My short summary on Mercator Lines (Singapore)

Mercator Lines Singapore Ltd (MLS) is one of the largest fleet owners in the Indian dry bulk shipping market. It has a total of 14 ships in its fleet of which 11 are owned by the company. Mercator deals with the transport of iron ore and coal between China, Australia and India. It recently won a Vale contract to transport iron ore from Brazil to China using its new VLOC (Very Large Ore Carrier). Most of its clients are repeat blue chips customers like the Tata Group, Mittal Steel group, Cosco etc.

Mercator Group History

Mercator LS is a listed subsidiary of Mercator LL India (an Indian company) which offers full logistics solutions to their customers from load port to the point of usage in India. MLS provides support to the Mercator Group by transporting bulk commodities via sea transportation. Mercator LL India owns over 70% of MLS. A strong parent will benefit a young company such as MLS as it allows her to tap into the managerial experience of her parent or gain financial support through the issue of convertible bonds or rights to her parent in order to acquire more ships. Moreover, most of MLS blue chips Indian clients favour it due to its affiliation with Mercator India which is considered to be a large domestic Indian player. This is further possible due a non-competition pact between the 2 entities.

MLS Fleet

MLS's fleet size is 14 vessels - 11 owned and 3 chartered ships. One more chartered ship will be delivered next year for a 10 year charter. This will bring the fleet size to 15 vessels by 2010. MLS Fleet consist of 7 gearless vessels, 1 VLOC and 7 geared vessels. 'Geared Vessels' have on-board cranes, which facilitate loading and unloading in undeveloped ports, such as those in India and Indonesia. These vessels gives Mercator an edge over its competitors since it has one of the largest geared fleet in the region and most of its clients (Indonesia and India) ports do not have much modern facilities such as cranes. Its new VLOC will ply the Brazil-China route for the next 14 years as part of MLS's recent contract with Vale. MLS fleet is very young and modern since the average age of its owned fleet is merely 6 years. MLS fleet capacity is 1.29mil DWT (excluding the incoming vessel next year). This makes it the second largest dry bulk shipper listed here just behind STX PO.

MLS Operation Style

It is focused on India and other high growth markets, such as China. They have established a strong market presence in the transportation of coal into India having rapidly grown its fleet of 14 vessels hence enabling it to get repeat business from reputable customers such as Tata Power, Cosco, Mittal etc. Its recent contract win from Vale shows that it has truly matured from toddler to a matured adolescent; allowing it to venture to new growth markets and attracting new blue chip clients.

MLS main operations - i) transport ores from Brazil to China using its VLOC, ii) transport of coal from Australia and Indonesia to India thermal plants, iii) transport of iron ores from India to China.

In order to fulfill their operations, MLS often hedge their exposure to the spot markets by committing themselves to long term contracts with their clients. Currently MLS Management has limited their exposure to spot markets by securing long term charters for 70% of their fleet capacity. This gives the MLS a predictable source of cash flow while steering clear of the volatility of the BDI and freight rates. Hence despite a difficult freight rate environment, fleet utilization maintained above 99%. This is unlike Courage Marine which focuses solely on short term charters whereby its utilization rate is merely 70%. This is one of the reasons why MLS remains profitable this year unlike spot charters such as Courage Marine or STX PO.

MLS Long Term Charter -

a) Tata Power -> $320mil, 3-4 geared vessels to transport 3.2m tons of coal from Indonesia, June 08 - May 12.

b) Vale -> Transportation of iron ore from Brazil to China via VLOC, 14 year from May 09 - May 23, $209mil approx

c) Cosco -> Sept 09 - Aug 12, 1 vessel, $39.5K/day

d) Arcelor Mittal -> Sept 08 - Aug 10, 1 vessel, $60K/day

e) European Charter -> Jul 09 - Jun 10, 1 vessel, $15.19K/day

The first 3 contracts alone will guarantee a combined revenue of over $110mil for 2010 and 2011. This is over 60% of FY 2009 revenue. Hence, despite the volatility of the BDI, MLS is well prepared to remain profitable and well-capitalised due to her Management usage of long term charters. This also illustrates the Management desire for 70% of her revenues to be derived from long-term charters.

It must be noted that 2 of the charters expire next year. If the company is unable to get an extension from Mittal or a new contract from a different company, it will place a burden on MLS finances.

Mercator Financial Highlights

Mercator Financial Year ends at March 31. We are now in 3Q 2010 in MLS Financial Calendar.

From 2006 to 2009, Mercator has recorded excellent growths of revenue, net profits, margins and equity. Revenue shot up 3 fold while net profit was up a whooping 15 fold from 4 mil to over 75mil. This is evident in the rise of net margins from 8% to 40% in 2009. This is due to a decrease in freight chargers as initially MLS only chartered their ship. Only in 2008, did MLS number of owned ships outweight its chartered ships (7 to 5). The Management exercise of its option to purchase one of the chartered ships (Ocean Senang) and its purchase of new ships eventually led to a respectable 11 owned ships and 3 charted ships today. MLS has stabilised its ROE at the 20% level for the past 2 years.

In its 1H 10, its revenues has dipped 34% and net profits has plunged by 59% while margins are at 28% levels. The decrease in revenue is largely due to decline in spot market day rates and renewal of long term contracts at rates lower than the previous rates. Due to the above, Time Charter Equivalent (TCE) rate per vessel per day for the half year ended September 30,2009 decreased to US$28,187 as compared to a TCE rate per day per vessel of US$48,327 for the corresponding half year in the previous year representing a decrease of 42%.

On the bright side, the total number of vessel operating days for the half year ended September 30, 2009 was 2,218 days compared with 2,089 days for the half year ended September 30, 2008. Moreover, its vessel hire charges for the half year ended September 30, 2009 decreased by 58% to US$7.1 million as compared to US$16.7 million for the half year ended September 30, 2008. This is due to a drop in hiring rates from shipping chartering companies.

After MLS IPO, its equity was 259 mil in 2008. It has managed to increase its equity to over 350mil in Sept 09. However liquidity and credit risk might be an issue. Its net current assets is negative for the first time in its history accompanied by a little over 14mil cash. Its total debts is 257mil (bank loans plus 13mil convertible bonds) of which 34mil are due this year. Its net debt to equity ratio is 0.69 slightly up from the previous year of 0.67. While its gross debt levels has been dropping over the past 2 years from 311 to 257 mil in Sept 09 due to its repayments, its net debt levels are rising. This is the result of MLS utilizing its cash to acquire more vessels.

MLS has a debt principal repayment commitment (excluding the CB) as follows-

FY 2010 - 19.4 mil
FY 2011 - 30.7 mil
FY 2012 - 25.7 mil
FY 2013 - 24.3 mil
FY 2015 - 23.6 mil

This would total up to over $124 mil. I am confident that MLS is able to meet its commitments as it commands high positive operating cashflow. For FY 08 and 09, its operating cashflow exceeded $100mil while 1H 10 recorded a cash inflow of $38mil. Since MLS has no more vessel acquisition plans for now, I believe most of operating cashflow will be diverted to debt repayments and other payables.

Share Price:

Its current share price is 30.5 SGD cents. Its annualised EPS for 2010 is USD 3.2 cents with a NAV of 28 USD cents. This means that it is trading at a PE of 6.9 and P/B of 0.79 with an annualised ROE of 11%. Considering that its fellow dry bulk counters (STX PO and Courage Marine) are in the red now, we cannot compare their PE ratios. STX PO P/B is 0.98 and Courage Marine P/B is 1.30. Since Mercator is profitable due to its long term charters, there is hardly any reason why it should be trading at such a valuation!

Outlook:

While the hey-days on Late 07- Mid 08 will not return for a long time, I do forsee a stable BDI between 3000-5000 levels for the next few years. There are 2 factors which affect the dry bulk industry - Supply of Ships and Demand of Commodities.

Demand - Emerging countries such as China and India require large amount of coal for their energy due to increased consumption from their growing population. Indian Goal 2012 seeks to have 10 000MW of energy from coal based plants. Current levels are only 5700MW hence there will be greater demands for coal from Australia and Indonesia. Iron ores imports will also increase as more steel needs to be produced to export and for expansion purposes.

Supply - Substantial number of ships have been cancelled/delayed or scrapped recently. As a result only around 40% of the 2009 orderbook was eventually delivered. Since this is expected to carry on in 2010, it will reduce the impact of vessel over-capacity in the near term. However the annual fleet growth will still be around 6%. Since the current BDI level already reflects this impact, I do not foresee any massive and prolonged drop in the current BDI level.

India and China needs coal to increase the power output for the increasing population and growing industries. Iron ore is needed to make steel to build up their economic infrastructure - ports, railways, bridges, roads and social infrastructures - houses and offices. In order to meet their demand, they need to utilize dry bulk carriers to transport the raw materials over from the supply zones like Indonesia and Australia. This is where Mercator comes in and this is why Mercator is still and will be profitable!