E

201

9E

202

0E

(Nos)

Real Demand Increase Actual Deliveries Overall Shortfall (RHS)


Between 10 and 13,

demand will risemore than deliveries,

thus spiking shortfall

and day rates

Between 13 and 17,

the opposite will

happen. Post 17, the

industry will stabilise

with normal growth

and shortfall will be

maintained at normal

levels


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18

Rigs Industry turning positive?

Excerpts from Rig Zone

Since the start of October, drilling companies have ordered at least 17 new rigs, a wave of spending

that signals optimism that oil prices will remain high and that producers will continue to demand the

latest advances in equipment as they tap increasingly hard-to-reach offshore reservoirs. These

orders mark a clear ending to a two-year drought in rig purchases as drillers such as Transocean,

SeaDrill and Atwood Oceanics look to update and bolster their fleet. Of the 17 orders so far thisquarter, 13 are for jackup rigs, by comparison, only eight jackups were ordered in the two years that

ended September 30.

According to some analysts, some of the recent rise can be attributed to pent-up demand that has

"sprung to life" with improved financing and construction costs that have fallen by as much as 20%

since 2008. Most of the orders are intended to address arising demand and rejuvenate aging fleets.

The global jackup fleet of 466 includes 338 rigs that were built before 1990, according to energy

analysts Tudor Pickering Holt & Co. Those older rigs are increasingly losing work to newer rigs,

which producers are choosing both because they need the added drilling power and because they

offer efficiencies, according to analysts. A rig with more storage space, for example, can mean

savings through fewer supply boat trips.

Like other companies, Atwood Oceanics cites the widening gap between the dayrates of newer rigs

and those of older ones in placing its orders. It expects the new rigs to bring in between US$130,000and US$150,000 per day once deployed in 2012.

According to other analysts, Brazil's Petrobras could order nine of its proposed 28 new deep-water

rigs before year's end. And analysts with Barclays Capital said in a recent study that companies in

India and China are planning orders.

Increasing expenditure by Indian Navy could provide further fillipThe Indian Navy makes large defence ships in government-owned shipyards, but

issues contracts to private shipyards such as ABG, Bharati and Pipavav for smaller

ships such as interceptor boats.

As the defence requirement is increasing, the Navy is also increasing its collaborationwith the private sector. While we do not expect high-value, big-ticket orders (example

aircraft carriers) to come to the private sector, low-ticket orders should provide strong

stability in the event of a downcycle in the shipping business.

Chart 33: Budget allocation to defence

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

FY09 FY10 FY11E FY12E

(Rs

bn)

Total Navy

Source: Ministry of Defence, I-Sec Research


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19

Key differentiators Indian shipyards & global peers

Extension of subsidy will provide strong boost

In 05, the Government extended the shipbuilding subsidy scheme to the private sector

(the scheme covered public sector shipyards). The scheme allowed private sector

shipyards to get 30% of the ship order price as subsidy from the Government. The

scheme was applicable on a certain class of ships and the price was to be determined

by the Directorate General of Foreign Trade. The scheme is, as of now, applicable to

only those ships for which orders were placed through April 02-August 07.

We have not factored in extension of subsidy, but it is plausible

Discussions are ongoing between the Ship Manufacturing Association of India and the

Government to extend and expand the scheme. We believe, while expansion of the

scheme may not be likely, the extension is plausible, especially when globally,

Governments are increasingly extending their support to the shipbuilding sector.

However, we have not included this possibility in our valuations, but have separately

valued subsidy that is due from the Government as on date.

How much subsidy is due?

Excerpt from The Hindu (April 1, 09)

New Delhi, April 1, ABG Shipyard can claim Rs17bn as shipbuilding subsidy from the Government,

followed by Pipavav Shipyard (Rs10.5bn) and Bharati Shipyard (Rs10bn) over the next four-five

years. Larsen & Toubro can claim Rs3.75bn, Tebma Shipyards Rs2.7bn and the Government-owned

Cochin Shipyard can claim Rs2.55bn, according to sources in the know.

The Government, in the last week of February, approved a move to disburse about Rs51bn as

shipbuilding subsidy to domestic shipyards for orders secured till August 15, 2007. The subsidy will

be disbursed when the shipyard concerned delivers the ships to its customers. So, in case a buyercancels his order due to any reason, the shipyard will not receive any subsidy for that order.

ABG Shipyard has deliveries lined up till 2013, for which it can claim the Rs17bn subsidy. Based on

our current delivery position, a subsidy of Rs1.2bn is already due. The Rs17bn subsidy is for orders

that will be delivered till 2013, Mr Dhanajay Datar, Chief Financial Officer, ABG Shipyard, told

Business Line. Bharati Shipyard, meanwhile, has already delivered vessels for which the

Government has to disburse subsidies of about Rs3bn.

The scheme positively impacted the sector

The scheme has had a strong impact on the sector providing ~4-10% EBITDA

margin boost, depending on revenue booking. However, it has not significantly aided

working capital management as payments by the Government have been delayedsignificantly. Nevertheless, continuation of the scheme will help the sector significantly

as it will allow shipyards to price more competitively in the current downcycle.


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20

Chart 34: EBITDA margin comparison Chart 35: Margin boost of 4-10% from subsidybooking

0%

5%

10%

15%

20%

25%

30%

ABG

ABGEx

Subsidy

Yang

Jiziang

Cosco

Hyundai

Heavy

Samsung

Heavy

Daewoo

India China Korea

EBITDAMargi

0%

5%

10%

15%

20%

25%

30%

35%

FY04 FY05 FY06 FY07 FY08 FY09 FY10

ABGEBITDAMa

rgi

Core Margin Subsidy

Source: Bloomberg, Company, I-Sec Research Source: Bloomberg, Company, I-Sec Research

Government support to shipbuilding extended globally

Shipbuilding has always been important for countries as it brings in foreign exchange,

employs many people and is essential for the development of trade. Thus, many

countries have had a focused strategy to promote shipbuilding. Hence, shipbuilding

industry, which was first centred in Europe, moved to Japan and then to Korea and

now seemingly to China China for example, has always provided working capital

loans at less than 3% interest rate and subsidy for inland ships. It is now also giving

17% subsidy to shipping companies that book ships in Chinese shipyards. Brazil has

been trying to grow its shipbuilding industry through a slew of public-private sector

initiatives. The Indian Government has not, as yet, extended the old subsidy scheme

(30% of ship price as determined by DGFT for ships ordered before August 07).

Table 8: Support schemes from Governments for shipbuilding

China India

17% subsidy on prices for Chinese ship buyers 30% subsidy but only for ships that were orderedbefore August 07

Preferential interest rates for buildersBanks to finance shipbuilding through USD bond issuanceAnd assist shipyards in M&As

Source: Industry

Government participation still high in the sector

The Government has strong presence in the Indian shipbuilding sector via seven

shipyards that build merchant, defence and offshore ships. In terms of orderbook,some Government shipyards may be smaller than private shipyards, but they have the

ability to build tankers, large cargo ships and defence ships. They also receive a

subsidy (export orders are subsidised 30% by the Government). This makes the

Government a stronger player in the industry.


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21

Chart 36: Shipyards in India

Kolkata

Vishakhapatnam

Goa

Surat

Kochi

Cochin Shipyard

Hoogly Dock

Hindustan Shipyard

Goa Shipyard

Garden Reach Shipbuilders

ABG Shipyard

Dahej

Dabhol

Pipavav

Mumbai

Chennai

Pipavav Shipyard

Bharati Shipyard

L&T Shipyard

Bharati Shipyard

Private

Government - Commercial

Government - Defence

Kolkata

Vishakhapatnam

Goa

Surat

Kochi

Cochin Shipyard

Hoogly Dock

Hindustan Shipyard

Goa Shipyard

Garden Reach Shipbuilders

ABG Shipyard

Dahej

Dabhol

Pipavav

Mumbai

Chennai

Pipavav Shipyard

Bharati Shipyard

L&T Shipyard

Bharati Shipyard

Private

Government - Commercial

Government - Defence



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22

Indian shipyards, recent entrants in building merchant ships

Until FY08, Indian private sector shipyards had been focusing on building offshore

support vessels used by the oil &gas industry. This allowed them to create their own

niche even as Chinese shipyards started competing with Korean counterparts in

merchant shipbuilding. The focus on offshore also protected them from the cyclical

nature of the shipping industry. However, it also limited scope of growth and in recentyears, we have seen larger private sector shipyards entering the merchant

shipbuilding arena ABGs expansion and Pipavavs IPO reflected this.

Increased dependence on offshore will continue

The oil & gas sector still plays a significant role. Both ABG and Bharati have ~50% of

their orderbooks based on offshore vessels and rigs. Even Pipavav Shipyard, which

focuses on merchant ships, has seen orderbook growth owing to ONGCs offshore

supply vehicle order of ~Rs5bn. This compares favourably with China where complete

focus is on building merchant ships and South Korea where focus is on building, apart

from merchant ships, sophisticated offshore equipment.

Chart 37: Offshore and related orderbook as a percentage of total orderbook

30%

35%

40%

45%

50%

55%

60%

ABG Bharati Samsung Hyundai

Indian Shipyards Korean Shipyards

Source: Industry

Indian shipyards strength Customisation of ships

The Chinese are focusing on economies of scale to build large dry bulk carriers and

tankers. However, they are not able to customise ships and it is this strength that

Indian shipyards have exploited in the offshore segment. On the other hand, Koreans

are building technologically savvy and sophisticated ships and offshore supportequipment and vehicles.

Thus, contracting with suppliers differs accordingly. International shipyards place

orders for steel plates at the time of requirement which ensures lower working

capital requirement but higher uncertainty as regards costs. On the other hand, Indian

shipyards normally lock in steel costs, but this increases working capital requirement.


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23

Chart 38: Indian shipyards differ from international peers in vendor contracts

Time 50-70% 20-40% 10%

Building event Contract Designing Steel cutting Keel laying Launching Delivery

Receivables

Payables

Raw materials

Main engine

Machinery

Steel

Execution Ordering by International Shipyards Ordering by Indian Shipyard

Time 50-70% 20-40% 10%

Building event Contract Designing Steel cutting Keel laying Launching Delivery

Receivables

Payables

Raw materials

Main engine

Machinery

Steel

Execution Ordering by International Shipyards Ordering by Indian Shipyard



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24

Index of Tables and Charts

Tables

Table 1: Indian shipyards inclined more towards offshore ................................................... 3Table 2: Growth drivers take off............................................................................................ 4Table 3: How will the dry bulk cycle play out? ...................................................................... 5Table 4: Assumptions ........................................................................................................... 5Table 5: Fleet retirement may not be helpful ...................................................................... 10Table 6: Orderbook will continue to grow ........................................................................... 13Table 7: and so have the rig rates................................................................................... 15Table 8: Support schemes from Governments for shipbuilding.......................................... 20Charts

Chart 1: Increasing oil price and E&P expenditure ............................................................... 4Chart 2: New orders Bull versus base case....................................................................... 5Chart 3: Percentage of SCI ships older than 20 years ......................................................... 6Chart 4: Macro indicators for merchant shipping have improved percentage change...... 7Chart 5: Some companies have raised ~US$3bn to fund asset acquisitions....................... 7Chart 6: GDP growth likely to be +4%... ............................................................................... 8Chart 7: while sea trade could touch ~6% ........................................................................ 8Chart 8: Baltic Dry sluggish, but similar to 03 levels ............................................................ 8Chart 9: and only tanker rates are sluggish ...................................................................... 8Chart 10: Oil prices and demand high............................................................................... 8Chart 11: New orders could easily cross ~60mnGT ............................................................. 8Chart 12: Dry bulk trade has rebounded............................................................................... 9Chart 13: Oil trade improving gradually with improving demand from Europe and US........ 9Chart 14: Led by GDP & world trade growth, new order CAGR at 25% in 1999-07............ 9Chart 15: Since, world trade, deliveries and freight rates correlated.............................. 10Chart 16: as the deliveries rise, current rates may come under pressure ...................... 10Chart 17: Shake up in dry bulk fleet imminent in 11-12 ..................................................... 11Chart 18: In 09 and 10, Chinas iron ore imports supported Asia Pacific trade................ 12Chart 19: Coal trade could boost growth in the future ........................................................ 12

Chart 20: Baltic Handysize & Supramax indexes more stable than Baltic Dry................... 12Chart 21: Trade growth of 10% implies continued contracting of new orders .................... 13Chart 22: Increasing global demand has gradually increased oil prices......................... 13Chart 23:..even though US & European demand is still subdued versus pre-08 levels 14Chart 24: when they contributed ~41% to global demand .............................................. 14Chart 25: Increasing dependence on new fields............................................................. 14Chart 26: means that E&P expenses will continue to rise........................................... 15Chart 27: E&P expenses linked to oil prices ....................................................................... 15Chart 28: AHTS rates have started inching up with increasing oil price......................... 15Chart 29: Number of operational rigs has also increased since 09 ................................... 16Chart 30: About 44% of the offshore fleet is >25 years old ................................................ 16Chart 31: OSV order cycle to revive as early as 11 ........................................................... 17Chart 32: Imbalance between demand and supply to stabilise post 17 ............................ 17Chart 33: Budget allocation to defence............................................................................... 18Chart 34: EBITDA margin comparison ............................................................................... 20Chart 35: Margin boost of 4-10% from subsidy booking..................................................... 20Chart 36: Shipyards in India................................................................................................ 21Chart 37: Offshore and related orderbook as a percentage of total orderbook.................. 22Chart 38: Indian shipyards differ from international peers in vendor contracts .................. 23


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Market Cap Rs22bn/US$0.5bn Year to Mar (Consol) FY10 FY11E FY12E FY13EReuters/Bloomberg ABGS.BO/ABGS IN Revenue (Rs mn) 18,077 23,200 29,056 39,337

Shares Outstanding (mn) 51 Rec. Net Income (Rs mn) 2,181 2,423 2,784 4,246

52-week Range (Rs) 484/192 EPS (Rs) 39.0 47.6 54.7 83.4

Free Float (%) 42.9 % Chg YoY 15.9 22.1 14.9 52.5

FII (%) 12.4 P/E (x) 11.1 9.1 7.9 5.2

Daily Volume (US$/'000) 20,423 CEPS (Rs) 46.6 58.8 72.1 102.0

Absolute Return 3m (%) 82.0 EV/E (x) 15.4 10.7 8.3 5.6

Absolute Return 12m (%) 103.7 Dividend Yield (%) 1.1 1.1 1.1 1.1

Sensex Return 3m (%) 7.6 RoCE (%) 9.7 9.4 10.3 13.1

Sensex Return 12m (%) 16.8 RoE (%) 20.5 20.6 19.7 24.4

ABG Shipyard BUY

In shipshape Rs432Reason for report: Initiating coverage

Equity ResearchDecember 6, 2010

BSE Sensex: 19967

Shipbuilding

Target price Rs579

Shareholding pattern

Mar10

Jun10

Sep10

Promoters 57.1 57.1 57.1Institutionalinvestors 30.1 27.7 28.9MFs and UTI 1.4 0.9 0.3FI&Banks 0.5 0.6 0.7FIIs 12.8 10.8 12.4

Others 12.9 15.3 14.1

Source: NSE

Price chart

150

250

350

450

550

Dec-09

Jan-10

Apr-10

May-10

Jul-10

Sep-10

Nov-10

(Rs)

Sanket [email protected] 22 6637 7159

ABG Shipyard is the largest shipyard in India with ~Rs141bn orderbook, of which

~Rs100bn is yet to be executed, providing revenue visibility till FY14E. This gives

ABG sufficient headroom to ride out volatile economic factors. The company is

well poised to exploit impending growth in the offshore business led by: i) core

strength and track record, ii) strong clientele, iii) completion of capacity addition

in FY12, increasing execution pace and technical capability and iv) its success in

receiving subsidy from the Government in FY10 alone, it received ~Rs750mn).

Based on FCFE, we value ABGs core business at ~Rs459/share and subsidy

payments at ~Rs120/share. We initiate coverage on ABG with BUY.

Well poised to exploit offshore dynamics. In the past two years, new orders had

dried up in the offshore industry, but given the improvement in industry dynamics inthe past one year and as >40% of the fleet (offshore + related) is still >25 years old,

it is only a matter of time before pent-up demand leads to new contracts.

Strength in offshore to minimise the impact of dry bulk concerns. We factor in

Rs12bn new orders in FY12E, ~Rs19bn in FY13E and ~Rs45bn FY14E onwards

from offshore vessels alone. Order cycle in dry bulk is unlikely to start before FY14,

but ABGs strength in offshore, current orderbook and strong client base are enough

to ride out concerns in the dry bulk segment.

Improving execution capability; rig business to provide further upside. ABG is

investing ~Rs3bn more to install large ship platform at Dahej, which will allow it to

build


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ABG Shipyard, December 6, 2010 ICICISecurities

26

TABLE OF CONTENTS

Investment argument.....................................................................................................27Valuations cheap...........................................................................................................28Current orderbook provides revenue visibility till FY14.................................................30New order expectations Initial growth to come from offshore....................................30Low risk of cancellation on orderbook; strong clientele ................................................32Large ship platform will increase execution capability at Dahej....................................33Margin erosion factored in for new orders ....................................................................34Subsidy To be or not be?...........................................................................................34

Consolidated financials.................................................................................................35Index of Tables and Charts...........................................................................................39


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27

Investment argument

What we prefer aboutABG?

Revenue visibility till at least FY14

Well poised to exploit offshore opportunity

Improving execution capabilities

Strong clienteleWhat concerns us?

Some clients (ex Scan Shipping) had cancelled ship building contracts in the past because of slow execution.ABG had to reschedule its deliveries to Precious Shipping because of construction problems. Significant delaysmay not go down well with clients

~22% of the orderbook is from group companies, though this could be positive as ABG is reportedly enteringcoal trading as well

What are potentialupsides?

Orders from the defence sector

Orders for rigs

Revenue from other businesses such as ship repairValuations

We value ABG at ~Rs459/share + 120Rs/share in subsidy; FCFE (CoE 14%, terminal year FY22, terminalgrowth 4%).

At the current market price of ~Rs432, our target price yields ~34% upside. Initiate with BUY.

Table 1: I-Sec assumptionsCurrent status I-Sec view

Revenue visibility The current orderbook is at ~Rs140bnand unexecuted book at ~Rs100bn. Thisgives revenue visibility till at least FY14

Revenue CAGR 22% till FY16E FY13 to be the peak year for execution of the current orderbook In FY14E, we expect ~49% of the revenues to come from new orders

New orderexpectations

New orders are not flowing in. In 10,ABG won orders for three cementcarriers and two rigs, amounting to~Rs24bn. However, ~Rs20bn worthorders have come from group company

ABG will benefit from early revival in offshore vessels We expect ~Rs12.3bn new orders in FY12E and ~Rs19bn in FY13E

all from offshore. We do not expect new orders from dry bulk shipping,till FY14E

We have not factored in any orders for rigs and navy, which willprovide potential upside

Cancellation risk onorderbook

Shipping companies are profitable at current freight rates Currently, ABGs three big clients have clean balance sheets, strong

history and replacement demand Thus, we do not believe ABG will face any cancellations

Pace of execution ofcontracts

As per our research, Scan Shipping hadcancelled its contract with ABG owing tolate delivery of ships, till Pacific FirstShipping (a group entity) stepped in. Thecontract value was ~Rs3.7bn. As percompany, the cancellation may havehappened owing to bankruptcy. ABGhad received ~50% of the value in anycase

While Dahej Shipyard is complete, ABG is installing a shift lift crane,which will expand capacity to build ~108,000-120,000dwt ships

This will increase execution pace for smaller ships Once this lift is complete, we expect execution rate to increase, thus

reducing delays

Subsidy ABG has booked ~Rs4.5bn of subsidyon its balance sheet, of which~Rs650mn is due from the Government.The rest will be due as and when thecompany completes its delivery

ABG has received ~Rs1.4bn cash subsidy so far from theGovernment

In FY10, ~Rs1.3bn was due, of which the company received~Rs750mn till date

We see no reason why we should not value subsidy due from theGovernment so far

We have not factored in continuation of the subsidy scheme For the current orders, we have taken a declining subsidy benefit (9%

in FY11E to ~2% in FY14E) to account for execution of orders placedtill August 07

Margins and steelprice rise

About 65% of the costs are linked tosteel prices. At present, ABG managesthis risk by purchasing steel at the timeof designing. This protects margins at~20% but increases working capitalcosts

We estimate ~60% of the current orderbook to be of 08 era whenhigh new build prices allowed margins of ~22%+.

For these and following orders, we have maintained EBITDA marginof ~20%

For new orders, we have reduced margins to ~17% to account forsteel prices and lower new build prices

Source: Company data, I-Sec Research


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Valuations cheap

We value ABG based on FCFE assuming FY22 as the terminal year, 4% growth and

14% (8%+1.2x*5%) as cost of equity. Thus, we ascribe ~Rs579/share value to ABG.

Core business and subsidy payments valued through FCFE

Our valuation includes ~Rs10.5bn as subsidy payment from the Government in the

next six years (~Rs4.5bn for subsidy booked till FY10, ~Rs6bn for subsidy to be

generated till FY14), which translates into ~Rs120/share. We have not assumed any

continuation of the subsidy scheme. The 60% stake in Western India Shipyard (WISL)

is valued at the market price (WISL trades at ~Rs14/share) less the cost of acquisition.

Since the WISL acquisition was a bankruptcy case, we believe ABG would have got

the company at a discount (acquisition price Rs10/share). According to ABG, the total

expenditure on WISL may amount to


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Peer comparison

The company is currently trading at ~8x FY12 EV/EBITDA compared to global peers

which trade at 6x-15x with lower EBITDA margins. We believe FCFE valuations

reflect a clearer picture as they factor in margin decline and lesser orders going

forward.

Table 6: Valuations attractive versus global peersPrice performance EBITDA Margin (%) EV/E (x) RoE (%) P/E (x)

BloombergYearEnding (6 mths) (5 days)

FY10/CY09

FY11/CY10

FY12/CY11

FY11/CY10

FY12/CY11

FY10/CY09

FY11/CY10

FY12/CY11

FY11/CY10

FY1CY1

Pipavav Shipyard PIPV IN 03/11 Y (10.9) 9.7 (16.5) 6.7 18.3 88.3 16.6 (3.2) 1.1 12.5 280.5 22ABG Shipyard ABGS IN 03/11 Y 72.7 6.4 17.8 19.3 18.6 10.7 8.3 20.5 20.6 19.7 9.1 7Bharati Shipyard BHSL IN 03/11 Y (12.3) 2.7 18.7 20.5 16.8 9.3 12.9 17.1 13.3 13.3 5.6 8Chinese shipyardsGuangzhou Shipyard Intl 600685 CH 12/10 Y 17.2 (5.6) 14.2 10.9 10.1 11.1 11.1 20.5 19.0 16.1 18.1 18Yangzijiang Shipbuilding YZJ SP 12/10 Y 50.0 4.4 21.5 23.0 20.9 10.5 9.6 38.8 34.5 27.7 12.9 12Cosco Corp Singapore COS SP 12/10 Y 47.2 3.4 11.4 14.3 14.6 10.3 8.7 11.2 16.6 18.2 24.1 19South Korean shipyardsDaewoo Shipbuilding 042660 KS 12/10 Y 57.8 (1.9) 7.2 9.5 9.0 5.9 6.2 27.8 20.9 17.6 7.5 7Samsung Heavy Industries 010140 KS 12/10 Y 43.2 (2.2) 9.3 10.2 10.0 7.0 7.0 27.2 27.5 21.8 8.5 8Hyundai Mipo Dockyard 010620 KS 12/10 Y 31.1 (4.0) 11.6 16.8 15.4 3.5 3.8 16.9 18.1 14.5 6.5 6Hyundai Heavy Industries 009540 KS 12/10 Y 60.7 (3.7) 12.6 17.2 15.6 7.9 8.1 29.9 29.4 21.8 7.9 8Stx Offshore & Shipbuilding 067250 KS 12/10 Y 100.5 (6.2) 3.6 5.9 5.2 12.8 15.1 9.2 8.7 10.1 12.5 10Japanese/Other shipyardsMitsui Engineer & Shipbuild 7003 JP 03/11 Y (3.9) - 7.3 8.3 8.5 5.5 5.4 12.5 9.4 15.0 11.2 9Sumitomo Heavy Industries 6302 JP 03/11 Y (1.7) 2.1 8.0 10.5 11.4 6.2 5.5 3.7 8.0 8.9 15.3 13Mitsubishi Heavy Industries 7011 JP 03/11 Y (11.7) (1.0) 7.5 7.9 8.0 9.6 9.1 1.1 2.0 2.2 41.6 30Bergen Group As BERGEN NO 12/10 Y (15.1) (1.8) 6.9 7.0 6.2 3.1 3.4 9.6 2.3 3.3 11.6 9Source: Company data, Bloomberg, I-Sec Research

Table 7: DCF valuations

(Rs mn)Valuation ex-subsidy FY11E FY12E FY13E FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E

EBITDA 4,115 5,045 7,133 7,153 6,977 8,966 9,959 10,108 9,414 9,046 9,070 9,096

Less interest 2,283 2,406 2,158 1,799 1,484 1,232 1,026 846 667 487 397 397Less taxes 416 579 1,330 1,447 1,490 2,222 2,612 2,713 2,537 2,468 2,498 2,500Operating cash flow 1,415 2,060 3,645 3,907 4,004 5,511 6,322 6,548 6,211 6,091 6,175 6,200Change in WC 7 (1,673) (4,090) (1,357) (698) (3,449) (1,589) (313) 959 463 (135) (142)Post WC 1,422 387 (445) 2,551 3,305 2,062 4,733 6,235 7,170 6,554 6,040 6,058Capex (2,015) (1,015) )247 (257) (259) (261) (264) (266) (269) (271) (274) (276)Debt repayment (2,000) (1,500) (3,996) (3,996) (2,996) (2,596) (1,996) (1,996) (1,996) (1,996) - -FCFE (2,593) (2,128) (4,687) (1,701) 51 (795) 2,473 3,974 4,906 4,287 5,766 5,781

- 1 2 3 4 5 6 7 8 9 10(2,128) (4,112) (1,309) 34 (471) 1,285 1,810 1,960 1,503 1,773 1,560

- 1 2 3 4 5 6 7 8 9 10

Subsidy 1,373 1,421 1,864 2,000 1,185 - - - - - -Discounted value 1,373 1,246 1,434 1,350 702 - - - - - -Terminal Value Rs bn 15.5Total Value Rs bn 20.5Subsidy Rs bn 6.1


Initiate with BUY

Our FCFE valuation suggests ~34% upside from the current market price. We initiate

coverage on ABG Shipyard with BUY recommendation.


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Current orderbook provides revenue visibility till FY14

At present, ABGs ~Rs140bn order book is the highest in the Indian shipyard industry,

even higher than some public shipyards orderbooks. The unexecuted portion of

~Rs100bn provides revenue visibility till FY14. This orderbook will continue todominate ABGs revenue till FY13, after which the companys dependence on new

orders will increase in our view.

In line with our positive view on offshore vessels and rigs, we believe short-term

growth in ABG will be offshore-led, which has been the companys core strength.

Growth in offshore and revenues from the current orderbook are adequate shields

against short-term concerns in dry bulk shipping.

Table 8: Orderbook break up

Segment Vessel type Number of ships Total (Rs bn)Defence Interceptor, pollution control 7 3.3

MerchantCement carrier 3 3.8Handysize 26 36.9Supramax 15 24.9

Total 44 65.7

Offshore & rigs AHTS 15 14.1Diving support 3 2.8Platform supply 3 6.5Rigs 4 41.3

Total 25 64.6

Others 7 8.0Total 83 141.7


Chart 1: ABGs net orderbook highest in India Chart 2: Current orderbook offers revenue visibilitytill FY14, but with rising reliance on new orders

0

20

40

60

80

100

120

ABG Pipavav Bharati Cochin

Shipyard

(Rsbn)

0

10

20

30

40

50

60

FY2010

FY2011

FY2012

FY2013

FY2014

FY2015

FY2016

Rsbn

Current Orders New Orders

6 yr CAGR: 22%

Note: Cochin Shipyard has an aircraft carrier, the value of which isunknownSource: Company, I-Sec Research

Source: I-Sec Research

New order expectations Initial growth to come from offshore


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We believe ABGs orderbook will be led by offshore vessel construction, which is

witnessing demand. We expect the net orderbook of ~Rs100bn to decline to ~Rs59bn

in FY13E before new orders from offshore and merchant shipping (in FY14) fuel

growth. The net orderbook will stabilise at ~Rs95bn after FY17E, with execution

keeping pace with new order inflows.

Chart 3: Merchant shipbuilding orders to stabiliseafter FY17 Chart 4: Offshore vessel construction will reportstrong order contracting from FY12

0

5

10

15

20

25

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY19

FY20

(Rsbn)

0

0.1

0.2

0.3

0.4

0.5

0.6

(mndwt)

Value Size (RHS)

05

10

15

20

25

30

35

40

45

50

FY11

FY12

FY13

FY14

FY15

(Rsbn)

05

10

15

20

25

30

35

40

45Value Nos (RHS)

Source: Industry, I-Sec Research Source: I-Sec Research

However, growth in offshore will change the orderbook mix ABGs dependence on

the offshore industry will increase to earlier levels.

Chart 5: Back to the future ABG will again depend more on offshore

Current orderbook at ~Rs141bn FY15E orderbook at ~Rs139bn

46%

54%

21%

79%

Merchant

Offshore & Others



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Rigs and defence orders Upsides not factored in

As of now, we have not factored in potential orders from rig construction and the

Indian navy. ABG is a new entrant in rig construction (it requires high technical

expertise) with its first delivery in 11-12 to the Essar Group.

As regards orders from the Indian navy, ABG, in our view, will face stiffer competition

from Bharati and Piavav, which have greater spare capacity to service the defencesector. Thus the orders will be erratic and we view them as an upside.

The rig business offers significant potential for ABG. The company started its rig

construction business in FY09 and is currently executing orders for Essar (two rigs)

and Drilling & Offshore (two rigs), a group company valued at ~Rs41.3bn.

Larger shipyards in Korea have started focusing on constructing sophisticated

deep water rigs, which has created an opportunity for companies such as ABG

some smaller clients may simply replace old rigs.

Anecdotal evidence suggests pent-up demand for rigs after insignificant orders. In

October 10 alone, ~13 jack-up rigs were booked versus just eight in the past twoyears globally. If oil prices remain stable, rig orders might grow significantly in 11.

We have not factored in orderbook growth in rigs, mainly because it requires

greater technological and technical expertise to establish presence in the industry.

ABG is a recent entrant and will make its first delivery in 11-12 to Essar.

Once the company proves its technological capability, it will gain significant

traction in the business.

Low risk of cancellation on orderbook; strong clientele

We have independent verified ~66% of ABGs current orderbook. Barring one, we are

fairly impressed by the strength of ABGs clients, both in terms of experience in theshipping business (Vogemann) and financial strength (Precious Shipping Company).

Chart 6: About 68% of ABGs orderbook robust

Unverified

10%

Verified

66%

Group Companies

22%

Indian Defence

2%



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Precious Shipping, Thailand. The company is listed and is cash positive, thus

providing greater security to ABGs orderbook. Precious Shipping sold nearly 10 old

vessels during the peak of 07 and has sold ~25 more ships since 09. This has rapidly

brought down its fleet size to 21. It has strong focus on regional trade and sub-handy

max ships. Thus, it may be able to withstand any pressure in the dry bulk shipping

area and can even expand its fleet to take advantage of lower prices.

Vogemann, Germany. Vogemann is a merchant player with stronger focus on dry

bulk. More importantly, it started operations in 1876 and given its experience, we do

not see any concern in its orderbook.

Deep Sea Supply, a listed offshore player, is relatively new to the industry and was

established in 06. Since then, the company has grown, having 25 ships in the offshore

space. Order cancellation is unlikely as orders are in the final stage of completion.

Key concerns. About Rs31bn of ABGs orderbook, of Rs141bn total, is dependent on

Pacific First Shipping and Drilling & Offshore, which are a part of the ABG Group. This

is negative as well as positive as ABG is reportedly venturing into coal trading which

can boost the shipyard business.

Chart 7: Client-wise breakup

Others

Pacific First

Drilling & Offshore

Essar

Precious Shipping

Vogemann

Deep Sea Supply

Indian

Coast Guard

0

10

20

30

40

50

60

70

80

90

100 The current order book does not do full justice. ABG has

delivered - 3 vessels in FY11 alone.

Fleet Size On Order D:EFrom ABG

24 5 75:254

21 13 NA12

21 18 25:7518

25+13 12+2 45:556+2

These tw o ompanies are group companies accounting for

~21% of the order book

Segement

Offshore

Merchant

Dry Bulk

Merchant +

Offshore


Large ship platform will increase execution capability at Dahej

ABG has faced delivery concerns in the past it had to renegotiate its delivery

schedule with Precious Shipping; also its group company had to step in to protect the

contract with Scan Shipping. However, we believe this risk will reduce substantially

going forward, especially when the company installs the large ship platform at Dahej.

ABG is spending ~Rs3bn for the crane, which will become operational by FY12 in our

view. Moreover, the crane will allow ABG to make ~120,000dwt of ships, which will

propel the shipyard into significantly higher league in terms of technological capability.


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Chart 8: Margin to stabilise at 17% post FY16

0

10

20

30

40

50

60

FY06 FY07 FY08 FY09 FY10 FY11EFY12EFY13E FY14EFY15EFY16E

(Rsbn)

10%

12%

14%

16%

18%

20%

22%

24%

26%Ship Building Margins (RHS)

Source: Company, I-Sec Research

Margin erosion factored in for new orders

ABG normally quotes prices which yield +20% EBITDA margin after factoring in raw

material cost. However a lag of ~3-6 months exists between winning a contract (which

more or less fixes the ship building price) and signing the corresponding contract with

the vendors (which depends on the final ship design). Marginal cost escalations have

always been factored into the contract, but in 08-09 when commodity prices fluctuated

wildly, ABG suffered either margin wise or in terms of locking inventory.

Now that the prices are more stable, we believe ABGs margins will remain stable at

~19-20% for execution of the current orderbook. However, we have factored in lower

margins of ~17% for the new orders, mainly to factor in lower new build prices.

Subsidy To be or not be?

ABG has benefited the most from subsidy, with ~Rs1.35bn cash receipts till date. In

April 09, reportedly, the Government allocated ~Rs51bn towards subsidy to shipyards,

of which ABG alone is entitled to ~Rs17bn by FY13E. While the budgetary allocation

may not indicate actual subsidy payment, it does ease up the cash receipt process. To

illustrate, in FY10, ~Rs1.3bn was due, of which ABG has already received ~Rs750mn.

We estimate ABG to receive ~Rs10bn subsidy in the next six years factoring in order

renegotiations, cancellations, ~Rs4bn subsidy booked to date but not due and further

execution of orders leading to ~Rs6bn subsidy. The 6bn subsidy is based on the

current net orderbook of ~Rs100bn, of which only ~Rs30bn would be eligible in ourview. While the rule is 30%, we believe, effectively it is ~20% of pricing or ~Rs6bn.

We have not factored in continued subsidy for orders received after August 07. Thus,

the subsidy component of revenues will decline from FY11 levels to nil by FY15.

ABG reached peak

margins of ~22%+

during the bull run,

when new build

prices were very

high. From thatphase, we expect

margins to drop to

17% as the company

executes new orders

acquired at lower

prices


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Consolidated financials

Table 9: Profit and Loss statement

(Rs mn, year ending March 31)FY09 FY10 FY11E FY12E FY13E

Net Sales 14,122 18,077 23,200 29,056 39,337of which Ship Building 13,481 16,250 21,285 27,156 37,582

of Which Subsidy 629 1,823 1,916 1,901 1,755of which Wind Mill Towers 5 - - - -of which Ship Repair 9 4 - - -

Other Operating Income 8 - - - -

Total Operating Income 14,130 18,077 23,200 29,056 39,337

Less:Consumption of Raw Materials & Components 8,431 10,163 13,197 17,108 24,127Manufacturing Expenses 1,025 1,494 1,809 2,308 3,194Personal Expenses 296 481 855 1,107 1,217SG&A 639 1,216 1,309 1,588 1,911

Total Operating Expenses 10,391 13,354 17,170 22,111 30,449

EBITDA 3,739 4,722 6,030 6,946 8,888EBITDA ex Subsidy 3,110 2,899 4,115 5,045 7,133

Depreciation & Amortisation 145 387 570 885 945Other Income 139 776 285 322 282

EBIT 3,733 5,112 5,745 6,383 8,225

Less: Gross Interest & Finance Charges 1,232 2,239 2,283 2,406 2,158

Recurring Pre-tax Income 2,501 2,873 3,461 3,977 6,066

Add: Extraordinary Income - 293 - - -Less: Extraordinary Expenses - - - - -

Less: Taxation 789 984 1,038 1,193 1,820

Net Income (Reported) 1,713 2,181 2,423 2,784 4,246

Recurring Net Income 1,713 1,985 2,423 2,784 4,246



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Table 10: Balance sheet

(Rs mn, year ending March 31)FY09 FY10 FY11E FY12E FY13E

ASSETSCurrent Assets, Loans & AdvancesCash & Bank balance 506 284 1,370 1,985 1,027Inventory 12,236 10,661 11,625 14,038 18,322Sundry Debtors 418 720 1,066 1,637 2,265

Loans and Advances 13,473 16,207 18,010 18,866 22,906Operational 8,559 9,018 10,205 11,160 15,445Subsidy 3,021 4,500 5,116 5,017 4,772Others 1,893 2,689 2,689 2,689 2,689

Total Current Assets 26,633 27,872 32,070 36,525 44,520

Current Liabilities & ProvisionsCurrent Liabilities 12,709 9,788 12,907 16,445 22,729Sundry Creditors 12,647 9,700 12,829 16,368 22,652Other Current Liabilities 62 88 78 78 78

Provisions 297 685 685 685 685

Total Current Liabilities and Provisions 13,006 10,472 13,591 17,130 23,414

Net Current Assets 13,627 17,400 18,479 19,395 21,106

InvestmentsStrategic & Group Investments 58 59 59 59Other Marketable Investments 235 6,035 3,695 3,695 2,695Total Investments 235 6,093 3,754 3,754 2,754

Fixed AssetsGross Block 6053 7377 21132 23132 24132Less Accumulated Depreciation 877 1380 1950 2835 3780Net Block 5,176 5,998 19,182 20,297 20,351

Add: Capital Work in Progress 10,076 13,754 2,000 1,000 231Less: Revaluation Reserve 478 463 448 433 418Total Fixed Assets 14,773 19,289 20,734 20,864 20,165

Total Assets 28,636 42,782 42,967 44,013 44,025

LIABILITIES AND SHAREHOLDERS' EQUITY

BorrowingsShort Term Debt & WC Loans 4,944 7,908 6,908 5,908 4,908Secured loans 9,344 14,466 15,466 15,966 13,970Unsecured loans 3,422 6,600 4,600 3,600 2,600

Total Borrowings 17,709 28,974 26,974 25,474 21,479

Deferred Tax Liability 2,220 3,158 3,158 3,158 3,158

Share CapitalPaid up Equity Share Capital 509 509 509 509 509

No. of Shares outstanding (mn) 51 51 51 51 51Face Value per share (Rs) 10 10 10 10 10

Reserves & SurplusShare Premium 2,350 2,350 2,350 2,350 2,350

General & Other Reserve 5,847 7,790 9,975 12,521 16,529

Net Worth 8,707 10,650 12,834 15,380 19,388

Total Liabilities & Shareholders' Equity 28,635 42,782 42,967 44,013 44,025



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Table 11: Cashflow statement

(Rs mn, year ending March 31)FY10 FY11E FY12E FY13E

Cash Flow from Operating ActivitiesReported Net Income 2,181 2,423 2,784 4,246Add:Depreciation & Amortisation 387 570 885 945

Less:

Other Income 776 285 322 282Net Extra-ordinary income 293 - - -Operating Cash Flow before Working Capital change (a) 1,500 2,709 3,347 4,910Changes in Working Capital(Increase) / Decrease in Inventories 1,576 (964) (2,413) (4,285)(Increase) / Decrease in Sundry Debtors (303) (346) (571) (628)(Increase) / Decrease in Operational Loans & Adv. (459) (1,187) (955) (4,285)(Increase) / Decrease in Subsidy (1,479) (616) 99 245Increase / (Decrease) in Sundry Creditors (2,947) 3,129 3,539 6,284Increase / (Decrease) in Other Current Liabili ties 414 (10) - -Working Capital Inflow / (Outflow) (b) (3,199) 7 (300) (2,669)Net Cash flow from Operating Activities (a) + (b) (1,699) 2,715 3,046 2,241Cash Flow from Capital commitments

Purchase of Fixed Assets (4,903) (2,015) (1,015) (247)Purchase of Investments (58) (0) - -Consideration paid for acquisition of undertakingCash Inflow/(outflow) from capital commitments (c) (4,961) (2,016) (1,015) (247)Free Cash flow after capital commitments (6,660) 700 2,031 1,994(a) + (b) + (c)

Cash Flow from Investing ActivitiesPurchase of Marketable Investments (5,800) 2,340 - 1,000(Increase) / Decrease in Other Loans & Advances (796) - - -Consideration received for sale of undertaking/divisionOther Income 776 285 322 282Net Cash flow from Investing Activities (d) (5,820) 2,624 322 1,282

Cash Flow from Financing ActivitiesProceeds from fresh borrowings 11,266 (2,000) (1,500) (3,996)Dividend paid including tax (238) (238) (238) (238)Reserve adjustments 938 - - -Net Cash flow from Financing Activities (e) 11,966 (2,238) (1,738) (4,234)Net Extra-ordinary Income (f) 293 - - -Total Increase / (Decrease) in Cash (222) 1,086 615 (958)(a) + (b) + (c) + (d)+ (e) + (f)

Opening Cash and Bank balance 506 284 1,370 1,985Closing Cash and Bank balance 284 1,370 1,985 1,027Increase/(Decrease) in Cash and Bank balance (222) 1,086 615 (958)



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Table 12: Key ratios

(Year ending March 31)FY09 FY10E FY11E FY12E FY13E

Per Share Data (Rs)Diluted Recurring Earning per share (DEPS) 33.6 39.0 47.6 54.7 83.4Diluted Earnings per share 33.6 42.8 47.6 54.7 83.4Recurring Cash Earnings per share (CEPS) 36.5 46.6 58.8 72.1 102.0Free Cashflow per share (FCPS-post capex) (479.7) (129.7) 13.7 39.9 39.2

Reported Book Value (BV) 171.0 209.1 252.0 302.0 380.8Dividend per share 2.3 4.7 4.7 4.7 4.7

Valuation Ratios (x)Diluted Price Earning Ratio 12.8 11.1 9.1 7.9 5.2Price to Recurring Cash Earnings per share 11.8 9.3 7.3 6.0 4.2Price to Book Value 2.5 2.1 1.7 1.4 1.1Price to Sales Ratio 1.6 1.2 0.9 0.8 0.6EV / EBITDA 12.5 15.4 10.7 8.3 5.6EV / Total Operating Income 2.8 2.5 1.9 1.4 1.0EV / Operating Free Cash Flow (Pre-Capex) (4.1) (26.3) 16.2 13.7 17.7EV / Net Operating Free Cash Flow (Post-Capex) (1.6) (6.8) 62.7 20.6 19.9Dividend Yield (%) 0.5 1.1 1.1 1.1 1.1Growth Ratios (% YoY)Diluted Recurring EPS Growth - 15.9 22.1 14.9 52.5Diluted Recurring CEPS Growth - 27.7 26.2 22.6 41.5

Total Operating Income Growth - 27.9 28.3 25.2 35.4EBITDA Growth - 26.3 27.7 15.2 28.0Recurring Net Income Growth - 15.9 22.1 14.9 52.5Operating Ratios (%)EBITDA Margins 23.0 17.8 19.3 18.6 19.0EBIT Margins 26.4 28.3 24.8 22.0 20.9Recurring Pre-tax Income Margins 17.5 15.2 14.7 13.5 15.3Recurring Net Income Margins 12.0 10.5 10.3 9.5 10.7Employee cost / Revenue 2.1 2.7 3.7 3.8 3.1Operating expenses / Revenue 4.5 6.7 5.6 5.5 4.9Other Income / Pre-tax Income 5.6 27.0 8.2 8.1 4.6Other Operating Income / EBITDA 0.2 - - - -Effective Tax Rate 31.5 34.2 30.0 30.0 30.0Return / Profitability Ratios (%)

Return on Capital Employed (RoCE)-Overall 17.9 9.7 9.4 10.3 13.1Return on Invested Capital (RoIC) 26.6 13.4 14.3 16.6 20.9Return on Net Worth (RoNW) 39.3 20.5 20.6 19.7 24.4Dividend Payout Ratio 7.0 12.0 9.8 8.6 5.6Solvency Ratios / Liquidity Ratios (%)Debt Equity Ratio (D/E) 2.3 3.0 2.3 1.9 1.3Long Term Debt / Total Debt 75.2 75.4 77.1 79.4 80.1Net Working Capital / Total Assets 45.8 40.0 39.8 39.6 45.6Interest Coverage Ratio-based on EBIT 3.0 2.3 2.5 2.7 3.8Debt Servicing Capacity Ratio (DSCR) 2.5 2.1 2.3 2.5 3.4Current Ratio 1.9 2.4 2.2 2.0 1.8Cash and cash equivalents / Total Assets 1.8 0.7 3.2 4.5 2.3Tur

shipbuilding sector icici dec10

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