Why Are Shipping Companies Becoming Investor Favourites?

Shipping stocks have outperformed over the last six months, indicating investors’ growing optimism with the sector.

Over the past six months, Mazgaon Shipbuilders has run up more than 150 per cent, Garden Reach has jumped up by 73 per cent, while another government owned company Cochin Shipyards has run up by 65 per cent — outperforming all broad indices including the S&P BSE SmallCap 50 index which has been a solid performer itself.

The BSE Small Cap Index is up 26 per cent over the last six months. 

Where does the Indian Shipping industry stand?

Over the past year, investors have been betting on a capex revival in the infrastructure, capital goods, and heavy engineering space.

The government’s large capex announcements and hopes of increased capex spending, in view of the 2024 elections, has caused investors to load up on shares of these companies.

The shipbuilding sector in particular has been a laggard in the space, with most of its orders coming from the government. Unlike the shipbuilding sector countries like Korea, Japan, and China, the Indian shipbuilding sector has not managed to bag large private sector clients in the way the former have.

According to a report by Department of Scientific and Industrial Research, various duties and levies in India end up putting Indian players at a disadvantage of 30-40 per cent compared to other shipbuilding countries where governments provide subsidies, and low rates of taxation.

For the last ten years, the shipbuilding sector globally suffered from lack of orders. Several private Indian shipbuilding companies like ABG Shipyard, Reliance Naval Shipyard, and Bharti Shipyard were three such large players that went bankrupt during these lean years.

The capital-heavy nature of the business requires companies to take loans, combined with other factors like lack of orders and financial mismanagement have led to defaults of nearly Rs 45,000 crore.

Government-owned players have managed to survive and be profitable over the same period, but have majorly focused on defence contracts. Large orders for commercial shipping lines are mostly awarded to the larger shipbuilding players, and India has lagged here as well.

Increasing Positives for Shipping Companies

However, the dependency on the government could reduce over time. Players in the space have begun bagging large orders from clients apart from the government.

For instance, Cochin Shipyards bagged an order worth Rs 1,000 crore for wind farm commissioning vessels and another order worth Rs 550 crore for a feeder container vessel.

So far, exports have contributed to a small part of Cochin’s revenues, making up less than five per cent of total revenues in financial year 2022 (FY22).

Another major reason for investor optimism is the sharp increase in revenue and profitability for the sector.

Garden Reach saw its operating profits jump 58 per cent, while Cochin Shipyard’s profit for the quarter doubled over the previous year. In addition, the order book of the companies is quite strong.

According to reports, Garden Reach commands an order book of nearly Rs 24,500 crore and expects to complete it by 2027, which could result in strong earnings growth over that period.

The rise in margins of these players, healthy order books, combined with higher revenues, possibility of revenue diversification, and positive management commentaries have pushed these stocks higher.

The current focus on Gati Shakti, and improving waterways and ports is also likely to help these players.

The government has also provided financial assistance to shipyards in the past, while reports suggest that the government will set aside Rs 5,000 crore to promote shipbuilding for inland waterways.

Nevertheless, investors should remember that these companies have lumpy revenues, and are dependent on the government for orders. In addition, bidding to land projects often means that margins are limited since there are several competitors in the business.

In addition, as the cases of several shipyard companies’ show, high debt and inability to bag contracts can often lead to trouble.

Further, these companies might face margin compression in case the contracts do not allow renegotiation of raw material price changes. Yet, the investors appear to be quite bullish on the sector for now.