EQUITY RESEARCH: Vardhman Special Steel (VARSPE)

Vardhman Special Steels Ltd is engaged in providing steel bars and rods. The Company gives merchandise, which include round bar and corner, peeled and centerless ground bar, drawn and centerless floor bar. The Company additionally offers Case Hardening Steel, Chrome Steel, Chrome Manganese Steel, Carbon Steel, Carbon Manganese Steel, Chrome-Moly Steel, Nickel Chrome / Nickel Chrome Moly Steel, through Micro Alloyed Steel, Vanadium Steel, Nitriding Steel, Hardening Steel, Boron Steel, Ball Bearing Steel, Free/Semi Free Cutting Steel, Spring Steel and High Titanium Steel. The Company offers merchandise in various diameters. The Company's plant is positioned at Ludhiana, India. The potential of the melt shop is 125,000 metric tons/annum. The Company manufactures products by the use of technology, consisting of Steel Melting, Bright Bar, Rolling Mill and Heat Treatment.

Vardhman Special Steel (VARSPE)

ABOUT

• With 90–95 percent of sales focused on the PV market, followed by the 2W, CV, and other segments, Vardhman Special Steel (VSSL), with its headquarters in Ludhiana (Punjab), is the industry leader in the production of special steel for automotive applications. Maruti Suzuki, Hyundai, Toyota, Hero MotoCorp, and Caterpillar are just a few of its major clients. Along with the automobile industry, it also supplies Bearing, Engineering, and other Allied Industries. Its installed capacity is 48,000 tonnes of brilliant bars, 2 lakh tonnes of rolled products, and 2.4 lakh tonnes of billets per year.

Product Segments:

Manufacturing plant:

SHAREHOLDING PATTERN

MANAGEMENT COMMENTS

Commenting on the results Mr. Sachit Jain, Vice Chairman and Managing Director said –
“This quarter our revenue declined by 12.75% mainly due to decline in volumes and prices as compared to last year. As mentioned in Q4 FY23 earnings call, this year will be a year of consolidation for us. Our production for Aichi Steel continues to be in sync as per our stated plan and that contribution will only continue to increase each year. I would like to express my gratitude towards our dedicated employees, partners and stakeholders. We continuously strive to keep up the momentum of efforts and hard work and keep performing as per stated targets.”

CONCALL AUG 2023

1. Corporate Updates:

• Vardhman celebrated its Golden Jubilee of steel business and announced a 1:1 bonus with increased liquidity in its shares.
• Soumya Jain, daughter of Sachit Jain, joined the Board as an Executive Director in the recent Board Meeting.

2. Sustainability and Carbon Neutrality:

• The company is focusing on carbon neutrality and reducing its carbon footprint, which is lower compared to its competitors.
• Planning to set up a solar power plant by the end of the next financial year to reduce power costs and carbon footprint.

3. Financial Performance:

• Q1 FY '24 total volume declined by 9% compared to the corresponding quarter of the previous year.
• Total revenue for Q1 FY '24 was INR 409 crores, with reported EBITDA of INR 36 crores.
• Q1 price settlement with OEMs is still open, and the company is demanding a price increase due to the increase in raw material costs.
• Targeting an EBITDA per ton figure of INR 10,000 to INR 12,000 in the future.
• Expects to reach a peak capacity of 230,000 to 240,000 tons saleable quantity.

4. Expansion and Capacity:

• Taking voluntary shutdowns to expand its rolling mill capacity.
• Management is focusing on consolidation and strengthening the organization's systems and processes.

5. Government Incentives:

• The company is eligible for PLI benefits and expects to receive INR 25 crores to INR 30 crores in 4 to 5 years.

6. Investor Relations:

• Open to investor visits and welcomes the opportunity to showcase its facilities and processes.

FINANCIALS:

• Q1 FY24 volumes stood at 47,435 tonnes, YoY decline of 9.24%.
• 12.75% YoY decrease in Revenue from Operations, mainly on account of lower sales volumes and decrease in prices.
• EBITDA (including other income) per ton for this quarter – Rs. 7,688.
• Decrease in EBITDA mainly due to decrease in sales volumes, increase in fuel cost (natural gas is costlier than furnace oil) and store consumables. Decrease in sales prices is also more than decrease in raw material prices.
•  Volumes for FY23 stood at 2,00,095 tonnes – YoY growth of 15.46%.
• Increase in Revenue from Operations mainly on account of higher sales volumes coupled with better realizations.
• EBITDA (including other income) per ton for FY23 – Rs. 9,000.
• Decrease in EBITDA of 11.11% mainly due to decrease in sale price by Rs. 1,750/- MT effective 1st Oct 2022 coupled with the higher price of fuel and consumables

INVESTMENT RATIONALE

• Fundamental levers for growth; VSSL – key PLI Beneficiary in special steel domain

The government has developed the PLI scheme for this sector with a total outlay of 6,322 crore during FY24E-30E with the goal of increasing domestic manufacturing of speciality steel and reducing imports. Given its current capex expenditures, VSSL, which is pursuing brownfield expansion, is a permitted participant under this plan. We anticipate the company to report 4.8% sales volume CAGR over FY23-26E due to steady growth prospects in the automotive industry, growth longevity particularly in the PV segment (VSSL's highest exposure segment), increased export play with ASC joining the team, and phase-wise commissioning of additional capacities. The subsequent net sales CAGR for FY23–26E is estimated to be 6.2%. Positive surprises could occur along the way.

• With operating efficiencies at bay, EBITDA/tonne to improve towards ₹10k level

As volumes increase and new grades are developed under the direction of ASC, along with favorable price negotiations with customers, we anticipate that EBITDA/tonne at VSSL will gradually increase to 10,000 levels by FY26E from 9,000 levels clocked in FY23 and 7,700 in Q1FY24.

RISK AND CONCERNS

• Dealy in commissioning of brownfield capacity

With sales of 2 lakh tonnes in FY23 and rolled product capacity of 2 lakh tonnes, VSSL is currently experiencing capacity difficulties. Any delay in brownfield capacity commissioning will result in a loss in volumes, which is detrimental to our target price calculation given our aim to increase export play with the aid of ASC and stable domestic demand outlook.

• Slowdown in domestic automobile sector, exposure to engine products – EV risk

90% of VSSL's revenue comes from the domestic auto industry, and the company even produces steel for some engine components like pistons, crankshafts, and camshafts. The risk to our investment call on the firm is therefore any downturn in the local auto industry paired with insufficient measures to diversify the product/customer base and thereby mitigate the EV threat.

• Inadequate and untimely price negotiation with customers

In the regular course of business, VSSL must periodically bargain with consumers about the pricing of the finished product. However, because the majority of these clients are significant conglomerates, such as auto OEMs, VSSL has less negotiating strength, which could jeopardise its short-term profitability in the event of a dramatic change in input costs. This is a risk that comes with making our investing call.

VALUATION

Aichi Steel Association- a structurally long-term positive: Aichi Steel, a multinational corporation that is a part of the Toyota Group, uses steel manufactured by ASC to make high-quality products that serve the automobile sector. Aichi Steel and VSSL had been pursuing a strategic partnership for a while now, and a deal was ultimately reached in 2019. ASC is anticipated to develop VSSL into a genuinely world-class organization that provides quality/value-added components for the automotive sector thanks to its technical and technological ability and high-quality standards in special steel fabrication. Brownfield expansion under execution, much larger vision for 2030: Despite sustained state expansion in the domestic vehicle market, the company is experiencing capacity constraints with a sales volume of 2 lakh tonnes in FY23. However, it is gradually increasing its brownfield rolled product capacity from 2 lakh to 2.5 lakh tonnes. This project, which will cost a total of 300 crore in capex and also includes site acquisition for a new facility, is projected to be finished by FY26E. Organically, we have planned for a 4.8% CAGR in sales volume over the next FY23–26E; as a result, sales/PAT growth is estimated to be 6.2%–8.6% over the same period. However, the company envisioned a far bigger role, with the ultimate goal of being India's top producer of special steel by 2030. With Aichi Steel Corporation's support and VSSL's ambition to succeed in the special steel industry, we rate the stock as BUY. We value VSSL at 260.

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