In Q1 FY08, Pennar Industries Ltd (PIL) reported net profit of Rs 76 mn on net sales of Rs1,289mn. Though net profit came in line with our estimates of Rs 74 mn, net sales were below our expectations.

Net sales grew by 5% (Y-o-Y) over previous year on account of higher sales from Cold Rolled Formed Steel (CRFS) segment driven by higher volume from Railways and Electro Static Precipitators (ESP) sub segments. However, sequentially gross sales (refer note1) declined by 4% due to lower realization in both the segments with a flat volume growth. While CRFS segment realization slipped by 12%; CRSS segment's realization declined sequentially. In the previous quarter, realization was higher driven by a large order from railways with better realization.

EBITDA for this quarter stands at Rs146mn, reflecting a margin of 11.3%, that is a margin expansion of 110 bps (QoQ) and 270 bps (Y-o-Y). This would be attributed mainly to lower raw material cost (72% of net sales in this quarter against that of 78% in previous quarter and 79% in last year). However some of the benefits are being off set as other manufacturing expenses have gone up significantly in the same period.

PIL reported a net profit of Rs76mn for this quarter, reflecting a net margin of 5.9% against 5% during last year and 5.3% during last quarter. This translates into an EPS of Rs 0.82, registering 13% growth (Y-o-Y) and a flat growth sequentially.

Valuation:

Currently the stock is trading 9X its FY08E EPS and 6X its FY09E EPS. We are positive on this stock considering its consistent margin improvement and on going capacity addition (new plant at Chennai), which is expected to start in Q2 FY08. We believe increasing mix of higher margin business (CRFS) would continue to drive margin expansion. Hence, we rate PIL a BUY retaining our price target of Rs29 based on 7X its FY09E EPS.

Segmental Performance:

CRFS segment still remains the main driver of margin. CRFS segment accounts for 67% of total EBITDA (with margin of around 15%) while revenue contribution is around 50.7% in this quarter. On the other hand CRSS contributed 33% to total EBITDA with a margin of 8%. We believe increasing volume from CRFS would lead to higher revenue contribution, which would attribute to margin expansion.