Buy Usha Martin, target of Rs 228: India Infoline

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Broking house, India Infoline is bullish on Usha Martin . It has recommended buy rating on the stock with a target price of Rs 228.

The India Infoline report on Usha Martin:

"Usha Martin posted strong results for Q2 FY07 with performance improving on sequential basis while registering robust growth on yoy basis. The sequential earnings growth was led by margin improvement whereas the yoy earnings growth was driven by flattish interest and depreciation and lower taxes. For H2 FY07, company expects further improvement in operational performance with strong volumes and higher benefits from iron ore integration. We rate the stock as 'Buy' with EPS estimates of Rs 26 for FY07 and Rs32.6 for FY08. Our one-year target price of Rs 228 based on 7x FY08 EPS implies 34% appreciation."

Performance Highlights

"On standalone basis, revenues have grown by robust 15.6% qoq and 19.0% yoy."

"The strong sequential growth comprised volume growth as well as realization improvement. Sales volumes of wire rods and bars (steel products) were flat qoq whereas it was higher by robust 21.4% qoq for wires and wore ropes (value added products). The production volumes in Q1 FY07 were depressed as company undertook a planned preventive maintenance shutdown of MBF and 25 MW CPP. Realizations were higher 2.2% and 3% for the steel division and value added products division respectively on sequential basis."

"The yoy growth in revenues was mainly volume led with lower realization for steel division compensated by higher realization for value added products. The sales volumes of steel division and value added products division were up 19% and 20.7% respectively on yoy basis."

"On consolidated basis (including 13 subsidiaries), revenues were up 12.1% qoq and stood at Rs 9.85 billion in H1 FY07."

"The standalone operating margin was 18.8%, up 140bps qoq and lower 140bps yoy. Sequential improvement resulted from better volumes and realizations for the two products categories and absence of costs shutdown related costs. The yoy contraction in margin is attributable to higher raw material costs especially iron ore and coal."

"In the quarter, the company did not get material benefits as majority of the mined ore could not be processed in the usable form due to monsoon. However, the mined output was significantly higher at about 0.5 million tons in the quarter against about 161,500 tons in the previous quarter."

"In line with standalone margin, the consolidated OPM also improved 120bps sequentially to 16.4%."

"The standalone net profit stood at Rs 237 million representing a sequential growth of 16.7% and yoy growth of 59.7%. Consolidated net profit was Rs 309 million in Q2 FY07 and Rs 582 million in H1 FY07."

Company's outlook for the year

• Rolled steel (Wire Rods & Bars) production to increase by 15% yoy
• Value added products (Wires, Strands & Wire Ropes) production to grow by 22%
• Prices/Realization likely to remain stable for the remaining part of the year
• Cost reduction from iron ore integration
• Coal mine administrative approvals with lease settled and land price paid to
  State Government
• Start of commercial production of 30,000tpa Wire Rope plant in USA
• Start of construction of 6,000tpa OT wires joint venture project with Joh Pengg of Austria

"Steel capacity expansion projects are progressing on schedule. Major orders for achieving steel capacity expansion of 0.6mn tons by Q2 FY09 have already been placed. Apart from the above expansion plans, company intends to increase value added products capacity by 150,000 tons through overseas acquisitions."

Our consolidated estimates on the company

"Revenues to grow by 16.3% in FY07 and 8.1% in FY08. In FY07 and FY08, we estimate cumulative sales volume growth of 10.2% and 7.6% respectively. We see a realization improvement of 2-4% in FY07 while FY08 would remain flat."

"We expect consolidated OPM to improve by 70bps yoy in FY07 to 17.5% driven by part captive iron ore supply benefits (~Rs180-200mn), savings from lower coke purchase prices (~Rs320-350mn) and higher volumes. However, we also expect significantly higher expenditure on zinc purchases in the year. In FY08, we expect OPM to improve by material 200bps to 19.5% driven mainly by captive iron ore supply benefits for the full year (~Rs500mn). We have not factored savings from captive coal supply due to regulatory and procedural delay risks involved before the start of actual mining and as we understand that quality mining (usable quality) takes time after the start of actual mining."

"Earnings of the company are anticipated to grow by 54% and 25.3% in FY07 and FY08 respectively despite increase in interest and depreciation. EPS to stand at Rs 26 in FY07 and Rs 32.6 in FY08."

"At CMP Rs 170, the company is trading at 6.5x FY07E EPS of Rs26 and 5.2x FY08E EPS of Rs 32.6. The current FY07 valuations are similar to commodity steel makers like Tata Steel and SAIL despite company's character of an alloy/special steel maker producing high value added products like Wires and Wire Ropes in majority."

"We feel that the key reason behind it is relatively lower margins of the company with comparatively lesser backward integration. However, now with increasing mineral integration over the next two years and relatively superior pricing power for its product portfolio, we expect significant upgrade in valuations. We believe that the stock would trade at 7x (factoring 0.5x multiple re-rating) FY08E EPS ie Rs228 one year forward representing 34% appreciation from current levels."