Sunflag Iron & Steel

I done a post on the company at my blog:http://dalaal-street.com/sunflag-iron-steel-cmp-31/

I have received the annual report today and I’m much more convinced on the stock. The stock seems to be a safe and tempting bet to me at these levels.

Views Invited.

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Hi Ayush,

I looked at sunflag iron after going through the details provided on your blog.

As you say, it looks very tempting at current levels. It looks like a stock getting ready to be re-rated. I bought some today.

Two small things nagging me:

First is power and fuel costs are increasing

Second is debt also seems to be increasing going by the interest payment in latest quarter.

Positive thing is promoters seems to be jacking up their holding from market purchases.

Valuation wise, looking at the consistency of its growth in sales and profits, it looks very good buy at current price and on declines.

regards

hitesh.

Key operating ratios

Year end Mar 10 Mar 09 Mar 08 Mar 07 Mar 06
EPS(Rs) 5.77 2.60 2.60 2.24 1.85
Book value(Rs) 25.50 20.23 18.13 16.03 14.03
CEPS(Rs) 8.10 4.51 4.97 4.71 4.72
NPM(%) 6.53 3.54 3.87 3.90 3.76
OPM(%) 13.49 9.67 10.00 10.62 11.71
ROCE(%) 22.87 14.38 13.83 13.59 15.31
ROE(%) 25.59 14.01 15.75 15.20 13.57
Debt/equity 0.86 0.97 0.94 0.83 0.73
Interest cover 5.26 2.90 3.59 5.09 5.65

There is a big positive shift in all key ratios. The 1QFY10 results are also very encouraging.

Sunflag Iron & Steel Company Ltd

Quarter ended Year to
Date
Year ended
201006
(3)
200906
(3)
% Var - - 201003
(12)
200903
(12)
% Var
Sales 399.03 285.08 39.97 NA NA NA 1349.63 1102.47 22.42
Other Income 0.20 0.15 33.33 NA NA NA 4.96 4.95 0.20
PBIDT 53.99 38.75 39.33 NA NA NA 196.02 119.26 64.36
Interest 9.42 7.50 25.60 NA NA NA 30.04 30.44 -1.31
PBDT 44.57 31.25 42.62 NA NA NA 165.98 88.82 86.87
Depreciation 9.84 7.29 34.98 NA NA NA 37.88 30.94 22.43
PBT 34.73 23.96 44.95 NA NA NA 128.10 57.88 121.32
TAX 9.36 8.00 17.00 NA NA NA 29.04 10.77 169.64
PAT 25.88 15.96 62.16 NA NA NA 94.91 43.60 117.68
Equity 162.20 162.20 0.00 NA NA NA 162.20 162.20 0.00

Why has these positives gone largely unnoticed by the market? Stock has remained in the same price range more or less from Dec 2009??

Excerpts from the AR 2010

STEEL INDUSTRY

Industrial climate during the year has improved particularly for the Steel Industry, Automobile and Auto Components Sectors. TheIndian Steel Industry also witnessed the recessionary conditions during the financial year 2008 -2009, but recovered in the latterpart of the year and the trend continued in the financial year under review.

The Alloy steel industry in general also showed goodimprovement in production, commensurate with the demand of steel for automobile application. The growth in the manufactureof commercial vehicles during the year was significant. In other areas of automobile industry, motorcycle production has showntremendous growth which improved the demand of alloy steel for component manufacture for this industry.

SUNFLAG STEEL having entered into the areas of manufacturing of wire rod and bars of alloy and special steel, aftercommissioning vacuum degassing, has benefited from this increase in alloy steel demand.

MATERIAL DEVELOPMENT

Taking advantage of the increased demand for its product, SUNFLAG STEEL has been able to increase its production andsales during the year by about 52% and 23% respectively over the previous year. Due to abnormal rise in the cost of inputs suchas iron ore and coke, full benefit could not be realised.

In order to achieve effective cost reduction and improvement in productivity, activity of Total Productive Maintenance (TPM)continued to be implemented by the Company during the year under review.

OPPORTUNITIES

SUNFLAG STEEL see more opportunities in the years to come due to continuous developments of new grades of highalloy steel as well wire rod and cold rolling sheets. Further, venturing into the self dependency of raw material and power indecreasing in the cost of production and enhancing the profitability.

THREATS

The global slowdown, raising and fluctuating prices of raw materials and energy cost (power and fuel) is adversely affected theoutput prices thereby causing hardship to the customers. The availability of the quality raw materials viz Iron Ore, Coal, LAMCoke is the cause of concern for the industry.

A quick read through this, it appears that as a producer of alloy steel/special steel, the automobile industry is the main customer for its finished steel products. So, if the auto industry is going to do well in FY11, Sunflag should do well too.

The flip side is raw material cost trends. Anyone has clear inputs on that? The captive power plant actually produced less power in FY10 than FY09??

Hi Hitesh,

Good to see some discussion on the stock…otherwise I was a loner here :wink:

The increase in interest cost in the last quarter seems to be an adjustment caus as per the latest annual report, the loan hasn’t increased much. Infact the debt-equity ratio is improving over the years.

If one goes through the last few years of annual reports, the biggest hidden positive is - they are investing aggressively in coal mines. They are trying to put up a hydro power plant trough a subsidiary. Going ahead these moves should have a major positive effect.

Regards,

Ayush

Sometimes markets take a long time to factor in positives. We have plenty of experience on this aspect on manjushree and other scrips. And since markets are correcting now, the focus will be more on the large/mid caps and risk aversion is quite high so people will not gather courage to buy such companies.

SUNFLAG IRON IS A VERY OLD COMPANY listed on boUrses way BACK IN 90s n it was more well known for Sunflag hospital in Faridabad rather its steel business in Nagpur.

Its rare to find companies specially in manufacturing sector owned by Brahmins.Bharadwajs if i remeber correctly were NRIs from Africa.Somehow the fire in Belly seems to be missing from these fairly old entrepreneurs.

Has a new dynamic young generation recently taken over which seems to leading to better performance?

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Whats the PE Of tata steel n why shud we not buy Tata steel or Bhushan or Adhunik instead of a small player like sunflag with backward linkage yet to happen.

Entering into cyclicals is always dangerous even though valuation today appear ok

Vivek,

Yes, new generation has taken part in the management of the company and the profile seems impressive.

The logic for investing is the very much improved performance in the company and cheap valuations.

Backward linkage (coal mines) is already there in Sunflag and its also operational.

Regards,

Ayush

Any chance of Sunflag being allotted a iron ore mines?

I find the chances slim as the plant is located iN maharashtra where are there any iron Ore mines?

Tell something more abt the 2nd generation promoters.

Pl also tell abt the comparative valuation of sunflag with Adhunik,Visa etc

Hi Vivek,

Summary of valuation of Sunflag is - CMP is 33, BV is 26 and PE is 5. Debt Equity is 0.8 : 1.

Had a glance at Visa - It is trading at 40, BV is 28 and PE 10. Debt Equity is more than 3.5:1

Adhunik: It is trading at 115, BV is 50, PE is 22. Debt Equity is more than 4:1

I think the above comparison would be enough the highlight the value and reason for mybullishness:)

Profile of the young director Mr Pranav Bhardwaj:

Mr. Pranav Bhardwaj, aged about 36 years, is a British National and person of India origin. He has graduated as B.Sc. Majoring

in Chemistry and Business Management (Joint Honors Degree) from the world renowned Imperial College of London.

Though he belongs to the Promoter Group, he preferred to join Sunflag Iron and Steel Company Limited as a Trainee to work and

have an experience at basic levels. During the period 1995 to 1999, he undergone intensive training in production, planning and

control, maintenance and service, quality control, purchase, marketing, customer satisfaction and human resource management.

He is instrumental in product development and export sales.

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Great work thanks buddy. I will add some Sunflag surely.

Adhunik , Visa , Prakash INd, Sarda Energy & Godavari ispat have the added advantage of iron ores n coal mines already allocated or in the process of being allocated.

nevertheless Sunflag is moving into next orbit.

What are your other picks now.I hv added pondy also on friday.Thanks again

We hadmentioned about Sunflag Iron Link: http://dalaal-street.com/sunflag-iron-steel-cmp-31/ . Link: http://dalaal-street.com/sunflag-iron-steel-cmp-31/ Since then then the stock price has appreciated by just 10% while the fundamentals and the outlook getting stronger.

We had mentioned that the**company has been acquiring coal blocks since last few years and getting backward integrated.**The latest annual report gives a strong confirmation on the same:

Excerpt from the FY 2010 annual report:

aDuring the year under review, the total coal production at Belgaon Coal Block is 140,147 MT as against of 51,234.41 MT in the previous year, which is about 174% higher than the previous year.a

If one analyses the Fixed Asset schedule and the investment section, the company has been stepping up the investments for captive coal blocks after the success from the Belgaon coal mine. For eg: The co has invested 10 Cr+ in subsidiary a Khappa Coal Mine which is JV between Sunflag Iron (63.27%) & Dalmia Cement (36.73%).

Future expansions as per the annual report:

Link: http://dalaal-street.com/wp-content/uploads/2010/09/Projects.jpg

Link: http://dalaal-street.com/wp-content/uploads/2010/09/Opportunities.jpg

Compelling Valuations at CMP of 34:

  • FY 2011 Expected turnover is 1650 Cr+, with expected NP of 110 Cr+
  • Stock is trading at less than 5 PE on expected FY 2011 earnings
  • Stock is trading at 1.25 times BV of 25.50
  • Debt Equity ratio has improved to 0.80 : 1

Promoters have been regularly buying from open market and have increased their stake from about 40% in September 2008 to about 51% as of now.

http://dalaal-street.com/sunflag-iron-update/ Link: http://dalaal-street.com/sunflag-iron-update/

Ayush,

Looking at this table below, what are the observations?

Adhunik Mukand Kalyani Sunflag
FY10 FY09 FY08 FY10 FY09 FY08 FY10 FY09 FY08 FY10 FY09 FY08
CMP 116.6 77.15 132.8 32.85
Eq Capital 123.5 91.23 91.23 73.12 73.12 73.12 21.86 43.69 43.69 162.2 162.2 162.2
FV 10 10 10 10 10 10 5 10 10 10 10 10
# of Shares 12.35 9.123 9.123 7.312 7.312 7.312 4.372 4.369 4.369 16.22 16.22 16.22
Sales 1345.5 1283.4 1104 2122.88 2150.22 2201.25 1153.5 1167 1155.6 1452.8 1233 1127
Op Cash flow 280.99 52.05 82.31 -70.44 91.67 123.62 98.17 98.18 -71.09 72.61 79.1 12.35
Opcflow/Sales 20.88% 4.06% 7.46% -3.32% 4.26% 5.62% 8.51% 8.41% -6.15% 5.00% 6.42% 1.10%
Eq Dividend 15.44 10.55 10.95 7.31 0 7.31 5.46 0 17.46 8.11 8.11 8.11
EPS 4.16 3.11 8.62 8.31 6.97 9.69 0.76 17.46 5.77 2.6 2.6
TTM-EPS 5.39 8.43 14.82 6.46
CFPS 22.75 5.71 9.02 -9.63 12.54 16.91 22.45 22.47 -16.27 4.48 4.88 0.76
BVPS 49.84 31.98 33.96 69.28 61.97 87.78 63.33 118.1 117.29 25.5 20.23 18.13
DPS 1.25 1.16 1.20 1.00 0.00 1.00 1.25 0.00 4.00 0.50 0.50 0.50
OPM 20.48 15.22 15.96 16.34 3.51 14.05 8.16 4.36 11.45 13.49 9.67 10
NPM 4.01 2.35 7.29 2.92 -5.85 2.37 2.78 -0.66 6.15 6.53 3.54 3.87
RoCE 12.52 11.12 15.79 14.06 0.85 14.01 10.08 2.52 17.73 22.87 14.38 13.83
D/E 2.72 3.46 2.31 3.17 2.43 1.88 0.58 0.46 0.32 0.86 0.97 0.94
P/E 28.03 9.28 13.70 5.69
P/E TTM 21.63 9.15 8.96 5.09
P/BV 2.34 1.11 2.10 1.29
P/Cflow 5.12 -8.01 5.91 7.34
Div Yield 1.07% 1.30% 0.94% 1.52%

My observations are:
1. Sunflag has the lowest debt among its peers. D/E always lower than 1. rare in this industry; Consequently the best NPMs, and also thebest RoCE among its peers-22%. roCE over 20% in Steel industry must be rare??
2. We know it has increased production by 52% in FY10 over FY09. Capacity beiong added for widening product range (blooming Mill), DRI Sponge Iron (captive use), and mining projects without a big debt burden
3. On a P/E (5.09) and P/BV (1.29) basis it is available the cheapest, if you ignore Mukand which had negative cash flows
4.The low-debt cushion is what makes Sunflag tick, it looks like. We should work out capacity utilisation levels and get an idea on current capex underway to see if this picture is going to change in FY11
5. Adhunik Metaliks also seems good. Look at the Op cash flow growth, its product mix has changed with power segment coming in and backward linkages have started improving OPMs (20%) substantially. Because of the debt burden NPMs and Returns are subdued; but this picture can change completely in the next 2 years. At the moment it is not cheap, but on some dips, the risk/reward picture may change.
Company specific risks are minimal.The debt picture might deteriorate (seems unlikely), Sunflag Iron has maintained D/E below 1 for last 6 years, yet grown at 10% plus CAGR.Raw material volatility (not enough backward linkages) and Steel market prices volatility will remain the risks applicable to a more or less extent to the entire sector.
Sunflag iron is quoting at the lower end of its historical valuation range (5x-9x). should see it rated towards the higher end. 8x TTM should see it past Rs.50?
This is the first time I am looking at Steel sector, I might have missed many issues.Views welcome.
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Looking at the table, Yes, Sunflag is available at very comfortable valuations. The best thing is - the co has been growing without debt…and a debt equity ratio of abt 0.80 : 1 is very comfortable.

ROCE has risen for this year only…otherwise Sunflag has had a dull ROCE in past (like the industry) but yes Sunflag has been a stable co and has had less volatility in earnings and growth.

Regards,

Ayush

Another important point is - nobody is trying to look ahead i.e… can the co continue the growth rates of last 2-3 yrs?? What will be the affect of the expansions going on?? As the co is acquiring further coal mines…won’t the margins get better?

Once the above positives are also factored in and risk-reward is considered - it will be highlyfavorable.

Are there better options in this market? :slight_smile:

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Donald, i think you are being short sighted by looking at just 3 years,please look at 10 year data and ROCE has been around 12-13%, thats the reason i said that this would be fairly valued at 1.8-2x BV . If i assume what ayush is saying about volume growth & capacity utilization & the benefits of coal mines, it remains to be seen whether they can maintain ROCE of atleast 15-20 %, then it is game on. i Have yet to go through the ARs will get back later. Better Options?? i missed Smartlink Networks which was a steal at around 50 in july now up almost 50% :frowning: .

Yes. Capacity additions and widening product range augur well for growth. As per AR fY10,The Blooming Mill will produce in the range of 75 mm dia to 160 mm dia thus widening the product range andmaking Sunflag, a Company offering a wide range of alloy steels products from 5.5 mm dia to 160 mm dia.

I am not so sure about the coal mine acquiring thing. Mining reserves are important when looking at backward linkages. the details I could find of allocated coal blocks as on June 2010 from Coal Ministry, for Sunflag are low reserves. Belgaon mines -some 15.3 Mt,ChoritandTailiaya -8.72 Mt, Khappa -53.6 Mt.

Other than Belgaon mine, there is no mention of proceeding on the other allocations in AR.Infact in Sep 2009 they have been warned for de-allocation(along with many others) for not progressing on allocations -did not submit BGs on time.

On the other hand, there is news of a JV coke oven project with GMDC for which the company has demanded caol blocks and written to coal ministry identifying 4 blocks in Bihar.The MoU signed by the two companies at the Vibrant Gujarat Global Investors’ Summit 2009 envisages setting up a coke oven plant with an initial capacity of 2 million tpa, to be expanded to 5 million tpa, based on an indigenous blend of coking coal with backward integration into coal mining. These mines have estimated reserves of 1078 million tonnes, and more!

If we get some concrete details here, that can let us take a more objective view on the impact of backward linkages. If the above findings are the actual situation, the backward linkages claim don’t amount to much.

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Yes RoCE has improved majorly in 2010. Thanks a lot, Ayush pointed that out too.

Perhaps we should look into the reasons for the jump in EBIT. If that is due to the coal block output rising by 174% over FY09, then there is a big impact of backward linkages. And that may mean sustainability of higher RoCE levels.

Sunflag is available at 1.2x BV. You are sayingfairly valued at 1.8-2x BV? Typo??

btw where are you looking at 10 yr data?

:)( .

I am looking at 10yr(11yrs in fact & 15 yrs of cash flow) data from Money Control…all though it is Standalone. I hope there is not much difference in standalone vs consolidated. Yeah there was a big jump in NP in 2010 thats why i thought it was a cyclical at its peak. It would be a great buy if we can determine the reasons for the jump & sustainability of ROCE(allthough being a cyclical it is going to be volatile).

Regarding P/BV , no it wasn’t a typo i meant it(have adopted same approach for Manjushree & not sold yet) . Its something i am trying out , i got this idea from Prof Bakshi. I compare the ROE/ROCE(depending on debt) to the risk free treasury rate (assume 7%) and accordingly a business returning 14% should be valued at twice Book Value. IT might not work always but i found the approach interesting & helps me pick good businesses at fair prices.

sayingfairly

Donald, i think you are being short sighted by looking at just 3 years,please look at 10 year data and ROCE has been around 12-13%, thats the reason i said that this would be fairly valued at 1.8-2x BV . If i assume what ayush is saying about volume growth & capacity utilization & the benefits of coal mines, it remains to be seen whether they can maintain ROCE of atleast 15-20 %, then it is game on. i Have yet to go through the ARs will get back later. Better Options?? i missed Smartlink Networks which was a steal at around 50 in july now up almost 50% :)( .