Business Today
Piping in profits
The ever-increasing demand for oil and its transportation is fuelling the growth of pipeline manufacturing. R Sree Ram picks out some attractive stocks.

Why is sector lucrative


• New pipeline projects in the offing to ensure strong order book for the next three years

• Proximity to Asian markets where most of the investment is happening

• No competition from global manufacturers whose capacities are full for the next two years

• Will not be affected by domestic or global slowdown

Click here to see graphic: Stocks to watch out for

Click here to see graphic: Promising future

The world is getting used to the fact that oil prices will inevitably go up. While wars are being fought for oil, on a more civilised and corporate level, oil exploration companies and governments are scouting for ways to secure energy supplies. More and more companies are conducting exploration activities and are heavily investing in new pipeline networks for transportation of oil and gas. This whole process of drilling and evacuation has meant increased profits for the global pipe industry.

“Increasing prices of crude makes exploration feasible in difficult and new territories, which, in turn, creates demand for pipelines. Pipelines are the most cost-effective means of transportation,” says Utpal Choudhury, research analyst at IDBI Capital.

Transportation through pipelines is cheaper by 40% than railways and 57% than road transport. An estimated 2,56,081 km (1 km =250 tonnes) of pipelines are expected to be laid down in the next few years.

The domestic advantage: With planned global investments of over $96 billion in oil and gas pipelines, Indian companies are expected to benefit more from this demand surge than their global counterparts. That’s because the global biggies have order books that are full— and no fresh capacity is expected.

“Indian players have planned their capacity additions well. With all major Indian players having surplus capacities or new plants coming up in the next year, it leaves room to accommodate world demand for pipes,” says Chintan Mehta, research analyst at Asit C Mehta.

Indian pipe manufacturers are not only well prepared to explore this opportunity (as they are adding more than one-fourth of the global capacity) but are also close to the markets in Asia and West Asia, which is expected to account for 48% of the new pipeline demand. Adding to this robust demand is the replacement opportunity of the existing pipeline networks. According to Credit Suisse estimates, some 85,000 km of oil and gas pipelines in the US alone are expected for replacement.

Future pipeline projects

Place
Length
(in ‘000 km)
% of total demand
Asia and West Asia 122.948
North America 53.9 21
Europe 35.5 14
Latin America 29.1 11
Rest of the world 14.7 6
Total256.1100 
Source: Simdex/Credit Suisse
Stocks to watch: “Pipe manufacturers provide better earnings visibility compared to steel producers; hence we believe they deserve a premium discounting. Investors with a medium- to long-term horizon can enter this sector, as many companies are quoting at singledigit PE multiples,” says Hemang Tanna, research analyst at Indsec Securities. Among the pipe manufacturers, analysts are most bullish on Welspun Gujarat and Jindal Saw.

Welspun Gujarat, which derives more than 85% of its revenues from exports, is well placed to explore the global opportunities. With a healthy order book of Rs 4,670 core in 2007-8, Welspun was able to decrease its raw material cost as a percentage of sales from 75.5% to 65.9%. The company’s focus on niche products and its strategy of streamlining raw materials supplies at the time of receipt of order has paid off, and operating margins are up 380 basis points.

The company recently secured orders worth Rs 1,075 crore for supply of HSAW pipes in North America, and analysts expect the order flow to continue as the company has participated in bids worth $2 billion. Indiainfoline recommends this stock: “We expect operating margins to improve significantly in light of backward integration.

Capacity additions, coupled with increasing capacity utilisation, will lead to robust volume growth.” The brokerage has set a target price of Rs 548 with a potential upside of 25.7%, and expects Welspun to register a CAGR of 48.6% until 2009-10 on strong volume growth coupled with higher realisations.

With an order backlog of $1 billion (Rs 4,100 crore), Jindal Saw is also expected to continue growing in its core business of steel pipe and tubes. The company has set up a subsidiary, Jindal ITF, to enter new business areas such as fabrication of shipping, wagon manufacturing and water transportation businesses.

While some analysts consider this diversification risky, others expect these ventures to act as a cushion. According to Emkay Share and Stock Brokers: “The new businesses would diversify its business model by de-risking it from raw material price volatility and currency volatility.” Emkay has set a target price of Rs 1,045 for the stock.

In the mid-cap and small-cap space, PSL and Ratnamani Metals & Tubes are considered to be the best picks. PSL, which concentrates on the domestic market, has the country’s largest HSAW pipes capacity. Its low capacity utilisation factor gives it leeway to take up new orders. “We strongly recommend PSL. It has large capacities in multiple locations. The low capacity utilisation factor (CUF) of the company allows it to bid for more orders than its peers,” says Amol Rao, research analyst at PINC.

Ratnamani Metals & Tubes is being recommended for its backward integration in securing its key raw materials. The stock is considered a buy in light of the upswing in the engineering industry and the company’s focus on customisation.
Get latest news & live updates on the go on your phone with our News App. Download The Business Today news app on your device
More from Sector Scenario