Strong growth in the domestic infrastructure sector has boosted many allied business segments, including companies which manufacture steel wires and rods.
There are a number of small players in this segment, but only companies with large volumes and backward integration capabilities are expected to do well. Godawari Power and Ispat (GPIL) is one such player. GPIL has invested in a steel billet unit, sponge-iron production plant, iron ore and non-coking coal mines, with the aim of insulating itself from the vagaries of input prices and improving operating profit margins. At the current price level GPIL’s financials and future plans make it an ideal pick for investors with a 2-3 year horizon.
BUSINESS: GPIL manufactures mild steel wires, which are used as binding wire and barbed wire. To manufacture this end product, it produces all the required raw materials.
This gives it two advantages — firstly, it is independent of the variability in the supply in raw materials, and secondly, it generates a higher operating margin. It also utilises waste heat generated during sponge iron-making process to produce power. This makes it self-sufficient in power. GPIL also manufactures ferro-alloy, which provides better operating margins.
GROWTH DRIVERS: GPIL has been allotted an iron ore mine with estimated reserves of 15 million tonnes (mt), the final approval for which is pending. Once the company obtains this approval, it will take around four months to start mining the ore. This means the company will have sufficient captive iron ore supply for the next 30 years.
This will also increase its operating margin to 35-40% of its net sales from the current 18%. GPIL is setting up a pellet plant at a cost of Rs 235 crore, which will utilise the iron ore fines to make quality coke.
This will improve its capacity utilisation. The company was granted a sales tax waiver of Rs 300 crore in early ’00, which can be utilised till ’11. This will directly add to its bottomline.
FINANCIALS: The company’s net sales and net profit have witnessed a compound annual growth rate (CAGR) of 59.8% and 89.8%, respectively in the past three years. Its current market capitalisation, at Rs 685 crore, is 1.55 times its FY07 net sales, which is the same as the industry average. GPIL’s operating margin, at around 18%, is nearly double that of peers like Ramsarup Industries and Bansal Wire Industries. Similarly, GPIL’s return on capital employed (RoCE) and return on equity (RoE) are 20% and 30%, respectively — slightly higher than that of other players in this segment.
VALUATIONS: The effect of the new pellet plant, captive iron ore and coal mines will be reflected in the company’s financials in FY10 and will also help to improve its operating margin to around 35%. The estimated EPS for FY09 and FY10 are Rs 47 and Rs 107, respectively. This translates into forward P/E multiples of 5.6x and 2.5x, respectively, at the current price level, providing sufficient upside growth potential. The EV/EBITDA multiples for FY09 and FY10 are 4.0 and 2.0, respectively.
Moreover, if GPIL increases its dividend payout ratio consistent with the past two years, it will result in a 10% dividend yield after three years at historical investment cost. Hence, investors are advised to buy this stock at current levels of Rs 265 with a horizon of 2-3 years.