September 18, 2011

Analysis: Maharastra seamless - conclusion

I wrote about maharastra seamless a few weeks back. The initial part of the analysis is here. The rest of the analysis follows

Competitive analysis

There are several companies in the steel tubes and pipes space. Some of the key companies in this space are Welspun corp, PSL, APL Apollo tubes etc.

Welspun corp is one the biggest companies in this space with a total capacity of around 1.5 MMT (3 times Maharastra seamless) which is slated to rise to around 2 MMT. The company is into LSAW, MSAW (higher dia pipes), ERW and seamless pipes. The company has maintained its ROE numbers at around the 20% levels. The company has also maintained its net margin levels at around 6-8% levels which is much lesser than MSL (at around 9-10%).

PSL is one of the largest HSAW pipe makers with a installed capacity of around 1.8 MMT. The company is expanding capacity by 75000 MT in 2012. The company also has a presence in the middle east (UAE) and US.  The company has maintained an ROE of around 15% with a net margin of around 3% in the last few years. The company however has a high debt equity ratio of around 1.6.

MSL seems to have better financials than the other companies in the same sector. The company has an operating margin which is higher than the other companies in the sector by atleast 4-5% which has led to a better ROC and higher cash flows. This higher operating margin seems to be the result of better pricing and lower overheads.

Management quality checklist

-          Management compensation: Management compensation seems to be reasonable. The MD made less than 0.5% of net profit in 2011 which is on the lower side for promoter led companies
-          Capital allocation record: The capital allocation record is a mixed bag. The company has consistently maintained a high gross margin on its product and thus been able to generate a high return on capital and good cash flows. These cash flows have been used to pay off debt and is also being used for capacity expansion (horizontal and vertical). At the same time the company raised money through an FCCB offer in 2005, which was not utilized by the company. I would give some benefit of doubt to the company on this point as they have been trying to expand into a billet plant (Which is the RM for ERW pipes) and have not been able to make progress due to land acquisition issues.
-          Shareholder communication: Seems adequate. The management provides adequate information about the business and has quarterly presentations about the same on its website. In addition the company conducts quarterly conference calls and shares the transcripts on its website
-          Accounting practice: Seems adequate and in line with the standards. Nothing stands out
-          Conflict of interest: There were no related party transactions which seem to be out of line. However the management has lent out around 177 Crs to a company (highlighted by the auditors) in 2011 which is a point of concern.

Valuation
The company sells at around 7-8 times  core earnings. One needs to exclude the impact of excess cash and non –core income (income from deposits and other sources) to arrive at the core earnings which were around 300 Crs last year. A normalized margin of around 14 % (rough average of last 5-6 years excluding impact of non core icome) gives an approximate net profit of around 270-290 Crs.

If  you exclude the excess cash on the books, the company is selling at around 7-8 times earnings.

The other companies in the same sector sell at around the same valuation. If one considers that maharastra seamless has superior financials, then one can make a case for a premium. The company is also selling on the lower side of its historical valuations, which has ranged between 5 to 20 times earnings.

In summary the company appears to be undervalued on various measures. At the same time, I still have doubts on the sustainability of the margins. In view of the capacity expansion in the industry and higher level of competition (due to dumping from china), it is quite likely the margins would trend downwards.

Conclusion
This is an industry with a limited number of players in india and with low levels of competitive advantage. The main competitive advantage comes from economies of scale and client relationships (takes time to become an approved supplier for the major O&G companies). In addition, there is a lot of competition from the Chinese companies in the same space and this has led to price pressure in india.
At the same time, the user companies of oil and gas, power utilities and water supplies are growing and is likely to result in robust demand over the medium and long term. We thus have two opposing trends (growth in topline and pressure on margins) and it is difficult (for me) to understand how this will impact profits eventually.
I have the company on a watch list for the time being and 10% drop in the price would be a good point for me to start a small position.

4 comments:

iwannabrich said...

hey broda, nice blog u got there.
was just going thru sum old posts and couldnt help but notice that u had a superior grasp of the financials than most ppl around (except maybe mr.marathe or ayush) ESPECIALLY considering that u r not in anyway related to the securities industry or accounting(incidentally, just 1 of the things that inspires me to go ahead and give a shot at value investing).anyways it seems that you are getting pretty short on ideas EVEN THOUGH THE WHOLE NBFC SECTOR is screaming to be bought,i understand that this 2 might seem like another "commodity" play to you but the valuations are pretty compelling(please dont plead ignorance about loan quality as there are perfectly good related biz like ADVISORY SERVICES such as brescon,ak capital and pioneer investcorp around). The brokerages and the banks are fine(one of your most enjoyable posts if i may add) but there is so much variety(ok i no this sounds a lil funny but excuse me since im from the fashion industry)
eager to learn your opinions and hope to have given you food for thought.
p.s.can i please have your permission to post the links to your bank and brokerage posts?

Rohit Chauhan said...

Hi
please feel free to post links to any posts you like.
on NBFC ..they may appear cheap, but quite a few have corporate governance issues and one has to be careful

rgds
rohit

Ankit said...

Rohit.. First of all let me congratulate you on the kind of hard work and analysis you have come up with... I started reading your posts from today only.. I liked this post on Maharashtra Seamless...on your last post you said 10 percent drop from that level can be a good entry point... do u think one can start entering now?
Regards,
Ankit

Mitran said...

Hi Rohit,
Topline and Bottom line had a hit heavily and it is available at very cheap now though PE is higher. What is your view presently and will it have turn around in recent future?