Live Mint – Double distress in the graveyard of ships: Crisil

Written by P. R. Sanjai

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16 November 2015 – Adverse currency movements and a meltdown in steel prices has hit the world’s biggest ship-breaking yard at Alang in Gujarat, rating agency Crisil said in a report on Monday.

India, Bangladesh, Pakistan and China break 80% of the world’s ships.

“The rupee had depreciated about 9% in the 12 months to 30 September, 2015—touching 66/$ from 61/$ seen in October 2014—adding to the woes of an industry already reeling under Rs.1,200 crore of cumulative forex losses in the last three fiscals,” Crisil said in the report.

Typically, ship-breakers buy vessels for demolition based on letters of credit (LCs) in foreign currency which usually has a maturity of six months. Most ship-breakers do not hedge foreign currency exposure since it depresses their already low operating margin of 4-5%.

“In the 12 months to 30 September 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 Rs.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 30 September, 2015, which will hurt the profitability of ship-breakers this fiscal,” Crisil said.

Also, muted demand for steel has resulted in a 23% decline in average realisation on scrap steel (major output of ship-breakers, and a key raw material in secondary steel making) from Rs.26,504 per tonne in October 2014 to Rs.20,398 in September 2015. The price of scrap steel, which was declining between 2% and 4% on a monthly basis, plunged nearly 20% 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,” the report said.

The tough conditions have meant the average number of ships dismantled has fallen to less than 10 a month from nearly four times that in 2013, the report noted.

To shorten their operating cycle further and contain the impact of volatile currency and steel prices, ship-breakers have been buying smaller vessels.

“It’s pertinent to note that forex and inventory losses would have been staggering had ship-breaking activity continued at the pace seen in 2013. 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,” the report said.

Alang has attracted criticism globally because of the frequent accidents reported at many of the recycling facilities that dot the coast in Gujarat’s Bhavnagar district. Some 470 workers have died in accidents in Alang since it started breaking ships in 1983, according to the Mumbai-based Tata Institute of Social Sciences.

The Alang ship-breaking yards has dismantled 6,604 vessels till 2014 and produced 3 million tonnes of scrap metal annually.