7 September 2018

Cochin Shipyard Stock Analysis

In this blog, we will do a Cochin Shipyard stock analysis to see if the stock is worth investing for the long term. What makes Cochin Shipyard interesting is that it has an order book of 10x it’s FY18 revenues.

Background

Cochin Shipyard was incorporated in 1972 and operates in the ship building and ship repair industry. The Government of India owns a 75% stake in the company and the company has been a cash cow for the Government with it’s liberal dividends. The company operates in two segments – Ship building & ship repairs. Further more, the company’s major source of revenue is the defense sector.
The company operates from it’s 170 acre campus adjacent to the Cochin port and recently, the company has further leased 42 acres of land from the Cochin Port Trust for expansion. The current capacity of the company in ship building is 110,000 DWT and in the ship repairing, the capacity stands at 125,000 DWT. In FY17, 90% of the revenues came from the defence sector.

Industry

Cochin Shipyard is India’s largest public sector dockyard. In terms of capacity, it is second to Reliance Defence, which has a capacity of ~ 400,000 DWT. India contributes just 1% of the global shipbuilding and repair market, while China, Korea and Japan make up ~ 90% of the global market.
The global supply and demand grew at a similar pace till 2009. By 2015, the industry was crippling with over-supply as demand fell sharply because of a global economic slowdown. Further more, it is estimated that over-supply in the ship building industry will persist till 2025.

Financial Snapshot

Cochin Shipyard operates in an industry where most of the players make losses. Defying the industry trend, Cochin Shipyard has remained profitable at both EBITDA and PAT levels as shown in the 10 year snapshot below.
To understand the revenues of Cochin Shipyard, we need to understand it’s business segments and the revenue recognition policy. We shall first understand the two business segments that the company operates in – Ship Building and Ship Repair.
Since FY15, the ship repair segment has grown very fast. In FY15, it made up just 11.91% of the firm’s revenues. In FY18, it’s revenue share rose to 24.5%. Majority of the Ship Building revenue comes from IAC (indigenous aircraft carrier).
The revenue recognition for ship-building as given in the annual report is different for non-IAC and IAC.

Cochin Shipyard, though profitable, loses cash. Over the last 5 years, the company has earned a total profit of Rs 1,356 Crores but the cash flow from operations is negative for the company. The company’s profits are locked in it’s trade receivables.

Peer Analysis

If we consider the entire profit pool of the ship building industry, then the public sector company’s enjoy most of the profits. Mazagaon Dock Shipbuilders Ltd and Cochin Shipyard Ltd have the lion’s share of the profit pool and enjoy above average profit margins.
The Indian Navy came to the rescue of the shipyard companies during the FY12-FY17 period when the commercial sector witnessed a heavy slump in demand. Public sector shipyards remained profitable and debt-free while the private sector companies made losses and saw a spurt in their leverage.

Expansion Plans

The company has lined up an expansion plan with an outlay of ~ Rs 3,000 Crores. The International Ship Repairing Facility (ISRF) will involve Rs 970 Crores of capex and the Stepped Dry Dock will involve Rs 1800 Crores of capex.
  • ISRF: The ISRF will enhance the ship repairing capacity of Cochin Shipyard by ~ 75 ships per annum.
  • Stepped Dry Dock: The new dock will enable Cochin Shipyard to undertake repairs of LNG Carries and drill ships

Outlook

i) Orderbook

Cochin Shipyard’s orderbook can be summarized as per the table given below:
Another reason why we did a Cochin Shipyard stock analysis is that the orderbook is nearly 10 times the current revenue from the ship building segment. This provides a  revenue visibility till FY22. The management’s guidance of revenue growth is 16% p.a. till FY20.

ii) Lower Margins

Ship building is going to be the major revenue generator (atleast till FY21). Ship building is a low margin business in comparison with ship repairs, thus Cochin Shipyard’s margin will shrink going forward. Since a major part of the orderbook is on a “cost-plus” basis, we will see lower margins going forward. Further more, other income will fall as the cash in the balance sheet gets utilized for capital expenditure.
Estimated EBITDA margin going forward could be ~ 15% to 16%

iii) Defense sector will dominate

The global shipping industry is still suffering the effects of over-supply in the ship building segment because of the pre-2008 expansion in capacities. We expect the defense sector to continue being the major contributor to the firm’s revenues going forward.
On the commercial sector front, ship building order book will benefit from the ambitious Sagarmala project. The Sagarmala project aims to strengthen India’s inland waterways. Only 6% of India’s trade takes place through inland waterways and the Sagarmala project aims to increase this share. It is estimated that the Sagarmala project will create an additional demand of ~ 200 vessels every year.

A proof of the slowdown in the shipping industry is the reduction of shipbuilding capacity of Chongqing. The yard plans to reduce it’s capacity by 200,000 DWT to 900,000 DWT because of a slump in the shipbuilding industry.

The pitfalls when the company is too reliant on the defense sector are:
i) Slow decision making due to bureaucratic intervention and red-tapism
ii) High dependence on Government’s spending on the defense sector
iii) High dependence on policies which can change with any change in the Government

iv) Growth

With a strong order-book and revenue visibility till FY21, Cochin Shipyard’s revenue growth is expected to be ~ 18% p.a. CAGR till FY21. With lower margins and lower other income, the PAT growth will be slower than the revenue growth rate.

v) Valuations

To complete our Cochin Shipyard stock analysis report, we need to understand it’s valuation. Compared to the rest of the market, Cochin Shipyard’s valuations might seem cheap. However, company’s which are heavily dependent on Government policies tend to command lower valuation multiples. While most of the cash on the Balance Sheet would be spent on expansion over the next 3 years, Cochin Shipyard will earn cash from it’s operations. We would assign a PE multiple of 12x to 14x for Cochin Shipyard.
Even if we assign a multiple of 14x the earnings, the returns work out to just ~ 11% p.a. If we assign a 12x multiple, then the returns work out to just ~ 5.5% p.a. In Cochin Shipyard stock analysis, we have made some major assumptions which are likely to go wrong:
  • Expecting margins to taper off
  • Assuming that the market will assign a low multiple to the stock
  • Assuming defence to be the major revenue contributor till FY21

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