Welspun Gujarat Stahl

Investors can consider buying shares in steel pipe maker, Welspun Gujarat Stahl. The price of Rs 277 gives the company a price earnings of 11.3 times the trailing four quarter earnings.

An integrated business model, improving margins and product mix and impending domestic and global demand make this business attractive. The above considerations may justify the premium over sector peers such as MAN Industries, PSL and Jindal SAW, which trade at seven times, eight times and 10.6 times respectively.

Over 80 per cent of the company's sales are accounted for by exports to markets such as the US and Canada. Sales and net profits have grown at a compounded rate of 54 per cent and 58 per cent between FY-05 and FY-09.

The first nine months of FY-10 saw sales rise by 27 per cent and operating profits by 77 per cent on the back of expanded capacity and lower raw material costs compared to the same period last year.

The company's order book stands at Rs 7,800 crore, which is just over one time the estimated FY-10 revenues. . The company's leverage as of March 31, 2009 stood at 1.4:1, which is higher than peers. However, with a good portion of the capacity expansion programme implemented, capital needs over the next few years may moderate. Interest coverage over the trailing 12 months stood at a comfortable 4.6 times (EBIT/interest costs).

The other possibly explosive driver could be government spending on water and sewage management for urban areas whose allocations are encouraging signs of things to come.

Growth drivers

Welspun produces 1.5 million tonnes of pipes at manufacturing locations in Gujarat and the US. The company produces 900,000 tonnes of helical submerged arc-welded (HSAW) pipes, 350,000 tonnes of longitudinal submerged arc-welded (LSAW) pipes and 250,000 electric resistance-welded pipes (ERW).

They are expected to add 600,000 tonnes over the next two years. Capacity utilisation figures which averaged 65 per cent through FY-09.

Simdex, which publishes upcoming pipe projects, indicates about 320,000 km of pipeline to be laid globally over the next five years.

This works out to 65 million tonnes of demand for the next five years at an approximate cost of $70 billion. Bulk of this demand will come from the US and Asia.

Welspun may have an edge by virtue of having supplied and being accredited by global oil majors, including Chevron and Aramco.

Domestic scenario

India's own natural gas plans include 7,500 km worth of gas pipeline spending over the next two years translates into 1.5 million tonnes of piping. Sewage lines and water lines will be another source of demand with both being an important part of the governments plan to improve rural life and upgrade decaying urban infrastructure. Roughly Rs 80,000 crore is expected to spent over the next five years under the Urban Renewal Scheme to improve waste management and water lines. All of the above make for a healthy demand side of the equation over the next five years.

. Welspun recently started producing its own slabs and coils which should give it tighter control over its supply chain, considering the risk a tightly supplied domestic market poses.

The biggest cost component remains steel, whose depressed prices through a large part of 2009 helped producers.

Raw material cost pressures and demand recovery are driving up steel prices this year and will result in margin pressure on pipe-makers, whose ability to pass on costs may be limited, given the abundant capacity.

Moves towards vertical integration include the recent Rs 400-crore acquisition of MSK Projects through a recently-formed subsidiary, Welspun Infratech.

The acquisition was funded through internal accruals. The intended 75 per cent stake in MSK will result in the ability to build pipes and lay them through the engineering, procurement, construction model.

This move would give the company a presence in the construction segment through MSK's Rs 500-crore order book.

Risks

A weakening dollar can result in lower realisation. This is hedged by raw material purchases from abroad and forward currency contracts.