MANAGEMENT DISCUSSION AND ANALYSIS REPORTThe Management of your Company is pleased to present below its analysis on theperformance of the Company for the financial year 2010-11 and its outlook for the future.
I. INDUSTRY STRUCTURE AND DEVELOPMENTS
The industry in which your Company operates can be broadly sub-classified into thefollowing segments viz. (a) Defence Shipbuilding, (b) Offshore Oil and Gas Exploration& Production Assets Construction, (c) Commercial Shipbuilding & Repairs, (d)Defence hardware & services required by Indian Armed Forces, and (e) HeavyEngineering.
a. Defence Shipbuilding
Global aspirations of economically strong India, with ever increasing geopoliticalchallenges have made the Indian Government realize the imperative need to strengthen itsdefence capabilities. The Government through its Defence Procurement Policy (‘theDPP’) is encouraging private players to participate in various defence acquisitionprograms and to create an indigenous network of suppliers. The opportunities that the DPPpresents to the domestic players are vast and domestic companies that meet the necessarydemands of the Indian Navy will benefit the most.
India sits in a prime position in the Indian Ocean, with over 7,517 kms. of coastline.Indian sea trade accounts for approximately 90% of volume and 77% of value of India’saggregate trade. Maritime interests are crucial for establishing a secure tomorrow, as theeconomy is dependent on the sea for sectors such as Oil and Gas exploration &production, Commercial trade, etc. Protecting maritime assets is an imperative for theIndian Navy and Coast Guard. The Government is continuously making efforts to ensure navalsecurity in the Indian Ocean, which ultimately will lead to demand for better qualitydefence vessels.
The present fleet of Indian Navy has approximately 171 ships on active duty with anadditional 36 ships in the process of being built. The Indian Navy needs over 100 ships ofdiverse variety, including submarines, destroyers, patrol vessels, etc. over the next twodecades, according to reports available in public domain. There is a need for domesticplayers to demonstrate technologically advanced capabilities and utilize effective costrationalization methods which will open up a huge opportunity for them. The DPP encouragesprivate domestic players to bid for acquisition programmes of defence vessels. In linewith the DPP you would be glad to know that your company became the first private sectorcompany post independence to enter this sector when it was awarded with the contract forconstruction of 5 warships viz. Naval Offshore Patrol Vessels worth Rs. 2,975 Crore by theIndian Navy. The theme of the DPP is "Buy Indian, Make Indian". The DPP willcontinue to provide a tremendous boost to domestic players in this segment and will ensurethat the Country becomes self sufficient in all its defence requirements. It will alsoensure, over a period of time, the acquisition and transfer of advanced technology toIndian companies further reducing our dependence on imports.
The Union Budget presented in Parliament by the Finance Minister, Pranab Mukherjee,highlights the importance of defence and increased allocation to the sector to Rs.1,64,415 crore. The allocation represents a growth of 11.9% year-on-year basis. In termsof capital expenditure, the Navy will utilize approximately Rs. 14,657 crore. The growthof 11.9% year-on-year in the defence budget has shown the Government’s desire tostrengthen the nation’s armed forces, particularly with regard to the modernizationof facilities and equipment.
b. Offshore Oil & Gas Exploration & Production Assets Construction
Demand for petroleum and liquid fuels will reach 95 million barrels per day by 2015 and118 million barrels a day by 2030 from the current level of 84 million barrels per day.Emerging markets demonstrating strong economic growth will contribute significantly to oildemand. Investment in the development of the offshore oil and gas exploration &production assets is expected to reach USD 45 billion in 2011. National oil companies haveleaned towards developing offshore assets to meet oil and gas demands. Rising crude oilprices, exacerbated by the crisis in the Middle East, will subsequently lead to greaterexploration activity and establishment of more offshore assets in the coming decade.
To prevent the country from becoming dependent on foreign oil subject to volatilefluctuations in the global market, the development of offshore oil and gas facilities hasbeen made a priority by the Indian Government.
The Government is exploring opportunities to meet the domestic demand of oil throughdomestic supply by encouraging the development of modern offshore assets.
The energy demand is expected to grow fourfold in the next two decades. The Governmentis stepping up its offshore oil and gas programme. The inability of aging offshorestructures i.e. rigs and platforms to operate in deeper water posts an advantage forbusinesses that can create new generation efficient offshore structures. Heavy Engineeringcompanies with access to waterfront will be better suited to develop modern offshorestructures. Globally, more than 75% of rigs were constructed before 1985, which indicatesthat most rigs will need to be replaced in the next decade. As it becomes more expensiveto purchase such offshore structures in Middle East & East Asian countries, economieshave been considering low cost destinations like India and many orders may be diverted toIndian builders. Lastly, the demand for supply vessels to offshore structures isincreasing significantly. Close to 50% of the Indian offshore support fleet is over 20years old and is not capable of servicing requirement of deep water rigs and platforms.With the advent of deep water offshore structures, the safety and technological capacityof existing offshore supply vehicles will need to be improved.
All in all, greater demand for oil and gas from emerging markets like India hasresulted in the need to develop domestic sources of supply of energy and curtail thedependency on foreign markets for imports, thus preserving the country’s security.
c. Commercial Shipbuilding and Ship Repair
Global Scenario
While the global shipbuilding outlook until 2011 looked subdued, it is expected thatthe commercial shipbuilding industry will turnaround by FY 2012-13.
Global trends show a demand for larger vessels as the pursuit of economies of scaledrives businesses to demand both bigger and fuel efficient ships. Since ships that cancarry larger cargoes translate into lower cost of transport, companies that are able todeliver large vessels will benefit. There is also a demand in niche sectors. For example,increased requirements for dredging have translated into demand for dredgers. Similarlythe emergence of LNG as a substitute for coal is resulting in a demand for LNG Carriers.Increased spending on infrastructure and subsea pipelines is resulting in greater demandfor Heavy Lift Vessels. Companies like yours capable of manufacturing these specialisedvessels would gain from this demand.
Indian Scenario
According to the Maritime Agenda 2011, there are currently 27 prominent shipyards inthe country, of which 8 are in the public sector. India advanced from 0.1% of the worldshare of shipbuilding in 2002 to approximately 1.5% in 2010. With respect to theshipbuilding and ship repair industry, the Government of India’s vision is:
"To have a well developed shipbuilding and ship repair industry of internationalstandard in India which will be self-sufficient in building and repairing commercialvessels required by the country by 2020 and generate huge investment and employmentopportunities."
The Ministry of Shipping has set several targets that they wish to meet by 2020, whichinclude gaining 5% of the global market share of commercial shipbuilding, developing astrong ancillary industry, strong research and development facilities, to beself-sufficient in any domestic repair requirements and become a prominent ship repaircenter in the Indian Ocean.
The goals to which the Government is aspiring provide a myriad of opportunities for theIndian maritime companies that will inevitably translate into greater profitability.
Labour cost accounts for relatively 10% of shipbuilding cost. India boasts availabilityof trained manpower in heavy engineering and shipbuilding sector with a strong base ofintellectual capital. India commands a natural advantage in terms of skilled labour andtechnological capacity for shipbuilding business and oil and gas assets, a benefit it hasover other countries that may have lower labour costs but lack in quality technology andinfrastructure.
Globalization has led to the wide dispersal of technology to emerging markets fromdeveloped countries. Your Company’s infrastructure is in line with Korean andJapanese counterparts in terms of quality. Secondly, as foreign companies are eager toenjoy the benefits of operating in a low cost country like India, the potential forstrategic partnerships has never been greater leading to further improvement andconstruction of quality vessels.
India enjoys a strategic location in the Indian Ocean. India’s long coastlineprovides suitable locations for setting up ship-repair facilities. India’s prominencein the region as an emerging power strengthens India’s position in commercialshipbuilding and ship repair.
d. Defence Hardware and Services for the Indian Armed Forces
As mentioned earlier, the opportunities in the defence segment are vast and yourCompany looks forward to capture all the opportunities offered in this space. The Companyis in the process of augmenting its reach through entire defence segment and establishingitself as a significant player.
e. Heavy Engineering
The heavy engineering sector offers huge potential for growth. The Government of Indiais going to great lengths to develop and strengthen the industry as well as build up andmaintain a robust infrastructure network.
The prospects for the aerospace segment, robotics, wartime machinery such as tanks, anddemands to modernize and contextualize the armed forces for the 21st century create greatopportunities for heavy engineering segment.
II. OPPORTUNITIES & THREATS
Opportunities
Defence Procurement Policy:
The Indian Government has encouraged indigenization of defence hardware withintroduction of the ‘Make Indian and Buy Indian’ category in its DefenceProcurement Policy. It is aimed at promoting production of defence equipment by capableIndian companies. Shortlisted Indian companies can arrange co-production and/ ortechnology transfers with foreign companies. Your company is ideally positioned to gainfrom the Government’s emphasis on self reliance in the defence production sector.
Rising demand for naval defence:
In view of global aspirations of economically strong India, ever increasinggeo-political challenges and the need for anti-piracy operations in the Indian Ocean, theIndian Navy and Coast Guard are being modernized for safeguarding our maritime interests.Moreover, the scope of naval defence is further widened by providing support to maritimeneighbors during natural disasters. This will require a massive as well as rapid expansionof our Naval and Coast Guard fleet. There is a huge replacement/ refurbishment demand fordefence vessels. There can be no substitute for meeting these requirements locally. It istowards this end your Company has commissioned India’s most technologically advancedinfrastructure geared for construction/ repair of the most sophisticated warshipsincluding aircraft carriers, submarines, landing platform docks, patrol vessels and othernaval products.
Large replacement demand:
About 40% of the commercial fleet is more than 20 years old and Indian ship owners areexpected to spend approx. USD 4 billion to replace these during FY 2010-2015. The ageingfleet of shipping companies in India is another factor energizing prospects for thecommercial shipbuilding and repair market in the country.
Huge demand in the offshore oil and gas sector:
In India, the demand for high-end offshore facilities such as drill ships andfloating production storage platforms amounts to approximately USD 20-40 billion. With theoil prices on a rise, the importance of this sector is building up. The increase in thedemand for offshore assets would lead to consequential increase in demand of OffshoreSupply Vessels ("OSVs") required to service them. Furthermore, higher productioncost of OSVs in other countries such as Japan may result in diversion of orders to India,consequently creating huge prospects for your Company. Your Company has established itselfin this area through its current construction programme of OSVs.
Inorganic opportunities:
Your Company is looking for acquisitions, strategic partnerships, tie-ups withoverseas companies catering to the Oil & Gas and Defence sectors. The hugeopportunities in these sectors increase the scope of tie-ups between Indian and overseasplayers, as foreign players look to combine their technology with cost effective Indianpartners.
Threats
Fluctuations in the raw materials costs:
The volatility in the prices of raw materials may weigh on profitability of theCompany.
Subsidy:
In the past the Indian Government had encouraged participation of Indian companiesin the commercial shipbuilding sector by providing subsidies of 30% of the price of thevessel to the shipbuilders. The Government is considering extension of the shipbuildingsubsidy scheme. However, in the event the Government of India decides not to notify a newsubsidy scheme, it could affect the profitability of this segment.
No Steady Order Flow and probable Order Cancellations:
Your Company has an outstanding order book of around USD 1.5 billion. In view ofthe difficult economic conditions worldwide the momentum of orders being sustained is aconcern. The possibility of orders cancellation can not be denied.
Shortage of specialized labour in the Maritime Sector:
Increasing sophistication of vessels and associated equipment as well as stringentpollution prevention norms in the maritime sector have led to greater importance on awell-designed education system for the maritime sector. Lack of such maritime institutesimparting the necessary knowledge creates a shortage of skilled technical force in India.
III. OUTLOOK
The financial year 2010-11 was a year of milestones for the Company. In November 2010,the Company was awarded the Warship Production License by the Department of Policy &Promotion, Ministry of Commerce & Industry, Government of India. Your Company is thefirst Indian Company to have been awarded the license. Your Company entered into strategicpartnerships with SAAB Dynamics, Northrop Grumman and Babcock group. These tie-ups willallow the Company to use their technical expertise to indigenously produce defenceequipment, hardware and develop aeronautical technology.
Going forward, the FY 2011-12 will mark the progress of the Company after all the keypillars have been established. As the Company has received the Warship Production License,the Company is ready for a new and exciting year of growth. Two Panamax vessels built byyour Company are ready for delivery.
Your Company will continue to develop global standards in capabilities, technology andsize. The order book is expected to grow multi-fold on the back of increasing defencedemand, greater demand for offshore assets, and the significant need for repair forvessels visiting/ passing through Indian waters. Your Company is also well-poised withmodern heavy engineering facilities to undertake both civil and non-civil heavyengineering projects, whether be the construction of civil nuclear reactors or land basedheavy defence machinery such as tanks. With offshore activities shifting to deeper watersand increasing demand from the naval sector, Indian industry will undergo a dynamic changein the coming years.
Having invested in state of the art facilities and having developed a world-class heavyengineering infrastructure with attached dry dock, your Company stands at the forefront ofprivate sector companies ready to capitalize on increased opportunities provided in thedefence and offshore oil and gas assets space and is set to experience robust growth andprofitability going forward.
IV. RISKS AND CONCERNS
Your Company is exposed to risks that are inherent to its businesses and theenvironment within which it operates. The Company is exposed to normal industry riskfactors such as competition, economic cycle, uncertainties in the international anddomestic markets, Foreign Exchange Risk, Liquidity and credit risks. Your Company managesthese risks by maintaining conservative financial profile and by following prudentbusiness and risk management practices.
The Company’s risk management framework establishes risk management processes,helps in identifying, assessing and mitigating risks that could materially impact theCompany’s performance in achieving its business objectives. The risk managementframework ensures compliance with the requirements of Clause 49 of the Listing Agreemententered into with the Stock Exchanges.
V. FINANCIAL PERFORMANCE
During the financial year 2010-11, your Company registered the operating income of Rs.859.93 crore i.e. increase of 36.63% over the financial year 2009-10. Your Company earnedprofit before tax of Rs. 48.16 crore as compared to previous year loss of Rs. 48.66 crore.Operationally, the interest cost was at Rs. 119.01 crore compared to the previous yearinterest cost of Rs. 72.99 crore.
VI. INDUSTRIAL RELATIONS & HUMAN RESOURCES
The relationship between the management and employees is very cordial and there are nooutstanding industrial disputes. The management also has well laid down HR Policies forits employees. Welfare, health and safety of employees are high priority areas. TheCompany has been implementing various HR initiatives in the form of training and seminarsto enhance the effectiveness of its employees.
VII. INTERNAL CONTROL SYSTEMS
The Company has adequate systems of internal controls to safeguard and protect fromloss, unauthorized use or disposition of its assets. All transactions are properlyauthorized, recorded, and presented to the management. The Company observes all theAccounting Standards prescribed for proper maintenance of books of accounts and reportingof financial statements. The Company has appointed independent internal auditors to reviewvarious areas of operations. The Audit Committee of the Board of Directors periodicallyreviews the Internal Audit reports as well as action taken on the matters reportedtherein.