Welspun Corp: Potential Liability For Defective Supply Hangs Heavy

To most investors, Welspun Corp‘s under-performance in the stock market must be baffling. Welspun Corp‘s figures show it to be a blue-chip. Welspun Corp‘s 3 Yr CAGR Sales was 41.93% while its’ 3 Yr CAGR Profit was 62.60%. Welspun Corp‘s Q on Q Sales Growth was 24.84% while its’ Q on Q Net Profit Growth was an impressive 70.26%. Welspun Corp‘s Return on Equity (ROE) was a healthy 27.37%. Welspun Corp‘s order book is healthy at Rs. 6400 Crore.

Welspun Corp reported good results in the 1st Quarter ended June 2010. Welspun Corp‘s Net profit increased 37.16% to Rs 189.57 crore in Q1 FY 2011 as against Rs 138.21 crore during the previous quarter ended June 2009. Welspun Corp‘s Sales increased 8.58% to Rs 2041.13 crore in Q1 FY 2011 as against Rs 1879.80 crore during the previous quarter ended June 2009.

Welspun Corp‘s future also looks bright. Welspun Corp has a huge opportunity in India with the government allowing private sector participation in the pipeline sector. Welspun Corp also has just commissioned its’ water pipeline project near Bangalore, in Karnataka so that should give Welspun Corp a hold into the water segment for the southern state. From the market perspective, the opportunities for Welspun Corp are good. Welspun Corp is consolidating its business on a global scale.

However, despite these impressive figures, Welspun Corp has been a gross under-performer on the stock exchange. At the CMP of Rs. 239, Welspun Corp‘s one-year return is a princely 3.32%! Throughout the year, Welspun Corp has been caught in a narrow range with no breakout in sight. At the FY 2010 consolidated diluted EPS of Rs. 28.40, the Price – Earning Ratio (PE) is only 8.41 which looks cheap for a company with this growth track record.

What is the reason for this gross under-performance in Welspun Corp‘s shares?

The one reason that we could think of for Welspun Corp‘s under-performance is the contingent liability of Rs. 139.34 crores (or is it Rs. 264 crores) that it is facing from its USA customers for alleged supply of defective material. Welspun Corp has got embroiled in at least two legal proceedings relating to supply contracts entered into by it. The first legal proceeding relates to a dispute as regards a supply contract dated December 2001 in connection with supply by Welspun Corp of steel pipe materials for a water transmission project. The counterparty in the case had encashed one of the bank guarantees issued by Welspun Corp allegedly without any justification, and W Welspun Corp initiated legal proceedings against the counterparty in 2003. Pursuant to a judgment dated December 1, 2008, the Muscat Court of Appeal directed the counterparty to pay an amount of US$537,951 and 50 percent of the appeal cost to Welspun Corp. Welspun has also filed an enforcement action which is now pending disposal before the relevant court. The second legal proceeding relates to a dispute regarding a supply contract entered into around September 2006 between Welspun Corp and a customer for Welspun Corp to supply pipes of specified steel certifications. The specifications particularly relate to the grade of the steel used in the manufacture of the pipes. The customer has sought common law remedies and damages of US$66 million against Welspun Corp and its agent in the United States of America alleging that the pipes supplied by Welspun Corp did not satisfy the specifications related to grade of steel. Welspun Corp had already replaced the defective pipes free of cost. It appears that Welspun Corp‘s customers who have gone to court are Kinder Morgan Louisiana Pipeline LLC, a subsidiary of Dallas-based energy giant Kinder Morgan Energy Partner LLP; Rockies Express LLC, a Kinder Morgan joint venture responsible for one of the biggest pipelines in the States; and T&R Pipeline Services. All three cases are filed in Harris County, Texas. Welspun Corp has alleged that the pipes were defective because ArcelorMittal, the world’s largest steelmaker, supplied defective steel to Welspun Corp for manufacturing the pipes.

The litigation is obviously very expensive and also resulting in bad press for Welspun Corp given that the opponents are huge customers.

Big-ticket investors are probably petrified that Welspun Corp may go the Punj-Lloyd way if the litigation goes against Welspun Corp. Punj-Lloyd never recovered after it suffered heavy losses of about Rs 220 crore on a litigation between its’ UK based subsidiary Simon Carves and SABIC Petrochemicals in the UK courts.

Looks like Welspun Corp‘s under-performance will cease only if the litigation between it and the petroleum majors in the US courts are resolved favourably. (See Also Welspun Gujarat Stahl Rohren: Pipeline to Profits)