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August 17, 2015

Defence contracts could turn the tide for L&T shipbuilding

 
After years of losses, Larsen and Toubro Ltd’s big bet on shipbuilding seems to have found a way to succeed—defence contracts.
In the past two quarters, L&T has won deals worth Rs.1,900 cr-ore, including contracts to make offshore patrol vessels for the Indian Coast Guard and a floating dock for the Indian Navy.
But that’s not how it started.
Rewind to 2007. The global shipping industry was booming. New ships were being ordered at a rate never seen before. Demand was high and even shipbuilding nations such as Japan, South Korea and China faced a capacity crunch, forcing global fleet owners to look towards destinations like India.
In India, existing shipyards expanded aggressively and new players looked to enter the sector. Among them was L&T, India’s biggest engineering and construction firm.
But there were a few concerns, too. The biggest among them was a subsidy given to local shipbuilders by the government—both for export and domestic orders. It was in its last lap.
The subsidy scheme offered shipbuilders, both state-owned and private, 30% extra for building ocean-going merchant vessels that were more than 80 metres in length and made for the domestic market. For export orders, however, ships of all types and capacities were eligible for the subsidy.
“Subsidy is a key issue for shipbuilding in the country. Without subsidy, it is not attractive to put up a shipyard,” Anil Manibhai Naik, who was the then designated CEO and managing director of L&T, said in an interview on 2 July 2007. “I would like to make one thing clear... that if the government stops paying subsidy to shipbuilding units, we may not go ahead with our plans.”
Naik is now the group executive chairman of L&T. His argument was pegged on the cost disadvantage arising from the lack of government support for the industry in India compared to China, which at the time was rapidly gaining market share in ship construction.
Naik said he met then finance minister P. Chidambaram in June 2007 to lobby for the continuation of the subsidy. “Before I put Rs.2,000 crore on the table for building a mega yard, I met the finance minister and asked him whether the subsidy is going to continue or not,” he said.
Naik was talking about the shipbuilding facility that L&T was planning to set up at Kattupalli, 40km north of Chennai.
Naik’s eagerness for the subsidy surprised many. But the fact is that the shipbuilding industry globally thrived on direct and indirect support given by governments.
The subsidy scheme ended on 14 August 2007 after a five-year run. Yet, L&T went ahead with its plan and invested Rs.3,989 cr-ore to build the Kattupalli yard.
L&T realised the need for such a yard to cater to future projects when the company worked on India’s first nuclear-powered submarine INS Arihant in 2009.
“Our investment in the shipbuilding facility at Kattupalli was made with a long-term strategic perspective to be future-ready. We foresaw the need for our navy to get indigenously manufactured replacements for an ageing fleet and also for fleet strength augmentation. This was inevitable from both a cost point of view and from a strategic perspective of our country’s needs”, said an L&T spokesman.
The Kattupalli yard was a sure sign that L&T’s prime focus was something else, said a Chennai-based shipbuilding executive who had served in the navy.
The Kattupalli yard started building ships in 2012. But, by then, the global shipbuilding industry had plumbed the depths after the collapse of the Lehman Brothers and the financial meltdown that ensued.
It has so far built—or is in the process of building—ships for offshore oil exploration, interceptor boats and offshore patrol vessels for the coast guard and a floating dock for the navy.
When commercial ship orders dried up following the global financial crisis, L&T struggled. But soon local shipyards got a lifeline from the government.
In 2011, the government ordered a series of offshore patrol vessels, fast patrol vessels and interceptor boats to strengthen coastal security after 10 gunmen entered Mumbai by the sea route on 26 November 2008, and killed at least 166 people and injured nearly 300 in one of India’s worst terror attacks.
Producing interceptor boats and offshore support vessels will not give L&T the kind of returns on the money it invested, according to the Chennai-based shipbuilding expert cited above.
L&T’s shipbuilding unit pos-ted losses of Rs.136.82 crore in 2012-13 and Rs.355.11 crore in 2013-14.
But defence contracts are set to get bigger and pricier over time as the government modernizes an ageing naval fleet. This includes making nuclear-powered submarines and stealth warships as part of the Make in India programme.
In March, the government approved a plan to build six submarines locally at an estimated cost of Rs.50,000 crore. L&T is a strong contender for the deal.
“It’s (interceptor boats and offshore support vessels) a consolation prize for them until the submarine orders mature. Their main focus in putting up the Kattupalli yard was to capture a larger pie of the defence orders. Because, having been involved in the Arihant submarine project, they knew that the Indian Navy will not stop at one, and automatically more orders would follow,” he said.
L&T is among the four private local shipbuilders that have a permit from the government to build warships. But the playing field will get bigger if the government accepts the prescriptions of a panel led by former home secretary Dhirender Singh on defence purchases.
One of the suggestions is that private firms eyeing defence co-ntracts under the Make in India programme should have a net worth of at least 40% of the estimated development and engineering costs of projects and a credit rating of Crisil/ICRA B++.
Additionally, companies seeking to become strategic partners of the navy for constructing warships costing over Rs.10,000 crore should not be in the middle of corporate debt restructuring.
That could put yards such as ABG Shipyard Ltd, Bharati Shipyard Ltd, Pipavav Defence and Offshore Engineering Co. Ltd out of the reckoning.
Typically, it will take anywhere between 6-8 years for a new yard of the scale and size of Kattupalli to break even. “The cost of funds is what cripples a yard. If you have a healthy order book, you can play around with the finance and lower the financing costs,” the Chennai-based expert said.
L&T’s shipbuilding unit is now waiting for the tide to turn.

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