Loha Ispaat IPO Analysis

Loha Ispaat is as an independent steel service centre (SSC), acting as an intermediary between primary metal producers who generally sell large volumes of limited size and configuration products and end-users requiring economical quantities and customized products. The company offers a variety of sizes, grades and standards of steel processed according to customer specifications. It purchases raw materials like hot rolled (HR), cold rolled (CR), hot rolled pickled and oils (HRPO), cold rolled closed annealed (CRCA) coils, sheets and plates from steel manufacturers and converts them into various shapes and forms through de-coiling, re-coiling, slitting, pickling, oiling, roll forming, and cutting. The product portfolio offers a diversified range of grades, thickness, widths and standard of HR, CR, HRPO, CRCA and galvanized coils and plates; chequered coils and plates; and trapezoidal blank coils as per orders.

Two subsidiaries, Loha Ispaat Hong Kong (100% owned) and Loha Ispaat Middle East Fz (90% owned), support marketing in international markets.

There are two manufacturing locations. The Khopoli unit in Maharashtra provides various lines for slitting and cut-to-length (CTL) facilities and is currently operating at capacity of nine lakh tonnes per annum (tpa). This would be augmented to 21.82 lakh tpa post expansion. Initial commercial production began from September 2012. The Tajoja unit in Maharashtra operates manual pickling of HR sheets and plates. The capacity is 1.05 lakh tpa. Initial commercial production has started at the cold rolling mill (CRM) complex at MIDC Taloja. With capacity of 30,000 tpa, this is a backward integration facility. Full commercial production of the expansions will be visible in FY 2015 earning. The entire expansion was undertaken at capex of about Rs 358 crore and was funded by debt and promoters' equity of about Rs 120 crore.

The initial public offering comprise 2.67 crore of equity shares of Rs 10 each in a price band of Rs 77-80. At the lower price band, about Rs 205.63 crore will be raised and at the higher price band about Rs 213.64 crore. Between December 2013 and February 2014, 35.36 lakh equity shares were allotted to pre-IPO investors at a price of Rs 78 per equity share aggregating to Rs 27.58 crore. The net proceeds of the issue and the pre-IPO placement funds will be utilised to meet the working capital requirement of the Khopoli and Taloja plants post expansion. The funds will take care of the working capital requirement till FY 2015.

Strengths

Of the total flat steel consumed in India, only about 13% gets routed through SSC in India as against about 60% internationally. Hence, even if the steel or the user industry does not grow, new customer base can continue to expand.

Small users would prefer the CSS model due to benefits of low inventory and working capital requirement, time-saving conversion process, and money-saving dedicated shops. Also, the R&D centre helps user industries to make the best and effective use of flat steel, which they may not be in a position to do due to lack of facility at their plants.

The diversified customer base consists of more than 500 regular large- and medium-sized domestic customers,, with no single customer accounting for more than 1% of total sales. Customers include original equipment manufacturers (OEMs) covering more than 100 types of industry segments and sub segments such as automobiles, bearings, fabrication, packaging, general engineering, pipe manufacturing, white goods, infrastructure, and home appliances.

Weaknesses

The business is low-tech, low value addition, and volume-driven.

Risks include raw material price fluctuations, customer default, high working capital requirement, high inventory and a very thin margin. The profit after tax (PAT) margin hovers around 1.7-2%.

Consolidated debt:equity ratio including short-term borrowings stood at 1.5 end September 2013. Consolidated inventory days stood at 75 days and consolidated debtors days at 77 days end March 2013. Post fiscal ending March 2015 (FY 2015), more working capital will be required for future growth.

High interest rates and a slowing economy make the business risky.

The full effect of the expanded capacity will be visible from FY 2015. If the economy and the number of clients do not improve, then higher interest and depreciation on the expanded capacity will hurt the bottom line.

Valuation

Consolidated net sales were Rs 3429.02 crore and PAT Rs 70.45 crore in FY 2013. Consolidated net sales stood at Rs 2021.65 crore and PAT Rs 38.90 crore in H1 of FY 2014. On fully diluted post-IPO equity share capital of Rs 101 crore, EPS for FY 2013 was Rs 7 and annualised H1 of FY2014 EPS Rs 7.7. At the lower price band of Rs 77 and higher price band of Rs 80, the offer price discounts FY 2014 annualised earning 10 times and 10.4 times, respectively. Most of the large steel players such as like JSW, Uttam Galva and Tata Steel have their own dedicated in-house lines, which act as SSC. But the contribution from these centres is low. There is no listed comparable player with focus on the SSC business. Such low value-addition and high working-capital-intensive business deserves P/E lower than 10.