By Vivek Ananth
There is no better time than now for a steel products maker to hit the public markets. The surge in demand for steel across the world has sent steel prices to new highs. This is despite efforts by China to cool domestic steel prices by imposing export duties, and taking steps to curb speculation.
The current surge in steel prices is a result of China cracking down on polluting industries over the past three years, compounded by the post lockdown jump in steel demand. We have dealt with how this phenomenon helped JSW Steel and Tata Steel. You can read them here and here to get a sense of how the steel industry is faring.
In the midst of the rising demand for steel comes the initial public offering (IPO) of Shyam Metalics and Energy. Its IPO consists of an offer for sale of up to Rs 252 crore and a fresh issue worth Rs 657 crore. Out of the fresh issue, Rs 470 crore will be used to pay off some of the company’s and its subsidiary’s debt, and the rest will be used for general corporate purposes. The IPO opens on June 14 and closes on June 16.
The issue is priced at Rs 303-306, and based on its financials for the nine months ended December 31, 2020, Shyam Metalics is valued between 15.5-15.7 times its earnings for the period ended December 31, 2020. If we annualise this, the company is valued at 11.8 times its expected FY21 earnings. This is lower than some large cap steel companies, but on a price-to-book basis, the company is valued at 2.2 times, which is higher than Tata Steel, but lower than JSW Steel.
Apart from making steel products like TMT bars, wire rods and pipe, and steel billets, the company also produces iron pellets, sponge iron and ferro alloys. It would seem that the company’s IPO is timed perfectly, considering investors’ interest in the steel sector has sent steel companies’ stock prices to new highs. But does this IPO hold up?
High steel prices shore up profits and cash flows
As Shyam Metalics’ red herring prospectus contained data only up to December 31, 2020, comparisons with peer performance will be a little difficult. But the trend in the steel industry of higher profits in FY21 didn’t elude Shyam Metalics. The company’s net profit surged in the period ended December 31, 2020, despite a modest rise in revenues. This is because most steel companies couldn’t make up for lost volumes in Q1FY21.
This led to a rise in the company’s margins for the nine months ended December 31, 2020. The thing to remember here is that there was a surge in steel prices from January 2021 onwards, hence these margins numbers almost certainly would rise for the full year FY21.
Now as margins rose, the company also started generating higher cash through its operations. So much so that its free cash flows rose for the period ended December 31, 2020.
This indicates that the prospects of the steel industry, and the metal space in general is looking up. But how long will this last is the question. The fact that the company’s return ratios are quite high for the industry will entice investors to look at the company as an investment prospect.
Another reason the company might appear to be a good investment prospect is its debt position. It has fairly decent debt ratios.
The company seems to be capable of generating enough resources internally to fund its expansion plans up to FY25 through internal resources. It currently has an average installed capacity of 5.71 million tonnes per annum (MTPA) and is planning a total capacity expansion, including various products, of 11.60 MTPA.
Future prospects hinge on a long economic growth cycle
The steel industry does well when the larger economy does well. Over the past decade, there were a few bumps in the road - but 2018 and 2019 were good years while FY21 was marred by the economic impact of the pandemic.
Going forward, infrastructure spending by many countries including India will support steel demand. Domestic demand will also be helped by the government’s push towards affordable housing. But apart from affordable housing, the rest of the real estate industry is in a funk. With some buyers postponing their home purchase waiting for prices to correct, it is not clear when demand for housing will revive. CRISIL Research expects steel demand to grow at a CAGR of 5-6% from FY20-25. This takes into consideration the dip in demand seen in FY21
Keeping this in mind, should investors bet on the new kid on the block? For that investors will have to ask whether they want to bet on an established integrated steel player, or an integrated steel company that is going public, that is valued at a level close to the sector’s largest players.