Emkay- Bhushan Steel

Company brief

Bhushan Steel Ltd. (BSL) is primarily a converter of HR coils to value added products, which find application in the auto and white goods industries. The company is shifting its business profile from a converter to an integrated steel producer by setting up an integrated steel plant in Orissa. The plant, once fully commissioned, will produce 1.9mtpa of auto grade HR coils, which will be internally consumed for further value added products at its existing facilities. We believe the company will save Rs2.5 bn in FY10 due to captive production of HR coils. We believe the major cost benefits will accrue in FY10 once the HR mill is commissioned.

Growth drivers

Currently, BSL procures Hot Rolled Coils (HRC) from the domestic market as well as through imports. After commissioning of Hot Strip Mill (HSM) at its Orissa plant, BSL will source entire its requirement of HRC from there. We believe the Orissa plant will be the growth engine for Bhushan over the next 3-4 years. We estimate, at 60% capacity utilization, BSL will save around Rs2,966/t (13.5% on HR prices assumed at Rs22,000/t), leading to total savings of Rs2.5 bn (31% of the total profits in FY10E). The project will be commissioned in modular fashion so that accruals from initial stages will partly fund capex for later stages. We believe the major thrust in margins will likely accrue in FY10 when HR coil production from its captive plant at Orissa replaces market purchases. We estimate EBITDA margin will grow from 19.3% in FY08E to 24.7% in FY09E but will jump to 38.1% in FY10E.

We believe the growth over the next 3 years will be fuelled by the current greenfield project at Orissa. BSL has already commissioned 2 kilns commissioned during the latter part of the second quarter of FY07. the third kiln has recently been commissioned taking the overall capacity to 0.51mtpa. We expect the partial benefit of these kilns to flow in FY08E and the full benefit in FY09. During FY08, the company will commission additional 5 kilns of 170,000tpa each taking the total sponge iron production to 1.36mtpa. We expect the benefit of the additional 5 kilns to flow in the latter part of FY08E and fully in FY09E as the capacities ramp up. During the 9 months ended Dec 31 2007, the new sponge iron plant has produced 20,141t of sponge iron and 5,868t of billets.

Risks and concerns

Since BSL is currently a converter, its margins are limited to the difference between its cost of procurement of HR coils/sheets & zinc and its realization on sale of CR and GPGC.

Any change in steel prices which is not passed on to the customers will have a material impact on the earnings of the company. BSL has embarked upon a large project at Orissa that will involve a capex of Rs51.5bn. Material delay in project execution or cost over run is likely to impact our earnings forecasts. Our earnings estimate for FY10E is based on the fact that the HSM will operate at 60% utilization rate during FY10E. In case the actual capacity utilization is different from our assumptions, our earnings estimate will be materially impacted.

Financials and valuations

At 6x our FY09E FDEPS estimate of Rs118, BSL is currently trading at a discount of 34.5% to SAIL on a PEG basis, which is trading at a PEG of 0.29 with 3 yr EPS CAGR of 19.9% and consensus FDEPS of Rs24.5 for FY10E. Although we rate the stock on FY09E FDEPS, we believe the value unlocking will largely happen during FY10 after commissioning of the HSM at Orissa complex. We maintain a BUY on the stock with a target price of Rs709.

Recent developments and announcements

Bhushan Steel also has plans to increase the capacity of its HR mill at the Orissa integrated steel complex from the current proposed capacity of 1.9mtpa to 3.1mtpa with an additional capex of Rs8.5 bn. The increased capacity will have an additional EAF that will have a capacity of 0.69mtpa and 4 additional kilns of sponge iron of 170,000tpa each. This will take the total sponge iron production capacity to 2.04mtpa from the current proposed capacity of 1.36mtpa.

Recently, Bhushan Steel signed an MoU with the government of West Bengal to setup a 2mtpa integrated steel plant with captive power plant in Burdwan district of West Bengal.

The steel plant will require 2,500 acres of land. The company will also setup a 0.5mtpa cold rolling and galvanizing plant that will cater to the automotive and white goods industry.

The cold roll and galvanizing plant will need additional area of 90 acres. Bhushan Steel has planned a total outlay of Rs88 bn for the West Bengal project which is likely to have captive coal mines.

Everest Kanto Cylinders

Company brief

Everest Kanto Cylinder Limited (EKC) is the largest domestic manufacturer of high pressure gas cylinders used for storage of industrial gases and CNG. While the first manufacturing facility (at Aurangabad) was set up in collaboration with Kanto Koatsu

Yoki of Japan in 1978, the subsequent facilities have been built using in-house technology. The company currently has four manufacturing plants located in Aurangabad, Tarapur, Gandhidham, and Dubai with a total capacity to produce 806,000 Cylinders p.a. An aggressive expansion plan including doubling of the Dubai capacity as well as a greenfield plant in China would see EKC’s production capacity increase to 2.3mn cylinders over the next 4-5 years.

Growth drivers

EKC direct beneficiary of exponential growth in demand for CNG cylinders: Under the

aegis of the Supreme court ruling, to convert all the city transport buses to CNG fuel; there has been a remarkable growth in demand from the CNG Cylinders and EKC has been the direct beneficiary of this. Going forward, as the Supreme Court ruling is implemented in other cities; we expect the demand for EKCs products to increase exponentially. The demand from the industrial segment is strong and is expected to grow further on the back of huge increase in industrial investment lined up over next few years.

Improving refueling infrastructure and availability of gas to further fuel demand: Cost

economics in favor of CNG fuel and rising awareness amongst rapidly changing pollution norms are direct drivers of demand for CNG cylinders. This coupled with rapidly improving refueling infrastructure for CNG and visibility of gas supplies would mean that CNG penetration in India would grow at an accelerating pace, which in turn would further fuel demand for CNG cylinders.

Export another major growth driver: The CNG story in the export market is no different and replicating its success in the domestic market, EKC has already tapped the export market for CNG cylinders by setting up a plant in Dubai.

Massive capacity underway to capitalise on growth: In order to capitalise on the huge growth opportunity EKC has chalked out an aggressive capacity expansion plan. After expanding its capacity almost 3xin last 4 years (from 270,000 cylinders in FY03 to 806,000 cylinder in FY07), the company is all set to repeat the feat with a total installed capacity going upto a massive 2.3 mn cylinders by FY12E. The total capex for this huge capacity ramp up exercise is estimated at USD 75 mn. The company has recently raised USD 20mn for part financing this expansion.

Exponential growth in earnings: Strong demand arising from industrial gases and from nearly Insatiable demand from CNG vehicles in India, would be key demand drivers over the next 3-4 years.

Risks and concerns

EKC sources almost all of seamless tubes from Tenaris. Though it sources from Tenaris’s plants located in different regions of the world and it has been maintain excellent relationship with Tenaris, it still runs business risks in sourcing from a single supplier.

Increasing competition from domestic and foreign manufacturer does post a threat to

EKC numero uno with major competitors setting significant capacities.

Financials and valuations

At current levels the stock is discounting its FY2007 annualized earnings of Rs31 by 37x

Recent developments and announcements

In April 2007, EKC bagged export orders worth Rs22bn for supply of specialized cylinders.

EKC has started construction work in China. The Company plans to invest US$50 mn in the first phase of its China operation. Commercial production is expected in the last quarter of the current calendar year with an initial capacity of 200,000 cylinders. EKC plans to rampup the capacity to 1.5mn cylinders in the next 3-4 years.

In Jan 2007, EKC secured Rs400mn orders from defence authorities for supply of specialized gas cylinders.

EKC via its EOGM dated December 23, 2006 transferred all the fixed assets of its Dubai unit engaged in the business of manufacture and marketing of cylinders, to EKC International FZE, its wholly owned subsidiary by way of sale for a consideration amounting to US$6.2mn (~Rs285mn)