CFA Institute Research Challenge hosted by CFA University of Moratuwa

University of Moratuwa - Student Research This report is published for educational purposes COLOMBO DOCKYARD PLC only by students competing in the CFA Sri Lanka Investment Research Challenge, part of CFA Institute Date: 1st October 2012 Industry: and Ship repair Global Investment Research Challenge. TICKER: DOCK.N0000 (CSE)

RECOMMENDATION: BUY H IGHLIGHTS TARGET PRICE (LKR): 263.30 Colombo Dockyard PLC (DOCK)’s Fundamentals Indicate a BUY: We initiate the coverage of DOCK with a target price of LKR. 263.30 with an upside of 14.97% from PRICE, 28th SEP 2012 (LKR): 229.00 the current stock price. DOCK is the only shipbuilder in Sri Lanka with multiple interests in ship building, ship repairs and heavy engineering. DOCK faced the UPSIDE: 14.97% global downturn in the shipbuilding industry by positioning themselves in a niche market of Offshore Supply Vessels (OSV) and deliverance of quality. MARKET DATA 52-week High (LKR) 275.00 The overall negative outlook in the shipping and shipbuilding industries, last year’s profit dip and investors’ sentiment on future prospects has resulted in DOCK 52-week Low ((LKR) 183.00 trading at a low price. However, an in-depth analysis of the shipbuilding industry Previous close (LKR) 208.2 suggests that DOCK would perform well due to the following reasons. Market cap (Mil LKR) 14961.03 Solid Revenue Prospects: DOCK presently possesses a strong order book at an Outstanding shares (Mil) 71.86 approximate value of US$ 165m. Company would operate at its full shipbuilding Main Shareholders capacity until 2014 Q1 amid a very gloomy global economic and a shipping industry -Onomichi Dockyard 51.00% climate. DOCK has established itself as a preferred supplier of OSVs with a 2.9% -Employees Provident Fund 14.82% stake of the global OSV order book until 2014 Q2.This would open up opportunities in replenishing the OSV fleet that is expected to grow at a CAGR of around 6%. The - Corporation 9.99% prospects are further affirmed by the growth in offshore explorations. Free float (%) 34.12% P/E Ratio (ttm) 7.09 Strong Financial Position: DOCK’s cash balance has increased from Rs.4.04 billion at the end of 2011 to Rs. 4.23 billion by June 2012.This helps DOCK to attract Dividend Yield 2.74% customers as it ensures timely delivery without yard bankruptcy. Coupled with top Average Monthly Volume 154,546 line growth and expected margin expansion, operating cash flow is expected to Beta 0.61 grow, leading up to an accumulation in cash balance. In addition to this DOCK is virtually debt free with a gearing ratio of 0.04% which is expected to come down to 0% by the end of 2012.

KEY FINANCIAL DATA Loyalty at the Forefront: DOCK has gathered a loyal clientele. Presently about 80% Book Value Per Share 131.59 of the repair customers are repeat customers. DOCK is yet to experience any order cancellations in an industry where a cancellation and slippage rate of 30% has been Earnings Per Share 26.36 reported in 2011/12. Dividend Per Share 6.00 Valuation: We value DOCK, using both Discounted Cash Flow (DCF) and Multiple NP Margin 14.14% Analysis valuation methods. Our base case DCF valuation stood at 251.00 and EBITDA Margin 17.21% multiple analysis valued DOCK at 292.00. Gearing 0.04% Main Risks to our Target Price: DOCK is reliant on a small customer portfolio. ROE 20.11% Difficulties faced by its customers would negatively affect DOCK. Other risks ROA 12.41% include the vulnerable exchange rate of Sri Lanka, the constant fluctuations in raw ROCE 22.00% material prices and the expansion constraint. EV/ EBITDA 5.60 Given this we believe DOCK will outperform expectations, thus making it a BUY. Source: Bloomberg, Company data, Student estimates FORECAST SUMMARY SHARE PRICE MOVEMENT 2010A 2011A 2012E 2013E 2014E 2015E 2016E 8000 300 LKR Millions

250 Revenue 14,506 12,803 14,491 16,102 14,318 14,938 15,586 6000

200 Net Profit 2,085 1,811 1,643 1,859 1,644 2,055 2,429

4000 150 EBITDA 2,251 2,203 2,438 2,833 2,649 3,137 3,590 ASPI 100 Per share(LKR) 2000 ASPI Trading Price Trading Earnings 30.40 26.36 22.79 25.79 22.78 28.51 33.70 DOCK 50

0 0 Dividend 8.00 6.00 6.00 7.00 6.00 7.00 8.00

Returns (%)

Total Asset 14.32% 12.41% 8.43% 8.75% 7.88% 9.30% 10.29%

9/29/11 1/29/12 3/29/12 5/29/12 7/29/12

11/29/11 Total Equity 26.91% 20.11% 16.05% 15.93% 12.81% 14.21% 14.79% Source: Bloomberg Source: Company data, Student estimates

Important disclosures appear at the back of this report

BUSINESS OVERVIEW Colombo Dockyard PLC (DOCK) was established in the Port of Colombo, Sri Lanka in 1974. DOCK is Sri Lanka's largest ship builder with the most advanced engineering expertise and facilities. It is a company with a majority Japanese collaboration (Onomichi Dockyard) which has won a repertoire as an organisation delivering high quality products. DOCK mainly focuses on the industry segments of shipbuilding, ship repairs, and heavy engineering. FIGURE 1: COMPANY STRUCTURE DOCK is relatively smaller in capacity compared to its competitors in the Asian region. However, DOCK has succeeded in differentiating itself by excelling in building unique vessels and is reaping the benefit of Sri Lanka being located in the middle of the East-West shipping route.

Two subsidiaries fall under DOCK’s umbrella. These are namely, Dockyard General Engineering Services (Pvt) Ltd and Ceylon Shipping Agency (Pte) Ltd (Figure 1). The former focuses on delivering heavy engineering services while the latter, which is incorporated in Singapore, focuses on optimising supply channels for DOCK.

DOCK has state of the art engineering facilities with four graving docks which encompass a maximum capacity of 125,000 Dead Weight Tonnes (DWT). DOCK can also accommodate over 20 afloat repairs at any given time. Currently DOCK is undergoing an upgrade with the crane capacity set to increase to 160 tonnes from 50 tonnes.

FIGURE 2: SEGMENTAL REVENUE The fact that the Port of Colombo is located in close proximity to the growth engines of India, China, South 100% East Asia and Middle East, all of which have seen a spike in shipping activities, augurs well for DOCK. In addition DOCK is reputed to have a very competent and skilled workforce with a very high employee 38% 42% retention rate. 66% 60% 50% Though the previous product mix had been 70% ship repairs and 30% shipbuilding there has been a shift in 54% 50% the product mix with more emphasis being given to new vessel buildings (Figure 2). Over the years DOCK 34% 29% has mastered building highly technical vessels and creating a niche market in those segments. 0% Currently the company is being sought after to build new Multi-Purpose Platform Supply Vessels (MPPSV) 2008 2009 2010 2011 and Anchor Handling Tug Supply Vessels (AHTSV) to be used for offshore hydrocarbon exploration Ship repair Shipbuilding Others Source: Company data activities as DOCK has created a niche market in this area. Three new ships of those types are in the production pipeline at DOCK at present. DOCK’s scope is not limited to this segment. They are also adept FIGURE 3: AVERAGE GEOGRAPHIC at an array of sub segments in shipbuilding (e.g. ferries, tugs and naval vessels) [Appendix 18]. SALES BREAKDOWN OF DOCK Rather than focus solely on one or two sub segments, DOCK is focused on striking the “right balance”, 7% while continuing to engage in ship repairs, which is a consistent source of income. In addition to that, 8% DOCK has become adept in being a key heavy engineering company of the country. The company is intent 14% 48% on further improving in this segment.

INDUSTRY OVERVIEW 23% The global shipping industry is cyclical and has hit a lean patch after a period of rapid growth. With the economic crises in USA and Europe the shipbuilding industry has seen a dip in new constructions, as the India Singapore Samoa demand for vessels is a derived demand from the international cargo trade. However, this alone does not Sri Lanka Other define the shipbuilding industry, as there are many other factors that affect demand for shipbuilding and Source: Company data repairs. The global shipbuilding order book shrank by 26% in 2011 and further 7% of the order book was cancelled during the same year.

Increase in offshore Historically the nucleus of shipbuilding had shifted from the Atlantic and the Baltic regions to the Far East exploration has given a new (Korea, Japan & China) a few decades back and presently it is shifting to South Asia.

market for DOCK O F F S H O R E S U P P O R T V E SSELS (OSV) SECTOR IN THE RISE The increase in offshore exploration has sprung a new market for . Offshore oil accounts to one FIGURE 4: CAPEX BUDGET ON third of the world oil production and it is the only segment that keeps growing. The world’s total mobile rig OFFSHORE EXPLORATION count is presently 825 and shows an increase in utilization from 78% to 83% throughout the past year. A CAGR 10.5% similar situation exists with offshore platform rigs with 84% utilization of the 297. Each rig would require 250 214 195 around 3-4 OSVs, which includes AHTSV and MPPSV [Appendix 13], thereby increasing the demand for 200 173 159 new OSV buildings. 137 137 150 Companies such as Petrobras, Pemex, Petronas and Oil and Natural Gas Corporation (ONGC) are heavily 100 involved in offshore activities which require OSVs. Petrobras has access to the Brazilian waters that are

US$ Billion US$ speculated to hold 50 billion barrels of oil reserves. Petrobras is positioned to be even larger than Exxon 50 Mobil by 2020 with a target oil production of 4.9 million barrels a day. In order to achieve this target, 0 Petrobras plans to increase their chartered vessel fleet to 450 from 250 by 2020. ONGC, the largest operator

of offshore rigs in South Asia, looks to replace 18 vessels starting from 2012. In the South-East Asian region,

2009 2010 2011

2012E 2013E 2014E Source: Clarkson Research Petronas has raised its 5-year capital expenditures (CAPEX) plan from 2012 to 2017 to US$ 100 billion, which is 80% higher compared to the last 5 years.

CFA Sri Lanka Investment Research Challenge -Student Research | Business Overview 2

Moreover, around 35% of the world’s OSV fleet is over 25 years old (Figure 5). Due to offshore drilling FIGURE 5: AGE PROFILE OF GLOBAL going into deeper waters, new equipment and capabilities are required from OSVs warranting either new 50% OSVS OSVs or modified OSVs, giving more opportunities to companies such as DOCK that specialise in OSVs. 40% T H E B A L T I C D R Y I N D E X (BDI): N O T A N I NDICATOR FOR ALL SHI PBUILDING 30% BDI is used as the common indicator of the shipping industry which stood at 774 at the close of trading on 20% 24th September 2012 (Figure 6). However, the BDI calculation depends only on time charter rates of shipping dry bulks such as grains, coking coal, steam coal and iron ore (Table 1) [Appendix 12]. The BDI 10% only indicates the demand for dry bulk carriers and does not represent the other shipping segments. As dry

0% bulk carrier segment only accounts for a small portion of DOCK’s revenue, it is not a good indicator of

5

-

15 20 25 30

10 DOCK’s future revenues.

- - - -

-

0

>30

5

10 15 20 25 Age O PPORTUNITIES IN DRED GING

FIGURE 6: BALTIC DRY INDEX ‚MahindaChinthana – Future Vision‛, the official policy document of the government of Sri Lanka, cites that it is the government’s vision to develop Sri Lanka as a maritime hub in Asia. Sri Lanka Ports Authority (SLPA) has invested in building and upgrading seven ports for this purpose. Furthermore, 575 acres of land will be reclaimed for the proposed ‚Port City of Colombo‛. These projects require an increasing number of dredgers. Even at present, over 10 dredgers are in operation in Sri Lanka at a given time.

P ROSPECTS FOR TUGS IN T H E R E G I O N SLPA has a regulation, which stipulates that two tug vessels should accompany a vessel entering its ports. Thus, with the on-going port expansion projects the number of tug boats will rise from its current number of 18. Further to that many ports are been expanded in the region, especially in the Middle East. However, it is a less technology intensive sector generating low profit margins. As SLPA uses its own repair yards for Source: Bloomberg regular repairs the repair opportunities in the tug sector would mostly be limited to the mandatory five TABLE 1: COMPOSITION OF BDI year dry docking for maintenance. Baltic Dry Index (BDI) T ANKER MARKET IN CONT RACTION The Baltic Exchange calculates the BDI by estimating the average As the European economies contract, Europe’s oil demand is reaching it’s lowest since 1996, while USA’s oil demand is at its lowest since 1999 as USA strives for energy independence. However, as China time charter rate of 20 dry bulk consumes over 9.9 million barrels of oil a day, crude oil is transported for longer distances. Thereby the routes representing 4 types of demand for Aframax oil tankers has declined by 12% this year and the industry demands for more Very vessels: Large Crude Carriers (VLCCs) and Ultra Large Crude Carriers (ULCCs). However, according to the global Vessel DWT Weightage order book, the supply of Aframaxes will increase by 6% in 2012 creating a massive surplus of the smaller Type tanker class [Appendix15]. This has pushed the owners to scrap the older vessels and reduce the spending Capesize 172,000+ 25% on repairs. Adding to the woes, the new IMO (International Maritime Organisation) regulation phased out Panamax 74,000 25% the single hull tankers in 2010. All of this had led to the increase in the average size of a tanker to 170,000 Supramax 52,454 25% DWT. Handysize 28,000 25% D EMAND DROP FOR DRY B ULK Source: Baltic Exchange According to the International Monetary Fund (IMF), the expected GDP growth of the developed markets in 2012 is only 1.2% while in the emerging markets it is 5.4%. Therefore, the growth in bulk haulage is not expected to go beyond 4-6%, even under the best world economic scenario. However, according to the order book for dry bulk carriers, an estimated 1390 ships will be delivered by the end of 2012. This will account to 20% increase in the dry bulk carrier capacity [Appendix15]. This will force the liners to scrap the Immunity to cyclical changes aging vessel, pushing the average age of scrapped vessels to 21 years. in business segments G R O W T H I N H E A V Y I NDUSTRIES With the massive development work being carried out in Sri Lanka under the government’s plan to make Sri Lanka the ‚Miracle of Asia‛, Heavy Engineering has been a growing market. Currently the Heavy Engineering sector in Sri Lanka has a number of players, such as Macrotech, Dynamic Technologies and Technokaru, out of whom there is no clear market leader. FIGURE 7: PORTER'S FIVE FORCES Threat of new COMPETITIVE POSITIONING Entrants 5 DOCK’s focal industries are three folds, covering shipbuilding, ship repairs and heavy engineering. This 4 has placed DOCK in a differentiated position compared to its regional competitors who predominantly Rivalry among focus on either shipbuilding or repairs. This has dampened the impact to DOCK from the independent 3 Threat of existing firms Substitutes cyclical changes in each of these segments. 2 1 S HIPBUILDING DOCK has placed itself very solidly in the shipbuilding industry based on its timely delivery and quality service. DOCK has strategically positioned itself as the main OSV builder for Greatship Global Offshore Services (GGOS) providing 9 of the 21 vessels in their fleet. Also, recently DOCK won a contract from GGOS to modify an old vessel to fit requirements in the Brazilian waters (Figure 7). GGOS charters its Bargaining power Bargaining of Suppliers power of Buyers OSVs to Petrobras, which is complementary to DOCK’s success. DOCK’s expertise in OSV is further established as they won a contract for 4 vessels from Adhart Shipping, Singapore.

CFA Sri Lanka Investment Research Challenge -Student Research | Industry Overview 3

The regional competition coming from India and China promotes itself predominantly on its cost

FIGURE 8: OSV REVENUE AS A advantage. However, the industry has deemed their products to be of lesser quality. Meanwhile the larger PERCENTAGE TOTAL BUILDING REVENUE ship building yards such as Keppel, Hyundai, STX OSV and Dubai Drydocks have anchored themselves in the industry based on higher quality at a premium price. DOCK has managed to establish themselves in 100% between these two extremes balancing both the quality and price. However, due to the low performance of 80% the shipping industry a price competition may occur, hurting DOCK’s margins. 60% Further to this, DOCK has the capacity to address the tug requirement. It already has built tugs for SLPA 40% and a few Middle Eastern clients.

20% S HIP REPAIRS

0% During the past few years, DOCK has repaired more than 15 types of vessels including LNG and LPG tankers, container carriers, passenger vessels, bulk carriers, barges and research vessels [Appendix 19]. 80% 2007 2008 2009 2010 2011 Source: Company data of the DOCK’s customers for ship repairs are repeat customers. Thereby we could expect stability in revenue from repairs in the future.

Tankers were one of DOCK’s main repair segments in the past and are under threat due to the increased

FIGURE 9: MAXIMUM DRY DOCK CAPACITY size of an average tanker as discussed in the industry overview section. However, despite the recent IMO regulations, single hull Aframaxes are still being used by Ceylon Petroleum Corporation [Appendix 21] DWT ('000) lessening a possible impact from loss of repairs. This is evident from the fact that tankers contributed 500 16.91% of the revenue of the repair segment in 2011. 400 300 DOCK also holds expertise in dredger repair and is the only dockyard in Sri Lanka with the ability to repair 200 dredgers. Thus, dredger operators in the Sri Lankan waters would find DOCK as the economical option for 100 repairs. In addition, DOCK is respected in the region as a quality LPG and LNG tanker repairer. 0 Master Divers is the other major ship repairer functioning in Sri Lanka, who is limited to afloat repairs as

ABG they don’t possess any dry dock facilities. Regionally, India and Singapore have shipyards that are focusing

keppel

DOCK

Cochin Barathi

Pipavav heavily on ship repairs. A new dedicated repair is being planned to be built in Cochin, which Mazgoan Shipyard Hindustan poses a competitive threat to DOCK as Indian ship owners may find it more convenient due to proximity. Source: Company data Under the present context, demolition is occasionally more economical than repairing an old ship. This is due to the excess supply of vessels as well as a dip in charter rates (Figure 9). Also, the ship owners have a FIGURE 10: OFFSHORE FLEET DEMOLITION higher power over the dockyards due to the limited requirement for repairs in the industry. 40 35 There is a possibility of new entrants in Hambantota. However, this would take approximately a decade to 30 establish a strong dockyard operation and it takes even more time to gain the reputation in a niche market 25 as DOCK has achieved. Hence, there is less risk from a new entrant. DOCK has established Ceylon 20 15 Shipping Agency (Pte) Ltd in Singapore. This subsidiary has allowed DOCK to identify the best suppliers

No.of Vessels Vessels No.of 10 and has helped to build strong relationships with its suppliers. 5 0 H E A V Y E NGINEERING

DOCK has been increasing their presence in the Heavy Engineering industry by taking part in lucrative

2009 2010 2011

2013E 2014E 2012E projects such as the Outer Circular Highway and the Mattala International Airport Oil Farm project Source: Clarkson Research [Appendix 21]. With the infrastructure development in Sri Lanka expected to grow, DOCK would have ample opportunities to expand its Heavy Engineering business.

FIGURE 11: BUILDING ORDER BOOK INVESTMENT SUMMARY We propose a buy recommendation on Colombo Dockyard PLC (DOCK) based on an end of the year 20000 150 target price of LKR. 263.30 with an upside of 14.97% from the current stock price. DOCK, the only ship 15000 builder in Sri Lanka, is trading at an attractive price with a trailing Price-Earnings ratio (P/E) of 7.09 100 [appendix 22]. GWT 10000 50 S TRONG REVENUE VISIBI LITY UNTIL 2014 Q1 5000 The world ship building market shows a marked decline due to the gloomy economic condition. However,

0 0 million) ($ Value Contract DOCK was able to secure two shipbuilding contracts to build four MPPSVs & two 400-tonne passenger

cum 250-tonne cargo vessels outbidding stiff competition from regional shipyards. Currently DOCK’s

2011 2012 2013 2014 GWT Value($ Mil) building order book stands at US$ 165m and will be running on full building capacity up until 2014 Q1(Figure 10). Source: Company and Student estimates F O C U S O N O F F S H O R E S U P P O R T V E S S E L S (OSV S ) DOCK has strategically placed itself as a leading Offshore Support Vessel (OSV) provider by possessing 2.9% of the global OSV order book till 2014 Q1 [Appendix 24]. Further DOCK will continuously benefit from the surging OSV market.

Increased investments on offshore oil exploration: Economies in Asia and Latin America were growing over the past decade and will continue for subsequent years. As oil is the main source of energy, new and existing players are investing more on offshore oil exploration (Figure 14). In the last 5 years, more than 50% of the new findings in the oil exploration were accounted by the offshore sector. With further growth

CFA Sri Lanka Investment Research Challenge -Student Research | Competitive Positioning 4

expected in the offshore oil industry in the ‚Golden Triangle‛ (Gulf of Mexico, Brazil and West Africa) demand for OSVs will rise. Moreover Global Deep-water CAPEX is forecasted to reach $62 billion by 2015 FIGURE 12: DRIVERS OF OSV DEMAND from $22 billion in 2010, fuelling the demand for OSVs with advanced features in future (Figure 11).

High energy Stability in price of new OSVs: Due to the depressed shipbuilding market, the Clarkson New Shipbuilding demand Price Index recorded 128.5 points at the end of July 2012, declined by 2.1% month-on-month, representing the lowest point since March 2004. However, the price for OSVs stabilizes during last 14 months demonstrating an intense outlook for the offshore builders (Figure 12) [Appendix25]. High energy & power CAPEX Thus, escalating demand for OSVs coupled with stability in new building price, DOCK is expected to boost its top line in the future.

Increase in DOCK HAS STRONG CASH BALA NCE offshore activity DOCK’s cash balance has improved from Rs.4.04 billion at the end of 2011 to Rs. 4.23 billion in June 2012. Shift towards balloon payments: Previously the norm had been for the ship owner to remit payments to Robust the ship builder in multiple instalments based on stage completions. Due to the gloomy industry OSV demand conditions, the trend has shifted towards balloon payment where the customers pay 20-50% of the total value upfront and pay 50-80% of the value at delivery. Having strong cash balance enables DOCK to smoothly cope with the changes in the payment terms.

Ship owners look for cash rich yards to place their orders: When choosing a shipyard, ship owners want FIGURE 13: NEW BUILDING PRICE OF to ensure the yard will deliver the vessel on time without financial difficulties as many small scale regional MEDIUM MPPSVS (3,200DWT) 40 yards especially in China are on the brink of bankruptcy [Appendix 27]. DOCK looks attractive for potential clients as it is in position to handle the working capital requirements and has the capacity to ease 30 up the payment scheme for the customer’s convenience against a bank guarantee. 20 N O ORDER CANCELLATION S

US $ million US 10 One of DOCK’s largest customers, Greatship Global Offshore Services (GGOS), has recently cancelled their vessel orders at Magazon Shipyard, Mumbai [Appendix 26]. Yet DOCK has not experienced a single

0 cancellation during the last five years in spite of the global cancellation &slippage rate of over 25% in 2011

10 09 11 12

09 10 11 12

- - - -

- - -

- order book. This has helped DOCK to post a reasonable performance amidst the unfavourable conditions in

Jul Jul Jul Jul

Jan Jan Jan Jan the world shipbuilding industry. Source: Marcon Internationals L O Y A L C LIENTELE B O O S T I N G R EPAIR BUSINESS

FIGURE 14: SLIPPAGE AND Throughout the 38 year history, DOCK has gathered repeat and loyal clientele. Presently 80% of the repair CANCELLATION BY SHIP TYPE, 2011/12 customers are repeat customers. DOCK’s demonstrated capability to repair various types of vessels together with the long relationships with the clients will source the future repair business. Moreover in 30% building segment, DOCK’s main customer in OSV buildings, Greatship India’s fleet of 21 consists of 9 vessels built by DOCK showcasing the recognition of DOCK as a prominent OSV builder. 20% DOCK HAS A CLEAR DIVIDEND P OLICY DOCK has a clear dividend policy with high yields for investors over the past 5 years. DOCK has earned 10% Rs. 26.36 per share in FY’11 with a dividend payment of Rs. 6 accounting to 23% dividend pay-out ratio. Further it is observed that during a year in which dividend payment was low, it has issued bonus shares, in 0%

order to compliment the low dividend payment [Appendix28]. Gas

Total E NDORSEMENT BY 8 C LASSIFICATION S OCIETIES Bulkers

Cancellation Tankers Approval from Classification Societies is essential for a good shipbuilder to stay on top of its game. DOCK Slippages Containers Source: Clarkson Research has the patronage of 8 major Classification societies such as Lloyd’s Registry, Det Norske Veritas (DNV), Bureau Veritas, Germanischer Lloyd and Class NK. This gives an added recognition to DOCK when FIGURE 15: ANNUAL NUMBER OF bidding new orders for ship building and ship repairs where many other regional competitors do not DEEP SEA OIL WELLS possess all these accreditations [Appendix 29].

600 Exploration TABLE 2: APPROVAL FROM CLASSIFICATION SOCIETIES Development Classification Det Norske Lloyd Bureau Germanischer Class NK American Bureau 500 Veritas Veritas Lloyd of Shipping 400 Colombo Dockyard       300 ABG  200 Bharati    Otto Marine  100 182 190 200

136 158 Cochin Shipyard  Number of Oil Wells of Oil Number 0

ARSIGHTED LEADERSHIP AND DEDICATED WORKFO RCE

2010 2011

2009 F

2012E 2013E Source: Data Monitor Due to the influence of the main shareholder, Onomichi Shipyard, the company’s management follows the ethics of the Japanese corporate. This has proven that DOCK is prepared to face the volatilities of the ship industry with farsighted and conservative decisions. The company remunerates the employees sufficiently

CFA Sri Lanka Investment Research Challenge -Student Research | Investment Summary 5

so that there is almost100% retention of workers. DOCK’s employees are liberally given leave of absence to work at shipyards across the world and return to DOCK after nurturing their skills. This broadens the horizons of employees at DOCK which in turn benefits the organisation. FIGURE 16: DOCK’S SHARE PRICE AND NEWS FLOW 330 31st - won an order to build 14th - delivered Greatship 15th - commissioned a 28th - launched the hull 'bollard pull' test facility 2 passenger ferries for Rashi, the 4th in a series of oil of Greatship India's Laskshadweep 310 industry offshore support in port of Trincomalee Rachna, the 2nd MPSV island administration vessels for Greatship (India) being built for 290 20th - Signs a ship GGOSL, Singapore repair agreement with 11th-delivered 1st of 270 Bernhard Schulte Ship 3 MPSVs for Management Group GGOSL, Singapore

Share Price Share 250

230 10th - Greatship India considers giving orders 7th - Begun building the 2nd for bigger and more 25th - Won a deal from 210 vessel in a contract for oil sophisticated vessels a Singapore-based platform supply vessels from 19th - Announced that it - delivery of Greatship owner to build four 190 Greatship Global Offshore was eyeing yacht repair Rohini 78-metre MPSVs Services of Singapore as a new markett 170

6/4/2011 3/4/2012 1/4/2011 2/4/2011 3/4/2011 4/4/2011 5/4/2011 7/4/2011 8/4/2011 9/4/2011 1/4/2012 2/4/2012 4/4/2012 5/4/2012 6/4/2012 7/4/2012 8/4/2012

11/4/2011 12/4/2011 10/4/2011 VALUATION Source: Bloomberg, Company Announcements TABLE 3: TARGET PRICE CALCULATION Target Price: Our estimated year-end target price for DOCK is LKR 263.30 per share. This implies a 14.97% Fair value Weighted Technique Weight upside from the current price of Rs.229.00. Hence, we feel that there is considerable return for investors per share Value DCF value 251.00 70% 175.71 who are willing to look beyond the short-term fluctuations. Relative Valuation methodology: Two valuation methods have been used to arrive at the target price of DOCK, Value 292.00 30% 87.59 Free Cash Flow to Equity (FCFE) and Multiple Analysis. We have assigned a 70% weight to the FCFE and Target Price 263.30 30% to the Multiples Analysis, as the relative valuation is inherently volatile, subject to market sentiment

and does not significantly reflect the price of DOCK due to the lack of comparability.

D ISCO U N T E D C A S H F L O W (DCF) B A S E D V ALUATION TABLE 4: SUMMARY OF FCFE BASED We have used the FCFE method to value DOCK and arrive at a base case intrinsic value of LKR.251.00 per VALUATION Fair Value Weighted share based on a Cost of Equity (ke) of 21.96 % (Table 6). We have used a 6 year forecasted time horizon and TV using Weight per share Value the Terminal Value (TV) at FY ’17 is calculated using two techniques: a Terminal Growth Rate (TGR) of 4% Terminal on FCFE and a terminal P/E multiple of 8.00 (Table 4). growth rate 246.10 50% 123.03 Terminal TABLE 5: FCFE CALCULATION P/E 255.94 50% 127.97 FCFE Method(in LKR ‘000) 2012E 2013E 2014E 2015E 2016E 2017E DCF Value 251.00 Profit After Tax & Interest 1,637,902 1,853,145 1,637,069 2,048,751 2,421,729 2,474,022 Free Cash Flow to Equity(FCFE) 1,988,065 5,256,515 (1,626,634) 2,424,691 1,290,575 2,808,153 TABLE 6: COST OF EQUITY Terminal Value( at 4% TGR) 16,261,018 CALCULATION Total 1,988,065 5,256,515 (1,626,634) 2,424,691 1,290,575 19,069,170 Cost of Equity Calculation The Cost of Equity: ke is derived based on 5 year Treasury bond rate of 14.2% as the proxy for risk free rate, Risk Free Rate 14.20% Adjusted Beta 0.8622 a market risk premium of 9.0 % and an adjusted beta of 0.8622 (based on raw beta of 0.7933)[Appendix 33]. Raw Beta 1 0.7933 The adjusted beta is selected due to the fact that valuation is forward looking and the beta value in the Market Risk premium 9.00% future period has been found to be on average closer to mean value of 1.We have carried out a sensitivity

Cost of equity (Ke) 21.96% analysis to assess the sensitivity of DCF valuation to key variables. 1-Adjusted beta= (2/3)*Raw beta+(1/3)(1)

TABLE 7: SENSITIVITY OF KEY VARIABLES FIGURE 17: CUMULATIVE REVENUE TGR P/E 3.0% 3.5% 4.0% 5.0% 6.0% 7.00 7.50 8.00 9.00 10.00 RECOGNIZED -AN S CURVE ke ke

100% 20.00% 261.85 265.23 268.82 276.71 285.74 20.00% 256.05 262.99 269.94 283.84 297.74 80% 21.00% 250.57 253.48 256.55 263.27 270.89 21.00% 249.36 256.00 262.63 275.90 289.17

60% 21.96% 240.91 243.44 246.10 251.90 258.43 21.96% 243.24 249.59 255.94 268.63 281.33 40% 22.50% 235.91 238.25 240.72 246.07 252.07 22.50% 239.92 246.11 252.30 264.69 277.08 20% 23.00% 231.53 233.72 236.02 240.99 246.56 23.00% 236.91 242.97 249.02 261.13 273.24 0%

1 2 3 4 5 6 7 Discounted Cash Flow (DCF) assumptions: Stages Source: Student estimates  The revenue outlook for DOCK is based on percentage completion basis where we have assumed that a shipbuilding process flows through 7major stages [Appendix 31, 32] and the cumulative revenue recognition follows an S-curve model.

CFA Sri Lanka Investment Research Challenge -Student Research | Valuation 6

 The base case valuation considers, within the next one year DOCK would win a contract to build offshore vessels which would occupy building dock space in early 2014 .The projected building schedule is shown in Appendix 32.  We have assumed a terminal growth rate of 4% beyond the explicit forecast period from FY’17 by considering the dollar inflation and capacity constraints faced by DOCK. Further Terminal P/E of 8 is based on the historic median trading P/E of DOCK.  We have assumed that the will appreciate against USD (to LKR/USD 125.00) in the medium term due to the improved Balance of Payments and increased foreign currency reserves [Appendix 50].  The costs of sales per revenue is expected to decline gradually with the CAGR of 1.80% to 76% in FY’17 with the productivity improvements expected mainly because of upgrading of production facilities and the expected reduction in steel plate price owing to slowing Chinese economy[Appendix 35].  DOCK is expected to make significant investments in the coming years funded via internally generated TABLE 8: PEER COMPANIES AND sources. The estimated capital expenditure for FY’12 and FY’13 is 1,018mn and 971mn respectively due MULTIPLES * to the expected improvements in yard facilities. COMPANY EV/ Debt/ P/B P/E EDITDA Equity R E L A T I V E V ALUATION DOCK 1.70 8.18 4.78 0.00 a. Regional Listed Competitors In this section we calculate a range of market based values by considering the Price and Enterprise ABG 1.50 9.73 7.14 1.93 multiples based on peer companies in the shipbuilding and ship repair industry. Bharati 0.19 6.38 7.78 3.58 Peer selection: DOCK operates in three businesses: Shipbuilding, Ship repair and Heavy Engineering. As Keppel 2.70 10.98 10.11 0.74 Nam Cheong 1.90 6.87 8.14 0.69 such, we view DOCK’s comparables as a mix group of companies operating in the above said areas. As the Average 1.57 8.49 8.29 1.73 only existing and publicly traded shipyard in Sri Lanka, there are no direct peers for DOCK. Among the b. Segmental Market leaders currently listed global companies, we identify three different groups of comparable companies as explained STX OSV 2.50 7.74 2.42 0.94 in the Table 8; (a) the regional companies that are direct competitors of DOCK; (b) segmental market SembCorp 4.61 16.57 13.10 0.02 leaders in offshore shipbuilding and ship repairs; (c) diversified large shipyards [Appendix 38]. Average 3.55 12.16 7.76 0.48 c. Large Scale Shipyards Multiples: We base our relative valuation on P/E and EV/EBITDA multiples. P/E is selected as it is widely Daewoo 1.01 9.19 6.71 1.06 recognized and used by investors and earnings power is regarded as the primary driver of investment Hyundai 1.20 9.33 6.91 0.73 value. EV/EBITDA is chosen primarily because enterprise value multiples are relatively less sensitive to the Samsung 1.73 10.49 7.14 0.36 effects of financial leverage (Table 8) than price multiples when comparing companies with varying capital Average 1.31 9.67 6.92 0.72 structure and EBITDA is a superior proxy for cash flow as it is unaffected by differences in accounting 1.93 9.70 7.72 1.12 Peer Average practices in recognizing depreciation, amortization and taxation across the geographical territory. *-For details see Appendix 38 Although, valuation based on Price to Book ratio (P/B) multiple is popular, we have decided not to use P/B Source: Bloomberg multiple as DOCK is yet to revalue its assets in compliant with IFRS, hence the valuation based on P/BV would be misleading.

As shown in Table 8, the peers have varying capital structure; hence we assign a weight of 66. 67% to the value derived using EV/EBITDA multiple and 33.33% towards P/E multiple (Table 9) [Appendix 37, 39].

Risks to our recommendation and price target TABLE 9: SUMMARY OF RELATIVE VALUATION  Currently institutional investors own 65.88% shares; hence, free float is low resulting in poor liquidity. Value Therefore investors might not be able to sell at the target price [Appendix 40]. Relative Weighted per Weight Technique Value  The value derived from FCFE model relies mostly on the Terminal Value (approximately 41% of fair share price depend on terminal value), which is determined largely by the assumed perpetual growth rate. P/E 250.15 33.33% 83.39 Even though two different methods have been used to derive the terminal value, the risk of EV/EBITDA 312.89 66.67% 208.59 Relative Value 292.00 erroneously forecasting perpetual growth rate and multiples remain as a concern.  In addition, there are certain operating assumptions in our model that the valuation is very sensitive to, such as projected secured contracts, ship repair revenues and long-run cost of sales [Appendix 36].

FIGURE 18: SENSITIVITY OF VARIOUS VALUATION METRICS Current Price Target Price 7-10x Terminal P/E

3-6% terminal growth rate

5.5-8.5x EV/EBITDA 9-11x P/E

Last 52 week range

180 220 260 300 340 Source: Student estimates

CFA Sri Lanka Investment Research Challenge -Student Research | Valuation 7

FIGURE 19: EXPECTED REVENUE FINANCIAL ANALYSIS GROWTH 20000 30% Revenue: Over the past 5 years, DOCK’s revenue increased at a Compound Annual Growth rate (CAGR) of 9.1%.Revenue for 2011 dropped by 11.76% due to the weakened shipping industry but is expected to 15000 20% recover in FY’12 and FY’13 due to the fully occupied order book for shipbuilding and secured contracts in

. 'mn . 10% 10000 heavy engineering business. This is evident from the FY’12 H1 results as DOCK recorded 7,679mn revenue, 0% LKR with 13.01% surge compared to FY’11 H1 results [Appendix 45].DOCK demonstrated solid resilience 5000 -10% against the recent economic downturn as it mainly focused on offshore segment which had not been 0 -20%

affected severely.

2009 2010 2011 2013E 2012E In the recent past shipbuilding remains the major source of DOCK’s revenue and accounts for 60% of total Revenue YOY% revenue in FY’11 with CAGR of 21.04% since FY’07and repair revenue marginally declined at a CAGR of Source: Company data and Student estimates 1.5% during the same period. FIGURE 20: SEGMENTAL OPERATING Margins: DOCK’s repair business enjoys higher average gross profit margin of 31% compared to 17% on PROFIT MARGIN 60% shipbuilding, due to the higher local value addition of around 65% (Figure 20).

Net Profit (NP) margin was 14.14% for FY’11 and is expected to decline to 11.34% and 11.55% in FY’12 and 40% FY’13 respectively due to the rise in imported equipment cost and the recent increases in fuel and electricity charges [Appendix 44]. In addition, company is undertaking huge capital expenditure, which will also 20% result in higher depreciation expenses in coming years. The company has also maintained average EBITDA Gross Profit Margin Profit Gross margin of around 18% over the past five years, which is greater than that of many global players except few 0% Indian shipyards which have government subsidy schemes over the past years (Figure 22, 23). EBITDA 2010 2011 2012 1H Shiprepairs Ship Building margin is expected to shrink to 16.82% in FY’12 and expected to increase subsequently to 18.5% by FY’14. Heavy Engineering Material Sales FIGURE 22: EBITDA MARGIN COMPARISON WITH PEERS FIGURE 21: NP MARGIN COMPARISON WITH PEERS

Source: Company data 50% 20% FIGURE 23 : CAPITAL EXPENDITURE 1200 15% 30% 1000 10% 800

Margin PAT 5% 10% 600 Margin EBITDA 400 0%

Rs. Million Rs. 200 -10% 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 ABG Bharati Keppel ABG Bharati Keppel 0 Daewoo Gunagzhou DOCK Daewoo Gunagzhou DOCK

Source: Company data

2008 2009 2010 2011

2013E 2014E 2012E Ample cash position: The company is cash rich (LKR 59.00/share as at 2QFY12). Based on the historic cash Source: Company data and Student estimates balance maintained and the dividend pay-out policy (23% pay-out in FY’11) it is expected that DOCK will FIGURE 24: PROFIT AND CASH continue to accumulate cash in the future. Further owing to the fact that 75 % of shipbuilding contract value POSITION is paid at the delivery of vessels, the need for cash is justified (Figure 24). Maintaining a healthy cash 6000 balance is a vital factor in securing new building contracts, as clients look for shipyards’ ability to deliver Net Profit vessels on time amidst financial crisis. 5000 Cash flow analysis: Net cash generated from/used in operating activities decreased to -544 million in FY’11 4000 Cash & Equivalents from 2518 million in FY’10. However it is expected to increase to 2477 million and 5604 million in FY’12 and 3000 FY’13 respectively due to delivery payments during the years. The Group maintained a similar level of

Rs. Million Rs. capital expenditure (CAPEX) as a percentage of cash generated by operating activities until FY’10, but 2000 during FY’11 DOCK recorded a CAPEX of 566mn with an increase of 19.07% compared to the previous 1000 year. This surge in CAPEX is expected to remain for the subsequent two years relating to the enhancement of yard facilities. 0 2007 2008 2009 2010 2011 Capital Structure: DOCK is having a strong financial position with an asset base of around LKR 14.6 billion Source: Company data and is virtually free of long-term interest bearing loans. The company was able to successfully reduce its 8% FIGURE 25: LEVERAGE gearing position from 67.2% in 1993 to 0.4% in 2011with the guidance of Japanese Management. The company is expected to be debt free in coming months owing to the settlement of remaining long-term 6% loans. The necessity of long term debt to finance CAPEX is doubtful given the healthy cash balance it 4% maintains. Compared to peers DOCK has continuously maintained a lower gearing as shown in Figure 25, which depicts its financial stability even in difficult times. 2% Liquidity: DOCK presents healthy liquidity ratios which prove its ability to reimburse its current 0% portion of liability and operating expenses. The current ratio and the quick ratio stood respectively at 2.59x

and 2.45x at the end of FY’11 [Appendix 43].

2007 2008 2009 2010 2011 2012E Source: Company data and Performance ratio: Both Return on Asset (ROA) and Return on Equity (ROE) has seen a decline in FY’11 Student estimates and stood at 12.44% and 20.11 % (Figure 26). ROE is broken down into its five components to identify the factors that are actually fuelling the performance of the company. It is observed that EBIT margin and

CFA Sri Lanka Investment Research Challenge -Student Research | Financial Analysis 8 equity multipliers are the key components that influence the ROE [Appendix 42].DOCK has high ROA and ROE versus industry peers as shown in Table 10 and Appendix 46.

TABLE 10: PEER FINANCIAL RATIOS FIGURE 26: PERFORMANCE RATIOS EBITDA NP Total debt/total Current 40% COMPANIES ROA ROE ROA ROE Margin Margin equity Ratio 30% DOCK 17.2% 14.1% 11.0% 19.7% 0.004 2.59 20% ABG 24.2% 9.1% 5.1% 15.3% 1.93 0.85 Bharati 29.4% 9.8% 2.5% 6.4% 3.58 1.98 10% Keppel 23.5% 18.3% 13.7% 18.4% 0.69 1.45

0% Nam Cheong 18.6% 15.4% 10.6% 13.6% 0.74 1.81 STX OSV 18.8% 12.9% 11.7% 49.1% 0.94 1.22 2007 2008 2009 2010 2011 SembCorp Marine 20.8% 19.4% 15.5% 31.6% 0.02 1.26 Source: Company data Daewoo 9.8% 4.5% 2.9% 12.0% 1.06 0.79 Hyundai 9.2% 9.0% 3.7% 11.0% 0.73 0.98

Samsung 11.5% 6.3% 4.8% 17.6% 0.36 0.96 Source: Bloomberg, Company data OTHER HEADINGS FIGURE 27: EMPLOYEE SAFETY E M P L O Y E E W ELFARE : Being in a dirty, dangerous and difficult industry, DOCK places a high emphasis INDICES OF DOCK on employee welfare. Opportunities are provided for employees to continuously develop their capabilities 6 3 and employees whose performance exceeds expectations are recognized and honored.

5 2.5  Employee Turnover Ratio: The employee turnover ratio of the company in 2011 was close to zero, signifying the high levels of job satisfaction and job security. The turnover ratio of contract basis 4 2 employees stood at 0.3%.  Benefits: Salary and remuneration benefits at DOCK are at the pinnacle of the local industry. An array 3 1.5 of additional benefits is also provided.  Training: The in-house training centre is fully equipped with facilities for training and skill 2 1 development programs for all employees, undergraduates and diploma students.  Safety: Numerous safety programmes are conducted for the benefit of employees. All employees are 1 0.5 provided with adequate personal protective equipment relevant to their tasks (Figure 27).  Foreign Exposure: Employees at DOCK are allowed to work for overseas shipbuilders to gather some 0 0 foreign exposure. 2006 2007 2008 2009 2010 2011 C O R P O R A T E G OVERNANCE : DOCK is devoted towards achieving high corporate governance Accident Severity Rate standards to protect and enhance shareholder value. The board comprises of nine directors of whom six are Linear (Accident Severity Rate) Non-Executive Directors (NED). The Board has established several Board Sub Committees, such as the Audit and Remuneration committee, primarily made up of NEDs to ensure that responsibilities are carried Accident Frequency Rate out efficiently. The independent internal Audit function assists the board and management to fulfill their Linear (Accident Frequency Rate) corporate governance responsibilities.

Source: Company data C O R P O R A T E S O C I A L R ESPONSIBILITY (CSR): DOCK conducts CSR activities, mainly focusing on health, education and knowledge development. Renovation and maintenance of hospital wards, donations to hospitals, donations to various child care centers and schools aim at improving living and education standard of the community [Appendix 47].

RISK ANALYSIS

S T R A T E G I C R ISKS

Dependence on a smaller customer portfolio: DOCK has been depending heavily on a narrow customer base for new builds. Financial instability faced by any of its customers would have a heavy impact on DOCK.

Expansion constrain within the Port of Colombo: The land area of DOCK is confined to a space of 11.5 FIGURE 28: CHINESE STEEL SHEET hectares. Due to dense occupancy within the Port of Colombo and the on-going widening of the port access PRICE INDEX MOVEMENT roads, there is no possibility of expansion within the current setting.

O PERATI ONAL R ISKS

Fluctuating raw material costs: Raw material prices have fluctuated constantly due to the volatility in the global economy (Figure 28). These fluctuations are bound to eat into predicted profits, as the variation in raw material costs cannot be passed down to the customer since DOCK is obliged to stick with the fixed price agreed in the contract. This is most true when it comes to steel prices, as approximately 17% of the total costs of a vessel go into steel plates. However, HSBC’s metals and mining team expects steel prices to fall by 2.1% during 2012. Source: Bloomberg

CFA Sri Lanka Investment Research Challenge -Student Research | Other Headings 9

Energy crisis: Sri Lanka is presently going through an energy crisis and the nation has the highest energy TABLE 11: REGIONAL ENERGY tariffs in the region (Table 11). This accounts to a major operational risk for DOCK which depends heavily COST COMPARISON on electricity to function [Appendix 48].

Country Tariff (US Possible order cancellations: Prominent shipyards across the globe like Dubai Drydocks and Keppel have Cents per kWh) seen their orders rescinded in the recent past. Although DOCK is yet to experience any order cancellations India 11.3 there is always a possibility due to a sudden unfavourable development. Pakistan 10.3 Bangladesh 5.4 Dip in oil prices: If the oil prices take a dip in the near future, investments into offshore drilling may tend Sri Lanka 12.8 to spiral down (Figure 29) [Appendix 49]. This in turn will result in a drop in demand for OSVs as its Source: World Energy Outlook demand is positively correlated with the world oil prices and offshore drilling. Delay in deliveries: In an instance when DOCK is unable to adhere to a committed delivery deadline for a FIGURE 29: CRUDE OIL PRICES new build, DOCK will have to pay a large compensation (between US$ 5,000 – US$ 10,000) for each day from the agreed delivery date to the actual delivery date. This in turn erodes into the profitability of the firm (Figure 30).

Risk relating to Occupational Health &Safety: Shipbuilding & ship repairs are considered to be a3D industry (Dirty, Dangerous and Demeaning) and Sri Lanka has labour friendly rules and regulations. Despite the fact that DOCK has seen a decline in accident rates, DOCK does not possess the globally acclaimed OHSAS 18001 certificate for occupational health and safety management system. A spike in severe incidents or a drop in health and safety records may trigger regulatory pressure and could also Source: Bloomberg, EIA (March 2012) discourage potential orders as safety is a prime concern among clients.

FIGURE 30: SENSITIVITY OF DELAY F I N A N C I A L R ISKS ON GP MARGIN Exchange rate Fluctuation: DOCK is exposed to exchange rate risk due to the sustained volatility of the Sri 16% 15.0% Lankan Rupee against hard currencies [Appendix 50]. A dip in the USD/LKR exchange rate would increase 15% 13.8% the Rupee value cost of sales which in turn will negatively affect DOCK’s profitability. 14% 12.6% 13% M A C R O R ISKS 12% 11.4% GP Margin GP Threat from the Indian industry: The Indian government rolled out a subsidy scheme to promote the 11% Indian shipbuilding industry from which Indian shipyards benefitted a lot. However, this subsidy was 10% curtailed in 2007 but there is a proposal to reintroduce it. The reintroduction of this subsidy would hurt DOCK as 47.64% of the revenue of DOCK has been coming from Indian ship owners over the past 3 years. Coincidentally the Government of India is investing heavily to make Cochin the new maritime hub of the Delay in Delivery subcontinent. As part of that, Cochin Shipyard Ltd, a public sector organisation, has expedited their Source: Student estimates operations and might pose a risk to DOCK’s future operations.

RISK MITIGATING FACTORS Regulations &Government policy: The current government of Sri Lanka intends to develop the Port of Small Customer Colombo as an international container shipping hub. A massive expansion project is presently underway to Portfolio expand the container capacity of Colombo under the name ‚Colombo South Port‛. Hence there exists a possibility of the government policies being geared to support the container shipping industry, while •Strong customer loyalty discouraging the shipbuilding industry at Colombo. •Flexible payment schemes •Capacity crunch Low cost competition: According to International Labour Organisation (ILO) statistics Sri Lanka has higher wage rates than many other countries in the region such as India, Bangladesh, Vietnam and China. As Expansion Constraint labour is a major cost addition in the shipping industry DOCK may face a cost disadvantage over regional competitors. •New facility at Kelani River Yard (KRY) Table 12 analyses abovementioned risks in terms its impact and probability of occurrence according to a Increase in Raw scale of 1-5, where 1 denotes low and 5 denote very high. Material Prices TABLE 12: RISK ASSESSMENT MATRIX •Hedging deals

Competition

Risks Small Small

•Established brand recognition Order

OHSAS

Delay in Delay in

Portfolio

Oil Prices Oil Cost Low

Customer

Deliveries

Expansion Expansion

Constraint

Indian yard Indian Regulations

•Niche market focus and expertise Fluctuations

Cancellation

Threat from from Threat Competition

Energy Crisis

Exchange Rate Exchange Material Prices •It's uneconomical for larger yards in Raw Increase to build OSVs Impact 2 4 3 5 5 3 3 3 3 3 4 2 Exchange Rate Probability 5 3 3 2 2 4 3 3 4 3 3 3 Fluctutation Rating M H L M M H L L H M H L •Strong dollar reserves R A T I N G S CALE : H H IGH M M EDIUM L L OW •Majority of the revenue earned in dollars Source: Student estimates

Source: Student estimates

CFA Sri Lanka Investment Research Challenge -Student Research | Risk Analysis 10

Appendix -Table of Contents HISTORICAL AND PRO FORMA FINANCIAL STATEMENTS ...... 13

Appendix 1: Statement of Comprehensive Income ('000s) ...... 13

Appendix 2: Statement of Financial Position ('000s) ...... 14

Appendix 3: Statement of Cash Flows ('000s) ...... 15

BUSINESS OVERVIEW ...... 16

Appendix 4: Birds Eye view of DOCK ...... 16

Appendix 5: Ship repair Clientele Distributions ...... 16

Appendix 6: Vessels build by DOCK from 2009-2013 ...... 17

Appendix 7: Type of vessels DOCK handle and its purpose ...... 18

INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING ...... 19

Appendix 8: Porter’s Five Forces ...... 19

Appendix 9: SWOTAnnaysis ...... 20

Appendix 10: Bloomberg Shipbuilding index ...... 21

Appendix 11: Shipbuilding Region Shift ...... 21

Appendix 12: Baltic Dry Index(BDI) for 3 years ...... 22

Appendix 13: World wide Rig Count & Utilization Rate ...... 22

Appendix 14: Growth in offshore oil production ...... 23

Appendix 15: Tanker and Dry Bulk Market Analysis ...... 23

Appendix 16: Global new order trend by ship type ...... 25

Appendix 17: Historic Revenue, NP Margin and GP Margin with trend line ...... 25

Appendix 18: Shipbuilding Revenue breakdown ...... 26

Appendix 19: Ship Repair Revenue breakdown ...... 26

Appendix 20: Heavy Engneering Revenue breakdown ...... 27

Appendix 21: DOCK Drydock Capacities and Purpose ...... 27

INVESTMENT SUMMARY ...... 28

Appendix 22: Historical Price Vs P/E and P/B band , Historical P/E Anaysis ...... 28

Appendix 23: Current Order Book of DOCK ...... 29

Appendix 24: AHTSV/PSV orders since April 2011 ...... 30

Appendix 26: PSVs, AHTSVs Building Price Vs Shipbuilding index ...... 32

Appendix 26: Greatship India order cancellation –News items ...... 33

Appendix 26: Struggling Chinese Shipyards–News items ...... 33

Appendix 28: DOCK’s Dividend Payout Analysis ...... 34

Appendix 29: A Brief Introduction into Classification Societies ...... 34

Appendix 30: DOCK share price with news flow (2007-2012) ...... 36

VALUATION ...... 37

Appendix 31: The shipbuilding Process ...... 37

Appendix 32: Shipbuilding Revenue recognition assumption and projected building schedule...... 38

CFA Sri Lanka Investment Research Challenge -Student Research | 11

Appendix 33: Beta Calculation ...... 39

Appendix 34: FCFE Calculation ...... 39

Appendix 35: Steel Price vs PMI ...... 40

Appendix 36: Scenario Analysis ...... 40

Appendix 37: Relative valuation Calculation ...... 41

Appendix 38: Peer Company Analysis and Peer Multiples ...... 42

Appendix 39: Multiple analysis ...... 43

Appendix 40: Top twenty shareholders ...... 44

FINANACIAL ANALYSIS ...... 45

Appendix 41: Key Ratios ...... 45

Appendix 42: Composition of ROE ...... 45

Appendix 43: Quick and Current ratio …………...... 46

Appendix 44: Net Profit, Gross Profit and EBITDA Margin………………………………………………………………………...…46

Appendix 45: Quarter Performance Analysis ...... 46

Appendix 46: Peer Ratio Analysis ...... 46

OTHER HEADINGS ...... 47

Appendix 47: CSR Philosophy of DOCK ...... 47

RISK ANALYSIS ...... 47

Appendix 48: Comparison of Electricity Supply in Regional Countries ...... 47

Appendix 49: GDP vs Oil Demand ...... 48

Appendix 50: Exchange rate Fluctuation (2000-To date): ...... 48

Appendix 51: List of Abbreviations ...... 49

CFA Sri Lanka Investment Research Challenge -Student Research | 12

HISTORICAL AND PRO FORMA FINANCIAL STATEMENTS

Appendix 1: Statement of Comprehensive Income ('000s) Source: Company documents, Student estimates

For the year ended 31st 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E

Revenue 14,505,673 12,803,164 14,490,928 16,101,539 14,317,721 14,937,711 15,585,901 15,991,754

Cost of Sales (11,223,924) (10,491,764) (11,882,561) (12,881,231) (11,311,000) (11,576,726) (11,845,285) (12,153,733)

Gross Profit 3,281,749 2,311,400 2,608,367 3,220,308 3,006,721 3,360,985 3,740,616 3,838,021

Other Income 83,424 631,907 591,107 192,715 194,340 195,980 197,638 199,311

Distribution Expenses (27,401) (26,655) (29,706) (32,203) (28,277) (28,942) (29,613) (30,384)

Administrative Expenses (1,591,279) (1,321,833) (1,425,907) (1,481,342) (1,470,430) (1,504,974) (1,539,887) (1,701,523)

Other (Expenses)/Reversal (1,355) 58,389

Net Finance Income/ (Expense) 183,679 179,558 260,219 368,088 302,850 483,503 593,620 721,805

Profit before Tax 1,928,817 1,832,766 2,004,078 2,267,566 2,005,204 2,506,552 2,962,373 3,027,230

Income Tax (Expense)/Reversal 156,230 (21,774) (360,734) (408,162) (360,937) (451,179) (533,227) (544,901)

Profit for the period 2,085,047 1,810,992 1,643,344 1,859,404 1,644,267 2,055,373 2,429,146 2,482,329

Attributable to:

Equity holders of the parent 2,080,744 1,804,004 1,637,902 1,853,145 1,637,069 2,048,751 2,421,729 2,474,022

Minority Interest 4,303 6,988 5,443 6,259 7,198 6,622 7,417 8,307

2,085,047 1,810,992 1,643,344 1,859,404 1,644,267 2,055,373 2,429,146 2,482,329

Earnings Per share (Rs.) 30.40 26.36 22.79 25.79 22.78 28.51 33.70 34.43

Dividends Per share (Rs.) 8 6 6 7 6 7 8 8

CFA Sri Lanka Investment Research Challenge -Student Research | 13

Appendix 2: Statement of Financial Position ('000s) Source: Company documents, Student estimates

As at 31st December 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E ASSETS Non-Current Assets Property, Plant and Equipment 2,273,498 2,545,757 3,238,203 3,795,174 3,916,619 4,120,284 4,334,538 4,429,898 Intangible Assets 6,008 3,175 1,588 794 - - - - Other Investments 57,410 58,610 58610 2110 2110 2110 2110 2110 Deferred Tax Assets 73,168 121,010 121,010 121,010 121,010 121,010 121,010 121,010 Total Non-Current Assets 2,410,084 2,728,552 3,419,410 3,919,088 4,039,739 4,243,404 4,457,658 4,553,018 Current Assets Inventories 640,924 667,469 724,546 805,077 715,886 746,886 779,295 799,588 Trade and Other Receivables 5,319,034 6,990,794 9,133,196 5,291,033 6,926,575 5,735,979 5,988,235 6,156,941 Income Tax Refund 9,916 ------Short Term Investment 619,500 108,908 108,908 108,908 108,908 108,908 108,908 108,908 Cash and Cash Equivalents 5,564,909 4,097,698 6,096,756 11,121,658 9,063,958 11,257,916 12,272,627 14,658,118 Total Current Assets 12,154,283 11,864,869 16,063,407 17,326,676 16,815,326 17,849,689 19,149,064 21,723,555 Total Assets 14,564,367 14,593,421 19,482,817 21,245,764 20,855,066 22,093,093 23,606,723 26,276,573

EQUITY AND LIABILITIES Stated Capital 684,370 684,370 718,589 718,589 718,589 718,589 718,589 718,589 Foreign Exchange Reserve 6,313 3,325 3,325 3,325 3,325 3,325 3,325 3,325 Retained Earnings 7,025,279 8,281,786 9,474,867 10,902,158 12,057,409 13,680,522 15,631,039 17,548,063 Equity Attributable to Parent 7,715,962 8,969,481 10,196,781 11,624,072 12,779,323 14,402,436 16,352,953 18,269,977 Minority Interest 31,326 36,284 41,727 47,986 55,183 61,805 69,222 77,529 Total Equity 7,747,288 9,005,765 10,238,507 11,672,057 12,834,507 14,464,242 16,422,175 18,347,506

Non-Current Liabilities Interest Bearing Borrowings 61,320 36,432 ------Deferred Tax Liability 44 12 12 12 12 12 12 12 Employee Benefit 958,974 972,851 1,050,679 1,134,733 1,225,512 1,323,553 1,429,437 1,543,792 Total Non-Current Liabilities 1,020,338 1,009,295 1,050,691 1,134,745 1,225,524 1,323,565 1,429,449 1,543,804 Current Liabilities Interest Bearing Borrowings 898,565 373,931 594,843 837,617 670,093 536,075 375,252 262,677 Trade and Other Payables 4,859,272 4,074,151 7,129,536 7,084,677 5,655,500 5,209,527 4,738,114 5,469,180 Income Tax Payable 0 66,707 405,667 453,095 405,870 496,112 578,160 589,834 Dividends Payable 14,912 16,757 16,757 16,757 16,757 16,757 16,757 16,757 Bank Overdraft 23,992 46,815 46,815 46,815 46,815 46,815 46,815 46,815 Total Current Liabilities 5,796,741 4,578,361 8,193,619 8,438,961 6,795,035 6,305,286 5,755,098 6,385,263 Total Equity, Liabilities 14,564,367 14,593,421 19,482,817 21,245,764 20,855,066 22,093,093 23,606,723 26,276,573

Net Assets per Share ( LKR) 113.30 131.59 142.48 162.43 178.61 201.29 228.53 255.33

CFA Sri Lanka Investment Research Challenge -Student Research | 14

Appendix 3: Statement of Cash Flows ('000s) Source: Company documents, Student estimates

For the year ended 31st December 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E Cash Flow from Operating Activities Net Profit Before Tax 1,928,817 1,832,766 2,004,078 2,267,566 2,005,204 2,506,552 2,962,373 3,027,230 Adjustments for: Depreciation of Property, Plant and Equipment 262,921 292,297 325,857 414,490 485,782 501,327 527,396 554,821 Impairment/Write off Property, Plant and Equipment - 203 ------Amortization of Intangible assets 3,947 4,163 1,588 794 794 - - - Provision for Retirement Benefit Obligations 212,978 107,881 116,742 126,081 136,168 147,061 158,826 171,532 Provision/(reversal) for Bad and Doubtful Debts 146,220 79,655 ------Provision for/(Reversal) of Obsolete Stocks 1,594 (61,988) ------(Profit)/Loss on Disposal of Property, Plant and (1,842) (18,652) ------Equipment Foreign Exchange (Gain)/Loss (Unrealised) (24,774) 61,257 (400,000) 250,000 - - - - Interest Income (239,439) (253,275) (366,397) (518,216) (460,127) (612,134) (694,240) (796,452) Dividend Income (18) (260) (260) (260) (260) (260) (260) (260) Interest Expenses 55,760 73,717 106,178 150,128 157,277 128,630 100,621 74,648 Operating Profit Before Working Capital Changes 2,346,164 2,117,764 1,787,786 2,690,583 2,324,838 2,671,178 3,054,716 3,031,519

(Increase)/Decrease in Inventory 136,414 35,443 (57,077) (80,531) 89,191 (31,000) (32,409) (20,293) (Increase)/Decrease in Trade and Other Receivables 1,607,474 (1,751,415) (2,142,402) 3,842,163 (1,635,541) 1,190,596 (252,255) (168,707) Increase/(Decrease) Trade and Other Payables 1,268,887 (785,120) 3,055,385 (44,859) (1,429,177) (445,973) (471,413) 731,066 Cash Generated from/(used in) Operating Activities 2,821,165 (383,328) 2,643,692 6,407,356 (650,690) 3,384,801 2,298,638 3,573,585

Interest Paid (55,760) (73,482) (106,178) (150,128) (157,277) (128,630) (100,621) (74,648) Gratuity Paid (45,363) (94,004) (38,914) (42,027) (45,389) (49,020) (52,942) (57,177) Income Tax Paid/Set off (201,614) 6,977 (21,774) (360,734) (408,162) (360,937) (451,179) (533,227) Net Cash Generated from/(used in) Operating Activities 2,518,428 (543,837) 2,476,826 5,854,467 (1,261,519) 2,846,213 1,693,896 2,908,533

Cash Flow from Investing Activities Purchases of Property, Plant and Equipment (475,617) (566,329) (1,018,303) (971,461) (607,228) (704,991) (741,651) (650,181) Proceeds from Disposal of Property, Plant and Equipment 1,562 20,217 ------Interest Received 239,439 253,275 366,397 518,216 460,127 612,134 694,240 796,452 Investment in short term investment (621,500) ------Redeem of BOC debenture - 510,592 - 56,500 - - - - Acquisition of Intangible Assets (772) (1,331) ------Dividend Received 18 260 260 260 260 260 260 260 Net Cash Generated from/(used in) Investing Activities (856,870) 216,684 (651,646) (396,484) (146,841) (92,598) (47,151) 146,532

Cash Flow from Financing Activities Repayment of Long Term Loans (52,958) (24,077) (24,288) (36,432) - - - - Repayment of Short Term Loans (3,677,947) (4,941,163) - - (167,523) (134,019) (160,822) (112,576) Loans Obtained during the period 4,301,463 4,349,464 209,404 279,206 - - - - Repayment of Leases (1,230) (1,454) (636) - - - - - Dividend Paid (547,497) (545,652) (410,602) (425,854) (481,818) (425,638) (471,213) (556,998) Net Cash Generated from/(used in) Financing Activities 21,831 (1,162,881) (226,122) (183,081) (649,341) (559,657) (632,035) (669,573)

Net Increase/(Decrease) in Cash and Cash Equivalents during the period 1,683,389 (1,490,034) 1,599,058 5,274,902 (2,057,700) 2,193,959 1,014,710 2,385,491 Cash and Cash Equivalents at the beginning of the period 3,857,528 5,540,917 4,050,883 6,049,941 11,074,843 9,017,143 11,211,101 12,225,812 Cash and Cash Equivalents at the end of the period 5,540,917 4,050,883 5,649,941 11,324,843 9,017,143 11,211,101 12,225,812 14,611,303

CFA Sri Lanka Investment Research Challenge -Student Research | 15

BUSINESS OVERVIEW

Appendix 4: Birds Eye view of DOCK

Source: Company Reports

Appendix 5: Ship repair Clientele Distributions Source: Company Reports

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Appendix 6: Vessels build by DOCK from 2009-2013

Source: Company Reports

Country 2009 2010 2011 2012 2013

GreatshipAbha GreatshipRekha (PSV) Executive Honour GreatshipRoopa Multi Purpose (AHTS) (AHTS) (PSV) PSV (scheduled – March)

GreatshipAditi GreatshipRamya Executive Pride GreatshipRachna Multi Purpose Singapore (AHTS) (PSV) (AHTS) (PSV) PSV (scheduled – August)

GreatshipRagini Multi Purpose (PSV) PSV (scheduled – December)

Arabian Sea GreatshipRashi (PSV) Passenger cum (Passenger) 250T cargo vessel (scheduled – August)

Lakshadweep Sea Passenger cum (Passenger) 250T cargo vessel India (scheduled – December)

GreatshipRohini (PSV)

VadaTharakai II (Passenger) Sri Lanka

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Appendix 7: Type of vessels DOCK handle and its purpose

Vessel Purpose Example

Tankers are ships designed to transport liquids in bulk. Major tanker types are oil tankers, gas carriers and chemical Tankers tankers. Tanker capacity ranges from several hundred tons to several thousand tons.

These are cargo ships that carry their loads in truck-size Container Carriers containers. They are generally used in commercial intermodal freight transport.

The primary function of a passenger ship is to carry passengers. They also include ships that are designed to Passenger Vessels transport a substantial number of passengers as well as freight.

The purpose of tugs is to maneuver vessels by either pushing or towing them. They move vessels that should not Tugs move on their own such as ships in a crowded harbor or vessels that cannot move on their own such as disabled ships and oil platforms.

Dredger vessels are mainly used to excavate and remove Dredgers sediment material from the bottom of water bodies.

These are ships that are designed to supply offshore oil platforms, their primary function being the transportation PSV of goods and personnel to and from offshore oil platforms and other offshore structures.

Offshore support Vessels The purpose of these vessels is to handle anchors for oil rigs, tow them to location and anchor them up. In some AHTSV occasions, they also act as an Emergency Rescue and Recovery Vessel (ERRV)

CFA Sri Lanka Investment Research Challenge -Student Research | 18

A barge is a flat-bottomed boat that is generally used for the Barges transport of heavy goods in rivers and canals.

These are specially designed merchant ships, built to Bulk Carriers transport unpackaged bulk cargo such as coal, grains, ore etc

INDUSTRY OVERVIEW AND COMPETITIVE POSITIONING

Appendix 8: Porter’s Five Forces

Bargaining Power of Suppliers

The bargaining power of suppliers is moderate in the shipbuilding industry due to low concentration of suppliers. Suppliers to the shipbuilding industry are mostly steel manufacturers or parts manufacturers and these suppliers do not have high influence because the switching cost of suppliers in quite low.

Bargaining Power of Customers

The bargaining power of buyers in the industry is high. This is so due to few buyers. Buyers base decision on price, quality, and delivery and government policy which is mostly sensitive to price. Key buyers are commercial clients who place very large orders giving them a high bargaining power.

Barriers to Entry

There are high entry barriers in the shipbuilding industry. The major barriers includes, huge capital investments for building dry docks, acquisition of highly specialized equipment, high taxes and tariff by the government, requirement of high-skilled labor, and flexibility in operations.

Threat of Substitutes

The threat of substitutes in the shipbuilding industry is very low. The direct available substitutes are airplanes, but the impact is low due to high cost on cargo.

Rivalry among existing firms

The industry looks bleak as a result of the global shipbuilding crisis and the growth rate is stagnant. However, rivalry is high as shipyards are fighting each other to secure new building contracts. The fact that there are an assortment of shipyards located across the region, and the added fact that they produce at lower costs do not help.

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Appendix 9: SWOTAnnaysis

Strengths:

 Strong order book: will occupy building dock space till 2014 Q1  Healthy cash balance: Rs. 59 Per share  Longstanding customer relationships: 80% of repair clients are repeat customers  Accreditation from 8 classification societies  Reputation as a high quality shipbuilder: Specialised in sophisticated vessels  Being the only dry dock repair provider in Sri Lanka  Highly skilled & satisfied workforce: 100% Retention rate in 2011  Stable and visionary management  Backing of Onomichi Shipyard, Japan

Weaknesses:

 Capacity constraint – Maximum dock capacity is Limited to 125,000dwt& no space to expand with in Colombo Port  Small customer portfolio  Focused niche market in building  Lack of OHSAS 18001 certification

Opportunities:

 Boom in offshore drilling activities: 6% CARG in offshore Drilling CAPEX  Offshore exploration in Sri Lankan Manner Basin  Sri Lanka’s drive to be a regional maritime hub : Development in Colombo South harbour and Hambanthota  Dredger repair market with extensive presence of dredgers in the region  Petrobras, Petronas, Shell and many other oil drilling companies planning to increase their OSV fleet  Tug demand will spike with port development activities in the region

Threats:

 Low cost competition  Indian ventures into ship repairs  New shipyards in India & Possible in Hambanthota  Exchange rate fluctuations  Raw material price fluctuations  High energy costs in Sri Lanka: Highest in the Region  Crude oil prices will affect Energy & Power (E&P) activities

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Appendix 10: Bloomberg Shipbuilding index Source: Bloomberg

Appendix 11: Shipbuilding Region Shift Source: Maritime Economics (2009)

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Appendix 12: Baltic Dry Index(BDI) for 3 years Source: Bloomberg

Appendix 13: World wide Rig Count & Utilization Rate Source: IHS Petrodata Rigbase

850 100%

800 95%

750 90%

700 85%

650 80%

600 75%

No. of rigs of No. 550 70%

500 65%

450 60%

400 55%

350 50% 09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4 12Q1 Quarter

Utilization Total fleet Contracted Working

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Appendix 14: Growth in offshore oil production Source: Offpex- Offshore Outlook

Appendix 15: Tanker and Dry Bulk Market Analysis Source: BIMCO, CRSL, Morgan Stanley Research

The tanker market has seen a spike in the volumes and distances they haul due to the growing demands. Due this the industry has moved into using larger, more fuel efficient vessels to utilize economies of scale. The absolute numbers of new builds in these VLCC & ULCC categories are small compared to smaller tanker vessels. Most of these larger crude vessels traverse the Atlantic, Pacific and Indian Oceans. However, smaller vessels are still required to navigate through shallower and tighter corridors. Most importantly, the VLCC & ULCC fleet can haul a larger amount of oil than the smaller tankers combined.

International trade has risen at a steady rate over the past decade. This is most evident among BRIC and CIVETS countries. One such example is the fact that Brazil’s major trading partner has become China by overtaking USA. Due to the trade of many bulk materials such as iron ore, grains, steels and etc, the dry bulk market has grown increasing the number of vessels in supply. However due to the recent downturn in the global economy and the stagnation of growth in China, India and other growth engines there has been a dip in the demand for dry bulk carriers leading to an excess supply.

Figure 2: Growth of Crude Oil and Major Bulk Figure 1: World trade volume of imports of goods Transportation

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Figure 3: Vessels Supply Growth

Figure 3: Tanker: Order Book Vs World fleet Figure 5:Bulk Carriers: Order Book vs. World Fleet 350 90% 200 60% 80% 180 300 50% 160 70% 140 250 40% 60% 120 200 50% 100 30% 80 150 40% 20% 60 30% 40 100 10% 20% 20 50 0 0% 10%

0 0%

Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1

------

-

1Q96 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12

1997 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1996 1996 Order Book (LHS) Order Book % of Fleet (RHS) Order Book (LHS) Order Book % of Fleet (RHS)

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Appendix 16: Global new order trend by ship type Source: Clarkson Research

100%

13 16 18 17 17 90% 23 26 28 29 3 2 32 33 80% 4 3 4 7

5 5 3 12 70% 5 3 19 31 2 4 17 60% 13 25 20 24 50% 26 48 59 20 45 40% 12 26 20 16 42 17 30% 16

20% 35 35 30 29 31 25 25 21 23 10% 17 18

0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year Tanker Bulker Carrier Container Offshore Others

Appendix 17: Historic Revenue, NP Margin and GP Margin with trend line Source: Company Reports

15,000 25%

12,000 20%

9,000 15%

LKR'mn 6,000 10%

3,000 5%

0 0%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Revenue NP Margin GP Margin Linear (Revenue)

Linear (Revenue) Linear (NP Margin) Linear (GP Margin)

CFA Sri Lanka Investment Research Challenge -Student Research | 25

Appendix 18: Shipbuilding Revenue breakdown Source: Company Reports 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 2007 2008 2009 2010 2011 Tugs Passenger Vessels Supply Vessels

Deck Barges Pilot Launches Naval Vessels Fisheries Protection Vessels

Appendix 19: Ship Repair Revenue breakdown Source: Company Reports 100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 2007 2008 2009 2010 2011

Tankers General Cargo Container Carriers Passenger Vessels Fishing Trawlers Tugs LPG Tankers Dredgers Navel Vessels Cement Carriers Offshore Support Vessles Barge Bulk Carriers Research Vessles Others

CFA Sri Lanka Investment Research Challenge -Student Research | 26

Appendix 20: Heavy Engneering Revenue breakdown Source: Company Reports

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0% 2007 2008 2009 2010 2011 Infrastructure Heavy Fabrication Services

Power Generation Repairs & Maintenance Others

Appendix 21: DOCK Drydock Capacities and Purpose Source: Company Reports

Dock Type Length Breadth Depth Capacity Lifting Purpose No (m) (m) (m) (Dwt) capacity (t)

1 Graving 213 26 9.7 30,000 50 Service general cargo vessels, dredgers, Dry dock container vessels, offshore support vessels and cement carriers. Ship building projects 2 Graving 107 18.5 6.7 9,000 50 Ship building projects Dry dock 3 Graving 122 16 5.5 8,000 10 Accommodating offshore support vessels, Dry dock tug boats, naval vessels, work boats and dredgers 4 Graving 263 44 8.9 125,000 50 Accommodating tankers, bulk carriers Dry dock and dredgers

CFA Sri Lanka Investment Research Challenge -Student Research | 27

INVESTMENT SUMMARY

Appendix 22: Historical Price Vs P/E and P/B band , Historical P/E Anaysis Source: Company data and Bloomberg

400

350

300

250 LKR.

200

150

100

50

0 1/1/2007 7/1/2007 1/1/2008 7/1/2008 1/1/2009 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012 7/1/2012

DOCK PRICE P/E -3x P/E -6x P/E -8x P/E -10x P/E -11x

12

11

10

9

8

7

6

5

4

3 2

2009 2010 2011 2012

P/E Mean Mean+SD Mean-SD

CFA Sri Lanka Investment Research Challenge -Student Research | 28

350

300

250

LKR 200

150

100 7/1/2009 1/1/2010 7/1/2010 1/1/2011 7/1/2011 1/1/2012 7/1/2012

DOCK PRICE P/B-1.5x P/B-1.8x P/B-1.9x P/B-2.1x P/B-2.5x

Appendix 23: Current Order Book of DOCK Source: Company Reports

Scheduled Project Name Yard No. Customer Country Delivery Multi Purpose Platform NC/0224 Greatship Global September 2012 Singapore Supply Vessel – Greatship Offshore Services (Pte) Ragini Ltd Multi Purpose Platform NC/0225 True Champion Pte Ltd March 2013 Singapore Supply Vessel – TBN* Multi Purpose Platform NC/0226 Abundant Assets Pte Ltd August 2013 Singapore Supply Vessel – TBN* Multi Purpose Platform NC/0227 High Fortune Pte Ltd December 2013 Singapore Supply Vessel – TBN* Multi Purpose Platform NC/0228 Blue Castle Pte Ltd May 2014 Singapore Supply Vessel – TBN* 400 Passenger cum 250T NC/0229 Union Territory of August 2013 India Cargo Vessel – TBN* Lakshadweep Administration Kavaratti 400 Passenger cum 250T NC/0230 Union Territory of December 2013 India Cargo Vessel – TBN* Lakshadweep Administration Kavaratti

CFA Sri Lanka Investment Research Challenge -Student Research | 29

Appendix 24: AHTSV/PSV orders since April 2011 Source: Hagland Offshore

The time span of the current order book for OSVs is up until 2014 Q2. DOCK will be working under full capacity until 2014 Q1 to complete their current orders making it impossible for them to take up further contracts before that. Thus it can be said that DOCK has a strong order book leading up to 2014 Q1.The following diagram depicts the OSV delivery schedule.

Delivery Shedule 30

26 25

20 20

15

9 9 10 8 8

Vessels of Number 5 5 2 2 0 0 4Q 2012 1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014 4Q 2014 2Q 2015

Yard Vessel Type Delivery Price Havyard PSV 12-Jan NOK 300mn Dubai Dry Docks,Batam (indonesia) PSV 12-Nov $42 m Dubai Dry Docks,Batam (indonesia) PSV 13-Jan $42 mn STX - Langsten PSV 1H12 NOK 300 mn STX - Vietnam PSV 1H13 NOK 300 mn Kleven Verft PSV 12-Nov NOK 380 mn Kleven Maritime PSV 2012 N/R Hellesoy Verft PSV 12-Nov N/R Eastern, Panama MPSV 13-Apr N/R STX Langsten 2xAHTS Apr/Jun 2013 NOK 1.2 bn Havyard Leirvik PSV 12-Dec NOK 350 mn STX Bervik 2xPSV 1Q/3Q13 NOK 750 mn Guanabara Navegacao Ltd 2xPSV 2013 $113.9 mn Sinopacific 2xPSV Sep/Dec 2012 N/R CPLEC yard 6xPSV TBA N/R Simek yard PSV 12-Jul NOK 200 mn Remontowa 3xPSV 2Q/3Q13 $120 mn Remontowa 3xPSV 2Q12, 3Q12,1Q13 $120 mn Colombo Dockyard 4xPSV 2013-1Q14 N/R Grandweld Shipyards 6xSupply vessels End-12 N/R Estaleiro Ilha 2xPSV 2013 N/R Remontowa Shipyard, poland 4xPSV Oct-12 to Aug-13 N/R Rosetti Marino, Italy 2xPSV End-13 N/R Otto marine 2xAHTS 3Q12 and 1Q13 $38.5 mn each Wuchang yard, China 1xAHTS 14-Feb N/R

CFA Sri Lanka Investment Research Challenge -Student Research | 30

Yard Vessel Type Delivery Price Rosetti Marino, Italy 2xPSV 4Q13/1Q14 $38 mn Simek yard PSV 2Q13 NOK 270 mn STX Brevik 2XPSV 1Q13 NOK 275 mn STX Brevik 4XPSV 3Q13/2Q14 Nok 250 mn each Astilleros Armon, Vigo 2xAHTS 1H13 N/R Kleven Verft, Norway PSV 1Q13 N/R Havyard, Leirvik PSV 2Q14 NOK 300 mn Havyard, Leirvik PSV 1Q13 NOK 250 mn Universal Shipbuilding Corp, japan 4xPSV 1Q14 N/R Kleven Myklebust PSV 12-Jun NOK 350 mn Asenav yard 2xAHTS Feb 2014/Jan 2015 N/R Damen 4xPSV 2013 N/R STX Brevik 2xPSV 2H13 N/R Simek yard PSV 4Q13/1Q14 $60 mn Shinan Heavy Ind PSV 1Q13 N&A Damen 2xPSV Nov/Dec 2013 NOK 185 mn Balenciaga, Spain 2xPSV 2Q13/4Q13 GBP 50 mn Remontowa 1XPSV 4Q13 N/R Havyard Leirvik 1XPSV Oct 2012/May Universal/Eisa 2x4 PSV 1Q142013 N/A STX Marin 2xPSV 2013 N/A Hyundai Mipo 4XPSV Nov 2013-May $197 mn STX OSV OSCV May2014-13 NOK 660 mn STX OSV Langsten 2XAHTS 1Q14 NOK 1.2 bn STX OSV Brevik MPSV Early 2014 NOK 500 mn STX OSV 2XOCV 3Q13/4Q13 N/R STX OSV AHTS Mid-13 N/R Bergen Group Fosen OCV 4Q13 NOK 750 mn Kleven OCV 13-Jun NOK 550 mn Mitsubishi HI Ramform 2013/2015 N/R Simek yard PSV 2013 N/R Hyundai Mipo 4XPSV 2013/2014 N/R Havyard Havyard 832 s 2014 NOK 270 mn TBN 2 X PSV 1Q14 Rosetti Marino, Italy 1XAHTS 1Q14 Ulstein Verft 4XPX 121 2013/2014 Kleven Subsea 1Q14 STX OSV 2XPSVInstallation 2Q/3Q14 Ulstein Verft Subsea Vessel STX OSV 2xPSV 2Q14 Bergen Construction 2Q14 Kleven SubseaVessel Support 1Q14 Simek yard MSV 2Q14 TBN PSV 1Q14 STX OSV OSCV 1Q14 NOK 1500 mn STX OSV PSV 1Q14 Kleven PSV 1Q14 Kleven PSV 1Q14

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Appendix 26: PSVs, AHTSVs Building Price Vs Shipbuilding index Source: Clarksons Research

AHTSV New building Price Trend 40

35

30

25

20

US $ Million $ US 15 Small AHTS 80 BP 10 5 Medium AHTS 120 BP 0 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

Medium PSV (3,200DWT) Price Trend 40

30

US $ Million $ US 20

10

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

New Building Price Index

42% lower than the previous high

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Appendix 26: Greatship India order cancellation –News items Source: Press release from Greatship : Found on http://greatshipsubsea.com/

Appendix 26: Struggling Chinese Shipyards–News items Source: http://www.businessweek.com, http://www.marinelink.com, http://www.asianewsnet.net/

CFA Sri Lanka Investment Research Challenge -Student Research | 33

Appendix 28: DOCK’s Dividend Payout Analysis Source: Company Data

It is observed that, DOCK issued bonus share when DOCK is having lower dividend payment ( lower dividend payout) . Recently, in 2008 and 2012 they issued one bonus share for every 20.

35 30%

30 25%

25 20%

20

15% Rs. 15

10% 10

5% 5

0 0% 2007 2008 2009 2010 2011

Earnings Per share (Rs.) Dividends Authorised Per share (Rs.)

Net Return Divident Pay Out Ratio

Appendix 29: A Brief Introduction into Classification Societies

Classification societies are organisations which established and maintain technical standards to design, construction and operation of vessels and other offshore structures. Traditionally these organisations are independent (devoid of any relations to the government or insurers) and will ensure the shipbuilding is done according to the required

CFA Sri Lanka Investment Research Challenge -Student Research | 34 standards. Once the vessel is inaugurated these societies will conduct frequent surveys to see whether the vessel complies with the above said standards and is seaworthy.

The classification society has a very important role to play in the lifespan of any vessel from its embryonic design stage to its retirement, keeping tabs on the seaworthiness of the vessel at all times. What makes classification societies so salient for the shipping industry is due to the huge value of vessels and cargo. Insurers and Protection & Indemnity Clubs (P&I) who ensure hull, cargo and passengers of the said vessel need to verify about the seaworthiness and standard of a vessel before they commit to an enormous insurance fee. Thus they rely on classification societies to provide the said assurance that the vessel meets the accepted standards. At the same time the flag state (where the vessel is registered) and port states have their own rules and regulations which should also be met. Classification societies chips in here as well as they can confirm whether the vessel complies with the said criterion. Besides the it is mandatory for a vessel to have a classification approval according to the International Maritime Organisation’s SOLAS (Safety of Life at Sea) convention.

Classification societies employ ship surveyors, mechanical engineers, chemical engineers, material engineers, electrical engineers and naval architects to do this, and have stamped their presence at ports across the world. Ship owners may have different classification societies they may prefer to work with.

In all, there are approximately 50 classification societies scattered across the globe. The oldest of them, Lloyd’s Registry, was founded in 1760.

Some of the most prominent Classification Societies are;

 Lloyd’s Register of Shipping (London)  Bureau Veritas (Paris)  American Bureau of Shipping (Houston)  Det Norske Veritas (Oslo)  Germanischer Lloyd (Hamburg)  Class NK (Tokyo)  RegistroItalianoNavale (Genoa)  Russian Maritime Register of Shipping (St. Petersburg)

CFA Sri Lanka Investment Research Challenge -Student Research | 35

Appendix 30: DOCK share price with news flow (2007-2012) Source: Bloomberg, LBO, Company announcement

Price Share

delivered 1st delivered

-

th

launched launched the

-

GGOSL,Singapore

of 3 MPSVs for 3 of

11

Announced that it Announced

th -

ship Signsa

GGOSL,Singapore

MPSV being built built for being MPSV

Rachna, the 2nd 2nd the Rachna,

hull of Greatship hull

28

th

-

as a new market market new aas

was eyeing yacht repair repair yacht waseyeing

19

th

Management Group Group Management

Schulte Ship Schulte

with Bernhard Bernhard with repair agreement repair 20

-

won won an

- st

acommissioned

administration

island

Laskshadweep

ferries for India's for ferries

passenger

order to build 2 build to order

31

-

metre MPSVs metre

-

Won a deal aWon

-

in port of port Trincomaleein

'bollard pull' test pull'facility 'bollard 15th 15th

th

four 78 four

based owner to build build to owner based

from a Singapore a from 25

Greatship Rohini Greatship

Begun building the the Begun building

-

th

Greatship India considers India considers Greatship

Services of Singapore of Services

Global Offshore Global

vessels from Greatship vesselsfrom

for oil platform supply platform supply oil for

2nd vessel in a contract avessel contract in 2nd 7

-

th

delivery of delivery

delivered delivered

-

more sophisticated vessels vessels sophisticated more

giving orders for bigger and and for biggerorders giving 10

-

for Greatship (India) Greatship for

offshore support support vessels offshore

in a series of oil industry industry of seriesoil a in

Greatship Rashi, the 4th 4th Rashi,the Greatship

14th 14th included included in the

-

nd

under a billion billion USdollars a under

200 Asian firms with salesfirmswithAsian 200

magazine list of the top top magazinethe listof

annual Forbes Forbes financial annual 02

westcoast.

- delivered the 2nd of 4 2nd the delivered

-

Global Offshore Services Offshore Global

MPSVs for Singapore'sGreatship for MPSVs 26th 26th

Announced willAnnounced focus that more it

–

begun building abegun

rd

oil off the island'sthe north off oil

on offshore work withoffshore work search the for on 3

-

st

zone, at Kelani River atYard Kelani zone,

former northern war northern former

ferry for for passengersin the ferry 21

Announced Announced that it -

th

new afloat repair unit repair afloatnew

ground work to setto a work up ground

motion the necessary the motion

has already placed placed in already has 17

Announced was that it Announced

-

rd

in the south Asian region region Asian south the in

heavy engineering division division engineering heavy eying more work for its more work eying 03

Announced Announced investment in –

th

infrastructure development development infrastructure

technology improvements and and improvements technology

6 Announced 1 for Announced a a

–

th

20 reserve capitalizationreserve 20

28

0

50

100

150

200

250

300 350

CFA Sri Lanka Investment Research Challenge -Student Research | 36

VALUATION

Appendix 31: The shipbuilding Process Source: Maritime Economics(2009)

Contract signing An agreement is made after determining the general layout, specifications, ship price, ship building process etc.

Raw material and equipment procurement Managing the delivery dates of the large volume of materials required for ship building is vital, to ensure timely and accurate procurement.

Fabrication and modular assembly Steel plates are cut and processed as required. Next, these cut and processed components are assembled block by block, in a phased manner.

Vessel Assembly

The assembled modules are now mounted on the vessel. Accurate positioning of each block is critical.

Painting and Fitting

At this stage, the final touches such as painting and attaching of other fittings take place.

Launching Launching at a dock means filling the dock with water to float the ship.

Sea Trials Speed, engine performance and operation of all equipment and instruments are tested.

Delivery After the delivery ceremony, the captain, chief engineer and crew embard on the ship's maiden voyage.

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Appendix 32: Shipbuilding Revenue recognition assumption and projected building schedule

Our earnings forecast for shipbuilding is based on a percentage completion basis, where it is assumed that the building process flow through seven stages. This revenue recognition assumption leads us to an S-shaped cumulative revenue recognition curve. The stages, the % completion and S-curve are given below.

Cumulative Revenue recognized -an S % of Revenue curve Stages Recognition 100% Detailed design 5 80% Raw Material Purchase 10 Fabrication: Sub assemblies 25 60% Assembling units 30 40% Outfitting and Coating 15 Launching 10 20% Sea trials and Deliveries 5 Total 100 0% 1 2 3 4 5 6 7 Stages

It is expected that each stage will span averagely 2-3 months period. For a repeat order, process will be limited to 6 stages as the design is already been carried out.

Stage 1-3 will be constructed in fabrication yards and the rest will be taken inside dry docks. By utilizing dry dock 1 & 2, DOCK is capable of handling 3-4 vessels in a given time .The forecasted shipbuilding schedule is given below, the lightly shaded colors indicate the period where building is handled outside the dry docks. Whereas the darkly shaded portion reflects the time spend on dry docks.

2012 2013 2014 2015 2016 2017 Vessels Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 MPPSV -NC 223 MPPSV -NC 224 MPPSV - NC 225 MPPSV - NC 226 MPPSV - NC 227 MPPSV - NC 228 NC 229 NC 230 NC 231 NC 232 NC 233 NC 234 NC 235 NC 236 NC 237 NC 238 NC 239 NC 240 NC 241

In the above diagram the blue colour blocks indicates the currently available orders whereas the green colour indicates the expected ship building.

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Appendix 33: Beta Calculation Source: Bloomberg, Colombo Stock exchange data

20%

15%

10% y = 0.7933x + 0.0006 R² = 0.1955 5%

0%

-6% -4% -2% 0% 2% 4% 6% 8% DOCK stock return(%)stock DOCK -5%

-10%

-15% Return on ASPI

Appendix 34: FCFE Calculation Source: Student estimates

2012E 2013E 2014E 2015E 2016E 2017E Profit After Tax & Interest 1,637,902 1,853,145 1,637,069 2,048,751 2,421,729 2,474,022 Depreciation 325,857 414,490 485,782 501,327 527,396 554,821 Impairment 1,588 794 794 0 0 0 Changes in WC Receivables -2,142,402 3,842,163 -1,635,541 1,190,596 -252,255 -168,707 Payables 3,055,385 -44,859 -1,429,177 -445,973 -471,413 731,066 Inventory -57,077 -80,531 89,191 -31,000 -32,409 -20,293 Capex -1,018,303 -971,461 -607,228 -704,991 -741,651 -650,181 Net borrowing 185,116 242,774 -167,523 -134,019 -160,822 -112,576

Total 1,988,065 5,256,515 (1,626,634) 2,424,691 1,290,575 2,808,153 Terminal Value(at 4 % TGR) 16,261,018 Free Cash Flow to Equity 1,988,065 5,256,515 (1,626,634) 2,424,691 1,290,575 19,069,170

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Appendix 35: Steel Price vs PMI Source : TONGYANG Securities, Mysteel

220 60

210 58

200 56

190 54

180 52

170 50

160 48

150 46

140 44

130 42

120 40

Jul Jul Jul Jul Jul Jul

Jan Jan Jan Jan Jan Jan

Sep Sep Sep Sep Sep Sep

Mar Mar Mar Mar Mar Mar

Nov Nov Nov Nov Nov Nov

May May May May May May

2007 2008 2009 2010 2011 2012

China's Steel Price Index (LHS) HSBC China mfg PMI (RHS)

Appendix 36: Scenario Analysis

The revenue is forecasted based on three different scenarios (base case, best case and worst case). The following diagram depicts our expectations about LKR/USD exchange rate in the medium term.

140

Best case

Base case USD 120\ Worst case

LKR

100

2011 2012 2013E 2014E

CFA Sri Lanka Investment Research Challenge -Student Research | 40

Scenarios

Best Case -The LKR/USD rate is expected to increase at a CAGR of 1.8% per annum (average last 5 year CAGR). -The number of repairs carried out is 10% more than the base case scenario. Base Case -It is assumed that the LKR would appreciate against USD to 125.00 in during 2Q 2013, given the improved Balance of Payments and increased foreign currency reserve. -The ex-rate is then assumed to normalize in the subsequent years. -DOCK will be able to secure would a contract to build vessels which would occupy building dock space in early 2014 Worst Case -The LKR/USD rate is expected to decline below the medium term expectation set out in the best case -The ex-rate is then assumed to normalize in the subsequent years. -The number of repairs carried out is 10% less than the base case scenario. -No new contracts to build in 2014, except current secured contracts.

FCFE Valuation % Change

Terminal growth rate Scenario based Terminal P/E based Intrinsic Value Intrinsic Value

Base Case 246.1 255.94 251.02 Best Case 285.76 298.35 292.06 16.35% Worst Case 227.07 232.59 229.83 -8.44%

The above table indicates that the best case results in an intrinsic value of 292.06 which is 16.35% higher than the base case value. Our worst case results in a 8.44% decline from the base case intrinsic value, however the possibility of the worse case happening is minimal.

Appendix 37: Relative valuation Calculation Source: student estimates

Relative Valuation EV/EBITDA based Valuation P/E based Valuation Peer EV/EBITDA Average 7.72 Peer P/E Average 9.70 2013 EBITDA 2,437,700,864 2013 Earnings 25.79 EV 18,819,050,670 less :Market Value of Debt (502,603,100) less: Minority Interest (39,005,300) add: Cash 4,206,606,000 Common equity value 22,484,048,270 Number of of shares 71,858,925

Price per share 312.89 Price per share 250.15

CFA Sri Lanka Investment Research Challenge -Student Research | 41

Appendix 38: Peer Company Analysis and Peer Multiples Source: Bloomberg, Company Reports

M'Cap COMPANY Ticker Country (US $ Building Repair Other Profile Mil) Sri Lanka's leading ship repair, ship building, heavy Colombo Dockyards PLC DOCK:SL Sri Lanka 108.4 Y Y Y engineering and offshore engineering facility a. Regional Listed Competitors

Indian yard, focused on building & Repair bulk

ABG Shipyard Ltd ABGSHIP:NSI India Y Y N carriers, deck barges, interceptor boats, AHTS, DSVs, 329.38 tugs, and other OSVs Indian yard, focused on building bulk carriers, deck

Bharati Shipyard Ltd BHSL:IN India Y N Y barges, interceptor boats, AHTS, DSVs, tugs, and other 39.13 OSVs Singapore rig-builder. Also has property, Keppel Corp Ltd BN4:SES Singapore Y Y Y 16,363.31 infrastructure arms. Malaysian builder with Chinese partner yards. Asset- Nam Cheong Ltd NCL:SP Malaysia Y N Y 306.07 light model. Pure play on OSV-builders. b. Segmental Market leaders

Norwegian yards, specialized in building world-

STX OSV Holdings Ltd SOH:SP Singapore Y Y Y record high specification OSVs. Pure play on OSV- 1,420.5 builders.

SembCorp Marine Ltd SMM:SP Singapore Y Y N Singapore rig-builder. Pure offshore play. 8,399.6 c. Large Scale Shipyards

Daewoo Shipbuilding & South South Korean manufactures naval and commercial

A042660:KSC Y N N Marine Engineering Co Ltd Korea 4,478.54 ships which is the second largest shipbuilder in world. Hyundai Heavy Industries South World's largest shipbuilding company, operating in for A009540:KSC Y N N Co Ltd Korea 16,416.00 commercial and military markets. focus is on constructing ships, offshore floaters, gantry Samsung Heavy Industries South A010140:KSC Y N Y cranes, digital devices for ships, and other construction Co Ltd Korea 7,937.50

and engineering concerns.

COMPANY Trailing P/E Estimated P/E P/B P/S Div Yield % EV/EBITDA

Colombo Dockyards PLC 6.07 8.18 1.51 1.02 5.71 4.69

a. Regional Listed Competitors

ABG Shipyard Ltd 10.30 9.62 1.30 0.76 1.11 7.80

Bharati Shipyard Ltd 1.78 6.00 0.19 0.14 4.50 7.89

Keppel Corp Ltd 8.91 10.98 2.48 1.60 3.80 10.41

Nam Cheong Ltd 5.26 8.41 1.97 1.38 0.93 8.68

b. Segmental Market leaders

STX OSV Holdings Ltd 5.45 7.43 2.22 0.71 9.84 2.47

SembCorp Marine Ltd 14.70 16.50 4.60 2.33 5.01 12.92

c. Large Scale Shipyards

Daewoo Shipbuilding & Marine Engineering Co Ltd 7.66 10.81 1.15 0.38 1.80 8.93

Hyundai Heavy Industries Co Ltd 5.36 10.36 0.93 0.26 1.61 6.21

Samsung Heavy Industries Co Ltd 10.13 10.39 1.86 0.64 1.27 6.92

CFA Sri Lanka Investment Research Challenge -Student Research | 42

Appendix 39: Multiple analysis Source: Bloomberg, Student estimates

The subsequent graph depict the estimated share prices of DOCK calculated using comparables’ multiples. In each of the three multiples, there are nine estimated share prices, each computed by applying the value of the multiple of each comparable company to DOCK’s fundamentals. It is observed that the price range is wider for EV/EBITDA multiple than the P/E multiple.

700.00

600.00

500.00

400.00

300.00

Current Price

200.00

100.00

0.00

0 1 2 EV/EBITDA3 P/B P/E

CFA Sri Lanka Investment Research Challenge -Student Research | 43

6 Frequency distibution

5

4

3

Frequency

2

1

0 < 140 140-170 170-200 200-230 230-260 2260-290 290-320 320-400 400-500 Higher Price range

Appendix 40: Top twenty shareholders Source: Company Reports Name 2011-12-31 % 2010-12-31 % 01 Onomichi Dockyard Company Ltd 34,902,906 51.000 34,902,906 51.000 02 Employees Provident Fund 9,956,808 14.549 9,956,808 14.549 03 Sri Lanka Insurance Corporation Ltd – General Fund 3,421,903 5.000 3,421,903 5.000 04 Sri Lanka Insurance Corporation Ltd – Life-Fund 3,421,475 4.999 3,421,475 4.999 05 Sri Lanka Ports Authority 2,082,087 3.042 2,082,087 3.042 06 Employees Trust Fund Board 1,146,610 1.675 1,146,610 1.675 07 National Savings Bank 611,500 0.894 380,400 0.556 08 Pershing LLC S/A Averbach Crauson & Co. 590,900 0.863 622,100 0.909 09 Aviva NDB Insurance PLC A/C No. 7 492,755 0.720 382,455 0.559 10 Mr. M M Udeshi 396,450 0.579 355,950 0.520 11 Bank of Ceylon – No 1 A/C 394,000 0.576 - - 12 Amana Bank Limited 384,200 0.561 - - 13 J.B. Cocoshell (Pvt)_Limited 371,200 0.542 - - 14 Bank of Ceylon – No 2 A/C 320,000 0.468 320,000 0.468 15 Pan Asia Banking Corporation PLC/Mr. Morarji Meghj 245,193 0.358 245,193 0.358 16 DFCC Band A/C 1 234,125 0.342 234,125 0.342 17 Union Assurance PLC/No 01 A/C 227,000 0.332 152,000 0.222 18 Lanka Milk Foods (CWE) Limited 209,475 0.306 209,475 0.306 19 MAS Capital (Pvt) Limited 195,900 0.286 - - 20 Mercantile Investment PLC 161,000 0.235 - -

CFA Sri Lanka Investment Research Challenge -Student Research | 44

FINANACIAL ANALYSIS Appendix 41: Key Ratios Source: Company data, Student estimates

Ratio 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E 2016E 2017E

Profitability Ratios GP Margin 23.3% 26.0% 22.6% 18.1% 18.0% 20.0% 21.0% 22.5% 24.0% 24.0% NP Margin 13.04% 15.98% 14.37% 14.14% 11.34% 11.55% 11.48% 13.76% 15.59% 15.52% EBITDA Margin 17.96% 20.84% 15.52% 17.21% 16.82% 17.59% 18.50% 21.00% 23.04% 22.87% ROA 11.51% 15.45% 14.32% 12.41% 8.43% 8.75% 7.88% 9.30% 10.29% 9.45% ROE 32.08% 34.70% 26.91% 20.11% 16.05% 15.93% 12.81% 14.21% 14.79% 13.53% ROCE 37.25% 39.61% 25.68% 22.00% 21.59% 22.12% 18.84% 19.87% 20.11% 18.38% ROI 13.62% 16.99% 13.24% 12.56% 10.29% 10.67% 9.61% 11.35% 12.55% 11.52%

Leverage ratio Long term Debt/Total equity 1.5% 0.8% 0.4% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Activity ratios Asset Turnover 1.071 1.145 1.193 1.079 0.902 0.929 0.851 0.837 0.814 0.736 Liquidity ratio Current ratio 1.43 1.72 2.10 2.59 1.96 2.05 2.47 2.83 3.33 3.40 Quick ratio 1.30 1.61 1.99 2.45 1.87 1.96 2.37 2.71 3.19 3.28

Market ratios EPS 21.24 31.45 30.40 26.36 22.79 25.79 22.78 28.51 33.70 34.43 Book Value per share 69.60 90.82 113.20 131.59 142.48 162.43 17861 201.29 228.53 255.33 EV/EBITDA 0.67 5.09 5.41 5.60 ------P/B 0.79 2.87 2.24 1.70 ------P/S 0.32 1.32 1.20 1.20 ------Dividend Yield 5.48% 2.69% 3.15% 2.68% ------

P/E 2.58 8.28 8.36 8.50 ------

Appendix 42: Composition of ROE Source: Company data 40% 4

35% 3.5

30% 3

25% 2.5

20% 2

15% 1.5

10% 1

5% 0.5

0% 0 2007 2008 2009 2010 2011 EBIT Margin (LHS) ROE(LHS) Interest burden(RHS) Tax burden(RHS) Asset Turnover(RHS) Equity Multiplier (RHS)

CFA Sri Lanka Investment Research Challenge -Student Research | 45

Appendix 43: Quick and Current ratio Appendix 44: Net Profit, Gross Profit and EBITDA Margin Source: Company data Source: Company data 3.00 30% 2.50 25% 2.00 20%

1.50 15%

1.00 10%

0.50 5%

0.00 0%

2007 2008 2009 2010 2011 2008 2009 2010 2011 2012E 2013E 2014E Current ratio Quick ratio GP Margin NP Margin EBITA margin Appendix 45: Quarter Performance Analysis Source: Company data

2Q'10 3Q'10 4Q'10 1Q'11 2Q'11 3Q'11 4Q'11 1Q'12 2Q'12 Net Revenue 3,301,958 4,825,577 3,739,698 3,261,171 3,533,446 3,488,134 2,520,413 3,719,079 3,960,012 Gross Profit 691,093 1,195,930 779,410 914,148 440,608 622,300 334,344 865,321 865,073 Operating Profit 277,912 827,239 377,800 482,186 196,586 446,080 528,355 772,574 466,187 PBT 316,380 865,007 451,303 514,830 233,567 495,406 588,963 818,680 506,487 Net Profit 282,720 796,948 741,520 468,135 210,830 455,814 676,213 746,742 452,942

Gross Profit Margin 20.93% 24.78% 20.84% 28.03% 12.47% 17.84% 13.27% 23.27% 21.85% Operating Profit Margin 8.42% 17.14% 10.10% 14.79% 5.56% 12.79% 20.96% 20.77% 11.77% Net Profit Margin 8.56% 16.52% 19.83% 14.35% 5.97% 13.07% 26.83% 20.08% 11.44% Quick Ratio 1.46 1.78 2.10 1.75 2.06 2.07 2.59 1.78 1.84 Current Ratio 1.36 1.67 1.99 1.69 1.89 1.99 2.45 1.66 1.72 Net Asset per share 87.98 99.34 109.81 108.51 111.41 117.72 126.74 130.23 135.89 EPS 4.13 11.62 10.80 6.82 3.08 6.66 9.84 10.39 6.28

Appendix 46: Peer Ratio Analysis Source: Bloomberg, Company data

EBDITA Margin PAT Div Payout Total Debt/Total COMPANY 2010 2011 2010 2011 ROA ROE Ratio Equity Colombo Dockyards PLC 15.5% 17.2% 14.4% 14.1% 11.0% 19.7% 22.8% 0.004 a. Regional Listed Competitors ABG Shipyard Ltd 26.1% 24.2% 12.0% 9.1% 5.1% 15.3% 12.6% 1.93 Bharati Shipyard Ltd 23.4% 29.4% 9.6% 9.8% 2.5% 6.4% 9.3% 3.58 Keppel Corp Ltd 19.9% 23.5% 16.5% 18.3% 13.7% 18.4% 32.6% 0.69 Nam Cheong Ltd 17.7% 18.6% 15% 15.4% 10.6% 13.6% 46.3% 0.74 b. Segmental Market leaders STX OSV Holdings Ltd 11.2% 18.8% 9.0% 12.9% 11.7% 49.1% 80.7% 0.94 SembCorp Marine Ltd 22.5% 20.8% 19.6% 19.4% 15.5% 31.6% 32.4% 0.02 c. Large Scale Shipyards Daewoo Shipbuilding & 10.7% 9.8% 5.82% 4.5% 2.9% 12.0% 18.0% 1.06 Hyundai Heavy Industries Co Ltd 17.5% 9.2% 8.30% 9.0% 3.7% 11.0% 23.1% 0.73 Samsung Heavy Industries Co Ltd 10.7% 11.5% 6.78% 6.3% 4.8% 17.6% 12.7% 0.36

CFA Sri Lanka Investment Research Challenge -Student Research | 46

OTHER HEADINGS Appendix 47: CSR Philosophy of DOCK Source: Company Reports

Create "New CDPLC Man" who is economically stable, socially responsible, organizationally loyal, internally disciplined, technically component, functionally knowledgeable and equipped with shared goals

- Establish employee family welfare - Encourage employees to initiate Social Work - Provide assistants to procees Social Works successfully

Collective CSR approach: 1 + Employee volunteerism, 2 + Corporate involvement + Synergy: 3 Customers', Suppliers', Subcontractors' and external society's partnership

RISK ANALYSIS

Appendix 48: Comparison of Electricity Supply in Regional Countries Source: Asian Development Bank

Past Forecast Installed Electricity Imports and Annual Annual Generation Peak Demand Access to Country Generation or Exports Demand Demand Capacity (MW) Electricity (GWh) (GWh) Growth Growth (MW) Rate (%) Rate (%) Total 215 MW 839 GWh 323 GWh n/a 6.6% 26% of the 475MW (of (Suppressed import through population which hydro Demand) 363 2020 Afghanistan is 261MW). MW Available (Unsuppressed capacity 270 demand MW estimate) Total 4,120 21,162 GWh None 9% (1996- About 8.2% 38% by area MW (hydro 3,592 MW (FY (FY 2005) 2003) per year and 20% by Bangladesh 218 MW) 2005) through population 2020 Total 481 105 MW (2003) 2.355 GWh Imports 25 7.3% (FY 11.5% 40% of the Bhutan MW (hydro (FY 2005) GWh Exports 1998 to FY through population 469 MW) 1764 GWh 2003) 2012

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Total 93,255 MW 617,510 Imports 1764 4.2% 6.7% to 55.8% of the 124,287 MW (FY 2006) GWh (FY GWh during FY 7.5% households (hydro actual peak 2006) (Bhutan) 2000 to FY through (census of India 32,300 MW) demand met: export 241 2004 2032 2001) 81,792 MW GWh (to Nepal) Total 684 557 MW (FY 2,643 GWh Import 241 11% FY 7.6% 40% of the MW (hydro 2005) (FY 2005) GWh Export 1997 to FY through FY households Nepal 627 MW) 111 GWh 2005 2020 (2001 census) Total 19,505 14,091 MW 87,114 GWh Import About 5% 7.9% 55% to 60% Pakistan MW (hydro (FY 2005) (FY 2005) 25MW (from (FY 1994- through of the 6,500 MW) Iran) FY 2003) 2025 population Total 2,426 1,516 MW 7,662 GWh None 5.1% 1999- 7.8% 73.4% of the Sri Lanka MW (hydro (2003) (2003) 2003 through population 1,247 MW) 2024 Total 113,479 MW 739,285 151,978 MW GWh Region (hydro 41,622 MW)

Appendix 49: GDP vs Oil Demand Source: Clarkson Research

7% GDP Growth Oil Demand Growth 6%

5% 4%

3% 2% 1%

0%

-1%

2007 2008 2009 2010 2011

2012E 2013E -2% -3%

Appendix 50: Exchange rate Fluctuation (2000-To date): Source: Central Bank of Sri Lanka, Student estimates

140

120

100 USD \

LKR 80

60

40

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

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Appendix 51: List of Abbreviations

3D – Dirty, Dangerous and Demeaning AHTSV – Anchor Handling Tug Supply Vessel BDI – Baltic Dry Index CAGR – Compound Annual Growth Rate CAPEX – Capital Expenditures CFA – Chartered Finance Analyst CSR – Corporate Social Responsibility DCF – Discounted Cash Flow DOCK – Colombo Dockyard PLC DNV – Det Norske Veritas DWT – Dead Weight Tonnes EBIT – Earnings Before Interest & Taxes EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization EV – Enterprise Value FCFE – Free Cash Flow to Equity FY – Financial Year GDP – Gross Domestic Product GGOS – Greatship Global Offshore Services IFRS – International Financial Reporting Standards ILO – International Labour Organisation IMF – International Monetary Fund IMO – International Maritime Organisation LKR – Sri Lanka Rupees LNG – Liquid Natural Gas LPG – Liquid Petroleum Gas Mn - Million MPPSV – Multi Purpose Platform Supply Vessel NED – Non Executive Directors NP – Net Profit OHSAS – Occupational Health and Safety Advisory Services ONGC – Oil and Natural Gas Corporation OSV – Offshore Support Vessel P/B – Price to Book Ratio P/BV – Price to Book Value P/E – Price-Earnings Ratio PLC – Public Limited Company ROA – Return on Assets ROE – Return on Equity SLPA – Sri Lanka Ports Authority TGR – Terminal Growth Rate TV – Terminal Value ULCC – Ultra Large Crude Carrier USA – United States of America USD/US$ – United States Dollar VLCC – Very Large Crude Carrier

CFA Sri Lanka Investment Research Challenge -Student Research | 49

Disclosures: Ownership and material conflicts of interest: The authors or a member of their household, of this report does not hold a financial interest in the securities of this company. The authors or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the authors of this report is not based on investment banking revenue. Position as an officer or director: The authors or a member of their household, does not serves as an officer, director or advisory board member of the subject company. Market making: The authors do not act as a market maker in the subject company’s securities. Ratings guide: Banks rate companies as a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period, and recommends that investors take a position above the security’s weight in the S&P 500, or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over the next twelve months. Investment Research Challenge and Global Investment Research Challenge Acknowledgement: CFA Sri Lanka Investment Research Challenge as part of the CFA Institute Global Investment Research Challenge is based on the Investment Research Challenge originally developed by the New York Society of Security Analysts. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the authors to be reliable, but the authors does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Sri Lanka, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

CFA Institute Research Challenge

CFA Sri Lanka Investment Research Challenge -Student Research | 50