Welspun Gujarat Stahl Rohren: Buy

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Welspun may benefit significantly from the increased spending by oil and gas companies on E&P activities.



The company has committed itself to a large capacity expansion drive.

Srividhya Sivakumar

Investments with a long-term perspective can be considered in the stock of Welspun Gujarat Stahl Rohren (Welspun), a leading manufacturer of steel pipes. The company's strong order backlog is supported by a well-timed expansion in capacities.

Backward integration by way of setting up of a steel plate manufacturing unit and the company's preferred vendor status with most global oil and gas companies suggest strong growth prospects.

At the current market price of Rs 375, the stock trades at about 14 times and 9 times its likely 2008-09 and 2009-10 earnings on a fully diluted equity base. While this is at a premium to its domestic peers such as PSL and Jindal SAW, Welspun's wider product mix, higher realisations and stronger presence in the high-margin export markets suggest better growth potential.

Robust Demand

The global demand for pipes is likely to remain buoyant given the increasing spends by oil and gas companies worldwide on E&P (exploration and production) activities, which require a pipeline network. The company's order-book, pegged at about Rs 4,600 crore (1.7 times its FY-07 revenues) reinforces a strong demand scenario.

Welspun's 'frame' agreements with Saudi Aramco and Chevron may also help improve its standing with other clients; since such agreements automatically qualify a company for every project that these companies may undertake.

On the domestic front, the proposed setting up of pipelines by players such as GAIL and the increasing number of onshore blocks being awarded in NELP may also offer Welspun alternative growth vistas.

Increase in capacity

To keep pace with the growing demand, Welspun has committed itself to a large capacity expansion drive. This appears timely given that most of the global pipe manufacturers are running on full capacities and are facing supply constraints in meeting this demand. Post-expansion , Welspun may enjoy an annual capacity of about 1.75 million tonnes per annum, compared to the current levels of over one million tonnes of pipes per year.

The company plans to increase capacity of both LSAW (longitudinal submerged arc welded) and HSAW (helical submerged arc welded) pipes in its domestic units; these expanded capacities are expected to commence operations from March 2009. Besides this, Welspun is also setting up spiral pipe manufacturing facility in the US. This facility, expected to become operational by September 2008, will help Welspun bring down its freight cost considerably and help it service demand from the continent more efficiently.

Backward integration

Welspun's strategy of backward integration into steel plate, a major raw material for pipes, holds significant potential. For one, it may provide flexibility to take orders with shorter delivery schedules. This may also help Welspun plan its production schedule more effectively since steel plates when procured from suppliers can have as much as 12 months as lead time.

Two, with a better control over its raw material cost, Welspun may also benefit by way of expansion in margins (management expects a 3-4 percentage point expansion in EBITDA margins once the new facility is commissioned). The steel plate facility (currently under trial production) is expected to commence operations from April 2008 and will have a capacity of 1.5 million tonnes per year.

Financials

The company's result scorecard underlines its improving business prospects. Welspun has, over the last five years, reported a compounded earnings growth of over 187 per cent supported by a 59 per cent growth in revenues.

For the quarter ended December 2007, Welspun more than doubled its profits on the back of a 39 per cent growth in revenues. Operating margins expanded by 4 percentage points to about 16.8 per cent. This expansion was driven by 25 per cent growth in realisation as against a lower growth in raw material cost (7 per cent).

Given Welspun's focus on niche products , the company may be able to maintain the average realisations at these levels. Additionally, these may be at levels higher than its domestic peers given Welspun's significant exposure to high-margin global markets (more than 90 per cent of revenues driven by exports).

However, on the margin front, while Welspun has so far managed to put up a decent performance, any further rise in steel price may squeeze margins.

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