APL Apollo Tubes - Proposed investment into Shankara to strengthen distribution of structural steel tubes

APL Apollo (APL) has announced a minority equity investment proposal by its wholly owned subsidiary APL Apollo Mart Limited (Apollo Mart) into Shankara Building Products Ltd (Shankara). APL will end up owning ~9.9% of Shankara for a total investment of Rs1.8bn (~6% of APL's total capital employed as on end-Dec'21). This will be through a combination of purchase of secondary promoter shares (1mn shares @Rs755/share) and proposed preferential allotment of convertible warrants (1.4mn shares @Rs750/share). Shankara was valued at 0.9x EV/sales (FY22 annualised). The investment will be funded via internal accruals and is expected to be EPS and RoCE accretive from the very first year. APL sees an opportunity to potentially double its existing sales from Shankara. We maintain BUY on APL with a target price of Rs1,110/share.

- Investment rationale. According to management, i) the investment is aligned with APL's growth plan, ii) Shankara would be an ideal launch platform for APL's new products, iii) there would be synergies through Shankara's retail/wholesale network, iv) expansion of the structural steel tubes market and v) association would ensure sales consistency as Shankara is amongst APL's key distributors.

- APL Apollo + Shankara associations. Shankara distributes ~0.1mnte of APL Apollo's volumes. In April'19, APL acquired Shankara's 0.2mnte Hyderabad plant for ~Rs700mn. APL recovered its entire investment cost within three years, boosting its overall ROCE. Current EBIDTA generation (estimated) from that plant is Rs400- 500mn pa. With the current investment, management expect sales consistency to be maintained along with growth momentum. APL sees an opportunity of potentially doubling sales through Shankara using its extensive retail/wholesale network.

- About the deal. The investment will be made through a combination of purchase of secondary promoter shares (1mn shares @Rs755/share) and proposed preferential allotment of convertible warrants (1.4mn shares @Rs750/share), taking the total investment size to Rs1.8bn (~6% of APL Apollo's total capital employed as at end-Dec'21). Apollo Mart will make an immediate investment of ~Rs1.018bn (secondary market purchase +25% warrant subscription money) and the remaining investment of ~Rs787mn will be made within 18 months (75% on warrant conversion). Shankara was valued at 0.9x EV/sales (FY22 annualised). The target deal is expected to be completed in Q1FY23 subject to approvals. Management expects the deal to the EPS and RoCE accretive from the very first year.

- Risks. We haven't factored in any additional investments for strengthening the distribution/retailing framework for APL. More such investments, going forward, may have implications for future RoCE.

- About Shankara Building Materials. Shankara is one of India's leading organised retailer/wholesaler of home improvement and building products. The company achieved revenue of ~Rs22bn (annualised FY22) with steel tubes/products forming majority of sales. Shankara has presence in 10 states with a cumulative store base of 90 covering 450,000 sq. ft. The company sells over 30,000+ SKUs across the entire home construction and renovation lifecycle.

- Case studies. i). Arcelor Mittal-DSTC FZCO: Arcelor Mittal invested in DSTC FZCO with an aim to create full-fledged distribution network in Gulf countries. DSTC had 450,000 sq. ft. stockyard in Al Quoz for steel storage. ii) Carrier Corp-AT Distributor: Carrier Corp invested in AT Distributor with an aim to gain greater control over distribution of its products. A.T. Distributors had sales of US$40mn. iii) UFP Industries- Shelter Products: UFP Industries invested in Shelter Products with an aim to meet growing demand of factory-built housing and distribute new products in South US. Shelter had sales of US$11.4mn with 87,800 sq.ft. warehouse.

Maintain BUY

We maintain BUY with a target price of Rs1,110/share. This is based on 25x FY24E P/E. The stock has seen a massive rerating in the past 18 months on the back of Tricoat acquisition, repayment of debt and steady growth. With an improving RoE and RoCE profile (significantly higher operating leverage), higher growth driven by constant efforts towards market creation, and steady increase in market share (to reach >60% in the next 3-4 years in our view), we believe that a multiple of 25x FY24E P/E is justified.

Key risks

Key risks to our earnings and margin assumptions are: falling steel prices and normalising spreads. We believe management's assessment that drive towards value addition would lead to a normalised EBITDA of Rs5,000/te as volumes grow towards 4mtpa.

We believe that a slower-than-anticipated pickup in steel tubes market or equal marketing and distribution push by peers can lead to market share erosion / lower than expected revenue growth for APL.

Exposure to intense competition: APL operates in an industry with low entry barriers and fragmented structure. Though the company had ~50% market share in FY21, and the second-best player is less than half of APL's size, APL's operating margin has been modest at 5-8%. The ERW pipes industry is largely unorganized and inherently competitive with the presence of multiple large established players like Surya Roshni, Hi-Tech Pipes, Rama Steel Tubes, etc. Further, as ERW pipes are standardised products and do not warrant a capital-intensive manufacturing process, steel pipe/tube players with a diversified network across India can enter the market, boosting competition. Also, competition from unorganised players is high.

Shares of APL Apollo Tubes Limited was last trading in BSE at Rs. 963.40 as compared to the previous close of Rs. 909.65. The total number of shares traded during the day was 21311 in over 4447 trades.

The stock hit an intraday high of Rs. 967.00 and intraday low of 911.00. The net turnover during the day was Rs. 20179587.00.

Shares of Shankara Building Products Limited was last trading in BSE at Rs. 819.75 as compared to the previous close of Rs. 748.45. The total number of shares traded during the day was 96322 in over 6553 trades.

The stock hit an intraday high of Rs. 838.10 and intraday low of 741.20. The net turnover during the day was Rs. 76657199.00.

Source : Equity Bulls

Keywords

APLApolloTubes INE702C01027 ShankaraBuildingProducts INE274V01019 Investment ICICISecurities