Buy : Mercator Lines CMP Rs48.60 with a target of Rs 58.50

(BSE: 526235 | NSE: MLL | ISIN: INE934B01028)


Potential upside: 20% Time Frame: 6 mths

Company Background Mercator Lines is the second largest private sector shipping company in India . Its fleet comprises very large crude carrier (VLCC), tankers and dry bulk ships amongst others. Through its Singapore-based subsidiary, the company is aggressively building its dry bulk tonnage.

Mercator carved a niche for itself in coastal trade by opening new avenues of transportation of molasses from Surat and minor ports in Ratnagiri. The company also handles transportation of coal at various locations. It has forayed into the oil & gas offshore business through its subsidiaries and placed an order for construction of new generation jack-up rig. The tonnage handled by Mercator has shown an exponential rise from 4,000 DWT in 1994 to about 2,260,444 DWT in 2007.

Investment Rationale

Fleet expansion to make Mercator major player in dry bulk segmentThe company has signed an agreement with an overseas company for acquiring four dry bulk ships totaling 305,000 DWT through Mercator Lines ( Singapore ) Pte at an estimated investment of Rs 1,000 crore. The vessels are expected to join the fleet of the company in Q2FY08. The company is financing the expansion through its subsidiary Mercator Lines ( Singapore ) Pte Ltd, which had successfully raised US$51 million by way of issue of convertible bonds that are listed on Singapore Stock Exchange.

During the past 12 months, Mercator Lines has committed to invest about Rs 2,750 crore in expanding its fleet and offshore business. With these acquisitions, the company shall become a dominant player in the dry bulk segment. The consolidated fleet will be of 27 vessels with a total capacity of about 2.45 million tonnes. Post expansion, Mercator is likely to be the key beneficiary of India ‘s increasing imports of coal due to the execution of the mega power plants happening at a faster pace. With dry bulk freight rates likely to remain firm in the medium to long-term basis, the outlook for the company in the dry bulk segment looks immensely positive.

Foray into shipbuilding sector to de-risk business

Mercator Lines is looking at entering the lucrative shipbuilding sector. The global shipbuilding industry is characterized by booked capacities of major shipyards and orders flowing to shipyards in countries like India , which have distinct advantage on the labour cost. Mercator is likely to build a shipyard in Palghar in Maharashtra , where it has bought 400 acres. The company is likely to invest around Rs 1,000 crore in this venture. The entry into shipbuilding will de-risk its business and also cushion its operating margins, as the order flows from foreign buyers to Indian shipyards has been robust with stable margins.

IOC order to boost top line

Recently, the company signed a contract with Indian Oil Corporation (IOC) to transport 12 million tonnes of crude for Rs 200 crore. The crude will be transported from the Persian Gulf to India via VLCC (very large crude carrier). There will be three parcels of VLCC every month. IOC has signed contract for nine months with two options, consist each of 3 months with maximum of 15 months period. One millions tonnes of crude will be transported to IOC each month for next 15 months, which will result in 15 million tonnes for whole period.

Forward integration into offshore oil exploration

The company is in the process of acquiring a Rs 75 crore drilling rig in a move aimed at forward integration by getting into the exploration business, which would also give it a captive market for its fleet of rigs and other offshore assets. The company is looking to bid for Indian offshore blocks under NELP bids, apart from overseas blocks, including some of the South East Asian and Arabian Gulf blocks.

Risks and Concerns Lack of expertise in new business

The company is planning to expand into newer businesses like shipbuilding and offshore oil exploration. The management does not have the experience in these areas and hitches in execution of expansion & diversification plan can impact the revenues and profitability of the company

Decline in freight rates Any substantial downward movement in the global freight rates can impact the revenues of the company.

Financials

On a consolidated basis, the company posted a growth of 36% in income from operations at Rs 1,122.75 crore for the year ending March 31, 2007 . EBIDTA was lower by 15% at Rs 295.64 crore. Net profit was also is lower by 32% at Rs 134.86 crore. The decline in profitability was mainly on account of higher dry-docking expenses incurred and charged off during the year amounting Rs. 54.82 crore. The expenses on dry-docking next year are going to be less than FY07 and this will enable the company to report better operating margins. We expect the company to report a consolidated turnover of Rs 1,346.40 crore for FY08E and a net profit of Rs 161.57 crore translating to an EPS of Rs 6.79.

Valuation

The expansion and de-risking of its business by forward integrating into offshore oil exploration along with its entry into the lucrative shipbuilding sector would drive revenue growth for Mercator. With acquisition of new vessels to be used in the buoyant dry bulk segment and reduction in dry docking expenses, the company would be able to attain stable operating margins. At the current price of Rs 48.60, the stock trades at a P/E of 7.2x FY08E consolidated EPS of 6.79 (on fully diluted equity of Rs 23.8 crore), which is at a 13% discount to Great Eastern Shipping (FY08E P/E: 8.1x). Given the huge business potential and de-risking of the business by entering into lucrative businesses, we rate the stock an outperformer with a price target of Rs 58.50, an upside potential of 20% in the next 6 months.

Technical Outlook

The stock has found support at Rs 32 levels where it was heavily accumulated. It displayed momentum by the rising relative strength indicator and also the crossover of the short term MACD average line. The stock is moving in an up-trend channel seen in the chart. A break outside the triangle above Rs 52 will fuel a further rally till Rs 64.

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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.