The global shipping downturn and weak
macro-economic headwinds since 2009 have facilitated the growth of the shipbreaking
industry with there being an increase in the supply of ships to be scrapped.
India, with its natural geographical advantage of a high inter-tidal gradient,
favourable weather conditions and low manpower costs, has emerged as a leader
in terms of both volume and number of ships broken. Further, the relatively
less stringent regulations related to environment and human health hazards has also
aided the growth of the shipbreaking business in India.
With the outlook on international
shipping freight rates being subdued over the near to medium term and large
tonnage expected to come on stream post 2012, the shipbreaking industry is
expected to continue witnessing a steady supply of vessels for demolition over
the medium term. Significant improvement in the global economic scenario
resulting in a pick-up in freight rates could present a downside for the shipbreaking
industry. However the pace of any such positive development is likely to be
moderate and to that extent the supply risk appears to be limited over the near
to medium term. At the same time, any further deterioration in the
macroeconomic scenario and shipping freight rates could provide additional
boost to the volume of ships available for dismantling.
The shipbreaking industry is dominated
by a few Asian countries namely India, Bangladesh, Pakistan and China owing to
certain natural, regulatory and cost advantages. The competitive intensity in
the business is high owing to low entry barriers with respect to capital and
technical intensity. In ICRA’s view some of the key factors which determine the
relative competitiveness of shipbreaking activity in various countries include
the government policies/regulations with respect to environment and human
health hazards of shipbreaking, import duty structure, currency movements and
local steel demand.
The Indian shipbreakers have witnessed
a healthy growth in operating income in recent years due to increased
availability of ships for dismantling. Profitability margins in the business
are inherently thin due to the low value additive and highly competitive nature
of business and have come under further pressure in the recent past owing to
steep rupee depreciation which has increased the cost of purchase of ships
coupled with decline in realisations of the end product, i.e. steel melting
scrap, due to slowdown in steel consuming sectors.
Regulatory risk remains high for the
shipbreaking business. The Supreme Court of India has recently passed an order
requiring stricter implementation of shipbreaking norms in view of the
environmental and health hazards. This as well as any other proposed regulation
could entail event based risks for Indian shipbreaking operators’ and may
affect their competitiveness against players in other competing countries
In ICRA’s view any further
depreciation in INR, decline in steel prices or increase in interest costs
would be some of the key downside sensitivities affecting the business and
financial risk profile of the Indian shipbreakers. ICRA also notes that Indian shipbreakers
have a high reliance on non-fund based facilities like import letter of credit
(LC) which are used for funding the purchase of ships. In comparison, their
fund based facilities are rather limited which exposes them to a risk of
liquidity crisis in case of significant delays in the shipbreaking process
which may take place at the approval level, before beaching or during
demolition. This coupled with the other risk factors as summarized above have
resulted in a weak credit profile for shipbreakers and ICRA expects this to
continue going forward as well.
BACKGROUND
Ship dismantling (also referred to as shipbreaking
or ship recycling), is an activity which involves deriving value from the
materials and equipments comprising end of life ships. The fundamental driver
of the shipbreaking activity is the fact that ships undergo a large amount of
wear and tear during their lifespan which typically averages a few decades, and
after the threshold levels are reached, ship dismantling makes more economical
sense than repairing and refitting. The scrap metal obtained on dismantling is
sold directly or is melted down and re-used for making steel rods/bars which
find application in the construction industry while the equipments (engines,
mechanical parts or furniture) are generally refurbished and reused.
Currently the shipbreaking industry is
dominated by South Asia particularly India, Bangladesh and Pakistan, which
according to latest available statistics, together account for close to 67%
(during CY11) of the global ship recycling market in terms of LDT1 broken.
Apart from these, significant recycling activity also takes place in China (21%
during CY11) while Turkey and other countries account for the balance 12%
(during CY11) of the market. The dominance of the Asian countries in shipbreaking
activity has been driven by their lower manpower cost and relatively less
stringent environmental and health regulations vis-à-vis western countries.
Further, India, Bangladesh and Pakistan by virtue of their naturally favourable
tidal conditions are able to use the beaching2 technique for shipbreaking which
is less capital intensive and hence more cost effective vis-à-vis the advanced
dry dock method. This has further enabled these countries to become the
preferred ship dismantling destinations.
In India, shipbreaking yards are
present in Gujarat, Maharashtra and West Bengal. However, majority of the shipbreaking
activity is concentrated in the Alang and Sosiya yards in Gujarat with Alang
alone accounting for more than 90% of the ships dismantled in India. The shipbreaking
industry in India was present only in a very limited form till the early 1990s
with about 72 plots existing at Alang. However, post liberalization in 1991,
the shipbreaking industry started growing rapidly following the increased
domestic steel requirements particularly from the large number of rolling mills
that were set up at the same time. The Gujarat Maritime Board (GMB) issued a
large number of licenses for plots and as per estimates there are currently
close to 160 plots for use as ship recycling facilities having a maximum
capacity of about 4.58 million tonnes per year of steel scrap production
(Source: GMB). The volume and number of ships dismantled has been on an
increasing trend and as per industry sources, more than 400 ships were
dismantled in FY 2011-12 in India.
KEY TRENDS & CREDIT IMPLICATIONS:
Demand for ship dismantling
inversely correlated to freight rates; Challenging market conditions for the
ship-owners has resulted in significant increase in tonnage dismantled
The supply of old ships for recycling
is inversely correlated to the freight rate of shipping vessels which in turn
is a function of the global demand for seaborne transport and supply of new
vessels. This is in contrast to the performance of the ship building industry
which is directly correlated with the freight rates. Driven by increased demand
for maritime transportation, the freight rates, as reflected by the Baltic Dry
Index3 (BDI), reached a peak value of 11,793 in May 2008. In order to cater to
this strong demand, even older ships were kept into operations resulting in
higher average operating life and the orders for new ships also witnessed an
increment. The result was a drop in the number of vessels scrapped globally to
around 500 to 800 ships per annum from a historical average of 1000 to 1100
ships per annum.
However, post 2008, following the
deterioration in the global economic situation; the demand for maritime
transportation witnessed a decline resulting in a crashing of freight rates and
significant pressure on the financial performance of shipping companies. The
companies which had acquired large tonnage during the boom period were the
worst affected and being barely able to recover the operating cost of vessels
preferred to go in for dismantling of fleet. Accordingly the shipbreaking
industry, confirming the inverse relationship with the freight rates, peaked in
2009 with about 1,300 ships being scrapped globally during that year. Although
the BDI has improved moderately after the trough witnessed in 2009, freight
rates still continue to be low due to vessel supply glut and accordingly shipbreaking
activity continues to be sustained at robust levels.
Shipbreaking yards
should remain busy in the medium term as the shipping market fundamentals are
unlikely to materially improve
During the boom period of the shipping
industry (CY 2007 and H1 CY 2008), a large number of orders for new vessels
were placed and most of these are now lined up for delivery in 2012 and 2013.
However with a sharp correction in the freight market scenario the viability of
shipping operations has been significantly impaired and the scenario is not
expected to change significantly over the near to medium term. ICRA notes that
currently more ships are available for dismantling annually than in the past 20
years and unless global market conditions change dramatically, a significant
part of this fleet will go for scrapping. Thus the medium term demand for
scrapping is not expected to fall to previous lows even if the global economy
picks up.
India’s leadership
position threatened by increased activities of other Asian peers; China
emerging as the major competitor
Over the past two decades, India,
China, Bangladesh, and Pakistan have emerged as the hubs for shipbreaking,
accounting for over 90 per cent of the global shipbreaking activity. As
mentioned previously, India, Bangladesh and Pakistan enjoy favorable
geographical conditions which enables them to use the more cost effective
beaching technique. Further, India enjoys an edge amongst these countries owing
to appropriate wind & tide conditions. In comparison, Gaddani in Pakistan
and Chittagong in Bangladesh, the two main other shipbreaking centres, are
characterised by strong winds and strong tides respectively which make them
more suitable for demolition of larger vessels; while in China, shipbreaking
activity is interrupted periodically during monsoon season due to the tycoons
on the seacoast.
While Bangladesh led the global shipbreaking
activities between 2004 and 2008, the uncertainties due to government
interventions have impacted the business in recent years. In the middle of
2009, the Supreme Court of Bangladesh issued a ban on all shipbreaking
activities for a year on account of environment and health hazards. Though the
ban was lifted conditionally in March 2011 after the shipbreaking industry took
adequate steps to reduce the level of environmental pollution and accidents,
the shipbreaking volumes in Bangladesh have remained low with India taking away
a large part of the market and emerging as the alternative leading shipbreaking
destination. The uncertainty regarding the regulations for shipbreaking still
persists in Bangladesh as the final guidelines for the shipbreakers remain to
be fully implemented. Further, the import tax of 5 per cent imposed on ships
imported for breaking has also contributed to loss of competitiveness for
Bangladeshi shipbreakers.
China, on the other hand, is emerging
as a major shipbreaking destination with increased focus of the government on
the development of the shipbreaking industry. The Chinese shipbreaking volumes
were constrained in the past mainly due to the premium that the breakers in the
Indian subcontinent were able to pay to the ship owners. However, with
depreciation in the INR as well as increased supply of vessels, the spread
between ship purchase price for Indian and Chinese shipbreakers has narrowed
significantly. Further, the quayside method (A top-down method wherein the
vessel is secured alongside the sheltered waters and the pieces are removed by
crane) employed by Chinese shipbreaking yards is considered safer in terms of environment
impact and health hazard for workers vis-à-vis the beaching method which is
employed by Indian subcontinent players and translates to lower regulatory risk
for operations.
The shipbreaking industry in Pakistan
has grown at a significant pace in the last few years supported by the
availability of labour at cheap cost, weak safety & environmental
standards, boom in the construction sector and lack of iron ore resources. With
the demand for iron and steel from scrapped ships continuing to gain traction,
Pakistan’s shipbreaking industry is expected to further grow in scale thus
intensifying global competition amongst shipbreakers. Scrap from ships
dismantled is estimated to meet nearly 60% of Pakistan’s total steel demand.
Increased contribution
from shipbreaking activities to total scrap steel supply in India making the
re-rolling mills increasingly dependant on them; contribution to total steel
production however remains small
The steel scrap generated from ship
recycling contributes to around 1% to 2% of India’s domestic steel demand
(Source: Annual report of Ministry of Steel) and is primarily a source of raw
material for the re-rolling mills which convert this scrap to mainly produce
rods and bars which find application in construction industry. On an average,
at least 70% of the overall LDT of a ship comprises re-rollable scrap; melting
scrap constitutes 6-10% while about 10% is formed by furniture, machineries,
non-ferrous scrap and used diesel oil. The balance 10% is weight loss cause by
wear and tear and rusting during the lifetime of the ship. The re-rollable
scrap produced from ship dismantling is of a superior quality in comparison to
other sources6 as ships are manufactured under strict specifications and
continuous monitoring and with material having better yield strength, ductility
and impact strength in order to withstand continuous strain, pressure and
impact, and to that extent is preferred as a raw material by the rolling mills.
Profitability of shipbreaking
players could be negatively impacted by the impending domestic overcapacity of
steel in the medium term
ICRA expects the Indian steel
consumption to show some moderation going forward, given the continuing
slowdown in demand from major consuming sectors like construction (accounts for
~65% of total consumption), capital goods (~15%), and automobiles (~8%). On the
other hand, almost 25 million tonnes of new steel capacity, which is about 30%
the country’s current production capacity, is expected to be commissioned in
the next 18-24 months which is likely to outpace domestic demand growth in the
medium term.
As a result the demand-supply equation
in the domestic steel industry is expected to deteriorate resulting in a
pressure on product prices which in turn would translate to subdued
realizations for shipbreakers. Besides, the shipbreakers also remain exposed to
the daily volatility in steel prices and any significant adverse movement can
impact the realizations and profitability, especially in case of significant
inventory holdings.
Approvals from related
entities critical before shipbreaking activity can be commenced; any delay in
approvals or slower rate of demolition can result in stretched liquidity
profile
The shipbreaking process involves the
ship owners selling the vessels to international ship recycler who in-turn
invite bids from various agents (cash buyers) in major ship scrapping
countries. These cash buyers purchase the vessels and subsequently either
directly or through brokers contact shipbreakers with all relevant details of
the ship to be scrapped. The pricing for the ship is then decided based on the
type of vessel, country of origin, manufacturing year, manufacturer of ship,
current owner, trading history of ship, and the nature of scrap that can be
recovered – steel content, machinery, non-ferrous content, etc.
The shipbreaker has to first pay the
earnest money of about 10% of the ship’s value in order to bring the ship to
the national anchorage point/high seas. The shipbreaking activity in India is
regulated at various levels and beaching can be undertaken only after
clearances from customs authorities (Customs authorities and Safety
Directorate), pollution control authorities (like Gujarat Pollution Control
Board), the department of explosives or the Atomic Energy and Radiation Board
and the maritime regulator (like Gujarat Maritime Board) have been obtained.
Further, regulatory authorities like GMB conduct regular monitoring activity to
oversee the compliance of shipbreaking rules and regulations during demolition
and disposal. On an average it takes around a month to get the regulatory
approvals and subsequently the average time to break a 5,000 LDT ship is around
three to four months.
A majority of Indian shipbreakers
establish 90-180 days letter of credit (L/C) from their banks for the purchase
price payable and repay the same as the shipbreaking is undertaken and the
resulting scrap is sold. In most cases the fund based limits, which are mainly
used to cater to the daily requirements like administration expenses, labour
charges and fuel expenses, are significantly lower than the non-fund based
limits. Hence, any delays in the approvals for beaching as well as delay in the
shipbreaking activity after beaching can result in substantial funding
mismatches with respect to the obligations related to the non-fund based limits
and can have an adverse impact on the liquidity profile of the concerned shipbreaker.
Increase in purchase
prices as a result of decline in INR expected to impact both profitability as
well as volumes; gain in INR necessary for sustainability of the shipbreaking
business
As steel content forms the majority of
the value of the ship, the international steel prices play an important role in
determining the prices of the ships to be scrapped. The vessel purchase
transaction is typically denominated in USD and is generally backed by 90-180
days of letter of credit. On the other hand the sale of scrap is typically in
the domestic market with realizations being denominated in INR. Consequently,
Indian shipbreaking players remain exposed to any adverse forex movements more
so as only a limited number out of these engage in foreign exchange hedging.
The significant depreciation in INR
(vis-a-vis USD) in the recent months has adversely affected the shipbreakers
having purchase payments due during this period. The problem has been further
compounded by the fact that the prices of steel in the Indian market have not
moved in synchronisation with INR depreciation resulting in an inability of the
shipbreakers to pass on their increased procurement costs to their customers
thereby resulting in a squeeze on profitability. The high volatility in USD-INR
has also resulted in a cautious approach by the shipbreakers with many of them
deferring new purchases. In ICRA’s view the sustenance of INR at present weak
levels or further deterioration and volatility, will create significant stress
on the credit profiles of shipbreaking players due to its adverse impact on
both volume of business as well as profitability.
Regulatory scenario to
continue playing a critical role in the sustainability and competence of Indian
shipbreakers vis-à-vis other countries
The shipbreaking process is regulated
at various levels as discussed previously. Further, The Supreme Court of India
in its ruling dated July 30, 2012 has banned import of ships carrying hazardous
and toxic wastes and has ordered the strict implementation of the UN’s Basel
Convention on the Control of Trans boundary Movements of Hazardous Wastes and
their Disposal. Under the Basel Convention, a ship has to be fully
decontaminated before being allowed to be anchored at a shipbreaking port. A
stricter implementation of the Basel convention in India can result in the
end-of-life ships being sent to other competitor countries that may not be
following the convention strictly and negatively impact the business volumes
for the shipbreaking industry in India.
Further, the plots for shipbreaking at
Alang were allotted under a 10-year lease arrangement in 2006. The present
lease rentals charged by GMB at the Alang yard are close to Rs. 200 per square
meter per year. However, GMB e-auctioned four plots at Alang during 2011, for a
five year lease with the same being given at significantly high premium of
about ten times over the prevailing prices. Any revision of the rental rates by
GMB in future will result in significant increase in the rental costs for Alang
shipbreaking yards and will have a considerable impact on the profitability of
the players.
At a diplomatic conference held in
Hong Kong, China in May 2009, The Hong Kong International Convention for the
Safe and Environmentally Sound Recycling of Ships was adopted. The convention,
the text of which was developed with inputs from IMO Member States and in
co-operation with the International Labour Organization and the Parties to the
Basel Convention, was attended by the delegates from 63 countries and aimed at ensuring
that the ships being recycled do not pose any unnecessary risks to human
health, safety and to the environment. The implementation of the aforementioned
convention in future can impact the volumes for the concerned shipbreaking
country, including India, though the same is expected to improve the operating
conditions as well as the reduce the current adverse impact of shipbreaking
activity on the environment.
Also, implementation of directives
like the steel ministry’s directive which mandates that all steel produced in
the country should confirm to the Bureau of Indian Standards, can negatively
impact the operations of the Alang Shipbreakers as the source of steel in
various components of the ship is generally different and difficult to trace.
Financial profile of
ICRA rated companies:
Healthy growth in
operating revenues in the last few years for ICRA rated entities
The growth in operating income (OI)
for ICRA rated entities (25 companies) has been healthy on account of reasons
stated previously. The growth in cumulative operating income for ICRA rated
entities has been more than 100% from FY09 to FY11, with combined revenues of
these entities growing to more than Rs. 900 crore in FY11 from about Rs. 400
crore in FY09.
Operating margins have
been at moderate levels and have come under pressure from high fragmentation
and competition; PAT margins are further subdued on account of high interest
costs
The major costs include purchase of
ship while the rest is on account of investment costs (including for equipment
and civil works such as cranes, forklifts, storage, etc.), financial costs,
labor costs, consumption of utilities (oxygen, LPG, diesel, electricity),
taxes, tariffs & import duty, rent for land use and costs for handling
hazardous wastes generated in the process of recycling.
The operating margins (OPBDIT level)
of the shipbreakers have been low given the limited value addition in the
business and are largely dependent on the spread between the actual ship
purchase price (based on USD-INR levels at time of payments) and the local
scrap steel price at time of selling the scrap. The operating margins for ICRA
rated entities have mostly been in a range of around 2-3% while the median
figure stands at 2.95% during FY11.
The margins have also come under
pressure due to high local competition given the low entry barriers such as low
capital and low technical requirements of the business as well as competition
from other nations (like Bangladesh, Pakistan and China) engaged in shipbreaking
activities. The net margins (PAT level) are further subdued on account of high
interest and LC charges in the light of a continued high interest scenario
during the last 18 months with median net margin figures at 1.72% for FY11.
RoCE of shipbreaking
players remains healthy on account of low level of capital employed
Most of the ships purchased for shipbreaking
in India are backed by LCs and are reflected as creditors in the balance sheet
of shipbreaking companies, thereby resulting in low capital employed and
capital structure for most of these companies. Given the low capital intensity
of the business, the return on capital employed for ship recyclers has remained
in an adequate range despite moderate to thin profitability. For the last two
year period FY10- FY11, the median RoCE levels have remained in the range of
21-23%.
Comfortable capital
structure although debt coverage indicators remain weak
As mentioned earlier, the capital
structure for most of the shipbreaking companies has remained comfortable on
account of purchases being made against LCs and moderate utilization of working
capital facilities. The debt coverage indicators for most of these companies
have however been weak owing to low profitability and cash accruals and high interest
costs. Moreover, liquidity remains an issue because of large LC exposure and
dependence on timely completion of shipbreaking process for cash generation to
settle liabilities.
Credit outlook subdued: Going forward,
ICRA expects the credit profile of the shipbreaking players to remain weak on
account of the combined effect of 1) pressure on steel scrap realisations due
to demand supply mismatches in domestic steel industry
2) lower yields due to high
competitive pressures
3) steep rupee depreciation and
4) increased interest costs.
Source: ICRA
Limited.
http://www.icra.in/Files/ticker/Ship%20Breaking%20Industry%20Note_25Sept2012.pdf
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