Shipping: In rough sea still

S. Vaidya Nathan

THE SHIPPING industry is steaming well with a notable recovery in the freight rates this fiscal though they are nowhere near the highs witnessed just before the South-East Asian economic crisis.

This is true of both dry cargo and tanker freight. Freight market trends of the last two years highlight the volatility and the divergent trends in the tanker and dry cargo market. But both segments seem to be sailing smooth the last few months.

The Great Eastern Shipping Company board of directors' report for 1999-2000 noted: ``The year 1999-2000 witnessed firming up of dry bulk earnings after months of dismal markets since 1997 following the Asian crisis. The market accelerated towards the end of the year and spot earnings ended the year almost 50 per cent higher than the start of the year. During most of 1999-2000, the tanker market experienced a significant downturn, correcting itself only in the final quarter of the year. In the first quarter of the millennium, factors such as environment concerns, increased OPEC production and a significant turnaround in Asian economies helped bring about a significant rally. The rally has continued gaining momentum which will reflect in earnings of the fiscal 2000-01.''

Dry cargo market

Dry cargo freight rates have been firm. The Baltic Freight Index is now a far cry from the lows of the first half of 1999. The index is a benchmark of the dry cargo freight rates. The rates, then at a two-year low, have recovered substantially due to the improved grain markets and the recovery of the Asian economies. This segment is critical to most listed companies as they have fleets heavily weighted in dry cargo bottoms.

In the last three years, the companies have been affected by the sluggish dry cargo market. This neutralised the benefits of the firm trends, prevailing till mid-1999, when a short slump began. To a large extent, the benefits of better dry cargo freight rates may be felt only this fiscal.

With most Asian economies showing good growth and the US harvesting a good grain crop, the firmness in this freight market segment might continue. The index continues to hover around 1,500-1,600. Though Indian companies do not operate on the routes covered by the index, the trends in the index percolate to other markets and dry cargo revenues might pick up this fiscal.

Volatile tanker markets

For companies deploying their oil tanker and product carrier fleets internationally, the last two years were volatile after three years of firm rates; the rates were slack only for a short period in late 1999. The average spot earnings of $17,000 a day for Suezmax Tankers fell to $12,000. But this quickly reversed as the underlying demand picked up and modern tonnage attracted better rates.

The spurt in crude prices and the high demand for petro-products has led to firmness in the tanker freight market. As for Indian companies, the firmness in the taker freight market is a small positive from the long-term perspective. This is true especially for the Shipping Corporation of India and can be attributed to the sharp rise in oil refining capacity in the last 18 months. As India moves towards greater refining capacity, there may be less emphasis on product carriers (see Gesco's optimism).

Company-specific factors

Though the overall industry scenario plays a major role in the performance and valuation of the stocks in any industry, as far as shipping goes, company-specific factors have weighed on the valuation of the stocks. Most of the companies diversified, restructured to restore focus, raised massive equity. Some have had intra-group problems in the last five years. These factors influence stock valuation.

There are indications that this could continue for the next couple of years. For instance, the stock of Shipping Corporation of India -- which owns the largest tonnage -- has the sword of the disinvestment programme dangling over it. The disinvestment has acquired no concrete shape, and unless the issue is settled, the industry fundamentals may take a backseat where this scrip is concerned.

The same holds for Essar Shipping. After taking on the burden of a port terminal project, which curtailed the company's ability to expand its fleet, it is changing tack. The port terminal project is being vested with a separate company so that the shipping division can get along with business. However, this proposed arrangement with a Malaysian company has not evoked positive sentiments.

The Great Eastern Shipping stock also faced similar problems with the restructuring of its property development and shipping business. While the sluggishness of the property development business dampened the market sentiment for the stock, the promoters' decision to raise their stakes has sparked interest. The takeover threat involving the sister concern Gesco Corporation lifted the stock's valuation, but the improvement may not last.

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Growth constraints

Though the freight rates are at better levels, Indian shipping companies are not exactly well placed to pursue expand their fleets. While they may have some flexibility in the debt markets, the equity market route -- domestic and foreign -- appears cut off. The internal cash accruals may be just about adequate to replace older vessels in the existing fleet. The latter is particularly a problem for the Shipping Corporation of India and Great Eastern Shipping.

It is estimated that the industry requires close to $5 billion to augment the fleet. The Ninth Plan target of 9 million tonne gross registered tonnage would be tough to achieve if the pace does not pick up. With the equity route likely to prove a major constraint on corporate plans, the possibility of Indian cargo being carried by foreign bottoms is a distinct possibility.

Though the industry has net forex earnings of Rs 3,500 crore (and should benefit from the rupee's depreciation), the flexibility on the resource front is limited. And any move into areas such as LNG transportation may require more investments, possible only with foreign collaboration. The resource constraint and the attendant impact on growth may lead to some action on this front.

Investment outlook

As for investments in shipping stocks, only the Great Eastern Shipping stock may be worth a close look. Here too, the scrip is unlikely to command the kind of valuations it did in the past.

The possibility of the promoters hiking their stake through a buyback and open-market purchases may lead to some upside in the scrip. The rest of the industry's stocks, such as Varun Shipping, Chowgule Steamships and Essar Shipping, can be avoided.

The same may hold good for the SCI scrip. However, any concrete disinvestment programme can trigger interest in the stock. But there are too many uncertainties on this and, therefore, to buy on this premise would be risky. Though the fundamentals may be better this fiscal, the shipping stocks can be avoided until signs of the industry delivering good sustainable growth are visible.