Srikalahasthi Pipes Ltd – A strong play in water infrastructure space
Srikalahasthi Pipes Ltd (SPL) is a leading manufacturer of Ductile Iron Pipes (DI Pipes) in India with 15% market share in overall India and 75% market share in south and western region. Company’s manufacturing facility is located at Tirupathi (AP) with a production capacity of 3 lac TPA of DI pipes. SPL also manufactures pig iron, cement, low ash metallurgical coke & generates power for captive consumption. Company also enjoys various competitive advantages which cements its position strongly in the industry.
DI pipes find application in transmission of raw / portable water and sewage management. The demand for these pipes is directly linked to investment in water and sanitation infrastructure. The central as well as state government’s efforts to provide water supply & sanitation infrastructure is helping the industry to grow at 13% year on year. SPL supplies DI pipes (available in various size ranging from 100mn to 1,100mn diameter) to various Water Boards, Municipal Corporations and Turnkey Contractors across the country for their Water Infrastructure Projects which is the thrust area of the Government of India. SPL being the leader in manufacturing DI Pipes is well placed to capture the huge growth opportunity.
Key advantages of SPL:
SPL is one of the top players in the DI pipe industry in India, and commands around 15% market share across India and 75% in South and Western Zone which it primarily caters to. The business accounts for 82% of the company’s total revenues with major contribution from Southern and Western region.
SPL is an associate company of Electrosteel Castings Ltd (48.5% stake), India’s leading DI Pipes manufacturer with five decade of experience in servicing the water infrastructure space. Together, the Electrosteel group commands around 40% market share of the Indian DI Pipes Market. ECL’s technical expertise has been adopted in SPL’s various backward and forward integration projects, thus providing it a competitive advantage. The alliance has also helped SPL achieve the economies of scale due to collective procurement of major items like import of coal, moulds and essential raw materials amongst others.
SPL has a fully backward integrated manufacturing facility which includes a sinter plant (5 lac TPA), coke oven plant (2.25 lac TPA), power plant (14.5 MW) and a sewage treatment facilities in the same complex spread over 300 acres, giving it a significant competitive advantage. In its constant attempt to remain low cost manufacturer, SPL has undertaken various cost reduction measures such as reduction of coke consumption in Mini Blast Furnace (MBF), HSD oil in Ductile Iron Pipe plant.
Since FY12, SPL has consistently expanded its DI pipes capacity by 67% (from 1.8 lac TPA in FY12 to 3 lac TPA in FY17 – 75,000 TPA has been expanded recently), which has enabled the company to meet the demand requirements and drive its revenue growth. The MBF capacity has also increased from 2.25 lac TPA to 2.75 lac TPA during the same period. SPL to continue with its capacity addition of DI pipes at a steady pace, which would enable the company to meet the rising demand from the user industries and maintain its healthy growth momentum.
Demand uptick to drive revenue growth.
With healthy demand from the user industries and capacity expansion, we expect a meaningful improvement in the volume growth of DI pipes over the next two years. The company reported a strong revenue growth of 37.2% in Q4FY17, largely led by volume growth revival. Led by capacity expansion and demand uptick, we expect SPL to register a healthy revenue growth of 15% on a CAGR basis over FY17-19E. SPL has a healthy order backlog (more than 1x its FY17 sales) and with robust demand environment, government initiatives and increasing preference for DI pipes, we expect order inflows to improve substantially over the next two years.
Operating leverage and backward integration to boost margins
SPL’s EBITDA margins improved significantly by 1,735bps to 23.3% over FY13-16 aided by backward integration initiatives and lower raw material prices. A steep rise in the coking coal prices impacted the margins sharply in Q4FY17, resulting into overall contraction of 317bps to 20.1% in FY17. However, we expect revival in margins (to 22%) over next two years, led by better capacity utilization and continued backward integration initiatives by the company. Declining interest cost (as we expect the borrowings to reduce) is likely to boost PAT growth and PAT margins.
Healthy cash flow generation to continue, return ratios to improve
SPL has a robust cash balance in its books, which stood at Rs 2.1bn as on March 31, 2017. The average operating cash flow generation over FY12-17 stood at Rs 1.4bn. With improving profits, we expect this healthy momentum to continue.
SPL’s return ratios improved consistently over FY13-16 (ROCE improved from 4.3% in FY13 to 24.8% in FY16), but came under significant pressure in FY17 (ROCE declined sharply to 16.4%) due to higher CAPEX and decline in profitability (especially in Q2FY17 due to planned shutdown of mini blast furnace for ~30 days and in Q4FY17 due to steep rise in the coking coal prices). However, with better profit growth, we expect the return ratios to improve meaningfully over the next two years.
At CMP of Rs 364, SPL is trading at 10xx FY17 EPS. The company deserves to trade at better valuations, given its impressive track record of growth, leadership position in DI pipes, bright growth prospects and declining debt-equity.