ABG Shipyard: Buy

A burgeoning order book, continuing capacity shortage in the global shipbuilding sector and the company's swift moves to capitalise on this scenario through capacity addition, make ABG Shipyard a good investment for those with a three-year perspective. At the current market price, the stock trades at 17 times its likely earnings for FY09. The stock may continue to trade at premium valuations, given the strong demand outlook for ships. This demand situation also suggests that new orders may be obtained at higher prices, which, in turn, may expand profit margins.

 

ABG Shipyard's present order book of Rs 8,277 crore is about 12 times the company's revenues for FY 07, lending earnings visibility for the next three to four years. The company has been ramping up its capacities to make sure that timelines on execution are maintained. For one, it has expanded its existing facility in Surat and also acquired a strategic stake in Vipul Shipyard located near the existing Surat unit. ABG is also setting up a new facility in Dahej, which is expected to commence operations from April 2008. Once this facility is fully operational, the company would be able to manufacture ships up to 1,20,000 DWT (dead weight tonnage), essentially implying ships with high profit margins.

 

ABG has also diversified its operations through the acquisition of the ailing Western Shipyard (WSI) – one of the largest private ship and rig repair companies. Apart from the strategic location of this acquired unit (in Goa), ABG is also likely to benefit from the highly lucrative repairs business. The ailing WSI, which has been troubled by mounting debt, has already received restructuring packages from banks and institutions. ABG's infusion of cash would further help in the turnaround process. We have, however, not factored revenues from this company into our estimates at present.

 

ABG has bagged a good number of repeat orders as well as orders for small bulk carrier vessels with similar specifications. Repeat orders are likely to result in operational efficiencies as well as economies of scale. This trend, together with higher priced orders is likely to protect operating profit margins from erosion due to any hike in steel prices. The company's operating margin for the September quarter rose to over 30 per cent, an increase of 160 basis points over the same period last year. A removal of the ship-building subsidy and slow execution are the key risks to earnings growth.