Bhushan Steel Ltd - Playing the right card of Backward Integration

The other day, on CNBC, investment Guru Mark Mobius, MD of Templeton Asset Management, said he was bullish on Indian commodities stocks. "People don’t realise India is one of the largest producers of iron ore in the world; companies like Sesa- Goa for example are good stocks to invest in," Mobius said, adding that steel and aluminum companies were worth looking at.

Bhushan Steel is all set to ride the boom in the Indian economy going forward with the solid plans of backward integration.

Equity Share Capital - 43.00 Cr
No. of equity shares – 4,24,71,662
Promoter holding – 69.15%
Institutions – 4.22%
General Public – 3.64%

Market Cap – Rs. 3450 Cr
Book Value – Rs. 476.7
Reserves – Rs. 19822 Cr
EPS (Rs) – Rs. 96.8

52 week high/low – Rs. 947/Rs. 260
CMP – Rs. 930

Company Profile:

Bhushan Steel Ltd formerly known as Bhushan Steel & Strips Ltd. is now India’s 3rd largest Secondary Steel Producer with an existing steel production capacity of 2.2 million tones per annum (approx.). The company has three manufacturing units in the state of Uttar Pradesh (Sahibabad Unit), Maharashtra (Khopoli unit), and Orissa Plant (Meramandali unit) in India and sales network is across many countries.

BSL is one of the last players to ride the band wagon of backward integration - is on the verge of commissioning its 2.2 mmT pa that will be fully ready and running by the second half of FY10 at an expense of Rs 6000 Cr. The green field facility will help the company service its requirement of the HR coils in-house, although it will be dependent on its requirement of raw material for Steel making on the spot market. Out of the 2.2 mmT steel made per year, 1.9 mmT will be fed to make Hot rolled coils (HR coils) while the rest for long products. The surplus HR coils would be offloaded to the market. Higher production will help drive the top-line of the company.

Back ward integration to drive the EBIDTA:
Bhushan Steel had been sourcing its raw material i.e. HR coils from different steel makers like SAIL and Tata Steel in addition to imports. With new steel making facility in force by Oct. ’09, its dependence on external suppliers will not only reduce but it will offload the surplus to the market. The company will gain from the increased spreads obtained due to the backward integration. Moreover, the gains from the sale of surplus Steel will shore up the top-line and the bottom line of the company.

Steel Demand to be robust:
India along with China is expected to be the only countries in the world to show positive growth in Steel making and consumption. Driven the stable government at the centre, Indian economy is expected to grow at a rate 5% plus rate discounting the failed monsoon. Steel and other metals would see a rise in consumption from the user industries. Automobiles and white goods industries are expected to put forth better growth numbers driven by the rising demand. Steel demand and hence prices are expected to be robust in the near to far future.

Further expansion:
Bhushan Steel has further plans of expansion by 3.2 mmT of Steel making by Oct.’12 at an expense of Rs. 6500 Cr. This will take the total capacity of the company to 5 mmT by FY13. With the increase in Steel making capacity the company is also planning to add the relevant downstream operations in future. Similarly, the company has been allotted iron ore and coal mines that will ensure its minerals security but it will take about 2-3 years to fructify.

Performance:
For Q1FY10, Net Sales were Rs. 1,337.5 Cr (Rs. 1,321.4 Cr) marginally up over previous year & Net profit was Rs. 171.9 Cr (Rs. 132.7 Cr).
For entire year FY08-09, total revenue grew by 19% to Rs. 4,957.6 Cr (Rs. 4,152.4 Cr) whereas Net profit was Rs. 411.3 Cr (Rs. 423.7 Cr), marginally declined. EBIDTA margins improved from 19% to 21% & EBIDTA was Rs. 1033.4 Cr (Rs. 807.4 Cr).
The estimated earnings for FY10 & FY11: Revenues of Rs. 5,510.7 Cr & Rs. 6987.2 Cr are expected which shows growth of 11.2% & 26.8%. Whereas Net profits of Rs. 569.7 Cr & Rs. 1,138.8 Cr, an increase of 38% & 50% Y-o-Y. This will result in an EPS of Rs. 134.10 & Rs. 268 from current Rs. 96.8.

Valuation:
At CMP of Rs. 930, the stock quotes at a PE multiple of 9.6x which is on the higher side. Also there is news of BSL planning to come out with an IPO of Bhushan Power. But if we look at the forward estimated earnings of FY10 & FY11, then it is available at P/E of 7 & 3.5 respectively which is in line with & below the industry standards. Price/BV ratio is around 1.9 to 2. Also if we think of expansion plans till FY13, then the sales could be four fold from now & besides that they may bring the IPO of Bhushan Power thus unlocking shareholders’ value. I think company will benefit from its endeavor of back ward integration and going forward it will reflect in the quarterly performance starting Q310 wherein it would have started partial production from Steel making units.

So, even if we consider P/E of 5x on FY11E earnings for the stock, it comes to around Rs. 1340, plus the Bhushan Power IPO & strategy of expanding total capacity to 5 million tones till 2013 will see upward revision of the price target. However, this is high beta stock, so it shows out performance in both directions & is highly volatile. Accumulate it for your mid-cap portfolio on every 10-20% decline for long term horizon of 3-5 years to reap the benefits of growing economy.