Prakash Steelage Limited has entered the capital markets with its maiden IPO which has opened on Thursday the 5th of August. The issue has closed for QIB’s and closes on Tuesday the 10th of August for HNI’s and retail investors. The price band is Rs 100-110 and the issue is for 62.5 lakh shares.

Business
Prakash Steelage is in the business of steel as the name suggests.  It is in the manufacture of seamless and welded stainless steel pipes, tubes and U-tubes. The company has two manufacturing units located in Silvassa and Umbergaon in Gujarat. The present installed capacity is 15,600 tons. Of the above 3,400 tons has been added at the end of the financial year 2009-10.
The business of stainless steel pipes and tubes has about four organised players like Ratnamani, Suraj Stainless, Zenith Birla (India) Limited and Prakash Steelage Limited. Besides the above organised players there are over a hundred players in the un-organised sector.

Objects of the issue
The objects of the issue are as follows: –

The company plans to raise between Rs 62.5 crs and Rs 68.75 crs.

Financials
Prakash Steelage Limited has two broad segments of business namely manufacturing and the other segment is trading in steel products. The traded segment accounts for roughly half the total sales of the company. Prakash Steelage has recorded total sales of Rs 232.38 crs in March 2008, Rs 322.47crs in March 2009 and Rs 438.39 crs in March 2010. The trading sales in these years were Rs 115.97 crs in March 08, Rs 130.62 crs in March 09 and Rs 219.38 crs in March 2010. If one were to look at trading sales as a percentage of total sales it was 52.85% in March 08, 44.94% in March 2009 and 50.19% in March 2010.

Coming to the profits earned by the company it was Rs 8.20 crs in 2008, Rs 7.37 crs in 2009 and Rs 17.82 crs in 2010. If one were to talk about profit after tax margins they were at 3.53% in 08, 2.28% in 2009 and a huge jump to 6.25% in 2010. The margin jump is quite substantial and a large part of it could be attributed to stability in the markets and also substantial capacity expansion which has been done by Prakash Steelage. The fact that there is such a high percentage of trading sales is a cause for concern and this seems unlikely to be reduced in the near term.

Valuations
Based on the profits for 2009, the company had an EPS of Rs 6.55 on the pre-IPO equity of 1.125 cr shares. In 2010 the EPS increased substantially and the same was 15.84. If one were to consider on a post IPO fully diluted equity basis the equity would increase to 1.75 cr shares, making the EPS for March 2009 Rs 4.21 and for 2010 Rs 10.18.

Ratnamani is the market leader in this sector and based on yesterday’s closing price of Rs 131.15 for a Rs 2 paid up share is quoting at a price earnings multiple of 7.4 based on March 2010 earnings.  Zenith Birla quotes at a PE multiple of 11.83 times while Suraj Stainless is quoting at a PE multiple of 13.51 times.

The share is being offered in a price band of Rs 110-110 which on a fully diluted basis is being offered at a price earnings multiple of 9.82 times at the lower price band and 10.81 times at the upper price band based on March 10 earnings.

Risks
The expansion done by Prakash in the last two years has been huge. The original capacity was 4,000 tons which was raised to 12,200 in 2007 and a further 3,400 tons were added in the year ended March 2010. The IPO proceeds would be utilised to add another 3,400 tons and raise the total capacity to 19,000 tons. This capacity expansion needs to be marketed and though one believes that while selling their own production and substituting the same with trading sales would help in improving margin, this is easier said than done as manufacturing and trading is not the same thing.

Working capital requirements would increase considerably and could be a drag on the company’s margins. Margins in trading and manufacturing are substantially different and if after operation of additional capacity sales become a concern this could affect the overall profitability.    

Subscription levels
QIB’s have subscribed 1.27 times the issue and the overall subscription at the end of the third day is 1.77 times. QIB subscription has closed and the issue would close for all investors on Tuesday the 10th of August.

Conclusion
There seems to be a lot of demand growth with the kind of spending and emphasis on infrastructure all over the country. India seems to be doing well for itself and this is a big comfort for the capacity expansion being set done by Prakash Steelage. The almost equal share of trading in the total turnover is a big concern because it dilutes the margins of the company and raises doubts unnecessarily on the quality of earnings and the earnings itself. The price earnings multiple at between 9.82 and 10.81 times March 2010 earnings at which the share is being offered is more or less fully priced. Speculative interest could see retail and HNI applications causing over subscription on the last day. If over-subscription does reach 8-9 times overall, there is likely to be some listing gains for investors, but the upside is limited and may not be worth the effort.

I believe it makes good sense to wait for the share to list and look to buy on dips below the issue price.

Sebi Disclaimer: – I do not intend to subscribe to the above issue