Business Standard – Ship-breakers’ profitability hit on falling scrap steel prices, weak rupee: CRISIL

Access the original article

16 November 2015 - The continuous fall in steel scrap prices coupled with depreciating trend in rupee value against the dollar will have hit profitability of domestic ship-breakers, ratings agency Crisil said in its report today.

In a span of 12 months, the local currency has depreciated 9 percent as on September 30, 2015, adding to the industry’s woes which was already reeling under Rs 1,200 crore of cumulative forex loss for the last three years, said the agency.

Ship-breakers buy condemned vessels based on letter of credit (LC) in foreign currency, which typically has a maturity of six months. As a business practice, ship-breakers do not hedge foreign currency exposure since it further depresses their already low operating margin of 4-5 percent. Due to this, in the last one year until September 30, 2015, the value of LCs opened by 59 CRISIL-rated ship-breakers, accounting for around half of the industry’s size, is estimated at Rs 1,600 crore.

With average exchange rate at the time of opening LCs estimated at 63/$, and assuming that payout on maturity was done at an average exchange rate of Rs 65/$, industry-wide forex loss would be Rs 100 crore as on September 30, 2015, which will hurt the profitability of ship-breakers this fiscal, it said.

Along side, in the last one year, domestic steel demand has remained muted, resulting in a 23 percent decline in average realisation on scrap steel (major output of ship-breakers, and a key raw material in secondary steel making) to Rs 20,398 in September 2015. The price of scrap steel, which was declining between 2-4 percent on a monthly basis, plunged nearly 20 percent after China moved to de-facto devalue the yuan in August 2015.

The ship-breaking industry operates on a short cash cycle. While a ship is dismantled over six months or so, sale of scrap takes place every month. But given the sharp decline in the price of scrap steel since August, the industry, despite its operating discipline, is estimated to have taken a knock of Rs 120 crore, said the ratings agency.

“These ill-winds have reduced the average number of ships dismantled to less than 10 a month from nearly four times that in 2013, when activity had touched a 5-year peak. To shorten their operating cycle further and to contain the impact of volatile currency and steel prices, ship-breakers have been buying smaller vessels,” said Crisil.

However, promoters with deep pockets have so far managed to sail in these choppy waters. The worry is, if steel prices don’t rise and the rupee remains volatile, the world’s largest graveyard for ships could turn one for ship-breakers, too.