Aditya Birla Money

IPO Note 24 September 2010

Electrosteel Steels Ltd. (ESL)  Short term Investors Subscribe

Company background and business model Long term Investors Subscribe

Electrosteel Steels Ltd (ESL), promoted by Electrosteel Castings Ltd. (ECL) -- a leading
producer of DI pipes --, is setting up a 2.2mn tonne integrated steel plant near Siyaljorii
village in Bokaro District of Jharkhand. The steel plant will be based on the Blast Furnace
(BF) - Basic Oxygen Furnace (BOF) route of steelmaking and will comprise 1.2mn tpa of Issue Details
long steel products (0.5mn tpa wire rods and 0.7mn tpa reinforcement bars), 0.33mn tpa
of DI pipes, 0.27mn tpa of commercial billets and 0.4mn tpa of pig iron. The project also Issue Opens Sept 21, 2010
consists of 120MW of captive power and sintering, captive coke and railway siding
facilities. Issue Closes Sept 24, 2010

The total project will entail a cost of Rs73.62bn, which will be funded 74% through debt Equity Offering (In mn shares) 225.5
and 26% through equity. The Rs54.47bn debt for the project has already been tied up.
Equity Offering (including green
Out of the Rs19.15bn equity requirement, Rs16.66bn has already been invested by ESL’s shoe option - in mn shares)
259.3
promoters (ECL) and renowned international and domestic strategic partners for the
project and the remainder is sought from the IPO. Among the major equity investors, ECL Face Value 10.0
and Stemcor have contributed 38.7% and 22.16% of the pre-IPO capital of ESL
respectively. Till June 30, 2010 about Rs41.68bn had been spent on the project. The Price Band Rs.10-11
project is expected to get commissioned in phases from October 2010. Issue Size (in Rs. Bn) 2.25-2.48
For the key raw material requirements of the steel plant, ESL has tied up 100% and 30% Issue Size (including green shoe
2.59-2.85
of its iron ore and coking coal requirements respectively with its main promoter company Option – in Rs bn)
Electrosteel Castings at an economical cost plus 20% basis.
Minimum Application Lot 600
The plant is being set up in technical, marketing and financial collaboration with Stemcor, Maximum Application(Retail) 9000
who has been in the business of international trade and marketing of steel for over 5
decades. Apart from assisting in the technical aspects of the project through equipment Issue Type 100% Book Building
supply and supervision of project implementation, Stemcor will also be an equity partner
in the project and source DI pipes and long steel products at market prices for a period of Post Issue Market Cap –
including green shoe option 22.75
three years from the date of commercial production. (in Rs bn)
While the land requirement of the proposed plant is expected to be roughly 800-900 Listing NSE & BSE
acres, ESL has acquired approximately 1,805 acres of land, taking into account the
scope for future expansion. IPO Grading 3/5 – CARE

BRLMs Edelweiss Cap

Key strengths Source: RHP

Raw material linkages for iron ore and coking coal: Iron ore and coking coal are key Shareholding Pattern (%)
inputs for success of an integrated steel project. As per the agreement dated July 21,
2008, ECL, the main promoter of ESL, has agreed to supply iron ore and coking coal to Pre Issue Post Issue
ESL on a cost plus 20% basis for a period of 20 years from the date of commencement of
commercial production. The economically attractive raw material linkage will enable Promoter 38.7 33.8
ESL to reduce its operating costs and ensure a steady supply of coal and iron ore MF/Banks/FI’s/FII’s/Publ
ic& Others 61.3 66.2
Integrated operations: The steel plant will be based on the Blast Furnace (BF) - Basic Source: RHP
Oxygen Furnace (BOF) route of steelmaking and will comprise rolling facilities. In
addition, the facilities will have access to power from its captive power plants and to
owned infrastructure, such as railway sidings. ESL has long term supply arrangements Issue Structure (In No Shares)
with ECL for the supply of iron ore and 30% of its coking coal requirement. Thus, ESL’s
proposed project shall span the entire value chain Issue size

of which Fresh issue by the company 225.5-259.3

Tie-up with Stemcor MESA DMCC: For the project, ESL has entered into a technical,
marketing and financial collaboration with Stemcor. The company has executed of which Offer for sale -
contractual arrangements with Stemcor, including a shareholder’s subscription Break-up of net issue to public:
agreement, an off-Shore supply contract, design supply contract, encompassing equity
investment, supply of major equipments, and supervision of project implementation. QIB's portion (minimum) 60%
Thus, ESL will benefit from Stemcor’s wide participation in the project in terms of Non-institutional portion (minimum) 10%
project implementation, equity financing and sales. Stemcor’s association with the
project enhances the overall profile of ESL Retail Portion (minimum) 30%
Source: RHP
Locational Advantages: ESL’s integrated steel plant located near village Siyaljori in
Bokaro District of Jharkhand is around 22 kms from Bokaro city, giving access to all
modern amenities. The steel plant is located only 6kms away from ECL’s coking coal Analyst Details
mine at Parbatpur and 230kms away its iron ore mine at Kodolibad. The plant is also  
closely connected with railways and highway roads, being approximately 18 kms from the Akhil Jain
state highway and 6kms from the nearest railway station at Talgheria. The strategic
022-42333540
location of the plant - being very close to sources of raw materials and means of
transportation and having access to modern amenities and manpower - will give Akhil.jain@adityabirla.com
ESL significant advantage in terms of low freight and procurement costs

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 Aditya Birla Money
IPO Note 24 September 2010

Object of the Issue

The objects of the fresh issue are:

 To part finance the construction of Integrated Steel and D.I. pipe plant having a capacity of 2.2 MTPA in Jharkhand, India
 To keep as margin money towards bank guarantees

Company’s strategy going forward

 

 Enhance and leverage the Electrosteel brand and the group resources: ECL is in the business of manufacturing CI spun pipes for
over four decades and Ductile Iron Spun Pipes since the last 15 years. ESL plans to leverage the brand equity of ECL built-up over
the years to expand its business.
 To use Stemcor’s marketing reach: Besides a delivery and marketing agreement with Stemcor MESA DMCC, the company will also
sell and deliver to Stemcor and Stemcor will buy steel of the type and quality mutually agreed by both parties in a series of regular
monthly consignment at a price reflecting market prices for a period of three years from the date of the commercial production. This
will enable ESL to successfully gain entry into the export markets.

Industry Overview – Our arguments and ESL

 

India’s per capita steel consumption in FY08 was only 48kg as compared to 301kg in China, 113kg in Brazil and ~425kg in the developed
countries. This highlights the huge potential of growth in domestic steel demand. Despite low per capita steel consumption, India has been
a net importer of steel since FY08 as domestic steel production has lagged the growth in domestic steel consumption. India’s crude steel
production has grown from 43.4mn tonnes in FY05 to 62.1mn tonnes in FY10 at a CAGR of 7.4%. India’s finished steel consumption, on
the other hand, has grown from 36.4 mn tonnes in FY05 to 56.3mn tonnes in FY10 at a CAGR of 9.1%. This has led to India importing
4.0mn tonnes of steel on a net basis in FY10. With India’s sustainable GDP growth rate expected at 8-9%, India’s steel demand is
expected to grow sustainably at ~9-10%. On the domestic steel supply side, green-field expansions are stuck on account of land
acquisition and resettlement issues, delay in raw material allotments and infrastructural bottlenecks. With India’s long term source of
domestic steel supply in a stalemate and demand expected to be secular, we expect India to continue to be a net importer of steel for quite
some time to come. Thus, domestic steel companies are likely to command a high regional premium to landed cost of imports and sales for
domestic steel companies are largely unlikely to be an issue.

Also, profitability of Indian steel producers are ensured on account of the cost arbitrage they enjoy in steelmaking with respect to Chinese
steel producers, the most likely source of cheaper priced imports, in terms of an import duty of 5% which translates into ~$35 per tonne, a
freight cost advantage of ~$25 per tonne and about a ~$70-100 per tonne advantage from captive raw material assets like iron ore.

ESL’s 2.2mn tpa tonne integrated steel project is one of the very few green-field projects that have not only taken off the ground but also is
in an advanced stage of implementation and is expected to get commissioned in phases from October 2010. Till 30th June 2010, ESL had
already spent ~Rs41.6bn of the total project cost of Rs74bn. ESL has also tied up 100% and 30% of its iron ore and coking coal
requirements respectively with its main promoter company Electrosteel Castings at an economical cost plus 20% basis. Electrosteel
Castings’ mines are located closely to ESL’s steel plant. Thus, low cost of mining and low freight costs to transfer the raw materials to the
steel plant will enable ESL to source a substantial portion of its raw material requirements at a substantial discount to the market prices of
raw materials (iron ore and coking coal). Further, captive power and pelletisation and sintering will add to ESL’s cost competitiveness.

We, thus, believe that ESL’s 2.2mn tonne integrated steel green-field project and its cost competitiveness make it an excellent long term
bet on the Indian steel story.
.
Key Risks
 

 Project delay: Steel projects have a long gestation period. Factors like contractor performance, unforeseen engineering problems,
dispute with workers, force majeure events, etc. could delay the completion of the project from the estimated time
Iron ore

 Iron ore delay: The MOEF clearance for the iron ore mine is yet to be obtained. Delay in clearance would mean ESL procuring iron ore
at market prices, which would be substantially higher than the cost of procurement from ECL.

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 Aditya Birla Money
IPO Note 24 September 2010

Outlook & Valuation

 

ESL’s 2.2mn tpa tonne integrated steel project is one of the very few green-field projects that is seeing the light of day. ESL’s integrated
steel project will also be cost competitive on account of tie-up of raw materials at a substantial discount to market prices (100% and 30% of
iron ore and coking coal requirements respectively at cost plus 20% basis), low raw material freight costs on account of source of raw
materials (parent ECL’s mines) being located close to its steel plant. The plant is expected to get commissioned in phases from October
2010. Seen in the context of secular domestic steel demand and domestic steel supply constraints and relative cost advantage of Indian
steel producers in steelmaking with respect to Chinese steel producers, ESL’ integrated steel project of 2.2mn tpa and its cost
competitiveness make it an excellent investment bet.
Given the cost competitiveness of the project and a substantial portion of the capex having been already spent (56.6% of Rs73.6bn), the
project on completion will create long term value for investors. Since ESL’s project is still in commissioning stage and there are no past
earnings or operating profit, P/B would be a good valuation metric to assess ESL’s IPO. On P/B, ESL has been priced quite attractively. At
the higher price band of `11, ESL’s IPO offering is only at a P/B of 1.1x, whereas major domestic steel producers (Tata Steel, SAIL and
JSW Steel) are trading at an average consensus P/B of 2.0x FY11E and 1.7x FY12E respectively. Thus, there is scope for listing gains too.
We, therefore, recommend SUBSRIBE, both from short and long term perspective, to Electrosteel Steels Ltd’s IPO at the higher price band
of Rs11.

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  2nd Floor, Sheil Estate, Dani Corporate Park, 158 CST Road, Kalina, Santacruz (East), Mumbai 400 098 | Tel: +91 22 42333400
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 Aditya Birla Money
IPO Note 24 September 2010

Income Statement

Profit & Loss Account (` In Mn) Dec06 to FY08 FY09 FY10 Q1FY11

Net Sales 0.0 0.0 0.0 0.0

Increase/(decrease) in stocks 0.0 0.0 0.0 0.0
Total Income

Expenditure
Raw materials consumed 0.0 0.0 0.0 0.0
Manufacturing expenses 0.0 0.0 0.0 0.0
Staff Cost 58.0 119.8 250.8 75.3
Other operating expenses 485.2 482.4 888.6 168.1
Total Expenditure 543.2 602.1 1139.5 243.3
EBITDA -543.2 -602.1 -1139.5 -243.3
% of sales
Depreciation & Amortisation 0.5 2.8 12.1 5.0
EBIT -543.7 -604.9 -1151.6 -248.3
Interest Expense 5.7 871.8 2198.9 671.7
Other Income 37.0 154.7 478.7 -268.2
EBT -512.4 -1322.0 -2871.8 -1188.3
Tax 13.4 25.2 0.1 0.0
PAT -525.8 -1347.2 -2871.9 -1188.3

Balance Sheet

Particulars (` In Mn) FY08 FY09 FY10 June 2010

Share Capital 0.9 3385.7 16657.6 16657.6
Reserves & Surplus 3099.4 3106.8 -0.2 -0.2
Net Worth 3100.3 6492.5 16657.5 16657.4
Debt 1330.6 17285.3 24693.6 25137.2
Total Liabilities 4430.9 23777.8 41351.0 41794.6

Fixed Assets 2669.9 21225.1 38872.3 41675.2

Investments 0.0 1764.3 1606.0 86.9
Current Assets 1824.8 967.8 1736.2 1141.0
Current Liabilities & Provisions 63.7 179.3 863.6 1108.4
Net Working Capital 1761.1 788.5 872.6 32.5
Total Assets 4430.9 23777.8 41351.0 41794.6

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 Aditya Birla Money
IPO Note 24 September 2010

Research Team
Vivek Mahajan
Head of Research
022-42333522
vivek.mahajan@adityabirla.com

Fundamental Team
Avinash Nahata Head of Fundamental Desk 022-42333459 avinash.nahata@adityabirla.com
Akhil Jain Metals & Mining 022-42333540 akhil.jain@adityabirla.com
Sunny Agrawal FMCG/Cement 022-42333458 sunny.agrawal@adityabirla.com
Sumit Jatia Banking & Finance 022-42333460 sumit.jatia@adityabirla.com
Shreyans Mehta Construction/Real Estate 022-42333544 shreyans.m@adityabirla.com
Dinesh Kumar Information Technology/Auto 022-42333531 dinesh.kumar.k@adityabirla.com
Pradeep Parkar Database/Production 022-42333597 pradeep.parkar@adityabirla.com

Quantitative Team
Rizwan Khan Technical and Derivative Strategist 022-42333454 rizwan.khan@adityabirla.com
Devarajan.S Derivatives Analyst 022-42333534 devarajan.s@adityabirla.com
Rahul Tendolkar Derivatives Analyst 022-42333532 rahul.tendolkar@adityabirla.com

Advisory Support
Lalitha.MR Advisory Desk – Retail 044-39181903 lalitha.r@adityabirla.com

Indranil Dutta Advisory Desk – HNI 022-42333494 indranil.dutta@adityabirla.com

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 Aditya Birla Money
IPO Note 24 September 2010

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