Dredging Corporation of India: In murky waters - Sell

The current policy thrust on national waterways and improving port infrastructure augurs well for companies that provide infrastructure in this segment. Investors have bet on growth in water-based transport, and with lack of options, pushed up the share price of Dredging Corporation of India (DCI), a public sector entity.

The stock has shot up 50 per cent in the last year, from ₹400 in June 2016. One reason for the positive price action was the news that the government may reduce its stake in DCI (currently at 73.5 per cent), as dredging is not considered a strategic sector. The stock price zoomed over ₹700, but has fallen from its high and trades at ₹616 per share. Investors can sell the share at the current levels as the valuation is expensive, revenue growth unclear and profits are under pressure.

The DCI stock’s valuation multiple is very high as its price ran up and profits dropped. In 2016-17, the company’s profit dropped 82 per cent as revenue fell and fixed expenses dented the bottomline. With the fall in earnings (to ₹2.54 from ₹15.5) per share and steep increase in stock price, DCI’s valuation has shot up to 236 times the trailing 12-month earnings, compared to the historical three-year valuation multiple of about 15 times.

True, DCI is the only government provider of dredging services and the market leader in maintenance dredging. The potential in the market is high — now, only 0.15 per cent of domestic cargo is transported by inland water transport in India, compared with 43 per cent in China.

Still, DCI’s valuation is expensive, even if we consider that the multiple in the sector may need to be re-rated. At these levels, positives such as potential contract wins seem to be more than priced in. And how fast DCI can acquire equipment and deploy them to capitalise on the opportunities also remains to the seen, given that competitors such as Jan De Nul Dredging India have more assets.

Also, if the government stake is reduced and given that competition has been growing, DCI’s revenue and profit may be impacted as it may not get preferential nomination for contracts.

DCI’s revenue and profit are likely to face hurdles as contracts move to competitive bidding from nomination by the government. The company owns a fleet of dredging equipment used for capital dredging (creating or deepening channels in water) and ongoing maintenance dredging operations. Its primary client is the port of Haldia, and it recently signed a five-year contract with the Kolkata Port Trust worth about ₹220 crore every year. Besides Indian ports, it won its first international contract for ₹102 crore from Bangladesh. It is also shortlisted for dredging the Haldia to Farakka section of Ganga river.

While there are many potential projects — Ganga river and various ports — contract awards may take time as environmental and other clearances may be needed.

Also, there is a lot of competition from foreign players and contracts would be awarded through competitive bidding. Another worry is the reducing size of the company’s maintenance dredging contract in the Kolkata port.

In 2016-17, revenue from operations fell 12 per cent y-o-y to ₹585 crore. In the March 2017 quarter, revenue fell 26 per cent y-o-y to ₹130 crore.

DCI’s profit may come under pressure as it may have to bid lower on contracts to boost revenue growth. In 2016-17, net profit plummeted 82 per cent y-o-y to ₹7.4 crore. In the March quarter, profit fell nearly 78 per cent y-o-y to ₹3.7 crore. One reason for the fall in profit was higher depreciation expenses, as the company had added new assets. While newer equipment purchases would aid revenue, lower utilisation of these assets would dent margins.

The company’s margins have been falling in the last few years mainly from fall in revenue. Operating expenses seem to be under control and hence there may not be much scope for improvement on that front. The company’s total debt reduced to ₹708 crore in March 2017, from ₹895 crore last year. The debt-to-equity ratio stands at 0.5 times.

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