Venus Pipes & Tubes (Venus) is a Gujarat-based company manufacturing stainless steel pipes. The company is raising ₹165 crore through an IPO as a fresh issue (no offer-for-sale) valuing the company at ₹662 crore. The issue has been subscribed 4.4 times (overall) on end of Day-2 itself, with retail subscription at 7.5 times. In spite of the oversubscription, investors on fence about the issue may want to look before they leap. The company will trade at 21 times 9MFY22 earnings (annualised) based on the post-issue shareholding. But this seems to be on the higher side compared with most peers, though it is lower than Ratnamani Metals which is trading at 37 times the earnings for the same period. However, the peers are of larger scale, which tips economies of scale in their favour in a commoditised industry.
Also, the company has a short operational history. We recommend investors avoid the issue, which is coming at the peak of steel price cycle.
Lack of long track record
The company was incorporated in 2015 and can present only 7 years of operational history before approaching the IPO market. However, to its credit, the company has added 55 per cent to the installed capacity since 2019. The company has an installed capacity of 10,800 MTPA and operates from a location in Kutch, Gujarat. But the scale of operations is significantly lower than that of listed peers like Ratnamani, Man Industries and Welspun Corp, whose sales are 6-14 times more. The lack of scale will deter reliable B2B sales which derives close to half of the sales from stockists and traders. The larger institutional orders, on the other hand, will want a strong track record, which has to be built. The credit history of the company is also shaky with discontinuation of credit rating on account of the company’s non-cooperation for the rating issued by CARE Ratings in December, 2020 and from Brickwork Ratings in April, 2022.
Valuation at peak steel prices
Steel prices have rallied since Covid to record highs both domestically and internationally, on account of steel shortages from China and the US and higher demand from construction and automobiles. Venus’ IPO valuation at 21 times earnings is based on these higher steel prices and higher margins as a result, apart from capacity expansion. While steel prices witnessed marginal correction from peaks in January-February 2022, the Russia-Ukraine conflict pushed prices higher again (still lower than earlier peaks). On the other hand, the interest rate hike cycle, which has started across economies, is expected to impact construction and automobile demand, leading to a weaker view on demand. A high valuation multiple at a time of peak earnings may lead to flat returns from related stock prices at best. In a best case scenario, as steel prices may regain high peaks, valuations which have factored in higher prices, may not expand further.
Venus manufactures two types of stainless-steel pipes - seamless steel pipes for higher pressure applications and welded pipes for petro-chemical applications. The fresh issue proceeds will be utilised for capital expansion of the seamless segment from 3,600 MTPA in 2021 to 9,600 MTPA and welded segment from 7,200 MTPA currently to 14,400 MTPA in the next two-three years. Also Venus will be investing in a piercing line for manufacturing hollow pipes for backward integration. While the proposed plan for capacity building looks to more than double the installed capacity, the extent of realisation on successful completion in two-three years will be dependent on steel prices prevalent then, which are already correcting from the peak. In case of declining steel prices, operating leverage which helped Venus increase its EBITDA margins from 7 per cent in FY20 to 12.8 per cent in 9MFY22 will reverse to an extent and on a higher fixed cost base of the added plants.
Financials and Valuation
Venus’ capital expansion and higher realisations aided a revenue growth of 74 per cent in FY21, of which 35 per cent was from capacity expansion. Annualised, 9MFY22 would indicate a 20 per cent YoY growth without significant volume growth contribution. Similarly, the margins also gained as gross and EBITDA margins improved from 14.4 and 7 per cent in FY19 to 18 and 12.8 per cent in 9MFY22. But in the period, Venus’ working capital cycle moved up from 88 days in March, 2019 to 108 days in December, 2021, as receivables and inventory holding period increased. Venus’ interest coverage ratio at 8 times for its ₹50 crore debt (Dec-2021) indicates a manageable level of debt, but a sharp correction in margins in the period of increasing interest rates would be a key monitorable.