Steelcast Ltd Stock Analyzer

Scrip ID STELTSEQNR Background: Industry Steel Castings CMP

(CMP: Rs 172.10) April 02, 2012

Recommended Action Add at Rs 147 Sequential Targets Rs 207 and Rs 244 Time Horizon 2 - 3 quarters

Rs 172.10 Buy at CMP and add on dips

Steelcast Ltd (SL), a Gujarat-based company incorporated in 1972 as Steelcast Bhavnagar Pvt. Ltd was converted into public limited company in 1988. It manufactures wide range of steel casting p roducts including carbon steel, low alloy steels and high chromium ferro alloys, catering to diverse industrial sectors like earth moving (largest exposure), cement, mining & mineral processing, industrial machinery and construction machinery. SL is also focusing on supplying to Railroad projects and reduce its dependence on earth moving equipment segment. It has carved a niche for itself and supplies casting to customers like Neyveli Lignite Corporation, Northern Coalfields, Century Cement, Kesoram Cement, Raasi Cement, Bharat Earth Movers, Hindustan Motors and BHEL among others. It also exports to various countries like the US, UAE, Saudi Arabia, Japan, Switzerland, Germany etc. In the past it had a technical collaboration with Kurimoto of Japan (for steel foundry products used in cement plants). However SL shifted its focus to earthmoving equipments some years back out of self-developed technology. Kurimoto still holds 2.53% equity stake in SL. It currently has a technology alliance with Michigan Steel of US for process improvements and technology up gradation. Its competitors in India include Sanmar of Chennai and Simplex Casting (part of its products). Shareholding Pattern (in %) Promoters Public & Others Total Q3FY12 43.51 56.49 100.00 Q2FY12 43.51 56.49 100.00 Q1FY12 43.51 56.49 100.00 Q4FY11 43.51 56.49 100.00 Q3FY11 40.82 59.18 100.00

The promoters have subscribed to the first tranche of preferential warrants of 1.98 lakh equity shares @ Rs.108 per share in Mar 2012 and may subscribe to the balance two tranches in FY13 taking the total equity to Rs.4.55 crs and the promoters stake to 50.9%. The company currently has a plant in Bhavnagar with annual manufacturing capacity of 17000 MT (up from 13000 MT in FY11) and plans to expand it to 22000 MT by FY13.

Triggers
Long Term pact with Caterpillar Steelcast Ltd has entered into a long-term agreement with Caterpillar Inc for supply of steel casting products to its Indian subsidiary with specifications given by the US major. Post agreement, SL's sales to Caterpillar could grow from Rs 40 crs in 2010-11 to about Rs 150 crs in 2015. As per the terms of agreement, Caterpillar would give an interest free loan of US $ 5 million (approx. Rs 25 crs) to SL with a repayment period of four years. The loan will be adjusted against the shipments made to Caterpillar. SL has been associated with Caterpillar for the last 20 years. Based on this long relationship and their confidence in its high quality manufacturing capability, the US major has, for the first time, entered into this unique new agreement with SL. Under this agreement, SL will set up dedicated manufacturing facility where steel-casting products with specifications given by the US major will be made. Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. A long-term agreement with Caterpillar Inc gives SL an assured off-take arrangement and proves the technological capability of SL. This arrangement could lead to a steady increase in sales for SL with assured margins. Further a large part of the funds required to enhance capacity to cater to this arrangement would come from Caterpillar and not strain its resources. Spending large capex over FY11 FY13 on latest technology for manufacture of high quality castings SL incurred major capital expenditure during FY11 and FY12 towards increased capacity and introduction of Automated NoBake Fast Loop Moulding Line of producing steel castings, which is world over, acknowledged and recognized for the production of high quality steel castings.

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The introduction of Automated No-Bake Fast Loop Moulding Line is done with a couple of motives. The first and the key motive is that this is a w orld acknowledged moulding line and hence opens gates for the company to venture into the global territory especially the US market where it is already eyeing few projects. The other significant factor is that, with the introduction of this line, the company has enhanced its capacity and hence could meet the growing demand for castings both in the Indian and US markets. It further eyes capex in FY13 to cater to the caterpillar tie-up and raise further capacity to meet anticipated demand. SL has a plan of increasing the sale of finish machined, ready to use and assembled castings from ~15% currently to ~40% by the year 2015. This enables raising entry barriers for new entrants and control costs. SL has over the years incurred capex to increase capacity and manufacture value added products. The pace of capex has increased lately as is evident from the chart below:

Movement of Gross Block (Rs Crs) 200.00 180.00 160.00 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 FY07 FY08 FY09 FY10 FY11 FY12E FY13E 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0.00

Gross Block LHS

Addition to Gross Block RHS

This will positively impact revenue growth in the coming 1-2 years.

Volumes & Capacity Utilization 20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 FY09 FY10 Sales Volume (LHS) FY11 FY12E FY13E 85.00% 80.00% 75.00% 70.00% 65.00% 60.00% 55.00% 50.00%

Capacity Utilization (RHS)

Eyeing the US Rail Market for sale of castings through Joint Venture with Michigan Steel, US It is planning to tap the multi-billion dollar US Railways demand for castings. A team from the USA inspected SLs manufacturing facilities located at Bhavnagar in Gujarat recently and the company could be granted certification by the month of May 2012. The US Rail certification will give SL a big advantage while bidding for contracts from the Indian Railways, especially from the upcoming Delhi-Mumbai Freight Corridor. Indian Railways have already extended Class-A foundry status to SL and sample orders for manufacturing couplers have been received by SL.

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One of the North American companies has already placed an order with the Company to manufacture railway castings for US Railways. This company is very actively interacting with SL for facilitating the AAR (Association of American Railroads) approval at the earliest possible. SL is all to set to transform from a small player to a sizeable player in the coming years. The supply of rail castings to the US railroad would be through a joint venture with Michigan Steel. SL has recently formed a 50:50 joint venture company with USA's Michigan Steel, to tap the US casting market. The US railways demand for castings is huge. In the first year (FY13) it expects sales of Rs 40 crore from Steelcast LLC, and revenues in excess of Rs 200 crore over the next five years from the JV. The product development shall be done at the Bhavnagar facility with technical support of Michigan Steel, while the JV company shall be doing the marketing. The farm equipment segment is also interesting as it now forms 10 per cent of the steel castings business globally. Pursuant to the JV agreement the board of SL has appointed as additional director, Mr. Vaughn W Makary (who holds a Bachelor's degree in Mechanical Engineering and Master of Business Administration degree) President and CEO of Michigan Steel USA. He has more than 39 years of experience in Metal casting & Rail Road Supply Industry. Strong Domestic and export Clientele SL is one of Indias largest steel castings manufacturing company in India. Strong demand from user industries in India and globally has put the company on a high growth trajectory. SL is expected to post revenues of over Rs. 225 crore in FY12 (vs. Rs.133.26 crs in FY11), with nearly 45% coming from exports, mainly to the USA and Germany. SLs product range includes industrial castings in carbon steel & low alloy steel. Some of the companys major clients are Caterpillar, Komatsu, JCB, Tatas, L&T, Essar, BEML, Neyveli Lignite. Century Cements, Bharat Earthmovers amongst others. The clients of the company have been with SL for many years showing the consistent performance and strong relationship of SL with these clients. The growing demand of the products could help SL report strong growth in its business going ahead. SL is consistently improving its client profile and is trying to enter into long-term relationships with them. This helps in getting clarity on the revenue visibility of the company going ahead. In the overseas markets, SL exports to companies like Komatsu Group of Companies etc. Pretty soon it could start exports to the US Railways also. Except for FY10 (dip due to global recession) the exports are rising continuously in absolute terms and as a percentage of sales as is evident from the chart below.

Exports Movement 60.00 50.00 40.00 35 30.00 30 20.00 10.00 0.00 FY06 FY07 FY08 FY09 FY10 FY11 25 20 45 40

Exports - Rs Crs (LHS)

Exports - % of Sales (RHS)

Encouraging Financial Results Q3FY12 and 9MFY12 SL reported its recent results for Q3FY12. It reported net sales of Rs 64.65 crs for Q3FY12 as against Rs 34.53 crs in Q3FY11 and Rs 55.09 crs in Q2FY12. The operating profit of the company stood at Rs 13.04 crs in Q3FY12 as against Rs 3.62 crs in Q3FY11 and Rs 9.55 crs in Q2FY12. The PAT of the company stood at Rs 4.96 crs in Q3FY12 as against Rs 0.82 crs in Q3FY11 and Rs 2.93 crs in Q2FY12. The company reported EPS of Rs 12.53 in Q3FY12 as against Rs 2.04 in Q3FY11 and Rs 7.40 in Q2FY12.

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For FY11, the company reported net sales of Rs 133.26 crs s against Rs 95.52 crs in FY10 while the operating profit stood at Rs 15.72 crs in FY11 as against Rs 12.29 crs in FY10. The PAT of the company stood at Rs 4.33 crs in FY11 as against Rs 2.78 crs in FY10. It has to be noted here that the company had a tough year during FY10. The global slowdown was at its peak and this had impacted the sales mainly due to deferment or cancellation of orders from several customers. The cost of inputs also rose during FY10, which led to harp drop in profits during the year. The company started to revive during FY12 and the 9MFY12 has seen strong improvement due to stronger demand from customers. In 9MFY12, the company reported net sales of Rs 165.27 crs as against Rs 93.39 crs in 9MFY11while the operating profit stood at Rs 30.21 crs in 9MFY12 as against Rs 10.49 crs in 9MFY11. The PAT of the company stood at Rs 10.35crs in 9MFY12 as against Rs 2.58 crs in 9MFY11, a jump of 301.2% y-o-y while the EPS of the company stood at Rs 26.14 in 9MFY12 as against Rs 6.83 in 9MFY11. Risks and Concerns The company has a high debt equity ratio of 1.34:1 (as of H1FY12) and this could increase further in the near term due to its ongoing capex plans unless the profitability keeps pace. This could strain its financials in the event of a slowdown or heightened competition. Further the company presently enjoys credit rating of BBB. The company is involved in exports and therefore is exposed to foreign currency risks. Any unfavorable movement (appreciation) of the rupee against the dollar could impact the business of SL. The key raw material for the company is steel. Hence the movement of steel prices influences the margins of the company. Higher steel prices could lead to increase in expenses, which may not be immediately passed on to its customers thereby impacting the margins. The Power & Fuel cost for the company constituted 16.55% of its overall expenses during 9MFY12 as against 16% in 9MFY11 and 16.2% in FY11. If this cost is not controlled, then the company could witness further pressure on margins going ahead. Uninterrupted supply of power from the state grid is essential for the company, as it does not have any back-up power. The company is also dependent on the economic growth of India and the world as any downturn in the overall economy could impact the demand scenario of the end users and hence impact the topline of the company. In FY10, the company had witnessed drop in its PAT due to deferment/cancellations from customers owing to global slowdown. In the event of recurrence of such a situation, the company could witness a drop in its top and bottomline. The company is eagerly working towards getting orders from US Railways for castings. In the event of delays/failure to get certification/orders, the revenue growth of the company could get negatively impacted. The major custo mer base of SL is that of the Earth Moving Equipment Industry. If the industry does not perform well, then the impact could also be reflected on the performance of SL. The company is currently enjoying export incentives from the Government. While these have already fallen from the earlier levels, continuation of the same is required for the company to avoid a hit on the bottomline of the company. The company pays low dividend and hence the dividend payout has been low over the years due to the capex requirements. There is no assurance that it may increase the dividend payout going ahead. Conclusion Steelcast Ltd is one of the leading manufacturers of steel castings in the country with an annual capacity of 17000 MT per annum. It manufactures wide range of casting products including carbon steel, low alloy steel and high chromium ferro alloys, catering to diverse industrial sectors like earth moving, cement, mining & mineral processing, industrial machinery and construction machinery. It has carved a niche for itself and supplies casting to customers like Neyveli Lignite Corporation, Northern Coalfields, Century Cement, Kesoram Cement, Raasi Cement, Bharat Earth Movers, Hindustan Motors and BHEL among others. The Company also exports to various countries like the US, UAE, Saudi Arabia, Japan, Switzerland, Germany etc The Company has incurred major capital expenditure during FY11 and FY12 towards expanding capacity and introduction of Automated No-Bake Fast Loop Moulding Line of producing steel castings, which is world over, acknowledged and recognized for the production of high quality steel castings. The capacity of the SL, which was 13000 MT in FY11, has risen to 17000 MT now and is slated to go up to 22000 MT in FY13. This could generate additional volumes, revenues and margins for the company.

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Steelcast Ltd has recently entered into a long-term agreement with Caterpillar Inc for supply of steel casting products to its Indian subsidiary with specifications given by the US major. Post agreement, SL's sales to Caterpillar could grow from Rs 40 crore in FY11 to about Rs 150 crore in 2015. The company has recently formed a 50:50 joint venture company with USA's Michigan Steel, to tap the US casting market. The US railways demand for castings is huge. In the first year (FY13) it expects sales of Rs 40 crore from Steelcast LLC, and revenues in excess of Rs 200 crore over the next five years from the JV. The company could continue to witness a sharp growth in its topline and bottomline in the coming quarters due to the above. We think that the companys revenue and profit visibility is strong going ahead and feel that investors could buy the scrip at CMP and add on dip to Rs 147 (3xFY13E EPS) for sequential targets of Rs 207 and Rs 244 (4.25 and 5xFY13E EPS) over the next 2- 3 quarters. Financials Quarterly Standalone Particulars Net Sales Other Income Total Income Raw Material Consumed Stock Adjustment Employee Expenses Power, Oil & Fuel Other Expenses TOTAL EXPENDITURE PBIDT Interest PBDT Depreciation PBT Tax Reported Profit After Tax EPS OPM% NPM% Income Statement Particulars Net Sales PBIDT OPM% Interest Depreciation Profit Before Tax Profit After Tax EPS Book Value Balance Sheet Assets & Liabilities Liabilities Share Capital Reserves & Surplus Total Loan Deferred Tax Liability Total Liabilities Assets Fixed Assets Investments Q3FY12 Q3FY11 % Chg Q2FY12 % Chg 9MFY12 9MFY11 64.65 34.53 87.23 55.09 17.35 165.27 93.39 0.02 0.00 0.00 0.00 0.00 0.38 0.09 64.67 34.53 87.29 55.09 17.39 165.65 93.48 31.76 17.91 77.33 27.63 14.95 86.76 49.85 -2.09 -0.063383.33 -1.21 72.73 -9.35 -1.92 4.78 3.25 47.08 4.11 16.30 12.42 8.63 8.25 5.02 0.00 7.31 0.00 22.42 13.50 8.93 4.79 86.43 7.70 15.97 23.19 12.93 51.63 30.91 67.03 45.54 13.37 135.44 82.99 13.04 3.62 260.22 9.55 36.54 30.21 10.49 3.15 1.17 169.23 2.73 15.38 7.82 3.00 9.89 2.45 303.67 6.82 45.01 22.39 7.49 1.94 1.25 55.20 1.89 2.65 5.71 3.72 7.95 1.20 562.50 4.93 61.26 16.68 3.77 2.99 0.38 686.84 2.00 49.50 6.33 1.19 4.96 0.82 504.88 2.93 69.28 10.35 2.58 12.53 2.04 512.52 7.40 69.28 26.14 6.43 20.17 10.48 17.34 18.28 11.23 7.67 2.37 5.32 6.26 2.76 FY09 132.82 16.31 12.28 5.60 4.16 6.55 3.83 12.63 102.00 FY10 95.52 12.29 12.87 3.26 4.85 4.18 2.78 7.26 105.93 % Chg FY11 76.97 133.26 322.22 0.35 77.20 133.61 74.04 70.39 386.98 -2.75 43.92 12.07 0.00 19.16 79.35 19.02 63.20 117.89 187.99 15.72 160.67 4.35 198.93 11.37 53.49 5.13 342.44 6.24 431.93 1.91 301.16 4.33 306.23 10.80 11.80 3.25 Rs Crs FY10 % Chg 95.52 39.51 0.14 150.00 95.66 39.67 47.43 48.41 -0.60 358.33 8.43 43.18 14.94 0.00 13.17 44.42 83.37 41.41 12.29 27.91 3.26 33.44 9.03 25.91 4.85 5.77 4.18 49.28 1.40 36.43 2.78 55.76 7.35 46.82 12.87 2.91
Source: Capitaline

FY11 133.26 15.72 11.80 4.35 5.13 6.24 4.33 10.80 112.72

FY12E 233.77 41.96 17.95 10.52 7.81 23.63 14.87 35.75 146.61

Rs Crs FY13E 319.00 55.98 17.55 12.10 10.70 33.18 22.23 48.86 188.43 Rs Crs 201303E 4.55 81.19 116.00 11.00 212.74 138.47 0.07
5

Source: Capitaline, HDFC Sec Estimates

201003 3.83 36.74 39.75 3.99 84.61 37.07 0.15

201103 4.01 41.19 64.98 4.84 115.02 62.62 0.02

201203E 4.16 56.83 79.00 8.00 147.99 81.74 0.03

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Current Assets, Loans & Advances Inventories Sundry Debtors Cash & Bank Balance Loans & Advances Current Liabilities & Provisions Current Liabilities Provisions Net Current Assets Total Assets One-Year Forward P/E Chart

57.73 16.30 22.47 12.22 6.74 10.34 8.54 1.80 47.39 84.61

67.13 22.18 29.29 5.27 10.39 14.75 12.53 2.22 52.38 115.02

94.92 30.60 44.00 6.32 14.00 28.70 26.20 2.50 66.22 147.99

111.80 34.50 59.00 7.80 10.50 37.60 33.60 4.00 74.20 212.74

Source: Capitaline, HDFC Sec Estimates

One Year Forward PE Chart 350.0 300.0 250.0 200.0 150.0 100.0 50.0 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Date Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 0.0 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

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Analyst: Tiju K Samuel (tiju.samuel@hdfcsec.com)

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Fax: (022) 3075 3435

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