Sterlite Technologies is currently trading at 21 times its FY20 estimated earnings, which is reasonable in the light of its growth prospects
Sterlite Technologies is riding the upturn in global optical cable demand and looking at growth through the organic as well as inorganic route. It recently acquired complete stake in European Metallurgica Bresciana (MB), which specialises in optical cables. The acquisition will help in two critical ways:Operating synergies
First, the acquisition will expand Sterlite’s product profile to some specialised and emerging categories. MB specialises in electrical and optical fibre cables, catering to sectors like railways, telecommunications, oil and gas, industrial automation, marine and defence. The company does not have a presence in some of these segments like railways. Besides it will now have its own manufacturing facility in Europe, thus saving on logistic costs.
Second, the acquisition will enhance its presence in the European market. The management has been focusing on Europe with its contribution going up from 11 percent in FY17 to 27 percent in FY18. MB has a sales turnover of about Rs 320 crore. With this acquisition, Sterlite’s exposure to the European market would touch about 35-37 percent.
There exist a huge operating leverage and scope for higher contribution in terms of improvement in margins and return on investment. MB is currently operating at 60 percent capacity utilisation and generating 20 percent return on capital employed (RoCE), which is similar to Sterlite’s own RoCE of 24 percent. MB has a manufacturing capacity of almost 3 million fibre kilo meter (fkm), which can be expanded up to 5 million fkm without much capex or incremental cost, leading to cost optimisation and improve return ratios further.
Moreover, the acquisition, which will cost about Rs 380 crore, would be funded through local loans to the extent of 89 percent of acquisition cost at an interest rate of 2 percent. The management is hoping to generate 20 percent internal rate of return from this investment with a payback period of about 4-5 years, which effectively means lot more savings at the parent level, particularly in light of the cost of funds used for the European acquisition.Valuations
The deal is valued attractively at 11.2 times MB’s FY17 earnings as against Sterlite’s own valuations of 35 times FY18 earnings. Post-acquisition, it will add to the overall market capitalisation of Sterlite.
Back home, Sterlite is operating at an order book of Rs 4,100 crore (product business), an all-time high, led by strong demand from the telecom sector. Close to 54 percent of its sales accrues from exports to many countries and big clients, including orders from British Telecom.
It has developed a strong product portfolio backed by innovation and research, with about 189 patents. This has provided it competitive advantages and led to high margins, with the contribution of high margin products increasing gradually.
On the back of these initiatives, earnings growth is expected to be robust with higher domestic and global demand, increasing share of high margin products and ongoing capacity expansion from 30 million fibre km to 50 million fibre km by December or mid-2019. After the announcement of the acquisition, Sterlite’s stock saw close to 9.5 percent spurt, closing at Rs 315 a share. It is currently trading at 21 times its FY20 estimated earnings, which is reasonable in the light of its growth prospects.Moneycontrol Research Page.