Stock Review: ELECTROSTEEL Castings Limited (ECL)

 

Most rural parts of India go without adequate supply of water. That is where Electrosteel Castings, the maker of ductile and cast iron pipes, comes in. Demand is such that its net sales have been on their way up over the past four years. But delay in the environmental nod may temper the mood, going ahead

 

ELECTROSTEEL Castings Limited (ECL), one of the leading pipe manufacturers in India, is seen gaining from the government's increased thrust on water infrastructure and poor water supply facilities in rural areas.

BUSINESS:

ECL manufactures ductile iron pipes and fittings and cast iron pipes for water transportation and sewerage industry. It also undertakes turnkey contracts in water infrastructure and sewage transportation.

   Its ductile iron pipes division, which has an annual capacity of 280,000 tonnes, contributes nearly 75% to its net sales. ECL corners about 60% of the domestic ductile iron market. Ductile iron pipes are increasingly preferred over cast iron pipes for transportation of liquids due to its high tenacity and better resistance to rust. Buyers of these pipes include government agencies, municipal agencies and infrastructure companies.

GROWTH DRIVERS:

Growth in the ductile iron pipes industry, estimated at 16-18% over the next two years, is seen as one of the main growth drivers for the company. The company is expanding its annual capacity by 330,000 tonnes. ECL is also venturing into steel manufacturing via Electrosteel Steel by setting up a 2.20-million tonne steel plant. The company will also benefit from the government's thrust on infrastructure projects. The government has planned to spend 1,11,689 crore on water infrastructure in the 11th Five-Year Plan.

   Over the years, smaller players like Electrotherm, Tata Metaliks Kubota, and Jai Balaji Industries have been gaining market share. To weather the competitive pressure, ECL is using the backward integration route, thereby insulating itself from price fluctuations in key raw materials - coking coal and iron ore.

   ECL has started operations at its Parbatpur mine with an output of about 5,000 tonnes per month. The coking coal mine, with total reserves of 231.2 million tonnes, is expected to increase its output to 0.7 million tonne annually over the next two years. Just over 30% of the output will be needed to meet ECL's requirement while the surplus will be sold. The company also has an iron ore mine at Kodolibad, Jharkhand, with reserves of 91.2 million tonnes, where it is awaiting a clearance from the environment and forest ministry. To curtail logistics costs, ECL is setting up railway sidings facilities between its coking coal and iron ore mines, for which it has already acquired two wagon rakes from the Indian Railways.

FINANCIALS AND VALUATION:

Over the past four years, ECL's net sales have been growing at 12% while net profit compounded annual growth rate was 28% on account of improved operational efficiencies. The company has been steadily generating cash from operations with a cash balance of 298.60 crore on its books. Its debt equity ratio is 0.8. During the third quarter of FY11, the company's net sales rose 10% year-on-year, driven by a rise in ductile iron pipe volumes. However, the rise in price of coking coal and iron ore, which the company procures from third parties, dragged its operating profit margin down 780 basis points. At 34, the stock trades at eight times its 12-month trailing price-to-earnings ratio.

CONCERNS:

The company has still not received the required mining approvals to begin operations at its iron ore mine at Kodolibad in Jharkhand. Till the government gives the necessary clearance, the company will continue to be exposed to high input costs.