i Develop Stocks Advisory

Adhunik Metaliks good investment stock

Beta: 0.75 Institutional Holding: 20.9% Dividend Yield: 0.9% P/E: 11.5 M-Cap: Rs 1,000 cr CMP: Rs 109.5 The global bull run in commodities has pushed up the prices of metals, especially steel, to historic highs. Mining and metal companies across the globe have raised their capacities to benefit from this boom cycle. This has put the smaller players with a diversified in a sweet spot. This is because during a bull run, they reap the benefits of faster demand growth, while in a downturn, they are better protected. Adhunik Metaliks (AML) is one such company with products ranging from sponge iron, steel billets and ferro-alloy, to mining materials like iron and manganese ore. It has embarked upon organic as well as inorganic growth paths to expand its product portfolio. The company provides a good investment opportunity for medium-term investors with a horizon of 3-4 years. BUSINESS: AML has a steel billet making capacity around 0.4 million tonnes (mt). Rising iron ore prices have increased the company’s input costs; in order to be self-sufficient, AML is set to begin commercial production at its iron ore mine in Orissa. The mine has total recoverable reserves of around 25 mt, which are sufficient to meet its requirements for the next 25 years. The scheduled initial annual production of 4 lakh tonnes of iron ore will start by the end of the current financial year. This will be further increased to 7 lakh tonnes by FY11. AML’s current ferro-alloy capacity is 16,000 tonnes. The company requires power to produce ferro-alloy and steel via the electric arc furnace route. Here too, it has a captive power plant with capacity of 17 mw and another 17-mw (through waste heat recovery method) plant is likely to be commissioned by this year-end. The company also has 24,000 tonnes of capacity to make forging components for the auto and railway sectors. GROWTH DRIVERS: The company’s main growth will come from four sources, improvement in operating margins due to backward integration, starting of its mining operations, conversion of iron ore fines (a mining waste) into pellets and finally, from its newly set up power business. Once AML starts getting its iron ore from captive sources, its operating margin is expected to expand by around 1,000 basis points, making it more profitable. Last year, the company acquired Orissa Manganese and Minerals (OMML) having iron ore and manganese ore (both are of high grade quality) reserves of 90 mt and 50 mt, respectively. AML plans to set up beneficiation and pallet plants of 1.2 mt capacity each to utilise the iron ore fines generated during mining operations. It is also setting up a power plant with 270 mw capacity through its subsidiary, Adhunik Power and Natural Resources (APNRL). The power generated from this plant will be available for commercial sale. All these expansion plans, except the 270-mw power plant, require an investment of Rs 1,100 crore to be funded through a debt-equity ratio (DER) of 2:1. The cost of the 270-mw power plant project, estimated at Rs 1,263 crore, will be financed through a DER of 3:1. FINANCIALS: The company has grown by leaps and bounds in the past few years. Its net sales have jumped by around eight times in the past three years, while its net profit has grown by 11 times during this period. AML has an average return on capital of 18%, slightly better than that of its peers like Mukand and Usha Martin. Its DER stands at 2.87 and the interest-coverage ratio is around 3. This means the company’s financial leverage is on the higher side and it needs to generate higher profits in future from its past capital expenditure (capex) to improve its interest-coverage ratio. AML has an operating margin of 16%, which is expected to improve to 25-30%, post-backward integration. The company’s net profit margin for trailing 12 months (TTM) declined by 259 basis points, mainly due to the incremental raised by AML to finance its capex. VALUATIONS: AML’s increased capacity (steel and ferro-alloy) will be fully reflected from FY09 onwards. OMML has also started mining from the first quarter of the current financial year. So, there will be a significant contribution (due to high margins) by OMML towards the consolidated net profit of AML. The company’s consolidated earnings per share (EPS) for FY09 and FY10 is estimated at Rs 28 and Rs 35, respectively. At the current price of Rs 108, the price-earnings (P/E) multiple works out to 3.9 and 3.1, respectively. This provides huge upside potential considering its two-year (AML was listed around two years ago) average P/E of 11.5. Further, once its power and pallet plants become operational from FY11-12 onwards, the company’s growth will get a boost. Hence, investors with a horizon of 3-4 years can accumulate this stock.