Godawari Power & Ispat: Buy

The shares of iron ore pellet and sponge iron producer, Godawari Power and Ispat, appear an attractive buy at current prices. The company's growth potential seems strong, thanks to its increased output from iron ore mines and improving utilisation rates at its pellet plants. The share trades at Rs 147, which is around 5.2 times the FY-11 earnings, a discount to larger peers in the steel industry, which trade at around 7-12 times earnings.

Rising Capacity Utilisation

Godawari Power and Ispat broadly operates in two segments — steel and power. Steel accounted for over 90 per cent of revenues in FY 2010-11 and two-thirds of operating profits. Growing sales in the segment, which produces iron ore pellets, sponge iron and steel wire rods have driven consolidated sales and profits over the last fiscal.

Sales in 2010-11 grew by 36 per cent year-on-year to Rs 1,100 crore, while profits grew by 50 per cent to around Rs 86 crore. This was a result of higher capacity utilisation and realisations across its product mix. Also chipping in were two bought-out entities which comprised of a ferro-alloy production unit, 20 MW of power and an iron ore crushing facility.

The company operates one iron ore mine in Chhattisgarh and is in the process of commissioning another by the end of the current fiscal. Its standalone pellet plant, which commenced operations in early 2010, has production capacity of 600,000 tonnes per annum.

Though it operated at just over 50 per cent utilisation levels in FY-11 due to stabilisation processes, the plant has been operating at near-full capacity in recent times. The company has 75 per cent stake in another pellet plant with identical capacity. This plant has been slow to take off, but is expected to attain 70-80 per cent utilisation rates over the next two fiscals.

With a consolidated capacity to produce 1.2 million tonnes of pellets and close proximity to iron ore rich belt in Chhattisgarh, Godawari Power and Ispat is well poised to emerge as a low cost producer of iron ore pellets.

GROWTH DRIVERS

The ramped up pellet output is expected to be the key driver of sales and profits over the next two fiscals. The company's pellet production stood at around 350,000 tonnes per annum in 2010-11. With 850,000 tonnes of slack capacity, the company is in a good position to cater to the growing steel market. The first five months of the year saw steel production rise by 4 per cent.

With Tata Steel, Essar Steel, JSW Steel, and SAIL, among others, set to commission substantial capacity over the next two years, demand for iron ore is set to grow in double-digits. The quarter ended March 2011 saw the company's sales and net profits grow by 40 per cent each over the previous year as a result of increased mine and pellet output.

A major competitive advantage for the company is its partly integrated structure. Saving on purchase of iron ore and generating power using captive plants is cost advantageous to the company. Its captive power capacity (around 73 MW) accounted for around 10 per cent of sales in 2010-11 and roughly a third of operating profits. However, with softening merchant power tariffs, it is currently being used mostly for internal purposes.

The company EBIDTA margins have hovered around 12-21 per cent over the last three fiscals, with FY-11 registering margins of 21 per cent. The company's debt equity at the end of FY11 stood at a reasonable 1.2 times while its interest cost was covered by EBIT 2.5 times over.

Quality iron ore remains in short supply in domestic markets and mine additions have been few in recent years. Godawari Power and Ispat, with scope to ramp up utilisation at its pellet production capacity and low raw material procurement cost due to vicinity to the iron ore belt could translate into a winner for investors.

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