Governance issues and execution delays have been a big drag for Prakash Industries. But capacity build-up plans offer some hope

OVER the past six months, the market has punished Prakash Industries, or PIL, against the backdrop of certain issues relating to governance and delays in execution. Coupled with this, higher raw material costs and capacity underutilisation in the past two quarters compressed operating profit margins, pushing the stock down 56%. Given the company?s plans to expand its steel capacity by 43% by the end of the year, its foray into the merchant power sector and commencement of operations of its captive iron ore mines, PIL is poised for good growth, and at current valuations, is cheap.

BUSINESS:

Prakash Industries, part of the Surya Roshni group, earns three-fourths of its revenue by manufacturing steel structural and wire rods used in construction projects. It also has operations in ferroalloys, PVC pipes and power generation.The company currently has a steel capacity of 0.7 million tonnes annually, which it plans to increase to 1 million tonnes by the end of 2011. It is currently operating at 65-70% of its total capacity. Its 100 mega watt captive power plant is running at full capacity. In April 2010, Prakash Industries was charged with allegedly selling coal in the back market. The case was investigated by the CBI, and after several months, the company was cleared of all these charges. This issue did not go well with the market and the stock was therefore beaten down.

GROWTH DRIVERS:

The company has plans to achieve full integration over the next two years. In order to achieve this, PIL has been allotted two iron ore mines ? in Chhattisgarh and Orissa ? which are expected to be operational in the next fiscal. This will reduce the company?s dependence on third parties by nearly 100%, and significantly improve its margins. The company also plans to expand its power generation capacity at its Champa facility by 625 megawatt. With this, PIL plans to make its way into the merchant power business.

FINANCIALS:

Net sales of Prakash Industries have been growing at a compounded annual rate of 18% over the past 5 years. The company provides a return on equity of 25% and a return on capital of 23%. It has been steadily generating cash flows from operations over the past 5 years, and with a low debt equity ratio of 0.23, it is in a comfortable position to raise funds, if required, to finance its major expansion plans. The company?s performance in the September-December 2010 quarter was negatively impacted by rising input costs which it could not completely pass on to its customers. As a result, its sales grew 6% year-onyear while its operating profit margin declined 600 basis points. At 76, the stock trades at a 12-month trailing price earnings multiple of 3.5 times.

CONCERNS:

The main concern for investors is the delays in project execution. The commissioning of the first phase of the 625 mw power plant at Champa, which was expected to be in place in April 2012, has been deferred till the June quarter of FY12. Due to regulatory issues, the firm has not been able to start mining operations in Chhattisgarh and Orissa. As a result, the company has postponed its planned steel capacity expansion to June 2011.