The Hindu Business Line : Gujarat NRE Coke: Buy

Encouraging outlook for coke, gains from ongoing expansions and backward integration, improving revenue mix and attractive valuations add fire to the Gujarat NRE Coke stock.

Investors can consider exposure at the current price of Rs 68 with a one/two-year perspective. The stock trades at a multiple of seven times its likely FY-07 per share earnings on an expanded equity base.

Improved market outlook

The market for metallurgical coke, after going through a weak phase last year, is now beginning to look up. International coke prices, after touching the historic high of about $420 a tonne in 2004, have corrected considerably since.

At about $180 a tonne now, the prices appear to have bottomed out. However, prices have gained by $20-30 per tonne over the last month and are likely to stabilise at these levels.

On the other hand, the prices of coking coal (primary raw material for making coke) are showing signs of softening after remaining firm over the last one year. This is indicated from the recent negotiations between Nippon Steel of Japan and BHP Billiton; long-term prices were contracted 8 per cent lower than the FY-06 level.

The demand for coke is likely to remain upbeat on the back of increasing requirements from user segments, especially the steel sector. India has largely been a buyer of coke, with more than 85 per cent of the imports coming from China. China's growing appetite for resources has resulted in domestic demand for commodities soaring to unacceptable levels.

Consequently, the Chinese government has adopted restrictive measures, including curbing coke exports, thus creating an imbalance in the global market. The growing need to feed China's expanding steel industry, along with the buoyancy in the Asian markets, is likely to augur well for the coke market over the medium term. Back home, the deficit in the coke market at about four million tonnes per annum now is expected to increase seven-fold over the next five years.

Growth Initiatives

Gujarat NRE Coke is the largest non-captive manufacturer of met coke with an annual capacity of one million tonne. It has two plants and is in the process of adding a third in Dharwad, Karnataka. The last is expected to begin production by July 2007, taking the company's total capacity to 1.4 MTPA. It recently commissioned a steel plant (steel bars) and co-generation power plant in Kutch. This is likely to diversify its revenue base and de-risk its earnings in the long term. The total planned capital expenditure is Rs 410 crore and the company has tied up 50 per cent of this. It proposes to raise the balance through debt and equity over the next couple of years.

Exports picking up

Gujarat NRE's revenue from the export of met coke has been growing rapidly, albeit on a smaller base. Volumes have risen five-fold in FY-06, while revenues have more than doubled. Over the next year or so, Gujarat NRE expects to increase the share of its exports to 25 per cent of its production from 20 per cent now.

The company's clientele — including Hindustan Zinc, Nirma, Gujarat Heavy Chemicals, Kalyani Steels and Birla Copper — in the domestic market lends credibility to its growth expectations.

Backward integration

Gujarat NRE Coke's recent overseas acquisitions of coking coal mines are likely to assure long-term supply of input. It has acquired two mines in Australia, which together have reserves of about 375 million tonnes. Gujarat NRE has received two shipments of about one lakh tonnes from NRE No.1 colliery that it acquired last year. We view this as a strong positive, as it would help the company reduce input costs.

Gujarat NRE recently picked up a stake in Pike River Coal Company (a subsidiary of New Zealand Oil and Gas) along with a contract to take four lakh tonnes per annum of its hard coking coal over the life of the mine.

The company has also acquired a stake in Australian exploration companies, Rey Resources and Zelos Resources, which are mining and mineral prospecting entities. The move would provide Gujarat NRE access to thermal, coking coal and uranium in Australia, and gold and copper in South America where the two companies are now prospecting.

We have, however, not factored in the impact of this development into our valuations, owing to the uncertainty about the commercial operations of the acquired entities.

Key concerns

The rising level of debt is likely to result in a higher interest outgo over the next couple of years. Higher depreciation charges may also impact its profits. However, the expected cost savings from backward integration offer protection on the downside. An appreciating rupee also remains a risk.

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