Cochin Shipyard has been sailing at full steam. Now, the weather is turning rough

How does it feel to win a prestigious global award but get snubbed at home? Angry, frustrated, or helpless? All of these and more was what 42-year-old Sandith Thandasherry was experiencing when Outlook Business caught up with him. The founder of NavAlt Solar & Electric Boats recently won the Gustave Trouve Award, the world's only international award, exclusively for electric boats.

The start-up built a low-cost passenger ferry called Aditya operating in the backwaters of Vembanad, plying commuters between Vaikom and Thavanakadavu. And it won the award for being not just ‘green’, but also a financially-viable mode of public transport — at an energy cost of just Rs.80/day. That’s against an average energy cost of Rs.8,000/day for a diesel-run ferry. This makes Aditya world’s cheapest public transport. “While the award is a motivation, the reality is that doing business is far from easy,” said Thandasherry, whose grouse comes from the fact that the Rs.80-million profitable start-up was overlooked for a tender to supply 23 electric boats for Kochi Metro since it failed to meet the networth criteria.

In fact, it wasn’t even considered when the winning PSU floated a tender for sourcing propulsion technology for the boats. “What’s the point of promoting ‘Atmanirbhar’ if Indian companies themselves don’t encourage MSMEs and indigenous technology start-ups like us?” laments Thandasherry, who has reached out to the administration to get him a foot in the door. But for the PSU in question, Cochin Shipyard (CSL), which is also the largest shipbuilder in the country, handholding firms is the least of its concerns. The ₹43 billion company in terms of market cap looks to grab every order — domestic and overseas — big or small.

Safe harbour

The company that went public in 2018 was founded in early 1970s, and today, has the maximum dock capacity in India, besides being a market leader in ship repair with 39% share. Of the Rs.34.22 billion topline clocked in FY20, shipbuilding accounted for 83%, while ship repairs made up for the remainder 17% (See: Staying afloat). A majority (87%) of its business across both the segments comes from the Indian Navy. For instance, it is building the indigenous aircraft carrier INS Vikrant, and in April 2019, it bagged the Rs.60 billion order for eight ASW Corvettes (anti-submarine warfare vessels) from the Navy. Besides defense, commercial business comes from the private sector, including exports to clients such as National Petroleum Construction Company (Abu Dhabi), the Clipper Group (Bahamas), Vroon Offshore (Netherlands) and SIGBA AS (Norway). Located on India’s West coast, CSL’s yard is mid-way on route connecting Europe, West Asia and the Pacific Rim, a prominent and busy maritime channel. The strategic location also helps it gain business from ships frequenting western India ports, offshore oil fields and the Middle East.

Over the past decade, CSL’s turnover has grown at 10.6% CAGR from Rs.12.48 billion in FY10 to Rs.34.22 billion in FY20, while profit has compounded at 11.08% — from Rs.2.23 billion to Rs.6.38 billion, making it the most profitable shipbuilder in the country. What is also working in favour of the PSU is that over the past five to seven years, competitive intensity has reduced with three private companies — ABG Shipyard, Reliance Naval and Bharati Shipyard — going under due to financial stress. Sandeep Tulsiyan, analyst, JM Financial, says, “As a result, competition from the private sector is limited to L&T Shipyard. Further, among the large public sector shipyards, Hindustan Shipyard and Garden Reach are not as profitable.”

Besides steady ship repair orders from the Indian Navy, CSL has pacts with various clients, including Lakshwadeep Development Corporation, the Directorate General of Lighthouses and Lightships and Dredging Corporation of India, to undertake ship repair work on bulk volume basis, ensuring a steady revenue stream. Ashwin Patil, analyst, LKP Securities, explains why for CSL this is a high-margin business: “It is not cyclical and it does not need too many employees or tech upgradation.” Moreover, he adds that Garden Reach, which has a robust order book, lags behind CSL since it is not into this segment. “Hence, it enjoys a margin of 5-6%; whereas CSL’s margin ranges in the 20% band,” he says.

But who could have thought having a virtual monopoly could bring its own problems? In fact, the company is going slow this year, and projecting revenue of Rs.5.5 billion (slightly lower than FY20) in a Rs.26 billion ship repair market. “We are unable to squeeze in anymore. We are doing much more than what we can actually chew,” said Rajesh Gopalakrishnan, GM (business development), during the Q4FY20 earnings call.

Meanwhile, to keep up with demand, the PSU is building an international ship repair facility (ISRF) for Rs.9.70 billion at Cochin Port, where CSL has leased a 40-acre plot, besides building a new dry dock. “And once these two are in place, we can take more ships. We have also opened up ship repair units in Mumbai and Kolkata and have recently commenced operations at Port Blair,” added Gopalakrishnan.

This, according to analysts, will improve CSL’s capability to construct and repair larger-sized ships, namely LNG carriers, semi-submersibles, jack-up rigs, drill ships, large dredgers and more. This, in turn, will open up more opportunities since PSU gas company GAIL has a contract to purchase 5.8 million tonne of LNG per annum for 20 years, which will require specialised carriers.

While there is a problem of plenty in the ship repair business, CSL does not have large orders in its core business. Currently, INS Vikrant constitutes a big chunk of CSL’s order book of Rs.146 billion (See: In-house buyer). From this project alone, CSL booked revenue of Rs.23.77 billion in FY20. Importantly, the shipbuilding orderbook shrunk 16% in FY20, because the company failed to book other large-sized orders due to the cyclical nature of the business.

This is despite management confirming that the Vikrant order will continue to contribute to the topline till FY24. “So, before that we need to take a big order and are actively bidding for many projects. It’s not that the company will not strike any orders for the next three years,” pointed out Jose VJ, director-finance, CSL during the concall. Additionally, the company has also bid for various projects from the ministry of defense for NGMV (next generation missile vehicles), multi-purpose vehicles and offshore patrol vessels collectively worth Rs.130 billion-150 billion. “Any order win out of these projects will further elevate the financials. Given CSL’s legacy of executing such orders, it has a good chance,” states an optimistic Patil.

However, Tulsiyan is not sold. He is of the view that even though the pipeline appears healthy, the conversion rate may be low. “The bulk of the pipeline consists of the NGMV bid, which is around 80% of the total pipeline, where it is pegged against stiff competition from both public and private players, while new aircraft carrier plans have been put on hold due to budgetary reasons,” he says.

Meanwhile, the company is working on a roadmap for 2030, which will also entail venturing into smaller vessels for fishing and inland waterways. With an overall navigable waterway length of around 14,000 km, there will be demand for more than 3,000 ships over the next 10 years, according to analysts. To cash in on this, CSL acquired Tebma Shipyard in March 2020 through NCLT for just Rs.650 million. Right now, the inland waterways segment comprises — passenger ferry order from Kochi Metro (₹3.97 billion) and mini cargo vessels from Jindal Steel (₹3.88 billion). The rest Rs.9 billion of the orderbook is for fishing and other smaller vehicles.

Docked in a corner

Its business may be safe and the orders may continue to flow in, but Thandasherry complains that these PSUs have not made any significant progress in terms of indigenisation compared to other global shipyards. For instance, CSL recently bagged a Rs.12.5 million order from Norway to supply two autonomous electric vehicles. But, the clincher is that CSL will be sourcing the entire technology from foreign firms, making this order just an assembly-cum-build. “This company was founded in the same year as Hyundai Heavy Industries in South Korea, the largest in the world. But, today, the South Korean firm makes every critical item of its ships, while CSL still imports every component and merely assembles them,” he protests.

This reliance on imports also means that CSL is exposed to currency volatility. Therefore, Tulsiyan is sceptical about the new Corvettes order that CSL has bagged from the Navy. Of the total cost of the order, 65% will be used for imported materials. “Given the kind of foreign currency fluctuations seen over the past two years and that CSL has just started working on this order, its profitability is under question,” he says.

For now, the management is taking comfort from the fact that it has orderbook visibility for the current year and the next and is sitting on cash pile of over Rs.20 billion. Tulsiyan points out that CSL typically operates on a negative working capital cycle owing to adequate advance received from Indian Navy, helping it maintain healthy liquidity as 90% of capital employed is in the form of cash. But being a government-dependent company also means that of late, advances are slowing down, as receivables rise.

That coupled with capex for two new facilities in Cochin has hurt CSL’s cash balance, which has fallen by 40% over the past two years to Rs.21.8 billion. “We expect this cash balance to decline by more than 50% over FY20-22, as customer advances decline further, even as it incurs capex in dry dock, ISRF and other ship repair facilities at Mumbai, Kolkata, Andaman and Nicobar and others,” cautions Tulsiyan.

As of March, total receivables stood at Rs.2.88 billion, of which around Rs.2.50 billion is from the government. But it’s unlikely that the money is coming soon as Jose said during the call: “The government’s priority now is towards MSMEs. So, PSUs will be paid only during the next stage. In March, we got around Rs.1 billion-1.50 billion from the Navy. But thus far, in FY21, we have not received anything. We expect the position to improve Q2FY21 onwards.”

Though not significant, CSL has made provision for unanticipated losses and expenditure of Rs.720 million in FY21. CSL follows an accounting policy where, if the receivables are outstanding for more than a year, it provides 5% of that total amount and if it is more than two years, 15% is provided for. If that extends to more than three years, then 100% provision is made. “Our major customer is the Navy. Because of the cut in the defense Budget, there is a delay in getting the money. It ranges up to three years in some cases but as per the accounting policy, we need to provide fully,” Jose explained in the call.

However, Patil is not too worried about the depleting cash kitty as he says that majority of the capex is going towards ship repair yards, besides the dry dock. “Since ship repair is a through-the-year affair, the capex is not creating idle capacity.” Further, CSL has no leverage barring a long term loan of Rs.1.23 billion. “So, net of cash, they are a debt-free firm,” he says, adding that the government has promised to pay 80% of its Q1FY21 receivables in the second quarter.

Reading the wind

Analysts expect FY21 to be either flat or slightly negative in terms of revenue but expect FY22 to be robust. “COVID-19 will push the delivery of Vikrant into 2022, which will lift up FY22 numbers while impacting FY21. However, ship repair business will continue to contribute more to the margins. An increase in capacity at this business with a high rate of return (10-11%) at its ISRF should augur well for profitability,” says Patil. On the other side is Tulsiyan, who is cautious. “Though there are bids in the range of Rs.40 billion-50 billion in the pipeline, the management does not have clarity on whether the orders will be converted in the current fiscal or the next,” he says.

The pandemic has also disrupted the company’s labour force participation since CSL has a flexible workforce, with a higher share of contracted and sub-contracted employees at 612 and 3,178, respectively. This meant a lot of workers left for their hometown when COVID-19 struck. The management revealed that a part of of their temporary workforce has started reporting to work again. “A lot of workers have expressed their willingness to come back. But, they have to be put through a mandatory 14-day quarantine, so there will be time overrun,” Gopalakrishnan said during the concall.

At the current level, the stock has a dividend yield of 5%, and trades at one-year forward multiple of 9x (JM Financial estimates) and 7x (according to LKP). Despite Tulsiyan’s caution over the company’s future performance, JM Financial sees an upside of about 6% from CSL’s current stock price of Rs.335. He adds that this small upside is not attractive enough to offset an investor’s opportunity cost.