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ShareWith economic growth picking up on the back of infrastructure spending and widening power deficit, Prakash Industries (PIL) is a good play on domestic consumption story.
Its initiative to become a fully integrated steel producer, proposed foray into merchant power, attractive valuations and strong balance sheet makes it an excellent long-term bet.
Business: PIL manufactures steel products and has recently diversified into mining and power generation to integrate its business. The company also has small PVC pipes and picture tubes businesses.
Steel: PIL derives almost 90% of revenues from steel, wire rods and ferro alloys. Its plants in Chhattisgarh produce 0.75 million tonne (mt) of finished steel products, 0.55 mt of semi-finished steel and 0.60 mt of sponge iron annually.
To fully integrate its production process and capacity, PIL is expanding capacity apart from vertical expansion in the next 2-3 years. PIL is looking to raise its semi-finished steel capacity from 0.55 mt to 1 mt and the sponge iron capacity from 0.6 mt to 1.2 mt.
Mining: PIL has 3 captive coal mines, of which one with reserves of 50 mt is operational. The second 50 mt mine, to be operational by March 2010, would cater to steel and power segments. The third 46 mt mine for the proposed power plant will start in next two-and-a-half years.
PIL has been allotted two iron ore mines with reserves of 10 mt and 75 mt, which will come onstream by April 2010. This will constitute 50% of company's iron ore requirement in FY11 and reach 100% from FY12.
Power: This segment would be the growth driver for PIL. Lower cost of generation due to captive coal blocks and higher realisations in merchant power would serve as source of income.
PIL, which generates 100 mw of power, is planning to raise its generation capacity by 625 mw over 5 years with the first phase of 125 mw expected by March 2011. Out of the total power capacity of 725 mw, the company would consume around 275 mw, while rest would be sold on merchant power basis. Revenues are expected to start from FY12 with average realisation of Rs 4 per unit.
Investment rationale: PIL is trying to optimise its product mix in line with demand and better profit outlook. It is focusing more on wire rods and TMT bars, which offer better margins than structural products. PIL has increased the wire rods capacity from 0.18 mtpa to 0.45 mtpa and converted part of its structural products plant to manufacture 0.15 mtpa TMT bars.
Its backward integration exercise will ensure lower input costs and better margins. Diversification into power will ensure protection against dependence on steel and improve margins.
PIL has strong balance sheet where debt to equity ratio as on March 2009 was just 0.3x with debt of Rs 260 crore. PIL debt is Rs 180 crore which it plans to reduce to Rs 100 crore by the year-end. This will reduce its interests outgo and improve net margins. PIL plans to fund Rs 3,300 crore of capex for steel and power expansion mostly through accruals.
Concerns: Steel business is cyclical in nature and depends on the economic growth activity and resultant commodity price movement. Any slowdown in economy and price correction will affect its volumes and profitability. However, its low cost of production and backward integration exercises would ensure margins are not affected much.
Any delays in capacity expansion would affect the volumes and margins. This would affect its power generation commissioning as capex is being funded through higher realisations from steel.
Valuations: PIL's revenue growth will be largely driven by expansion and contribution from the high-margin merchant power segment. We expect operating margins to improve significantly due to better product mix, high margins on merchant power and cost reduction.
PIL's revenues for FY10 are expected to be at same levels as last year on account of lower selling price which would be compensated by higher volumes. But the net profit is expected to be significantly better due to lower interest costs and cost reduction. PIL revenues are expected to grow at CAGR of 13% over FY09-FY13E and net profit at CAGR of 46% between FY09 and FY13E.
At the current market price of Rs 143.40, PIL trades at a P/E of 7.05x & 4.53x its FY10E & FY11E earnings respectively. In view of its integrated business model, diversification and good fundamentals, PIL can be looked at current levels from a long-term perspective.
Disclaimer: The writer does not hold any shares in the company.
