The potential investments in domestic pipeline infrastructure, easing interest and cost pressures and robust order book augur well for PSL.
Even as the global liquidity crisis and economic slowdown is hurting companies across the world, there are some bright spots where the prospects are healthy. One such is PSL Limited, which is among the largest pipe manufacturers and offers a good investment opportunity.
While a healthy order book provides revenue visibility over the next 15 months, easing interest rates and liquidity should also help given the high debt on the company’s books. With some domestic customers expected to announce new orders, PSL with a good track record, should gain and add to its order book. Overall, even as there are some concerns which are reflecting in valuations, there are other factors that indicate good upside for this stock.
Macro gains
As India’s energy needs rise and companies invest in oil and gas exploration/production, the demand for supplementary infrastructure to transport these resources should also rise. Given that pipelines are a more cost efficient and convenient way of transporting, investment towards setting up an extensive national pipeline network are also seen rising. Add to this the investments on infrastructure for water transportation, and huge opportunities open up for pipe makers like PSL.
Likewise, there is good potential for growth in markets like the US and West Asia. However, the current global slowdown and decline in crude oil prices has led to a slowdown in investments in these regions. Analysts indicate that things should look up once crude oil prices stabilise, allowing companies to rework project dynamics.
Strategic moves
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PSL is among the largest manufacturers of HSAW (helical submerged arc welded) steel pipes in the country, which find application across sectors. The company, which dominates the domestic market, has factories located in Gujarat, Andhra Pradesh, Tamil Nadu and Rajasthan with a combined installed capacity of 1.1 million tonnes per annum (MTPA).
This strategy of having units (across states) closer to consuming markets, to an extent, provides an advantage in terms of freight costs; analysts estimate that transportation expenses work out to about 2-3 per cent of the value of finished pipes.
| PIPING HOT | |||
| in Rs crore | FY09 * | FY09 E | FY10 E |
| Net sales | 2,271.00 | 3,424.00 | 4,316.0 |
| OPM (%) | 7.70 | 7.70 | 8.0 |
| Net profit | 72.00 | 105.00 | 142.0 |
| EPS (Rs) | 16.81 | 24.40 | 33.0 |
| PE (x) | - | 2.84 | 2.1 |
| * actual for nine months ended December 2008 | |||
To tap the demand in the gulf and the US, the company has set up a unit each in Sharjah, UAE (75,000 tonnes) and the US (300,000 tonnes; 78 per cent stake); the former went on stream in June 2007, while commercial production at its US-based plant will start from March 2009. Given that the US facility has an order worth $418 million, which is to be executed till March 2010, it should help increase PSL’s consolidated volumes in 2009-10.
In order to provide complete solutions, the company has set up integrated pipe coating (internal and external coating) facilities in India as well as abroad. The pipe manufacturing and coating business, which accounts for nearly 95 per cent of revenues, has facilities that meet international specifications like API.
Based on the requirement and application, PSL’s facilities can provide steel pipes with polyethylene, coal tar enamel, fusion-bonded epoxy, concrete weight and internal coatings. In short, PSL’s business model helps it in emerging as one of the preferred suppliers of steel pipes in the country.
Concerns easing?
Among key concerns that have cropped up in recent months is the company’s stagnant order book at about Rs 6,000 crore. Since 65-70 per cent of these are domestic orders and that the domestic market is seen growing at a steady, albeit a slower, pace, PSL is relatively insulated from the global economic slump. Notably, the total order book is equivalent to two times the company’s annualised 9-months sales (ended December 2008) and is to be executed over the next 15 months, which provides comfort.
Additionally, analysts say that GAIL, a key pipe consumer, is expected to award projects worth 800,000 tonnes by March 2009. Since PSL is among the larger players with capacity at its disposal (440,000 tonnes production expected in 2008-09; 40 per cent capacity utilisation) it should be able to bid and secure sizeable quantity of the new orders.
The other concern pertains to the sharp rise in interest costs by 134 per cent to Rs 38 crore in Q3 FY09; up 70 per cent to Rs 71 crore in nine months ended December 2008. This was largely responsible for an 18 per cent decline in net profit to Rs 24.68 crore in Q3 (net profit was up 8.9 per cent at Rs 72.33 crore in first nine months of FY09).
The rise in interest costs was partly due to an increase in working capital (driven by higher volumes; debt-equity ratio is high at 1.6 times) and also on account of firm interest rates. The pressure on this count too, however, is expected to ease from Q4 onwards led by better working capital management and lower interest rates. However, a part of these gains could get offset on account of the impact of fluctuation in foreign exchange rate, which the company says will be accounted for at the end of the fiscal year.
Investment rationale
The investments needed in pipeline infrastructure in India as well as abroad augur well for pipe manufacturers like PSL. In fact, orders worth Rs 7,000 crore at least are expected to be awarded by players (like GAIL) over the next 2-3 months. And, PSL is well placed to improve its already robust order book and sustain a 25 per cent growth in revenues and 30 per cent in profits in FY10.
Since most of the capex is done, working capital management is seen improving and profits likely to rise 30 per cent in FY10, expect the debt-equity ratio to improve gradually. Also, since its $100 million US plant was set up with a debt component of about $75 million, where repayment is to start from the 17th year of commencement of operations, debt would hardly be a concern.
In the long run, since the costs to transport oil and gas through pipelines is relatively lower as compared to road or rail transport, the demand for pipes should also remain healthy. At Rs 68.75, the stock trades at 2.1 times the estimated FY10 earnings and an attractive dividend yield of 7.2 times (based on 50 per cent dividend rate), and can deliver 20-25 per cent in a year’s time.