Initiating Coverage: Maharashtra Seemless Ltd - BUY - TP Rs.560 - Kotak

We initiate coverage on Maharashtra Seamless MSL (MSL) with 'BUY' rating and a target price of Rs 560 based on 9x EV/EBITDA FY19E earnings. We believe that MSL valuations can get rerated on back of strong growth in company's consolidated profits through FY17-19E driven by 1) recovery in demand for seamless pipes in the domestic/international market 2) imposition of anti-dumping duty on Chinese imports would lead to demand shifting towards domestic industry and 3) limited competition from domestic players who are struggling with their highly leveraged balance sheets. We project 49% CAGR between FY17-19 in consolidated profits from Rs.1.15 Bn in FY17 to Rs 2.6 Bn in FY19E. At current price of Rs 472, MSL stock is trading attractive at 7.4x EV/EBITDA and 12x P/E on FY19E earnings.

Key Investment argument

- Anti-dumping duty levied on Chinese imports along with fading competition from other Indian players offers competitive advantage to the company. MSL business suffered severely between FY12-16 due to dumping of cheap products by Chinese players into Indian markets. Earlier, MSL used to command nearly 70% market share in India until FY12. Due to dumping of cheap products, MSL suffered heavy loss as almost entire market shifted towards the Chinese players.

In FY16, in a bid to protect the domestic industry from cheap Chinese imports, Directorate General for Anti-dumping and Allied Duties (DGAD) had recommended to impose provisional anti-dumping duty on import of certain types of iron and steel pipes from China used in oil and gas exploration including seamless pipes.

This move favoured MSL in two ways. 1/Company earnings exploded in FY17 (revenue up c.41%YY at Rs 14.3 Bn, EBITDA margin reported at 15.7% vis-à-vis 3.8% in FY16) due to market shifting back to domestic manufacturers and 2/ company faced limited competition from other domestic players as most them are struggling with their stretched balance sheets, severed between FY12-16. As a result, MSL has started to regain its lost market share and leadership positioning, leading to a significant growth in earning.

- MSL is well positioned to benefit from recovery in increasing capex in domestic hydrocarbon industry. New Exploration Licensing policy (NELP) and Hydrocarbon Exploration Policy (HELP), has emphasized on maximizing the domestic exploration of oil and gas to attain self-sufficiency by 2022. We believe that this augers well for company's business as it would entail huge capital expenditure of over Rs 2.3 trillion through FY17-20 by major Hydrocarbon companies. This is expected to generate meaningful demand for company's products. Seamless pipes constitutes to nearly 8-11% of overall capex incurred by upstream/downstream companies.

Further, we note that the penetration level of pipelines in oil and gas transportation and other sectors is very low in India as compared to the global benchmark. This provides a huge scope for growth of the pipe industry. We believe that, MSL is well placed to cater to the increased domestic demand due to these factors.

- International footage offers geographical diversification to take advantage of the growing demand in Europe/US market. MSL has presence in Europe, USA and is also exploring business opportunities in Canada and Turkey. MSL has also registered itself with British petroleum. Exports constitutes to nearly 25% of MSL's revenue pie currently.

Also, as per our understanding, the fall in crude oil price over past few years has led to diminished global spending on oil and gas exploration. However, meanwhile shale gas producers have reduced the operating costs and have turned profitable. We believe that the demand for OCTG (Oil country tubular goods) pipes from shale gas producers shall also improve going ahead.

- High growth in revenue/PAT to flow into FY18/FY19; recovery in operating margins likely to aid to free cash flow generation. We project 33.5% CAGR between FY17-19 in consolidated revenues from Rs.14.3 Bn in FY16 to Rs 25.6 Bn in FY19E on back of 1) recovery in demand for seamless pipes in the domestic/international market and 2) imposition of anti-dumping duty on Chinese imports would lead to demand shifting towards domestic industry and 3) limited competition from domestic players who are struggling with their highly leveraged balance sheets.

We expect EBITDA margins to expand over FY18E and FY19E on back of improved pricing (aided by limited competition) and operating leverage. In our projections, we build EBITDA margin at 16.3% and 17.4% in FY18E and FY19E respectively.

The company has net cash/investments worth Rs15.3 Bn (including equity/short & long term investments and preferential investments in related companies). Company has a consolidated debt of Rs 6.4 Bn. MSL operates at c.50% capacity utilization and does not have plans of setting up incremental capacity in near term.

We project 49% CAGR between FY17-19 in consolidated profits from Rs.1.15 Bn in FY17 to Rs 2.6 Bn in FY19E.

- Key Concerns: 1/MSL revenues are heavily concentrated around capex made by the Hydrocarbon sector (both upstream and downstream players). Any delays in these spends pose downside risk to our estimates. 2/Sharp increase/volatility in input prices could bear downward pressure on operating margins 3/ Further Company has invested a major portion of its cash (c. Rs 11.71 Bn) in non-strategic assets - 6 oil rigs and a coal mine. These assets have not contributed much to cash flows so far.

Shares of MAHARASHTRA SEAMLESS LTD. was last trading in BSE at Rs.474 as compared to the previous close of Rs. 475.9. The total number of shares traded during the day was 7286 in over 348 trades.

The stock hit an intraday high of Rs. 481.5 and intraday low of 466. The net turnover during the day was Rs. 3464271.

Source : Equity Bulls

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