Electrosteel Steels IPO Analysis

Promoted by Electrosteel Castings (ECL), Electrosteel Steel is setting up a 2.2-million tonne per annum (MTPA) integrated steel and ductile iron (DI) spun pipes project in Jharkhand, India. ECL has obtained mining blocks of iron ore and coking coal in Jharkhand and has set up Electrosteel Steel for implementing the integrated steel and DI pipe plant.



ECL has been manufacturing cast iron pipes for over four decades and ductile iron spun pipes since the last 15 years. For FY 2010, ECL recorded consolidated net sales of Rs. 1580.77 crore and net profit of Rs 234.25 crore. ECL has four manufacturing facilities, two located at Khardah and Haldia in West Bengal, one at Elavur in Tamil Nadu, and one coal washery plant at Parbatpur in Jharkhand.

Electrosteel Steel is setting up the proposed plant near Siyaljori village in Bokaro District of Jharkhand. The proposed plant will be based on Blast Furnace (BF)-Basic Oxygen Furnace (BOF)-Billet Caster and Hot Rolling Route and will produce 1.2 MTPA of long steel products, comprising 0.5 MTPA of 5.5-12.0 mm diameter wire rods in coil form and 0.7 MTPA of reinforcement bars in straight lengths and bundled in the range of 8-32 mm and plain rounds up to 60 mm diameter. The plant will have a 0.33 MTPA DI pipe production facility in the same complex and will be provided with hot metal from the blast furnaces. The plant will also have production facilities for 0.27 MTPA of commercial billets and 0.40 MTPA of pig iron.

The company has 1804.70 acres of land under possession. It will use around 600 acres for the current 2.2 MTPA plant, while the rest will be used for future expansion.

ECL has agreed to supply iron ore and 30% of coking coal requirement of EIL on a cost plus 20% basis for 20 years from the date of commencement of commercial production. Limestone would be procured locally and from Dubai and Thailand, while dolomite would be procured from the Birmitrapur region. ECL has geological reserves of 231.2 million tonnes of coking coal and 91.2 million tonnes of iron ore in Jharkhand.

Electrosteel Steel is also planning to have is own private railway siding located at the plant, which further reduces its logistics cost. The company will have a captive 108-MW power plant, which would cater to 63% of the peak plant requirements.

ESL has entered into a delivery and marketing agreement with Stemcor for international marketing for 3 years after COD.

The company expects to sell 50% of its products in east zone, considering majority of new power plants, steel plants, roads & railway developments will concentrate around Bihar, West Bengal, Jharkhand, Orissa and North-eastern states, while 10% to be sold in the west zone, which is the country's leading industrial production area. 15% of products are to be sold in the north zone and 5% to be sold to the south and central zones. The company hopes that exports can constitute 20% of total sales volume, factoring in off-take agreements with Stemcor.

The company is coming with an IPO, offering 25.93-crore equity shares including green shoe option of up to 3.38-crore equity shares at a price band of Rs 10-Rs 11 per share aggregating Rs 259.3 crore at the lower band of Rs 10 and Rs 285.23 crore at the upper band of Rs 11 (assuming green shoe option is exercised). If green shoe option is not exercised, the company shall raise Rs 225 crore at lower band of Rs 10 and Rs 248.05 crore at the upper band of Rs 11 per share. The issue constitutes 11.08% of the fully diluted post-issue paid-up capital of the company, assuming the green shoe option is not exercised and 12.54% of the fully diluted post-issue paid-up capital, assuming green shoe option is exercised in full.

The company has made allotment of 14.32-crore equity shares through pre-IPO placement, amounting to Rs 154 crore, with GPC Mauritius II LLC and Franklin Templeton Asset Management (India).

The company intends to use the IPO proceeds to part finance the construction of the integrated steel and DI pipes plant with a capacity of 2.2 MTPA in Jharkhand, margin money towards bank guarantees, and for general corporate purposes.

Strengths

The company has long-term supply arrangements with its promoter ECL for supply of iron ore and 30% of coking coal requirement, resulting into assured supply of raw materials.

Promoter ECL is in the business of manufacturing CI spun pipes for over four decades and DI pipes since the last 15 years. Domestic DI pipes have a current demand of 8 lakh tonnes per annum. Out of this, 5 lakh tonnes per annum are produced locally along with promoter Electrosteel Casting and enjoy a market share of 53%, followed by Jindal Saw at 27%, Tata Metaliks 13%, and Electrotherm India 7%.

Factory site is close to most of raw material resources and evacuation facilities, which would result in optimal logistics costs and management

Industrial and residential construction along with infrastructural development and increasing export thrust to sustain demand for long steel products going forward. Demand for long steel products expected to grow at 8.3% p.a.

Weaknesses

Promoter and certain group companies may have a conflict of interest as they are in similar line of business manufacturing DI pipes and pig iron.

India is witnessing massive steel capacity expansions by frontline players like Tata Steel and SAIL, which are established players and have integrated facilities. Relatively, Electrosteel Steel is less integrated and has to depend on its parent company, ECL. Execution of mining lease is pending for receipt of approval from the Ministry of Environment and Forests, Government of India, for ECL's proposed iron ore mine at Kodolibad, Jharkhand. If clearances are not received in time, then Electrosteel Steel will be at a disadvantage as ECL may have to procure iron ore and coal at much higher cost, which will be a pass-through item against Electrosteel Steel.

With significant excess capacity in the global steel industry during 2009-10, cheap imports from China and CIS continue to pose threats for domestic suppliers. India could become the target for cheap steel exports, with growth in developed countries somewhat shaky. For the past few years, India is a net importer of steel. But with massive domestic capacity expansions, the country may have to export surplus capacity to ensure high capacity utilization. Relative to global players in general and China in particular, India is at a disadvantage.

The Indian rupee has strengthened against the US dollar in recent times. Further appreciation of will adversely impact the price line for the steel sector as the domestic prices for steel are determined by the landed cost of imports.

The debt equity ratio of the Electrosteel Steel is relatively high at 2.5 compared to 1.77 of Tata Steel, 0.50 of SAIL and 1.07 of JSW Steel

The iron ore and coking coal- mines of the promoter are still under development.

Steel Industry is cyclical in nature, sensitive to general economic environment conditions.

Valuation

Electrosteel Steel is expected to commence commercial operation in October 2010 for its first blast furnace. Promoters till now have put in money at Rs 10 and the pre-IPO placements have been made at Rs 10.75.

Electrosteel Steel EV per tonne at the lower band of Rs 10 comes at Rs 3346.4, while at the higher band of Rs 11 it comes at Rs 3510.1 if the green shoe option being exercised. This can be compared well with EV per tonne of JSW Steel at Rs 4171.5, SAIL at Rs 5130.0 and Tata Steel at Rs 2841.3.