Eyeing investment in steel space? MOST suggests 5 best bets

Motilal Oswal has come out with a report on Mid-cap steel companies. Stocks tracked by Motilal Oswal are Bhushan Steel, Adhunik Metaliks, Godawari Power & Ispat, Jai Balaji Industries, Monnet Ispat, Prakash Industries, Sarda Energy & Minerals and Tata Sponge Iron.

Mid-cap steel companies: Struggling to maintain profitability:

Over the next 12-15 months, ~20mtpa of steel production capacity is scheduled for commissioning in India. The sudden increase in domestic supply will put pressure on steel prices. During the period of global financial crisis, most mid-cap steel companies were able to switch to sale of power instead of producing steel. However, this no longer presents a good trade-off as merchant power rates have collapsed in the last two quarters. Also, delays in opening of captive mines and rising raw material prices are impacting cash flows. As a result, most mid-cap steel companies are available at attractive valuations. We recommend buying selectively.

Bhushan Steel: Bhushan has delivered superior margins in the last few quarters due to focus on value addition and strict control over costs. Volumes will continue to grow as HSM's capacity utilization is improving every quarter. Ongoing expansion to 5mtpa will add further to steel volumes in FY13. We expect earnings to grow at a CAGR of 22% over FY10-13. The stock is trading at 6.6x FY12E EPS and an EV of 6.9x EBITDA. We value the stock at Rs598 (2x FY12E BV). Maintain Neutral.

Adhunik Metaliks: We believe Adhunik is on a strong earnings growth path on the back of rich mineral resources and focus on growth. Over FY11-13, manganese ore production will grow at a CAGR of 18% to 300k tons and iron ore production at a CAGR of 22% to 1.5m tons. Commissioning of pellet plant and captive iron ore mine will help expand margins further. We expect earnings to grow at a CAGR of 19% over FY10-13 without considering estimates of Suleipat iron ore mine and 540MW IPP. The stock is trading at an EV of 5x FY12E EBITDA. Re-iterate Buy.

Godawari Power & Ispat: We expect iron ore and pellet production to increase at a CAGR of 28% and 37% over FY11-13 to 700k tons and 500k tons, respectively. Widening spread between thermal coal and steel prices is the key earnings driver. We expect earnings to grow at a CAGR of 26% over FY10-13. The stock trades at an EV of 4.2x FY12E EBITDA. Re-iterate Buy.
 
Jai Balaji Industries: Large coal reserves along with significant capacity addition plans to monetize these reserves will help the company to post strong earnings growth over the next 3-4 years. We expect earnings to grow at a CAGR of 110% (on a lower base of FY10, when JBIL suffered on account of high coking coal costs and reduced demand) over FY10-13. The stock trades at 8.6x FY12E EPS and an EV of 7.9x 150 FY12E EBITDA. Maintain Buy.

Monnet Ispat: We expect Monnet's earnings to grow at a CAGR of 12% over FY10-13. We value the stock at Rs510 based on 6.5x FY12E core business EBITDA, Rs23b for its equity stake of 87.5% in Monnet Power (1,050MW project) and Rs4.2b for Orissa Sponge. The stock is trading at 9.6x FY12E EPS and an EV of 11.8x FY12E EBITDA. Though our target price still does not fully capture the value of its coal mining assets, there remains project execution risk. Maintain Neutral.
 
Prakash Industries: We expect earnings to grow at a CAGR of 18% over FY10-13 on commissioning of 125MW power plant and partial raw material integration. The stock trades at 2.9x FY12E EPS, 0.5x FY12E BV and at an EV of 2.9x FY12E EBITDA. Maintain Buy.

Sarda Energy & Minerals: Faster ramp-up of pellet production, re-starting of iron ore mine and timely completion of Vizag ferro project will drive earnings and help to reduce leverage. However, in the near term, execution risk remains. Though it has a very rich mineral portfolio, raw material integration is likely to be lower in the near term. The stock is trading at 7.7x FY12E EPS and an EV of 8.2x FY12E EBITDA. Maintain Neutral.

Tata Sponge Iron: TTSP is one of the best managed sponge iron plants in the country. Its location in Barbil is of strategic advantage in sourcing iron ore. The arrangement with Tata Steel helps in sourcing iron ore at reasonable long-term prices. It has a strong balance sheet with surplus cash (Rs1.3b) and consistent track record of paying dividend (80%). Valuations are attractive. The stock trades at 5.2x FY12E EPS and at an EV of 2.1x FY12E EBITDA. Maintain Buy.

Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management.Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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