Paramount: A perfect fit

UK acquisition will enhance company's portfolio through value-added products.

Paramount Communications seems to have got itself a good deal with the acquisition of UK-based cable manufacturer AEI Cables.

AEI has sales of £65 million or Rs 535 crore. Paramount will pay an enterprise value of £26.5 or about 0.4 times revenues, which is reasonable.

The reason for the cheap valuation, according to the management, was that AEI made a loss in the past year. AEI is present in cables used across power, railways and telecom sectors as well as in industrial projects.

Besides, AEI has strong R&D, which will come in handy for Paramount to manufacture speciality cables. AEI's speciality cables are used especially by defence, besides railways, power and mining sectors.

The management also emphasised that the acquisition will not be much burden on Paramount's financials as the company will invest only Rs 25 crore from its FCCB issue that it had raised in November 2006. The rest of the funding will come through debt in its UK subsidiary against AEI's assets, without any recourse to Paramount.

With this acquisition, Paramount will be able to offer value-added products to its portfolio and also tap other international markets, where AEI has presence. Paramount will continue manufacturing operations at AEI's UK plant.

To improve profitability at AEI, Paramount plans to improve efficiencies and reduce raw material costs through common purchases. The management says that this deal will be EPS accretive this year as it will be able to bring AEI in the black this year. Also, AEI will add Rs 110 crore to Paramount's consolidated net worth.

In the June 2007 quarter, Paramount's top line expanded 123 per cent y-o-y owing to rising demand for its power cables and the new capacity that came up in FY07. Its low tension power cable capacity went up from 25,000 km to 55,000 km and high tension capacity increased by 2,000 km to 3,500 km.

However, raw material costs of metals as well as polymers increased by over 600 basis points y-o-y. This resulted in operating profit margin declining 650 basis points to 16.9 per cent.

The Paramount stock had declined by 33 per cent over previous year, but since the company announced that it was considering the AEI Cables acquisition, it has gone up 28 per cent. At its current price of Rs 34.60, the stock trades at under six times FY08 estimated EPS and looks promising.

Pipes sector: Gushing orders

The large players supplying pipes to the oil and gas sector continue to enjoy strong order inflows - for instance, PSL has recently won a Rs 165-crore order from Indian Oil.

For pipe manufacturers such as PSL, operating margins from such contracts are typically between 9 and 12 per cent, given little control over raw material costs.

In the June 2007 quarter, PSL's net sales grew merely 9.5 per cent y-o-y, as its sales volume of 56,642 tonne in Q1 FY08 was much lower than its production of 87,064 tonne, highlight analysts.

Its operating profit margin was also more or less steady on a y-o-y basis at 9.9 per cent in the last quarter.

At Man Industries, the operating profit margin improved 50 basis points y-o-y to 11.9 per cent in the last quarter thanks to its adjusted raw material costs as a percentage of net sales declining 580 basis points y-o-y to 72.2 per cent.

Also, Welspun-Gujarat Stahl's operating profit margin grew 390 basis points y-o-y to 16.5 per cent in the last quarter.

Going forward, demand conditions for players in the pipe sector appear to remain strong, given no signs of weakness in oil and gas sector investments.

As a result, investor sentiment has remained buoyant for this sector "" for instance, PSL has gained 10.5 per cent during the past two months as compared to a 4 per cent rise in the Sensex. Welspun-Gujarat has gained 8 per cent during this period, while Man Industries rose nearly 2 per cent.

To leverage growth opportunities, PSL is setting up two-step pipe mill with an installed capacity of 300,000 tonne along with its coating facility.

This project is expected to be fully operational in Q1 FY09. Meanwhile, Welspun-Gujarat Stahl's 1.5 million tonne plate mill project for backward integration is on schedule for commissioning in December 2007.

PSL trades at 11.5 times estimated FY08 earnings, while Man Industries it is 11 times.