godawari power & ispat ltd - initiating coverage

EmkayResearch

Godawari Power & Ispat Ltd.Linking it right

3rd June, 2008

C-6, Ground Floor, Paragon Center Pandurang Budhkar Marg, Worli, Mumbai – 400 013. India

Init

iati

ng

Vishal Chandak

[email protected]

+91 22 6612 1251

Chirag Khasgiwala

[email protected]

+91 22 6612 1254

We initiate coverage on Godawari Power and Ispat Ltd. (GPIL) with a BUY and a PriceTarget of Rs418, based on 6x FY10E FDEPS of Rs69.6. GPIL is on a strong growthtrajectory with an expected earning CAGR of 41% over FY08-10E, led by capacityexpansion and backward integration. GPIL is a manufacturer of sponge iron (capacity- 0.495 mtpa) and steel billets (capacity - 0.4 mtpa). GPIL also manufactures HB wires(capacity of 1.2 mtpa), which is a value added product in its portfolio. It has 53MW ofcaptive power plant (CPP) (out of which 42MW is waste heat recovery based and11MW is coal fired), meeting 100% of its power requirement. To further accelerate itsgrowth momentum, GPIL is setting up a 0.6mtpa pelletization plant, which is expectedto generate contribution of Rs150mn in FY10E. As a part of its backward integrationprocess, GPIL has secured coal linkage for 80% of its expanded capacities, which isexpected to generate savings of Rs726mn in FY09 and Rs778mn in FY10. GPIL hasbeen allocated 2 iron ore mines, which are expected to generate savings of Rs364mnin FY10. Overall, we like GPIL's strategy of capacity expansion and backward integration,which would lead to accelerated growth momentum. Moreover, at CMP of Rs194, thevaluation at 2.8x FY10E FDEPS and at 2.4x FY10E EV/EBITDA, is undemanding.

Construction and infrastructure boom to fuel demand for long products

The demand for long products has been on an uptrend over the past few years, thanks tothe booming construction and infrastructure sector. According to CRISIL Research, growingIndia's population, rising income levels and urbanization may translate into a demand for23.4mn units of housing stock during 2007-11. The government's infrastructure spend inthe 12th Five-year plan is expected to be around Rs28,000bn (Rs14,717bn in 11th Five-Year plan).

Increased capacity utilization and higher prices to drive topline and margins

GPIL increased capacities across all the product categories. With the ramping up ofenhanced capacity, capacity utilization across the board is expected to move up, leadingto volume growth. Higher prices will ensure better margins. GPIL's topline is expected togrow at a CAGR of 24% from FY08E to FY10E, while core EBITDA margin is expected toincrease from 19.4% in FY08 to around 22.2% in FY10E.

Raw material linkage and captive mines to expand margins

GPIL has secured linkage for 80% of its coal requirement (from Coal India Ltd) and for50% of its iron ore requirements (from NMDC) on expanded capacities. We expect thecoal linkage to generate savings of Rs726mn in FY09 and Rs778mn in FY10. The blendedcost of iron for GPIL is around Rs4,525/t as against spot market rate of Rs5,250/t. This isexpected to generate savings of Rs373mn in FY09 and Rs400mn in FY10. GPIL has beenallocated 2 iron ore mines. We expect the mine to be operational by FY10 and generatesavings of Rs364mn in FY10.

Valuations

At the CMP of Rs194, the stock is trading at 2.8x FY10E FDEPS of Rs69.6. We value GPILat Rs418, which is 6x FY10E FDEPS of Rs69.6. With large steel players currently tradingin the range of 9-14x 1 yr forward PE, we believe GPIL offers deep value with low risk.

YE Net EBITDA PAT EPS EPS RoCE P/E EV/ P/BMar Sales growth EBITDA

Rs mn Rs mn (%) Rs mn Rs (%) (%) (x) (x) (x)FY07 4,722 867 18.4 542 23.3 49.0 16.9 8.4 8.4 2.2FY08E 7,998 1,633 20.4 967 35.2 50.9 21.3 5.5 4.4 1.2FY09E 11,121 2,313 20.8 1,511 55.0 56.3 23.4 3.5 3.2 0.9FY10E 12,276 2,873 23.4 1,914 69.6 26.7 23.7 2.8 2.4 0.7

Key financials

BUY

Price TargetRs194 Rs418

Sensex - 16,063

Price Performance

(%) 1M 3M 6M 12M

Absolute (8) (20) (34) 33

Rel. to Sensex 1 (12) (20) 21

Source: Bloomberg

Stock Details

Sector Metals & Mining

Reuters GDPI.BO

Bloomberg GODPI@IN

Equity Capital (Rs mn) 281

Face Value (Rs) 10

No of shares o/s (mn) 28.1

52 Week H/L (Rs) 376/132

Market Cap (Rs bn/USD mn) 5/128

Daily Avg Vol (No of shares) 110854

Daily Avg Turnover (US$ mn) 0.5

Shareholding Pattern (%)

Mar ’08 Dec ’07 Sep ’07

Promoters 56.2 63.4 63.4

FII/NRI 12.4 8.1 5.1

Institutions 12.1 13.7 11.1

Private Corp 5.0 3.8 6.1

Public 14.3 11.0 14.3

Source:Capitaline

3 June, 2008 2Emkay Research

Godawari Power & Ispat Ltd. Initiating

Company profile

Company backgroundGodawari Power and Ispat Ltd (GPIL), incorporated in 1999, is engaged in themanufacturing of billets, wires and ferro alloys. It is a part of the Raipur based Hira groupof industries. It was listed in Apr '06. GPIL raised Rs700mn through its IPO, the issue priceof which was Rs81/share. The company has plants located at Siltara industrial estate,near Raipur, Chhattisgarh. It has a 100% subsidiary, R.R.Ispat, which is engaged inmanufacturing wire rods and wires. R.R.Ispat sources billets from GPIL and in turn sellswire rods to GPIL for converting into wires.

Business modelGPIL is engaged in the manufacturing of sponge iron, billets, wire rods, wires and ferroalloys. The company sources iron ore and coal from the market and converts them intosponge iron. GPIL manufactures sponge iron through coal based rotary kilns (one 350tpdrotary kiln and three 430tpd rotary kilns). The sponge is converted into billets throughinduction furnace, ladle refining furnace and continuous casting machine. These billetsare then supplied to R.R.Ispat for converting into wire rods. R.R.Ispat consumes 30% ofwire rods produced, for manufacturing HB wires and supplies balance 70% to GPIL formanufacturing of HB wires. GPIL is also manufacturing ferro manganese/silicomanganese. The company has a 9MVA Electric Arc Furnace to produce ferro alloys.

GPIL has 53MW power generation capacity, out of which 42MW is a waste heat recoverybased power plant (WHRP) and the balance 11MW is coal fired. WHRP works on the fluegases from sponge iron kilns.

Company profile

Existing Capacities

Product Unit Capacities

Sponge Iron tpa 495,000

Billets tpa 400,000

HB Wires tpa 120,000

Ferro Alloys tpa 16,500

Power MW 53

Additional facilities under 100% subsidiary R.R.Ispat

Wire rods tpa 100,000

HB Wires tpa 30,000

Source: Company



Business model

Iron Ore (50%-NMDC & 50%-spot market)

Coal (80%-Coal India &

20%-spot market)

Sponge Iron (4 coal based

kilns)

Captive consumption

(70% for billets)

Wire rods (R.R.Ispat)

15-20% external sales

Manganese ore & coke

(spot market)

Ferro alloys

80-85% sales to GPIL for

Wires

External sales (30%)

Billets

External sales (70%)

30% sales to R.R.Ispat

(100% Sub) for w ire rods

Wires External sales

Company profile



Total sales Rs5,456mn

Ferro alloys5% Billets

37%

Wires35%

Others14%

Sponge iron9%

Total sales Rs13,793mn

Ferro alloys5%

Billets41%

Wires35%

Others8%

Sponge iron11%

Product profile

GPIL began its operations as a sponge iron producer in Raipur, Chhattisgarh. Gradually,

it moved up the value chain and made significant changes to its product mix to introduce

billets, wire rods, wires and ferro alloys. Going forward, GPIL plans to maximize thecaptive consumption of billets. GPIL has a 53MW captive power plant. It consumes 90%

of the power captively and sells balance 10%. In FY07, wires contributed 35% to the total

revenue and billets contributed 37%. We expect billets' share to increase to 41% inFY10E.

Sales mix FY10E

Source: Company, Emkay Research estimates

Sales mix FY07

Company profile



Investment Rationale

Construction boom and infrastructure spending to fuel demand forlong products

The demand for long products (like TMT bars, wire rods, angles, channels, wires etc) hasbeen on an uptrend over the past few years, thanks to the booming construction sector.

The demand for these products has been continuously increasing with rising demand for

households and other structures. According to CRISIL Research, India's population isexpected to grow by 63.6mn during 2007-11. This, along with other factors like rising

income levels and urbanization, may translate into a demand for 23.4mn units of housing

stock during the period at an average annual rate of 4.7mn units. With this, the total stockof housing units is expected to go up to 152.7mn units by 2011 from 129.4mn units in

2006. As per Planning Commission estimates, the total number of urban dwelling units

are expected to increase from 58.8mn units in FY07 to 66.1mn units by FY12. This impliesan average annual increase of 1.45mn units over the 11th Five Year Plan. India is in the

developing stage with its thrust on infrastructure development continuously increasing.

The government's infrastructure spend in the 12th Five-year plan is expected to be aroundRs28,000bn. Infrastructure spend in 11th Five-Year plan is Rs14,717bn. The increasing

infrastructure spend will entail more and more construction of power plants and other

industrial structures, which will drive up the demand for long products. We believe that theongoing construction activity and infrastructure builds are likely to ensure strong demand

for long products in the coming years. GPIL is a direct beneficiary of the construction and

infrastructure boom.

Enhanced capacities to ensure higher volume growth

GPIL increased capacities across categories in 2HFY08. With the enhanced capacity

being available at an opportune time, we expect GPIL to reap the benefits of highervolumes from FY09 onwards. GPIL is currently operating at an average capacity utilization

of 58%, which is expected to increase to 70% in FY09 and 75% in FY10. We expect the

billets and wires sales volume to grow at a CAGR of 14% over the FY08-10E period . Withthe current buoyancy in the long products market, we believe that GPIL's expansion

program has come on-stream at the right time.


Expect increased capacity utilizationto boost topline

Capacities and Capacity utilization

FY07 FY08 FY09E FY10E

Sponge iron capacity (t) 495,000 495,000 495,000 495,000

Capacity utilization 34% 58% 70% 75%

Billets capacity (t) 250,000 400,000 400,000 400,000


Wire rods capacity (t) 70,000 100,000 100,000 100,000


Wires capacity (t) 92,500 150,000 150,000 150,000


Ferro Alloys capacity (t) 16,500 16,500 16,500 16,500


Source: Company, Emkay Research



0

50,000

100,000

150,000

200,000

FY04 FY05 FY06 FY07 FY08 FY09E FY10E

tonn

es

Sponge Iron Billets Wires

0

100,000

200,000

300,000

400,000

FY04 FY05 FY06 FY07 FY08 FY09E FY10E

tonn

es

Sponge Iron Billets Wires

Higher volumes of wires to lead to value addition

Billets form 37% share of total revenue, while wires contribute 30%. Going forward, we

expect the share of billets to increase to 41% of total sales in FY10. However, value

addition will chip in from increased sales of the high value wires. GPIL has increasedwires capacity by 66% to 150,000tpa. At 75% capacity utilization, the increased capacity of

wires may increase sales volume by 52% from FY07 to FY10E. We expect average (gross)

realization of wires to increase from Rs25,715/t in FY07 to around Rs42,500/t in FY09E.The higher sale of wires is expected to increase EBITDA by Rs183mn in FY09E and by

Rs236mn in FY10E.

GPIL to benefit from strong pricing environment

GPIL is expected to reap the benefits of the strong pricing environment in sponge iron andbillets market. Increased capacity utilization in a rising price scenario is likely to enable

the company to expand margins. GPIL captively consumes 75-80% of the sponge iron

produced, for manufacturing billets and sells the balance 20-25% in the market. Coalbased sponge iron prices have increased by 35% in the past one year. Billets form 37%

share of the total revenue, the prices of which have increased by 30% in the past one year.

GPIL consumes 30% of the billets produced captively for converting into wires and sellsbalance 70% in the market. The share of billets is expected to increase to 41% of the total

sales in FY10. Going forward, we expect the prices to remain firm. We expect average

(gross) sponge iron prices to increase from Rs12,904/t in FY07 to around Rs20,000/t inFY09E, while billets prices are expected to increase from Rs24,372/t to Rs30,000/t over

the same period. Increased capacity utilization combined with higher prices is expected

to result in a 24% CAGR in revenues over the FY08-10E period.

Expect value addition to chip in fromhigher sales of wires

Strong pricing environment to lead tohigher EBITDA and PAT, reflectingstronger EPS

Sales trend for key products


Production trend for key products



Godawari Power & Ispat Ltd. InitiatingInvestment Rationale

Raw material linkage to lead to cost savings

In FY08, GPIL had coal linkage from Coal India for 50% of its requirement on its pre-

expansion capacities, at an average cost of Rs2,200/t. The company has already securedadditional coal linkage for its expanded capacities and will have 80% coal linkage on

expanded capacities from Jun. '08 onwards. GPIL will be sourcing balance 20% of the

coal requirement through e-auction at an average cost of Rs4,000/t. Post linkage, theblended cost of coal for the company is expected to be around Rs2,500/t. This may reduce

the raw material cost of GPIL significantly. We expect the coal linkage to generate savings

of Rs726mn in FY09 and Rs778mn in FY10.

GPIL has iron ore linkage for 50% of its requirement from NMDC, the cost of which works

out to Rs3,800/t. The company sources balance 50% requirement from the spot market at

an average cost of Rs5,250/t. The blended cost of iron ore for the company is aroundRs4,525/t. This is expected to generate savings of Rs373mn in FY09 and Rs400mn in

FY10.

Pelletization and backward integration to add to bottomline

GPIL is setting up a 0.6mtpa pelletization plant, 0.1mtpa beneficiation plant and 1.2mtpairon ore crushing plant. The pelletization plant is expected to be operational in 2HFY10.

Assuming 40% capacity utilization and average realization of Rs4,000/t, we expect pellets

to generate contribution of Rs150mn in FY10. The beneficiation plant will enable thecompany to utilize the low grade iron ore fines, which are available at a lower cost, thereby

reducing the raw material cost. We have not factored in any savings from beneficiation

plant, which is expected to be fully operational in FY11.

Coal linkage to generate savings ofRs726mn in FY09 and Rs778mn inFY10

Iron ore linkage to generate savingsof Rs373mn in FY09 and Rs400mnin FY10

Captive mine to reduce cost of production

GPIL has been allocated 2 iron ore mines - Ari Dongri and Borai Tibbu. The mines have

estimated reserves of around 15mt, having Fe content of 65%. Forest clearance for themines is pending. We expect the mines to be operational by FY10 and expect the company

to be 15% captive for iron ore in FY10. The mines are expected to ramp up faster as

compared to other greenfield mines, as these mines were previously operated by SAIL. Inthe rising iron ore prices scenario, the captive mine is expected to generate savings of

Rs364mn in FY10. The cost of mining from the captive mines is expected to be around

Rs850/t of iron ore in FY10.

We expect GPIL to be 50% captive for iron ore in FY11. With the blended cost of iron ore

expected to be around Rs4,800/t and cost of mining to be around Rs1,000/t, the captive

mines may lead to savings of Rs1,046mn in FY11. The company also has coal mines asanother strategic cost saving option, which is expected to start only after successful

ramping up of captive iron ore mines. We have not factored in any savings from coal

mines.

Capex breakup

Plant details Target Completion date Capacity Total capex (Rs mn)

1 Iron ore Pelletization Plant Jun – Sep ‘09 0.6mtpa 1,360

2 Iron ore Beneficiation Plant FY11 0.1mtpa 240

3 Iron Ore Crushing Plant FY11 1.2mtpa 120

4 Railways siding FY11 150

5 Other infra related FY11 380

6 Mining Capex 100

Total Capex 2,350


Iron ore mine to start operations in 6months post forest clearance. Expect15% captive on iron ore in FY10;earlier forest clearance could be apositive surprise



Savings from iron ore mines

FY10E FY11E FY12E

Total iron ore requirement (t) 631,125 631,125 631,125

Iron ore from captive mines (t) 94,669 31,5563 63,1125

% captive 15% 50% 100%

Cost of mining (Rs/t) 850 1,000 1,100

Iron ore prices (Rs/t) 5,250 4,800 4,000

Savings (Rs/t) 660 1,900 2,900

Total savings - post tax (Rs mn) 364 1,046 1,598

Source: Emkay Research

Capex fully tied up - no further dilution expected

GPIL is setting up a 0.6mtpa pelletization plant, 0.1mtpa beneficiation plant and 1.2mtpa

iron ore crushing plant at an estimated total capex of Rs2.35bn, which will be funded

through debt of Rs995mn and equity of Rs1,355mn. The company has recently issued1mn warrants to promoters @Rs324/warrant. All the funding requirements are fully tied

up and no further dilution is expected.

QIP Rs1,000mn

(73.8%)

Total funds required Rs2.35bn

Equity contribution

Rs1,355mn (57.7%)

Debt contribution

Rs995mn (42.3%)

Preferential allotment Rs324mn (23.9%)

Internal accruals Rs31mn (2.3%)

Rupee debt Rs600mn (60.3%)

ECB (USD10mn) Rs395mn (39.7%)

CER income is all set to increase

The Carbon Emission Reduction (CER) certificates are governed by Clean DevelopmentMechanism (CDM) of the Kyoto Protocol. This mechanism enables climate protection

projects to be realized in emerging markets and developing countries and the emission

reductions achieved to be converted into tradable emission credits.

The company has already secured 72,000 CERs in respect of utilization of waste gases

from 17MW captive power plant. Further, GPIL has recently applied for registration of its

25MW waste heat recovery based power plant as CDM under United Nations FrameworkConvention on Climate Change (UNFCC). It expects to receive 175,000 to 200,000 CERs

per annum FY09 onwards. The sale of CER is expected to generate revenue of Rs130mn

both in FY09 and FY10 respectively.




Financials and key assumptions

We expect the topline to grow at a CAGR of 24% over the FY08-10E period to Rs12,276mn

in FY10E. EBITDA is expected to grow at a faster rate of 33% CAGR during the FY08-10E

period. This is primarily on account of the strong pricing and cost savings arising out ofraw material linkages and captive mines. PAT is also expected to report growth at a CAGR

of 41% over the FY08-10E period, supported by proceeds from sale of CERs. The company

is expected to increase the capacity utilization rate across the product range over theperiod from FY07 to FY10E. However, we do not expect GPIL to increase its capacity

utilization beyond 75% for its sponge iron production due to bought out coal, which is

expected to contain higher ash content. The utilization might increase once the companystarts mining coal from its captive mines, which we believe will likely be FY11 onwards.

We expect GPIL to witness significant margin expansion FY10E onwards, wherein the

company will reap the benefits of both raw material linkages and captive mines. Weexpect GPIL to be 15% captive for iron ore in FY10, which is expected to increase to 100%

by FY12E. We believe company will also start reaping benefits of captive coal mines by

FY11-12. The company's EBITDA margins are expected to increase from 16.9% in FY07 toaround 22% in FY10E. This is expected to increase further going forward, with the ramping

up of captive iron ore mines and commencement of captive coal mines. GPIL's ROCE is

expected to increase from 16.9% in FY07 to 24% in FY10E, backed by volume growth andmargin expansion. We expect ROE to decline from 34.8% in FY07 to around 29% in

FY10E, as the company will have excess cash balance in its books. However, its ROIC is

expected to increase from 19.5% in FY07 to around 28% in FY10E.

Volume and capacity assumptions


Sponge iron

Capacity (t) 495,000 495,000 495,000 495,000

Production (t) 170,340 285,862 346,500 371,250

% yoy 68% 21% 7%

Capacity utilization (%) 34% 58% 70% 75%

Billets

Capacity (t) 250,000 400,000 400,000 400,000

Production (t) 130,979 209,166 260,000 280,000

% yoy 60% 24% 8%


Wire rods

Capacity (t) 70,000 100,000 100,000 100,000

Production (t) 66,294 70,000 75,000 80,000

% yoy 6% 7% 7%


HB Wires

Capacity (t) 92,500 150,000 150,000 150,000

Production (t) 73,763 86,369 97,500 112,500

% yoy 17% 13% 15%


Ferro Alloys

Capacity (t) 16,500 16,500 16,500 16,500

Production (t) 9,283 9,169 9,900 10,725

% yoy -1% 8% 8%






Realization assumptions (Rs/t on gross basis)


Sponge iron 12,904 16,675 20,000 20,000

% yoy 29% 20% 0%

Billets 24,372 26,400 30,000 30,000

% yoy 8% 14% 0%

HB Wires 25,715 32,000 42,500 42,500

% yoy 24% 33% 0%

Ferro Alloys 32,009 53,500 65,000 65,000

% yoy 67% 21% 0%


Raw material assumptions (Rs/t)


Iron ore 2,428 3,500 4,525 4,590

% yoy 44% 29% 1%

Coal 2,251 2,200 2,500 2,200

% yoy -2% 14% -12%

Manganese ore 4,058 4,500 7,500 7,500

% yoy 11% 67% 0%


Sensitivity to billets and wires prices

Sensitivity of earnings to billet and wire prices in FY09

EPS sensitivity to billets pricesBillet prices 27,000 28,500 30,000 31,500 33,000

% change in pricesfrom base price -10% -5% 5% 10%FDEPS 40.9 47.9 55.0 62.0 69.0

% change -25.5% -12.8% 0.0% 12.8% 25.5%

Source: Emkay Research estimates

EPS sensitivity to wires pricesWire prices 38,250 40,375 42,500 44,625 46,750

% change in prices

from base price -10% -5% 5% 10%

FDEPS 44.0 49.5 55.0 60.4 65.9

% change -19.9% -9.9% 0.0% 9.9% 19.9%

Source: Emkay Research estimates

Sensitivity of earnings to billet and wire prices in FY10EPS sensitivity to billets pricesBillet prices 27,000 28,500 30,000 31,500 33,000

% change in prices


FDEPS 54.4 62.0 69.6 77.3 84.9

% change -21.9% -10.9% 0.0% 10.9% 21.9%Source: Emkay Research estimates

EPS sensitivity to wires pricesWire prices 38,250 40,375 42,500 44,625 46,750

% change in prices


FDEPS 57.0 63.3 69.6 76.0 82.3

% change -18.2% -9.1% 0.0% 9.1% 18.2%Source: Emkay Research estimates




0

200

400

600

Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08

6x

Price

4x

2x

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200

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1.5x

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0.5x

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Valuations

We value GPIL at 6x our estimated FY10 FDEPS of Rs69.6. We believe that the companyhas good growth potential, with the expected volume growth from the recently

commissioned capacities and ability to expand margins through backward integration.

GPIL increased its sponge iron capacities from 0.235mtpa to 0.495mtpa, billets capacitiesfrom 0.25mtpa to 0.4mtpa, wire rods capacities from 0.07mtpa to 0.1mtpa, HB wires

capacities from 0.06mtpa to 0.12mtpa and power generation capacities from 28MW to

53MW. The company has also embarked on a backward integration plan involving settingup of iron ore beneficiation, pelletization and crushing plant. GPIL has been allocated 2

iron ore mines and 3 coal blocks. It has also secured iron ore and coal linkages for its

expanded capacities. These projects and mines, once operational, are likely to lead to areduction in the company's cost of production.

Valuation charts

Historically, GPIL has traded in the PE band of 3-4x while the large players have traded at6-8x 1yr forward earnings. However, with the recent re-rating of global and domestic steel

stocks, the large steel stocks are now trading in the band of 9-14x 1yr forward. We believeGPIL also deserves a re-rating due to its size (now it is India's 4th largest sponge iron

producer) and its thrust on backward integration and value addition. Further, the stock is

extremely low leveraged as compared to larger companies like Tata Steel and JSW. Thelow leverage offers lower risk in case the steel cycle faces a downturn.

At the CMP of Rs194, the stock is trading at 2.8x our FY10E FDEPS of Rs69.6 and at 2.3x

on FY10E EV/EBITDA. We initiate the coverage on the stock with a BUY recommendationwith target price of Rs418 (with a potential upside of 115%). At our target price, the stock

will likely trade at a P/E of 6x, EV/EBITDA of 4.6x.

Source: Bloomberg, Emkay Research Estimates

P/E Band

Valuations

4x

2xPrice

6x

8x

P/B Band EV/Ebitda Band



CMP Rating Net Sales EBITDA EBITDA PAT Net EPS Valuationmargin margin

Rs mn Rs mn % Rs mn % Rs PE EV/EBITDA

GPIL 194 BUY 11,121 2,163 19.5% 1,511 13.6% 54.9 3.5 3.2

Tata Steel 903 BUY 1,238,070 206,537 16.7% 94,443 7.4% 108.3 8.3 6.4

JSW 1,171 BUY 166,731 41,522 24.9% 18,620 11.2% 92.88 12.6 7.8

Monnet Ispat 586 BUY 12,045 2,969 24.6% 1,548 12.8% 27.2 21.6 11.3

SAIL 160 NR 505,616 127,450 25.2% 82,516 16.3% 19.9 8.0 4.4

JSPL 2,342 NR 94,713 42,838 45.2% 25,283 26.7% 167.0 14.0 9.4

Bhushan Steel 909 BUY 63,429 11,074 17.5% 5,195 8.2% 116.5 7.8 8.1

Relative ValuationRelative Valuation for FY09E

Source: Emkay research estimates, FactSet

CMP Rating Net Sales EBITDA EBITDA PAT Net EPS Valuationmargin margin

Rs mn Rs mn % Rs mn % Rs PE EV/EBITDA

GPIL 194 BUY 12,276 2,724 22.2% 1,914 15.6% 69.6 2.8 2.4

Tata Steel 903 BUY 1,264,372 194,259 15.4% 86,164 6.7% 98.8 9.1 6.9

JSW 1,171 BUY 228,168 59,828 26.2% 27,673 12.1% 138.0 8.5 5.7

Monnet Ispat 586 BUY 14,949 3,250 21.7% 1,681 11.2% 29.5 19.9 11.3

SAIL 160 NR 535,663 144,833 27.0% 95,895 17.9% 23.4 6.8 4.1

JSPL 2,342 NR 114,937 59,590 51.8% 33,175 28.9% 215.0 10.9 6.8

Bhushan Steel 909 BUY 62,968 18,413 29.2% 7,415 11.8% 158.3 5.7 4.8

Relative Valuation for FY10E

Source: Emkay research estimates, FactSet

Valuations



Key Risks

The key risks associated with GPIL are a slowdown in construction demand since GPILextensively caters to the demand requirements of this segment. However, with the

government's current thrust on infrastructure development (as is visible in the GDP growth

forecast of 8.7% and 8.5% for FY08 and FY09) and increasing infrastructure spending, wedo not expect the construction demand to slowdown and GPIL is likely to be able to

achieve the expected volume growth.

Slowdown in construction demand

Housing demand is expected to grow by 23.4mn units from 2007-11. Demand for retailspace in India is expected to grow from 50mn sqft in 2007 to ~200mn sqft in 2010. The

number of malls is expected to increase from 96 in 2006 to 650 in 2011. If all the projected

investment plans do not fructify as anticipated, there could be a slowdown in constructionactivities, leading to a reduction in demand for long products. This may hinder the growth

plans of the company. However, we believe that given the industrialization and urbanization

phase which India has entered into, the demand for construction steel will remain strongover the next few years.

Delay in forest clearance for mines

GPIL has been allocated two iron ore mines in Chhattisgarh, with total reserves of around

15mt. The company has received all the approvals except forest clearance. We expect thecompany to be 15% captive for iron ore in FY10. If there is any delay in receiving the forest

clearance, then the company may not be able to achieve expected benefits from the

captive iron ore mines and our EPS will be impacted by 19%. However, in case the minesare operational ahead of our expectation, the impact will be in favor of the company to the

extent of the number of months, for which the mine starts operations ahead of ourexpectation.

Delay in commissioning of backward integration plans

GPIL has embarked on a backward integration plan of Rs2.35bn, to reduce the cost of

production. The company is planning to set up iron ore beneficiation and crushing plants.The plants are expected to be operational by FY11. However, any delay in commissioning

of the project may not enable the company to reap the benefits of cost savings.

Reduction in scrap prices

Sponge iron is the cheaper substitute of steel scrap, used in Electric Arc Furnace. Spongeiron prices follow scrap prices. With the current lack of availability of steel scrap, steel

producers are increasingly substituting sponge iron for scrap. If there is any change in

regulations to increase the imports of scrap or the scrap price starts reducing, then it maylead to reduction in demand of sponge iron. Steel scrap is preferred over sponge iron

owing to its high (95%+) Fe content and any reduction in scrap prices is likely to fuel a

decline in sponge iron prices also.

Key Risks



Captive mines

Iron ore mines

GPIL has been allocated two iron ore mines - Ari Dongri and Borai Tibbu in Chhattisgarh.The mines have total estimated reserves of 15mt.

Ari Dongri

The mine is spread over an area of 216 hectares and is 150kms from the Raipur plant.The mine was previously being operated by Bhilai Steel plant of SAIL. The mine has anestimated reserves of 7-8mt with Fe content of around 65%.

Borai Tibbu

This mine is spread across 110-116 hectares in Rajnandgaon district of Chhattisgarhand is 150km from Raipur plant. It has proven reserves of around 6-7mt with a Fe contentof around 62%. However, the management expects the reserves to be more than theproven reserves. The fines generation is likely to be higher in this mine at around 50-60%,necessitating setting up of a pelletization plant.

The company has received all the environmental clearances, except forest clearance forthe mines. Post forest clearance, GPIL expects the mines to be operational in 4-6 months.The company has already been allocated 200 hectares of land about 5 years ago. Hence,the land acquisition cost has been taken care of.

Additional prospecting license - Dhalli Rajhara

The company has received additional prospecting license for 754 hectares in Durg district.The mine is 100km from the plant site. GPIL estimates the reserves to be around 50mt.The company is yet to receive forest clearance for the mine.

Expected savings from mines

FY10E FY11E FY12E

Total iron ore requirement (t) 631,125 631,125 631,125

Iron ore from captive mines (t) 94,669 31,5563 63,1125

% captive 15% 50% 100%

Cost of mining (Rs/t) 850 1,000 1,100

Iron ore prices (Rs/t) 5,250 4,800 4,000

Savings (Rs/t) 660 1,900 2,900

Total savings - post tax (Rs mn) 364 1,047 1,598


Coal mines

GPIL has been allocated 3 coal blocks in consortium. The total mineable reserves of theblocks are 243mt, of which the share of GPIL is around 63mt

Coal Block - Nakia I & II

The company has been allocated a block in coalfield Nakia I & II in consortium (ChhattisgarhCaptive Coal Mining Co Pvt Ltd (CCCMPL)) with 4 other players - 1) Vandana Global 2)Bajrang Power & Ispat 3) Nakoda Ispat & 4) Ind Synergy. GPIL has been a pioneer informing JVs to get allocation of coal blocks. It is the first consortium to be granted coalmining lease by the central government. The total reserves of the coalfield are 198mt, ofwhich the share of GPIL is 51.5mt. The company expects the mines to be operational byFY11.

CCCMPL has been allocated 2 more coal blocks - Madanpur (North) and Madanpur(South) in consortium with other players.

Captive mines



Coal Block - Madanpur (North)

CCCMPL has been allocated Madanpur (North) coal block in consortium with 7 otherplayers 1) Sunflag Iron & Steel 2) Ultratech cement 3) Nav Bharat Explosives 4) PrakashIndustries 5) Anjani Steel (P) Ltd 6) Singhal Enterprises 7) Vandana Energy & Steel. Theshare of CCCMPL in this block is around 15mt of mineable reserves with an average "E"grade coal. The company expects mining to start by FY11.

Coal Block - Madanpur (South)

CCCMPL has also been allocated Madanpur (South) coal block in consortium with 4other players 1) Hindustan Zinc 2) Sarda Energy & Minerals 3) MSP Steel & Power and 4)Akshay Ispat Udyog (P) Ltd. The share of CCCMPL is around 30mt of mineable reserveswith an average "E" grade coal. The company expects mining to start from FY11.

The coal mines can be another strategic cost saving option for the company. However,coal mines will be operational post successful ramping up of iron ore mines. We havenot factored in any savings from coal mines.

Captive mines



0%

5%

10%

15%

20%

25%

30%

2000 2001 2002 2003 2004 2005 2006

0

10

20

30

40

50

60

70

2000 2001 2002 2003 2004 2005 2006

World India

Industry overview

Sponge iron - rapidly substituting scrap

India is the largest producer of sponge iron in the world with a total production of 15mt inCY06. India has a 25% share in the global sponge iron market. India's share in the globalsponge iron market has increased from 13% in CY00 to 25% in CY06. The production ofsponge iron has grown at a CAGR of 18% over a period of CY00 to CY06. Sponge iron ismainly used by the steel producers using induction furnace/electric arc furnace route,along with scrap, to produce billets, which are used in manufacturing of long products forconstruction. However, in the recent past, the share of sponge iron has been increasingowing to limited scrap availability. The share of sponge iron has increased from 52% inFY00 to 68% in FY07. The consumption of sponge iron has grown at a CAGR of 21% overa period of FY02 to FY07.

Sponge iron is made through coal based kilns or gas based kilns. As the distinction isdrawn on the basis of fuel used, gas based sponge iron is purer as compared to coalbased and therefore commands a premium. Investment in setting up gas based spongeiron plant is high as compared to coal based. Capacities up to 1mtpa can be setup usingcoal based technology. The production share of gas based sponge iron in total spongeiron production has declined from 52% in FY03 to around 30% in FY07. Coal basedsponge iron faces shortage of coal as Coal India Ltd (CIL) assigns priority to the powersector. Consequently, sponge iron producers have to depend on low grade of coal (D andE) and spot purchases at higher rates. Iron ore and coal forms around 80% of the operatingcost of manufacturing sponge iron.

Source: CRISIL Research

Sponge iron production (mt)


India's share in global sponge iron market

Industry overview



0%

20%

40%

60%

80%

100%

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07

Sponge iron share Scrap share

0

2

4

6

8

10

12

14

16

FY02 FY03 FY04 FY05 FY06 FY07

0%

5%

10%

15%

20%

25%

30%

Sponge iron consumption (mt) % yoy


Sponge iron consumption


Share of sponge iron in metallic pool

Shortage of scrap to drive up sponge iron demand

Steel scrap is one of the most preferred charge for the Electric Arc Furnace owing to itshigh Fe (95%+) content. US and Russia are the major exporters of scrap, with US accounting

for 15% and Russia accounting for 10% of the global market share. However, owing to

various regulations and rising prices, availability of scrap has been declining. Export fromRussia declined from 12.8mt in CY04 to 9.8mt in CY06. International prices of scrap have

almost doubled from USD250/t in Feb. '07 to USD500/t in May '08.

The lack of availability of steel scrap is urging steel producers to substitute more andmore of scrap with sponge iron. The share of sponge iron in the metallic pool has increased

from 52% in FY00 to 68% in FY07.

Industry overview



0

5000

10000

15000

20000

25000

Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08

100

300

500

700

900

12-Feb-07 12-May-07 12-Aug-07 12-Nov-07 12-Feb-08 12-May-08

Heavy metling Shredded Bushelling

Source: IISI

Russia scrap exports

Source: World Steel Dynamics Steel Benchmarker TM

International Scrap prices (USD/t)


Sponge iron: Domestic prices (Rs/t)

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006

-40%

-20%

0%

20%

40%

60%

80%

100%

Russia scrap exports (mt) % yoy

Industry overview



96

650

0

100

200

300

400

500

600

700

2006 2011E

CAGR 47%

110

129

153

0

30

60

90

120

150

180

2001 2006 2011E

Construction boom to drive demand for long products

Sponge iron is mainly used for making products used in construction like bars, rods etc.

The demand for these products is continuously increasing with increasing demand for

households and other structures. India's population is expected to grow by 63.6mn during2007-11. According to CRISIL Research, this, along with other factors like rising income

levels and urbanization, shall translate into a demand for 23.4mn units of household

stock during the period at an average annual rate of 4.7mn units. With this, the total stockof housing units is expected to go up to 152.7mn units by 2011 from 129.4mn units in

2006. As per Planning Commission estimates, the total number of urban dwelling units

are expected to increase from 58.8mn units in FY07 to 66.1m units by FY12. This impliesan average annual increase of 1.45mn units over the 11th Five Year Plan.

Construction of various industrial structures and commercial real estate is also expected

to drive up the demand for long products. NASSCOM estimated IT/ITES industry (whichaccounts for 70-75% of commercial real estate demand) to reach USD50bn in FY08.

Even after assuming a modest 25% growth, the industry is expected to reach USD80bn by

FY10. Assuming addition of 1.3mn new employees to the industry in next 3 years, ITindustry is expected to post a demand of 160mn sqft. of commercial space in the next

three years. Demand for retail space in India is expected to increase from 50mn sqft in

2007 to ~200mn sqft by 2010. The number of shopping malls in India is expected toincrease from 96 in 2006 to around 650 in 2011.

All the above developments depict a construction boom to be witnessed by India in the

coming years, signifying good demand for long products.


Expected Housing Stock addition in India (in mn units)

Source: Emkay research

Expected number of malls in India

Industry overview



0

5

10

15

20

25

30

2001 2002 2003 2004 2005 2006

0%

10%

20%

30%

40%

50%

60%

70%

80%

Indian crude steel production through EAF (mt) % yoy

0

100

200

300

400

500

2001 2002 2003 2004 2005 2006

0%

2%

4%

6%

8%

10%

Global crude steel production through EAF (mt) % yoy

Steel making through EAF route in India driving sponge irondemand

Currently, about 70% of the world's crude steel is manufactured through blast furnace and

remainder is from direct reduction process. However, currently in India, around 47% of the

crude steel production is through blast furnace-basic oxygen furnace (BF-BOF) route;while around 50% is through Electric Arc Furnace (EAF) route and balance through open-

hearth process. The production through BF-BOF route is advantageous over EAF route

because of its high volume of production per unit of time. However, the BF-BOF route iscapital intensive and is not suitable for small and medium scale manufacturers (not

producing more than 1mtpa). To overcome the high capital investment in BF-BOF route

and non-availability of scrap, EAF route manufacturers are opting for sponge iron as themain input for crude steel production.

Growth in sponge iron industry triggered by…

1) Lack of availability of steel scrap. Scrap is facing a worldwide shortage, owing to

increasing demand (due to 95%+ Fe content) and various regulatory issues relatedto import of scrap. As sponge iron is a cheaper substitute of steel scrap, prices of

sponge iron follows scrap prices.

2) Shorter gestation period and lower initial investment in setting up a sponge ironfacility.

Sponge iron industry is being characterized by sub-optimal capacity utilization levels. The

reason being - lack of sufficient pelletization facilities in India and also utilization of lowgrade coal (usually D and E grade). GPIL is setting up a 0.6mtpa pelletization plant, which

will enable it to increase capacity utilization.

Source: IISI

Indian crude steel production through EAF

Source: IISI

Global crude steel production through EAF

Industry overview


Godawari Power & Ispat Ltd. InitiatingFinancials tables

Balance Sheet Rs Mn

FY07 FY08E FY09E FY10E

Equity Capital 237 279 279 279

Reserves & Surplus 1,837 3,985 5,372 7,141

Networth 2,074 4,264 5,651 7,421

Total Debts 2,894 2,594 2,594 2,594

Net def Liabilities 19 19 19 19

Capital Employed 4,991 6,881 8,267 10,037

Gross Block 3,117 3,817 4,117 6,517

Less Depreciation -344 -574 -891 -1,317

CWIP 1,034 700 1,600 800

Net Fixed Assets 3,852 3,988 4,871 6,046

Investments 49 49 49 49

Inventory 761 1,094 1,518 1,738

Debtors 281 504 753 945

Cash and Bank 125 1,236 951 982

Loans & Advances 407 603 894 1,076

Total Cur. Assets 1,575 3,437 4,116 4,740

Current Liabilities 258 337 467 497

Provisions 228 257 301 301

Total Cur. Lia. & Prov. 485 594 769 798

Net Current Assets 1,090 2,843 3,347 3,942

Misc. Assets 0 0 0 0

Total Assets 4,991 6,881 8,267 10,037

Source: Company, Emkay research

Income Statement Rs Mn


Gross External Sales 5,456 9,193 12,496 13,793

Less: Excise 734 1,195 1,375 1,517

Net Sales 4,722 7,998 11,121 12,276

Raw Material Consumption 3,433 5,694 7,922 8,403

As a % to Net Sales 72.7 71.2 71.2 68.5

Power & Fuel 82 130 158 167

As a % to Net Sales 1.7 1.6 1.4 1.4

Staff Cost 56 80 111 123

As a % to Net Sales 1.19 1.00 1.00 1.00

Other Expenses 354 544 767 859

As a % to Net Sales 7.5 6.8 6.9 7.0

Total Exp 3,926 6,448 8,958 9,552

EBITDA (Core) 796 1,550 2,163 2,724

EBITDA (%) 16.9 19.4 19.5 22.2

Other Income 71 82 149 149

Depreciation 122 230 317 425

EBIT 674 1,320 1,846 2,298

Interest 125 296 265 255

PBT 621 1,107 1,731 2,193

Tax 79 141 220 279

ETR (%) 12.7 12.7 12.7 12.7

A PAT 533 967 1,511 1,914

Ratios


EBITDA - Core (%) 16.9 19.4 19.5 22.2

EBIT (%) 14.3 16.5 16.6 18.7

NPM (%) 11.3 12.1 13.6 15.6

Adj ROCE (%) 16.9 21.3 23.4 23.7

Adj ROE (%) 34.8 30.5 30.5 29.3

ROIC (%) 19.5 26.6 27.2 27.5

Adj EPS 22.9 35.2 55.0 69.6

Cash EPS 28.2 43.5 66.5 85.1

Book Value 89.2 155.1 205.6 269.9

DPS 3.1 3.1 3.9 4.5

Payout (%) 13.6 8.9 7.0 6.5

Net Debt to Equity (x) 1.3 0.3 0.3 0.2

PE (x) 8.4 5.5 3.5 2.8

P/BV (x) 2.2 1.2 0.9 0.7

EV/Sales (x) 1.5 0.9 0.7 0.6

EV/EBITDA (x) 8.4 4.4 3.2 2.4

Div Yield (%) 1.6 1.6 2.0 2.3

Source: Company, Emkay researchSource: Company, Emkay research

Source: Company, Emkay research

Cash Flow Statement Rs Mn


PBT 612 1,107 1,731 2,193

Depreciation 122 230 317 425

Net Chg in WC -405 -643 -789 -563

Others -51 -141 -220 -279

CFO 277 553 1,038 1,776

Capex -1,893 -366 -1,200 -1,600

Net Investments made -5 0 0 0

Others Investing Activities 1 1 1 1

CFI -1,897 -366 -1,199 -1,599

Change in Share capital 736 1,574 350 450

Change in Debts 1,168 -300 0 0

Div. & Div Tax -54 -101 -124 -145

Others -150 -250 -350 -450

CFF 1,700 923 -124 -145

Total Cash Generated 81 1,110 -286 32

Cash Opening Balance 44 125 1,236 951

Cash Closing Balance 125 1,236 951 982


Godawari Power & Ispat Ltd. InitiatingThe team

www.emkayshare.com

Emkay Rating Distribution

BUY Expected total return (%) of stock price appreciation and dividend yield) of over 25% within the next 12-18 months.ACCUMULATE Expected total return (%) of stock price appreciation and dividend yield) of over 10% within the next 12-18 months.REDUCE Expected total return (%) of stock price appreciation and dividend yield) of below 10% within the next 12-18 months.SELL The stock is believed to under perform the broad market indices or its related universe within the next 12-18 months.NEUTRAL Analyst has no investment opinion on the stock under review.

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Institutional Equities Team

Anish Damania Business Head [email protected] 91-22-66121203

Research Team

Ajay Parmar Head Research [email protected] 91-22-66121258Ajit Motwani Cement & Capital Goods [email protected] 91-22-66121255Amit Adesara Logistics, Engines,Real Estate [email protected] 91-22-66121241Chirag Shah Auto, Auto Ancillaries [email protected] 91-22-66121252Kashyap Jhaveri Banks [email protected] 91-22-66121249Manik Taneja IT [email protected] 91-22-66121253Manoj Garg Pharma [email protected] 91-22-66121257Naveen Jain Construction, Real Estate [email protected] 91-22-66121289Pritesh Chheda, CFA FMCG, Engineering, Mid -Caps [email protected] 91-22-66121273Rohan Gupta Paper, Fertilisers, Real Estate [email protected] 91-22-66121248Sumit Modi Telecom [email protected] 91-22-66121288Vishal Chandak Metals [email protected] 91-22-66121251Chirag Dhaifule Research Associate [email protected] 91-22-66121238Chirag Khasgiwala Research Associate [email protected] 91-22-66121254Pradeep Agrawal Research Associate [email protected] 91-22-66121340Prerna Jhavar Research Associate [email protected] 91-22-66121337Vani Chandna Research Associate [email protected] 91-22-66121272Meenal Bhagwat Database Analyst [email protected] 91-22-66121322

Sales Team

K.N.Sreenivasan Asia Sales Desk [email protected] 91-22-66121264Meenakshi Pai India / UK Sales Desk [email protected] 91-22-66121235Rajesh Chougule India Sales Desk [email protected] 91-22-66121295Falguni Doshi Institutional Equity Sales [email protected] 91-22-66121236Palak Shah Institutional Equity Sales [email protected] 91-22-66121277Ashok Agarwal Associate Inst.Equity Sales [email protected] 91-22-66121262Roshan Nagpal Associate Inst.Equity Sales [email protected] 91-22-66121234

Dealing Team

Kalpesh Parekh Senior Dealer [email protected] 91-22-66121230Ajit Nerkar Dealer [email protected] 91-22-66121237Dharmesh Mehta Dealer [email protected] 91-22-66121232Ketan Mehta Dealer [email protected] 91-22-66121233

Derivatives Sales Team

Sandeep Singal Co Head Institutions - Derivatives [email protected] 91-22-66121355Nupur Dhamani Institutional Trader Derivatives [email protected] 91-22-66121222Manish Somani Dealer Derivatives Desk [email protected] 91-22-66121221Faraaz Khan Sales Trader [email protected] 91-22-66121213Manjiri Mazumdar Dealer Derivatives Desk [email protected] 91-22-66121224Pradnya Kulkarni Dealer Derivatives Desk [email protected] 91-22-66121223Sameer Desai Dealer Derivatives Desk [email protected] 91-22-66121220Nishant Singhania Dealer Derivatives Desk [email protected] 91-22-66121218Trupti Dhanani Dealer Derivatives Desk [email protected] 91-22-66121215Kalpesh Hirpara Dealer Derivatives Desk [email protected] 91-22-66121214Manish Bangera Dealer Derivatives Desk [email protected] 91-22-66121218Vishal Thakker Dealer Derivatives Desk [email protected] 91-22-66121227Nirav Vira Dealer Derivatives Desk [email protected] 91-22-66121225Venugopal Swamy Dealer Derivatives Desk [email protected] 91-22-66121214Devendra Vora Dealer Derivatives Desk [email protected] 91-22-66121226

Technicals Research Team

Manas Jaiswal Technical Analyst [email protected] 91-22-66121274Suruchi Kapoor Jr.Technical Analyst [email protected] 91-22-66121275

Derivatives Research Team

Sameer Shetye Associate Analyst [email protected] 91-22-66121276

godawari power & ispat ltd - initiating coverage

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