Welspun Corp: Sell

Intense competition among producers of welded pipes in a lacklustre demand scenario has pressured the margins of Indian producer Welspun Corp. Investors should consider reducing their exposure to the scrip in favour of Maharashtra Seamless, which is into more lucrative segments.

At Rs 141, the Welspun Corp stock trades at around 15 times the trailing 12-month earnings, higher than Maharashtra Seamless' eight times multiple.

WHAT WELSPUN DOES

Welspun makes welded steel pipes and plates. It acquired a sponge iron producer, Max Steel, last year. Its infrastructure arms are Leighton Welspun and Welspun Projects (formerly MSK Projects).

The company's key welded pipes cater to the oil and gas segment and are also used to transport water. Welspun's capacity has risen over two-fold in the last five years to around 2.2 million tonnes per annum. However, only part of the capacity is being utilised with utilisation rates of around 40 per cent.     

WEAK PERFORMANCE

Weslpun's consolidated sales during the nine months ended December 2011 rose by six per cent to Rs 6,229 crore. During the same period, consolidated net profits slipped by 77 per cent to Rs 119 crore as a result of input cost pressures.

As a percentage of sales, raw material and labour costs spiked by ten percentage point to 72 per cent of sales. The company's operating margins during the period slid by eight percentage points to around 9.6 per cent.

The core pipe business did not fare well during the nine months ended December 2011, with sales volumes slipping by around four per cent due to a weak global investment climate.

Welded pipe players have struggled to up utilisation rates due to high competition and lacklustre demand growth. In the US, the company has also run into challenges in the form of clauses demanding domestic procurement of pipes.

The company plans to circumvent this by investing more in its US production facility to step up sourcing there. However, potential boost to order book and margins could be two years away.

DIPPING ORDER BOOK

Oil and gas companies have also shortened their order duration to minimise the impact of volatile input costs. This has further impacted the order book of pipe companies, including Welspun Corp.

The company is sitting on an order book position of around Rs 5,220 crore.

This provides visibility for two-three quarters. While in-line with peers such as Jindal SAW and Maharashtra Seamless, competition and resulting cost pressure in the welded segment could keep margins depressed over the next one year.

SUBSIDIARY TROUBLE

The company had bought sponge iron producer, Welspun Max, from the parent group for a stiff price in 2011. The bet was on backward integration.

The company was to utilise the steel produced by the subsidiary and convert it into pipes. However, this bet went awry when the low-cost gas supply for the unit from the KG Basin was curtailed. Resorting to imports, which costs four times more, made a huge dent in the cost structure of the steel making subsidiary. Another bet, which is yet to pay off, is the company's forward integration as a project execution player with Leighton and MSK Infrastructure.

While the company has racked up an order book of close to Rs 4,000 crore, the move does not seem to have aided the company's volumes significantly.

While the company has a net gearing of only 0.85 times, interest cover has reduced on falling profit and rising interest costs.

WHY MAHARASHTRA SEAMLESS

In contrast to Welspun, Maharashtra Seamless has a net cash and investment position of Rs 520 crore.  

The company managed 38 per cent growth in top-line to Rs 1,673 crore, led by higher volumes in the nine months ended December 2011. Robust rig counts amidst high oil prices have kept demand high for seamless tubes.

Net profits (excluding other income) rose by about 1.6 per cent to Rs 202 crore. Higher raw material costs had blunted operating margins by around nine percentage points to 19 per cent.

But, most encouraging, is that volume demand for seamless tubes has remained stronger than that of welded tubes. The company expects to add two lakh tonnes of seamless capacity. This should improve its product mix providing scope for higher volume and margin growth.   

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