WELCORP to capitalize on recovering oil and gas demand
WELCORP is ideally positioned to capitalize on cheaper inputs and an increase in oil & gas demand, though dependency on macro tailwinds and commodity prices needs to be watched closely. We are LONG.
WELCORP, the parent company of the $3bn Welspun Group, is a global top 3 manufacturer of pipes. Specifically focused on large diameter ‘line pipes’, WELCORP has a strong foothold in India, Middle East & the United States and has been capitalizing on the buoyant transportation requirements for the oil, gas and water sectors. India is presently the 3rd largest oil consuming economy behind US/China. India’s share of global oil demand is expected to jump from 5% to 10% by FY 2045, effectively growing at 4% annually. Global oil & gas pipeline market is expected to grow by 6% CAGR during FY 2021-26.
Policy push and broader macro tailwinds providing support
Demand outlook appears favorable with govt’s plans to invest over c. INR7,500bn in oil & gas infrastructure, with authorization for a 33,764km natural gas pipeline network in place since March 2021. Policies like the Jal Jeevan mission with a capital outlay of INR3,600bn are expected to further support growth. Gas demand is also expected to pick up as PNGRB estimates a requirement of 174,000inch-Km pipelines, of which only 75,224inch-km has been laid out as at September 2020.
Local business with a global foothold
WELCORP derives 63% of its revenue from India, followed by 25% from US and 12% from Saudi Arabia. It is the 1st Indian company to join H2Pipe, a joint project to develop the "world's first guideline” for transportation of hydrogen gas in collaboration with global oil & gas majors. The company is well positioned to take advantage of increasing demand from Saudi Aramco with whom it has a LTA, where multiple capital projects (incl. desalination) are being rolled out with deployment expected from Q3.
Streamlining and diversifying product portfolio
WELCORP is diversifying into newer products like ductile iron pipes for which a greenfield project with capacity of 44KMPTA and capital outlay of INR1,550cr is expected to be commissioned by FY 2022. Steel products are another category considering management’s plans to acquire Welspun Steel Limited for a consideration of INR363cr. There’s a thrust on localization of steel products coupled with a shift towards Hydrogen and Carbon capture pipelines due to renewable substitution, presenting significant LT opportunities and a hedge against excessive exposure to traditional oil & gas demand.
Improving financials and strengthening balance sheet de-risks the investment profile
Revenue/EBITDA saw a CAGR of 18%/20% during FY 2017-20 (pre Covid) helping the company deliver a lofty 15.4% ROCE and 10.9% ROE (L4Y average). While FY 2021 revenue fell by 35.3%, EBITDA margin has increased by c. 3% on account of changing product mix towards higher margins and cost optimization. Leverage is fairly accommodative with debt-to-total assets of 0.1x and debt-to-equity of 0.2x resulting in 11.8x interest coverage as at FY21, up from 2.5x as at FY19. Cash Flow generation looks strong with FCFF of INR639cr as at FY21. Revenue for Q2 FY22 stood at INR1,306cr, increasing by 1% on q-o-q basis and 13% on y-o-y basis.
Valuation on absolute and relative terms looks fairly attractive
WELCORP currently trades at 7.8x P/E and 4.5x EV/EBITDA on FY23F. Close Comps Ratnamani Metals (NSE: RATNAMANI) trades at 21.9x P/E and 15.5x EV/EBITDA and Jindal Saw (NSE: JINDALSAW) trades at 4.8x P/E and 2.1x EV/EBITDA on FY23F but with much lower ROE/ROCE. FIIs have diluted their stake by c. 3.7% in previous quarters.
Our Position
The price of Steel being the primary raw material is critical. Hitting INR65,000/MT levels thus resulting in slim margins in FY21, steel prices are now expected to moderate thus potentially enabling margin expansion. A global foothold, a strong balance sheet and low debt make WELCORP ideally positioned to capitalize on cheaper inputs and an increase in oil & gas demand. However, this is a cyclical business and its dependency on macro tailwinds and commodity prices will remain potential risk factors to be considered and watched closely. We are LONG.
Disclaimer: The views expressed above are the views of Arkvega Partners LLP, and are subject to change at any time based on market and other conditions. This is neither an offer nor solicitation for the purchase or sale of any security, and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. We strongly advise you to do your own research and consult an accredited investment advisor before investing based on what you read in a newsletter. Arkvega Partners LLP or its employees may have exposure in the financial instrument discussed above and can close positions in the future without prior intimation.
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