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Buoyed By High Crude Prices

The rising crude oil prices augur well for pipe manufacturers like Maharashtra Seamless…

With crude prices remaining firm, Maharashtra Seamless’s prospects have turned buoyant. High crude prices lead to fresh investments into exploration and production (E&P) activities the world over — a trend that has started to manifest itself. The company is positioning itself to take advantage of the opportunities ahead. Its plant in Romania is expected to come online this year and will lead to higher volumes. Meanwhile, a strong order book and huge cash reserves provide comfort to a potential investor in the company. Valuations too are reasonable currently.

Strengths and opportunities
Favourable international environment: High crude price is good news for pipe manufacturers like Maharashtra Seamless. With prices remaining firm at $100 per barrel levels, investments in the E&P sector are expected to start kicking in. Higher E&P activities directly improve the demand for seamless pipes and tubes. The number of rigs in operation has already reached levels seen prior to the 2008 global recession. (Rigs are big clients for pipe companies like Maharashtra Seamless.)
The key markets that are witnessing robust demand include Latin America and the Middle East. In the LatAm market, Brazil, Argentina and Columbia are at the forefront of increased E&P activities. Drilling is on the rise in Brazil and Columbia, while in Argentina, the “Gas Plus” programme (that lifted gas price restrictions on fields lying idle since 2004) has boosted E&P activities.
Buoyant domestic environment: Demand in the domestic industry too has started increasing once again. Four new refineries are under construction and are expected to go online by next year. These include Bharat Petroleum’s Bina refinery, Hindustan Petroleum’s Bhatinda refinery, Indian Oil Corporation’s refinery in Paradip and Nagarjuna group’s refinery at Cuddalore. It is estimated that an investment of around Rs60,000-65,000 crore will be incurred over the next one year on these new refineries. Companies like Maharashtra Seamless stand to benefit from these investments.
Impact of anti-dumping duties: Pipe companies like Maharashtra Seamless stand to benefit from anti-dumping duties imposed in the US and Europe on seamless pipe imports from China. Such proceedings are still going on in India. If the government imposes anti-dumping duties on Chinese suppliers, it will be a positive for domestic pipe manufacturers.
Higher realizations: The company’s realisations have improved due to a robust environment. At Rs60,574 per tonne (Q4FY11), sales realisations from seamless pipes are 20.7 per cent higher than the Rs50,183 per tonne realised in the corresponding period of the previous year. Volumes for seamless pipes too have jumped 31.7 per cent y-o-y to 68,840 tonnes (Q4FY11), and are up 42 per cent on a q-o-q basis. EBIDTA of seamless pipes increased 6.4 per cent y-o-y to Rs18,274 per tonne on account of lower inventory costs and the execution of high-margin export orders.
Realisation of ERW pipes too came in higher at Rs42,650 per tonne vis-à-vis Rs39,855 in the corresponding period of the previous year. During Q4FY11, ERW volumes increased 13 per cent q-o-q but were down 7 per cent y-o-y. EBIDTA per tonne of ERW pipes decreased by 10.5 per cent y-o-y during Q4FY11, to Rs5,882 per tonne as compared to Rs6,569 per tonne in the corresponding period of the previous year, on account of higher operating costs.
Strong order book: Order inflows have improved since the December 2010 quarter, with order backlogs breaching the Rs500 crore mark. During the second half of FY11, order backlog for the company remained in the Rs400-450 crore range. The current order book stands at Rs523 crore, out of which orders worth Rs283 crore (54 per cent) come from the domestic market while the rest come from export markets. Seamless pipes dominate the order book with 78 per cent share; ERW pipes account for the balance 22 per cent.
Capacity expansion to boost volumes: Maharashtra Seamless is putting up a plant in Romania which when completed (expected by Q2FY12) will boost the company’s capacity by 2,00,000 MT per year. Ramp up to full production though may still be two to three years away, according to the company. This additional capacity will help the company turn out greater seamless volumes. For FY12 the company has capex plans amounting to Rs120-130 crore. This investment will go into setting up the Romania plant and into a solar plant that the company is coming up with in Rajasthan.
Cash comfort: The company has reported cash of Rs685 crore (Q4FY11). At Rs97 per share, it amounts to about 27 per cent of its current market cap. After taking into account the capex, analysts expect the company to report free cash flow in the region of Rs400-500 crore.

Threats
No anti-dumping duties on Chinese suppliers: Perhaps the biggest threat to domestic pipe manufacturers is if the Indian government does not impose anti-dumping duties on Chinese suppliers. Chinese players will give domestic companies tough competition if such duties are not imposed on them. There are two main reasons for this. First, a lot of capacity has been added in China that has yet to be fully utilised. Second, the US, which accounts for nearly a third of global demand, is no longer viable for Chinese companies after the imposition of duties. Under these circumstances, industry analysts expect heightened competition and lower realisations if anti-dumping duties are not imposed.
Lower realisations in future: Realisations will be the first casualty in case the Indian government does not impose anti-dumping duties on Chinese suppliers. “That could lead to significant erosion in margins in future,” says Jasdeep Walia of Kotak Institutional Equities. According to Walia, if anti-dumping duties are not imposed, EBITDA margins in the domestic business could fall from the current levels of around Rs16,500 per tonne to Rs10,500 per tonne. Seamless pipes could see erosion in EBITDA margins from Rs17,971 per tonne (FY11) to about Rs13,500 in the current year. Similarly, margins for ERW pipes could decline from the current levels of Rs5,882 per tonne to Rs5,000 per tonne.
Exports to the rescue: What is expected to save the day for companies like Maharashtra Seamless is its high-margin exports. Currently exports, which account for 30 per cent of seamless volumes, earn margins of Rs18,000 per tonne. Industry analysts are cautiously optimistic that the company will be able to maintain the current margin levels in FY12 as well.
In spite of the above concerns, with crude remaining high and increased E&P spending seen ahead, these are opportune times Maharashtra Seamless. A healthy order book, higher seamless volumes, and strong cash position are positives for the company. Realisations in the domestic business have not yet fallen.

Valuation
At the current market price, the company is trading at a 12-month trailing PE of 7.44. This is lower than its five-year median PE of 8.87. The PEG ratio (based on five-year EPS growth rate) stands at 0.57, which is quite attractive. Maharashtra Seamless is well placed to grow its earnings, given the high price of crude oil currently.