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Global rig count has been rising
since April ’09, which augurs well for the demand of seamless pipes that are used in oil
and gas exploration. With MHS quoting at the lower end of its 1-year forward EV/EBITDA
range, valuations are discounting the bleak global industry scenario. Any positive surprise
in the order book could spring meaningful returns in the stock price. We reiterate our
BUY on MHS.
Rising crude oil price = rising rig count = higher demand for seamless pipes
With crude oil price rising consistently and trading at $88/bbl currently, worldwide rig count has
been rising mom since April ’09 (Exhibit 1), which augurs well for demand of seamless pipes.
We expect greater traction on the exports front for the company going forward. With the plant
imported from Romania expected to come on line by the end of FY2011E, MHS would be
favorably placed to drive sales volumes in FY2012E.
Romanian plant – a good investment
The plant imported from Romania (0.2 mn tons) should become operational in FY2012E. The plant
has been constructed at a very low capital cost of Rs3 bn as compared to a green field plant (60%
cheaper). Even assuming lower than current margins (Rs12,000 vs Rs18,000 per ton in 2QFY11),
at only 60% capacity utilization, the plant would generate high ROCE (~30%). The other benefits
that it would bring to the table include:
` It would enable MHS to upgrade its product basket by gradually moving into higher value
added ‘drill pipes’, which earn higher margins per ton.
` It would enable MHS to compete for larger orders from the global oil majors. Earlier, the small
size of MHS’s operations (0.35 mn tons) was an impediment for qualifying for larger orders.
Risk – Chinese competition in the domestic market
In the 2QFY11 conference call the management alluded to Chinese companies coming back in the
market to bid for domestic orders from ONGC, OIL etc. at prices which are ~10% lower than MHS.
We note that currently there are anti-dumping proceedings going on against the Chinese
producers and there are expectations of imposition of anti-dumping duty in the range of 10-15%
on Chinese imports with retrospective effect. According to the management, these imports are
being done with an implicit understanding that the anti-dumping duties, if imposed, would be
passed on to the Chinese. As per the management, the presence is limited to a few orders and as
of now there appears to be no threat to the current margins realized by the company.
Seamless pipes – business with good long-term prospects
The business of manufacturing seamless pipes is quite consolidated at the global level with
the top-7 players having a market share of 76%. We note that MHS manufactures seamless
pipes at the lower end of the product slate (API grades), which account for ~80% of the
global OCTG (Oil Country Tubular Goods that include drill pipes, casing and tubing) demand.
Immediate prospects marred by excess capacities; discounted in the valuations
In the immediate term, the margins per ton in the industry have been marred by excess
capacities, particularly in China and Russia. According to our estimates, as of now the
industry is operating at utilization levels of ~50% globally. Under ideal conditions, the
industry can operate at 75% utilization, given that there is considerable down time as the
pipe size is changed during the manufacturing process. In India also, incremental capacities
have come up or are in the process of being commissioned.
` ISMT has commissioned a 0.3 mn tons seamless capacity in May ’10.
` Jindal Saw has commissioned 0.15 mn tons capacity in FY2010.
` OCTL (Oil Country Tubular Ltd) is in the process of setting up a capacity of 0.2 mn tons,
which should come on line in the middle of FY2012E.
Barring a large uptick in the crude oil price, we expect the capacity utilization of the industry
at a global level to approach reasonable levels of ~56% from FY2013E onwards. Therefore,
in the current scenario we expect the margins per ton in the seamless segment at MHS to
remain static in the immediate future (Rs15,000-Rs18,000 per ton) depending on the
product mix. This is amply reflected in the valuations with the stock quoting at the lower
end of its historical 1-year forward EV/EBITDA multiples.
Risk – Chinese competition in the domestic market
The management has earlier alluded (in 2QFY11 conference call) to the Chinese companies
coming back in the market to bid for domestic orders from ONGC, OIL etc. at prices which
are ~10% lower than MHS. We note that currently there are anti-dumping proceedings
going on against the Chinese producers and there are expectations of imposition of antidumping duty in the range of 10-15% on Chinese imports with retrospective effect.
According to the management, these imports are being done with an implicit understanding
that the anti-dumping duties, if imposed, would be passed on to the Chinese. As per the
management, the presence is limited to a few orders and as of now there appears to be no
threat to the current pricing realized by the company.
Also, we note that the traction on the exports front that has been achieved by MHS is
largely on account of US and Europe imposing anti-dumping duties on Chinese pipe. The
markets vacated by the Chinese in US and Europe have been captured by seamless pipes
companies from other regions with MHS being one of them.
The Chinese companies are under a lot of pressure (excess capacity) on account of the major
export markets being barred on account of anti-dumping duties. As a result, there is excess
supply in the Chinese industry, which is reflected in the financials of one of the major players
in the Chinese seamless industry – Wuxi Holdings Ltd – which has a capacity of
manufacturing ~1.5 mn tons of seamless pipes. The company did not even have positive
margins at the gross level in 1HCY10.
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