- Initiating Coverage Welspun Gujarat Stahl Rohren (WELGUJ) Report by ICICI Direct

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Initiating Coverage Welspun Gujarat Stahl Rohren (WELGUJ) Report by ICICI Direct

Saturday, 15 September 2007

Welspun Gujarat's net profit is expected to grow at a CAGR of 50% over FY07- 09E. However, we believe the same may not get captured into EPS growth due to equity dilution.
Our DCF model fetches a value of Rs 246 against the current price of Rs 240. RoNW is likely to decline from 21% in FY07 to 18% in FY09E. We expect the top line to grow at a CAGR of 31% to Rs 4,559 crore over FY07-09E. We rate the stock HOLD.

Robust order book of over 2x FY07 revenue

The company is sitting on a robust order book of Rs 6,150 crore (US$1.5 billion converted at Rs 41/$), which is over twice its FY07 net revenue. The orders, to be executed in 12-15 months, give higher visibility to top and bottom line growth. We expect turnover to grow at a CAGR of 31% and bottom line to grow at a CAGR of 50% over FY07-09E.

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Backward integration to ensure raw material supply at lower cost

Welspun Gujarat is integrating backward to manufacture steel plates and coil at an investment of Rs 1811 crore, which would go on stream in December 2007. We expect lower raw material cost to expand operating margin to 15% in FY09E from 12.32% in FY07.

Valuation

The company’s RoCE is likely to rise from 13% in FY07 to 17% in FY09E while RoNW would decline from 21% in FY07 to 18% in FY09E on account of back ward integration and equity dilution.

Though the backward integration is value accretive, we perceive a risk. We foresee increased competition in the steel plate segment as many plate mills are coming up in the country. Due to higher competition, we believe RoCE of plate mill might be lower and the break-even for it may get extended.

However, the pipe business would thrive well. At the current price of Rs 240, the stock trades at 7.24x its diluted FY09E EPS of Rs 33.17 and 7.34x diluted FY08E EPS of Rs 32.69. Our optimistic DCF model gives a fair value of 297 while our base case scenario fetches the fair value to Rs 246 which is closer to the current levels. We rate the stock hold with price target of Rs 264.

Company Background Welspun Gujarat Stahl Rohren

Welspun Gujarat Stahl Rohren (WSGR) was established in 1995 to manufacture SAW pipes. The company manufactures longitudinal submerged arc welded Pipes (LSAW), helical submerged arc welded Pipes (HSAW) and electric resistant welded Pipes (ERW) pipes ranging from half an inch diameter to 100 inches in diameter, in varying qualities and grades.

During the last 9 years, it has grown at a CAGR of 74% from a top line of Rs 18.7 crore in 1998 to Rs 2678.5 crore in 2007. Welspun Gujarat is one of the largest SAW Pipes companies in Asia and among top five companies in the world. The company has accreditations from every major Oil and Gas company from across the Globe like Shell, BP, Gazprom, Total, Gail, Reliance, etc. it has executed orders from the world's largest companies like Exxon Mobil, Kinder Morgan, Enterprise etc.

Robust order book of over 2x its FY07 revenue

The company is sitting on a robust order book of Rs 6,150 crore (US$1.5bn converted at Rs 41/$), which is more than twice the FY07 total net revenue. These orders, to be executed in next 12-15 months, give higher visibility to its top and bottom line growth. We expect turnover to grow at a CAGR of 31% and bottom line at a CAGR of 50% over FY07-09E.

The company should be able to execute the orders on time, as it is well equipped with capacity. The order flow to Welspun is quite robust and we believe that the company would be able to maintain its target order book to sales ratio of 1.6x. With the order flows, we expect the top line to grow at a CAGR of 31% to Rs 4558.98 crore in FY09E while the bottom line to grow at a CAGR of 50% to Rs 311.52 crore in FY09E during FY07-09E.

Increased capacity to start fetching revenue

WGSR is set to start fetching revenue from the newly developed pipe capacities across the segment. The company has expanded the HSAW pipe capacity from 50000 tonne per annum to 4 lakh tonne per annum in FY07. The increased capacity has started fetching revenue from FY07. We expect traction in capacity utilization going forward.

Foraying into global markets through organic route

Welspun Gujarat is venturing into the US markets on its own. It had signed a joint venture with an US company, Loan Star, but another US steel company acquired Loan Star in April 2007.

The Welspun management does not have the understanding with the new owners and has decided to go it alone in its plans to set up a $100-million facility in the US. The project will come up in Arkansas and will have a capacity of 300,000 tonne per annum of tubular steel pipes. The US is one of the largest markets for linear pipes.

Backward integration to ensure raw material supply at lower cost

The company is integrating backward to manufacture steel plates at an investment of Rs 1,811 crore, which it buys currently from European suppliers. The plate-making plant would go on stream in December 2007.

The company would be buying steel slabs, convert them at to plates and coils and integrate backwards for its entire range of offering. Current plate price is pegged at US$900 per tonne, while the slabs will cost the company only US$ 550 per tonne at a conversion cost of US$50 per tonne to plates and US$70 per tonne to coils.

On plates, the company would be saving US$ 300 per tonne while on coils it would save US$150 - 200 per tonne. The savings on raw material cost is set to improve the margins. We expect the operating margins to be 15% as in FY09E as against the FY07 operating margin of 12.44%.

Valuation Welspun Gujarat Stahl Rohren

RoCE is likely to rise from 13% in FY07 to 17% in FY09E while RoNW would decline from 21% in FY07 to 18% in FY09E on account of back ward integration and equity dilution for capex.

Though the backward integration is value-accretive, we perceive a risk. Going forward, we believe competition in the steel plate segment would increase as many plate mills are coming up in the country. Due to higher competition, we believe the RoCE of plate mill would be lower and breakeven for it may get extended, but the pipe business would thrive well.

At the current price, the stock trade 7.24x diluted FY09E EPS of Rs 33.17 and 7.34x diluted FY08E EPS of Rs 32.69. Our optimistic DCF model gives a fair value of 297. In a more realistic environment of long-term operating margin of 10% and perpetual growth of 1%, fair value works out to Rs 246.

The scrip has been trading at around 12x the one-year forward earnings. At 12x FY09E EPS, the price works out to 398. Factoring the large capex, dilution and the probable price decline in plates, we have worked out the DCF value of Rs 246. We rate the stock hold with price target of 264.

Source : ICICI Direct

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