Stock Call. Why National Infrastructure Pipeline will be good for Tata Metaliks stock

Tata Metaliks, a supplier of pig iron (PI) and ductile iron pipes (DIP) and a subsidiary of Tata Steel, appears well-placed to benefit from the Centre’s focus on water and sanitation infrastructure as a part of the National Infrastructure Pipeline (NIP) in the long run.

The company’s operating performance has been improving steadily over the past few years (except in FY20, largely due to the impact of Covid-19 in the fourth quarter).

The company has been on the path to de-commoditise the business — to insulate from the volatility in commodity prices — through increased focus on expanding capacity of high-margin DIP production.

At ₹514, the stock is valued at about 10 times the trailing 12-month earnings. This is close to its three-year historical average PE of10.5 times.

The company’s peer in the DIP business, Srikalahasthi Pipes, a small-cap company, however, trades at a lower valuation of 3.9 times. The higher valuation of Tata Metaliks could be on account of the premium attached to the brand and its promoters.

Having said that, the stock is currently at a 20 per cent discount to the price levels witnessed just before the correction began in February 2020. This presents investors with a good opportunity to accumulate the stock gradually.

Demand visibility

Tata Metalik’s manufacturing plant near Kharagpur, West Bengal, has a production capacity of 5.50 lakh tonnes per annum (ltpa) for hot metal (from which pig iron is produced) and 2 ltpa for DIPs.

The company’s PI is used as a raw material for different types of casting applications in industries such as auto, agri, power, railways and sanitary castings. On the other hand, DIP is used in the water industry for transmission and distribution of potable water, transportation of sewage and waste water, irrigation and industrial usage in power plants, etc.

Pig iron and ductile iron pipes contributed about 48 per cent and 52 per cent, respectively, to the company’s revenues in FY20.

The average blended operating profit margin of the company has been steady at 15-16 per cent, with PI margins on the lower side and DIP on the higher.

Going ahead, the company wants to focus on the downstream business and increase the share of revenue from the high-margin DIP to 70-75 per cent and to insulate itself from the volatility in commodity prices.

Tata Metaliks, as per reports, has about 12 per cent market share in the DIP market in India. There are 7-8 other players in the industry.

The demand for DIP is driven by investments in water, sanitation and irrigation infrastructure projects of the government. The medium- to long-term outlook in the DIP business seems healthy with 10 per cent of the government’s capital expenditure budget of ₹111-lakh crore during FY20 to FY25 allocated towards irrigation and agriculture and food processing infrastructure, as per NIP.

Focus on projects such as ‘AMRUT’ (Atal Mission for Rejuvenation and Urban Transformation), ‘Har Ghar Jal’ (to provide piped drinking water to all rural homes by 2024), and lift irrigation is also a positive.

As per the company management, currently, tenders for DIPs are in the pipeline from Andhra Pradesh and Uttar Pradesh to an extent of 1-1.2 million tonnes. However, caution was expressed on near-term execution of orders due to the financial stress on the State governments.

The direct business from the government is only to an extent of 10-15 per cent of the DIP business; the rest is through the EPC (engineering, procurement and construction) contracts from companies such as L&T and Voltas.

To meet the higher demand, Tata Metaliks is currently doubling the capacity of DIP to 4 ltpa, which is expected to be completed within the next 2-3 years.

Financials

The operational performance of the company, especially the pig iron segment, depends on the prices of the raw materials — coke and coal — as well as pig iron itself. Since the output prices are also commodity market-linked, any hike in input cost is not easily transferable to the customers.

In FY20, the revenue and net profit of the company fell by 5 per cent and 9 per cent year-on-year to ₹2,051 crore and ₹166 crore, respectively.

The decline in revenue and profit was primarily due to suspension of manufacturing operations and sales during the latter part of March 2020 to combat the Covid-19 pandemic and also the impact of depressed demand from the user industries of pig iron.

In the current fiscal, though the first quarter’s operating performance has been weak, the turnaround in the second quarter has grabbed attention. In the first six-month period, despite a 28 per cent (y-o-y) fall in revenue to about ₹730 crore, the net profit went up by a whopping 62 per cent to about ₹70 crore.

This was on account of lower raw material costs, reduction in cost of production due to a new cost-efficiency project (that saves raw material cost to an extent of ₹10,000 for per tonne of coal used by the company) and better realisations for pig iron in the second quarter.

This was all reflected in the blended operating profit margin of 21 per cent in the quarter ended September 2020 as against the general 15 per cent levels.

Going ahead, the profitability could be under stress in the near term, as prices of iron ore and coking coal have moved up recently and realisations may not increase sharply amidst the lull in demand. But long-term prospects seem sanguine.

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