Stock Review: Tata Sponge Iron

ORISSA-BASED Tata Sponge Iron is India's leading manufacturer of sponge iron. A secured raw material supply from Tata Steel, high operating efficiency and higher contribution from its power business will fuel the company's growth. Long-term investors can consider the stock.

BUSINESS

Tata Sponge Iron is an associate company of Tata Steel. It has its manufacturing facility in Bilaipada, Orissa. It is a pure sponge iron player as it drives 93% of the revenue from sponge iron business while power contributes the rest. The company currently has a sponge iron capacity of 39,000 tonnes and uses the electric arc furnace method of production. It has a power generation capacity of 26 megawatt.

GROWTH DRIVERS

Being a manufacturing company, power and fuel costs are an integral part of its operations. The company produces power from the waste heat recovery process. Heat generated during sponge iron manufacturing is used for power production. This process is economical as compared to the conventional coal-based generation. The company is expanding the capacity to 50 mw over the next two to three years. After meeting its own consumption, the company can sell excess power to the grid. The share of revenue from the power segment is expected to increase by 10-12% of sales in the next three to four years. Power business is highly profitable, which can boost overall margins.

   The company has an assured supply of iron ore from Tata Steel with a long-term pricing arrangement. As for its coal requirements, it currently depends on Coal India and imported coal. The company also owns a 45% stake in a coal block in Orrisa with estimated reserves of 120 million tonnes. The captive mine will lead to savings of 1,100 per tonne on coal, when it starts the commercial operation in FY12.

   Sponge iron prices have increased in recent months in tandem with the rise in Chinese domestic steel prices. They are expected to gain further momentum given the demand for long products.

FINANCIALS

Over the past 10 financial years, the company has grown its net sales at an average annual rate of 15%. This has been on the back of a 5% annual growth in volumes and 9% annual improvement in realisation. In the quarter ended September 2010, the company reported sales growth of 55% to 175 crore compared to the previous year. Net profit, however, fell by about one-fourth to 10 crore due to higher raw material prices. As these prices have moderated in the current quarter, it would help the company improve its margins. The company has almost no debt on its books. It has been consistently paying dividends in the past.

VALUATIONS

At the current market price of 357, the company's stock is trading at six times its trailing 12 - month earnings. This is at a discount to most of its peers like Usha Martin and Monnet Ispat that trade at a price multiple of 16 and 10, respectively. Backward integration and increasing power business contribution will help the company report higher profits in future, giving an upside potential to the company's stock.