Braving headwinds

Updated: Feb 27 2012, 06:16am hrs
Following managements recent analyst conference call, which added more detail on the last earnings report, we see greater cost pressures and tough competition hurting volumes and margins. Rising coal costs and uncertainty of iron ore availability is hurting the domestic ductile iron pipes business.

Even in the large diameter pipes, the global slowdown has adversely impacted capital expenditure decisions for large projects. Line pipe manufacturers have been hurt by policy paralysis across the globe from policymakers and private corporates which has led to delay in pipeline projects. While political leaders have been trying to avoid tough decisions pending elections, private companies have been waiting for financing conditions to improve and commodity prices to settle down. These tough economic conditions have also led to nationalistic fervour resulting in projects being awarded to companies with domestic presence.

But with global expansions and commissioning of mines JSAW is well positioned: JSAW (Jindal Saw Ltd) has expanded its ductile iron pipe capacity in the UAE, it took over lease rights in a European pipe mill and has recently started its trial runs for seamless pipes in the US. These plants are likely to get the benefit of being localised and will benefit from orders intended towards generating local employment. JSAWs iron ore mine is also now close to commissioning, which will add to profitability and improve raw material availability.

Infrastructure business now close to break even: JSAW had entered into infrastructure space involving water management, waste management, waterways, waste to power and rail manufacturing. All these businesses are now close to generating profits with its rail manufacturing unit getting its first order, waste to energy plant commissioned and its waterways business getting a seven year contract with NTPC. We believe these businesses will soon start supporting profitability.

Valuation and risk: We cut our earnings by 13-38% to incorporate the impact of slower demand. We roll forward our valuation to FY14e EPS (earlier FY13e) but maintain our PE (price-to-earnings) multiple at 8x (times). We now eliminate the value of the investments from our valuation as they have been hived off to a separate company. As a result our target price falls to R210 (from R280), but we maintain our Overweight rating. Key risks to our earnings estimate and price target are a further slowdown in pipeline projects, increase in competition and delay in commissioning of the iron ore mine.

Risk and sensitivities: Delay in commissioning iron ore mine. Iron ore mine is expected to commission by Jun12. This has

already been pushed back from September 2011.

Any further delay could affect our earnings estimates and stock price performance. Earnings and valuation are primarily

sensitive to volumes and the margins which they are able to command.

A 10% increase in SAW pipes volumes will increase FY13e net profit by 6%. A 10% increase in DI pipe volumes will increase net profit by 4%. A 10% increase in seamless pipe volumes will increase net profit by 2%. A 10% increase in Ebitda/tonne will increase net profit by 15%.

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