Angel Broking- Buy on Prakash Industries -Target Rs. 124.- 3QFY2011 Update

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  Prakash Industries – 3QFY2011 Result Update

           Angel Broking maintains a Buy on Prakash Industries with a Target Price of Rs. 124.

Higher realisation aid top-line growth: For 3QFY2011, Prakash Industries (PIL)

reported a 6.1% yoy increase in net sales to `382cr due to higher realisations and

power and sponge iron sales. In December 2010, PIL sold 15MW of power to

CSEB at `3.15/unit. During 3QFY2011, PIL sold 11kt of sponge iron (nil in

3QFY2010). Billet sales increased by 17.3% to 13kt, while wire rod sales declined

by 6.6% yoy to 99kt. Average net realisations for sponge iron, billet and wire rod

stood at `17,900, `24,000 and `27,000, respectively.

Margin impacted due to higher iron ore cost: Raw-material cost during the

quarter increased by 22.5% yoy to `239cr due to higher iron ore cost, which

stood at `5,500/tonne. Consequently, EBITDA margin contracted by 569bp yoy to

18.8% and EBITDA fell by 18.6% yoy to `72cr. Depreciation increased by 22.7%

yoy to `17cr on account of commissioning of new units; however, interest expense

declined by 84.5% yoy to `1cr. Thus, net income fell by 17.6% yoy to `54cr.

Power expansion delayed, whereas steel expansion put on hold: PIL has delayed

the commissioning of the first 125MW unit (5x25MW) to June 2011 (earlier

January 2011). The 0.2mn-tonne sponge iron expansion has also been delayed

by three months to June 2011, whereas billet expansion has been put on hold.

Outlook and valuation: PIL is currently trading at 4.1x and 3.5x FY2011E and

FY2012E EV/EBITDA, respectively. With increased sponge iron and power

capacities, we expect EBITDA to witness strong growth over the coming five years.

Furthermore, given the steep decline in the stock price, we maintain our Buy

recommendation on the stock with a revised Target Price of `124 (`205), valuing

the stock at 4.5x FY2012E EV/EBITDA. A key catalyst for the stock would be

commencement of mining operations at the company’s Orissa mine.

Result highlights

Higher realisation aid top-line growth

PIL’s net sales increased by 6.1% yoy to `382cr mainly on account of higher

realisations. The company undertook production cuts during the quarter as

margins were low in the steel and ferro alloy segments. In December 2010, PIL

sold 15MW of power to Chhattisgarh State Electricity Board (CSEB) at `3.15/unit.

Sponge iron production increased by 40.0% yoy to 114kt. PIL sold 11kt of sponge

iron in 3QFY2011 (nil in 3QFY2010). Billet sales during the quarter increased by

17.3% to 13kt, while wire rod sales declined by 6.6% yoy to 99kt. Ferro alloy

production fell by 30.5% yoy to 8,091 tonnes, while sales declined by 36.5% yoy to

6,160 tonnes. During the quarter, average net realisations for sponge iron, billet

and wire rod stood at `17,900, `24,000 and `27,000, respectively.

Margin impacted by higher iron ore cost

Raw-material cost increased by 22.5% yoy to `239cr due to higher iron ore cost,

which stood at `5,500/tonne. As a result, EBITDA margin contracted by 569bp yoy

to 18.8%, which led to EBITDA declining by 18.6% yoy to `72cr. Depreciation cost

increased by 22.7% yoy to `17cr on account of commissioning of new units;

however, interest expense declined by 84.5% yoy to `1cr. Effective tax rate was

almost nil as PIL was entitled for MAT credit on account of power sales. Thus, net

income fell by 17.6% yoy to `54cr during the quarter.

Key concall takeaways

􀂄 The average cost of purchased iron ore during the quarter was `5,500/tonne.

􀂄 PIL incurred capex of `450cr in 9MFY2011. For the next four years, the

company plans to spend `600cr per year to fund its expansion projects.

􀂄 Net debt at the end of the quarter stood at `100cr.

􀂄 During 2QFY2011, PIL had received the mining plan approval for its

Sirkaguttu iron ore mine in Orissa. The company expects to receive forest and

environmental clearance by 2HCY2011.

􀂄 PIL witnessed exceptionally low demand for steel in 3QFY2011. Hence, the

company cut its steel production and instead sold power to CSEB at an

average rate of `3.15/unit.

􀂄 Nevertheless, steel price products rose by ~25% during

December 2010–January 2011 and iron ore prices rose by 15% in January

2011. Merchant power rates have also increased in the past one month.

􀂄 PIL has delayed the commissioning of the first 125MW unit (5x25MW) to June

2011 (earlier January 2011). The 0.2mn-tonne sponge iron expansion has

also been delayed by three months to June 2011, whereas billet expansion

has been put on hold.

􀂄 Two units of 100MW each are expected to come on stream by March 2012

and March 2013, respectively.

Investment rationale

􀂄 Expanding capacity to address imbalance and enhance integration levels:

Currently, PIL sources ~30% of its sponge iron requirement from third parties.

In its bid to reduce this dependence on external parties, PIL is expanding its

sponge iron capacity from 0.6mn tonnes to 0.8mn tonnes by FY2012.

􀂄 Net long on power from FY2012: PIL is expanding its power capacity from

100MW to 775MW by March 2015E. The company is setting up a 625MW

coal-based power plant, with each unit being set up in 12 months starting

from 1HFY2012. The company will have a surplus of 40MW in FY2012, which

the company plans to sell in the merchant power market.

􀂄 Captive iron ore production to aid margin growth: During 2QFY2011, PIL

received the mining plan approval for its Sirkaguttu iron ore mine in Orissa.

The company expects to receive forest and environmental clearance quickly by

2HCY2011, as clearance is required from the state government only. The

company will steadily move towards a fully integrated business model with the

grant of new iron ore and coal mines along with the existing Chotia coal

mine, thus improving margins drastically. We expect EBITDA per tonne to

improve by `3,000–4,000 after it commences iron ore production.

Outlook and valuation

PIL is currently trading at 4.1x and 3.5x FY2011E and FY2012E EV/EBITDA,

respectively. On P/B basis, it is trading at 0.6x and 0.5x FY2011E and FY2012E,

respectively. With increased sponge iron and power capacities, we expect EBITDA

to witness strong growth over the coming five years. Furthermore, given the steep

decline in the stock price, we maintain our Buy recommendation on the stock with

a revised Target Price of `124 (earlier `205), valuing the stock at 4.5x FY2012E

EV/EBITDA.

A key catalyst for the stock would be commencement of mining operations at PIL’s

Orissa mine.

We have lowered our production and sales estimates to factor in the delay in

expanding the sponge iron capacity. Further, we have raised our 4QFY2011 and

FY2012 realisation estimates as we now build in higher product prices. Overall,

our net sales estimates stand lower for FY2011 and FY2012. Also, we have

lowered our profitability estimates for FY2012 as we expect raw-material prices to

remain firm during FY2012.