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Sunday, March 25, 2007

Tube Investments: Buy


Investors with a medium-term perspective can consider fresh exposure in the Tube Investments of India (TII) stock. At the current market price of Rs 53, the stock trades at about eight times its likely FY-08 earnings per share.

Robust demand environment, planned expansion in capacity and an expected improvement in operating margin are likely to enhance earnings growth.

The boom in the automobile industry is also likely to rub off positively on TII's metal-forming division, which, we believe, will be the growth driver.

Though the stock price has declined in the recent past, the planned expansion and growth prospects are likely to favour its performance in the long run.

Business Segments

TII has its presence across three business segments — metal-forming, engineering and cycles. The metal-forming division supplies doorframes to car manufacturers such as Maruti and Hyundai for their specific models.

This unit is likely to propel growth, given that both the companies are well established and could come up with new models . In addition to this, TII plans to set up a new car doorframe plant near Pune, which is a positive.

With a 65 per cent market share in the manufacture of roll-formed car doorframes, TII is likely to be a big beneficiary of an automobile boom. However, since the doorframes are model-specific, revenues for this division depend, to a large extent, on the success of the particular car models.

The division also makes chains for automotive and industrial purposes. The revenue contribution from this segment is likely to improve on the back of a healthy demand environment in the two-wheeler industry. In addition to this, the existence of a sizeable replacement market for such chains underscores the growth prospects for this segment.

TII is an established player in precision tubes and steel strips — the two key products of the engineering division. The capacity expansion in the precision tubes segment, which was postponed last year due to delay in getting clearance from the Pollution Board, is likely to be in place in FY-08. The positive demand outlook from its user industries, coupled with TII's plan to nearly double its capacity, suffuses more confidence on the prospects of this division. In addition to this, with the increased capacity skewed in favour of manufacture of cold-drawn welded tubes, which enjoy higher realisations, the bottomline contribution from this division is likely to improve .

The cycle division of TII, however, has been a laggard. In spite of double-digit sales figures, the division's contribution to the overall profitability was only about 8 per cent for the last financial year. However, the shift in the company's product mix towards more of engineering and metal-forming goods is likely to reduce its dependence on the cycle business. Also, TII's holding in Cholamandalam MS General Insurance and Cholamandalam DBS Finance could see some value unlocking in the future. However, the same has not been factored into the valuation of the stock.

For the quarter-ended December 2006, the topline recorded a marginal growth of about 6 per cent over the corresponding quarter last year. Revenues from the metal forming and engineering divisions rose 25 per cent and 13 per cent during the period. However, in terms of earnings, the engineering division continues to be highest contributor (about 56 per cent in the last quarter).

The quarter also saw a 411 basis points dip in operating profit margin. Rise in input costs and muted revenue growth could be responsible for this. However, with the addition of capacities, change in product mix and a stable steel price outlook, the margin pressure is likely to ease.

Concerns

Given that a significant portion of TII's revenues (about 60 per cent) depends on the performance of the auto sector, any slowdown is likely to affect its earnings negatively. This apart, the threat of imports from China, rising raw material costs and the inability to pass on input cost hikes to its customers fully, could pose downside risks to our recommendation.