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Welspun Corp Ltd
Downgrading to N: Tough environment at home and abroad
Tough demand environment will continue to hurt earnings
growth and low investor confidence will prevent stock re-rating
However, global expansion to provide some solace
We downgrade to Neutral from OW and cut our TP to INR165
from INR265
Recent earnings report and post-earnings conference call point to tough environment.
The company reported lower-than-expected sales volume and we believe it is likely to miss its
full year guidance on sales volume as well. The global slowdown has adversely impacted
capital expenditure decisions for large projects. Line pipe manufacturers like Welspun have
been hurt by policy paralysis across the globe from policymakers and private corporates, which
has led to delays in pipeline projects. While political leaders have been trying to avoid tough
decisions pending elections, private companies have been waiting for financing conditions to
improve and commodity prices to settle down. These tough economic conditions have also led
to nationalistic fervour, resulting in projects being awarded to companies with domestic
presence. Consequently, pipe manufacturing companies are facing pressures in their nondomicile
markets.
Welspun diversification strategy has negatively impacted investor sentiment. Welspun
has been an aggressive player with a global reputation, adding capacity in anticipation of
demand, and forging newer global relationships. However, over the last year, the adverse
business environment and its aggressive approach has hurt its credibility badly. Its acquisitions
of Leighton Infrastructure and the MSK projects have had nothing to show so far. Similarly, its
backward integration plan through the acquisition of Maxsteel is now looking like a bad
business decision as a result of falling domestic gas production.
Welspun’s global expansion is its only saviour. Welspun is adding capacity in US and Saudi
Arabia. Both of these countries are likely to give preference to companies that have domestic
presence. Consequently, we expect these new plants to ensure both margins and order flow.
This is likely to provide some support for the stock.
Valuation and risk. We are no longer bullish on the demand environment and the company’s
diversification strategy is yet to show results. Hence, we cut our earnings estimates by 45-60%.
We also roll forward our valuation to FY14e EPS (previously FY13e) but continue to value the
business at 7x, leading to valuation of INR165 (earlier INR265). We now rate the stock as
Neutral downgraded from Overweight. Our biggest concern on the stock remains demand
growth and lack of investor confidence on corporate governance.
Investment view
The stock has underperformed the market by 19% over the last 12 months on the back of global slowdown,
which has led to declining order books and investor concerns on corporate governance.
Tougher environment in global and domestic markets. We don’t expect the demand environment to
improve from current levels. We are witnessing the following trends in the pipes market:
Large projects in US are not moving forward on environmental concerns and policy paralysis
Companies are pushing orders back in search of cheaper raw material pricing and better financing
Due to tight financial conditions, there is a dearth of replacement demand
Order book cycles have become shorter as companies want to avoid commodity price volatility
There is a growing emphasis on nationalism as governments try to pacify their citizens with
employment prospects and income growth. This has led to domestic companies bagging a higher
proportion of orders.
Infrastructure activity in domestic market has also dried up as the Indian government tries to balance
its budget and deficit
Welspun diversification strategy has negatively impacted investor sentiment. Welspun has been an
aggressive player with a global reputation, adding capacity in anticipation of demand, and forging newer
global relationships. However, over the last year, the adverse business environment and its aggressive
approach have hurt its credibility badly. Its acquisitions of Leighton Infrastructure and the MSK projects
have had nothing to show so far. The purchase of Leighton by the company, which was previously
presumed to be bought by its parent has not gone over well with the investors. Similarly, its backward
integration plan through the acquisition of Maxsteel now appears to be a bad business decision, courtesy
of falling domestic gas production. Maxsteel was purchased from its parent and consequently any bad
performance is now attributed to governance.
Welspun’s global expansion is its only saviour. Welspun is adding capacity in US and Saudi Arabia. Both
these countries are likely to give preference to companies that have domestic presence. We expect these new
plants to ensure both margins and order flow. This is likely to provide some support for the stock.
We reduce our sales volume estimates to account for tough market conditions. We largely keep our
margin assumptions unchanged as its new plants in global markets should ensure good margins.
Valuation
Given the cyclical nature of order inflows, we value the company using a PE methodology. In the past
five years, Welspun stock has traded at a one-year forward PE of between 5x and 35x, depending on how
“hot” the capex cycle was. We value the company on 7x PE to account for 13.2% WACC, 3% growth,
and 11% ROE using the Gordon growth model. We, however, roll forward our valuation to FY14e EPS
(previously FY13e) to value the company at INR165.
Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppt above and below
our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. Our INR165 target price
implies a potential return, including dividend yield, of 10.8%, which is within the Neutral band; thus, we rate
our stock Neutral, downgrading it from Overweight
Risks and sensitivities
The biggest risk to our rating is the improvement in demand environment. .Post the US elections in
September 2012, some of the large pipeline projects can get permission to commence construction. These
can lead to large orders for pipe manufacturers and can boost the stock price.
The biggest concern for investors, in our opinion, is corporate governance. The final order from
Securities and Exchange Board of India (SEBI) on corporate governance issue is still due. Any adverse
decision can negatively impact the stock
Sensitivities: Our earning estimates and target price are sensitive to volume growth and margins trends. We
calculate that a 10% increase in total pipe volumes would increase net profit by 15%. 10% increase in
blended pipes EBITDA/tonne would increase net profit by 15%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Welspun Corp Ltd
Downgrading to N: Tough environment at home and abroad
Tough demand environment will continue to hurt earnings
growth and low investor confidence will prevent stock re-rating
However, global expansion to provide some solace
We downgrade to Neutral from OW and cut our TP to INR165
from INR265
Recent earnings report and post-earnings conference call point to tough environment.
The company reported lower-than-expected sales volume and we believe it is likely to miss its
full year guidance on sales volume as well. The global slowdown has adversely impacted
capital expenditure decisions for large projects. Line pipe manufacturers like Welspun have
been hurt by policy paralysis across the globe from policymakers and private corporates, which
has led to delays in pipeline projects. While political leaders have been trying to avoid tough
decisions pending elections, private companies have been waiting for financing conditions to
improve and commodity prices to settle down. These tough economic conditions have also led
to nationalistic fervour, resulting in projects being awarded to companies with domestic
presence. Consequently, pipe manufacturing companies are facing pressures in their nondomicile
markets.
Welspun diversification strategy has negatively impacted investor sentiment. Welspun
has been an aggressive player with a global reputation, adding capacity in anticipation of
demand, and forging newer global relationships. However, over the last year, the adverse
business environment and its aggressive approach has hurt its credibility badly. Its acquisitions
of Leighton Infrastructure and the MSK projects have had nothing to show so far. Similarly, its
backward integration plan through the acquisition of Maxsteel is now looking like a bad
business decision as a result of falling domestic gas production.
Welspun’s global expansion is its only saviour. Welspun is adding capacity in US and Saudi
Arabia. Both of these countries are likely to give preference to companies that have domestic
presence. Consequently, we expect these new plants to ensure both margins and order flow.
This is likely to provide some support for the stock.
Valuation and risk. We are no longer bullish on the demand environment and the company’s
diversification strategy is yet to show results. Hence, we cut our earnings estimates by 45-60%.
We also roll forward our valuation to FY14e EPS (previously FY13e) but continue to value the
business at 7x, leading to valuation of INR165 (earlier INR265). We now rate the stock as
Neutral downgraded from Overweight. Our biggest concern on the stock remains demand
growth and lack of investor confidence on corporate governance.
Investment view
The stock has underperformed the market by 19% over the last 12 months on the back of global slowdown,
which has led to declining order books and investor concerns on corporate governance.
Tougher environment in global and domestic markets. We don’t expect the demand environment to
improve from current levels. We are witnessing the following trends in the pipes market:
Large projects in US are not moving forward on environmental concerns and policy paralysis
Companies are pushing orders back in search of cheaper raw material pricing and better financing
Due to tight financial conditions, there is a dearth of replacement demand
Order book cycles have become shorter as companies want to avoid commodity price volatility
There is a growing emphasis on nationalism as governments try to pacify their citizens with
employment prospects and income growth. This has led to domestic companies bagging a higher
proportion of orders.
Infrastructure activity in domestic market has also dried up as the Indian government tries to balance
its budget and deficit
Welspun diversification strategy has negatively impacted investor sentiment. Welspun has been an
aggressive player with a global reputation, adding capacity in anticipation of demand, and forging newer
global relationships. However, over the last year, the adverse business environment and its aggressive
approach have hurt its credibility badly. Its acquisitions of Leighton Infrastructure and the MSK projects
have had nothing to show so far. The purchase of Leighton by the company, which was previously
presumed to be bought by its parent has not gone over well with the investors. Similarly, its backward
integration plan through the acquisition of Maxsteel now appears to be a bad business decision, courtesy
of falling domestic gas production. Maxsteel was purchased from its parent and consequently any bad
performance is now attributed to governance.
Welspun’s global expansion is its only saviour. Welspun is adding capacity in US and Saudi Arabia. Both
these countries are likely to give preference to companies that have domestic presence. We expect these new
plants to ensure both margins and order flow. This is likely to provide some support for the stock.
We reduce our sales volume estimates to account for tough market conditions. We largely keep our
margin assumptions unchanged as its new plants in global markets should ensure good margins.
Valuation
Given the cyclical nature of order inflows, we value the company using a PE methodology. In the past
five years, Welspun stock has traded at a one-year forward PE of between 5x and 35x, depending on how
“hot” the capex cycle was. We value the company on 7x PE to account for 13.2% WACC, 3% growth,
and 11% ROE using the Gordon growth model. We, however, roll forward our valuation to FY14e EPS
(previously FY13e) to value the company at INR165.
Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppt above and below
our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price. Our INR165 target price
implies a potential return, including dividend yield, of 10.8%, which is within the Neutral band; thus, we rate
our stock Neutral, downgrading it from Overweight
Risks and sensitivities
The biggest risk to our rating is the improvement in demand environment. .Post the US elections in
September 2012, some of the large pipeline projects can get permission to commence construction. These
can lead to large orders for pipe manufacturers and can boost the stock price.
The biggest concern for investors, in our opinion, is corporate governance. The final order from
Securities and Exchange Board of India (SEBI) on corporate governance issue is still due. Any adverse
decision can negatively impact the stock
Sensitivities: Our earning estimates and target price are sensitive to volume growth and margins trends. We
calculate that a 10% increase in total pipe volumes would increase net profit by 15%. 10% increase in
blended pipes EBITDA/tonne would increase net profit by 15%.
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