Bharati Shipyard - Too much pessimism

Bharati Shipyard has a current order book of US$975m, tied up funding for two new yards and procured 90% of its steel requirement. Therefore, execution will generate profits. We estimate 20% order book growth for FY09. Maintaining Buy. 

Execution of order will lead to profit growth 

Bharati is setting up two greenfield yards for US$250m, which it hopes to complete by December 2010, to execute its US$975m order book, which is also due to be largely executed by December 2010. Yard funding has been tied up at 0.8x debt:equity, with about 80% of debt having been drawn already. We believe the balance debt will not be required for another 12 months. Assuming execution completes by FY11, we estimate a 25% FY08-11 earnings CAGR. 

But what about order book growth, steel prices and subsidy 

Ytd, Bharati has received new orders of US$68m, which is lower than our expectation. That said, order flow can be lumpy and we expect additional new orders of US$125m in FY09 (20% order book growth). Further, 68% of order book is from the offshore oilfield sector, which is unlikely to face cancellation risk. Bharati has also procured 90% of its steel requirement, which should protect margins from steel price volatility. But we cut EBITDA margins from 20.4% in FY08 to 17% by FY10F. About 65% of the order book is eligible for subsidy as orders were received before August 2007. Thus, Bharati is entitled to subsidy on execution of orders through FY11. That said, the stock is trading ex-subsidy, in our view. We estimate ex-subsidy EPS of Rs32.6 for FY09, Rs42.5 for FY10 and Rs66.1 for FY11. The stock has recently seen a sell-off on concerns of a change in the MD's commission from 0.5% of profit to the lower of 0.15% of revenue or 1.5% of profit. This should have only 1% impact on FY09F PAT. 

Going very cheap, in our view 

We cut FY09-11F EPS by 15-45%, but estimate a 25% earnings CAGR over FY08-11. The earnings revisions reflect cut in revenue and margin estimates. Based on three-year forward RoE of 22% and CoE of 15.5%, we get a target FY11F P/B of 1.4x (vs 1.7x earlier), which we discount (8.5%) back to FY09F, resulting in a target price of Rs455 (Rs700 previously). On Bloomberg consensus estimates, global shipyards are trading on 4.4x EV/EBITDA and 5.4x PE on three-year forward earnings, while Bharati Shipyard is trading at a deep discount of 2.6x EV/EBITDA and 2.4x PE. We maintain our Buy rating.