PSL - A strong pipeline

INVESTMENT COUNTER/ PENNY WISE

Though the company is on a robust growth path, valuation appears stretched at present.

The boost to infrastructure development in the past couple of years or so has had a positive impact on many sectors and companies. While it is old news that big and small companies in infrastructure-related sectors like cement, metals, power and construction have been making hay while the sun shines, there is another set of companies which have been doing well of late.

Needless to say, the stocks have been buzzing too. Stocks of pipe manufacturing companies like Man Industries, Jindal Saw and Welspun Gujarat have been on the rise at the bourses in the past year. But the best of lot has been PSL, which has seen an appreciation of nearly 160 per cent in its price, compared to Man Industries, Jindal Saw and Welspun Gujarat (131 per cent), (134 per cent), (129 per cent) respectively.

The overall outlook on infrastructure-related companies continues to be good and combined with a management projection of a minimum growth of 15-20 per cent on topline and substantial improvement in profitability, the outlook for PSL stock looks good.

The Business

PSL Ltd, a flagship company of PSL group, is the largest spiral weld (HSAW) pipe manufacturer in India and operates 10 pipe-making mills with an annual capacity of about 10.25 lakh tonnes.

It manufactures large diameters spiral weld pipes (as big as 120" inches, which is the company's speciality), which basically find application in oil and gas transportation, water pipelines etc. Majority of its pipe mills are located at port based regions of Kandla, Vizag, Chennai and Daman.

PSL's sales have grown at a CAGR of 28.40 per cent and operating profit and net profit at a CAGR of 9.10 and 1.10 between FY02 and FY05 respectively. However it is not only the good numbers that has held up the stock.

According to analysts, PSL have the necessary fundamental strength which will ensure a smooth ride forward. According to the company's managing director, Ashok Punj, manufacture of HSAW pipes of diameters as big as 120" inches, captive manufacture of machinery required to make pipes and less reliance on imported raw material (like HR plates used by its competitors) gives the company an edge over other domestic players. Industry sources say that imports of HR plates form about 50 per cent of total raw material requirement.

Moreover, geographic location of its 10 pipe mills and that too port-based locations and the option to relocate mills as and when required (which saves transportation costs, an important component of total cost) and domestic availability of its main raw material, HR coils, makes the company the least cost producer of pipes in the country. The company also avails of tax incentives for having facilities in Gujarat (for next 4 years).

Swelling order book

PSL was handed a recent boost when it won an order amounting to $55.5mn (approximately Rs 250-300 crore) from the Qatar Government's Dolphin Pipeline project. The project involves coating (anti-corrosion) its offshore pipe line for 180 km out of the total 750 km.

The company expects the benefits of this order to reflect on its book in next half of this fiscal. The order is expected to add to the topline and improve its profitability in FY06 as generally such offshore export contracts are profitable and yield higher margins.

There are some more waiting in store. The company has got other projects from IOC, a water project from the government of Gujarat, Andhra Pradesh (project is in advance stages), L&T (water project) and BHEL.

Thus, the company's unexecuted order book position stands at around Rs 1100 crore which is 75 per cent of the turnover achieved in FY05. PSL is also hopeful of winning new projects from GAIL and Reliance (KG basin gas line), going forward.

Punj expects a minimum growth of 15-20 per cent on topline and substantial improvement in profitability if the company receives more offshore contracts. The share of oil and gas and water projects in the total revenue is expected to be in the ratio of 60:40 in FY06 (70:30 in FY05) as demand for water projects has been growing faster than demand for oil and gas projects.

Similarly ratio of exports vs. domestic revenues, which stood at 70:30 in FY05, is expected to be 35:65 in FY06. It is expected that domestic players like HPCL, GAIL are also likely to invest heavily on pipelines plus the water projects in domestic market, which will increase the domestic share of revenues for PSL, provided they win some contracts.

Punj also expects international market to be active in pipeline contracts as the upward movement of crude prices has driven up refining margins prompting international companies to make investments in pipe laying.

Bright industry outlook

According to analysts, pipe manufacturing is expected to gather pace especially for water projects due to UPA government's thrust on improving irrigation facilities in rural and urban areas.

Though pipeline projects in the oil and gas sector by the domestic downstream companies is expected to be slow on account of prevalence of high crude prices, analysts believe that there is lot of scope for Indian players to grab the opportunity on the overseas front especially in Middle East countries as high crude prices would boost investments in pipeline in that region.

Moreover domestic demand for pipeline would continue to remain high for the gas transportation segment as pipelines are the only means of transport for gas supply.

According to industry players, there are plans for laying pipelines of approximately 21000 km over next few years for transporting oil and gas. Moreover low penetration of pipelines in India has opened great avenues of growth for pipe manufacturing industry.

But there is a catch

The company's margins could be under pressure if steel prices move up substantially. Though Punj expects steel prices to remain stable in the medium term, steel analysts of leading brokerage firms hold a contrary view.

They believe that steel prices, after witnessing a sharp correction in last six months, are expected to go up from the current levels by around 4-10 per cent in the near term before stabilising.

Financials

In FY05, sales leapt by 61.7 per cent year-on year (y-o-y) and operating profit and net profit jumped by 31.6 per cent and 14.3 per cent respectively.

However margins (both operating and net margins) were under pressure due to sharp rise in steel prices. Steel accounts for about 60-70 per cent of input costs and the ratio of raw material to net sales jumped from 71.3 per cent in FY04 to 84.8 per cent in FY05. 
 

Financials
(In Rs crores)	FY05	FY04	%chg	Q1FY06	Q1FY05	% chg
Net Sales	1440.54	890.66	61.70	433.87	200.23	116.70
Operating profit	111.01	84.36	31.60	35.59	17.55	102.80
OPM (%)	7.70	9.50		8.20	8.80
Net profit	32.01	28.01	14.30	12.01	5.08	136.40
NPM (%)	2.20	3.10		2.80	2.50
EPS (Rs)	11.00	9.60	14.30	4.20	1.80	137.10
Trailing 12-month P/E                                                            20.70

The company expects to exceed its performance achieved in FY05 and if steel prices remain stable, margins will also be better in FY06. Analysts expect overall improvement of 150-200 bps in margins of all players in the segment including PSL.

Valuations

Shares of PSL are quoting at P/E of around 25x at a market price of Rs 284 on September 29, 2005. The overall valuations look risky at the current levels and one may be unlikely to witness the same kind of return on the stock going ahead amid the overall volatile market.