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Friday, June 04, 2010

KR Choksey Calls A Buy On SRF
CMP: Rs 221  Target Rs 304

SRF established in 1973 and today has operations in 04 countries. The company has three major business segments - 1) Technical textile business (TTB) to manufacture Nylon Tyre Cord Fabric (NTCF), 2) Chemical and polymer business (CPB) to manufacturer refrigerants and specialty flurochemicals and 3) Packaging film business (PFB) to manufacturer Biaxially Oriented Poly Ethylene Teraphthalate (BOPET) and Polyester (PET) films.

Key Investment Rational: Stable revenue growth in NTCF business: The company is the market leader in NTCF segment and its inorganic expansion activities is likely to contribute in top line growth. Segment is expected to register a long term stable performance on the back of consistent demand from radical and non-radical tyres used in commercial and passenger vehicles respectively. Its recent initiative to manufacture Polyester Industrial Yarn (PIY) used in passenger vehicle tyres is providing a further boost to revenues as well as margin performance.

Unlocking growth potential in Chemical business: Chemical business is exponentially growing on the back of significant demand from SRF’s core and pure chemicals. The company is also planning to invest heavily to manufacture fluorine based specialty chemicals for its international clients. Moreover being a sole integrated manufacturer of refrigerant gases in India, SRF’s revenues are expected to grow exponentially by catering increasing demand from domestic markets. The company is also manufacturing high margin customized flourochemicals for pharmaceuticals and latter’s expected growth in demand is likely to reflect in overall profitability. Furthermore trading in carbon credit is providing a further upside to the valuation.

Recent capacity addition to drive growth: Packaging business to provide long term upside potential with changing industry demand dynamics for consumption of processed food in India. The company has doubled its PET capacity recently in March 2010 which is expected to reflect in higher revenue performance, going forward in FY11.

Attractive valuation: Based on current P/E of 4.1x, when we assign a forward P/E of 5x based on FY11 EPS of Rs 60.9, we arrive at a 12 month target price of 304, with a potential upside of 39%.

Key risks: 1) CER pricing is subject to change in the Kyoto Protocol. Lower than expected CER prices and depreciating Euro may be a concern.
2) Lower than expected demand for SRF’s products may hamper business growth.

Our view: Revenue in FY11 is expected to grow 15% on the back of acquisitions in FY09 and capacity additions taken place in March 2010. Backward integration to yarn fabrics for radical tyres and increasing revenue contribution of high margin chemical business is expected to boost profitability going forward. Furthermore, expected growth in carbon credit to provide upside potential in the stock.


Batlivala & Karani Calls A Buy On Electrosteel Castings

CMP: Rs 46   Target Rs 86

Electrosteel Castings Ltd. (ESCL) manufactures and sells DI pipes and fittings and CI pipes in the domestic and overseas markets and has a significant 60% domestic market share. It derives 82% revenue domestically and 12% from exports. ESCL is strategically backward integrated into coking coal and iron ore mining to secure supply of key raw material and achieve significant cost savings.

An IPO for EIL, its subsidiary through which it is setting up a 2.2 mn tonnes steel plant by FY12, would unlock value/ Backward integration into key raw material, iron ore and coking coal would ensure sustained supplies of these materials at competitive prices and would improve EBITDA margin significantly by 840 bps over FY10-12

Listing of Electrosteel Integrated Ltd. (EIL), ESCL’s subsidiary, would unlock value for shareholders of ESCL. We expect ESCL’s core business to record 29.5% earnings CAGR over FY10- 12 supported by the Government of India’s (GoI’s) significant investment plans in the water supply and sanitation infrastructure

We value ESCL using the SOTP method. We value ESCL’s core business at 7x FY12E earnings, its investment in Lanco Industries Ltd. (LIL) based on holding company discount of 50% to current market capitalisation, and its investment in EIL on book value. Our SOTP valuation gives us a target price of Rs 86 (88.4% upside). We initiate coverage with Buy rating.


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