In a market full of stocks with sky high valuations not necessarily backed by strong fundamentals, select PSU stocks offer an opportunity for investment with a margin of safety. Cochin Shipyard (CSL), the country’s largest public sector shipyard, is one such company. The GOI holds 73 per cent stake in CSL.
A robust order book, impressive margins – operating profit (EBIT) and net profit margins of 18-23 per cent and 16-22 per cent, respectively during FY18-FY21 – and almost no debt along with a long execution track record are some of the key business positives.
With 20-25 per cent share of India’s shipbuilding capacity and 40-45 per cent of the organized ship repairing segment, Cochin Shipyard is strongly positioned. The Indian shipbuilding industry also comprises defence PSUs such as Mazagon Dock Shipbuilders and Garden Reach Shipbuilders and Engineering, and many financially stressed private sector shipbuilders such as ABG Shipyard and Reliance Naval and Engineering.
Given its healthy long-term business prospects, strong industry position and the reasonable stock valuations, long-term investors can consider buying the CSL stock. The company has also been a consistent dividend payer with an average payout ratio of 34.5 per cent during FY16-FY21.
Attractive valuation
From a high of ₹440 per share in January 2020, the CSL stock fell 51 per cent by the March low. Since then, the stock has gained 73 per cent. Today at ₹372 per share, the stock trades at a trailing twelve-month (TTM) P/E of 8 times, a good discount to its 3-year average P/E multiple of 9.4 times. This is also well below the stock P/E of 14.5 times at the time of the company’s IPO in August 2017 (based on the issue price of Rs. 411 and the company’s FY17 earnings). CSL’s listed peers such as Mazagon Dock Shipbuilders (largest by revenue) and Garden Reach Shipbuilders & Engineers trade at TTM P/E ratios of 9.4 and 17.5 times, respectively. Both have significantly lower operating profit margins compared to Cochin Shipyard which has lower employee expense thanks to its reliance on outsourced labour.
Set for growth
CSL has a dock for building ships of up to 1.1 lakh deadweight tons (DWT) and another one for repairing ships of up to 1.25 DWT. In FY21, the company derived 84 per cent of its revenue from shipbuilding and the rest largely from ship repair. It is executing two major expansion projects – the new dry dock and the international ship repair facility (ISRF) at Kochi. The ongoing expansion projects, targeted to be commissioned by FY23 will boost the company’s capacity for ship repair and shipbuilding, including that of many technologically advanced vessels.
CSL’s order book of ₹12,218 crore, largely defence-related as of March-end 2021 translates into a book-to-bill ratio of 3.6/ 4.3 times (based on FY20/ 21 revenue). CSL has also emerged as the lowest or L1 bidder in tenders worth Rs. 10,000 crore. CSL recognises revenue, costs and profit from shipbuilding operations only once the actual production work begins based on the percentage of work completion.
The company management has guided for ₹3,500 crore revenues for FY22 which translates into a 24 per cent growth compared to FY21. Once the work related to the Indigenous Aircraft Carrier (IAC) is completed, profit margins though healthy may not sustain at the same high levels as in FY21.
While the blended EBITDA margins, taking both ship building and repair into account are expected to be 19-20 per cent in FY22, the higher revenue growth should keep the EBITDA growth intact. At the net profit level, however, higher depreciation once the new capacities are commissioned, can have an impact.
Mitigating risk
The dominance of defence contracts in CSL’s orderbook reduce its susceptibility to the cyclicality of the shipbuilding industry. Also, while the dependence on a few bulk orders exposes it to client concentration, with the government of India (Indian Navy and Indian Coast Guard) as the counterparty, this risk is mitigated.
The IAC for the Indian Navy, for instance, accounted for 84 per cent of Cochin Shipyards’ FY21 revenue and boosted the overall margins. IAC Vikrant is the first aircraft carrier designed and built in India and is expected to be commissioned by the Indian Navy by August 2022.
While most of CSL’s contracts (except for the IAC) are fixed price based, it is able to manage its costs well. Ordering its entire steel-related requirements once a contract is signed along with the applicability of the exchange rate variation clause on imported equipment on all its defence-related contracts helps.
The government’s focus on promoting inland and coastal shipping, too should provide opportunity for building and repair of high-speed ferry crafts, dredgers and large capacity passenger ships. CSL also expects to double its ship repairing revenue (₹409 crore in FY21) by FY24 thanks to the commencement of operations at the Kolkata and the Mumbai ship repair units.
Strong financials
Shrugging off the impact of the pandemic on its operations in the first half of FY21, CSL registered a recovery in performance in the latter half. The outbreak of the second Covid wave, however, put a break on this. With the subsequent reopening of the economy, and backed by a sufficiently large orderbook that offers revenue visibility over the next few years, the company is on course to returning to its pre-pandemic growth.
CSL grew its revenue at 14.4 per cent CAGR to ₹3,422 crore between FY16 and FY20. During this period, the company’s operating profit grew 19.6 per cent CAGR to ₹ 658 crore.
However, impacted by Covid-induced production halts and shortage of labour, FY21 revenue declined 17.6 per cent to ₹2,819 crore and operating profit stagnated at ₹656 crore compared to the year-ago period.
Despite this, thanks to the higher-margin IAC project, CSL reported operating and net profit margins of 23 per cent and 22 per cent, respectively in FY21. These were higher than the respective margins of 16-19 per cent and 13-18 per cent during FY16 and FY20.
For the half-year ended September 2021, CSL reported year-on-year 3.6 per cent rise in revenue to ₹1,026 crore. Helped by 13 per cent lower raw material cost, the company’s operating profit rose 31 per cent to ₹152 crore compared to the year-ago period. With most of the IAC production work already complete, the raw material cost was lower in the latest quarter.
The company has a strong balance sheet - almost zero debt and its cash on books (excluding customer advances) of ₹1,011 crore as of September 30, 2021, equals one-fifth its current market capitalisation.