January 19, 2016 / 15:24 IST
Rama Steel Tubes Limited (RST) has an aggressive expansion plan to raise its capacityto 340,000 metric tonnes per annum (MTPA) over FY19-20E from around 99,000 MTPA currently. The expansion is targeted in the value-added segment, commanding highermargins.
The industry faces a problem of high logistics cost which the company is trying to fix byfull-fledged production at its Khapoli (Maharashtra) plant. This strategically-located plant (near the port) will gradually cater to rising demand from the export market. It now caters to demand from Maharashtra and Gujarat. Assuming that it cuts transportation and logistics cost by being located closer to the port, the expense component could come down by nearly 20% (of selling and distribution expenses).
With commencement of production of an additional 72,000 MTPA (from two new plants) along with higher capacity utilisation rates, we believe that margin expansion will be seen from 1Q FY17. Production from the first plant commenced in June 2015 and the management expects the second plant to start by April 2016. This will not only raise the revenue but will also improve the overall margin.
In April 2015, RST set up M/s RST International Trading FZE, a wholly-owned subsidiary in Dubai to open avenues for more international business in steel products. With negligible costs of running the trading business, the company wishes to leverage its goodwill of having been in the business for more than four decades. The management anticipates that its Dubai foothold will serve as a stepping stone to other markets in European and African nations. We expect that in FY16 revenue from the subsidiary would cross Rs 600-650 mn with a PAT margin of 5-6%, with handsome ROI.
Valuation: We initiate a Strong Buy report on RST at CMP of Rs 925 with a target price of Rs 1,346, a ~46% upside. Our target price is based on a sum-of-parts valuation methodology (50% weight) and DCF valuation methodology (50% weight). Valuation of RST’s core business is Rs 1050/share and valuation of the Dubai subsidiary is Rs 321/share after offering a discount of 20% on derived valuation. We reach a sum-of-parts valuation of Rs 1,371 and our DCF valuation is Rs 1,322 based on WACC of 11.7% and perpetual growth rate of 4%. At the CMP of Rs 925, we recommend a “Strong Buy” with a target price of Rs 1,346/share, a ~ 46% upside.For all recommendations, click here Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies 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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