Bhushan Steel (BSL), India's leading value-added steel producer, has extended its presence in the steel value chain with the commissioning of its
1.9mt HR steel capacity.

KEY INVESTMENT RATIONALE:

Moving up the Value Chain: From being a mere convertor, the company is planning to move up the value chain to a fully integrated primary steel producer by indulging itself into a major backward integration cum expansion project in Orissa in three Phases.

Captive Resourcing: Backward integration programme of the company would lead to margins expansion to the tune of 35.57% and 36.17% during FY11E and FY12E from 25.76% in FY10. The company is in the process to secure major raw material from its captive sources.

Catering to Niche Segment: Currently, the Indian automakers import nearly 30% of high-grade automotive steel, which creates a big opportunity for value-added players like Bhushan Steel. BSL drives nearly 35% of its sales from auto sector and is one of the preferred suppliers in the segment.

VALUATIONS: At the current price of Rs. 450, the stock is trading at just 9.88x and 8.05x times of our estimated FY11E & FY12E earnings. We thus recommend a `Accumulate' with a price target of Rs 518. We believe that the expansion project in Orissa along with the rising demand from auto sector would be the key growth driver for BSL.

Moving on Higher Value Chain: The company is undergoing a major backward integration cum expansion project. The project has to be phased out in three steps. The first phase has already been executed successfully in the year 2007, whereas phase-2 plans are on the brink of completion. This would enhance BSL's production capacity by 1.9MT taking it to 2.2MT (currently BSL has billet making capacity of 0.3MT). Phase-3 is scheduled to be commence from the calendar year 2013-14. The company has already placed orders for major equipments that would be required in the Phase-3 operations. After the completion of Phase-3, the production capacity would increase to 5.2MT.

The commissioning of Orissa expansion project will ensure sufficient supply of HR Coils to its value- added plants (Sahibabad and Khopoli), while the excess HR coils will be offloaded in the open market, as no major capacity expansion is being added to these.

The company is planning to increase its captive power capacity upto 458MW under the Phase-2 of its major expansion plan by adding 300MW
(150MW x 2), through Bhushan Energy Limited (BEL) a 26% associate company, BEL has already commissioned 150MW at Orissa plant.

The captive HR Coils will lead margins expansions in term to the tune of Rs 14300/ton During FY11E from Rs 9792/ton during FY10. The company is all set to gain from increased spreads as a result of backward integration.

Captive Resourcing: Steel industry is highly raw material intensive industry, the raw material accounts for over 64% of the total expenditure, the company is in process to secure major raw material from its captive sources. BSL currently meet its entire iron ore requirement from market, while for coking coal it is dependent on Australia.

Iron Ore: The company has been allotted iron mines at Barbli Orissa to the tune of 60MT. BSL is in the process of obtaining necessary environmental clearance, the mines are expected to be operational by the end of FY13.

Coking Coal Mines: BSL has been allotted the Utran coking coal mine, which has grades of soft coking coal with reserves of 55MT. This mine will reduce the company's coking coal dependence as the coal from these mines will be blended with hard coking coal from Australia.

Thermal Coal Mines: BSL has been allotted coal mines in New Patrapara, Orissa, in a joint venture with Visa Steel, SMC Power Generation Ltd, Orissa Sponge Iron and Steel, Deepak Steel and Power, Sri Metaliks and Adhunik Corp. The company holds majority chunk (50% stake) in the joint venture. Total reserves are estimated to the tune of 650MT, of which BSL's share will be 325MT, the mines are expected to be operational by Q2 of FY13.

Bowen Energy: As a strategic move, the company has acquired 60% stake in Bowen Energy Australia through its subsidiary Bhushan Steel (Australia) for Rs70cr, with an aim to ensure long term supply of quality coking coal. Bowen Energy has licences to explore 3 coking coal blocks in Bowen basin in Queensland, Australia.

Catering to Niche Segment: The company primarily caters to Auto and Auto ancillary industry and white goods Industry. Auto and auto ancillary contributes nearly 35 % while white goods contribute 13-14% to BSL's revenues. Current Indian automakers import nearly 30% of high-grade automotive steel and this augurs well for value-added players like Bhushan Steel. BSL, is the one of the preferred supplier in these segment. It is one of the leading CR Coils manufacturer in India, with manufacturing facilities located at Sahibabad (UP) and Khopoli (Maharashtra).

Shaibabad, being located near NCR region, gives BSL access to major OEMs located in Delhi and Gurgaon, while Khopoli gives access to western Indian and a major source of overseas market, being located near to ports.

The company has diverted its focus from trade to OEMs and exports. During FY10 OEMs contributed 62% to the revenue witnessing a considerable increase from a contribution of 56% in FY04. The trade segment witnessed a decline of 7% in FY10 from 15% in FY04

Strong Brand Value: Bhushan Steel has carved a niche for itself from the repeated order wins from existing and new clients. The company has entered into long term technical association with Japanese major Sumitomo Metals, thereby adding competitive advantage to the company. Recently, Sumitomo has inked an agreement with BSL for sourcing HR coils from the latter's new plant in Orissa.

BSL has wide variety to its kitty ranging from widest CR mill (1700 mm) to producing galume to special steel grades (upto 25.4 mm thickness). BSL's profound knowledge of products, technologies, implementation skills and its understanding of market will help it to reap its slice of cake from the growth of Industry.

Maruti Suzuki, Tata Motors, Hyundai, Ford Motors, Honda, LG Electronics India, Godrej & Boyce, Whirpool of India, BSPL, Indian Steel Industries, etc are the big names they serve.

Consistently rewarding its shareholders: The company has been consistently creating value for its shareholders by paying rich dividends since its inception. For FY10 BSL has paid 25% dividend resulting in lowest ever dividend yield of 0.15%.

Capacity expansion: Bhushan Steel plans to invest Rs. 20,000cr through Bengal Steel project as part of its expansion plans. It's a green-field 6MT steel plant. Sumitomo is very keen to acquire a stake in the new steel company. The project is still in its budding stage and the land acquisition will take some time. The project will not be commissioned before 2014-15. The steel project in Bengal is definitely a large investment and the company is looking for a JV with Sumitomo. The debt equity has to be worked out which is expected to be in the range of 2:1. The company has got enough accruals and putting up a project of size Rs 3,000cr over the period 2012 2015 would not be a problem.

Venturing in ERW pipe Business - Forward integration: Bhushan steel is setting up 0.5MT large diameter pipe facility in Maharashtra by investing Rs 1200cr, the facility is expected to be visible in the books by Q4FY12. The raw material (HR Coils) would be sourced from its Orissa plant after the commission of phase-3 expansion.

Bhushan Energy Limited: Bhushan Steel has plans to set up a 1000MW power plant at its fully integrated steel plant in West Bengal through Bhushan Energy Limited
(BEL), a 26% associate company of BSL. This will make BSL a fully integrated company in terms of captive power.

KEY CONCERNS:

Rise in input cost: The backward integration of the BSL would be completed by next 2-3 years. Any adverse movement in key raw material prices in this period could have negative effect on margins of the company.

Fall in prices: Any negative movement in product prices can have its effect on the realization, thereby affecting the profit earning capabilities of the company.

Higher debt a concern: The company's debt stands over Rs 10870cr, resulting in Debt-Equity ratio of 3.23 during FY10. With its proposed capex of nearly Rs 2500-3000cr it is expected to rise further. This will limit further expansions of the company and taking its toll on the bottom-line, resulting in lower earnings for the stakeholders.