Dear Shareholders
This year I wish to address through the Chairman's Letter a host of issues fromcovering a deeper understanding of our business to our philosophy on investments and someof the challenges we face as an Indian ship-owner.
Excellence not short-term profits is what drives us. This is not to say that profitsare unimportant; after all profit determines our ability to pay dividends and provides usthe necessary resources to grow our business. However our focus on excellence is what Ibelieve will create an organizational DNA that will stand for something valuable ageneration or two from now while enabling the company to outperform over the longterm. Inthe end this will help to create superior value for our stakeholders.
Shipping as we know too well is a truly global business in every respect as well as acyclical and volatile one in which many moving parts across the world has a bearing onearnings as well as asset values. It is not unusual to see swings of 50% or more inearnings and swings of 30% or more in values within a period of twelve months. The naturaloutcome is that shipping is not a linear result oriented industry and hence issues such asquarter-on-quarter growth of revenue or profit are of little relevance.
This therefore begs the question as to the most prudent strategy for a management teamto follow towards creating long term value in such an industry.
At its core success in the commodity shipping business can come by doing two basicthings well: buying and selling the right ships at the right price and time and runningthe ships well in the interim. Let us discuss our approach to both of these.
Shipping is a highly capital intensive business where allocation of capital is one ofthe key determinants of long term profitability. As you may have noticed interest anddepreciation which are directly affected by the capital cost of the asset constitutealmost half of our operating cost base. This shows the key role that the acquisition priceof ships plays in our profitability.
This leads to critical decisions that the management needs to take on when is the'right' time to buy and whether long term returns are better served by being diversifiedor focusing on a single sector of the industry. On both these issues we have had intenseinternal discussions. On the issue of diversification within shipping we believe thatstaying diversified is more beneficial as shipping cycles across sectors do not move intandem and thus we gain more trading opportunities across assets whilst also reducing thetime we need to sit on 'cash'. This is of course not to say that moving across assetclasses will be seamless and therefore there will be periods of time when cash is the bestbet for building long term value.
We have done a lot of work trying to identify the right price for different types ofassets. In most cases this coincides with very weak freight markets which means thatcharter rates are unremunerative if not lossmaking i.e. earning a very low or negativecurrent yield. As a result the purchase decision which is good for the long term is oftendetrimental to the short term profitability of the company. Conversely an asset bought inthe high part of the freight rate cycle is likely to produce strong returns in the shortterm but is likely to produce sub-par returns when considered over the life of theproject.
While we believe that above approach will lead to superior returns on our futureinvestments it is not possible to time troughs and peaks perfectly. However we expectthat investing with such a 'value- based' rather than a 'momentum-based' approach willdeliver US Dollars returns on capital in excess of 10% over an investment horizon of 3 to5 years. With some leverage thrown in this can translate to an even higher return onequity.
The one possible downside with the value investing method is that there may besignificant periods of time when we are unable to invest due to prices not being right. Insuch times and with a focus on longer term returns we will resist the temptation to movefrom 'low yielding' cash to 'higher yielding' assets.
Another important aspect of the value investing framework and reason for holding cashis risk management. Since investments are done in a down-cycle when operating cash flowsare low there is a need to ensure that your company can continue to operate withoutstress while waiting for the cyclical upturn. This requires cash and your company willalways have adequate amount of cash on its balance sheet at all times. Though this does intheory result in a lower overall return on the balance sheet we believe that having thisflexibility enhances our ability to take the correct commercial decisions without beingforced to by financial stress. I call this 'patient capital'.
Yet another challenging aspect of buying ships particularly second-hand ones isidentifying quality. Our assessment team more often than not gets less than a day in suchidentification! And therefore in this limited time available experience in assessment isinvaluable. Last year for example we inspected 44 ships to buy just 11. Just as buyingquality ships at low points of the cycle is important so is the decision on how to tradethem. Each day our marketing team is left to decide whether it is prudent to commit theship for a 'spot' voyage of 10 to
50 days for a year or indeed to commit the vessel for 3 to 5 years. This is never aneasy decision but one that can make significant difference in the eventual returns on theproject. The reason I say that it is a difficult decision is that in weak markets longerterm earnings are in contango (i.e. higher than short term earnings) while in strongmarkets they are in backwardation (lower than short term earnings). The temptation isalways to capture the higher of the two. This is more often than not a classic trap; along term study of markets has revealed that it is better to keep the assets trading'spot' in weak markets and vice-versa. This again brings us to the old conflict of longterm results versus short term profitability where we have concluded that results arebest judged over the long term rather than on an annual basis. Again keeping cash in handto ride out the markets gives us this flexibility.
Shipping being a service industry it is paramount that our assets are kept to very highstandards and that the quality of people who run them are second to none. The safety ofour seafarers cargo and ships is most important to us. Our dedicated quality safetyand training teams regularly visit ships imparting training and ensuring that robustsystems are laid out and followed without compromise.
On the technical front in order to ensure that our ships are kept to the higheststandard each ship is visited on average four to six times in a year with every aspect ofthe ship being microscopically analyzed. This focus on quality does not always lead toextra earnings particularly so with our Indian PSU customers who are unfortunatelyguided only by the cheapest rate and tend not to reward strong overall performance.
I would implore Indian PSUs to reconsider this approach with a strong emphasis onquality for only then will Indian shipping as a whole move towards achieving excellence.
We have built a dedicated team that will focus solely on the quality of seafarers.Members of our crew are eventually our brand ambassadors on our ships that trade acrossthe world. They are often our link to our customers and their efficiency of performanceleads to customer satisfaction something which is very important in our business. Withthe performance of our crew so critical to not just our brand but the brand of the Indianshipping industry as well it is very important we must have the ability to hire the besttalent in the market. That talent may or may not be Indian. Sadly - and this is a majorimpediment to us as an Indian shipowner - we are prohibited to source overseas talent toman our ships. Due to Indian taxation issues we lose some of our best Indian talent tooverseas companies. While peers in our industry across the world can pick and choose froma host of nationalities we in India cannot. Ironically nothing precludes us fromemploying foreign nationals to work with us in our offices! I firmly believe that thisarchaic rule that restricts us from employing the best global talent needs to be addressedexpeditiously without which we will always be disadvantaged. This is not to take away fromthe quality of people on our ships just to point out that we need more flexibility to beable to compete. If the Indian government is serious in its intent of unshackling seriousconstraints on industry and has a genuine desire to create global players from amongst usit must act expeditiously on this.
On the subject of Government I believe that their understanding of the nuances of ourindustry and what it takes to create global competitiveness is at times inadequate. Themain role of any Government is to provide an environment which encourages growth easesbusiness impediments and then demands best in class performance from the industry. WeIndians are second to none in capability and I for one strongly believe that providedwith the right environment we can put Indian shipping at the very top in the world.
Let me now discuss our investment and state of affairs in the offshore sector in whichour largest subsidiary Greatship (India) Limited operates. Currently this sector isexperiencing its worst phase in recent memory with oil prices having witnessed asignificant drop. All E&P companies are curtailing fresh expenditure and squeezingcosts and we are feeling the full brunt of this as a service provider.
Luckily for us we have successfully paid down a large part of the debt in Greatshipover the last ten years and are thus in a better position to weather the storm than mostof our peers. Amidst all the gloom that currently surrounds this sector there will emergea greater demand for well capitalized companies with a high degree of operationalefficiency. On both these counts we score very highly and this will undoubtedly stand usin good stead in obtaining business for our assets.
As a direct consequence of the extreme market conditions asset values too are at multiyear lows. The logical question that begs discussion is whether we should be investing atcurrent levels. Unlike shipping the business of offshore has an added challenge ofutilization and therefore depending on the length of this weak phase of the cycle thereis a significant negative carry on incremental investments. We are currently in theprocess of an internal debate on how best to respond to the current market situation.
To conclude the management is taking every possible step in raising the bar be ittowards operational efficiency maintenance of assets attracting the best talent orimproving its process of capital allocation. We believe that all of this together willprovide a superior long term return to the shareholders in time to come.
Thank you!
With warm regards
K.M.Sheth
Chairman
