Buy Bihar Tubes; target of Rs 172: Religare Securities

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Religare Securities is bullish on Bihar Tubes and has recommended buy rating on the stock with target price of Rs 172.

Religare securities report on Bihar Tubes:

New product forays and backward integration plans to boost earnings

1) Rising demand for pipes and tubes, particularly from the oil & gas and construction sectors; BTL has raised cumulative capacity from 60,000mtpa to 125,000mtpa in FY06-FY07 to meet demand from both domestic and overseas markets

2) Foray into auto tubes and high-end 20" diameter tubes, along with backward integration (via set-up of a skelp mill for captive raw material) will ramp up turnover and expand margins

3) Apollo Metalx, a 100% subsidiary, with a capacity of 24,000mtpa willsupply 85% of its production to BTL, and prove EPS-accretive

4) Technology from Kusakabe, Japan has helped expand product range, scale up production efficiency and enhance quality

5) Revenue CAGR of 101% expected over FY07-FY09 to Rs 8.4 billion with a PAT CAGR of 125% to Rs 3.5 billion; Initiate coverage with Buy with an end-FY08 target price of Rs 172, an appreciation of 83%

Operates in four segments

At present, the company operates in four segments - hollow section (square and rectangular), pre-galvanised, ERW and galvanised tubes and pipes. BTL's current capacity of 125,000mtpa is interchangeable and can be tailored to demand conditions. Typically, 30-35% of the production comprises hollow tubes and pipes, 20-25% is galvanised, 20-22% is for ERW and 30% is for pre-galvanised tubes and pipes. The company is now focusing on raising production of pre-galvanised products since these earn relatively higher realisations.

Investment rationale

Large-scale capacity expansion

The company has increased its overall capacity of steel pipes and tubes from 60,000mtpa to 125,000mtpa during FY06-FY07 at a capital expenditure of Rs 65 million. With increased capacity it can now generate turnover from Rs 3.5 billion to Rs 4 billion on the current gross block.

Scaling up the value chain

Foray into high-end automobile tubing products: BTL is now foraying into the automobile sector by creating a capacity of 35,000mtpa in Sikandarabad for boiler tubes, air heated and shock absorber tubes. The project entails a capex of Rs 100 million and will be funded via internal accruals. The land for the project has already been acquired and work is expected to commence from December 2007. The company is in the final stage of talks with automobile companies for the off-take of its products. We expect this division to contributing to revenues from FY09 onwards and boost margin growth.

Manufacture of 20" diameter tubes: BTL currently manufactures tubes up to 12" diameter. The company is now looking to scale further up the value chain via the manufacture of 20"-diameter tubes and is currently setting up a tube mill for this purpose. This will enable BTL to compete with companies like SAW Pipes, MAN Industries and Welspun Gujarat.

Backward integration to assure cost-effective input supply

Raw material accounts for 80-85% of the cost of the finished goods. With a view to cutting input costs, the company is undertaking backward integration via the set up of a fully integrated 100,000mtpa HR skelp plant at Sikandarabad. The plant will be set up at a cost of Rs 500 million to be partially financed by a warrants issue at Rs70 per share (after bonus), amounting to Rs 450 million. Approximately 75-80% of the production from the skelp plant is expected to be utilised for captive consumption while the surplus will be sold. The unit will assure BTL of an uninterrupted supply of raw material at a discount to market price, which will strengthen margins. We expect the benefits of this project to flow in from H2F

Valuation

The company currently trades at a P/E of 4x on FY08E. On an EV/EBITDA basis, the stock is trading at 3.3x on FY08E and 2.4x on FY09E, which is highly attractive. From the table below, we see that the company currently quotes at a discount of 250% to Welspun and 14% to Technocraft Industries on FY09 P/E valuation. Other steel pipes and tube player trade within a P/E band of above 7-10x on FY08E. We expect BTL to outperform its peers in the long run considering its focus on the infrastructure and agricultural segments which are showing robust growth.

Initiating coverage with Buy

We have valued the company using a discounted cash flow (DCF) valuation, and accordingly have a target of Rs 172 for the scrip. At our target price the stock will be available at 7.4x and 6.2x on FY08E and FY09E earnings of Rs 23.2 and Rs 27.7 respectively. We initiate coverage with a Buy recommendation.