CRISIL Equities Assigns Fundamental Grade 2/5 to MSP Steel & Power Limited
| July 30,2010 11:35 am IST
CRISIL Equities has assigned a CRISIL IER fundamental grade of 2/5 to MSP Steel & Power Limited (MSP). The grade indicates that the company’s fundamentals are ‘moderate’ relative to other listed equity securities in India.
CRISIL Equities has assigned a valuation grade of 3/5, indicating that the current market price of Rs. 40 (as on July 28, 2010) is ‘aligned’ with our one-year fair value of Rs. 44.
The grades are not a recommendation to buy, sell or hold the graded instrument, or a comment on the graded instrument’s future market price or its suitability for a particular investor. The assigned fundamental grade reflects MSP’s established presence in the steel business since 1993. By virtue of this position, MSP will benefit from the expected growth in the steel industry triggered by higher economic activity in the country, especially in the construction and infrastructure sectors. CRISIL Research expects domestic demand for steel to grow at a CAGR of 9-10% through FY10-14. The grade also takes into account MSP’s presence across the value chain of steel production, leading to higher margins due to lower cost of production.
The grade is constrained by the impact of weak debt service indicators. MSP plans to fund its massive capacity expansion through a mix of internal accruals and preference shares issued to promoters, and debt in the ratio of 1:2. This is expected to worsen the gross debt-equity ratio to 3.0x by March 2011 from 2.4x as on March 2010, which will put pressure on MSP’s financial flexibility. The grade is also influenced by the fact that the players in the steel business have a low bargaining power and are exposed to the cyclicality of the industry. Fluctuations in iron ore prices will affect MSP’s margins in the medium term. This may be negated once MSP’s captive iron ore mines become operational in 2014.
CRISIL Equities expects MSP’s revenues to grow at a two-year CAGR of 73% to Rs. 11.8 bn in FY12.
EBITDA margins are estimated to improve over the next two years to 18.4% with the commissioning of a pellet plant, an 18 MW captive power plant and a structural rolling mill. CRISIL Equities expects EPS to almost triple to
Rs. 14.7 in FY12 from Rs. 5.4 in FY10. With increased capacity and margins, we expect RoE of 29.3% in FY12 vs. 16.9% in FY10. Even though earnings look promising, execution risks remain due to high debt and cyclical nature of the industry.
Valuation grade 3/5 – The current market price is aligned with the fair price
CRISIL Equities has used the discounted cash flow method to value MSP. We have used an explicit cash flow forecast for the FY11-15 period. We have arrived at a one-year fair value of Rs. 44 per share. At this value, the implied PE is 5.4x FY11 EPS.