APL Apollo Tubes shares are expected to give up to 28 percent returns, say experts, citing the company's decision to pump Rs 180 crore into its key distributor Shankar Building Products.
Both the stocks have not seen much reaction after the news, but they have rallied 21 percent and 27 percent, respectively, in the last one month. In fact, Shankara Building has given 62 percent return since February 4.
APL Apollo Tubes recently announced investments of Rs 180.5 crore in Shankara Building Products through its wholly owned subsidiary APL Apollo Mart. The investment would be made through a combination of secondary market purchase (10 lakh shares at Rs 755 apiece) and proposed preferential warrants (14 lakh warrants at Rs 750 per share). The investment will be funded through internal accruals.
APL will make an immediate investment of Rs 101.8 crore (through secondary market purchase plus 25 percent warrant subscription money), and the remaining investment of Rs 78.7 crore (75 percent on warrant conversion) will be made within 18 months.
With this investment, APL will end up owning around 9.9 percent stake in Shankara Building Products, a organised retailer of home improvement and building products in India with more than 125 stores in 10 states and one Union Territory.
The investment in Shankara is in line with APL's growth plan to become India's largest market platform for steel building materials by expanding its distribution reach in untapped markets.
"Through this investment, APL aims to improve sales and volumes by leveraging Shankara's store network and further strengthening its long relationship with the distributor. The deal is valued at 0.9x enterprise value (EV)/Sales (FY22 annualised)," says Sharekhan that maintained a 'buy' rating on APL with an unchanged price target of Rs 1,100 (implying 17 percent potential upside from Tuesday's closing levels) as structural earnings growth drivers and likely improvement in earnings quality would narrow valuation gap with building material players like Astral.
APL is the India's largest producer of structural steel tubes, with a capacity of 2.6 million tonnes per annum, having an extended distribution network of warehouses and branch offices in 29 cities across the country catering to domestic as well as 20 countries worldwide.
APL's management expects the investment in Shankara to be EPS/RoCE (earnings per share and return on capital employed) accretive in the first year. "We await more clarity on plans to achieve the same. Investment to provide sales consistency from Shankara could aid volume/utilisation at its Hyderabad plant," says Sharekhan.
With the current investment, management expect sales consistency to be maintained along with growth momentum. APL sees an opportunity of potentially doubling sales through Shankara using its extensive retail/wholesale network.
APL Apollo and Shankara have a business association of over 15 years, with Shankara being one of the key distributors of APL Apollo's products. "APL Apollo’s association will ensure consistency in sales through Shankara's retail and wholesale network and will create synergies for APL Apollo Tubes," says APL in its BSE filing on March 21.
Shankara distributes around 0.1 million tonnes of APL Apollo's volumes. In April 2019, APL acquired Shankara's 0.2-million-tonne Hyderabad plant for around Rs 70 crore. "APL recovered its entire investment cost within three years, boosting its overall RoCE. Current EBIDTA generation (estimated) from that plant is Rs 40-50 crore per annum," says ICICI Direct which also maintained a 'buy' rating on APL with a target price of Rs 1,110 per share, implying 18.4 percent potential upside from Tuesday's closing levels.
The brokerage has not factored in any additional investments for strengthening the distribution/retailing framework for APL. "More such investments, going forward, may have implications for future RoCE."
Shankara will be a launch platform for APL's new products and help APL focus on expanding in the structural steel tubes market. The investment will provide APL an opportunity to sell other steel building material products through Shankara (Apollo Mart's business model).
"The total deal is valued at 0.8x of Shankara's trailing 12 months EV/sales," says Motilal Oswal which also has a buy call on APL with a target of Rs 1,300 per share, implying 28 percent potential upside.
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