Sunday, September 27, 2009


Pipers find their tune

Initiate coverage on pipe sector with positive view
We believe Indian pipe producers are poised to benefit significantly from robust global demand. Pipe companies provide strong earnings visibility despite the current uncertain environment. The Indian pipe stocks have significantly underperformed the NIFTY and the mid-cap indices in the past year on a perception that they are leveraged plays on crude oil prices. The Indian pipes sector is quoting at more than a 20% discount to five-year historical average PER. We highlight five Indian pipe makers in this report and initiate coverage on two of these – Welspun Gujarat and Jindal Saw – with Outperform ratings.

Demand outlook strong for welded, sluggish for seamless
Since the oil & gas sector is the biggest consumer of steel pipes globally, the market perceives crude oil prices to be a key indicator of pipe demand. We believe that demand for welded pipes for oil & gas transmission is driven more by structural factors, like long-term infrastructure requirements, new oil & gas sources and the shift to cleaner fuels than medium-term oil price fluctuations. Despite the low oil price, oil & gas pipeline investments in the US look set to rise
in 2009. Consultancy Simdex estimates 326,000km of pipelines will be built in the next five years, which we estimate would require US$78bn worth of pipes.

On the other hand, seamless pipe demand is highly correlated to exploratory activities, which depends on crude oil prices. We do not expect meaningful E&P activity improvements until the second half of 2010.

High visibility in the uncertain environment
The Indian pipe producers offer strong revenues and earnings visibility despite uncertainty in commodity prices. The strong order book positions of the welded pipe producers can provide comfort at the top line. Large planned capacity additions, coupled with strong global demand, may drive top-line growth. Raw materials (plates/coils) comprise 70–75% of the total cost structure. Pipe producers tie up raw-material and book freight rates as soon as they get a new
order, making the steel cost a pass-through. This has enabled companies to maintain their margins despite the steel price volatility.

Key risks – oil prices and Chinese competition
Any signiciant fall in crude prices may cause oil majors to delay their capex plans, which could hurt demand. However, Macquarie Oil economist Jan Stuart expects prices will rise above US$70/bbl in 2010. Competition from China, especially in seamless pipes, is a risk; however this is mitigated by the US and EU imposing anti-dumping duties on imports of Chinese steel pipes.

Welspun top pick amongst pipe producers
Our target prices of Rs375 for WGS and Rs890 for JSAW imply a 14x FY11/2010E PER, at a 20% discount to the global peer average despite their stronger earnings growth over FY10–12E. Our earnings forecasts for WGS and JSAW are 15% and 7% higher than the Street’s as we believe the market may not be fully factoring in earnings from future orders. We prefer WGS for its stronger order book, large capacity additions and margin gains from backward integration.

To see full report: PIPES SECTOR