Godawari Power could see radical improvement in its profitability driven by the cost savings accruing from captive iron ore and coal.

After raising about Rs 70.43 crore in the year 2006 through its initial public offer, Godawari Power and Ispat (GPIL) embarked on doubling its manufacturing capacity and integrating backwards. And today, after augmenting its capacity according to the earlier plan, Godawari is ready for the next phase of growth.

Over the next two years, the company would reap rich dividends from its additional capacity. The substantial cost savings likely to accrue to the company because of the iron ore and coal reserves awarded to it by the Chattisgarh government last year would alter its profitability dramatically. Carbon credits would also add to its profits.

GPIL is an integrated manufacturer of sponge iron, steel billets and wires. The company generates about half of its revenues from wire manufacturing while the rest comes from selling intermediary products (sponge iron, ferro alloys and steel billets). The company is a major player in Chattisgarh with a market share of about 30-35 per cent.

The gold mine
A key milestone for the company and a big boost to its business came last year when the Chattisgarh government awarded it some reserves of iron ore and coal, the two most essential constituents for manufacturing sponge iron.

“Over the next two years our major raw material for sponge iron, which includes iron ore and coal would become 100 per cent captive and we will not have to depend on the market. This will not only increase our bottom line but also insulate us from any fall in steel prices,” says, Dinesh Gandhi director finance, Godawari Power and Ispat.

According to an understanding between the company and the Chattisgarh government, the former has to increase its sponge iron capacities over three fold from 2.5 lakh tonne in the year 2006 to 8.45 lakh tonne.

The company has already achieved 58 per cent of its commitment by adding 2.6 lakh tonne this year, taking its total sponge iron capacity to 4.95 lakh tonne per year. Along with this, the company also raised its steel billet capacity from 2.5 lakh tonne to 4 lakh tonne. The new capacities have started production in April 2007 and are likely to go on stream by September.

Bottom line impact
The company has been allotted two iron-ore mines near its plant in Chattisgarh. Each of these mines have expected reserves of 8–10 million tonne. Godawari has completed the formalities including the environment clearance; however, application for the forest clearance is still pending and is expected to be awarded within 2-3 months.

With the commissioning of captive iron ore mining, the company will have its own iron ore supply at a cost of about Rs 1000 per tonne as compared to the market price of about Rs 2500-3000 per tonne. A cost saving of about Rs 2000 per tonne would translate into an overall saving of Rs 90-95 crore per year considering a 60 per cent capacity utilisation for sponge iron.

“The captive iron ore alone can improve the company's operating margin by about 6-7 per cent. But this will happen only over the next two years when the utilisation of these mines and the additional sponge iron capacity will go on stream,” says Dinesh Gandhi.

Besides the iron ore, the 63 million tonne of coal reserves allotted to the company will result in additional cost savings. Godawari currently sources about half of its coal requirement from a subsidiary of Coal India and the other half from the auction market. The average landed cost per tonne of coal at the plant site is Rs 2000.

According to company estimates, the cost per tonne from the captive coal mine could be around Rs 1100 per tonne, resulting in an annual savings of Rs 46 crore, again assuming a 60 per cent utilisation of the sponge iron capacity for FY10.

On top of this, the gases emitted while burning the coal is tapped and sent to wasted recovery boilers to generate power for captive consumption. Thanks to the capacity expansion and availability of coal, the company has enhanced its power generation capacity from 28MW to 53 MW recently.

This is sufficient to meet its entire internal demand which again will result in a substantial saving as the captive power generation will result in a variable cost of about Rs 0.60-0.70 per unit compared to the prevailing commercial rate of Rs 3.50 per unit.

The company's waste heat recovery power plant is qualified for carbon credit. In FY07, the company received carbon credit for 66,000 CERs (certified emission reductions) amounting to Rs 5.25 crore. It expects to receive similar credit in FY08, which will go up to 1.75 lakh CERs in FY09 translating to about Rs 12.5 crore at about 13.5 euro for every CER.

Power your portfolio
Overall, the benefits of capacity expansion will start reflecting in the financials this year onwards and the substantial cost savings because of the newly acquired reserves will augment the profitability substantially from next year.

Currently, the company has more capacity for sponge iron and billets than it can absorb for making wires. Considering this gap, the company is investing further in augmenting its wire manufacturing to 5 lakh tonne per year. Gradually, the company will focus on wire business alone and phase out selling of intermediate products such as sponge iron and billets, a move that will impact margins positively.

“There is enough demand for wires in the region but as our capacities increase we will explore opportunities in other parts of the country. We will also change our product mix and enter into value added wires like the ones required for power transmission lines since the demand is quite high in this segment,” says Gandhi.

However, as the company is adding huge capacities, the biggest challenge lies in marketing these products and entering into new markets. Going forward, analysts believe that there would be more competition from larger players and the company may not sustain its high margins in the long-run.

While, the company seems well set to generate a return on equity of nearly 31.9 per cent this fiscal, the stock trades at 4.5 times its estimated FY08 and 2.6 times FY09 earnings respectively which is cheap.