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1

INDIA

Institutional Research

STEEL

Initiating Coverage

Electrosteel Castings Limited

Near term pain with long term gain...

Initiating Coverage Networth Research is also available on Bloomberg and Thomson

Date: 2nd November, 2011

AVP Research: Surya Nayak [email protected]

Tel No. : 022 3022 5901 Analyst: Jignesh Vayda [email protected]

Tel No. : 022 3022 5904

Kolkata based Electrosteel Castings Ltd (ECL), is India’s largest Ductile Iron Pipe manufacturer catering chiefly to the Government and Urban Local Bodies in the transportation of drinking water & sewerage on domestic market front besides fulfilling the requirement of overseas market. ECL also executes DI pipe related EPC projects on a turnkey basis

Investment Rationale

Water infra thrust to boost demand

The XIth 5‐year plan saw an investment of ~Rs1tn in the water infrastructure space. The Government has emphasized the investment in the sector in increased vigour during the XIIth plan as well. The industry is expected to sustain a growth of 15% CAGR for FY12‐13e.

Captive coking coal and iron ore mining will boost margins

With the start of coking coal mining along with coal washery facility, the company would be able to obviate the raw material volatility seen in recent times. We estimate ~15% and 10% cost reduction in the coke in FY12e and FY13e respectively. Further, in FY13e, the iron ore mining is expected to feed the entire requirements of ECL, which will further reduce the cost. We estimate ~50% reduction in ore cost on such development.

JV for Non‐coking coal remains positive upside

ECL has entered into a JV with Domco Pvt Ltd for prospecting of non‐coking coal, which would feed partially to its sponge iron plant at Haldia. ECL has 49% stake in the venture. The balance production is planned to be sold in the market. Also, ECL is developing dolomite mines allocated to it, which will be partially routed to the production of sponge iron and pig‐iron. However, we have not accounted for any upside from Non‐coking coal and dolomite mining.

Key Investment Risk

Delay in development of Iron ore mining

Disruption of iron‐ore supply from Orissa

Significant price rise in imported coking coal

Valuation – strong upside potential

We aver that 2012E would pan out to be a difficult year for all ferrous companies (sans RM linkage) considering the tight situation prevailing in the raw material side. But situation is expected to subside for the better in FY13E on benefits accruing from ECL’s own mining. ECL is trading at PE of 5.6x and EV/EBITDA of 7.6x of its FY11 earnings. We expect the company to post an EPS of Rs.10.5 for FY13e. Based on 4x FY13e EPS, we arrive at one year price target of Rs.42 giving 62% upside from the current market price.

Rating BUY Target Price `42 CMP `26 Upside 62%

Sensex 17544

Key Data Bloomberg Code ELSC IN

Reuters Code ELST.BO

NSE Code ELECTCAST

Current Share o/s (mn) 326.8

Diluted Share o/s (mn) 326.8

Mkt Cap (`bn/$mn) 8.1/165

52 WK H/L (`) 44/26

Daily Vol. (3M NSE Avg) 373910

Face Value (`) 1

Beta 0.69

1 USD/` 49.1

Shareholding Pattern (%) Promoters 48.5

FII 5.3

Others 46.3

Price Performance (%) 1M 6M 1yr

ELECTCAST ‐8.9 ‐7.9 ‐36.5

NIFTY 7.8 ‐2.8 ‐11.5

Source: Bloomberg; *As on 1st Nov, 2011

Financial Summary (Standalone): (Rs. In mn) Year Revenue YoY EBITDA EBITDA Margin PAT EPS (Rs.) EV/EBITDA (x) P/E(x) 2010 14,586 ‐22% 3,087 21% 2,063 6.3 5.9 4.1 2011 17,457 20% 2,809 16% 1,520 4.7 7.6 5.6 2012 E 17,949 ‐3% 2,486 15% 896 2.7 10.3 9.5 2013 E 24,161 43% 6,488 27% 3,424 10.5 4.4 2.5

Source: Company, Networth Research

2 Initiating Coverage

Company Profile

Electrosteel Castings Ltd (ECL) was incorporated as Dalmia Iron and Steel Limited in 1955, which the current management took over in 1963 and subsequently named it as Electrosteel Castings Ltd in 1965. Over the years ECL has emerged as one of India’s largest players providing valuable inputs to water infrastructure space in the form of drinking water supply & sewerage systems.

ECL is mainly engaged in manufacturing of Ductile Iron (DI) Pipes and Fittings. It has also limited presence in the Cast Iron (CI) Pipes mainly used in water infrastructure and sewerage industry. Over the time, ECL has extended its interest into the execution of DI pipe related EPC projects on a turnkey basis.

60,000 TPA DI Pipe plant at Khardah set up

109,000 TPA Pig Iron facility setup at Khardah

D I pipes capacity expanded to150,000 TPA and Pig Iron to 200,000 TPA

Acquired 46% stake in DI Pipe player from South India Lanco Ind. Ltd.

D I pipes capacity raised to 200,000 TPA .

Commissioned 150,000 TPA coke oven battery plant and 30,000 TPA sponge iron plant at Haldia.

Allotted a Coking Coal mine at Parbatpur, Jharkhand.

DI Pipes and Blast Furnace capacity enhanced at Khardah. Set up 12 MW Power plant and another 30,000 TPA Sponge iron plant at Haldia.

Allotted an Iron Ore mine at Kodolibad, Jharkhand and a NonCoking Coal mine in 49% JV with Domco Pvt. Ltd at North Dhadhu.

Commissioned 360,000 TPA sinter plant at Khardah. DI pipe and blast furnace capacity enhanced.

Commissioned fourth coke oven battery taking the total capacity to 295,000 TPA at Haldia

Started mining of coking coal at Parbatpur, Jharkhand

To start mining iron oreat Kodolibad, Jharkhand

1994

1996

19992001

2002

2006

20082009

2011

2013

20032005

Organisation & Facilities: A Bird’s Eye‐view

The company has facilities at Khardah, Haldia in West Bengal and Elavur in Tamil Nadu. In FY08, ECL had taken vital stake (48.54%) in one of its competitor in the southern market, Lanco Industries Ltd. The Electrosteel group commands 51.3% market share (production) in FY11.


Location Product Capacity/Status

Khardah,

West Bengal

DI pipe 280,000 TPA

Pig iron 250,000 TPA

Sinter 360,000 TPA

Power plant 3.75 MW

DI fittings 5,000 TPA

Haldia,

West Bengal

Coke 295,000 TPA

Sponge iron 60,000 TPA

Power plant 12 MW

Elavur,

Tamil Nadu

CI pipes 90,000 TPA

Parbatpur,

Jharkhand

Coking coal mine

Geological reserves of 231.2 mn MT

Coal washery 2 mn TPA

Kodolibad,

Jharkhand

Iron ore mine Lease yet to be

granted

50% JV with

Domco Corp

Non‐coking Coal Mining Plan

submitted

International Subsidiaries

Name of the subsidiary

Stake Target Market

Electrosteel Europe SA

100%

Germany, Italy, France, Spain, Portugal and Poland

Electrosteel UK Ltd

100% UK

Electrosteel Algeria SPA

100%

Algeria and other African countries

Singardo Int’l Pte Ltd

60%

Singapore, Indonesia,Brunei & Malaysia

Electrosteel USA LLC

100% USA

Waterfab LLC *

100% USA

Associate companies

ECL is setting up an integrated steel plant with a capacity of 2.2 MTPA in Jharkhand through Electrosteel Steel Limited (ESL), its subsidiary, in which it holds 35% stake. The plant is expected to be operational later part of FY12.

Business segments

DI pipes and fittings

Domestic Market: Sustaining growth on Government plans DI pipes and fittings is the main product segment of ECL, used in inter and intra‐city transportation of drinking water and sewerage. The company has an installed capacity of 280,000 TPA of DI pipes at its Khardah plant, manufacturing pipes in the range of 80‐1,100mm diameter and 6mt in length. The fittings are made at its Khardah plant that has an installed capacity of DI Fittings is 5,000 TPA. Lanco Industries Limited, an Associate Company has an installed capacity of 225,000 TPA of DI pipes.

Export Market: Growing Steadily The Company has entrenched position in the international market through its wholly owned marketing subsidiaries in key international destinations (except in Singapore, 60%). Export constitutes 35% of its revenue in FY11 and the management plans to scale it up to half of its top line by FY14E.


CI Pipes Cast Iron pipes are manufactured at Elavur facility. Cast Iron pipes, whose usages are gradually declining owing to limitation in its properties vis‐à‐vis other competing materials, are used in the domestic sanitation management. Company has also started production of pipes having specification class “D” which are mainly used in ash handling system at Thermal power stations.

Turnkey projects The company also entered into turnkey projects in water infrastructure and sewerage management. It undertakes design of systems, engineering and procurement of components, construction operations, and commissioning of the project. As part of the turnkey activity, ECL also supplies and lays substantial quantities of its DI pipes and fittings and thus enhances use of the company’s products.

ECL: The Manufacturing Process

Coking Coal

Iron Ore

Thermal

Coal

Other Minerals

Mining Started from FY12

Mining & Mfg to start from FY13E

Bought outsCoking Coal Fines

Iron Ore Fines

SinterSpongeIron*

Ferro Silicon Plant*

Coke

Blast Furnace

Steel Melting Shop

Pig Iron

Alloy Steel

Coke Oven

Battery*

Sintering Plant

DRI*

SpongeIron

DIPipes

Intermediary Processes

Intermediaries

Basic Raw

Materials

Final Product


Facility Overview

As a part of backward integration strategy the company has set up supporting facilities for production of DI pipes.

Coke Oven Battery Plant: Respite from rising Coking coal prices

Low ash metallurgical coke (LAMC) is the key fuel for the production of pig iron. Pig Iron is the building block of DI pipes and fittings. The LAMC is made from Prime Coaking Coal, which till recently was entirely sourced from Australia. But with its own coaking coal mine became operational from FY12, ECL’s import content will be reduced by 30%, ECL has set up huge coal washeries to reduce ash content of coal. ECL has four coke oven batteries at Haldia with an aggregate capacity of 295,000 TPA, generating the requisite LAMC for the group operation.

Pig iron plant

Pig iron, in molten form, is used to cast DI pipes and fittings and CI pipes. ECL has a pig iron manufacturing plant with a capacity of 250,000 TPA at its Khardah facility. Iron ore is the key raw material required for the production of pig iron. Currently, the iron ore requirements of this plant are met through mines in Orissa. For its CI pipe facility at Elavur, the company is sourcing pig iron from local manufacturers. From FY13e onwards ECL will start sourcing iron ore from its own mines. Currently, the mine development process is awaited for environment clearance, which the management has guided of prospecting from FY13e.

Sinter plant

To cash in on the cheaper fines of iron ore and coking coal the ECL management has set up a Sintering unit with a capacity of 360,000 TPA, at its Khardah facility. Sinter ore improves the productivity of the blast furnace besides exploiting abundant supply of mineral fines in proximity to its plant.

Sponge iron plant

Sponge iron, an alternative to scrap steel used in the steel melting shop, is being produced at Haldia with a DRI (Direct Reduced Iron) capacity of 60,000 TPA. This obviates ECL resorting to costlier/volatile imported scrap metals for its Induction Furnace. Surplus production is sold in the local market.

Power plant

ECL is running a 12MW power plant that uses waste heat generated from the coke oven battery and sponge iron plants. Approximately 10MW of power is sold to the West Bengal State Electricity Board, after meeting out its own requirement at Haldia of 2MW. At Khardah, a 3.75MW steam turbine generator based captive power unit is in operation based on the heat from waste gases emitted by the mini blast furnace. Balance requirement of ~20MW is sourced from CESC.


Mines: Upside in profitability to kick‐in from FY13E

The major raw materials used in the manufacture of DI pipes and fittings are iron ore and coke. Presently, ECL sources iron ore from mines in Orissa at spot price and imports coking coal from Australia at quarterly contracts.

On the wake of rising raw material prices and its scarce availability in the domestic market, ECL has envisioned few years back to ensure raw material security in its business process.

Coking coal mine – ECL was awarded an underground 8.8 sq km coking coal mine block at Parbatpur, Jharkhand, with geological reserves of 231.2 mn tonnes in 2005. The mining lease agreement with respect to the same has been signed with the Government of Jharkhand in January 2008 for 30 years from 11 January 2008. The company has already acquired the requisite land for the same with environmental clearance. Mining activity started from June 11. Further, a 2MTPA coal washery has been set up to reduce ash content of the coking coal. But, due to inferior quality of Coking Coal, only 30% of the requirement would be sourced from captive mines and the balance continue to be imported from Australia. This would enable ECL to partially insulate its business from price volatility in the open market. We estimate ~15% and ~10% savings in coking coal cost owing to supplies from the captive mine in FY12e and FY13e respectively.

Iron ore mine – In June, 2006, ECL received allotment of an open cast iron ore mine in Kodolibad, Jharkhand from the Ministry of Mines, GoI, with geological reserves of 91.2 mn tonnes. The proposal for the forest diversion is with Ministry of Environment and Forest for grant of clearance. On receipt of the final clearance, the mining lease agreement will be executed in ECL’s favour. The management expects this mine to be operational by FY13E. We expect this backward integration measure to enable ECL to reduce its iron ore costs by 50% and ensure a steady supply of iron ore.

Non‐coking coal mine – ECL, through a 49% JV, has been awarded North Dhadhu open cast non‐coking coal mine block, with geological reserves of 238 mn tonnes (ECL’s share – 120 mn tonnes), in Latehar district, Jharkhand. The JV has submitted the requisite bank guarantee to the Ministry of Coal Mining and has made the lease application. The mining plan is being submitted to the Ministry of Coal.


Permit Approving Authority Coking Coal Iron Ore

Mine Allocation Ministry of Coal Received Received

Approval of Mining Plan Ministry of Coal Received Received

SPCB Clearance JSPCB Received NOC Received

Environmental Clearance MoEF Received Received, but applicable once forest clearance is received

Railway Transport Clearance Railway Board Received To be received along with forest clearance

Forest Clearance MoEF Not Applicable Forest Diversion Proposal already submitted.

Signing of Mining Lease State Govt of Jharkhand Received Will be applied for after Forest Clearance is received.


Macro Review

Water supply scenario in India

India has approximately 16% of the world’s population but only has 4% of the world’s water resources. The country’s water supply requirements are mainly met from monsoon which is highly unpredictable and unevenly spread across the country. Water resources are being over‐exploited as the total water resource availability in the country remains constant, the per capita availability of water has been steadily declining.

Dwindling per capita surface water availability (cu meters)

5177

2309

19021625 1465

1235

1951 1991 2001 2010 2025E 2050E

<1700 ‐Water Stressed

<1000 ‐Water Scarce

Source: Ministry of Water resources, Government of India

The main water resource for the country as a whole in terms of annual precipitation (average rainfall, snowfall and glacier melt in terms of volume) is about 4,000 billion cubic metres (BCM). However, the water availability for the country as a whole has been assessed as 1,869 BCM. Further, it is estimated that only about 1,123 BCM can be utilised, comprising 690 BCM of surface water and 433 BCM of replenishable ground water resources. The country has already entered the water stressed condition in 2010 with only 1625 cu meters of per capita availability. Sectorial Waterequirement 2010 2025 2050

Irrigation 557 611 807

Drinking water 43 62 111

Industries 37 67 81

Energy 19 33 70

Evaporation losses 42 50 76

Others 12 20 35

Total 710 843 1,180

Source: Planning Commission, Government of India (figures are in BCM)


Spread of water among broad sectors

Agriculture78%

Industry8%

Domestic6%

Others8%

2010

Agriculture69%

Industry13%

Domestic9%

Others9%

2050

Source: Company, Networth Research

Health budget to be raised to 2.5% from 1.8% of GDP in XIIth Plan

The XIth Plan had noted that the total public expenditure on health in India by Centre and the States was less than 1 % of GDP and it needed to be increased to 2 or 3 % . The process has begun and the percentage is estimated to have increased to around 1.8% in 2011‐12 (Budgeted Estimate). The Government has emphasized that a larger allocation of resources will definitely be needed in the 12th Plan to achieve the objective. The 12th Plan approach paper is aiming to increase total health expenditure as percentage of GDP to 2.5 % by the end of 12th Plan. Programme Ministry/Department Total XI th Plan (Rs in Crore)

Accelerated Irrigation Benefit Programme and Other water resources programme

Water Resources

46,622

Rajiv Gandhi Drinking Water Mission (Rural Drinking water) – NRDWP and Total Sanitation Campaign (TSC)

Drinking Water Supply

46,722

JNNURM Urban Development 48,485 Source: XII Plan Approach Paper, Planning Commission, GoI

As per industry and government sources, approximately Rs1 lac crore (Rs1 trillion) was spent in water supply and sanitation in urban and rural areas during XIth plan. Assuming 7.5% average growth in the GDP during the XIIth plan period (FY13‐17), minimum Rs1.1 trillion is likely to be spent in water supply and sanitation sector.

Huge demand from Domestic and Industry Sector envisaged


Sanitation facilities

Urban Sanitation: India As the country has very poor sewerage networks India is facing challenges in providing proper sanitation facilities. 4861 out of the 5161 cities/towns do not have even a partial sewerage network. According to 2007 estimates, sanitation covers only 49% of India’s total population. Nearly 63% urban population has access to sewerage and sanitation facilities (47% from sewers and 53% from low cost sanitation). Huge opportunity

The investment for urban infrastructure over the 20‐year period (2012‐31) is estimated at Rs 39.2 lakh crore. Sectors delivering urban services such as water supply, sewerage, and solid waste management will need Rs 5.6 lakh crore (or 14.4%). Total Urban Infrastructure Budget estimation for next 2 decades (Rs in Crore)

3918670

1728941

449426

408955

320908

242688

191031

101759

97985

48582

18580

309815

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

4000000

4500000

Total Expenditure

Urban

Roads

Urban

Transport

Renewal and Redevelopm

ent

Including Slums

Water Supply

Sewerage

Storm

Water Drains

Capacity Building

Traffic Support Infrastucture

Solid W

aste Management

Street Lighting

Other Sectors

Source: Report on Urban Infra & Services, Mar 2011, Isher Judge Ahluwalia

Rural Sanitation Scene

Rural sanitation has grown impressively in rural India following the launch of Total Sanitation Campaign in 1999; which received a special boost after the Nirmal Gram Puraskars (NGPs) were announced in 2003. More than 22,000 NGPs have been awarded so far. By September 2009, rural sanitation coverage had grown to 62%t of the households. (Source: 11 Plan Mid‐term appraisals Report). The investment in the rural area is on fast track and Government has target of achieving 100% sanitation in 12 plan period.


Progress in Rural Sanitation

1 4

11

3 10

11 14

6

17 18

22 22

23 27

31

38

45

57

62

0

10

20

30

40

50

60

70

1,980

1,988

1,989

1,990

1,991

1,993

1,994

1,996

1,997

2,000

2,001

2,002

2,003

2,004

2,005

2,006

2,007

2,008

2,009

(%) % Sanitation coverage

1980 ‐1990 International drikingwater and sanitation decade

1986 ‐1999 Central Rural Sanitation

2003Nirmal Gram Puraskar

1999 Launch of Total sanitation Campaign

Source: Mid‐term Appraisal of XIth Plan, Planning Commission

Industry to benefit from increased investment in water supply and sanitation

On the back of increased spending, the domestic DI pipes industry grew at a two‐year CAGR of 13.3% over FY08‐10. According to industry sources, demand is expected to grow at ~15% over the next two‐three years on the back of increased government spending. Additionally, the export market offers a sizable opportunity due to the cost benefit in India.

DI Pipe Demand ‐Supply Scene

2007‐O8 2008‐09 2009‐10 2010‐11 2011 12 2012 13 2013‐14 2014‐15 2015‐16 2016‐17

Domestic Demand 424 500 590 697 822 915 1,087 1,250 1,438 1,653

Projected Export 182 214 263 299 352 405 466 536 616 709

Estimated import 42 50 72 70 82 65 109 125 144 165

Reqd Supply 563 665 781 925 1,092 1,256 1,444 1,661 1,910 2,197

Total Demand 606 715 853 995 1,174 1,320 1,553 1,786 2,054 2,362

‐

500

1,000

1,500

2,000

2,500

Thousand Ton

Source: Industry, Company


Competitive Landscape:

The industry is dominated by organized players with ~ 88% production share. ECL along with its group company Lanco industries is a major player in the industry.

Major fresh capacities are accruing during FY12‐13 period from Jindal Saw Ltd. But, it is since facing problem of iron ore sourcing in Bellary, and hence may revisit its pipe capex plan in near future depending on its mining development plan in Rajasthan. Also, Jindal Saw is planning a 300,000tpa DI pipe facility at Abu Dhabi.

Even if the new capacities as planned by Jindal Saw fructifies their (capacities’) utilization hinges on the easing of supply constraints of raw materials (iron ore and Coking Coal) in conjunction with rising prices in the e‐auction environment as opposed to earlier long‐term supply arrangement from NMDC. We believe, so long as the raw material security (own mines) issue is not addressed by each of the players, the volatility in profitability would going to be a regular phenomenon in days ahead.

Capacity & Mining asset overview of competitors

Players Electrosteel Castings Ltd

Jindal SAW Ltd

Jai Balaji Industries

Lanco Industries

Electrotherm

Tata Metaliks Kubota

Rashmi Metaliks

Capacity (MT) 280,000 300,000 240,000 225,000 192,000 110,000 48,000 Production (MT) 270,327 254,700 26,319 134,779 82,998 20,402 NA Capacity Utilisation 97% 85% 11% 60% 43% 19% NA R M Linkages Coking Coal × × × × ×

Iron ore × ×

Non Coking Coal × × × × ×

*Jindal SAW’s mine development is likely to be completed by FY13eSource: Company, Networth Research


Financial Overview

Consistent growth in revenues

ECL has reported strong revenue growth in the last decade. However, on account of growing competition and rise in raw material costs the revenue would moderate for current year and would accelerate FY13e onwards. We expect the revenues to increase at a three year CAGR of 18% to Rs.24.2 bn in FY13e driven by mining revenues.

Increasing focus on exports Mining to boost revenue FY13e onwards

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY10 FY11 FY12e FY13e

Domestic Export

‐5%

0%

5%

10%

15%

20%

25%

30%

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0


Revenues (Rs.bn) Growth (%)

Source: Company, Networth Research Source: Company, Networth Research

Distorted margin picture to get respite post mining development

We expect EBITDA margin to correct due to higher raw material cost and aggressive marketing

strategies of competitors to gain market share. However the company will regain its strength in terms

of low cost manufacturing to compete with new players once the mining activity begins in FY13e. The

mining revenues will have a significant impact both on EBITDA and PAT margins FY13e onwards. EBITDA margins to boost post FY13e Improving PAT margins FY13e onwards

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00


EBITDA (Rs.bn) EBITDA Margin

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


PAT (Rs.bn) PAT Margin


We expect the revenues to increase at a three year CAGR of 19% to Rs. 24.2 bn in FY13e


Return ratios to improve

Return ratios have been witnessing a downward trend on the back of lower profitability in the year

gone by. The situation is expected to deteriorate this year also and would improve once mining

operations start from FY13e.

Return ratios to rebound from FY13e Debt equity at comfortable levels

0.0%

5.0%

10.0%

15.0%

20.0%


ROE ROCE

0.0

0.2

0.4

0.6

0.8

1.0

1.2


Term Debt /Equity Debt /Equity


Financial gearing to stay in comfort zone

Current capex requirement for mine development and sustained operating cash flow once mining operations start and timely repayment of debt will soothe the Debt/Equity ratio in coming years.


Valuation Outlook

Strong competitive pricing pressure and rising raw material pricing scenario has taken a toll on the valuation of ECL. But, the backward integration into mining will prove to be a game changer from high operational margins viewpoint. We believe, subject to performance into mining, the stock is expected to rebound to healthy valuation.

Peer Analysis

We have compared ECL to other leading player Jindal Saw from a relative valuation perspective. Accordingly we have kept our target multiple at 4x FY13e lower than the consensus PE multiple of 5x FY13e of Jindal SAW.

We believe the multiples are muted due to stiff completion and raw material price fluctuations, which are set to grow FY13e onwards once the mining linkages are in place. Hence, ECL is set for improvement in valuation in the near to medium term considering its leadership position in the market, sustainable business model post mining operation.

We aver that 2012E would pan out to be a difficult year for all ferrous companies (sans RM linkage) considering the tight situation prevailing in the raw material side. But situation is expected to subside for the better in FY13E on benefits accruing from ECL’s own mining. ECL is trading at PE of 5.6x and EV/EBITDA of 7.6x of its FY11 earnings. We expect the company to post an EPS of Rs.10.5 for FY13e. Based on 4x FY13e EPS, we arrive at one year price target of Rs.42 giving 62% upside from the current market price.

Risk Factors

Delay in developing the mines and making them operational would negatively impact margins as the company would not be able to offset the impact of increasing spot prices of key raw material.

In recent years the competition has intensified with accrual of fresh capacities by peers. High market share and brand equity has been enabling ECL to pass on raw material price increases to combat the aggressive marketing plans of new peers to gain market share. Continuance of such policy by peers in future may lead to compression of margins.

As water and sanitation infrastructure development is a State subject, any adverse financial health of any State Government or Urban Local Bodies may impact budget spending which may weigh on the demand for DI pipes.

Pipes of alternative materials like Fiber Reinforced Polymer (FRP) have been getting steady acceptance in water infrastructure in China and other developed countries. Though in India, adoption of such pipes is quite lukewarm, but looking at spiraling metal prices reversal in future government stand can’t be ruled out.


Financial Snapshot:

Income Statement (`mn)

Y/E March FY10 FY11 FY12E FY13E

Net Sales 14586 17457 16949 24161

Change (%) ‐21.8 19.7 ‐2.9 42.6

EBIDTA 3087 2809 2486 6488

EBIDTA margin (%) 21.2 16.1 14.7 26.9

Depreciation 523 544 651 763

EBIT 2564 2265 1835 5726

Interest 464 786 1026 1127

Other Income 979 644 547 611

PBT 3079 2123 1356 5210

PBT margin (%) 21.1 12.2 8.0 21.6

Tax 1016 603 460 1787

PAT 2063 1520 896 3424

Change (%) 46.9 ‐26.3 ‐41.0 282.0

PAT Margin(%) 14.1 8.7 5.3 14.2

Balance Sheet (`mn)


Equity Capital 327 327 327 327 Preference shares 0 0 0 0 Reserves 15511 16522 16940 19885 Net Worth 15838 16848 17267 20212 Loans

Term Loan 10047 9586 12682 17848 Working Cap Loan 2372 5130 4447 4782 Net Deferred Tax 470 441 473 597 Capital Employed 28727 32005 34869 43440 Gross Block 8420 9144 10748 13383 Less: Depreciation 3174 3763 4414 5176 Net Block 5246 5381 6335 8206 Capital WIP 3910 4472 8671 9827 Investments 10240 13999 13261 16434

Current Assets 12328 14074 10941 13389 Inventory 3567 5198 3897 3612 Debtors 3741 4886 5435 5267 Cash& Bank 2809 1897 109 2510 Loans& Advances 2210 2093 1500 2000 Current Liab & Prov. 2996 5920 4338 4416 Current Liabilities 1830 4603 3360 2938 Provisions 1167 1317 978 1478 Net Current Assets 9331 8154 6603 8973 Misc exp 0 0 0 0

Total Assets 28727 32005 34869 43440

Cash Flow Statement (`mn)


PBT before EO items 3,079 2,149 1,356 5,210

Add:

Depr. & others 169 935 957 1,121

Change in WC 1,883 (272) (237) (32)

Direct Taxes (1,076) (600) (428) (1,662)

CF from Operations 4,056 2,212 1,648 4,637

(Inc)/Dec in Fixed Assets (1,802) (1,226) (5,153) (3,028)

(Inc)/Dec in Investments (3,239) (3,008) 738 (3,173)

CF from Investments (4,958) (4,161) (4,415) (6,201)

Inc/(Dec) in Equity 290 ‐ (0) ‐

Inc/(Dec) in Debt 5,427 2,614 2,413 5,501

Dividend (407) (407) (409) (409)

CF from Fin. Activity 2,852 1,038 978 3,966

Inc/(dec) in Cash 1,950 (912) (1,789) 2,402

Add: Opening Cash 860 2,809 1,897 109

Closing Cash 2,809 1,897 109 2,510

Financial Ratios


Basic Ratios (Rs)

EPS 6.3 4.7 2.7 10.5 Cash EPS 7.9 6.3 4.7 12.8 Book Value 48.5 51.6 52.8 61.8 Dividend (%) 125.0 125.0 125.0 125.0

Valuation Ratios (x) P/E 4.1 5.6 9.5 2.5 Cash P/E 3.3 4.1 5.5 2.0 Price/Book Value 0.5 0.5 0.5 0.4 EV/EBDITA 5.9 7.6 10.3 4.4 EV/Sales 1.2 1.2 1.5 1.2 Mkt Cap/Sales(x) 0.6 0.5 0.5 0.4

Profiltabilty Ratios(%) ROE 13.0 9.0 5.2 16.9 ROCE 13.9 9.5 6.9 14.8

Turnover Ratios Debtors Days 96 104 125 125 Creditor Days 46 42 42 24 Leverage Ratio Interest Coverage (x) 6.7 3.6 2.4 5.8 Term Debt/ Equity (x) 0.6 0.6 0.7 0.9 Gross Debt/Equity(x) 0.8 0.9 1.0 1.1

E: Networth Estimates Source: Company, Networth Research


Annexures‐1 Recent Iron Ore Supply Issues

Karnataka Iron Ore production at risk to Impact major DI Pipe makers: Supreme Court, in its recent order, has banned iron ore production and transportation in Chitradurga and Tumkur districts of Karnataka, citing damage to the environment. Earlier, the Supreme Court had banned mining in the Bellary district of Karnataka, thus impacting 45mt of iron ore production. Since 20% of Indian steel capacity is in Karnataka, the court has allowed the government‐owned NMDC to continue and ramp up mining and also start auctioning the iron ore stocks in the state. NMDC, which was mining close to 5mtpa in the state, has been allowed to ramp up to 12mtpa. This will be available only for domestic markets. But, we doubt NMDC’s capability to more than double its throughput in short period.

Orissa Iron Ore production In a separate development, the Orissa government recently constituted a high‐level committee to look into the issue of scarcity of iron ore faced by steel units, including sponge iron producers, in the state. The committee plans to decide how much iron ore produced by the miners in the state should be reserved for use by domestic steel units, especially sponge iron producers in the state itself, and whether the ratio of iron ore earmarked for domestic use and export should be 60‐40 or 70‐30.

The government has shut down Gandhamardana mine for 20 months to clean the iron ore fines stashed there. Similarly, Daitary mine has been shut down as their dumping yard area was coming under forest land. Gandamardana mine produced 0.2mn tonne per month (MTPM) while Daitary mine’s capacity was 0.5 MTPM. (http://www.steelguru.com/sfTCPDF/getPDF/MjI2MDQ5/Indian_iron_ore_mining_mess_‐_Orissa_steel_mills_to_lay_off_workers.html)

Ban on iron mining in Goa The Directorate of Mines & Geology, Goa has asked miners not to work, handle or sell the dumps till a system is put in place to supervise, monitor and move any such quantity removed, handled or transported. The M B Shah Commission, probing illegal mining in Goa, will not restrict the inquiry of illegal mining to 90 operational mines, but will also probe whether the non‐operative mines are being used to extract the ore illegally. (http://www.business‐standard.com/india/news/goa‐bandumps‐may‐hit‐iron‐ore‐supply/450798/)

NMDC’s recent response: On 28 Sept 2011, Chairman of NMDC, hinted of shifting to e‐auction of iron ore, which will supersede the long‐term supply arrangement with major steel players. (http://www.thehindubusinessline.com/todays‐paper/tp‐corporate/article2494642.ece)

Impact of NMDC’s measures on the pipe makers: The aforementioned development may affect the utilization level of leading pipe makers like Jindal Saw, Tata Kubota, Lanco Industries, who source from Bellary. Jindal Saw’s raw material risk may mitigate if the recently acquired iron ore mine in Rajashthan is operated in the 2H2012E as per the management’s guidance. Tata Metaliks similarly is facing hiccups in its Kharagpur operation, which supplies pig iron to its DI Pipe JV. Production, which was very low (~18% utilization level) in FY11, is also, likely to remain at subdued level in FY12e and FY13e. Similarly, the utilization level of Lanco Industries may be hit. The operational performance of Electrotherm is not so encouraging.(43% Utilization)

Iron Ore Production (mn ton)

States 2004‐05 2005‐06 2006‐07 2007‐08 2008‐09 Orissa 41.7 5.0 64.2 69.9 74.1 Karnataka 37.9 39.8 40.7 49 45.9 Goa 22.7 24.0 28.7 30.5 33.0 Chhattisgarh 23.1 26.1 28.7 31.0 30.1 Jharkhand 16.7 18.0 18.6 20.8 21.2 Andhra Pradesh 2.8 4.1 5.0 9.2 9.9 Madhya Pradesh 0.2 0.5 1.2 2.3 0.8 Maharashtra 0.7 0.5 0.5 0.7 0.4 Total 145.8 118 187.6 213.4 215.4

Source: Indian Bureau of Mines


Annexures‐2 Experienced Management Team

ECL has an experienced management having established track record in identifying growth opportunities. The company was the first to enter the domestic DI pipes market in 1994 and is currently the market leader with a share of ~40%. It also expanded its DI footprint to other geographies like South East Asia, South Asia, the Middle East, Africa and Europe which contributed ~35% to total revenues in FY10. The company has implemented various backward integration processes like coke plant, sinter plant, pig iron plant, etc. which have resulted in significant cost benefits. Also, it has made investments in coking coal and iron ore mines in Jharkhand to ensure raw material security and reduce volatility in their prices in spot market.

Mr Umang Kejriwal‐ MD, has 36years’ of experience in the pipe manufacturing business. He is visionary and contributed to the growth of ECL.

He is supported by his brother, Mr Mayank Kejriwal, who handles the marketing and sales functions, and nephew Mr Uddhav Kejriwal, who handles commercial and finance verticals.

Mr. Pradip Kumar Khaitan, Chairman – Served as director since 1972. He is also on the board of various companies including CESC Limited, Emaar MGF Land Limited, India Glycols Limited, etc.

Dr. Jamshed Jiji Irani,‐ Non‐executive Director‐ He is Ex‐MD, Tata Steels Co. currently holds directorships in many companies including Tata Steels Limited, Tata Sons Limited, HDFC Limited, Kansai Nerolac Paints Limited and Repro India.

Mr. Naresh Chandra‐ Non‐executive Director – Retd IAS. After he retired from the civil service he was appointed by the Indian Government to chair a committee on corporate governance. Mr. Chandra holds directorships in many companies including Vedanta Resources Plc, London, Bajaj Auto Limited, ACC Limited, Cairn India Ltd etc

Mr. Binod Khaitan ‐ Non‐executive Director – Has been in the board at non‐executive director position since 1975. A retired businessman with wide experience in industries such as plywood, tea, jute, tyre, tube etc.

Experienced senior management

Some key managerial personnel have been associated with the company for more than two decades:

Mr V. M. Ralli, the head of operations, has been associated with the company since 1972 and has vast experience in the field.

Mr R. S. Singh, who was previously handling the mining operations at Tata Steel, to head its mine development and operations vertical.

Mr N. C. Bahl, who has extensive technical experience, handles the operations of Electrosteel Steel Ltd.


Annexures‐3 Manufacturing process for DI pipes and fittings

The manufacturing process comprises the following sub‐processes: metal extraction, liquid metal refining and treatment, casting, heat treatment, grinding, inspection and coating. A short summary of each of these phases is provided below:

Metal extraction: Iron ore and coke are charged into a mini blast furnace ("MBF") to smelt and extract the liquid iron which is the base material for the production of DI Pipes and DI Fittings. Any liquid metal which is in excess of plant capacity and cannot be utilised immediately is cast into pig iron for later use or sale.

Liquid metal refining and treatment: The liquid iron from the MBF is transferred to the induction furnaces where the temperature and composition of the molten metal is adjusted. Then the metal of required composition and temperature is poured into a converter and added to a measured quantity of magnesium. The magnesium burns in the molten iron and the flake form graphite contained in the molten iron is changed to modular form.

Casting: The liquid metal is then cast into pipes of various diameters by centrifugal casting machines or fittings of various shapes and specifications by casting in moulds.

Heat treatment: The spun cast pipes are heat treated in an annealing furnace to develop the required metallurgical and mechanical properties, hardness, corrosion resistance etc.

Grinding: The inside surface of the spun cast pipes is subjected to grinding to remove impurities and to clean the inner surface.

Inspection: The cast pipes and fittings are subjected to stringent quality testing including hydrostatic leak‐proof testing and dimensional checks for any non conformity to the prescribed standards. Any pipes or fittings that fail the quality tests are rejected and melted for reuse.

Coating: The pipes and fittings are externally coated with a thin zinc metal layer to increase corrosion resistance. The pipes are also internally lined with spun cast cement mortar to improve surface smoothness, to decrease friction on through flow, and corrosion resistance. A bitumen coating is then applied to the external surface of the zinc coated pipes and fittings to impart high corrosion resistance. Finally, if required, the pipes and fittings may be coated with a layer of poly‐urethrane or epoxy coating.


Annexures‐4 Classification of pipes

Pipes are essential for transporting gases, and fluids such as oil and water, across the country. Pipe transportation is an economical mode of transport compared with the traditional modes of rail, road and sea transport. This mode of transportation also helps save scarce natural energy resources and transportation time. India, with its large geographical area, has low pipe penetration levels of 32%, compared with the global average of 79% i n oil & gas transport.

Sanitation levels are also lower at 33% compared with 91% in Sri Lanka and 100% in France. Only 40% of the 140mn hectares cultivable land in India is irrigated. The lower penetration levels offer immense scope for the Indian pipe companies.


Networth Research: E‐mail‐ [email protected]

Surya Nayak AVP Research [email protected] 022‐30225901

Minal Dedhia Banking/Midcaps [email protected] 011‐47399803

Vishal Kothari Pharma & Chem. [email protected] 022‐30225900

Jignesh Vayda Midcaps [email protected] 022‐30225904

Suhani Patel Construction/Cement [email protected] 022‐30225900

Shruti Raut Logistics/ Retail (Associate) [email protected] 022‐30225900

Siddharth Deshmukh Telecom/I.T (Associate) [email protected] 022‐30225900

Derivatives & Technical Research

Akshata Deshmukh AVP Derivatives & Technical’s [email protected] 022‐30641744 Kekin Maru Derivatives Analyst [email protected] 022‐30641621

Akhil Rathi Research Associate ‐ Derivatives [email protected] 022‐30641746

Institution Sales [email protected]

Viral Malia AVP Institutional Sales [email protected] 022‐30225902

Key to NETWORTH Investment Rankings

Buy: Upside by>15, Accumulate: Upside by +5 to 15, Hold: Upside/Downside by ‐5 to +5, Reduce: Downside by 5 to 15, Sell: Downside by>15

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