WELSPUN CORP Top play in pipes :: Edelweiss

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􀂃 Consolidated pipe sales steady at 230 KT; closing order book of 650 KT
Welspun Corp’s (WLCO) consolidated Q2FY11 pipe sales volume stood at 230 KT,
up 9.9% Y-o-Y but down 6.8% Q-o-Q. This comprised 75 KT of LSAW, 137 KT of
HSAW (including 58KT of US sales) and 18 KT of ERW sales. Plate sales were
higher at 128 KT (up 25% Q-o-Q and 13% Y-o-Y) due to execution of some key
orders (from IOCL, Energy Transfer etc.) during the quarter. The company’s
closing order book for Q2FY11 is lower at 650 KT for pipes from 675 KT in
Q1FY11, due to the slow pickup in global oil & gas capex which we expect to
improve, going forward. Plates order book has picked up to 150 KT in Q2FY11
compared to 100 KT in Q1FY11. We expect plate volumes to pick up as WLCO
has started selling shipping-grade steel plates recently. The outstanding order
book provides earnings visibility for the next nine months.




􀂃 Pipes EBITDA at USD 254/MT; standalone PAT lower than expectations
WLCO reported blended EBITDA margin (HSAW, LSAW, and ERW) of USD
254/MT (INR 11,800/MT), lower then USD 285/MT (INR 13,000/MT) in Q1FY11
due to some high margin orders booked in the previous quarter. Consolidated
PAT at INR 1.76 bn, dipped 7.7% Q-o-Q (due to higher depreciation and interest
expenses) but increased 25.5% Y-o-Y (due to higher pipes EBITDA margins).
However, standalone PAT at INR 503 mn was lower than expectation due to
revenues/volumes being booked in WLCO’s 100% subsidiary, Welspun Trading
(w.e.f. 31-March-2010), used for the company’s sales and marketing operations.

􀂃 Outlook and valuations: Top play in pipes; maintain ‘BUY’
With crude prices remaining stable at a higher range, we expect oil & gas
companies to increase their FY12 capex budgets, leading to new order accretion
for the pipe industry. The offshore rig market (a leading indicator of pipe capex)
has also improved recently. With WLCO being recognised and associated with
large clients globally, it will be amongst the first companies to benefit from an
uptick in the pipes sector. Going forward, potential stock triggers are: (1) strong
order accretion in the Middle East and South East Asia; (2) commissioning of
WLCO’s plant in the Middle East; (3) improvement in utilization of the plate mill.
We are rolling forward our fair value date to March 2012 and now estimate
WLCO’s fair value at INR 401/share (INR 361 earlier). At INR 249/share, WLCO
trades at an attractive P/E of 7.3x FY12E EPS and EV/EBITDA of 3.6x FY12E. Our
earnings do not factor any upside from MSK’s integration and value from its
assets. We maintain ‘BUY/ Sector Outperformer’ recommendation/rating on
the stock and regard the stock as the top pick in the pipes sector.



􀂃 Key highlights
• Total consolidated pipe sales of 0.48 MMT in H1FY11 in line with WLCO’s volume
guidance of 1 MMT for FY11.
• WLCO continues to maintain its guidance of blended EBITDA margins at INR 10,500-
11,000/MT for pipes and INR 5,500 for plates for FY11.
• In terms of value, order book has dipped to INR 45 bn at the end of Q2FY11 (10%
lower Q-o-Q) due to slippages in global steel prices. New order accretion in the
quarter was INR 13 bn. We believe revenue-based order books are not indicative of
the order situation due to fluctuation in global steel prices.
• MSK Projects is now a subsidiary of WLCO w.e.f. August 16, 2010. The company has
consolidated MSK’s earnings post August 16, 2010, in its books. Consolidated
EBITDA of INR 3.44 bn for WLCO is inclusive of INR 90 mn from MSK.
• Depreciation expenses, at INR 615 mn, jumped 13.6% Q-o-Q and 63.5% Y-o-Y due
to capitalization of the Mandya plant and MSK Project’s depreciation now
consolidated in WLCO’s books.
• Interest costs at INR 374 mn dipped 22% Y-o-Y on repayment of high-cost debt but
was up 72% Q-o-Q on account of consolidation of MSK’s debt and fresh NCCDs of
INR 10 bn raised during the quarter.
• Debt stood at INR 38.9 bn, whereas cash was at INR 13.1 bn. Liquid investments
were at INR 11 bn out of total investments of INR 13 bn.

􀂃 Revising estimates to account for lower interest costs and higher other income
We are revising our earnings estimates for WLCO after updating the annual report data
and factoring in the growth in earnings from the newly acquired HSAW plant in Saudi
Arabia and higher capacity utilisation of the US HSAW plant. We are broadly maintaining
our estimates for EBITDA margins in line with management guidance. We are also
revising up our estimates for PAT and EPS for FY11 and FY12 after adjusting for lower
interest costs and higher other income. Our earnings currently do not factor any upside
from MSK Project’s integration and value from its assets.


We recently met the management of Welspun Corp (WLCO) to get an update on
the company. Following are the key takeaways of our interaction:
􀂃 Sufficient growth visibility; focus on sustaining margins
WLCO’s management has indicated that there is enough visibility of growth in earnings
with demand expected from the US (shale gas capex picking up) and the Middle East
(high growth in the water pipelines segment). The company is also planning to focus on
the North African region with pipeline activity picking up in the region. With its new plant
in Saudi Arabia (JV) getting streamlined by Q4FY11 and higher margin orders being
booked in the US, management is bullish on growth in export earnings.
The domestic environment, however, continues to remain competitive, exerting pressure
on EBITDA margins, which continue to remain low. Management is firm that it is
unlikely to compromise on profitability in lieu of higher volumes and bigger orderbook
size by extensively bidding for low margin domestic orders.

􀂃 Volumes / order book to improve as indicated by rig market
• As per the company, the outlook continues to be favourable with potential bids
outstanding for new projects in Myanmar (~0.4 MMT) and in India (further capex by
GAIL and GSPL).
• Management is positive on the TransCanada order coming through and is banking on
leveraging its superior positioning in the LSAW space. Technical qualifications for the
order are being sorted out currently, but management believes that earnings from
the order may possibly start kicking in only around 2015.
• WLCO is also planning to focus on the water segment now with high demand
visibility from the Middle East (~1.5 MMT) and margins picking up for DI pipes.
• The volume pick up in the plate mill is not optimal (FY11 capacity utilization
guidance = 40%) due to non-availability of API grade slabs for manufacturing
plates. Commercial grade plate volumes are expected to pick up as the company has
started selling shipping-grade steel plates only five months ago. Currently, WLCO is
the largest supplier of plates for the wind energy and heavy plates segments.
• Management has guided to pipes volume of 1 MMT in FY11 and ~1.2-1.3 MMT in
FY12 and plates volume of 600 KT in FY11 and 800 KT in FY12.




Our View: The pipe industry has been facing lower order accretion for some time which
has impacted net order books of all pipe companies, including WLCO. However, we
expect orders to pick up as capex in the oil & gas sector gathers momentum. We expect
oil & gas companies to reasonably increase their capex budgets in FY12 as crude prices
have remained stable at higher range for the past few months. The rig market (a leading
indicator of pipe capex) has also improved recently as new jack-up day rates moved
from USD 120,000/day to ~USD 150,000/day. With WLCO being recognised and
associated with large clients globally, it will be amongst the first companies to benefit
from an uptick in the pipes sector.

􀂃 EBITDA margin guidance for pipes and plates maintained
Management has maintained guidance on EBITDA margins for FY11 in the INR 10,500-
11,000/MT range for pipes and INR 5,000-5,500 for plates. The company is targeting an
EBITDA margin of USD 200/MT for the new plant in Saudi Arabia.
Our view: WLCO had reported blended EBITDA margin (HSAW, LSAW, and ERW) of USD
285/MT (INR 13,000/MT) in Q1FY11 on some high-margin orders which dipped to USD
254/MT (INR 11,800/MT) in Q2FY11. Going forward, we expect overall margins to
normalize further in line with management’s guidance for FY11 and FY12. We also
believe that margins from WLCO’s Saudi Arabia plant may be lower due to execution of
water pipeline orders. We have factored in margins of USD 150/MT for the Saudi Arabian
plant.


􀂃 Expansion in capacities to boost growth
WLCO is currently planning to expand its LSAW capacity at Anjar to 700 KT by Q1FY12
from 350 KT currently. The company has already commissioned a 100 KT HSAW plant at
Mandya (near Bengaluru) in June 2010 and is planning to set up another 100 KT HSAW
plant in Madhya Pradesh (exact location not yet fixed) by FY12 (expansion on hold
currently). The company plans to spend ~INR 7 bn for funding its domestic expansion.
In terms of its capex plans abroad, WLCO is planning to spend USD 150 mn for the
acquisition/capex of the 270 KT HSAW plant in Saudi Arabia. The plant is expected to
come on-stream latest by Q4FY11 as approvals are expected anytime. It is also planning
to spend USD 75 mn over its double joint and coating facility in the US.
The above expansion projects (domestic and overseas) will increase WLCO’s total pipes
capacity from 1.45 MMT in FY10 to 2.27 MMT by FY12 end.


Our view: We expect total pipe volumes at 1.0 MMT for FY11E and 1.2 MMT for FY12E
after factoring in sales from the newly acquired HSAW plant in Saudi Arabia and higher
capacity utilization of the US HSAW plant. We also expect capacity utilization of the plate
mill to increase to 53% in FY12 (with the company selling shipping-grade steel plates
now), in line with management’s guidance of plates volume of 600,000 MT in FY11 and
800,000 MT in FY12.

􀂃 Balance sheet improves after repayment of high cost debt
WLCO’s net debt has dipped significantly in FY10 after cash inflows from FCCB (USD 150
mn and conversion at INR 300/share) and QIP issue (USD 100 mn @ INR 279.25/share)
were used to repay high-cost debt. The company has indicated that going forward, it will
be using its net cash flows to pay off high cost debts for debentures issued and also
repay the entire debt of the US plant by FY15.
Going forward, WLCO’s net debt will reduce significantly (assuming conversion of FCCBs
into equity in FY13) with an estimated total debt of INR 1.8 bn and estimated cash
reserves of 1.3 bn by FY13. The non-FCCB net debt to equity ratio stood at 0.1 in FY10,
which is expected to turn negative by FY14 (assuming conversion of FCCBs).


Our view: We expect that going forward, WLCO may utilize its incremental free cash
flows in increasing its geographical presence either through acquisitions or by setting up
new capacities in places like North Africa. The company may also try to increase its
presence in the growing water pipeline segment in Asia by increasing its capacities.
However, cash requirements for those regions may not be sufficient to utilise the entire
cash flow. The company’s diversification in the infrastructure business (after taking
control over MSK Projects) is probably where the incremental cash flows will be
deployed.


MSK Projects: In consolidation mode
WLCO had announced the completion of transfer of management control of MSK Projects
through Welspun Infratech in August 2010 with its net holding in the company at
61.12%. WLCO management has indicated that it is currently in the process of
integrating MSK Projects within the group and will give a definitive guidance on its
earnings only post consolidation. Although we are currently not factoring in earnings
upsides from MSK Projects in our estimates due to lack of clarity on the same, we
believe that going forward WLCO may leverage on this strategic acquisition and forward
integrate into laying pipelines and undertake related projects to boost its earnings
further.


􀂃 Outlook and valuations: Top play in pipes; maintain ‘BUY’
The pipe industry has been facing lower order accretion for some time. This has
impacted net order books of all pipe companies, including WLCO. However, we expect
orders to pick up as capex in the oil & gas sector gathers momentum. We expect oil &
gas companies to reasonably increase their capex budgets in FY12 as crude prices have
remained stable at higher range for the past few months. The rig market (a leading
indicator of pipe capex) has also improved recently as new jack-up day rates moved
from USD 120,000/day to ~USD 150,000/day. With WLCO being recognised and
associated with large clients globally, it will be amongst the first companies to benefit
from an uptick in the pipes sector. Going forward, potential stock triggers are: (1) strong
order accretion in Middle East and South East Asia; (2) commissioning of WLCO’s plant in
the Middle East; and (3) improvement in utilization of the plate mill.


We are rolling forward our valuations from March 2011 to March 2012 with the fair value
of the stock revised to INR 401/share from INR 361/share earlier. Assigning a 1-year
forward P/E of 11x for March 2012 yields a fair value of INR 408/share while a 1-year
forward EV/EBITDA of 6x for March 2012 yields a fair value of INR 417/share.
At CMP of INR 249/share, WLCO is trading at a P/E of 7.3x FY12E EPS, EV/EBITDA of
3.6x FY12E and P/BV of 1.2x FY12E which is attractive considering the higher trading
multiples of global pipe companies (refer Table 3). We maintain ‘BUY/ Sector
Outperformer’ recommendation/rating on the stock.