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Growth faces near-term cost headwinds

Mishra Dhatu Nigam’s (Midhani) Q2FY23 performance was steady led by higher scrap utilisation. Key takeaways: 1) EBITDA margin came in at 32.4%, despite firm raw material and power costs, owing to higher scrap utilisation; 2) orderbook rose to Rs15bn (Q1FY23: Rs11.2bn); 3) H1FY23 value of production (VoP) rose 41.8% YoY to Rs4.8bn; 4) launched six new products at Def Expo-22; and 5) 8te vacuum induction melt furnace has fully started at Rohtak (in Haryana) for producing armour plates. Going ahead, while we see exciting prospects from wide plate mill and Rohtak plant, at Rs5bn each in steady state, near-term margin pressure is likely to keep stock performance constrained. Besides, revenue target of Rs10bn for FY23 looks daunting. We re-initiate coverage on Midhani, valuing the stock at 14x FY24E EBITDA, capturing the potential upside from ramp up of wide plate mill and Rohtak armour plant, resulting in TP of Rs230, implying 4% upside from the CMP. We re- initiate coverage on the stock with HOLD rating.

* Margin pressure in store in H2FY23. Midhani’s Q2FY23 EBITDA of Rs587mn rose 13.1% YoY despite sustained raw material pressure. Key highlights: 1) Raw material cost stayed firm as alloying elements’ prices did not decline; 2) higher scrap utilisation, lower consumption rate and better yields resulted in robust EBITDA margin of 32.4% (Q2FY22: 27.6%; Q1FY23: 28.7%); 3) inventory rose 20% compared to Mar-22 level of Rs12.8bn owing to elevated raw material prices; 4) cashflow from operations was impacted by working capital accretion in H1FY23. Going ahead, we expect margin to come under pressure as most contracts of Midhani are fixed priced in nature. That said, we expect additional revenue from wide plate mill and armour factory at Rohtak in H2FY23. Going by H1FY23 revenue of Rs2.9bn, we find management’s guidance of Rs10bn for FY23 daunting.

* Growth opportunities exist; long gestation period for products might constrain value creation in near term. The management has guided for steady state revenue rate of Rs5bn each from wide plate mill and armour factory in Rohtak. We expect both these revenue streams to further increase revenue in H2FY23. Besides, management is awaiting LCA-related certifications and traction from nuclear/space programmes in the ensuing quarters. That said, we believe long gestation period of 7-8months and bill/book ratio of 1.5x might keep meaningful earnings growth constrained in near term.

* Outlook and valuations: We expect wide plate mill and Rohtak armour factory to start contributing from H2FY23. However, in our view, the stock performance is likely to underperform in the face of stubbornly high raw material prices. We value Midhani at 14x FY24E EBITDA- higher end of its historical valuation band- taking cognisance of growth opportunities. We re-initiate coverage on Midhani with HOLD rating and TP of Rs230.

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