Electrosteel Steels Limited (ESL)

Electrosteel Steels Limited (ESL) E q u i t y Re s e a r c h D e s k IPO Note Sector - Steel 21 st September, 2010 Highlights of the Issue Issue Snapshot Issue Open: 21-Sep-10 Issue Close: 24-Sep-10 Price Band ` 10 to 11 Issue Size (` Mn) 2,255.2 to 2,480.7 Market Cap (` Mn) 20,345.4 to 22,379.9 Recommendation: SUBSCRIBE Electrosteel Steels Limited is promoted by Electrosteel Castings Ltd., to set up a 2.2MTPA Integrated Steel and Ductile Iron plant in Jharkhand. ESL is setting up the proposed plant in Bokaro District of Jharkhand. The proposed plant will be based on Blast Furnace (BF) - Basic Oxygen Furnace (BOF) - Billet Caster and Hot Rolling Route. Issue Size (No. of Shares) 225,516,188 QIB: 135,309,713 Non-Institutional: 22,551,619 Retail: 67,654,856 Face Value (`) 10.0 Book Value (`) as on FY10 9.2 Capital Structure (` Mn) Pre Issue Equity 18,090.2 Post Issue Equity 20,345.4 * The issue has a Green Shoe Option of 33,827,428 shares Shareholding Pattern Pre Issue (%) Post issue (%) Promoter & Promoter Group 38.7% 34.4% DII, FII & Others 61.3% 54.5% Public 0.0% 11.1% Total 100.0% 100.0% Total Shares 1,809,018,835 2,034,535,023 Objects of the Issue No. Particulars ` Mn. 1 Part Finance the integrated steel and DI plant 2,492.4 2 Margin Money towards Bank Guarantees 220.0 3 General Corporate Purposes [.] Total [.] Means of Finance No. Particulars ` Mn. 1 From Equity and Pre-IPO Placement 16,657.3 2 Through loans 54,470.0 3 Net Issue of Proceeds 2,492.4 Total 73,619.7 Investment Rationale ESL is setting up an integrated steel and DI pipe plant. The plant will be present across steel s entire value chain. The integrated operations will help ESL reduce costs, thereby being margin accretive. ESL has acquired more than 1,800 acres of land, taking into account requirements for the current plant and also any expansion if required. The company is also constructing 2x60MW of power plant for its captive consumption. The company has entered into a 20-year agreement with ECL to procure 100% of its iron ore and 30% of its coal requirements at cost plus twenty percent, ensuring raw material availability. ESL s plant is in close proximity with the nearest highway, station and raw material source, thus reducing freight costs. The company is leveraging ECL s established marketing network and has also entered into an agreement with Stemcor to sell its products in the international markets. Valuation & Recommendation At the upper band of ` 11, the stock is available at a P/BV of 1.2x based on post issue BVPS of ` 9.4. As compared to its peers P/BV of 2.0x and 2.5x, ESL is reasonably valued, however, any delays in the commissioning of plant s operations may affect ESL s performance. Hence, investors with a long term horizon can Subscribe to the issue. Ankit Shah ankit.shah@spasecurities.com I n s t. D e a l i n g D e s k : S P A H o u s e, N y a y s a g a r, N e a r G u r u n a n a k H o s p i t a l, K a l a n a g a r, B a n d r a ( E ), M u m b a i 5 1 T e l. N o. : 0 2 2-4 2 8 9 5 0 0 0, F a x N o. 2 6 5 7 3 7 0 8 / 9 E m a i l : r e s e a r c h @ s p a s e c u r i t i e s. c o m Page 1 of 5

Investment Rationale Integrated Operations ESL has been setup as a part of ECL s backward integration strategy. The 2.2mn tonnes plant will be present across steel s entire value chain, from Blast Furnace (BF) - Basic Oxygen Furnace (BOF) - Billet Caster and Hot Rolling Route to Wire Rods, TMT Bars, DI pipes, commercial billets and Pig Iron. The integrated operations will help the company to reduce costs and dependency on other companies. Land Acquired Land required for the proposed plant is close to 600 acres with another 200-300 acres required for construction and storage of materials. ESL has however acquired close to 1,805 acres taking into account scope for future expansion. Raw Material Security Iron ore and Coal are the key raw materials for manufacturing steel and steel products. ESL has entered into a long term agreement for 20 years with ECL to source 100% of its iron ore requirements and 30% of its coal requirements on cost plus twenty percent. The raw material linkages with ECL provide ESL with much needed raw material security. Captive Power ESL is constructing 120MW (2x60MW) power plants for captive consumption. Of the two power plants of one will be based on Waste Heat Recovery System and the other on Thermal Coal. The company has linkages with Coal India for its thermal coal requirements. Location Advantages ESL s steel plant located near village Siyaljori in Bokaro District of Jharkhand is around 22km from Bokaro city. This belt has a supply of key raw materials, such as Dolomite, Quartzite, Ferro alloys and additives. The plant is located within 18km from the state highway and the nearest railway station. The coking coal and iron ore mines are located at a distance of 6km and 230km respectively from the plant, thereby reducing transportation and procurement costs. ESL is also planning to have their own railway siding, which will further reduce the logistics cost. Marketing Tie-Ups ESL will leverage on ECL s established network to sell its products in the domestic markets and has entered into a tieup with Stemcor, an international player which has been in the business of international trade and marketing of steel for over 5 decades. ESL has entered into a Delivery and Marketing Agreement with Stemcor for international marketing of its products. As per this agreement, Stemcor will buy DI pipes, and long steel products consisting of billets, beam blanks, bars, rods, square and/or structural steel for a period of three years from the date of commercial production in a series of regular monthly consignments at a price reflecting market prices. Top Investors Institutional investors both domestic and international hold 61.3% of the pre-issue capital. Post issue this is expected to be diluted to 54.5%. Some of the top institutional investors are Shareholding as on 9-Sep-10 % Holding Stemcor Cast Iron Investments Limited 22.2 IFCI Ltd 5.5 GPC Mauritius II LLC 4.8 PGS Invest Limited 4.2 IL&FS Financial Services Limited 4.2 Franklin Templeton Private Equity 3.1 Investment Concerns ESL only has one integrated steel and DI pipe plant which is under construction. This plant is expected to be commissioned over the next six to nine months. ESL will report revenues only after the plant is commissioned. Any delays in the commissioning of the plant may affect ESL s financial performance. Company Background Electrosteel Steels Limited is a part of Electrosteel Castings Ltd. ECL, focusing on its strategy to integrate backwards has obtained iron ore and coal mining blocks in Jharkhand and has set up ESL to implement the integrated steel and DI Pipe plant. ESL is setting up the proposed plant in Bokaro District of Jharkhand. The proposed plant will be based on Blast Furnace (BF) - Basic Oxygen Furnace (BOF) - Billet Caster and Hot Rolling Route. The breakup of the proposed capacity is as under. Product Capacity Size Wire Rods 0.50 5.5-12mm TMT Bars 0.70 8-32mm; 60mm dia DI Pipe 0.33 Commercial Billets 0.27 Pig Iron 0.40 Total 2.20 Source: Company; Capacity: MMTPA 2 S P A S e c u r i t i e s L i m i t e d

Industry Overview The Indian Pipe Industry is among the top three manufacturing hubs after Japan and Europe. However, the penetration level of pipelines in oil & gas transportation is quite low at 32% in India as compared to 59% in USA and 79% globally. The low penetration of pipes in the domestic market provides a huge business opportunity. The Indian line pipe industry is around ` 235bn. Pipelines are also the most economical mode for transporting fluids and gases as compared to roads and rail. Ductile Iron (DI) Pipes DI Pipes are used in water and wastewater systems. DI Pipes are fast replacing CI pipes as they are lighter, stronger, cheaper and more durable than the latter. DI pipes also have a lower lifecycle cost and hence are preferred over polyvinyl chloride concrete, polyethylene and steel pipes. Currently, the total demand for DI Pipes in India is 800,000MT, of which close to 68% is produced locally. State and Central governments are the major consumers of these pipes. With the government s increased thrust on Oil & Gas sector, improved water supply & sanitation infrastructure and irrigation, the line pipe demand is expected to remain robust in the coming 3-5 years. Schemes ` Bn Rajiv Gandhi Drinking Water Mission 73 Addition to irrigation facilities 1,580 Total 1,653 Promoter s Profile ESL is a part of Electrosteel Castings Limited, which is in the business of manufacturing CI pipes for more than 40 years, DI pipes since last 15 years and in DI fittings. ECL has four manufacturing facilities, of which two are located in West Bengal, one each in Tamil Nadu and Jharkhand. For FY10, ECL reported consolidated revenues of ` 15,807.5mn. The plant in Khardah, West Bengal has an installed capacity of 0.27MTPA for manufacturing DI pipes, while Haldia, West Bengal plant has an installed capacity of 0.30MTPA for production of coke and 0.06MTPA for producing sponge iron. ECL has its third plant in Elavur, Tamil Nadu having an installed capacity of 0.09MTPA for manufacturing steel castings and CI pipes. The fourth plant is a coal washery plant in Parbatpur, Jharkhand. Valuation ESL s partially integrated operations will help the company to reduce operational costs and in turn be margin accretive. The company is leveraging on its promoter s well established marketing network for its sales. At the upper band of ` 11, the stock is available at a P/BV of 1.2x based on post issue BVPS of ` 9.4. As compared to its peers P/BV of 2.0x and 2.5x, ESL is reasonably valued, however, any delays in the commissioning of plant s operations may affect ESL s performance. Hence, investors with a long term horizon can Subscribe to the issue. Source: Planning Commission, SPA Research Given the advantage of DI pipes over steel pipes in lower diameter range, the demand for DI pipes is expected to grow at a CAGR of 15% for the next couple of years. 3 S P A S e c u r i t i e s L i m i t e d

Financials Balance Sheet as on 31 st March ` Mn Share Capital 0.9 3,385.7 16,657.6 Share Application Money 3,099.6 3,106.9 Net Worth 3,100.3 6,492.5 16,657.5 Borrowed Funds 1,330.6 17,285.3 24,693.6 Total Liabilities 4,430.9 23,777.8 41,351.0 Gross Block 475.7 1,277.2 2,031.6 Less: Depreciation 0.5 3.1 15.3 Capital work-in-progress 2,194.7 19,951.1 36,856.0 Net Block 2,669.9 21,225.1 38,872.3 Investment - 1,764.3 1,606.0 Net Current Assets 1,761.1 788.4 872.6 Total Assets 4,430.9 23,777.8 41,351.0 Income Statement as on 31st March ` Mn Income from Operations - - - Operating Expenditure 556.6 627.3 1,139.6 Other Income 37.0 154.7 478.7 Inc/(dec) in stock EBIDTA (519.6) (472.6) (660.9) Depreciation 0.5 2.8 12.1 PBIT (520.1) (475.4) (673.0) Financial Charges 5.7 871.8 2,198.9 Profit Before Tax (525.8) (1,347.2) (2,871.9) Tax Expenses - - - Profit after tax (525.8) (1,347.2) (2,871.9) Cash Flow Statement as of 31 st March ` Mn From Operating Activities - - - From Investing Activities (2,765.1) (19,579.3) (14,987.2) From Financing Activities 4,425.4 18,475.1 15,374.3 Net Cash Flow 1,660.3 (1,104.2) 387.1 Opening Cash 119.5 169.5 132.8 Closing cash 1,779.8 (934.7) 519.9 Ratios as of 31 st March Debt to Equity (x) 0.4 2.7 1.5 BV/Share (`) 1.7 3.6 9.2 P/BV at 310 (x) 6.4 3.1 1.2 *Pre Issue Figures Peer Comparison Company CMP (`) Shares (Mn) M-Cap (` Mn) BVPS (`) P/BV (x) ESL @ 10 10.0 2,034.5 20,345.4 9.3 1.1 ESL @ 11 11.0 2,034.5 22,379.9 9.4 1.2 Uttam Galva 155.1 119.8 18,582.5 77.2 2.0 SAIL 204.9 4,130.4 846,319.1 83.5 2.5 *BVPS is calculated using post issue shares 4 S P A S e c u r i t i e s L i m i t e d

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