Lanco Industries BUY (cmp : 43Rs)

Owned by Electrosteel Castings, Lanco Industries manufactures about 180,000 tpa of ductile steel pipes that are primarily used for the transportation of drinking water.

Backdrop: Water-related demand – thrust should continue We believe water and irrigation offers a very strong business opportunityfor Indian pipe manufacturers, in addition to the opportunity from the energy sector. A combination of greater government focus on irrigation,higher multilateral lending for water-related sectors and enhanced private sector participation in water supply projects increase the potential for rise in demand from this segment

Key focus area for the government according to 11th plan Irrigation remains a key focus area for the government and more so for the state governments due to the politically sensitive nature of the investments. Combined with water supply and the sanitation segment, which is essentially driven by the government plan for Jawaharlal Nehru National Urban Renewal Mission (JNNURM) projects, this segment is thesecond-mostimportant focus for the government after the power sector as perthe 11th five-year plan. The 11th plan envisages ~US$83bn of investments in irrigation and wate supply and sanitation over FY08–12.Bharat Nirman programme – significant addition of 5.9m hectares of irrigation potential in four years Under the irrigation component of Bharat Nirman (the flagship programme ofthe government of India to improve infrastructure in rural areas), there was a four years target (FY06–09) to create additional irrigation potential of10m hectares. This was planned to be met largely through expeditious completion of identified ongoing major and medium irrigation projects in addition to minor irrigation schemes through surface flow and ground wate development. Irrigation potential added in five key states The programme succeeded in creating additional irrigation potential of 5.94mPradesh, Maharashtra, Gujarat and Rajasthan leading the way, creating 66% of the additional potential among them. However, there still remains a deficitof 34.6m hectares irrigation potential in India. India’s estimated irrigation potential is around 139.9m hectares; after the four-year BharatNirman plan, the irrigation potential could be 105.3m hectares.

Andhra Pradesh remains the leader in providing thrust to irrigation investments the re-elected government in Andhra Pradesh has plans to double spending on irrigation over the next five years. This could also lead to higher irrigation spending by neighbouring states such as Maharashtra and Madhya Pradesh. Urban Infra – rapid approval of projects augurs well for order inflows Investments in Urban Infra tend to be much in doubt given the fiscal scenario of state governments and urban local bodies. However, significan Jawaharlal Nehru National Urban Renewal Mission (JNNURM) projects have been approved during the past year, with project approvals having increased to Rs494bn from Rs270bn a year ago. The major positive is the increase in assistance released by the government of India (GOI) in the past year; that assistance has gone up almost three-fold from Rs29bn to Rs74bn. Water supply/sewage projects contribute 76% of total project Water supply, sewage and drainage projects account for 76% of all project approvals. The mass rapid transport system (MRTS) and roads follow with contributions of 10% and 7%, respectively. The top six sectors accountfor 97% of all the approved projects.32% of government’s contribution already disbursed – expect surge in order flows.

The total contribution of the central government is Rs234bn, representing 47% of the total project cost. The central government has already releasedRs74bn under the first instalment for 461 projects in 21 states and Union Territories. We view the release of funds by the government of India as a proxy to progress on the ground because funds are only released for specific projects for which detailed project reports (DPRs) have been approved. Given the strong activity on the ground, we expect a surge in orders in the areas of water supply, sewage and drainage during the next 6–12 months.

The Rs 650 crore entity had a reasonably good FY09, withafter tax profits at Rs 18 crore, that work out to Rs 5 in EPS. For the Q1to June 2009, Lanco Industries has reported a 24 per cent increase in Revenues to Rs 169 crore (Rs 136 crore), with after tax profits of Rs 9.8crore-a qoq jump of 50 per cent. With cost key raw material inputs having come down and rupee appreciation actually making imported coke cheap the margins of the corporate are looking up. At a prospective EPS of Rs 10 for FY10, Lanco Industries is the cheapest stock in the ductile pipes space. A reasonable PE for this type of business would be 7 to 10 giving the scrip a 12 month prospective price target of Rs 70 to Rs 100.