The Hindu Business Line : Dredging Corporation: Book profits

THE growth opportunities for dredging companies is immense as a number of projects are in the pipeline. Dredging Corporation of India (DCI), so far the dominant player in the industry, is facing competition from foreign players.

With core competence in maintenance dredging operations, the company has to gear upfor the capital dredging projects coming up the next few years. The company has its hands full for the next couple of years with the running maintenance contracts and the Sethusamudram project.

At Rs 620, the stock is trading at 10 times its expected FY06 per-share earnings. DCI is likely to face a challenging environment.

Considering the moderate revenue growth expected over the next two years and the effect of the tonnage tax already factored in, we think investors concerned about opportunity loss in the stock markets can book profits.

However, investors will need to monitor the stock closely for positive developments that could serve as potential re-entry points into the stock.

The year 2007 will be a significant for DCI. A new dredger will be added to its fleet with a second addition to follow soon after. The existing agreements for maintenance dredging with major ports, such as Haldia and JNPT are due to expire. Key factors that will decide growth path of the company are:

Its success in forging partnerships with foreign companies to participate in new capital dredging projects.

Retaining its existing plum maintenance-dredging customers in a competitive market.

Pumping up its capacity by expanding its fleet or chartering equipment.

Opportunities galore

The Indian dredging market will have many growth opportunities over the next few years. Major ports have announced plans to deepen channels/berths to accommodate bigger vessels. The Rs 2,400-crore Sethusamudram project, to be completed in three years, would also offer many dredging opportunities.

The nature of dredging is also expected to change from predominantly maintenance dredging (maintaining existing depths) to capital dredging as new projects take off. The Indian dredging market is expected to grow to Rs 5,000 crore over the next few years.

Revenue stream secure

DCI is known to enter into long-term (three/five-year) contracts for annual maintenance dredging with ports. Its contracts are secure till 2007 with major ports such as Haldia, JNPT and Vishakapatnam accounting for close to 50 per cent of its turnover in 2005.

DCI has also received a portion of the dredging contract for the Sethusamudram project. Over the next two years, DCI will dredge 13-million cubic metres of the total projected dredging quantity of 82.5 million cubic metres. The value of the contract is yet to be finalised. The Sethusamudram project is expected to provide business worth Rs 1,600-1,700 crore for dredging companies. Being capital in nature, it also commands higher margins.

Key challenges

Augmenting capacity will be the main challenge for DCI, if it is to participate in the expanding market. So far, the capital-dredging segment has contributed less than 15 per cent of its turnover. A major portion of its fleet is capable of handling maintenance projects. It has comparatively little experience and capacity in the capital-dredging segment. Most of the greenfield projects planned, including the Sethusamudram and a number of deepening projects by ports, are capital in nature. DCI has to increase its capital-dredging capacity to take advantage of the opportunity in this segment.

Its another challenge is to stay competitive. According to the proposed new dredging policy, DCI will have to win a competitive bid to bag a contract, unlike earlier when it was nominated to a project.

To go are also the purchase preference policy and the first right of refusal. This puts DCI on a par with other foreign players while competing for a project. However, DCI has not taken advantage of these provisions often and has been competitive on its own. A number of foreign companies have set up Indian subsidiaries and have been chipping away at DCI share in the maintenance market too. DCI's aging fleet is a drawback. Foreign companies also score on technology.

Gearing up

To strengthen its position, DCI is expanding its fleet; it is in talks with foreign players to form joint ventures and is looking at chartering equipment to augment capacity. Two new dredgers with capacities of 5000 cubic metre per hour (cmph) and 2000 cmph are being added to its fleet. The company has placed an order for one dredger to be delivered in 2007; the other is yet to be finalised.

These additions will help it take up capital dredging projects. However, this would expand the capacity by only 5 per cent, which, in our view, is not adequate in the context of the opportunities ahead.

DCI is also in talks with two foreign companies to form joint ventures. This will allow it to collectively bid for greenfield projects. The joint venture route will help it ward off competition and give it access to projects take on its own. DCI is looking at access to an expanded fleet and technology from the joint venture.

To augment capacity, it is also looking at opportunities to charter equipment. If this fructifies, DCI could have access to a larger fleet and be able to take on more contracts. However, these plans have only been proposed and nothing concrete has emerged as yet. Two factors will be crucial for re-rating the stock.

One-time prop

Dredging has shifted to the tonnage tax system from 2005-06. This has led to an almost 80 per cent reduction in taxes for the first half year ended September 2005. The effect is magnified as the Section 33C benefit available to shipping companies was removed in the year 2004-05. Earnings and cash flows for the current year will rise disproportionately due to this one-time adjustment.

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