- Initiating Coverage Jindal SAW (SAWPIP) Report by ICICI Direct

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Initiating Coverage Jindal SAW (SAWPIP) Report by ICICI Direct

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Initiating Coverage Jindal SAW (SAWPIP) Report by ICICI Direct

Saturday, 15 September 2007

Jindal SAW (JSL) remains our top pick despite the divestment of its US operations. We believe the divestment is earning accretive, as the company will now have a focused approach towards its robust high-margin
Indian operations, wherein it follows an integrated and diversified business model. Further, de-bottlenecking and capacity additions would yield healthy EPS growth due to improved product mix. With all the business drivers in full throttle, lower P/E multiple of 6.5x FY09E EPS makes the stock risk-reward favorable.

Divestment of US business – EPS accretive

We believe divestment of US operation, which contributed about 44% to FY06 turnover, is earnings accretive. EBIDTA margin is set to improve FY08 onwards due to the following reasons:
(1) US operations had low EBIDTA margin;
(2) parking of the proceeds in high-margin Indian operations; and
(3) reduction in interest cost on account of de-leveraging of business.

Ramping up seamless pipe capacity by 2.5x

JSL is expanding its seamless pipes capacity from 1 lakh tpa to 2.5 lakh tpa by the end of FY08 at an investment of Rs 300 crore. With the expansion, JSL is setting up PQF mill, which would improve the seamless pipe’s yield from 78% to 88%. We believe gross contribution (sales less raw material cost) would rise and seamless pipe’s sales contribution would be doubled.

Favourable risk reward

It is the only company in Indian pipe sector that provides total large DI pipe solution to the water management and oil & gas sector. Being the most diversified, it is also integrated for DI. Intra group, it is integrated for its entire offering.

Valuations Jindal SAW

We expect the EPS to grow at a CAGR of more than 39% over FY06-09E. Historically, the stock has traded in the P/E band of 4x-12x against the EPS CAGR of 24% over FY02-05. Currently the stock trades at 6.55x FY09E EPS of Rs 92.37. At the P/E of 8x FY09E EPS, the 12-15 month target price works out to 738.

Company Background Jindal SAW

Jinsal SAW (JSL) is India’s one of the largest producers of SAW pipes. It is integrated for DI pipes and seamless pipes. JSL has a diversified product portfolio. It produces SAW pipes, carbon, alloy and stainless steel seamless tubes, which are manufactured by conical piercing process and used for industrial application & ductile iron (DI) pipes for water and sewage transportation.

JSL is a market leader and a global major in providing total pipe solutions. Its business operations are structured with three strategic business units (SBUs) – SAW pipes, seamless tubes and DI (Ductile Iron) Spun Pipes.

Every SBU has its own dedicated sales marketing targets and operations. The company recently sold its fourth SBU in the American market. The sale of the SBU in US is likely to fetch post tax US$200 million, which the company plans to utilize for de-leveraging the balance sheet and in enhancing the capacity in LSAW and HSAW pipes. Besides these, JSL also provides various value added products and services like anti-corrosion coatings for pipe and bends, bends and connector casings.

Divestment of US business – EPS accretive

We believe divestment of US operation, which contributed about 44% to FY06 turnover, is earnings accretive as EBIDTA margin are set to improve FY08 onwards. The reasons being 1) US operations low EBIDTA margin; 2) parking of the proceeds in high margin Indian operations; and 3) reduction in interest cost on account of de-leveraging of business.

1) US operations had low EBIDTA margin

We believe post divestment of US operations, EBIDTA margin would improve as 45% of total turnover (which was coming from US operations) was generating EBIDTA margin of 8-9% while the 55% (from Indian operations) was generating EBIDTA margin of 16-18%. With divestment of US operations in FY07 (year ending Sept 30), we expect a combined EBIDTA margin of 11.60% for FY07E. From FY08 onwards we expect EBIDTA margin to expand to 15% in FY08E & 17.72% in FY09E.

2) Parking proceeds in high-margin Indian operations

With the proceeds of the sale of US operations of US$200 million (post tax), the company plans to enhance its LSAW as well as HSAW capacity. The company has already 800,000 tonne LSAW capacity and it plans to ramp it up to 1 million tonne. Looking at the rising demand of HSAW pipe in the domestic markets the company decided to ramp up the HSAW capacity as well.

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Its 200,000 tonne capacity is coming in March 2008. With the proceeds of the sale, the company plans to set up another HSAW capacity of 200,000 tonne, taking the total HSAW capacity to 0.55 million tonne. We believe the strategy to secure the short to medium term business through HSAW pipes and grow in long term with good margins is
praiseworthy.

3) Reduction in interest cost on account of de-leveraging of business

With the proceeds of the sale of US operations, the company plans to de-leverage the business by paying off the short-term loans. We believe interest expenses would decline from Rs 129 crore in FY06 to Rs 81 crore in FY08E.

However with the commissioning of new capacities, we expect leverage to increase due to higher working capital requirement on expanded capacity base.

Largest LSAW pipe manufacturer

We believe JSL would be one of the prime beneficiaries of the drive for creating oil & gas transportation infrastructure as it is the largest LSAW pipe manufacturer in the country.

The company plans to expand LSAW capacity by 200,000 tonne with proceeds from the sale of US operations. With higher exposure to LSAW pipes, we expect margins to expand. As the company already has a presence in seamless and DI (ductile iron) pipes segment, it would cater to the rising demand from oil exploration segment as well as water resources management.

Strong order book position to drive growth

After the sale of US operations, JSL has an order book of US$0.7 billion to be executed in next 12-15 months. Execution of these projects gives visibility to turnover for FY08E and FY09E. We expect JSL to report net sales growth at a CAGR of 7% over FY06-09E to Rs 4691.81 crore.

Capex in seamless pipe – margins to expand & capacity to be doubled

JSL is expanding its seamless pipe manufacturing capacity from 1 lakh tpa to 2.5 lakh tpa at an investment of Rs 300 crore. The new capacity would be operational by the end of FY08. It is also installing balancing equipment, whereby the yield of the seamless pipe plant is likely to improve from current 78% to 88% by FY09E.

Valuations Jindal SAW

The company is the most diversified in terms of product offering and is vertically integrated for DI pipes. Intra group, the company is vertically integrated for its entire product offering, including LSAW, HSAW and Seamless pipes and tubes.

The integration and diversification de-risks its business model. Moreover, JSL’ 50% market share in the domestic market provides a comfort on revenue front. On the back of the de-bottlenecking and capacity expansion, we expect the EPS to grow at a CAGR of over 39% over FY06-09E. Currently, the stock trades at 6.55x FY09E EPS of Rs 92.37. We rate the stock an OUTPERFORMER with a target price of 738, 8x FY09E EPS for the investment horizon of 12-15 month.

Historically, the stock has traded consistently around 8x one year forward EPS and no P/E re-rating has been seen. Our one-year target price of 8x FY09E EPS is justifiedr on this ground.

In terms of EV to EBIDTA, the stock is trading at a multiple of 2.87x FY09E EBIDTA.
Our DCF method fetches a value of Rs 738.

Source : ICICI Direct

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