>GODAWARI POWER & ISPAT LIMITED: Pellet paving the way for a prosperous future

A backward integrated business comprising captive iron ore mines and a flexible sales product mix of steel, pellets and power make Godawari Power & Ispat Ltd, GPIL, an interesting investment bet in the midcap steel space. Ramp up in captive iron ore mining and pellet production together with increased steel product sales is likely to result in impressive net sales and EBITDA CAGR of ~23% and ~15% respectively over FY11-14E. We initiate coverage on the stock with a Buy rating and target price of Rs157.


■ Flexible business model with rich product portfolio: GPIL has created a strong niche for itself in the midcap steel space through its rich product portfolio forward integrated into HB Wire and backed by backward integration from iron ore and pellets. The product mix of GPIL remains flexible to derive
maximum profitability.


■ Pellet making to double in two years, drive earnings: GPIL is doubling its pellet making capacity to 2.4 mtpa by FY14E through the set up of a new pellet plant of 1.2 mtpa at Chhattisgarh at a capex of Rs3.8bn. Pellets result in cost saving on iron ore feed for sponge iron unit and enjoy EBITDA margin of ~40% on spot merchant sales when captive fines are used. We see merchant pellet sales growing at a CAGR of 21% during FY12-14E and account for ~65% of overall pellet production by FY14E thus driving the earnings
of GPIL.


■ Captive iron ore back on track: GPIL’s Ari Dongri iron ore mine of 0.6 mtpa results in crucial cost savings for pellet and sponge iron making and is back on track after facing problems on mining and logistics in H1FY12E. We see 80% capacity utilization in iron ore mining for GPIL in FY13-14E.


■ Power provides hedge to steel business volatility: GPIL’s 53 MW power portfolio provides a natural hedge for steel business volatility and we expect the company to continue selling a mix of steel and merchant power to maximize returns.


■ Solar power foray remains an unrelated diversification: We remain concerned on GPIL’s foray into solar power generation (50 MW capacity at a capex of ~Rs8bn with 70:30 debt: equity) and view it as an unrelated diversification. GPIL has thus far invested Rs1210mn as equity into the project and the project is expected to commission by May’2013. We have not factored the same in our earnings and valuation as
of now and await more clarity on the same.


■ Valuations – attractive, Buy: The stock trades at Rs100, which discounts its FY13E EPS and EV/EBITDA by 3.2x and 4.1x. We see earnings growth ahead driven by pellet volumes and value the stock at 4x FY14E EV/EBITDA to arrive at a fair value of Rs157. We don’t factor in any value for the solar power investment by the company as of now. We initiate coverage on GPIL with a Buy rating and target price of Rs 157.

■ Key Risks: Lower sales volumes, drop in steel and pellet prices, hike in royalty on iron ore and lower returns from investment into solar power.
RISH TRADER