We visited Godawari's (GPIL) Raipur plant to conduct a ground check on operations of 0.6mn tpa pellet plant and 20MW biomass-based power plant. We also visited plant of Hira Ferro alloys, which is to become GPIL's 51% subsidiary post completion of proposed amalgamation of group companies - RR Ispat and Hira Industries.

Pellet plant: 0.6mn tpa pellet plant is currently operating at 100% capacity utilization. The total cost of production at Rs3,750/ tonne consists of iron ore fines cost of Rs2,050/t (from captive mine, incl. yield loss of 12-14%) and conversion cost of Rs1,700/ tonne. Even though market price of pellet is Rs6,500-7,000/tonne, majority of pellet is captively consumed as availability of lumpy iron ore for DRI production is not sufficient (see next point). Iron ore operation: 140ktpa of output is expected from captive Ari Dongari mine for Q3FY11. The landed cost is Rs1,500/tonne (freight cost of Rs500). However, since the magnetite ore from this mine is not suitable for direct usage in DRI kiln, ~85% of ore is first converted into pellet, which is then mostly consumed captively for DRI production (see pg3 for DRI costing with captive pellet).

20 MW biomass-based power plant: The company has commenced operation at recently commissioned plant. However, cost of power generation is high because of high fuel cost (husk cost of Rs2.3/unit of power).

Sponge iron: In spite of producing only ~120kt of DRI in H1FY11, the company is positive of producing 160-170kt of DRI in H2FY11. Higher usage of pellet to help in better DRI yield
(67% compared to 65% when using lumpy ore of the same grade).

Power tariff a dampener: Power tariff remains low at Rs2-2.8/unit, as a result of which the trade-off is in favour of producing billet and Ferro alloys rather than selling power on merchant basis.

Ardent Steel (not visited): Operation of 0.6mn tpa pellet plant at GPIL's 75% subs. Ardent Steel is yet to stabilise fully and can contribute to profitability significantly from Q4FY11 onwards only. The company would be using iron ore fines purchased from 3rd party miners. However, owing to freight advantage, the company expects good profitability.

Amalgamation of group companies expected soon: GPIL is merging Hira Industries and RR Ispat (100% subsidiary) with itself; which would result in 13% equity dilution.

VALUATIONS AND RECOMMENDATION

Although slow offtake in steel demand, declining global steel prices and strong raw material prices could keep steel profitability under pressure in the near-term, we expect GPIL to benefit from earnings CAGR of 50% over FY10-FY12E on volume growth and margin expansion driven by recently commissioned 0.6 mntpa pellet plant, 20 MW biomass power plant and Ari Dongri Mine. At CMP of Rs189, the stock is attractively valued at 3.4x EV/ EBITDA and 4.6x P/E on FY12E basis. We recommend conviction `BUY' on the stock with a target price of Rs 276.