Stock Review: Prakash Industries Ltd

Prakash Industries Ltd. (PIL) is an integrated steel manufacturer which produces sponge iron, mild steel, wire rods, TMT bars, and ferro alloys. The company also undertakes mining and generates power to meet its own requirements.

 

Sectoral outlook

Steel production in India rose by 4.2 per cent to 60 million metric tonnes (MMT) in FY10. India emerged as the world's fifth-largest steel producer. In the same year its steel consumption rose 8 per cent over the previous year.

The government is supporting the industry through favourable reforms, while the private sector is supporting it with large investments. In a fast developing economy such as India's, the industry has massive growth potential. Industry estimates indicate that the steel industry will continue to grow at a rapid pace since urbanisation and infrastructure development will lead to huge demand for steel.

 

Among the negatives, uncertainty in the availability of key raw materials like iron ore plague the industry. Although India has iron ore reserves of approximately 13 billion tonnes, its high volume of export to China and other countries has aggravated the situation for domestic steel manufacturers. The latter have been experiencing the brunt of short supplies and spiralling ore prices constantly.

 

Company profile

PIL is part of the Surya Roshni group. The company's integrated steel plant is located at Champa in Chhattisgarh. It has set up its own mining and crushing division in Sundargarh, Orissa. The company has been allotted iron ore mines by the state government in Nergaon and Metabodali in Chhattisgarh and Sirkagutu mines in Orissa. In addition, the company is one of the leading exporters of iron-ore fines via Haldia port. It presently generates power using waste hot gases generated from rotary kilns and also by using coal fines and washery rejects.

 

PIL has been allotted two captive coal blocks by the central government - Chotia and Madanpur in Hasdeo-Arand coal fields in Chhattisgarh.

 

Strengths

Good performance. The company has posted a three-year compounded annual growth rate (CAGR) of 17.2 per cent in sales and 26.1 per cent in profit after tax.

 

In Q1FY11 its net revenue increased 27.3 per cent year-on-year (y-o-y) but was flat on a quarter-on-quarter (q-o-q) basis. However, its EBITDA margin dipped slightly by 185 basis points y-o-y to 20 per cent on account of higher iron-ore prices. Net profit rose by 18 per cent y-o-y.

 

Expanding capacity. Currently PIL sources around 30 per cent of its sponge iron requirements from third parties. According to a report by Angel Broking, in its bid to reduce dependence on external parties, the company is expanding its billet capacity from 0.7 million tonnes to 1.0 million tonnes by June 2011 and sponge iron capacity from 0.6 million tonnes to 1.2 million tonnes by FY12. As new iron ore and coal mines are granted to add to supplies from the existing Chotia coal mine, PIL will steadily move towards a fully integrated business model.

 

Opportunities

The company has already initiated its plan to achieve full integration at all levels throughout its chain of steel operations. This plan is expected to be completed in the next two years.

 

Further, the company is making a foray into power production by planning to set up a 625 MW thermal power plant at its existing plant site at Champa for captive use. The first phase is expected to be commissioned in the current year. Thereafter subsequent phases will come up in a phased manner over the next three years.

 

According to an Angel Broking report, PIL has raised US $110 million through foreign currency convertible bonds (FCCBs) over the last six months to fund its capital expenditure (capex) plan. As capacity gets added in a modular fashion, the company's net debt-equity is likely to be stable at 0.1x over FY2010-12 as internal accruals will be sufficient to fund its capex requirements.

 

Concerns

Due to inadequate supply of iron ore, which is the company's key input, iron ore prices have been witnessing a high level of volatility. This is in turn resulting in unstable margins for steel.

 

Another major concern for the company is that allegations have been levelled against it that it has indulged in illegal mining and black-marketing of coal from its Chotia mine. However, the company has declared these allegations to be false. According to a leading newspaper report, the Coal Ministry has stated that it will decide on the issue after the completion of CBI's inquiry.

 

Valuations

PIL is currently trading at a price-to-earnings ratio (P/E) of 8.8 (September 20, 2010) which is slightly higher than its five-year median P/E of 7.2.

It posted a three-year CAGR growth of 30.9 per cent in earnings per share (EPS). Its price-earnings to growth (PEG) ratio is 0.29, which is attractive.

While valuation-wise the stock is attractive, its price could remain volatile in the short to medium-term till the controversy around the stock gets sorted. To be on the safer side, we recommend that you invest in the stock after the cloud that is hanging over it dissipates.