Given the stiff valuations, a lacklustre performance, tightening pricing environment in the steel sector and a high level of gearing, VMP may not provide an attractive entry point through this IPO.
At an offer price of Rs 20, the VMP stock is priced at about eight times its per share earnings for 2004-05. This appears stiff compared with companies such as Tata Sponge Iron, Monnet Ispat and Jindal Steel and Power, which are trading at about six-seven times their trailing earnings.
The earnings growth may not be adequate to support the expansion in equity base, given the risks and the uncertainties associated with the expansion projects.
The company manufactures and trades sponge iron and ferro alloys. Over the past few years, VMP's performance has remained subdued. Low capacity utilisation and thin margins appear to have affected the business.
A number of other companies in the Impex group (run by the promoters), mainly into trading ferro alloys, have also shut operations after running up losses for several years.
VMP now proposes to set up a mini-integrated steel plant, which includes doubling its existing sponge iron capacity of 65,000 tonnes per annum and setting up a steel billet facility, a ferro alloy unit and a power plant.
A sizeable proportion of the project cost (over 55 per cent) is to be funded through debt. Although the project qualifies for various subsidies and assistance, we believe the higher depreciation and interest outgo will strain earnings in the medium term.
The pricing environment does not offer a great degree of comfort. Sponge iron prices, after shooting though the roof last year, have cooled off by 20-25 per cent. They are likely to sustain at current levels of about Rs 13,000 a tonne.
Shortage of coal and iron ore (the principal raw materials for producing sponge iron) in the medium term is likely to provide a stable outlook for sponge iron prices.
The greater risk is the likely downward pressure on steel prices in the near term on the back of slack demand and inventory build up.
The pricing effect is likely to be more pronounced in the stainless steel market where the demand has been sluggish in the last few months and may take a while before it picks up. Considering this, the company's ferro alloy plant, which is likely to be commissioned next year, is expected to contribute to volume growth from FY-07. Growth in terms of value, is however, likely to be flat because of lower realisations.
Owing to its small size and scale of operations, limited geographical presence and absence in downstream operations, VMP may find it difficult to withstand any cyclical downturn.
Consolidation in the domestic steel sector, which is likely to change the industry dynamics in the long term, also remains a threat.
Offer details: On offer are 125 lakh shares at a price of Rs 20 each. Post-offer, the promoters' shareholding will be 64.4 per cent. Microsec India is the lead manager. The issue opens on October 24 and closes on October 28.