Religare Research has recommended buy rating on PSL with target price of Rs 420. At target price of Rs 420, the stock would trade at 10.0x 2-year forward diluted earnings.

Religare Research report on PSL:

PSL is likely to report strong growth in sales and earnings on the basis of its robust order book and stable margin scenario. Over the period of FY07-09E, we expect the company to report CAGR of 54% and 61% for revenues and diluted EPS respectively. The stock holds value, despite a re-rating over the last few months.

Robust order book

The current order book is Rs 22 billion, which is 1.4x FY07 sales; this is to be executed over the next 9-12 months. In the domestic market, the company has participated in various tenders valued at Rs 25 billion and it expects to win a reasonable share of them. This will lead to a considerable growth with its order book going forward.

Margins to improve

In all its recent orders, the company has built-in EBITDA margins of 10-11%, and given the strong demand for steel pipes in India, Middle East and US, we do not foresee any major threat to margins. After any order win, the company will immediately enter into forward contracts for the supply of raw materials.

Expansion plans consistent with growth

The company has recently set up a 75,000 MT saw pipe plant in Sharjah; this will enable it to increase its exposure to the lucrative Middle East market. The capacity of this plant will be increased to 150,000 MT by the end of FY09. In FY09, its 300,000 MT HSAW pipe plant in US will be commissioned, which is a 75:25 JV between PSL and A&L group. In India, there will not be any new capacity addition as it currently operates at capacity utilization levels of 30%.

Poor working capital management

The major threat to PSL’s profitability is its working capital management. It has a working capital cycle of 4 months. The company has ruled out further equity dilution. Thus, the growth of the company will have to be funded through borrowings, which will increase the company’s leverage ratio from 1.8 in FY07 to 2.5 in FY09E, which is one of the highest in the industry.

Valuations are attractive

PSL currently trades at 10.5x and 7.4x FY08E and FY09E diluted earnings respectively. Robust order book provides strong sales visibility for the next few years. Margins are expected to rise due to the higher capacity utilization. In view of strong earnings growth and attractive valuations, we recommend Buy. At our target price, the stock would trade at 10.0x 2-year forward diluted earnings.