March 16, 2010 BUY HIGH RISK PRICE Rs TARGET Rs.300. APAT (Rs mn) Revenue (Rs mn)

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1 ANALYST Ishpreet Batra Shreyas Bhukhanwala SALES: Devang Shah /61 Nishit Shah Prakash Industries Ltd. (PIL) was started in the year It is a diversified Company with operations across steel, ferro-alloys, power generation and mining. It is now a partiallyintegrated steel producer, located in the mineral-rich belt of Eastern India, producing steel through the sponge iron induction arc furnace route. Its operations are mainly located at Champa and Raipur in Chhattisgarh. De-bottlenecking exercise to boost capacity utilization Prakash Industries currently has Sponge iron capacity of 6 lakh TPA, billets 5.5 lakh TPA and finished steel 7.5 lakh TPA. The Company uses sponge iron and billets for the production of its end products i.e. finished steel. As the intermediary products lag the capacities of its finished products, the Company is expanding its sponge iron and billets capacity to 1 MTPA by FY13E. This would result in higher capacity utilization level from current ~45% to 90% by FY13E and higher operating profit margins, as captive production of sponge iron would result into a cost saving of ~24%. Backward Integration- Iron Ore mining to increase EBITDA As part of its strategic vision to be a fully integrated player by FY13, PIL is not only increasing its intermediary products capacity, but is also going for iron ore mining. PIL currently sources iron ore from the open market at a relatively higher cost vs the captive mining cost of Rs.1,600 per tonne. This would lower the sponge Iron cost further by 60% per tonne. As a result its EBITDA/tonne is likely to grow at a CAGR of 29.2% in the next 3 years, while its EBITDA margin is likely to increase from the current 23.4% (9MFY10) to 38.4 % by FY12E. Venturing into Merchant Power Business Foreseeing huge opportunities in the power sector, the Company has decided to foray into merchant power business by setting up power capacity of 625-MW over a period of next 5-6 years. This expansion will be done in various phases, the first phase of which is likely to get operational by Dec 10. Higher realization coupled with lower cost of production on back of captive coal mines would enable the Company to fetch higher margins from the power venture. Hence, foray in merchant power business would not only help to boost its top line, but also would help in improving its overall margin. OUTLOOK & VALUATION Prakash Industries a competitive steel player is set to enter a bigger league on the back of its aggressive backward integration plans and rationalization exercise. Higher sponge iron and billets capacity is likely to boost the capacity utilization of the Company from the current level of ~45% to 90%. Moreover, the backward integration by the Company in the form of captive iron ore mines is likely to stimulate its profitability in a big way. Moreover, the foray into the highly profitable merchant power business is also likely to boost the EBIDTA margins of the Company beyond FY12. PIL s EBIDTA margin is likely to expand from the current 23.4% (9MFY10) to 38.4% by FY12E. At Rs.219.7, the stock is currently trading at an EV/EBITDA and P/BV of 3.6x and 1.3x its FY12E estimates. Considering huge margin expansion and EPS growth, we maintain a positive outlook for the Company, and thereby recommend a BUY with a target price of Rs.300 through SOTP methodology. We have valued its steel business at Rs.230 based on a EV/EBITDA multiple of 5x its FY12 estimates, and power business at Rs.70 by DCF methodology. KEY FINANCIALS Prakash Industries Ltd. BUY HIGH RISK PRICE Rs TARGET Rs.300 Metal SHARE HOLDING (%) Promoters 54.3 FII 12.6 FI / MF 4.8 Body Corporates 13.3 Public & Others 15.0 STOCK DATA Reuters Code Bloomberg Code BSE Code NSE Symbol Market Capitalization Shares Outstanding PRKI.BO PKI.IN PRAKASH Rs mn US$ mn mn 52 Weeks (H/L) Rs.240 /39 Avg. Daily Volume (6m) Price Performance (%) 329,753 Shares 1M 3M 6M Days EMA: Rs.161 Part of Bonanza Please refer to important disclosures at the end of the report Initiating Coverage Y/E Mar. Revenue (Rs mn) APAT (Rs mn) AEPS (Rs) AEPS (% Ch.) P/E (x) ROCE (%) ROE (%) P/BV (x) FY (4.8) FY10E FY11E (25.3) FY12E For private Circulation Only. Sushil Financial Services Private Limited Office : 12, Homji Street, Fort, Mumbai Member : BSEL, SEBI Regn.No. INB/F NSEIL, SEBI Regn.No.INB/F Phone: Fax: info@sushilfinance.com

2 COMPANY BACKGROUND Prakash Industries Ltd. (PIL) was started in the year It is a diversified Company with operations including steel, ferro-alloys, power generation and mining. It is now a partially-integrated steel producer, located in the mineral-rich belt of Eastern India, producing steel through the sponge iron induction arc furnace route. The company s operations are mainly located at Champa and Raipur in Chhattisgarh. Product Flow Champa plant - Products Raipur plant- Products Sponge Iron 600,000 TPA Induction Arc Furnace Billets 550,000 TPA Structural steel/ TMT 300,000 TPA Wire Rod Mill 450,000 TPA Ferro-Alloys 48,000 TPA Power Plant - Captive 100 MW Source: Company The Company currently has a sponge iron capacity of 6 lakh TPA, Billets 5.5 lakh TPA and Finished steel i.e. Wire Rod Mills 4.5 lakh TPA and TMT/Structural steel 3 lakh TPA. It also has a small ferro-alloy division with a capacity of 48,000 TPA. The Company has installed latest technology submerged arc furnaces to produce high quality ferro-alloys to meet its in-house requirements and also to cater export as well as domestic market for supply of high quality Ferro Alloys. To meet its power requirements PIL has a captive power plant of 100-MW, which is completely used internally. As a part of its strategic initiative, PIL plans to be a fully integrated company by As a step forward in the same direction the Company is increasing its sponge iron capacity to 1 MTPA and billet capacity also at 1 MTPA. Moreover, it has been allotted 2 iron ore mines and 2 more coal mines in addition to the 1 coal mine it already has. 2

3 INVESTMENT RATIONALE De-bottle necking exercise to boost capacity utilization Prakash Industries currently has sponge iron capacity of 6 lakh TPA, billets 5.5 lakh TPA and finished steel i.e. Wire Rod Mills 4.5 lakh TPA and TMT/structural steel 3 lakh TPA. The Company only sells finished steel in the form of Wire Rod Mils and TMT bars in the market, while it uses sponge iron and billets for the production of the end product. The Company produces steel through the sponge iron induction arc furnace route i.e. the Company first produces sponge iron then billets and then finished steel. To produce 1 tonne of billet, ~1 tonne of sponge iron and ~0.2 tonne of scrap is required. While to produce 1 tonne of finished steel, ~1.03 tonne of billet is required. The current sponge iron and billet capacity therefore created capacity imbalances, thereby resulting into lower capacity utilization levels of finished steel as shown in the figure below: Bottle-Neck Sponge Iron Sponge IronCapacity 600,000 TPA (~1 tonne required to produce 1 tonne of billet) Scrap Billets Billets Capacity 550,000 TPA (~1.03 tonne of Billet required to produce 1 tonne of Finished steel) Finished Steel (Wire Rods & Structural Steel/TMT) Capacity 750,000 TPA (Internal Resources thus unable to meet the needs of the end product, resulting into Bottle Necking) Source: Company, Sushil Finance The Company is therefore undertaking a rationalization exercise in order to combat this capacity imbalance. It is therefore increasing its sponge iron and billets capacity to 1 MTPA by FY13 as shown in the figure in the next page. 3

4 Sponge Iron & Billets Capacity at 1MTPA much above the Finished Steel capacity of 750,000TPA 1000 Capacities ('000 Tonnes per Annum) FY09 FY10E FY11E FY12E FY13E Sponge Iron Billets Finished Steel Source: Company, Sushil Finance Estimates The Company currently sources ~15-20% of its sponge iron requirement from the open market at the cost of ~Rs. 16,500 (inclusive of excise duty). While the cost of production without iron ore integration and captive coal sourcing works out to ~Rs. 12,200 per tonne. Thus as sourcing of sponge iron from open market results into very lower margins, the Company had lower level of capacity utilization for its finished steel product. PIL s capacity utilization is therefore likely to increase from the present level of ~45% to 90% by FY13E. Increase in sponge iron and billets capacity is not only going to increase the capacity utilization level for the Company, but will also help increase its operating profit in terms of, captive sourcing resulting into 24.3% cost saving and declining fixed cost as a result of increase in capacity utilization level. 4

5 Backward Integration- Iron Ore mining to increase EBITDA As part of strategic vision to be a fully integrated player by FY13, the Company is not only increasing its intermediary products capacity, but is also going for iron ore mining. The Company has been allotted two iron ore mines one each in Orissa and Chhattisgarh. Mines Iron Ore Orissa, Sirkagattu Chattisgarh, Kawardha Chattisgarh, Chotia Coal Chattisgarh, Madanpur Chattisgarh, Fatehpur Reserves (MT) Grade 65% Fe 66-67% Fe D E&F Operational FY11 FY12 Operational FY11 FY12 Source: Company Its Sirkagattu mine has 10MT of reserve of 65% Fe content, and the Kawardha mine has reserves of 75MT of 66% Fe grade. The Sirkagattu mine is likely to be operational by Oct 10, while the Kawardha mine will be operational from FY12. PIL currently sources iron ore from the open market at a relatively higher cost vs. captive mining cost of Rs. 1,600 per tonne. The Company has been allotted 2 coal mines as well in Chhattisgarh. Its Chotia mines are operational since the last four years having reserves of 50-MT. Currently, the Company is using this mine for its steel as well as captive power purpose. Its Madanpur mine with reserves of another 50-MT will be operational by Aug 10. This mine will also largely be used for steel business. While the Fatehpur mine of E&F grade will be operational by FY12 and will be mainly used for the Power business. PIL s landed coal cost from captive mines works out to Rs. 850 per tonne vs. the current market price ~Rs. 4,500 per tonne (thermal coal 6,700Kcal). The Company is thus likely to see a massive growth in its Operating profits by FY13 on the back of cost saving from the iron ore front, as shown in the table and figure below: Sponge Iron Cost break-up Without Integration (Rs. per tonne) Sponge Iron Cost break-up With Integration (Rs. per tonne) Sponge Iron Cost reduces by 60% due to fall in iron ore cost to Rs.2720/tonne % % % % % % Iron Ore Coal Power & Overhead Iron Ore Coal Power & Overhead Source: Sushil Finance Estimates 5

6 The iron ore cost post-integration is likely to come down by 73% to Rs. 2,720 per tonne considering the captive iron cost of Rs. 1,600 per tonne. This will eventually result into lower sponge iron cost, which will come down by ~60%. As a result of decline in the sponge iron cost by a whopping 60%, the operating profit is likely to increase at a CAGR of 41.5% by FY12E. The Company s EBITDA/tonne is likely to grow at a CAGR of 29.2% in the next 3 yrs as shown in the diagram below: 16,000.0 EBITDA/tonne (Rs.) Billets and Sponge Iron Capacity will increase to 1MTPA and 8 lakh TPA respectively Sponge Iron Capacity 1MTPA. Fully Integrated EBITDA/tonne to grow at a CAGR of 29.2% 13, ,000.0 Sponge Iron Capacity increased to 6 lakh TPA Billets Capacity will increase to 7 lakh TPA 9, , , , , FY10E FY11E FY12E FY13E Source: Sushil Finance Estimates The Company is therefore likely to witness robust growth in the financials on the back of backward integration and higher capacity utilization level. 6

7 Venturing into Merchant Power Business: Increasing power demand coupled with lower supply has resulted in higher power deficit in the country over the past several years. Foreseeing huge opportunities due to this demand-supply mismatch, the Company has decided to foray into merchant power business by setting up power capacity of 625-MW over a period of next 5-6 years. Currently, the Company operates a power plant of 100-MW, which is used for captive purposes for the production of billets. Out of the additional 625-MW ~ 25-MW would be used for captive purposes, while the remaining would be available for sale on merchant basis. Power Capacity Additions 725 MW 600 MW 475 MW 350 MW 225 MW 100 MW FY09 FY12E FY13E FY14E FY15E FY16E Source: Company The Company plans to set-up 5 units of 125-MW each, with 1 st unit to get operational by Dec 10. The remaining units of 125-MW each are likely to get commissioned after a gap of one year each from the date of commissioning of the previous unit. Considering the long gestation period, we have taken into account only first three units of 125-MW each in our financial model with a delay of one year for the last unit. The Company also has a captive coal mine at Fatehpur with reserves of ~46 MT, which is likely to get operational by Feedstock for these plants will be sourced from its captive mines from 2012 resulting into the landed cost of ~Rs. 850 per tonne. Until the captive coal mine gets operational, the Company is planning to source its raw material from coal linkages / e-auction which would cost ~Rs. 1,150 per tonne. In our calculations, we have assumed realization of ~Rs.3.7 per unit through its merchant sale while the cost of production is expected to be in the range of Rs per unit, resulting into EBITDA margins of ~55-60%. Also we have assumed that the entire funding 7

8 will be done through internal accruals. Hence, the foray in merchant power business would not only help to boost its top-line, but would also help in improving its margin. Improving Financials Considering the strong backward integration plans and rationalization exercise being undertaken by Prakash Industries, we believe the Company is set to enter a different in league in the next two-three years. Lower raw material and intermediary product cost is likely to result into higher operating cash flow and EBITDA margins of the Company. The Company s Operating Cash flow is likely to grow at a CAGR of 13.3% for the next 3yrs. It s operating profit and net profit are likely to grow at a CAGR of 41.5% and 43% respectively for the next 3 years. Growth in the net profit is higher than the growth in the operating level mainly because of the declining interest cost. Backed by strong cash flows from the steel business, PIL s debt is decreasing, thereby reducing the interest cost. EBIDTA to grow at a CAGR of 41.5% NP to grow at a CAGR of 43% 9,000.0 EBIDTA ,000.0 Net Profit , , , , , , FY09 FY10E FY11E FY12E - - FY09 FY10E FY11E FY12E - EBIDTA (Rs.Mn) EBIDTA Margin (%) Net Profit (Rs.Mn) Net Profit Margin (%) Source: Sushil Finance Estimates 8

9 OUTLOOK & VALUATION Prakash Industries a competitive steel player is set to enter a bigger league on the back of its aggressive backward integration plans and rationalization exercise. Higher sponge iron and billets capacity is likely to boost the capacity utilization of the Company from the current level of ~45% to 90%. Moreover, the backward integration by the Company in the form of captive iron ore mines is likely to stimulate its profitability in a big way. Moreover, the foray into the highly profitable merchant power business is also likely to boost the EBIDTA margins of the Company beyond FY12. PIL s EBIDTA margin is likely to expand from the current 23.4% (9MFY10) to 38.4% by FY12E. At Rs.219.7, the stock is currently trading at an EV/EBITDA and P/BV of 3.6x and 1.3x its FY12E estimates. Considering huge margin expansion and EPS growth, we maintain a positive outlook for the Company, and thereby recommend a BUY with a target price of Rs.300 through SOTP methodology. We have valued its steel business at Rs.230 based on a EV/EBITDA multiple of 5x its FY12 estimates, and power business at Rs.70 by DCF methodology. Valuation (Rs. Mn) Steel Business (FY12 Estimates) EBITDA * Target EV/EBITDA Multiple 5.0 EV Debt Cash MCAP 31,927.2 Diluted No Shares Target (Rs.) - (a) Power Business FCFF (assuming plant life of 25 years) WACC (%) 13% Target (Rs.) - (b) 70.0 SOTP Target (a+b) *Steel business financials 9

10 PROFIT & LOSS STATEMENT (Rs.mn) Y/E March FY09 FY10E FY11E FY12E Revenues Net Raw Material Employee Cost Other Expenditure Total Expenditure Operating Profit EBIDTA (%) Dep. & Amortisations Interest PBT excl OI Other Income PBT incl OI Tax APAT APAT(%) Extraordinary Items (61.3) RPAT RPAT(%) FINANCIAL RATIO STATEMENT Y/E March FY09 FY10E FY11E FY12E Growth (%) Net Sales EBITDA PAT (4.8) 29.2 (10.2) Profitability EBIDTA Margin (%) Net Profit Margin (%) ROCE (%) ROE (%) Per share data EPS (Rs.) CEPS (Rs.) BVPS (Rs) Valuation Ratios PER (x) PEG (x) P/BV (x) EV/EBITDA (x) Dividend Yield Turnover Days Debtor Days Creditor Days Gearing Ratio D/E (x) BALANCE SHEET STATEMENT (Rs.mn) As on 31 st March FY09 FY10E FY11E FY12E Equity Share Capital Reserves & Surplus Networth Total debt Deferred tax liability Minority Interest Capital Employed Net Block Capital WIP Investments Current Assets Inventories Sundry Debtors Cash and Bank Loans & Advances Current Liabilities & Prov Net Current Assets Total Assets CASH FLOW STATEMENT (Rs.mn) Y/E March FY09 FY10E FY11E FY12E Net Income Before Tax Depreciation Operating profit before w.cap changes Change in WC (437.1) 1.2 Cash Flow From Operations Chg. In Gross Blocks (2326.4) (3300.0) (4850.0) (5800.0) Chg. In Investment 4.9 (0.0) Cash Flow from Investing (2300.9) (3541.2) (4943.0) (6024.8) Chg In Debt (920.5) (1950.0) (400.0) Chg In Share Capital 0.0 (113.8) Chg In Reserves Dividend Cash flow from Financing (920.5) (400.0) Cash & Cash Equivalent Source : Company, Sushil Finance Research Estimates 10

11 Rating Scale This is a guide to the rating system used by our Equity Research Team. Our rating system comprises of six rating categories, with a corresponding risk rating. Risk Rating Risk Description Low Risk Medium Risk High Risk Predictability of Earnings / Dividends; Price Volatility High predictability / Low volatility Moderate predictability / volatility Low predictability / High volatility Total Expected Return Matrix Rating Low Risk Medium Risk High Risk Buy Over 15 % Over 20% Over 25% Accumulate 10 % to 15 % 15% to 20% 20% to 25% Hold 0% to 10 % 0% to 15% 0% to 20% Sell Negative Negative Negative Neutral Not Applicable Not Applicable Not Applicable Not Rated Not Applicable Not Applicable Not Applicable Please Note Recommendations with Neutral Rating imply reversal of our earlier opinion (i.e. Book Profits / Losses). Indicates that the stock is illiquid With a view to combat the higher acquisition cost for illiquid stocks, we have enhanced our return criteria for such stocks by five percentage points. Desk Research Call is based on the publicly available information on the companies we find interesting and are quoting at attractive valuations. While we do not claim that we have compiled information based on our meeting with the management, we have taken enough care to ensure that the content of the report is reliable. Although we have christened the report as Desk Research Calls (DRC), we intend to release regular updates on the company as is done in our other rated calls. Additional information with respect to any securities referred to herein will be available upon request. This report is prepared for the exclusive use of Sushil Group clients only and should not be reproduced, recirculated, published in any media, website or otherwise, in any form or manner, in part or as a whole, without the express consent in writing of Sushil Financial Services Private Limited. Any unauthorized use, disclosure or public dissemination of information contained herein is prohibited. This report is to be used only by the original recipient to whom it is sent. This is for private circulation only and the said document does not constitute an offer to buy or sell any securities mentioned herein. While utmost care has been taken in preparing the above, we claim no responsibility for its accuracy. We shall not be liable for any direct or indirect losses arising from the use thereof and the investors are requested to use the information contained herein at their own risk. This report has been prepared for information purposes only and is not a solicitation, or an offer, to buy or sell any security. It does not purport to be a complete description of the securities, markets or developments referred to in the material. The information, on which the report is based, has been obtained from sources, which we believe to be reliable, but we have not independently verified such information and we do not guarantee that it is accurate or complete. All expressions of opinion are subject to change without notice. Sushil Financial Services Private Limited and its connected companies, and their respective directors, officers and employees (to be collectively known as SFSPL), may, from time to time, have a long or short position in the securities mentioned and may sell or buy such securities. SFSPL may act upon or make use of information contained herein prior to the publication thereof. 11