WS IND

WS Industries (India) Ltd (WSI), a leading manufacturer of porcelain insulators, which are used in power distribution, is all set to reap the benefits of a three-fold increase in investment in the transmission and distribution (T&D) segment in India.
A strong order book of about Rs110 crore coupled with rising exports and a shift to higher-margin product of hollow insulators will drive the company''s earnings at a compounded annual growth rate (CAGR) of a staggering 147% over FY2005-07.
WSI has tied up with The Chatterjee Group (TCG) to develop a 10-lakh-square-feet information technology (IT) park at Porur in Chennai. This, we believe, will result in the unlocking of the huge potential value of the land. We believe the fair value of the IT park is about Rs80 per share of WSI.
Business overview
Market leader with 20% share The total market for porcelain insulators in India is approximately Rs600-crore big and WSI is the leader with a 20% share. Jayshree Insulators, a division of Indian Rayon, and Bharat Heavy Electricals Ltd (BHEL) are the other key players in the industry with a market share of 17% and 15% respectively.
Impressive client baseWSI boasts of an impressive client base consisting of power utilities like Power Grid Corporation of India Ltd (PGCIL) and National Thermal Power Corporation as well as equipment majors like ABB, BHEL, Larsen and Toubro (L&T) and Siemens. Over the years WSI has executed several big orders for PGCIL mainly for usage in systems of capacities 220 kilo volt (KV) and 400KV. In addition, the company has also executed large orders for several state electricity boards (SEBs) as well as the major transmission line/sub-station contractors like ABB, BHEL, L&T, Siemens, Crompton Greaves etc.

Investment arguments

WSI to reap benefits of a three-fold rise in T&D investmentsWSI, a leading manufacturer of porcelain insulators, is all set to reap the benefits of a three-fold increase in investments in the country''s T&D sector. The T&D sector is all set to attract huge investments for several reasons. We have discussed them below.
A skewed generation/transmission ratio The world over the ratio of new investment in generation projects and that in transmission projects is around 50:50. However in India at 70:30 the generation/transmission ratio is skewed towards generation. Meaning in India traditionally the transmission segment attracts lesser investments compared with the generation segment. But with the country''s renewed attempts to improve the efficiency of its T&D sector and power transmission capacity, the T&D sector, especially the transmission segment, has started attracting more investments. The recent Draft National Electricity Plan in Transmission envisages the addition of around 7,000 megawatt (MW) of transmission capacity in FY2006 and FY2007 as compared with the 4,400MW transmission capacity added over FY2003-05. As per the plan, new transmission capacities of 11,400 megvolt (MV) and 16,000MV would be added in the 10th Five-Year Plan and the 11th Five-Year Plan respectively. Further in the distribution segment, sub-stations of capacities 25,555 megvolt ampere (MVA) and 7015 MVA are going to come up in FY2006 and FY2007 respectively.
The Accelerated Power Development & Reforms Programme The country has been perennially plagued by power shortages on account of the T&D losses of the SEBs. Due to the lack of adequate investment in the T&D systems, the losses of the SEBs have been consistently mounting and the same reached a whopping Rs21,000 crore in FY2005. To reduce the T&D losses of the SEBs the government introduced the Rs40,000-crore Accelerated Power Development & Reforms Programme in the 10th Five-Year Plan. The plan, we believe, will encourage the SEBs to invest in their T&D systems. This would involve the upgradation of the existing T&D lines and the installation of new transmission lines and distribution stations.
Planned capacity addition
Source: Central electricity authority
Planned investments in transmission, distribution and rural electrification (Rs crore)
Source: Central electricity authority
The proposal to increase India''s power generation capacity by 60% The government proposes to increase the power generation capacity of the country by 60%, from 41,110MW in the 10th Five-Year Plan to 64,739MW in the 11th Five-Year Plan. This initiative too will generate the need for more evacuation and transmission equipment, and distribution stations.
Even if these T&D projects were to materialise only partially, the same would translate into significant business for the porcelain insulator industry, as porcelain insulators are used in both transmission lines and distribution stations. Needless to say that being the market leader WSI is expected to make the most of the resulting golden opportunity.
Business initiatives to capitalise on growth opportunitiesTo capitalise on this "powerful" opportunity WSI has drafted a two-pronged strategy. As part of this strategy, the company plans to manufacture high-end porcelain insulators and enter new export markets. In addition it proposes to change its sales mix in favour of the high-margin hollow porcelain insulators.
Manufacturing high-end porcelain insulators and entering new export marketsWSI enjoys the status of an export house and exports its products to Europe, West Asia, East Asia, Australia, Canada etc. It is now looking at entering the US markets for which it has developed new products, like disc, pin and solid core porcelain insulators, as per the American National Standards Institute standards. The initiative to enter new export markets has been successful and consequently the company''s exports grew by 31.5% to Rs36 crore in FY2005.
Changing sales mix in favour of high-margin hollow porcelain insulators The margins in hollow insulators are usually two times that in solidcore insulators. Over the past few years, WSI has shifted its sales mix in favour of the hollow insulators, thereby arresting the erosion in its margins on account of high raw material prices. The company is also expanding its hollow insulator capacity from the present 5,000MT to 6,000MT at a cost of Rs5-6 crore. The additional capacity is expected to be fully operational by the end of this fiscal.
Healthy order book position ensures strong earnings visibilityHelped by the surge in investments in the T&D sector the order position of WSI has reached a high level of Rs110 crore, which is approximately nine months’ revenue (based on average monthly sales for the first half of FY2006). The strong order book position and the new orders expected owing to the T&D opportunity provide strong visibility to the company''s earnings.
Margins to improve by 340 basis points, earnings to grow at a 147% CAGRDriven by the change in the sales mix and the resulting higher operating leverage (30% of WSI operating expenditure is fixed and will not grow at the same rate as the revenue), WSI''s operating profit margin (OPM) is expected to improve by 340 basis points. With a 20% growth in the top line and the improvement in the OPM, we expect the company''s operating profit to grow at a 41% CAGR over FY2005-07. However with depreciation more or less stable and the reducing interest cost on account of debt repayment, WSI''s earnings are expected to grow at a CAGR of a whopping 147%. The company should report earnings per share of Rs2.8 in FY2006 and of Rs7.2 in FY2007.
Use of idle land to build IT park to result in huge value unlockingWith the rationalisation of its Chennai factory lay-out, WSI has restricted the areas covered by its Perur plant. Consequently, the company has been able to save a huge area of land measuring 10 lakh square feet. The same piece of land shall now be developed into an IT park. For the project WSI has joined hands with TCG of Kolkata. An application to this effect has already been filed with the Chennai Metropolitan Development Authority and the construction work is all set to commence.
The IT park will come up on the Chennai-Bangalore National Highway, just outside the city limits. According to real estate industry sources, there is a growing demand for quality IT space in the area, as with the crowding of the Old Mahabalipuram Road the land prices on the Chennai-Bangalore highway have escalated. As Perur is close to the Chennai airport and located in the vicinity of star hotels, we believe the site is ideal for IT majors. The project shall be implemented in two phases, with 250,000 square feet being developed in phase one; the work in the first phase should be completed by the end of FY2007.
Fair value of the IT park: Rs40 per share of WSIThe commercial rates in and around the area where WSI intends to develop the proposed IT park are close to Rs4,000 per square feet. Assuming that the entire area shall be developed over a period of eight years and discounting the future value of the same to its present value, we have arrived at the fair value of the IT park: approximately Rs80. Even on an extremely conservative basis (ie at a 50% discount to the fair value), the value of the IT park comes to Rs40 per share of WSI.
Investment concerns
Rising fuel costs could affect marginsThe fuel cost, which normally forms 20% of the total cost in such businesses, is a major cause for concern to WSI. Due to the sharp rise in crude oil prices during FY2005, the company''s fuel cost surged by 33%, negating the effect of a 15% growth in its top line and resulting in a negative operating profit growth. However crude prices have corrected sharply in recent times and are expected to soften further going forward. Thus the threat of high fuel cost, we believe, has receded significantly.
Strengthening of rupee against dollar could hurt export realisationDuring FY2005, the continued strengthening of the Indian Rupee against the US Dollar affected the company''s realisation from its dollar-denominated export orders, which form the bulk of its export orders. However the recent depreciation in the rupee''s value could actually benefit WSI.
Slowdown in investments in transmission segment can restrict revenue growthAs the transmission segment has still not been privatised and as all the new investments in the segment are a function of the government''s commitment to its power reform initiatives, any slowdown in the investments in the segment could hurt WSI. Similarly the lack of progress of plans to reform the state utilities and privatise the distribution segment will adversely affect the insulator industry in the medium to long term.
Valuation and view Even though WSI is a small-sized power equipment company, it operates in a niche industry that is highly concentrated with the top three players controlling more than 50% of the market. Add to it the fact that the company is the market leader in the porcelain insulator segment. We believe WSI is all set to move into a high growth trajectory with its strategy of focusing on high-margin hollow insulators and entering new export markets.

At the current market price of Rs 51 the stock is discounting its FY2007E earnings by 7x and its FY2007E earnings before interest, depreciation, tax and amortisation (EBIDTA) by 5.3x. The valuations are much cheaper as compared with that of WSI''s peers. 120 seems to be fair value taking Rs72 as the value of the core business and Rs40 (50% of the fair value) as the value of the IT park.