IT Services, Union Bank of India, Jindal SAW, Nelcast

IT Services, Union Bank of India, Jindal SAW, Nelcast

Nelcast: Invest at cut-off

Investors with a two/three-year perspective can consider investing in the initial public offering (IPO) of Nelcast. In the Rs 195-219 band, the offer is priced at 11-13 times the likely FY-08 per-share earnings on the post-offer equity base. In the business of manufacturing casting components, Nelcast is likely to scale up its growth, given the increased demand for castings in both the domestic and foreign markets. It is also likely to benefit from its proposed increase in focus on exports and machined casts. This apart, its set of established clients such as Ashok Leyland, TAFE and TATA Cummins also lends confidence to its earnings growth prospects.

Investment rationale

Nelcast, which derives more than 50 per cent of its revenues the commercial vehicles segment, could witness increased demand on the back of an expected growth in freight traffic and the proposed introduction of emission and loading norms. However, any slump in the growth of the interest rate-sensitive commercial vehicles industry may mute Nelcast's earnings.

In this context, Nelcast's decision to widen its product base towards small castings to cater to passenger cars and light commercial vehicles is a positive. This apart, the proposed increase in the manufacture of machined casts, aimed at 20-25 per cent of total production by the next fiscal year, could give a further fillip to the bottomline, as these products enjoy better pricing and margins.

On the export front, outsourcing of casting components is likely to remain buoyant, given the strict environmental norms, rising labour costs and shortage of skilled labour in markets such as the US and Europe.

Encouraged by this rising demand scenario, Nelcast proposes to dedicate about 25 per cent of its capacity (post-expansion) for exports. While Nelcast already has a presence in US through its subsidiary and supplies to Volvo Sweden through its Tier-I supplier, Arvin Meritor, the increased thrust on exports is likely to help it strengthen its presence in the global arena. Further, as exports enjoy better realisation, revenues should rise.

For the financial year ended March 2007, the company reported a revenue growth of about 30 per cent to about Rs 350 crore. The earnings recorded a 182 per cent increase to about Rs 7 crore.

On the operational front, margins expanded by about 5 percentage points to 25 per cent on the back of increased sales realisation and pruning of costs.

The earnings per share on a fully diluted basis stood at about Rs 11 for FY-07.

Objects of the issue

The issue proceeds will be used to fund the expansion and modernisation of production facilities at both the units of Nelcast. The company plans to increase capacities from about 102,000 tonnes to about 120,000 tonnes by FY-08 and an additional 30,000 tonnes by FY-09.

Concerns

While Nelcast's decision to increase its focus on exports is a positive, its ability to source orders from global players could be crucial. Our concern stems from the increased competition in the export market from both the domestic and Chinese players. This apart, since most of the existing players in the domestic market are on an expansion mode, it could lead to an excess supply scenario, which could cap Nelcast's earnings. Offer details

The offer is open from June 4 to June 8. The company seeks to raise about Rs 95 crore through this offer. Karvy Investor Services and Bigshare Services Private Limited are the lead manager and registrar to the issue respectively.

Nelcast : Dependent on the auto industry

Nelcast, promoted by P.Radhakrishna Reddy, is a TS 16949 accredited organisation. The product range includes around 200 items in SG (Spheroidal Graphite) Iron Castings and grey iron castings. Cylinder blocks, rear hubs, spring shackle, brackets, and exhaust manifolds manufactured by the company are used in heavy commercial vehicles (HCVs) and tractors.

The cost of expansion/ modernisation of the existing production facilities from 72,000 tpa to 1,50,000 tpa is estimated at Rs 61.46 crore, while incremental working capital requirement is projected at Rs 25 crore.

Part of the expansion has already been carried out: Installed capacity has increased to 1,02,000 tpa from 72,000 tpa end of the second half of the year ending March 2007. Further expansion is on the anvil at both the existing plants to achieve a total capacity of 1,50,000 tpa FY 2009. The expansion would be undertaken in a phased manner. Capacity would be increased from 1,02,000 tpa to 1,20,000 tpa by September 2007, and from 1,20,000 tpa to 1,50,000 tpa by September 2008.

Right now, Neelcast exports about 9% of its sales Globally, export of castings to developed nations is on the rise on account of rising costs, lack of skilled foundry people and environmental restrictions in these markets. The export target is 30% of sales by 2010.

Strengths

* The composition of machined castings is about 10% of production. This is to be increased to about 20%-25% over the next two years so as to improve margin.

Weaknesses

* More than 70% of revenue is derived from the HCV and tractor segments. Both these user industries are set to slow down significantly in FY 2008 even as the company is implementing substantial capacity expansion.

* Ancillaries to domestic auto and auto components sectors often have to maintain their prices despite rising raw material cost due to a limited number of clients. Margin is down from 11.9% in FY 2004 to 8.9% in FY 2006, though it jumped to 13.4% in FY 2007.

Valuation

At a price band of Rs 195–Rs 219, Nelcast’s P/E works out to 17.2–19.3 times FY 2007 earning on post-diluted equity. Industry peer Ennore Foundries is trading at a P/E of 19.0.