Pick of the Week 16 Jan 2017

RETAIL RESEARCH
Kalyani Steels Ltd
Industry CMP Recommendation Add on Dips to band Sequential Targets Time Horizon
Steel Downstream Rs. 332.70 Buy at CMP and add on declines Rs. 300-310 Rs. 367 & Rs.404 2-3 quarters

HDFC Scrip Code KALSTEEQNR Established in 1973, Kalyani Steels Ltd (KSL) is part of the over $3 bn Kalyani Group. The company was set up primarily to
meet the groups in-house requirement of forging quality steel. Over the years KSL has become a leading manufacturer of
BSE Code 500235 forging and engineering quality carbon & alloy steel using blast furnace route. Although domestic forging industry is the
NSE Code KSL primary market for KSL, it supplies to manufacturers of various components for CVs, 2-W, diesel engines, bearings, tractors,
turbines and railways. It has an integrated steel complex at Hospet, Karnataka with hot metal capacity of 675,000 TPA of
Bloomberg KS IN
carbon and alloy steel.
CMP as on 13 Jan 17 332.70
Eq. Capital (Rs Cr) 21.83 Investment Rationale
Falling commodity prices over the last few years to help improve margins, recent fall (after a brief rise) to help overcome
Face Value (Rs) 5.00 fears of hit on margins
Equity Sh. Outs (Cr) 4.37 Strong parentage to ensure revenue growth
Market Cap (Rs Cr) 1452.34 Auto revival to boost demand
Increasing investments by Indian railways
Book Value (Rs) 154.35 Boost from Make in India initiatives in defence
Avg. 52 Week Vol 396000
52 Week High 412.75 Concerns
Raw material price volatility and currency fluctuation
52 Week Low 120.50
High dependence on group companies
Slowdown in domestic economy in industrial/automobile segment (especially CV) further accentuated by
Shareholding Pattern-% (Sep-2016) demonetization
Margins for H2FY17 could fall compared to H1FY17 due to raw material price hike (not fully passed over) and low
Promoters 60.60 capacity utilization
Institutions 1.19
Non Institutions 38.21 Financial Summary
(Rs Cr) Q2FY17 Q2FY16 YoY (%) Q1FY17 QoQ (%) FY15 FY16 FY17E FY18E
Total 100.00 Net Sales 330.2 318.2 3.8 345.0 -4.3 1226.6 1180.5 1212.5 1376.2
EBITDA 73.0 58.5 24.8 87.1 -16.2 167.1 235.3 268.1 307.1
Research Analyst: Atul Karwa PAT 37.6 29.5 27.7 46.8 -19.7 83.3 113.6 134.2 160.4
atul.karwa@hdfcsec.com EPS (Rs) 8.6 6.7 10.7 19.1 26.0 30.7 36.7
P/E (x) 17.5 12.8 10.8 9.1
EV / EBITDA (x) 10.6 7.5 6.6 5.8
RoE (%) 13.6 19.9 22.1 22.3
(Source: Company, HDFC sec)

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Outlook and Recommendation

KSL has a long track record of over four decades in the manufacturing of forging and engineering quality carbon and alloy
steel backed by strong R&D. It is likely to benefit from the overall industrial revival in India. Initiative like Make in India and
increased spending on defence and infrastructure, especially railways could further provide a boost to topline. It also
receives strong support from its group company Bharat Forge which is looking to record strong topline growth over the next
few years. Kalyani Steel has a clear focus on industry segments with critical application, targeted approach towards
approvals with OEMs for niche segment products with long term partnerships, along with service level improvements. It
sells highly customised products to its customers resulting in stickiness. MIP was not applicable to Kalyani Steels and hence
it did not derive any benefit. Conversely it will not be impacted negatively on expiration of MIP in Feb 2017 or later.

Post the recent softness in coking coal prices and expecting a revival in demand post the demonetisation related slowdown,
we expect Kalyani Steel to do well going forward. Although 2HY17 numbers may be hit by slow demand and rising coking
coal prices, we feel that FY18 could be a better year. Even though Kalyani Steels is a commodity player, its presence in
specialised steel, its high margins and parentage could attract a higher P/E.

We feel investors could buy the stock at the CMP and add on declines to Rs 300-310 band (8.25-8.5x FY18E P/E) for
sequential targets of Rs 367 (10x FY18E EPS) and Rs 404 (11x FY18E EPS) in 2-3 quarters.

Company Overview
Kalyani Steels Limited (KSL) is a part of the $3 billion Kalyani Group. Established in 1973 in Pune, Kalyani Steels is one of the
leading manufacturers of special carbon and alloy steel, engineering and alloy steel ingots, blooms and billets conforming to
international standards. In 1997, KSL shifted base to Hospet, Karnataka to set up a world class integrated steel plant with
hot metal capacity of 2.9 TPA. Over the years, KSL has been continuously and extensively upgrading its technology and
infrastructure. Currently, this integrated steel complex has hot metal capacity of 6.5 TPA of carbon and alloy steels, with
three mini blast furnace, two rolling mills, Sinter plant, and power plant in a sprawling 375 acre campus. The establishment
was of extreme strategic importance with southern region being automotive hub, and Karnataka being state rich in iron
ore. The original Pune facility, through a Joint Venture with Carpenter Corporation, USA, came to be known as Kalyani
Carpenter Special Steels Ltd.

KSL has one subsidiary company i.e. Lord Ganesha Minerals Pvt. Ltd. with 77.5% holding. Besides KSL has 2 associate
companies; Hospet Steels Ltd. and Kalyani Mukand Ltd. with a stake of 49.99% and 50% respectively.

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Group Profile

(Source: Company, HDFC sec)

Investment Rationale

Falling commodity prices over the last few years to help improve margins, recent fall (after a brief rise) to help overcome
fears of hit on margins
The slowdown in the global economy has resulted in sharp decline in demand for commodities. Commodity prices had
fallen to their lowest levels in over a decade in 2015 providing margin expansion opportunities to companies like KSL with
its major raw materials being iron ore and coking coal. Although commodity prices have recovered from the lows achieved
in 2015, the gains are likely to remain subdued as the global economy makes a gradual recovery. EBITDA margins of KSL has
more than quadrupled from 4.4% in FY12 to 19.9% in FY16 on back of falling raw material prices.

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Commodity meltdown augurs well for KSL

(Source: Company, HDFC sec)

The Australian coking coal prices which had touched a high of $308.80/tonne (spot FOB premium hard coking coal price) in
Nov-16 have retreated by more than 35% and are now trading below $200/tonne and expected to correct further. Citigroup
has forecast an average iron ore price of $56/MT CFR in 2017 and $48/MT next year. Post the recent rally both iron ore and
coking coal are likely to face downward pressure as China tries to calibrate the excess capacities built during prosperous
times. We expect KSL to improve its operating margins to a range of 20-21% over the next couple of years.

Raw material prices on a correction mode (Coking Coal)

(Source: Steelmint, HDFC sec)

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Finished goods prices are on the up though with a lag

After sharp decline in 2014 and 2015 prices of rolled products have been increasing in 2016. Cold rolled coil (CRC) prices
have doubled since Jan 2016 to ~Rs 50000/MT while that of Hot Rolled Coil (HRC) have jumped by almost 50% to ~Rs
45000/MT. With the demand improving these prices are likely to be sustained providing topline growth for the company.
Rolled products prices are on an uptrend

(Source: Steelmint, HDFC sec)

Strong parentage to ensure revenue growth

KSL was set up to primarily meet the groups in-house requirement of forging quality steel. Kalyani Group has a combined
turnover in excess of $3 bn. It is also the parent company of the worlds largest forging company, Bharat Forge Ltd. Bharat
Strong support from group companies

(Source: Company, HDFC sec)

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Forge caters to several industries like defence, energy, oil & gas, aerospace, rail & marine and other infrastructure related
businesses and has plans to grow its topline strongly over the next few years. KSL supplies high quality steel to Bharat Forge
and Kalyani Carpenter Steel which contributes to ~35-40% of its topline.

Auto revival to boost demand

KSL is the preferred supplier of forging quality steel for variety of automotive applications like crankshaft, connecting rods,
gears, axle beams, transmission shaft. Its steel finds application in commercial vehicles, passenger cars and construction
equipment. Its steel that goes into bearings has high stability to withstand fatigue, distortion, speed and temperature. After
infrastructure, automotive industry is among the largest consumer of steel accounting for 10-12% of the steel output. The
Indian Auto industrys production has grown at a CAGR of 9.3% over FY10-FY16 and reached 24 million units in FY16. India
is expected to become a major automobile manufacturing hub and the third largest market for automobiles by 2020,
according to a report published by Deloitte.

Automobile production in India

Source: SIAM, HDFC Sec

With the increasing growth in demand on the back of rising income, expanding middle class and a young population base, in
addition to a large pool of skilled manpower, growing technology and higher export sales, the automobile segment is
expected to witness strong growth resulting in promising growth for the bearing industry.

Increasing investments by Indian Railways:

Plagued with a long spell of underinvestment, Indian Railways is firming up a plan for infrastructure development with an
ambitious target of pumping in more than Rs 8 lakh cr over the next four years. The massive investment plan would involve
high-speed rail connectivity, station redevelopment and capacity augmentation across the country. Aimed at decongesting
the existing rail network, the Indian Railways is targeting to commission 2,800 km of new track in FY17. Railways have plans

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ready to lay new tracks besides starting work on three new freight corridors that will further take the load off the tracks and
increase the average speed of passenger trains.

In the year 2015-16, railways commissioned nearly 2,500 km of new track which was 40 per cent more than the previous
year's achievement of 1,983 km. The drive is expected to gather further pace in 2017-18 when average 13 km of rails will be
laid km every day. According to an action plan formulated to bolster rail network, Railway Ministry officials said the bar will
be raised further in 2018-19 to 19 km per day.

The huge investment planned by Indian railways is likely to open wide range of opportunities for players like KSL as steel
(especially special steels) is one of the most crucial components for infrastructure development.

Boost from Make in India initiatives in defence

Defence is another sector for which KSL provides high quality steel and is expected to contribute more in the revenue mix
going forward. PM Modi announced Make in India campaign in Sep-2013 to increase the share of manufacturing sector in
GDP from 15% to 25% with a focus on defence indigenization. The Defence Production Policy promulgated in 2011, aims at
achieving substantive self-reliance in the design, development and production of equipment, weapon systems, platforms
required for defence in as early a time frame as possible. The government is targeting a level of 70% defence indigenisation
by 2027 from ~30-35% currently. The focus of government to improve its defence services and increase self-reliance in
manufacturing augurs well for quality manufacturing companies like KSL.

Bharat Forge has been a key supplier of components to the Indian defence establishment for over 30 years. Bharat Forges
arm Kalyani Strategic Systems entered into a joint venture partnership with Israel's Rafael Advanced Defense Systems in
Feb 2016 to bid for defence programmes in India, including infantry combat vehicle BMP II upgrade. This will also have an
upside to revenues of Kalyani Steels going forward.

Budget allocation for defence

2012-13 (Actuals) 2013-14 (Actuals) 2014-15 (Revised) 2015-16 (Budgeted)
Army 91,451 99,464 1,19,435 1,30,658
Navy 29,594 33,393 32,443 40,529
Air Force 50,509 57,709 53,897 56,687
DGOF -267 1,298 2,333 3,644
DGQA 696 766 816 850
R&D 9,795 10,869 13,447 14,358
Total 1,81,776 2,03,499 2,22,370 2,46,727

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Sanity in China in steel capacity could improve pricing and sentiments for Kalyani Steels
The support provided by the Chinese government in terms of cheap finance, land and labour resulted in huge steel
manufacturing being built over the past few years. However, the lack of demand led to underutilization of capacities. It has
become difficult for some of the overleveraged companies to even make interest payments on their debt. China will be
closing all of its medium frequency furnaces by June 2017. These furnaces contribute close to 9 percent to Chinas total
steel capacity. It is expected and hoped that Chinese manufacturers will be saner in manufacturing and/or pricing their
products which may lead to better pricing power for manufacturers of steel/steel products.

Purchase of land worth Rs.92 cr in FY14-FY16 denotes expansion plans which may be finalised shortly
KSL has purchased land worth Rs 92 cr in the last few years to expand its capacities in anticipation of huge orders from
Government in defence/railway segment. It is also looking to add a service centre for its products and few corporate offices
on that piece of land.

Healthy financials debt falling, high return ratios

The company has been able to take advantage of softer raw material prices and improve its operating margins from a low
of 4.4% in FY12 to ~20% in FY16. Return ratios have also seen an improvement over FY12-FY16 with RoCE improving from
6.7% to 23.1% and RoNW from 5% to 21.3%. With the expansion of its capacity complete it is now looking to utilize its cash
flows to pare down its debt levels. The return ratios are likely to remain above 20% in the coming years.

Concerns
Raw material price volatility and currency fluctuations
Key raw materials used by the company like iron ore and coking coal have highly volatile prices and any adverse movement
could directly impact operating profit. KSL imports ~45% of its raw materials and is exposed to currency fluctuations. Any
strengthening of USD could impact its raw material costs and margins.
Raw materials consumed as % of sales

Source: Company, HDFC Sec

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High dependence on group companies

Almost 35-40% of KSL sales come from group companies Bharat Forge and Kalyani Carpenter steel. Slowdown in these
companies could impact demand for KSL products.

Slowdown in domestic economy in industrial/automobile segment (especially CV) further accentuated by

demonetization
The slowdown in the domestic economy had impacted the industrial segment as well as CV sales. As we were witnessing
signs of revival, the demonetization move by the Government has pushed the recovery further down.

No dividend for FY15 and FY16

KSL has not paid dividends in FY15 and FY16 despite having decent profits as it needed to conserve cash for its capacity
expansion.

Margins for H2FY17 could fall compared to H1FY17 due to raw material price hike (not fully passed over) and low
capacity utilization
Increase in raw material prices is not being fully reflected in the financials of the company as the impact comes with a lag.
EBITDA margins which have increased by ~500 bps yoy in H1FY17 could shrink going forward. The capacity utilization of KSL
in 2HFY17 was also in the range of 65-70% and it might be difficult for the company to increase prices further.

Money locked in investments in subsidiaries/group companies

KSL has more than Rs 213 cr locked up in investments in subsidiaries/group companies earning nil to negligible returns. It is
uncertain when the company would be able to unlock value from these investments that has impacted its return ratios so
far.

Outlook and Recommendation

KSL has a long track record of over four decades in the manufacturing of forging and engineering quality carbon and alloy
steel backed by strong R&D. It is likely to benefit from the overall industrial revival in India. Initiative like Make in India and
increased spending on defence and infrastructure, especially railways could further provide a boost to topline. It also
receives strong support from its group company Bharat Forge which is looking to record strong topline growth over the next
few years. Kalyani Steel has a clear focus on industry segments with critical application, targeted approach towards
approvals with OEMs for niche segment products with long term partnerships, along with service level improvements. It
sells highly customised products to its customers resulting in stickiness. MIP was not applicable to Kalyani Steels and hence
it did not derive any benefit. Conversely it will not be impacted negatively on expiration of MIP in Feb 2017 or later.

Post the recent softness in coking coal prices and expecting a revival in demand post the demonetisation related slowdown,
we expect Kalyani Steel to do well going forward. Although 2HY17 numbers may be hit by slow demand and rising coking
coal prices, we feel that FY18 could be a better year. Even though Kalyani Steels is a commodity player, its presence in
specialised steel, its high margins and parentage could attract a higher P/E.

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We feel investors could buy the stock at the CMP and add on declines to Rs 300-310 band (8.25-8.5x FY18E P/E) for
sequential targets of Rs 367 (10x FY18E EPS) and Rs 404 (11x FY18E EPS) in 2-3 quarters.

Financial Statements
Income Statement
Particulars FY14 FY15 FY16 FY17E FY18E
Income from operations 1116.0 1226.6 1180.5 1212.5 1376.2
Material Cost 558.6 585.1 441.3 443.7 507.7
Employee Cost 57.8 66.4 82.7 84.9 95.0
Other expenses 80.7 90.2 104.3 100.3 111.1
Total expenses 987.4 1059.5 945.2 944.4 1069.2
EBITDA 128.6 167.1 235.3 268.1 307.1
Depreciation 34.0 31.0 51.7 56.2 61.6
EBIT 94.7 136.1 183.6 212.0 245.5
Other Income 11.8 2.7 2.7 3.0 3.4
Interest 17.0 14.8 12.0 11.7 9.6
PBT 89.5 124.0 174.2 203.3 239.4
Tax Expenses 30.9 40.7 60.6 69.1 79.0
PAT 58.6 83.3 113.6 134.2 160.4
EPS 13.4 19.1 26.0 30.7 36.7
(Source: Company, HDFC Sec)

Balance Sheet
Particulars FY14 FY15 FY16 FY17E FY18E
EQUITY AND LIABILITIES
Share Capital 21.9 21.9 21.9 21.9 21.9
Reserves and Surplus 376.0 454.1 567.7 701.8 862.2
Shareholders' Funds 397.9 475.9 589.5 723.7 884.1
Long Term borrowings 147.9 193.7 175.3 105.3 55.3
Deferred Tax Liabilities (Net) 43.6 51.7 61.4 61.4 61.4
Other Long Term Liabilities 91.9 91.9 91.9 91.9 91.9
Long Term Provisions 0.2 1.0 1.5 1.5 1.8
Non-current Liabilities 283.6 338.2 330.1 260.2 210.4
Short Term Borrowings 58.4 24.9 151.8 166.8 176.8
Trade Payables 244.6 209.9 144.8 139.1 150.4
Other Current Liabilities 33.9 33.9 36.6 59.6 60.1
Short Term Provisions 16.2 1.3 1.8 1.8 2.1
Current. Liabilities 353.0 270.0 335.0 367.4 389.4

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TOTAL 1034.5 1084.2 1254.6 1351.2 1483.8

ASSETS
Fixed Assets
Gross Block 644.1 780.3 855.9 935.9 1025.9
Less: Acc. Depreciation 305.1 337.9 368.1 424.3 485.8
Net Block 339.0 442.4 487.7 511.6 540.0
Capital work-in-progress 10.1 13.5 0.4 0.4 0.4
Non current Investments 31.2 76.8 213.5 213.5 213.5
Long-Term Loans and Advances 92.1 9.7 10.7 12.1 13.7
Other Non-current Assets 0.0 0.0 0.0 0.0 0.0
Non-current Assets 123.3 86.5 224.2 225.6 227.2
Current Investments 0.0 0.0 35.6 60.6 90.6
Inventories 170.9 156.1 109.1 106.0 112.8
Trade Receivables 331.6 327.6 345.9 347.8 375.9
Cash and Bank Balances 16.8 4.9 7.0 50.8 81.2
Short-Term Loans and Advances 36.4 42.2 33.7 38.7 43.6
Other Current Assets 6.4 11.1 11.1 9.8 12.1
Current Assets 562.1 541.8 542.3 613.7 716.2
TOTAL 1034.5 1084.2 1254.6 1351.2 1483.8
(Source: Company, HDFC Sec)
Cash Flow Statement
Particulars FY14 FY15 FY16 FY17E FY18E
Profit Before Tax 89.5 124.0 174.2 203.3 239.4
Depreciation 34.0 31.0 51.7 56.2 61.6
Others 10.8 15.6 12.1 10.3 8.0
Change in working capital -67.3 -28.5 -26.1 14.9 -29.9
Tax expenses -27.7 -28.0 -51.2 -69.1 -79.0
Cash flow from Operating activities 39.3 114.2 160.7 215.5 200.0
Net Capex -32.3 -145.7 -84.0 -80.0 -90.0
Other investing activities 22.6 -43.6 -170.2 -25.0 -30.0
Cash flow from Investing activities -43.5 -106.9 -255.2 -105.0 -120.0
Proceeds from Eq Cap 0.0 0.0 0.0 0.0 0.0
Borrowings / (Repayments) 0.0 0.0 108.5 -55.0 -40.0
Dividends paid -7.7 -15.3 -0.1 0.0 0.0
Interest paid -16.5 -16.3 -11.8 -11.7 -9.6
Cash flow from financing activities 12.0 -19.2 96.7 -66.7 -49.6
Net Cash Flow 7.8 -11.9 2.2 43.8 30.4
(Source: Company, HDFC Sec)

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Financial Ratios
Particulars FY14 FY15 FY16 FY17E FY18E
EPS 13.4 19.1 26.0 30.7 36.7
Cash EPS (PAT + Depreciation) 21.2 26.1 37.8 43.5 50.8
Book Value Per Share(Rs.) 91.0 108.8 134.8 165.5 202.2

PE(x) 24.8 17.5 12.8 10.8 9.1

P/BV (x) 3.7 3.1 2.5 2.0 1.6
Mcap/Sales(x) 1.3 1.2 1.2 1.2 1.1
EV/EBITDA 13.8 10.6 7.5 6.6 5.8

EBITDAM (%) 11.5 13.6 19.9 22.1 22.3

EBITM (%) 8.5 11.1 15.5 17.5 17.8
PATM (%) 5.3 6.8 9.6 11.1 11.7

ROCE (%) 16.8 21.0 22.8 22.2 23.2

RONW (%) 15.6 19.1 21.3 20.4 19.9

Current Ratio 1.6 2.0 1.6 1.7 1.8

Quick Ratio 1.1 1.4 1.3 1.4 1.5
Debt-Equity 0.5 0.5 0.6 0.4 0.3
(Source: Company, HDFC Sec)

Quarterly Financials
Particulars Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17
Income from Operations 296.5 302.3 301.6 318.2 258.6 301.8 345.0 330.2
EBITDA 42.4 44.4 57.4 58.5 57.2 62.1 87.1 73.0
EBITDA margin 14% 15% 19% 18% 22% 21% 25% 22%
Depreciation 8.5 8.5 9.4 11.3 14.0 17.0 13.6 13.2
Other Income 0.6 1.4 0.3 0.4 0.2 2.0 0.9 0.7
Interest 4.2 1.6 3.2 2.4 3.0 3.4 3.0 2.4
Tax 9.0 11.7 16.2 15.7 14.3 14.5 24.5 20.4
PAT 21.2 24.0 28.9 29.5 26.1 29.1 46.8 37.6
PAT margin 7% 8% 10% 9% 10% 10% 14% 11%
EPS 4.9 5.5 6.6 6.7 6.0 6.7 10.7 8.6
(Source: Company, HDFC Sec)

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1 year price movement 1 year Forward PE

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Fundamental Research Analyst: Atul Karwa, atul.karwa@hdfcsec.com

RETAIL RESEARCH Tel: (022) 3075 3400 Fax: (022) 2496 5066 Corporate Office

HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 3075 3400 Fax: (022) 2496 5066
Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com.

"HDFC Securities Ltd. is a SEBI Registered Research Analyst having registration no. INH000002475."

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Research entity has not been engaged in market making activity for the subject company. Research analyst has not served as an officer, director or employee of the subject company. We have not received any
compensation/benefits from the Subject Company or third party in connection with the Research Report.

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