The Hindu Business Line : The Great Eastern Shipping Company: Buy

Investors in Great Eastern Shipping will get shares in the new company that will own the offshore services business. Given the group's track record, the valuation and share allotment ratio are likely to be in the interest of shareholders.

Mr K. M. Sheth, Executive Chairman of The Great Eastern Shipping Company: Dividing the business between the family members in a shareholder-friendly manner.

AS THE business of The Great Eastern Shipping Company is carved into two separate outfits, owning shipping and offshore services, over the next few months, there could be an unlocking of value.

The stock has risen about 15 per cent in the few days following the announcement of the board meeting to consider the restructuring plan. While the board has approved the split, the nitty-gritty is to be tackled over the next month.

Mr Bharat Sheth will be in charge of the shipping business and Mr Vijay Sheth will manage the offshore services business. This arrangement ensures continuity, as this has been the extant structure. The shipping business accounts for about 80 per cent of revenues, 85 per cent of earnings and 65 per cent of capital employed.

There could be further upside potential over a one-to-two-year period as the split takes effect. The new company may also take six-to-twelve months to get listed. But the removal of the uncertainty over asset division between promoters, as also the imminent reduction in capital and the emergence of focussed entities are likely to lead to an improvement in the valuation of the stock.

The sluggish trends in revenues and earnings of the offshore business have also acted as a drag. As this is vested in a separate company, the valuation of the shipping business could improve in a sustainable manner.

We have maintained a positive view on Great Eastern Shipping over the past three years with several `buy' recommendations outstanding at various price points; the latest was at about Rs 170, earlier this year. In the wake of the restructuring exercise, we remain bullish on the prospects of the two companies that will emerge from this exercise. Shareholders can retain their holdings in Great Eastern Shipping and accumulate the stock on weakness.

Last week, we had identified Great Eastern Shipping as one of the top ten picks to utilise the robust growth in cash flows in a manner that will lead to substantial gains for shareholders over the long term (`Cash-rich, and investing wisely, too', Business Line, August 28).

The proposed split does not change this view. It could lead to more effective deployment of the cash generated, especially in the shipping business.

Investors in Great Eastern Shipping will get shares in the new company that will own the offshore services business. The latter's shareholding pattern will mirror that of Great Eastern Shipping. Given the group's track record, the valuation and share allotment ratio are likely to be in the interest of shareholders.

There is no reason for any concern on this score; but the manner in which the cash pile is divided between the two businesses bears monitoring.

The company had cash and cash equivalents of about Rs 1,100 crore as of March 2005; it earned cash profits of about Rs 500 crore in the first quarter of FY06. The shipping business has raked in cash over the past two years on the strength of a buoyant freight market. Its investment plans would use this cash flow in phases, over the next couple of years. In FY05, even as the investment in the shipping business declined, that in the offshore business rose sharply. The company also sold a very large crude carrier in the first quarter of this fiscal and this, too, resulted in a massive one-time cash flow. During this period, revenues, operating profits and earnings in the offshore services business were flat.

If the cash is divided in a way that takes cognisance of profitability patterns and asset sales, there should be no cause for alarm for shareholders. There have been indications that this will indeed be the case, as the holdings of the two groups in each other's companies are to be settled in the private domain. Any deviation in the script on cash division would be the principal restructuring-linked risk to the stock price.

As the capital is allocated between the two businesses, critical financial parameters suggest that the shipping company will end up with an equity base of about Rs 160 crore. This would mean a reduction of close to 20 per cent in the equity that enjoys the earnings of this business.

Even if the earnings growth in the next couple of years is flat or declines moderately, the reduction in equity could magnify per share earnings in the shipping business and this enhances the comfort level for investors. We also expect the liberal dividend policy to continue; a dividend of Rs 9 per share was paid last year. There is also scope for expansion in dividend, as the payout ratio is low, at about 30 per cent of earnings over the past two years, and as there would be a lower equity base that is entitled to the earnings of the shipping business.

Both the companies are likely to benefit from the investment initiatives announced. There is likely to be a substantial addition to the shipping fleet tonnage over the next three years. This would help modernise the fleet and ensure that a larger proportion of the tanker fleet is contemporary. This business will not enjoy the magnitude of freight rate increases that it did over the past couple of years.

In this backdrop, earnings growth may be flat or fall slightly compared to FY05, which was `the year of the ship-owners' as they raked in record profits. This aspect has been priced into the stock's valuation. In absolute terms, earnings are likely to remain at robust levels and this will place the company on a sound footing to finance its fleet expansion plans.

The offshore and maritime services business does not face a threat of a decline in pricing its services. Its fleet is likely to expand over the next twelve months and the benefits may be evident from FY07 onwards. The imminent increase in oil exploration activities and modernisation of ports should create growth opportunities for this business.

In the near term, expect a continuation of the trend of FY05, as growth rates in revenues and earnings may be sluggish. Socks of companies in comparable businesses have enjoyed fancy in recent months and the new company could benefit from this trend.

The rising prices of crude and other petroleum products represent the main threat to profitability and is the principal risk to our positive view.

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