Should you subscribe to the IPO of Shyam Metalics and Energy?
Shyam Metalics and Energy (SME), an integrated metals production company, is closing in on the primary market to raise around 909 crore. The IPO is a combination of a new share issue (for around 657 crore) and an offer for sale (₹ 252 crore). After the IPO, the promoter’s stake will drop to around 88.35%, from 100% currently. The market capitalization of the company after the IPO is said to be around 7,800 crore. A significant part of the public offer procedure will be used for the repayment or early repayment of the debt held by the company / its subsidiaries.
Put into service in 2005, SME mainly produces intermediate and long steel products, such as iron pellets, sponge iron, steel billets, TMT, structural products, rods and ferroalloys products. . The diverse nature of the product portfolio, low leverage and cost control measures in place are strengths for the company. The company’s plan to double the finished steel capacity from about 0.8 million tonnes per year (mtpa) to two mtpa, which is expected to be commissioned in fiscal year 24, will give the company a a step ahead of its profits provided the right conditions are in place.
At the high end of the price, the stock is valued at 11.8 times its FY21 annualized earnings (19.53 yen per share for 9 months of FY21). There are no immediate comparable companies for the company due to its diverse production. However, since half of the turnover is generated by finished steel, we try to analyze the valuation of SMEs at the offer price with the autonomous operations of Indian steel players (excluding operations abroad) .
The big players in the steel industry, Tata Steel, JSPL and JSW Steel are trading at 9.79, 6.0 and 20.9 times year-over-year earnings, respectively. Obviously, the SME at its offer price seems more expensive than the stand-alone activity (Indian operations which are more comparable to the SME which operates only in India) of already established steel players – Tata Steel and JSPL. Even at a consolidated level, JSPL trading at 7.8x is cheaper. The valuation of SME at a discount compared to JSW Steel is also justified because of its size and scope, as well as the higher margin that the latter can achieve. The SME EBITDA margin for the nine-month period ending December 2020 was 18%, compared to 26.7% for JSW Steel’s Indian operations.
While the outlook for the company looks healthy, long-term investors may now opt out of the IPO due to the valuation.
SME has three manufacturing plants with capacities throughout the steel value chain: granules (2.4 mtpa), sponge iron (1.38 mtpa), billets (0.9 mtpa), finished products (0.8 mtpa) and ferroalloys (0.2 mtpa). In 9MFY21, about 51.4 percent of revenue came from steel (including billets), 21.8 percent from pellets, 15.5 percent from ferroalloys, and about 11 percent from iron sponges. Being a well-diversified entity helps the company to have the flexibility to sell as middlemen as well as use them for captive consumption of value-added end products such as TMT, wire rod, etc. In addition, SME intends to increase the pellet capacity by 50 percent to 3.6 mtpa and more than double the capacity of spongy iron, billets and TMT to 2.9 mtpa, 2 mtpa and 2 , 07 mtpa. He has a 2,900 crore investment plan to spend in phases up to FY25.
In FY20, SME’s operational performance was poor due to the closure of the plant due to maintenance and modernization and the impact of Covid-19. Between FY18 and FY20, total sales increased at a CAGR of nearly six percent to 4,400 crore. But the operating profit margin fell to 14% in FY20, from 18% in FY18. As a result, net profit increased from 520 crore in FY18 to 340 crore in FY20.
However, the turnaround in the commodities cycle from the second half of 2020 has helped the company. Sales in the nine-month period ending December 2020 increased 20% to 4,000 crore yen, operating margin rebounding to 18% and net profit to 460 crore yen (up from 77%). In terms of leverage, the company seems comfortable with a gross debt to equity ratio of 0.27 times compared to December 2020 (compared to 0.47 times compared to March 2020). Despite the investment plans, management has decided to keep the leverage ratio below 0.5 times and expects it to be funded by internal provisions.
While the fundamentals of the company look good, how earnings will move through a volatile commodity cycle remains unclear. There are currently differing opinions on whether the current commodity cycle will last long or whether it is in a liquidity bubble. Given this uncertainty and the fact that established listed players are valued cheaper, the valuation is not attractive either. Therefore, long-term investors can avoid the IPO right now.
Given the low public listing after listing, the stock can also be volatile on both sides. Investors can monitor the performance of the company over the next few quarters, when more information about the company related to quarterly performance and its resilience to withstand the volatility of the commodity cycle becomes available.