The Great Eastern Shipping Company - Sailing on the high seas

This is one stock that was in the blue-chip category not long ago. The punters on Dalal Street called it 'GREAT'. But, as in the affairs of men, the global shipping industry's fortunes too ebb and tide and GESCO was not left untouched. And in a fit of seasickness the company decided to deploy men and material for inland activities. It tried to dabble in investing in real estate and commodity trading but without much success.

So what is it now that has turned the tide in GESCO's favor? Well, there are clear signals that the shipping industry has come out of its stupor and heading for the high seas. Let's look at some of the important indicators.

International freight rates in the dry bulk and tanker segments are at record levels…
The economic recovery in Southeast Asian countries and Japan is now a matter of fact and the US economy, despite the recent warning signals, is still strong. Demand for commodities have recovered and with it the demand for higher tonnage and larger number of carriers. All this has translated into higher freight rates. In the dry-bulk cargo, the Baltic Freight Index has crossed the 1,600 levels in the month of April 2000.

In the tanker segment, which is more important for GESCO, freight rates have not lagged behind. For example, notice how the World Scale Index for crude and product tankers has progressed in the last seven months.

Source: ssyonline.com

The pace of fleet addition has picked up…
In the past six months, the global dry bulk fleet saw an addition of 44 ships or 4.2mn dwt. The largest growth was in the Panamax sector (60-79,999 dwt) where 27 vessels of nearly 2mn dwt were delivered, whilst only 6 ships of 0.4mn dwt were deleted. A net increase of 3.1mn dwt was recorded in the tanker fleet in the first six months of this year. Deliveries amounted to 96 ships of 11.6mn dwt, whilst removals were 71 vessels of 8.5mn dwt. Orders for building new tankers has also been strong with 131 new orders totaling 15.9mn dwt since the start of January. The rate of scrappage has also come down. In the past six months, the combined carrier fleet declined by just two vessels of 183,551 dwt. Despite there being 40 ships of pre-1980 vintage, the current freight rates have delayed owners committing their vessels for scrap.

This increase in tonnage is a logical follow up to the recent rise in freight rates. Like many others, the shipping industry also runs on the law of supply and demand. An increase in freight rates is followed by an increase in tonnage, which will ultimately balance out freight rates. However, there is one important difference. Capacity addition does not take place overnight, which means that freight rates will sustain for some time to come.

One other reason for the pace of fleet addition to pick up is the ERIKA accident off the French Coast in December last year. A 24-year-old ship spilled 3mn gallons of oil and created a slick, which had the environmental lobby up in arms against the use of old tankers. This has had its effect and international maritime organizations have firmed up regulations, which have forced owners of scrap 15 year old plus tonnage's rather than incur increasing costs towards repair and dry-docking.

Having convinced ourselves of the uptrend in the industry, let's look at GESCO's credentials as the largest private sector shipping company in India.

GESCO owns and operates 13 bulk carriers, 4 mini-bulk carriers, 13 product tankers, 3 crude tankers and 1 LPG carrier. The company also has 11 offshore supply vessels, 4 anchor handling tugs and 8 harbor tugs to complement its presence in the oilfield services segment. The bulk carrier fleet has a capacity of around 0.5mn dwt while the tanker capacity stands at 0.85mn dwt. The average age of the combined fleet is about 14 years, which compares well with the international standards.

GESCO's capable of creating a slick…
The company's fleet of tankers contributes to about 70% of its total operating profits and if recent indications are something to go by it is slated to go up even further. Given the present freight rate levels, the company has gone in for expanding its fleet and has ordered one Aframax tanker in the first quarter of FY01.

What will also fuel the growth in the tanker segment is the recent decision of OPEC nations to increase output to bring down crude prices. Our country, too, is not blessed with huge oil reserves (in fact production has fallen by 2.2%yoy to 32mn tons last year) and now with the 27mn ton Reliance refinery in Jamnagar up and running, the demand for crude is expected to rise. In the current year, import of crude is expected to rise to 68mn tons from 57mn tons last year.

For GESCO it is not all oil…
GESCO's offshore supply vessels are used for supplying materials to the offshore oil platforms owned by public sector operators like the Oil and Natural Gas Corporation Ltd (ONGC) and private operators like Enron, Hardy Oil etc. This division contributed 26% of the total operating profits of the company in FY2000. This has increased from 11.6% in FY96. This could rise even further as future prospects seem bright.

A part of the reason is the government's new National Exploration Licensing Policy (NELP). As part of this, the government has awarded contracts for exploring 25 blocks were given. Around 7 blocks among these are deep-water blocks. In the second round of bidding slated for September 2000, more deep-water blocks along the western coast of India would be thrown open for bidding. So what does this mean for GESCO? The company has purchased an Anchor Handling Tug Supply Vessel last year, supposed to be the most advanced in its class, in the last quarter of 1999. This will be used as part of the company's foray into the market for deep water drilling activity.

GESCO's earnings profile…
A cursory look at the table below would show that in the past five years, GESCO has managed to negotiate the rough waters better than many of its peers.

Operating profits from the shipping division has increased from a little less than Rs2.1bn in FY96 to Rs2.7bn in FY2000. As a percentage of total operating profits, the contribution from the shipping division has increased from 66.7% in FY96 to 73.4% in FY99. Clearly, a better fleet mix (bulk carriers, tankers, OSVs etc) has stood the company in good stead. Now when freight rates are touching new highs, GESCO has is deploying a larger number of ships on spot charter rather than on time charter as spot rates are around 10% higher.

GESCO's 'real (e)state' of affairs…
Finally in FY2000, GESCO decided to stop building castles and instead focus more its core business of shipping. The property division is now a separate company, which it should have been from the beginning. GESCO's long-term investment in equities, preference shares and debentures/bonds has come down from Rs1.1bn in FY96 to Rs657mn in FY2000. In the corresponding period, investment in fleet has increased from 14.5bn in FY96 to Rs18bn. Clearly, the company is putting money where its mouth is.

Valuation - it cannot be any cheaper
At present, the company is worth Rs4.5bn in the stock markets while its flotilla of ships is worth around 4 times of that!! A P/E of 2.6x at Q1 FY01 earnings is what is on offer. The word undervalued will be an understatement. So you know our orders…. embark vessel and stay afloat.

Abhijeet Dey

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