Stock Pick from Iron & Steel/Interm.Products Sector

HERE IS WHY

• De-risking with diversifi ed business model
• Improving ROE on back of increased capacity utilization and margin expansion
• Progressively evolved to manufacture value added products

Pennar Industries diversified over the years from being just another cold-rolled steel manufacturer into a prominent engineering-driven enterprise. Pennar widened its product mix to address the growth coming out of four business segments, de-risking itself from an excessive dependence on any one segment. It is a manufacturing company with presence in 1) Steel products ‐38 per cent revenue 2) Pre Engineered Building Systems, PEBS - 32 per cent revenue 3) Tube - 12 per cent revenue 4) Systems and Projects ‐ 11 per cent and 5) Industrial components ‐ 5 per cent of revenue.

From leverage side, the good part is that the company does not have significant long term debt (D/E ratio of 0.40x). All debt is working capital related. Hence even if economic recovery is delayed due to whatsoever reason it will not hurt the company too much. On the converse side, in case of faster recovery, the company can absorb the advantage very fast as it is ready with capacity.

Pennar is looking to unlock the value of its subsidiary -- Pennar Engineered Building Systems (PEBSL) through IPO which could be the additional trigger. It was incorporated in February 2008. Pennar, with a capacity of 90,000 metric tons, is the 4th largest player in PEBs segment in the country. In the last 5years, the demand and awareness about PEBs has grown multifold. Given the infrastructural needs of India over the next two decades, the demand for PEBs will increase by 6 times. In 2014, PEBSL recorded 28 per cent growth in top line at Rs 417.2 crore over the previous year. Even  operating profit posted a worth of Rs 37.14 crore and a net profit of Rs 18.26 crore, representing 4.5 per cent and 26.87 per cent growth, respectively as compared to last year.

Steel products business is expected to grow more than Rs 450 crore in 2015 as against Rs 426 crore in 2013. The company is expecting double-digit growth in business from Railways in 2015. As of now, this business has an order book of Rs 120 crore. As per management, the company’s overall revenue will grow to around 20-25 per cent with better margin improvement.

But capacities in all segments are underutilized since last 4 years due to lack of demand. Therefore, return on equity (ROE) for the company in past three years has been very low at 12.9 per cent. However, in 2015-16, the ROE of the company may improve by 350 bps points in each year on back of increased capacity utilization and margin expansion.

Currently, Pennar is trading at TTM PE ratio of 25 and. on the basis price to book, it trades at 1.85x. We believe Pennar has high growth potential in sectors like railways, power, logistics and water treatment besides solar power projects, railway and PEBs business where it earns more than 10 per cent margin. Progressively evolved to manufacture niche value-added products; the proportion of revenues from value-added products increased from 15 per cent in 2011-12 to 50 per cent in 2013-14. We recommend our readers to buy the scrip with expectation of 45 per cent curving upwards from its current market price in the next one year.