Shipbuilding Sector ICICI Dec10

Equity Research
December 6, 2010 BSE Sensex: 19967
INDIA
Shipbuilding
Cruising to recovery
Reason for report: Initiating coverage
ABG Shipyard BUY Pipavav Shipyard SELL 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, wherein shipbuilding 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.
Please refer to important disclosures at the end of this report
Sanket Maheshwari
sanket.maheshwari@icicisecurities.com +91 22 6637 7159
Shipbuilding, December 6, 2010
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TABLE OF CONTENT
Investment argument.......................................................................................................3 Indian shipyards more offshore centric .......................................................................3 wherein favourable demand drivers are manifesting ..................................................3 Pent-up demand to boost offshore orderbooks...........................................................4 even as merchant shipbuilding takes time to cast anchor...........................................4 Indian shipyards may see immediate triggers ................................................................5 Stock picking to be the key .............................................................................................6 Global shipyard Calm waters ahead?.........................................................................7 After turbulence, some stability sighted.......................................................................7 as industry fundamentals have perked up in 10 .....................................................7 but merchant shipbuilding still caught in undercurrents ..............................................9 Offshore Demand drivers exist ..................................................................................13 Key differentiators Indian shipyards & global peers ..............................................19 Extension of subsidy will provide strong boost .............................................................19 Government participation still high in the sector ...........................................................20 Indian shipyards, recent entrants in building merchant ships .......................................22 Increased dependence on offshore will continue..........................................................22 Indian 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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Investment argument
Indian shipyards more offshore centric
Most private shipyards in India, excluding Pipavav, started as offshore vessel builders and then branched out into merchant ship building. Even today, ~50% of ABGs & Bharati Shipyards orderbooks are from offshore. Table 1: Indian shipyards inclined more towards offshore
Segment Key segment drivers Merchant shipbuilding World trade, GDP, replacement and regulations Offshore Oil prices, E&P, oil demand, replacement & regulations Defence Government budget Simple Complica ships ted ships such as such as intercept aircraft or boats carriers Remarks ~30 years of experience, orderbook ~Rs45bn (net)+an aircraft carrier >20 years of experience, primarily in offshore. Net orderbook ~Rs100bn Commercialisation in 10, among the largest yards in Asia. Net orderbook ~Rs53bn Net orderbook ~Rs15.8bn. Strong experience in offshore
Shipyard Public Cochin Shipyard Private ABG
Location
Dry bulk carriers Tankers
Others
OSVs
Simple rigs
Sophisticated equipment and rigs
Cochin
Surat, Dahej
Pipavav
Pipavav
Bharati International Samsung Hyundai Yangdijiziang Full presence
Various Locations
South Korea South Korea China partial presence No presence
Source: Industry, I-Sec Research,
wherein favourable demand drivers are manifesting

Rise in oil prices, pick-up in demand from the US and Europe and rising upstream E&P expenditures indicate a revival in the global offshore industry. While day rates for rigs and OSVs are low, they have recovered from 09 levels. Given the nascent recovery in demand from the US and Europe and at +US$80/bl oil price, there is enough room for companies to hike upstream E&P expenditures. In 10, major oil companies such as BP, Shell etc. spiked E&P expenditures 27-34%. Also, >40% of the global offshore fleet is >25 years old and thus, should be replaced in the next few years.
Shipbuilding, December 6, 2010 Chart 1: Increasing oil price and E&P expenditure Upstream E&P expenditures have increased ~27-34% for major companies. They will continue to increase in the long term as more and more oil will come from fields that are yet to be developed
120 100 80 60 (%) 40 20 0 (20) (40) (60) 2007 2008 2009 BP Exxon Mobil
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Royal Dutch/Shell Conoco Philps Oil Prices(RHS) 140 120 (US$/bbl) 100 80 60 40 20 2010E 0
160
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 Growth in oil demand (%) 2 New ships required 143 Scrapping 308 Increase in demand 451 Deliveries 310 Overall shortfall in system 166 Day rates for offshore Good All units in nos: Source: Industry, I-Sec Research 2012E 3 218 308 526 178 514 Great 2013E 3 225 308 533 411 636 Great 2014E 2 155 308 463 502 597 Great 2015E 2 158 308 466 600 462 Good 2016E 2 161 308 469 600 331 Good 2017E 2 164 308 472 600 203 Good 2018E 2 167 308 475 475 203 Good
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.
Shipbuilding, December 6, 2010 Table 3: How will the dry bulk cycle play out?
2006 General economic situation Dry bulk trade (bn te) Converted into ship demand (mn dwt) Increase in demand Actual available Fleet (mn dwt) Net increase in fleet size Capacity utilisation Baltic Dry Index New order contracting Source: Industry, I-Sec Research 2.8 322 2007 Boom 3.0 351 29 386 22 91 Great 148 2008 3.1 369 18 411 26 90 Great 105 2009 3.0 368 -1 438 27 84 Low 30 2010E 2011E Volatile 3.4 3.6 406 38 486 48 84 Low 70 426 20 522 36 82 Low 2012E 3.7 447 21 525 3 85 Decent 30
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2013E 3.9 470 22 529 4 89 Good 2014E Growth? 4.1 493 23 550 21 90 Great 80 2015E 4.3 518 25 582 32 89 Good 62 2016E 4.5 544 26 611 29 89 Good 41
363 89 Good 50
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
90 80 70 60 (mn dwt) 50 40 30 20 10 0 2011E 2012E 2013E 2014E 2015E 2016E 2017E
Source: Industry, Bloomberg, I-Sec Research Source: I-Sec Research
Table 4: Assumptions
Base case Growth in dry bulk trade (%) Planned delivery from current orderbook (mn dwt) Cancellations from existing orderbook (mn dwt) New orders 11-13 Ship capacity utilisation (%) 5 363 165 30 89 Bull case 10-5 363 116 140 89
Base Case
Bull Case
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.
Shipbuilding, December 6, 2010 Chart 3: Percentage of SCI ships older than 20 years
120 100 80 (%) 60 40 20 0 Tankers
Source: SCI
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Bulkers
Offshore
SCI stake purchase plans will provide a benchmark

SCI also plans to buy a minority stake in an Indian shipyard, which could provide benchmark 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 against emerging 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 shipping have improved percentage change
2009 vs 2008 2010 vs 2009 GDP Sea Born Trade
Chart 5: Some companies have raised ~US$3bn to fund asset acquisitions

900 800 700 600 (US$mn) 500 400 300 200 100 0 India Malaysia Japan Thailand Taiwan Middle Eaat
Tanker Rates Baltic Dry
Capesize VLCC Container Ships (80) (30) (%)

Source: Industry, Bloomberg, I-Sec Research
20
70
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.
Shipbuilding, December 6, 2010 Chart 6: GDP growth likely to be +4%...

5.0 4.5 4.0 3.5 3.0 (%) (%) 2.5 2.0 1.5 1.0 0.5 0.0 2010E 1999 2000 2001 2002 2003 2004 2005 2006 2007
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Chart 7: while sea trade could touch ~6%
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 2010E
2010E 2010E
1999
2000
2001
2002
2003
2004
2005
2006
2006 2006
Source: Industry, Bloomberg, I-Sec Research, IMF
Source: I-Sec Research
Chart 8: Baltic Dry sluggish, but similar to 03 levels

8000 7000
Chart 9: and only tanker rates are sluggish

50 45 40 ('000 US$/day) 35 30 25 20 15 10 5 0 1999 2000 2001 2002 2003 2004 2005 2010E
6000 5000 4000 3000 2000 1000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007
Chart 10: Oil prices and demand high

88 86 84 82 (mn bbd) 80 78 76 74 72 70 2010E 1999 2000 2001 2002 2003 2004 2005 2006 2007 Oil Demand Oil Prices (RHS) 90 80 70 60 (US$/bbl) 50 40 30 20 10 0
Chart 11: New orders could easily cross ~60mnGT

200 180 160 140 (mn GT) 120 100 80 60 40 20 0 1999 2000 2001 2002 2003 2004 2005 2007
Source: Industry, Bloomberg, British Petroleum, I-Sec Research
2007
2007
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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 is

We 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
10% 8% 6% 18 (mn bbd) 4% 2% 0% -2% -4% 2006 2007 2008 2009 2010E 16 14 12 10 2006 2007 2008 2009 2010E
Chart 13: Oil trade improving gradually with improving demand from Europe and US
22 20 US Europe Oil Trade (RHS) 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5%
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 Consistent growth in sea trade and GDP, IMO regulations and age profile led to new orders growing at ~25% CAGR in 1999-07
200 180 160 140 (mn GT) 120 100 80 60 40 20 0 2010E 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -4 0 4 ~25% CAGR (% YoY) 8 12 New Orders (LHS) World GDP Sea Trade 16

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
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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 freight rates correlated
Demand for shipping space Supply of shipping space Scrap
Chart 16: as the deliveries rise, current rates may come under pressure
18 16 14 12 growth (%) 10 95 8 6 4 90 85 80 2010E 2011E 2012E 2013E Gross Fleet World trade Freight Rates (RHS) 105 100 (Index) 110
Economy
Trade
Fleet
Delivery
Freight
Order
Backlog
2 0
Biggest risk from dry bulk, where even 20% scrapping may not help
The orderbook for dry bulk is more than sufficient to meet trade increases and fleet retirement 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) 6.7 dwt (mn) 449 Orderbook (dwt) (mn) 114 Orderbook (% of fleet) 25 Fleet retirement (%) 10 Net fleet growth (three-year CAGR) 4.9
Tankers
Prospects Demand from the US and Europe is still low ~7.5% of the fleet is single hull. Actual fleet retirement could easily be in excess of 10%
Crude oil Oil product & others Bulk carriers
2.1 4.6 8.2
320 129 513
90 25 236
28 19 46 20 8.0 Trade is unlikely to grow at this rate. We expect cancellations/delays and scrapping to increase in 11
Dry bulk 7.0 468 200 Ore 0.1 30 33 Others 1.1 15.5 3 Others 10.2 281 61 Source: Bloomberg, Industry, I-Sec Research; fleet as of October 10
43 110 18 22
NA
10
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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 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
650 600 550 (mn dwt) 500 450 400 350 300 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E Demand Supply Capacity Utilisation (RHS) 95% 90% 85% 80% 75% 70% 65% 60% 55% 50%
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.
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Shipbuilding, December 6, 2010 Chart 18: In 09 and 10, Chinas iron ore imports supported Asia Pacific trade
70 60 200 50 (mn te) (mn te) 40 30 20 10 0 Oct-08 Oct-09 Apr-08 Apr-09 Apr-10 Oct-10 Jan-08 Jan-09 Jan-10 Jul-08 Jul-09 Jul-10 50 0 2010E 2011E 150 100 India's coal import to rise by 22% CAGR
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Chart 19: Coal trade could boost growth in the future
250 India Imports World Imports (RHS) 1,000 900 800 700 500 400 300 200 100 0 2012E 2013E 2014E 2015E 2007 2008 2009 (mn te) 600
Source: Bloomberg, I-Sec Research
Source: CEA, I-Sec Research
Chart 20: Baltic Handysize & Supramax indexes more stable than Baltic Dry 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 from India
180 160 140 120 100 80 60 40 Oct-10 May-10 Mar-10 Nov-09 Dec-09 Mar-10 Feb-10 Aug-10 Sep-10 Apr-10 Oct-10 Jan-10 Jun-10 Jul-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%.
12
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Demand Supply Capacity Utilisation (RHS) 95% 90% 85% 80% 75% 70% 65% 60% 55% 50% 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E
Chart 21: Trade growth of 10% implies continued contracting of new orders If trade keeps on growing at ~10%, capacity utilisation and thus, freight rates are unlikely to come down. We may see spurt in order booking in 12-13, after which orders will normalise
750 700 650 600 (mn dwt) 550 500 450 400 350 300
Table 6: Orderbook will continue to grow

World trade (mnte) New orders (mn dwt) Source: Company data 11E 3,720 25 12E 4,055 54 13E 4,379 61 14E 4,686 41 15E 4,967 44 16E 5,215 46 17E 5,476 48 18E 5,750 50 19E 6,038 52 20E 6,339 54
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. 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 subdued signs of recovery Chart 22: Increasing global demand has gradually increased oil prices
88 World Demand World Supply Oil Price (RHS) 160 140 87 (mn bbd) 120 (US$/bbl) 100 86 80 60 85 40 20 84 2007 2008 2009 3Q2010 0
Source: Bloomberg, IEA, I-Sec Research
13
Shipbuilding, December 6, 2010 Chart 23:..even though US & European demand is still subdued versus pre-08 levels
21 20 19 (mn bbd) 18 17 16 15 14 Q1 2010 Q2 2010 Q3 2010 2007 2008 2009 US 23%
Source: IEA, BP, I-Sec Research
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Chart 24: when they contributed ~41% to global demand
China 9% India 4% Europe 18%
US
Europe
Others 46%
Source: Bloomberg, IEA, I-Sec Research
E&P expenditures have started increasing and will continue to rise in the long term
After a decline in 09, major oil companies have increased upstream E&P expenditure in conjunction with rising oil prices. As per our analysis of the quarterly performance, all major oil companies (except Conoco Phillips) have increased their upstream E&P expenditure 27-34%. Various reports suggest that E&P expenditures will continue to rise in the long term as new fields will have to be developed to support even the current production levels. Chart 25: Increasing dependence on new fields
Unc onv ention al oil Natural gas liquids 100 Crude oil: fields y et to be found Crude oil: fields y et to be develop ed Crude oil: c urrently producing fields 80
60 mb/d ~4050mnbd will com e from new oil fields
40
20
0 1 990 1995 2000 2005 2010 2015 2020 2025 2030 2 035
Source: IEA, I-Sec Research
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Shipbuilding, December 6, 2010 Chart 26: means that E&P expenses will continue to rise
400 350 Capex & Opex (US$bn) 300 250 200 150 100 50 0 2010E 2011E 2012E 2013E 2004 2005 2006 2007 2008 2009 100,000 0 Africa Australiasia Latin America North America Asia Eastern Europe & FSU Middle East Western Europe (US$mn)
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Chart 27: E&P expenses linked to oil prices
500,000 400,000 125 100
200,000
50
25 0 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
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 AHTS day rates generally move in line with oil prices. They have just started recovering after the fall in 09
500 450 400 350 300 250 200 150 100 50 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Oil Prices vs AHTS Prices Oil Prices Index AHTS Prices Index
Source: Industry, BP, I-Sec Research
Table 7: and so have the rig rates

Type of rig High Spec Jack-ups Old Jack-ups 5G Harsh 5G International Source: Industry, I-Sec Research Estimated rates 150 80-100 500 450-500 Current 130 70-90 450 400 6 mnths ago 120 80 525 450 1 year ago 120 70 525 510
(US$/bbl)
300,000
75
15
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Chart 29: Number of operational rigs has also increased since 09 As oil prices fell in 08-09, many rigs were shut down. However, with increasing oil prices, the number of operational rigs has started rising again
4,000 3,500 3,000 2,500 2,000 1,500 Oct-08 Oct-09 Feb-09 Feb-10 Dec-08 Dec-09 Jun-09 Apr-10 Aug-08 Aug-09 Aug-10 Apr-09 Oct-10 Jun-10
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 era when 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
(Nos)
>10 years
>15 years
>20 years
44%
>25 years
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 oil prices 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.
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Shipbuilding, December 6, 2010 Chart 31: OSV order cycle to revive as early as 11
10,000 9,000 8,000 7,000 (nos) 6,000 5,000 4,000 3,000 2,000 1,000 0 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E Fleet Size New Orders (RHS)
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700 600 500 (nos) 400 300 200 100 0 2019E 2018E 2020E 2019E 2020E
Between 10 and 13, demand will rise more 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
Chart 32: Imbalance between demand and supply to stabilise post 17

700 600 500 (Nos) 400 300 200 100 0 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E Real Demand Increase Actual Deliveries Overall Shortfall (RHS)
17
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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 this quarter, 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$130,000 and 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 fillip

The 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 collaboration with 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
1,800 1,600 1,400 1,200 (Rs bn) 1,000 800 600 400 200 0 FY09 FY10 FY11E FY12E Total Navy
Source: Ministry of Defence, I-Sec Research
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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 buyer cancels 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 delayed significantly. 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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Shipbuilding, December 6, 2010 Chart 34: EBITDA margin comparison
ICICI Securities
Chart 35: Margin boost of 4-10% from subsidy booking
35% 30% ABG EBITDA Margin 25% 20% 15% 10% 5% 0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 Core Margin Subsidy
30% 25% EBITDA Margin 20% 15% 10% 5% 0% Hyundai Heavy Yang Jiziang Cosco Samsung Heavy Korea ABG Ex Subsidy ABG Daewoo
India
China
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 17% subsidy on prices for Chinese ship buyers Preferential interest rates for builders Banks to finance shipbuilding through USD bond issuance And assist shipyards in M&As Source: Industry India 30% subsidy but only for ships that were ordered before August 07
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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Shipbuilding, December 6, 2010 Chart 36: Shipyards in India
ICICI Securities
Dahej ABG Shipyard Pipavav Shipyard Pipavav Surat Mumbai Dabhol Bharati Shipyard Goa Goa Shipyard
Garden Reach Shipbuilders
Hoogly Dock Kolkata Bharati Shipyard
Vishakhapatnam Hindustan Shipyard
Chennai L&T Shipyard Kochi Cochin Shipyard Private Government - Commercial Government - Defence
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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 recent years, 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
60% 55% 50% 45% 40% 35% 30% ABG
Source: Industry
Indian Shipyards
Korean Shipyards
Bharati
Samsung
Hyundai
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 support equipment 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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50-70% Contract Designing Steel cutting 20-40% Keel laying Launching 10% Delivery
Chart 38: Indian shipyards differ from international peers in vendor contracts
Time Building event Receivables Payabl es Raw materials Main engine Machinery Steel
Execution
Ordering by International Shipyards
Ordering by Indian Shipyard
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Index of Tables and Charts

Tables
Table 1: Indian shipyards inclined more towards offshore ................................................... 3 Table 2: Growth drivers take off............................................................................................ 4 Table 3: How will the dry bulk cycle play out? ...................................................................... 5 Table 4: Assumptions ........................................................................................................... 5 Table 5: Fleet retirement may not be helpful ...................................................................... 10 Table 6: Orderbook will continue to grow ........................................................................... 13 Table 7: and so have the rig rates................................................................................... 15 Table 8: Support schemes from Governments for shipbuilding.......................................... 20
Charts
Chart 1: Increasing oil price and E&P expenditure ............................................................... 4 Chart 2: New orders Bull versus base case....................................................................... 5 Chart 3: Percentage of SCI ships older than 20 years ......................................................... 6 Chart 4: Macro indicators for merchant shipping have improved percentage change ...... 7 Chart 5: Some companies have raised ~US$3bn to fund asset acquisitions....................... 7 Chart 6: GDP growth likely to be +4%... ............................................................................... 8 Chart 7: while sea trade could touch ~6% ........................................................................ 8 Chart 8: Baltic Dry sluggish, but similar to 03 levels ............................................................ 8 Chart 9: and only tanker rates are sluggish ...................................................................... 8 Chart 10: Oil prices and demand high............................................................................... 8 Chart 11: New orders could easily cross ~60mnGT ............................................................. 8 Chart 12: Dry bulk trade has rebounded............................................................................... 9 Chart 13: Oil trade improving gradually with improving demand from Europe and US ........ 9 Chart 14: Led by GDP & world trade growth, new order CAGR at 25% in 1999-07............ 9 Chart 15: Since, world trade, deliveries and freight rates correlated .............................. 10 Chart 16: as the deliveries rise, current rates may come under pressure ...................... 10 Chart 17: Shake up in dry bulk fleet imminent in 11-12 ..................................................... 11 Chart 18: In 09 and 10, Chinas iron ore imports supported Asia Pacific trade ................ 12 Chart 19: Coal trade could boost growth in the future ........................................................ 12 Chart 20: Baltic Handysize & Supramax indexes more stable than Baltic Dry................... 12 Chart 21: Trade growth of 10% implies continued contracting of new orders .................... 13 Chart 22: Increasing global demand has gradually increased oil prices......................... 13 Chart 23:..even though US & European demand is still subdued versus pre-08 levels 14 Chart 24: when they contributed ~41% to global demand .............................................. 14 Chart 25: Increasing dependence on new fields ............................................................. 14 Chart 26: means that E&P expenses will continue to rise........................................... 15 Chart 27: E&P expenses linked to oil prices....................................................................... 15 Chart 28: AHTS rates have started inching up with increasing oil price ......................... 15 Chart 29: Number of operational rigs has also increased since 09 ................................... 16 Chart 30: About 44% of the offshore fleet is >25 years old ................................................ 16 Chart 31: OSV order cycle to revive as early as 11........................................................... 17 Chart 32: Imbalance between demand and supply to stabilise post 17 ............................ 17 Chart 33: Budget allocation to defence............................................................................... 18 Chart 34: EBITDA margin comparison ............................................................................... 20 Chart 35: Margin boost of 4-10% from subsidy booking..................................................... 20 Chart 36: Shipyards in India................................................................................................ 21 Chart 37: Offshore and related orderbook as a percentage of total orderbook.................. 22 Chart 38: Indian shipyards differ from international peers in vendor contracts .................. 23
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Equity Research
INDIA
ABG Shipyard
In shipshape
Shipbuilding
Target price Rs579 Shareholding pattern
Promoters Institutional investors MFs and UTI FI&Banks FIIs Others Source: NSE Mar 10 57.1 30.1 1.4 0.5 12.8 12.9 Jun 10 57.1 27.7 0.9 0.6 10.8 15.3 Sep 10 57.1 28.9 0.3 0.7 12.4 14.1
BUY
Rs432

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 in the 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 <120,000dwt ships and increase execution capability for smaller ships. At present, we factor in ~22% revenue CAGR till FY16E and ~17% EBITDA margin from new orders (20% from old orders booked in 08). We have not factored in any new rig orders because of limited track record, thus providing scope for upside. FCFE valuation at ~Rs579/share; initiate with BUY. We have valued ABG on FCFE cost of equity 14%, terminal year FY22 and terminal growth 4%. Our target price of ~Rs579/share separately values subsidy payments at ~Rs120/share. The companys DPS is at ~Rs4, (yield of ~1%), which implies ~34% upside from current market price. We initiate coverage on ABG with BUY rating.
Market Cap Reuters/Bloomberg 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$/'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Shares Outstanding (mn) Rs22bn/US$0.5bn ABGS.BO/ABGS IN 51 484/192 42.9 12.4 20,423 82.0 103.7 7.6 16.8 Year to Mar (Consol) Revenue (Rs mn) Rec. Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield (%) RoCE (%) RoE (%) FY10 18,077 2,181 39.0 15.9 11.1 46.6 15.4 1.1 9.7 20.5 FY11E 23,200 2,423 47.6 22.1 9.1 58.8 10.7 1.1 9.4 20.6 FY12E 29,056 2,784 54.7 14.9 7.9 72.1 8.3 1.1 10.3 19.7 FY13E 39,337 4,246 83.4 52.5 5.2 102.0 5.6 1.1 13.1 24.4
Price chart
550 450 (Rs) 350 250 150 May-10 Dec-09 Jul-10 Nov-10 Jan-10 Sep-10 Apr-10
Sanket Maheshwari
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ABG Shipyard, December 6, 2010
ICICI Securities
TABLE OF CONTENTS
Investment argument.....................................................................................................27 Valuations cheap...........................................................................................................28 Current orderbook provides revenue visibility till FY14.................................................30 New order expectations Initial growth to come from offshore....................................30 Low risk of cancellation on orderbook; strong clientele ................................................32 Large ship platform will increase execution capability at Dahej....................................33 Margin erosion factored in for new orders ....................................................................34 Subsidy To be or not be?...........................................................................................34 Consolidated financials.................................................................................................35 Index of Tables and Charts ...........................................................................................39
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Investment argument
What we prefer about ABG?
What concerns us?
Revenue visibility till at least FY14 Well poised to exploit offshore opportunity Improving execution capabilities Strong clientele 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 delays may not go down well with clients ~22% of the orderbook is from group companies, though this could be positive as ABG is reportedly entering coal trading as well Orders from the defence sector Orders for rigs Revenue from other businesses such as ship repair We value ABG at ~Rs459/share + 120Rs/share in subsidy; FCFE (CoE 14%, terminal year FY22, terminal growth 4%). At the current market price of ~Rs432, our target price yields ~34% upside. Initiate with BUY.
What are potential upsides?
Valuations
Table 1: I-Sec assumptions

Revenue visibility Current status The current orderbook is at ~Rs140bn and unexecuted book at ~Rs100bn. This gives revenue visibility till at least FY14 New orders are not flowing in. In 10, ABG won orders for three cement carriers and two rigs, amounting to ~Rs24bn. However, ~Rs20bn worth orders have come from group company I-Sec view
New order expectations
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 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 will provide potential upside 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 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
Cancellation risk on orderbook
Pace of execution of contracts
Subsidy
As per our research, Scan Shipping had cancelled its contract with ABG owing to late delivery of ships, till Pacific First Shipping (a group entity) stepped in. The contract value was ~Rs3.7bn. As per company, the cancellation may have happened owing to bankruptcy. ABG had received ~50% of the value in any case ABG has booked ~Rs4.5bn of subsidy on its balance sheet, of which ~Rs650mn is due from the Government. The rest will be due as and when the company completes its delivery
ABG has received ~Rs1.4bn cash subsidy so far from the Government 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 the Government 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 placed till August 07 We estimate ~60% of the current orderbook to be of 08 era when high new build prices allowed margins of ~22%+. For these and following orders, we have maintained EBITDA margin of ~20% For new orders, we have reduced margins to ~17% to account for steel prices and lower new build prices
Margins and steel price rise
About 65% of the costs are linked to steel prices. At present, ABG manages this risk by purchasing steel at the time of designing. This protects margins at ~20% but increases working capital costs
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<1.4bn Table 2: Sum-of-the-parts
Rs bn Core value Add cash Subsidy Western India Shipyard (net value) Rs/share
17.5 5.1 6.1 0.8 29.5 344 99 120 16 579
Risk free rate (%) Market risk premium (%) Beta CoE (%) Terminal year Terminal growth (%) No of shares 8 5 1.20 14 FY22 4 51
Sensitivity
Table 4: Valuation and subsidy payment
Rs bn Core value Add cash Subsidy Western India Shipyard (net value) Source: Company data, I-Sec Research Rs/share 50% subsidy payment 150% subsidy payment
17.5 5.1 6.1 0.8 29.5
344 99 120 16 579
344 99 60 16 519
344 99 180 16 639
Table 5: Valuation sensitivity to terminal growth and cost of equity

3% 13% Cost of equity 14% 15% Source: Company data, I-Sec Research Terminal growth 4% 5%
621 551 494
658 579 515
705 613 541
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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 peers
Bloomberg PIPV IN ABGS IN BHSL IN Year Ending 03/11 Y 03/11 Y 03/11 Y Price performance EBITDA Margin (%) EV/E (x) RoE (%) P/E (x) FY10/ FY11/ FY12/ FY11/ FY12/ FY10/ FY11/ FY12/ FY11/ FY12/ (6 mths) (5 days) CY09 CY10 CY11 CY10 CY11 CY09 CY10 CY11 CY10 CY11 (10.9) 9.7 (16.5) 6.7 18.3 88.3 16.6 (3.2) 1.1 12.5 280.5 22.2 72.7 6.4 17.8 19.3 18.6 10.7 8.3 20.5 20.6 19.7 9.1 7.9 (12.3) 2.7 18.7 20.5 16.8 9.3 12.9 17.1 13.3 13.3 5.6 8.7
Pipavav Shipyard ABG Shipyard Bharati Shipyard Chinese shipyards Guangzhou Shipyard Intl Yangzijiang Shipbuilding Cosco Corp Singapore South Korean shipyards Daewoo Shipbuilding Samsung Heavy Industries Hyundai Mipo Dockyard Hyundai Heavy Industries Stx Offshore & Shipbuilding
600685 CH YZJ SP COS SP
12/10 Y 12/10 Y 12/10 Y
17.2 50.0 47.2
(5.6) 4.4 3.4
14.2 21.5 11.4
10.9 23.0 14.3
10.1 20.9 14.6
11.1 10.5 10.3
11.1 9.6 8.7
20.5 38.8 11.2
19.0 34.5 16.6
16.1 27.7 18.2
18.1 12.9 24.1
18.0 12.3 19.8
042660 KS 010140 KS 010620 KS 009540 KS 067250 KS
12/10 Y 12/10 Y 12/10 Y 12/10 Y 12/10 Y
57.8 43.2 31.1 60.7 100.5
(1.9) (2.2) (4.0) (3.7) (6.2)
7.2 9.3 11.6 12.6 3.6
9.5 10.2 16.8 17.2 5.9
9.0 10.0 15.4 15.6 5.2
5.9 7.0 3.5 7.9 12.8
6.2 7.0 3.8 8.1 15.1
27.8 27.2 16.9 29.9 9.2
20.9 27.5 18.1 29.4 8.7
17.6 21.8 14.5 21.8 10.1
7.5 8.5 6.5 7.9 12.5
7.7 8.7 6.8 8.5 10.4
Japanese/Other shipyards Mitsui Engineer & Shipbuild 7003 JP 03/11 Y Sumitomo Heavy Industries 6302 JP 03/11 Y Mitsubishi Heavy Industries 7011 JP 03/11 Y Bergen Group As BERGEN NO 12/10 Y Source: Company data, Bloomberg, I-Sec Research
(3.9) (1.7) (11.7) (15.1)
2.1 (1.0) (1.8)
7.3 8.0 7.5 6.9
8.3 10.5 7.9 7.0
8.5 11.4 8.0 6.2
5.5 6.2 9.6 3.1
5.4 5.5 9.1 3.4
12.5 3.7 1.1 9.6
9.4 8.0 2.0 2.3
15.0 8.9 2.2 3.3
11.2 15.3 41.6 11.6
9.0 13.0 30.9 9.1
Table 7: DCF valuations

(Rs mn) Valuation ex-subsidy EBITDA Less interest Less taxes Operating cash flow Change in WC Post WC Capex Debt repayment FCFE FY11E 4,115 2,283 416 1,415 7 1,422 (2,015) (2,000) (2,593) FY12E 5,045 2,406 579 2,060 (1,673) 387 (1,015) (1,500) (2,128) (2,128) 1,373 1,373 15.5 20.5 6.1 FY13E 7,133 2,158 1,330 3,645 (4,090) (445) )247 (3,996) (4,687) 1 (4,112) 1 1,421 1,246 FY14E 7,153 1,799 1,447 3,907 (1,357) 2,551 (257) (3,996) (1,701) 2 (1,309) 2 1,864 1,434 FY15E 6,977 1,484 1,490 4,004 (698) 3,305 (259) (2,996) 51 3 34 3 2,000 1,350 FY16E 8,966 1,232 2,222 5,511 (3,449) 2,062 (261) (2,596) (795) 4 (471) 4 1,185 702 FY17E 9,959 1,026 2,612 6,322 (1,589) 4,733 (264) (1,996) 2,473 5 1,285 5 FY18E 10,108 846 2,713 6,548 (313) 6,235 (266) (1,996) 3,974 6 1,810 6 FY19E 9,414 667 2,537 6,211 959 7,170 (269) (1,996) 4,906 7 1,960 7 FY20E 9,046 487 2,468 6,091 463 6,554 (271) (1,996) 4,287 8 1,503 8 FY21E 9,070 397 2,498 6,175 (135) 6,040 (274) 5,766 9 1,773 9 FY22E 9,096 397 2,500 6,200 (142) 6,058 (276) 5,781 10 1,560 10 -
Subsidy Discounted value Terminal Value Rs bn Total Value Rs bn Subsidy Rs bn Source: Company data, I-Sec Research
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 to dominate 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 Defence Merchant Cement carrier Handysize Supramax Total Offshore & rigs AHTS Diving support Platform supply Rigs 3 26 15 44 15 3 3 4 25 7 83 3.8 36.9 24.9 65.7 14.1 2.8 6.5 41.3 64.6 8.0 141.7 Vessel type Interceptor, pollution control Number of ships 7 Total (Rs bn) 3.3
Total Others Total Source: Company data, I-Sec Research
Chart 1: ABGs net orderbook highest in India
Chart 2: Current orderbook offers revenue visibility till FY14, but with rising reliance on new orders
60 50 40 Rs bn 30 20 10 0 FY2010 FY2011 FY2012 FY2013 FY2014 FY2015 Current Orders 6 yr CAGR: 22% New Orders
120 100 80 (Rs bn) 60 40 20 0 ABG Pipavav Bharati Cochin Shipyard
Note: Cochin Shipyard has an aircraft carrier, the value of which is unknown Source: Company, 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 stabilise after FY17
25 20 15 (Rs bn) 0.3 10 0.2 5 0 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 0.1 0 Value Size (RHS) 0.6 0.5 0.4 (mn dwt) (Rs bn)
Chart 4: Offshore vessel construction will report strong order contracting from FY12
50 45 40 35 30 25 20 15 10 5 0 FY11 FY12 FY13 FY14 FY15 Value Nos (RHS) 45 40 35 30 25 20 15 10 5 0
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
46% Merchant
FY15E orderbook at ~Rs139bn

21%
Offshore & Others
54%
79%
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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 defence sector. 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 two years 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 the shipping business (Vogemann) and financial strength (Precious Shipping Company). Chart 6: About 68% of ABGs orderbook robust
Unverified 10% Indian Defence 2%
Verified 66%
Group Companies 22%
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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
100 90 80 Deep Sea Supply 70 60 50 40 30 20 Drilling & Offshore 10 Pacific First 0 These tw o ompanies are group companies accounting for ~21% of the order book Essar Merchant + Offshore 25+13 12+2 6+2 45:55 Precious Shipping Dry Bulk 21 18 18 25:75 Vogemann Offshore Merchant 24 21 5 13 4 12 75:25 NA Indian Coast Guard Others Segem ent The current order book does not do full justice. ABG has delivered - 3 vessels in FY11 alone. Fleet Size On Order From ABG D:E
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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ABG Shipyard, December 3, 2010 Chart 8: Margin to stabilise at 17% post FY16 ABG reached peak margins of ~22%+ during the bull run, when new build prices were very high. From that phase, we expect margins to drop to 17% as the company executes new orders acquired at lower prices
60 50 40 (Rs bn) 30 20 10 0 Ship Building
ICICI Securities
26% 24% 22% 20% 18% 16% 14% 12% 10%
Margins (RHS)
FY06 FY07 FY08 FY09 FY10 FY11E FY12E FY13E FY14E FY15E FY16E
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 our view. 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.
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ICICI Securities
Consolidated financials
Table 9: Profit and Loss statement
(Rs mn, year ending March 31) Net Sales of which Ship Building of Which Subsidy of which Wind Mill Towers of which Ship Repair Other Operating Income Total Operating Income Less: Consumption of Raw Materials & Components Manufacturing Expenses Personal Expenses SG&A Total Operating Expenses EBITDA EBITDA ex Subsidy Depreciation & Amortisation Other Income EBIT Less: Gross Interest & Finance Charges Recurring Pre-tax Income Add: Extraordinary Income Less: Extraordinary Expenses Less: Taxation Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research FY09 14,122 13,481 629 5 9 8 14,130 FY10 18,077 16,250 1,823 4 18,077 FY11E 23,200 21,285 1,916 23,200 FY12E 29,056 27,156 1,901 29,056 FY13E 39,337 37,582 1,755 39,337
8,431 1,025 296 639 10,391 3,739 3,110 145 139 3,733 1,232 2,501 789 1,713 1,713
10,163 1,494 481 1,216 13,354 4,722 2,899 387 776 5,112 2,239 2,873 293 984 2,181 1,985
13,197 1,809 855 1,309 17,170 6,030 4,115 570 285 5,745 2,283 3,461 1,038 2,423 2,423
17,108 2,308 1,107 1,588 22,111 6,946 5,045 885 322 6,383 2,406 3,977 1,193 2,784 2,784
24,127 3,194 1,217 1,911 30,449 8,888 7,133 945 282 8,225 2,158 6,066 1,820 4,246 4,246
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ABG Shipyard, December 3, 2010 Table 10: Balance sheet

(Rs mn, year ending March 31) FY09 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Loans and Advances Operational Subsidy Others Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Less: Revaluation Reserve Total Fixed Assets Total Assets LIABILITIES AND SHAREHOLDERS' EQUITY Borrowings Short Term Debt & WC Loans Secured loans Unsecured loans Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs) Reserves & Surplus Share Premium General & Other Reserve Net Worth Total Liabilities & Shareholders' Equity Source: Company data, I-Sec Research FY10
ICICI Securities
FY11E
FY12E
FY13E
506 12,236 418 13,473 8,559 3,021 1,893 26,633
284 10,661 720 16,207 9,018 4,500 2,689 27,872
1,370 11,625 1,066 18,010 10,205 5,116 2,689 32,070
1,985 14,038 1,637 18,866 11,160 5,017 2,689 36,525
1,027 18,322 2,265 22,906 15,445 4,772 2,689 44,520
12,709 12,647 62 297 13,006 13,627
9,788 9,700 88 685 10,472 17,400
12,907 12,829 78 685 13,591 18,479
16,445 16,368 78 685 17,130 19,395
22,729 22,652 78 685 23,414 21,106
235 235
58 6,035 6,093
59 3,695 3,754
59 3,695 3,754
59 2,695 2,754
6053 877 5,176 10,076 478 14,773 28,636
7377 1380 5,998 13,754 463 19,289 42,782
21132 1950 19,182 2,000 448 20,734 42,967
23132 2835 20,297 1,000 433 20,864 44,013
24132 3780 20,351 231 418 20,165 44,025
4,944 9,344 3,422 17,709 2,220
7,908 14,466 6,600 28,974 3,158
6,908 15,466 4,600 26,974 3,158
5,908 15,966 3,600 25,474 3,158
4,908 13,970 2,600 21,479 3,158
509 51 10
509 51 10
509 51 10
509 51 10
509 51 10
2,350 5,847 8,707 28,635
2,350 7,790 10,650 42,782
2,350 9,975 12,834 42,967
2,350 12,521 15,380 44,013
2,350 16,529 19,388 44,025
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ABG Shipyard, December 6, 2010 Table 11: Cashflow statement

(Rs mn, year ending March 31) FY10 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Less: Other Income Net Extra-ordinary income Operating Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. (Increase) / Decrease in Subsidy Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Purchase of Marketable Investments (Increase) / Decrease in Other Loans & Advances Consideration received for sale of undertaking/division Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Proceeds from fresh borrowings Dividend paid including tax Reserve adjustments Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research 2,181 387 776 293 1,500
ICICI Securities
FY11E 2,423 570 285 2,709
FY12E 2,784 885 322 3,347
FY13E 4,246 945 282 4,910
1,576 (303) (459) (1,479) (2,947) 414 (3,199) (1,699)
(964) (346) (1,187) (616) 3,129 (10) 7 2,715
(2,413) (571) (955) 99 3,539 (300) 3,046
(4,285) (628) (4,285) 245 6,284 (2,669) 2,241
(4,903) (58) (4,961) (6,660)
(2,015) (0) (2,016) 700
(1,015) (1,015) 2,031
(247) (247) 1,994
(5,800) (796) 776 (5,820)
2,340 285 2,624
322 322
1,000 282 1,282
11,266 (238) 938 11,966 293 (222)
(2,000) (238) (2,238) 1,086
(1,500) (238) (1,738) 615
(3,996) (238) (4,234) (958)
506 284 (222)
284 1,370 1,086
1,370 1,985 615
1,985 1,027 (958)
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ABG Shipyard, December 3, 2010 Table 12: Key ratios

(Year ending March 31) FY09 Per Share Data (Rs) Diluted Recurring Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per share (CEPS) Free Cashflow per share (FCPS-post capex) Reported Book Value (BV) Dividend per share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Sales Ratio EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Employee cost / Revenue Operating expenses / Revenue Other Income / Pre-tax Income Other Operating Income / EBITDA Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Long Term Debt / Total Debt Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Debt Servicing Capacity Ratio (DSCR) Current Ratio Cash and cash equivalents / Total Assets Turnover Ratios Inventory Turnover Ratio (x) Assets Turnover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research 33.6 33.6 36.5 (479.7) 171.0 2.3 FY10E 39.0 42.8 46.6 (129.7) 209.1 4.7
ICICI Securities
FY11E 47.6 47.6 58.8 13.7 252.0 4.7
FY12E 54.7 54.7 72.1 39.9 302.0 4.7
FY13E 83.4 83.4 102.0 39.2 380.8 4.7
12.8 11.8 2.5 1.6 12.5 2.8 (4.1) (1.6) 0.5
11.1 9.3 2.1 1.2 15.4 2.5 (26.3) (6.8) 1.1
9.1 7.3 1.7 0.9 10.7 1.9 16.2 62.7 1.1
7.9 6.0 1.4 0.8 8.3 1.4 13.7 20.6 1.1
5.2 4.2 1.1 0.6 5.6 1.0 17.7 19.9 1.1
15.9 27.7 27.9 26.3 15.9
22.1 26.2 28.3 27.7 22.1
14.9 22.6 25.2 15.2 14.9
52.5 41.5 35.4 28.0 52.5
23.0 26.4 17.5 12.0 2.1 4.5 5.6 0.2 31.5
17.8 28.3 15.2 10.5 2.7 6.7 27.0 34.2
19.3 24.8 14.7 10.3 3.7 5.6 8.2 30.0
18.6 22.0 13.5 9.5 3.8 5.5 8.1 30.0
19.0 20.9 15.3 10.7 3.1 4.9 4.6 30.0
17.9 26.6 39.3 7.0
9.7 13.4 20.5 12.0
9.4 14.3 20.6 9.8
10.3 16.6 19.7 8.6
13.1 20.9 24.4 5.6
2.3 75.2 45.8 3.0 2.5 1.9 1.8
3.0 75.4 40.0 2.3 2.1 2.4 0.7
2.3 77.1 39.8 2.5 2.3 2.2 3.2
1.9 79.4 39.6 2.7 2.5 2.0 4.5
1.3 80.1 45.6 3.8 3.4 1.8 2.3
2.3 1.0 145.0 5.4 246.4
1.6 0.5 259.0 11.5 343.9
2.1 0.5 226.9 14.1 267.7
2.3 0.7 183.0 17.0 269.1
2.4 0.9 149.0 18.1 261.3
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ICICI Securities

Tables
Table 1: I-Sec assumptions ................................................................................................ 27 Table 2: Sum-of-the-parts ................................................................................................... 28 Table 3: Assumptions ......................................................................................................... 28 Table 4: Valuation and subsidy payment............................................................................ 28 Table 5: Valuation sensitivity to terminal growth and cost of equity ................................... 28 Table 6: Valuations attractive versus global peers ............................................................. 29 Table 7: DCF valuations ..................................................................................................... 29 Table 8: Orderbook break up .............................................................................................. 30 Table 9: Profit and Loss statement ..................................................................................... 35 Table 10: Balance sheet ..................................................................................................... 36 Table 11: Cashflow statement ............................................................................................ 37 Table 12: Key ratios ............................................................................................................ 38
Charts
Chart 1: ABGs net orderbook highest in India ................................................................... 30 Chart 2: Current orderbook offers revenue visibility till FY14, but with rising reliance on new orders ............................................................................................................................ 30 Chart 3: Merchant shipbuilding orders to stabilise after FY17............................................ 31 Chart 4: Offshore vessel construction will report strong order contracting from FY12 ....... 31 Chart 5: Back to the future ABG will again depend more on offshore............................. 31 Chart 6: About 68% of ABGs orderbook robust ................................................................. 32 Chart 7: Client-wise breakup............................................................................................... 33 Chart 8: Margin to stabilise at 17% post FY16 ................................................................... 34
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Equity Research
INDIA
Pipavav Shipyard
Risks too high, as of now
Shipbuilding
Target price Rs64
SELL
Rs77

Where ABG Shipyard is clearly a play on offshore industry, Pipavav Shipyard (Pipavav) is a play on merchant shipping. Pipavavs key strengths lay in 1) Featuring amongst the largest shipyards in Asia; 2) Great execution capabilities; and 3) Clean balance sheet and greater focus on defence sector. However, we are concerned about its low orderbook, revenue visibility and inexperience in ship building. Its focus on merchant ship building comes at a time when the near-term prospects do not look inspiring. Fundamentals notwithstanding, the stock may remain under pressure in the near term as lock in period for ~12% of holders expired in Oct1. We initiate with SELL on Pipavav with a FCFE-based target price of ~Rs64/share. Strong execution capabilities, but low revenue visibility. Pipavavs strength lies in its ability to make ships of any kind, and it is modelling itself on the lines of Korean and Chinese shipyards. However, it has started operations at a time when merchant shipbuilding is going through a downturn and thus, the company has revenue visibility only up till FY13. Orderbook growth will be erratic, defence orders could provide some upside. Because of Pipavavs focus on merchant shipping, we expect its orderbook growth to be erratic initially driven by smaller orders from offshore business (FY12-13) but later by big-ticket orders from merchant shipping companies. Pipavav has already got warship building license from Indian Navy, and we have factored in ~Rs25bn new orders from the Navy every two years. Nevertheless the companys orderbook growth will be erratic owing to higher focus on merchant. Risky play on merchant shipping. We believe that Pipavav is a play on merchant shipbuilding riskier, because the immediate prospects for merchant shipbuilding do not look good. We are confident about the companys operational abilities but are concerned about the low visibility of new orders. Current valuations expensive, initiate with SELL: Our FCFE valuation (terminal year FY22, terminal growth 4%, Cost of Equity ~14%) pegs Pipavav at ~Rs64/share. We believe that the company is high-risk at current valuations at the current market price (CMP) it is ~17% more expensive. Initiate with SELL.
Market Cap Reuters/Bloomberg Shares Outstanding (mn) 52-week Range (Rs) Free Float (%) FII (%) Daily Volume (US$/'000) Absolute Return 3m (%) Absolute Return 12m (%) Sensex Return 3m (%) Sensex Return 12m (%) Rs53.3bn/US$1.2bn PIPA.BO/PIPV IN 666 116/52 55.2 9.0 22,209 (28.8) 33.7 7.6 16.8 Year to Mar (Consol) Revenue (Rs mn) Rec. Net Income (Rs mn) EPS (Rs) % Chg YoY P/E (x) CEPS (Rs) EV/E (x) Dividend Yield (%) RoCE (%) RoE (%) FY10 6,294 (461) (0.7) NA NA (0.1) NA 1.1 (3.2) FY11E 11,320 183 0.3 NA 280.5 1.2 46.2 3.1 1.1 FY12E 21,467 2,305 3.5 1,161.2 22.2 4.9 15.1 9.3 12.5 FY13E 33,179 3,544 5.3 53.7 14.5 7.0 10.7 12.4 16.5
Shareholding pattern
Promoters Institutional investors MFs and UTI FI&Banks FIIs Others Source: NSE Mar 10 39.6 22.9 4.1 5.4 6.8 37.5 Jun 10 44.8 22.7 3.5 5.2 7.4 32.5 Sep 10 44.8 24.0 3.2 5.3 9.0 31.2
Price chart
120 100 (Rs) 80 60 40 Feb-10 Dec-09 Jul-10 Nov-10 Sep-10 Apr-10
Sanket Maheshwari
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ICICI Securities
TABLE OF CONTENTS
Investment argument.....................................................................................................43 Valuations .....................................................................................................................44 What concerns us?........................................................................................................45 Low revenue visibility ....................................................................................................45 New orders may not come easily..................................................................................45 What we prefer about Pipavav? ...................................................................................47 Best-in-class execution capabilities ..............................................................................47 Greater exposure to defence and Indian clients ...........................................................47 Clean balance sheet .....................................................................................................48 What upsides have not been factored? ........................................................................48 Financials........................................................................................................................49 Index of Tables and Charts ...........................................................................................53
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Pipavav Shipyard, December 6, 2010
ICICI Securities
Investment argument
What concerns us? What we prefer about Pipavav?
What can go wrong against our call?
Valuations
Low revenue visibility New orders may not come easily Good execution capabilities Greater exposure to defence and Indian clients Clean balance sheet Orders for new tankers Orders for deep water rigs Strong growth in ship repair We have valued Pipavav on FCFE, CoE at 14%, T year 22 and TG 4%. At the CMP, our target price of ~Rs64/share yields 17% downside. Initiate with Sell.
Table 1: Our core assumptions Current situation versus expectations

Revenue visibility Current The current orderbook is at ~Rs63.7bn; of which ~Rs53.9 is still unexecuted. This gives revenue visibility till at least FY13. Since the IPO, the company has won ~Rs25bn worth orders from the Indian Navy. I-Sec view 93% revenue CAGR till FY13E, however the company will become increasingly dependent on new orders FY13 to be the peak year for execution of the current orderbook We expect a drop in revenue post FY14 as the company will find it difficult to get new orders
New order expectations
Erratic growth in new orders as the company will slightly struggle initially New orders will come from offshore industry before the bulk order cycle
starts in FY14
Only after considering 2-4% MS of new orders from offshore and dry bulk,
~Rs25bn from the Indian Navy, net order book CAGR is ~22% till FY16E Cancellation risk on order book The company was involved in arbitration proceedings with Golden Ocean, which had ordered 4+2 Panamaxsized bulk ships. The issue was resolved in July 10. Slight delay; installation of the second Goliath crane is almost complete. The company has booked subsidy of ~Rs881mn in FY10 and ~Rs383mn in H1FY11 About 65% of the companys costs are linked to steel prices
While there have been issues with individual clients, overall, ~39% of the
orderbook comes from the Indian Navy and ~8% from ONGC.
Nevertheless, it will be difficult for the company to attract new clients

initially.
Pace of execution of contracts Subsidy
The company has been slow in delivering on its contracts by at least a

year. We believe that this was largely due to the downturn in the industry since 08. However, we expect current orders to be delivered by FY13.
The company is yet to receive cash from the Government However, we believe that the company would be eligible for ~Rs1.9bn
subsidy till FY12E for orders that were placed before August 07.
Margins and steel price rise
We have not factored in continuation of the subsidy scheme Being a new shipyard, margins are currently unstable. However, in terms of size and execution, Pipavav is comparable to Chinese
and Korean shipyards, which generate ~14-16% EBITDA margin.
The company is focusing on larger bulk carriers and tankers. These ships
require less customisation, which increases the turnaround, thereby reducing the working capital cost. On flip side this however reduces margins. Thus, we expect the companys margins to be within 18-20% for the current book, but 15-17% for the new orders.
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ICICI Securities
Valuations
We value Pipavav based on FCFE, arriving at a target price of ~Rs64/share. At the current market price this implies 17% downside. We initiate coverage with SELL.
Revenue visibility and less experience, key concerns

Pipavavs revenue visibility, even after factoring in the one year delay in execution, is at most till FY13. While the company has strong potential, it has significantly lesser experience and in the uncertain environment for merchant shipping, this is a clear negative. We have been fairly liberal in: 1) our orderbook assumptions 2-4% share of new orders in offshore and merchant shipbuilding; 2) ~Rs25bn of new orders from the Indian Navy every two years; and 3) 14% Cost of Equity even though Pipavav has lack of experience and stronger focus on merchant shipbuilding, Table 2: Sum-of-the-parts
Core value Add cash Source: Company data, I-Sec Reserach Rs bn 38.9 3.4 42.3 Rs/share 58 5 64
CoE (%) Terminal year Terminal growth (%) No of shares 14 FY22 4 666
Sensitivity
Table 4: Valuation sensitivity to terminal growth and cost of equity
3% 13% Cost of equity 14% 15% Source: Company data, I-Sec Research Terminal growth 4% 5%
68 61 55
72 64 57
77 67 59
Table 5: DCF valuations

Valuation ex-subsidy EBITDA Less interest Less taxes Operating cashflow Change in WC Post WC Capex Debt repayment FCFE FY11E 713 872 (79) (80) (5,294) (5,373) (1,000) 1,800 FY12E 3,858 932 198 2,728 (4,025) (1,297) (273) 218 (1,352) 0 (1,352) FY13E 5,920 1,050 377 4,492 (3,637) 855 (276) (1,200) (620) 1 (544) FY14E 4,795 1,091 260 3,444 2,551 5,995 (278) (1,449) 4,268 2 3,284 FY15E 5,726 976 363 4,387 (2,150) 2,238 (281) (1,449) 508 3 343 FY16E 10,112 860 812 8,440 (8,739) (299) (284) (1,449) (2,032) 4 (1,203) FY17E 14,255 744 1,237 12,274 (7,674) 4,600 (287) (1,449) 2,864 5 1,488 FY18E 11,093 628 931 9,534 5,766 15,299 (290) (1,449) 13,561 6 6,178 FY19E 9,601 512 792 8,297 2,690 10,986 (293) (1,449) 9,245 7 3,695 FY20E 9,203 396 763 8,043 678 8,722 (296) (1,449) 6,978 8 2,446 FY21E 9,227 280 776 8,171 (103) 8,068 (298) (1,449) 6,321 9 1,944 FY22E 9,470 222 805 8,443 (506) 7,937 (301) 0 7,636 10 2,060 20,597
Terminal Value Total Value 38,935 Source: Company data, I-Sec Research
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ICICI Securities
What concerns us?

Low revenue visibility
Pipavavs orderbook currently stands at ~Rs63.7bn, of which ~Rs53.9 worth of orders are still unexecuted. We do not expect this orderbook to last beyond FY13 even after factoring in the one year delay in capacity expansion. Hence, the company has to look for new orders FY12 onwards. Chart 1: Pipavav will require new orders FY12 onwards
40 35 30 (Rs bn) 25 20 15 10 5 0 FY10 FY11E FY12E FY13E FY14E FY15E
Current Orders
New Orders
New orders may not come easily

With focus on merchant shipping and issues pending with existing clients, we believe that it will not be easy for Pipavav to procure new orders. Further, unlike ABG, the company does not have a buffer of strong offshore construction track record. In merchant shipping while the company does have the ability, we do not expect global revival in dry bulk till 13. While tanker order cycles may revive earlier, we believe it will be some time before Pipavav gets any orders unless it is from Indian companies such as Shipping Corporation of India (SCI). We are currently factoring in ~4% market share in new dry bulk contracts and 2% pie in new offshore contracts. We are also factoring in new contracts from the Indian Navy, where we believe the company stands better chance vis--vis peers.
45
Pipavav Shipyard, December 6, 2010 Chart 2: Erratic growth in revenues and new orders Stability in net orderbook in FY1213 is owing to the Indian Navy orders. However, as pent-up demand comes in from merchant shipping, order book and revenues will boom in FY15-17 before normalising in FY18.
120 100 80 (Rs bn) 60 Revenue New Orders Net Order Book (RHS)
ICICI Securities
140 120 100 80 60 (Rs bn)
40 20 0 FY10 FY11E FY12E FY13E FY14E FY15E FY16E FY17E FY18E
40 20 0
Table 6: Order cycle for Pipavav Dry bulk

Global contracting (mn DWT) New orders for Pipavav (mn DWT) Total value (Rs mn) Source: Company data, I-Sec Research FY14E 30 0.171 4,117 FY15E 80 2.400 57,829 FY16E 62 1.860 44,818 FY17E 41 1.226 29,545 FY18E 43 1.277 30,763 FY19E 44 1.330 32,041
Table 7: Order cycle for Pipavav Offshore & related vessels

FY12E Global new orders (nos) 50 New orders for Pipavav (nos) 20 Order value (Rsmn) 14,400 Source: Company data, I-Sec Research FY13E 400 20 14,400 FY14E 500 24 17,280 FY15E 600 24 17,280 FY16E 600 24 17,280 FY17E 600 19 13,688 FY18E 475 19 13,784 FY19E 479 13 9,447
Stock may remain under some pressure as PE investors book profits

Excerpts from Moneycontrol CNBC, Oct1 2010
Some private equity firms are selling their stake in Indian shipbuilder Pipavav Shipyard Ltd, its top official said on Friday, causing the shares to plummet nearly 11%. A lock-in period for investors in the stock ended on October 1, prompting some of them to sell, Pipavav Chairman Nikhil Gandhi told Reuters., The pre-IPO investors who are expecting 3-4 times (returns) in less than 3 years may book some profits," Gandhi said. New York Life Insurance, Indus Capital, Trikona Capital, Standard Chartered Private Equity and Citadel are among companies holding 100 million shares, which would be about 12%, he added. It was not immediately clear who was selling the stakes. According to BSE data, New York Life Insurance held 4% stake and Citadel Mt Trading held 3.45% as on June 30. Pipavav Shipyard raised USD100 million via an IPO in September 2009 and issued shares at a price of Rs 58 each. The resurgence of the stock market may have also been a trigger for selling, he added. There is so much of money being made, so there is a temptation to sell some stake, if not all," Gandhi added.
46
ICICI Securities
What we prefer about Pipavav?

Best-in-class execution capabilities
Pipavav is among the largest shipyards in the world with the capacity to manufacture ~400,000dwt ships, the company is the only Indian player which has the ability to make VLCC tankers. The company is in the process of installing its second Goliath crane, which will significantly bring down the execution time for constructing ships. Currently, the company can build Panamax vessels (~75,000dwt) in less than two years, allowing for better management of its working capital. Table 8: Strategic tie-ups with the best in the industry
With KOMAC (Korea) SembCorp (Singapore) Top global defence yards Source: Company For Design support, material procurement Technical support Defence segment Partner profile Establishment naval architects and marine engineers Global leader in marine and offshore engineering business
Greater exposure to defence and Indian clients

Orders from the Indian Navy form 39% of Pipavavs orderbook and this reduces the companys client risk as well as its dependence on shipping cycles. It has got War Shipbuilding license from Ministry of Defence, which will allow it to build even sophisticated vessels for the Navy. While the current orderbook may not be a measure of the companys ability to make inroads into the defence sector, we believe, as a shipyard it has the maximum potential to bag orders from the Indian Navy and the Indian Coast Guard because of its superior technology and significant spare capacity. Because of the spare capacity and technical abilities, Pipavav has the greatest potential to bag orders from SCI. Chart 3: Stronger focus on defence Chart 4: and Indian clients
International Clients Unverified 5% Indian Navy 39%
Defence 39% Dry Bulk Panamx Vessels 53%
Offshore 8%
International Clients Verified 48% ONGC 8%

47
ICICI Securities
Clean balance sheet

Most of the Indian shipyards have a high D:E of ~2:1, which increases the balance sheet risk, especially if the offshore business does not pick up. Pipavav, on the other hand, fresh with proceeds from IPO has a D:E comparable with international peers and that too in spite of a higher capital expenditure.
What upsides have not been factored?

Contracts for tankers
As of now, Pipavav is the only shipyard in India that has the ability to manufacture tankers. We believe that the tanker market may revive faster than dry bulk, but we have not factored in the new orders from the same, as with almost no experience in ship making, it will be a while for Pipavav to break into the more sophisticated tanker construction market.
Orders for deepwater rigs

Pipavav is positioning itself as a full-fledged shipyard with ability to make anything that floats. It already has the capacity to manufacture merchant ships of any size and in line with the global practices, the company is developing a separate offshore division which will be able to build deepwater rigs. It has tied up with SeMB Corp for the purpose, but we are not factoring upside from this business as of now.
48
ICICI Securities
Financials
Table 9: Profit and Loss statement
(Rs mn, year ending March 31) Net Sales of which Ship Building of Which Subsidy Trade Sales Other Operating Income Total Operating Income Less: Purchase of Traded Goods Cost Of Goods Sold Manufacturing Expenses Personal Expenses SG&A Total Operating Expenses EBITDA Depreciation & Amortisation Other Income EBIT Less: Gross Interest & Finance Charges Recurring Pre-tax Income Less: Taxation Prior Period Items Net Income (Reported) Recurring Net Income Source: Company data, I-Sec Research 6,294 11,320 21,467 33,179 FY10 6,294 4,453 881 959 FY11E 11,320 9,710 650 959 FY12E 21,467 20,140 368 959 FY13E 33,179 32,220 959
948 2,823 1,569 220 747 6,306 (13) 377 675 286 730 (444) 16 (21) (482) (461)
948 6,155 1,601 476 777 9,956 1,364 635 346 1,075 872 203 20 183 183
948 12,766 1,611 707 1,208 17,241 4,226 943 211 3,494 932 2,561 256 2,305 2,305
948 20,639 2,900 839 1,933 27,259 5,920 1,097 165 4,988 1,050 3,938 394 3,544 3,544
49
Pipavav Shipyard, December 6, 2010 Table 10: Balance sheet

(Rs mn, year ending March 31) FY10 ASSETS Current Assets, Loans & Advances Cash & Bank balance Inventory Sundry Debtors Subsidy Loans and Advances Operational Others Other Current Assets Total Current Assets Current Liabilities & Provisions Current Liabilities Sundry Creditors Other Current Liabilities Provisions Total Current Liabilities and Provisions Net Current Assets Investments Strategic & Group Investments Other Marketable Investments Total Investments Fixed Assets Gross Block Less Accumulated Depreciation Net Block Add: Capital Work in Progress Total Fixed Assets Total Assets
ICICI Securities
FY11E
FY12E
FY13E
6,402 1,330 70 881 4,505 4,148 358 13,189
3,351 2,923 146 1,532 4,385 4,027 358 12,337
2,520 5,781 1,445 1,400 8,671 8,313 358 19,817
2,049 9,090 2,273 900 13,635 13,278 358 27,947
7,757 7,480 277 1,486 9,243 3,946
4,662 4,385 277 1,486 6,148 6,189
8,948 8,671 277 1,486 10,434 9,383
13,913 13,635 277 1,486 15,399 12,548
78 78
78 78
78 78
78 78
11,873 459 11,414 14,416 25,830 29,854
19,873 1,094 18,779 7,416 26,195 32,462
27,289 2,037 25,252 273 25,525 34,986
27,562 3,134 24,428 276 24,704 37,330
LIABILITIES AND SHAREHOLDERS' EQUITY Borrowings Short Term Debt & WC Loans Secured loans Unsecured loans Total Borrowings Deferred Tax Liability Share Capital Paid up Equity Share Capital No. of Shares outstanding (mn) Face Value per share (Rs) Share Warrents Reserves & Surplus Share Premium General & Other Reserve Less: Misc. Exp. not written off Less: Revaluation Reserve Net Worth Total Liabilities & Shareholders' Equity Source: Company data, I-Sec Research
1,500 9,811 1,988 13,299 15
2,500 10,611 1,988 15,099 15
2,500 10,829 1,988 15,317 15
2,500 9,629 1,988 14,117 15
6,658 666 10 0
6,658 666 10 625
6,658 666 10 625
6,658 666 10 625
10,365 (483)
10,365 (300)
10,365 2,005
10,365 5,549
16,540 29,854
17,348 32,462
19,654 34,986
23,197 37,330
50
Pipavav Shipyard, December 6, 2010 Table 11: Cashflow statement

(Rs mn, year ending March 31) FY10 Cash Flow from Operating Activities Reported Net Income Add: Depreciation & Amortisation Deferred Taxes Less: Other Income Operating Cash Flow before Working Capital change (a) Changes in Working Capital (Increase) / Decrease in Inventories (Increase) / Decrease in Sundry Debtors (Increase) / Decrease in Operational Loans & Adv. & Subsidy (Increase) / Decrease in Other Current Assets Increase / (Decrease) in Sundry Creditors Increase / (Decrease) in Other Current Liabilities Working Capital Inflow / (Outflow) (b) Net Cash flow from Operating Activities (a) + (b) Cash Flow from Capital commitments Purchase of Fixed Assets Purchase of Investments Consideration paid for acquisition of undertaking Cash Inflow/(outflow) from capital commitments (c) Free Cash flow after capital commitments (a) + (b) + (c) Cash Flow from Investing Activities Purchase of Marketable Investments (Increase) / Decrease in Other Loans & Advances Other Income Net Cash flow from Investing Activities (d) Cash Flow from Financing Activities Issue of Share Capital during the year Proceeds from fresh borrowings Reserve adjustments Net Cash flow from Financing Activities (e) Net Extra-ordinary Income (f) Total Increase / (Decrease) in Cash (a) + (b) + (c) + (d)+ (e) + (f) Opening Cash and Bank balance Closing Cash and Bank balance Increase/(Decrease) in Cash and Bank balance Source: Company data, I-Sec Research (482) 377 15 675 (765)
ICICI Securities
FY11E 183 635 346 471
FY12E 2,305 943 211 3,038
FY13E 3,544 1,097 165 4,476
1,853 (70) (3,748) (2,948) 1,011 (3,902) (4,667)
(1,593) (76) (530) (3,095) (5,294) (4,823)
(2,858) (1,299) (4,154) 4,286 (4,025) (987)
(3,310) (827) (4,464) 4,964 (3,637) 839
(2,835) (2,835) (7,502) (0)
(1,000) (1,000) (5,823) (0)
(273) (273) (1,260) (0)
(276) (276) 563 0
407 (34) 675 1,048
346 346
211 211
165 165
855 1,763 3,620 6,238 (216)
625 1,800 0 2,425 (3,051)
218 218 (831)
(1,200) 0 (1,200) (472)
6,618 6,402 (216)
6,402 3,351 (3,051)
3,351 2,520 (831)
2,520 2,049 (472)
51
Pipavav Shipyard, December 6, 2010 Table 12: Key ratios

(Rs mn, year ending March 31) FY10 Per Share Data (Rs) Diluted Recurring Earning per share (DEPS) Diluted Earnings per share Recurring Cash Earnings per share (CEPS) Free Cashflow per share (FCPS-post capex) Reported Book Value (BV) Repoerted Book Value (ex Subsidy) Dividend per share Valuation Ratios (x) Diluted Price Earning Ratio Price to Recurring Cash Earnings per share Price to Book Value Price to Sales Ratio EV / EBITDA EV / Total Operating Income EV / Operating Free Cash Flow (Pre-Capex) EV / Net Operating Free Cash Flow (Post-Capex) Dividend Yield (%) Growth Ratios (% YoY) Diluted Recurring EPS Growth Diluted Recurring CEPS Growth Total Operating Income Growth EBITDA Growth Recurring Net Income Growth Operating Ratios (%) EBITDA Margins EBIT Margins Recurring Pre-tax Income Margins Recurring Net Income Margins Employee cost / Revenue Operating expenses / Revenue Other Income / Pre-tax Income Effective Tax Rate Return / Profitability Ratios (%) Return on Capital Employed (RoCE)-Overall Return on Invested Capital (RoIC) Return on Net Worth (RoNW) Dividend Payout Ratio Solvency Ratios / Liquidity Ratios (%) Debt Equity Ratio (D/E) Long Term Debt / Total Debt Net Working Capital / Total Assets Interest Coverage Ratio-based on EBIT Debt Servicing Capacity Ratio (DSCR) Current Ratio Cash and cash equivalents / Total Assets Turnover Ratios Inventory Turnover Ratio (x) Assets Turover Ratio (x) Working Capital Cycle (days) Average Collection Period (days) Average Payment Period (days) Source: Company data, I-Sec Research (0.7) (0.7) (0.1) (11.3) 24.8 23.5 -
ICICI Securities
FY11E 0.3 0.3 1.2 (8.7) 26.1 -
FY12E 3.5 3.5 4.9 (1.9) 29.5 -
FY13E 5.3 5.3 7.0 0.8 34.8 -
NA NA 3.1 8.1 NA 9.2 (12.4) (7.7) -
280.5 62.7 3.0 4.5 46.2 5.6 (13.1) (10.8) -
22.2 15.8 2.6 2.4 15.1 3.0 (64.9) (50.8) -
14.5 11.0 2.2 1.5 10.7 1.9 75.4 112.3 -
NA NA NA NA NA
NA NA 79.9 NA NA
1,161.2 297.3 89.6 210.0 1,161.2
53.7 42.9 54.6 40.1 53.7
(0.2) 4.5 (6.4) (6.6) 3.5 11.9 (152.0) (3.7)
12.0 9.5 1.7 1.6 4.2 6.9 170.6 10.0
19.7 16.3 11.8 10.6 3.3 5.6 8.2 10.0
17.8 15.0 11.8 10.6 2.5 5.8 4.2 10.0
1.1 (0.1) (3.2) -
3.1 5.2 1.1 -
9.3 13.7 12.5 -
12.4 17.5 16.5 -
0.8 88.7 (8.2) 0.4 0.9 1.4 21.4
0.9 83.5 8.7 1.2 1.9 1.9 10.3
0.8 83.7 19.6 3.7 4.5 1.9 7.2
0.6 82.3 28.1 4.7 5.4 1.8 5.5
2.8 0.3 (276) 2 1,707
5.3 0.4 (5) 3 984
4.9 0.6 76 14 832
4.5 0.9 92 20 1,094
52
ICICI Securities

Tables
Table 1: Our core assumptions Current situation versus expectations ........................... 43 Table 2: Sum-of-the-parts ................................................................................................... 44 Table 3: Assumptions ......................................................................................................... 44 Table 4: Valuation sensitivity to terminal growth and cost of equity ................................... 44 Table 5: DCF valuations ..................................................................................................... 44 Table 6: Order cycle for Pipavav Dry bulk ....................................................................... 46 Table 7: Order cycle for Pipavav Offshore & related vessels .......................................... 46 Table 8: Strategic tie-ups with the best in the industry .................................................... 47 Table 9: Profit and Loss statement ..................................................................................... 49 Table 10: Balance sheet ..................................................................................................... 50 Table 11: Cashflow statement ............................................................................................ 51 Table 12: Key ratios ............................................................................................................ 52
Charts
Chart 1: Pipavav will require new orders FY12 onwards.................................................... 45 Chart 2: Erratic growth in revenues and new orders .......................................................... 46 Chart 3: Stronger focus on defence ................................................................................ 47 Chart 4: and Indian clients............................................................................................... 47
53
ICICI Securities
I-Sec investment ratings (all ratings relative to Sensex over next 12 months) BUY: +10% outperformance; HOLD: -10% to +10% relative performance; SELL: +10% underperformance
ANALYST CERTIFICATION
We /I, Sanket Maheshwari, MBA; research analysts and the authors of 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. Nonrated 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 judgement 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. 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 Sanket Maheshwari, MBA; 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 affiliates 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 Sanket Maheshwari, MBA; 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. This report has not been prepared by ICICI Securities, Inc. However, ICICI Securities, Inc. has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed.
54
ICICI Securities
EQUITIES
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Shipbuilding Sector ICICI Dec10

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Shipbuilding Sector ICICI Dec10

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Equity Research

December 6, 2010 BSE Sensex: 19967

Shipbuilding, December 6, 2010

Note: Prices and Sensex as on December 3, 2010

Shipbuilding, December 6, 2010

Shipyard Public Cochin Shipyard Private ABG

Dry bulk carriers Tankers

Sophisticated equipment and rigs

Bharati International Samsung Hyundai Yangdijiziang Full presence

South Korea South Korea China partial presence No presence

Source: Industry, I-Sec Research,

wherein favourable demand drivers are manifesting

Source: Bloomberg, Company data, I-Sec Research

Pent-up demand to boost offshore orderbooks

even as merchant shipbuilding takes time to cast anchor

Indian shipyards may see immediate triggers

SCIs ~Rs135bn boost will give concrete revenue visibility

SCI stake purchase plans will provide a benchmark

Revival of the subsidy scheme

Stock picking to be the key

Shipbuilding, December 6, 2010

Global shipyard Calm waters ahead?

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

Tanker Rates Baltic Dry

Capesize VLCC Container Ships (80) (30) (%)

Source: Industry, I-Sec Research

as industry fundamentals have perked up in 10

Shipbuilding, December 6, 2010 Chart 6: GDP growth likely to be +4%...

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

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

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

Source: Industry, I-Sec Research

Shipbuilding, December 6, 2010

but merchant shipbuilding still caught in undercurrents

Demand not a concern, supply is

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

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

Source: Industry, I-Sec Research

Shipbuilding, December 6, 2010

Source: Industry, I-Sec Research

Source: I-Sec Research

Table 5: Fleet retirement may not be helpful

Crude oil Oil product & others Bulk carriers

2.1 4.6 8.2

320 129 513

Shipbuilding, December 6, 2010

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

Source: Company data

Handymax and Handysized Silver lining does exist

Source: Bloomberg, I-Sec Research

Source: CEA, I-Sec Research

Source: Bloomberg, I-Sec Research

What if trade continues to grow at 10%?

Shipbuilding, December 6, 2010

Source: Industry, I-Sec Research

Table 6: Orderbook will continue to grow

Offshore Demand drivers exist