Ambit Capital Expects This Pipemaker To Gain  80% In Two Years
Hexagonal profile steel pipes sit stacked (Photographer: Lisi Niesner/Bloomberg)

Ambit Capital Expects This Pipemaker To Gain 80% In Two Years

India’s largest maker of structural steel pipes by value has lost nearly a third of its market capitalisation since its February peak as domestic equities tracked a global Covid-19 selloff.

The stock now trades at 10 times its FY20 earnings compared with five-year average of 21.68 times and is also cheaper than peers.

But Ambit Capital sees APL Apollo Tubes Ltd. as an opportunity for investors. The brokerage, which initiated coverage on the stock with a ‘Buy’, expects it to surge about 80 percent in two years, with a target price at Rs 2,200 apiece. That’s about 12 times its estimated earnings for FY22.

Here’s why Ambit Capital is bullish on the pipemaker.

A PVC Pipe-Like Redux

APL Apollo has a capacity of 2.55 million tonnes, with 70 percent of that coming from hollow sections and pre-galvanized pipes, according to Ambit. The company supplies pipes for water and sewage, power and oil and gas sectors and fabricating roofing and structures at airports, metros stations and buildings; and scaffolding to the construction industry.

Ambit sees a potential rerun of the 2000-01 to 2014-15 period when more-durable plastic pipes by companies such as Supreme Industries Ltd. and Astral Pipes Ltd. replaced galvanised iron pipes in home pluming. The brokerage sees a similar transition from rigid metal conduit to structured steel pipe as a lower weight provides similar tensile strength, helping save on up to 30 percent costs. Structured steel also offers better aesthetics than RMC and reinforced concrete, Ambit said.

The company is investing about 10 percent of its operating income in branding and experimenting with ‘function-specific’ products to expand the structural steel market while keeping per unit cost in check, according to Ambit.

Innovation

Ambit said APL Apollo has been at the forefront of launching innovative products, starting with pregalvanised steel tubes in 2003. The company has introduced new products under Signature (designer roofing), Chaukhat (steel door frames) and Tricoat brands. This, according to the brokerage, will enhance the awareness of their products.

Dominance, Economies Of Scale

APL Apollo has aggressively increased its capacity, improving the company’s bargaining power with distributors, Ambit said. That has reduced working capital. days, Ambit said has improved significantly leading to lower working capital days.

According to Ambit:

  • APL Apollo as working capital days, or time taken to convert working capital into revenue, is about 30 days. That compares with 50-70 days for peers.
  • The company has a debt-to-equity ratio of 0.5-0.6 times against 0.7-1.6 for peers.

Overleveraged peers with a stretched working capital cycle is likely to drive supply consolidation in the sector, Ambit said.

Ambit said other things going in favour of APL Apollo include:

  • Deeper distribution among structural steel pipe players.
  • Acquisition of Apollo Tricoat (margins of 11 percent vs APL Apollo Tubes’ 7 percent) will help it sustain margins.
  • Scale-related cost advantages coupled with higher assets aids higher return on capital employed.
  • Focus on creating a ‘consumer’ brand.
Ambit Capital Expects This Pipemaker To Gain  80% In Two Years

Risks

The Covid-19 lockdown is expected to lower Ebitda per tonne in the ongoing fiscal ending, with a risk to margins underperforming.

Due to a steep fall in demand, AL Apollo is likely to sustain higher inventory losses. The company will have to support its distributors to lower the impact of lockdown, which could stretch receivable days to time taken to collect dues from them to 35 days in FY21 from about 26 days in FY20.

Ambit, however, sees Covid-19 impact easing after FY21. According to Ambit, the markets have failed to understand the efficiency of APL Apollo because of inefficient peers and lower return on capital employed of the pipe-making industry. A reason it’s trading at a discount to peers, Ambit said.

What Other Brokerages Say

Reliance Securities

  • APL Apollo deserves premium valuation compared to peers on the back of lean working capital, low debt, and ready capacity.
  • It has a ‘Buy’ on the stock with a target price of Rs 1,520. (The stock closed at Rs 1,212 on Monday)
  • The brokerage values the stock at 14 time its estimated earnings for FY23.

Systematix Institutional Equities

  • A force majeure situation like Covid-19 can exert further stress on the balance sheets of smaller regional units and they may be compelled to shut operations permanently.
  • This would be a favourable situation for APL Apollo to gain market share, given its size and scale with plants across India, wide reach and brand equity.
  • The brokerage on April 3 had a target price of Rs 1,671 per share.
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