Our Thoughts on... RHI Magnesita India
"Forging Foundations: Unveiling the Unseen Role of Refractories in India's Progress"
In our previous editions, we wrote about an FMCG major and a Housing credit NBFC. So, this week, we decided to write about something that we don’t see or notice in our routine, but it is an important part of our lives. Today, we will write about a refractory business. A business that has tremendous execution skills, high entry barriers for competitors and clean accounts gives us a peaceful sleep when it's bought at a decent valuation. In an investment world dominated by SaaS and banking research reports, we hope our dive into the old school manufacturing side of the Indian business will provide a fresh perspective and help gain some insights along the way.
Introduction
image source: Fortune India, Union Budget
In the last decade, Indian government has relentlessly focused on spending on large infrastructure projects which can be outlined in the above numbers. A jump of nearly 5x. This is a signal that we have entered a new phase of development.
For instance, the Union Budget for FY 2022-23 outlined the roadmap for growth across infrastructure creation, which focusses on roads, mass transport, logistics, housing, mobility, and commercial real estate, among others. Hence, this growth will create a beneficial intersectional ripple effect across multiple industries and different segments.
To understand the true picture of this growth, it is important to understand the role of refractory as the key enabler for making of Steel, Cement, and by extension infrastructure building and construction.
Let’s look at some numbers for a clear picture. India’s steel capacity is targeted at 300 MT by 2030, as per India’s Steel Policy. Cement production is expected to grow to 230 MT by that time from 118 MT in FY 22. The cement industry is expected to grow by 12% against CAGR of 6% historically.
This means that an unprecedented need gap is waiting to be addressed by the refractory industry. Growth like never before exists as a possibility, right in front of us.
However, this growth is incumbent upon ‘Refractory’, a critical but lesser-known component for the functioning of the Steel and Cement factories.
So, what is a refractory?
Refractories are essential to produce steel, iron, aluminum, copper, and other metals that are used for making cars, buildings, bridges, machines, and many other things. In other words, no steel, cement, glass, aluminum, copper or for that matter any metal or non-metal requiring high temperature process, can be produced without refractory.
source: company presentation, September 2022
As per the company’s presentation:
1 tonne of steel demands 10-15 kgs of refractory materials to be heated at 1,760-degree Celsius
1 tonne of cement demands 1 kg of refractory materials to be heated at 1,500-degree Celsius
1 tonne of glass demands 5 kgs of refractory materials to be heated at 1,650-degree Celsius
1 tonne of aluminum demands 6 kgs of refractory materials to be heated at 1,250-degree Celsius
1 tonne of copper demands 3 kgs of refractory materials to be heated at 1,350-degree Celsius
As India's steel capacity is targeted to reach 300 MT and Cement industry to targeted to reach 230 MT by 2030, one can safely assume that requirement of the refractories will keep going up over time. Historically, revenue growth of refractory players has been 1.5 times the growth in steel production. Hence, an investor is rest assured that demand for such an industry is not going down anytime soon.
Hence, the next logical question that comes is the ability to supply.
Does RHI Magnesita have the capacity to deliver on the expected demand?
Let’s have a look.
As per the research and markets report (click here), “the global market for Refractories estimated at US$25.4 Billion in the year 2022, is projected to reach a revised size of US$34 Billion by 2030, growing at a CAGR of 3.7% over the analysis period 2022-2030.”
So where does RHI Magnesita stand in this Global landscape?
source: company presentation
As per company’s own presentation, globally it commands a market share of 15%. There’s a stiff competition from small and medium Chinese companies which command a 34% market share. Hence, an investor should keep in mind that there will be margin pressures on the company. Reading the annual statements and quarterly conference call reports will give them a sense of how the company deals with such pressures.
In India, it’s heartening to see RHI Magnesita commanding a market share of 25%. This enables massive pricing power, and an investor can expect stability in margins going forward.
The company has expanded its presence and portfolio through strategic acquisitions, such as Dalmia Bharat Refractories Limited in 2023 and Hi-Tech's refractory business in 2022. Dalmia OCL acquisition adds 5 facilities in west and south while Hi-Tech acquisition adds Jamshedpur.
With a consolidated turnover of over 2700 crore INR and a production capacity of 1,40,000 metric tons per annum, the company has become the leading supplier of high-grade refractories in India with a mix of 84% domestic and 16% export.
The management has committed approximately INR 400 crore of phased investment by FY 2026 to expand its production capacity in India. The company aims to double its production to almost 3,00,000 tons per annum by 2026. About INR 50 crore of this was invested during FY21-22 to expand the capacity of its Vizag plant by almost 30%.
An investor can expect the strong performance of refractories to continue due to robust government spending on schemes like National infrastructure projects, PLI scheme, Jal Jeevan Mission, housing schemes, etc. With RHI Magnesita India commanding a 25% of market share, it will take a massive advantage of these schemes.
Companies like Google, Microsoft, Apple took off due to a massive wave in personal computing, we see a similar trend in refractories taking off due to a massive wave in India’s infrastructure story.
The China Factor!
Currently, the company is broadly dependent on China for most its key raw materials. Hence, there is always some delay or margin pressures. It applies to every refractory in India.
However, the company has incurred massive capex to increase their backward integration to solve this problem. Yet, the China factor will always remain. We still have a long way to go and ignoring China will be a very big mistake for investors.
Additionally, the management has been prudent in the cash management of the company. As per the latest conference call transcript, management has indicated that their cash conversion cycle has remained flattish at 87 days (about 3 months) versus 85 days (about 3 months) in March and this is a strong improvement from 105 days (about 3 and a half months) in September 2022.
The cash conversion cycle depends on the days payable to its creditors for purchase of raw materials, inventory days and days receivable from its suppliers for sale of finished goods.
Not letting their creditors from China dictate terms of engagement, the company has been able to prudently maintain their inventory levels too.
An investor should carefully look at China’s de-growth in exports and softening of inflation number going forward. These 2 can spoil the party for commodity companies despite the massive infrastructure wave. However, the impact will only be a short-term one in our assessment. So, if there is an emotional strength to ride this volatile condition, we are surely going to see refractories dishing out decent investment returns to their shareholders.
Conclusion
In conclusion, our exploration into the realm of refractories has illuminated a critical yet often overlooked aspect of India's burgeoning growth story. As the nation embarks on a remarkable trajectory of infrastructure development, the refractory industry emerges as an indispensable enabler for the production of steel, cement, and various other metals. The soaring demand projections for steel and cement, driven by ambitious targets and governmental initiatives, underscore the pivotal role refractories play in this transformative journey.
Through our analysis, we've glimpsed the impressive potential of RHI Magnesita India, a leading player in the global refractory landscape. The company's strategic acquisitions, substantial market share in both India and globally, and concerted efforts to expand production capacity position it to harness the substantial opportunities stemming from the country's infrastructure surge. However, challenges persist, notably the dependence on China for raw materials and the resultant margin pressures. Yet, the company's astute management of cash conversion cycles and inventory levels instills confidence in its ability to navigate these obstacles.
While the volatility in global markets, particularly China's evolving role, presents a potential short-term hindrance, the long-term prospects for the refractory sector remain compelling. As India's infrastructure narrative unfolds, refractories stand poised to deliver substantial returns to investors who exhibit the emotional resilience to weather market fluctuations. By delving into this often-underappreciated facet of industrial progress, we've gained a fresh perspective on investment opportunities and witnessed the critical interplay between the unseen components and the visible edifices of growth.
Disclaimer: Indigenous Investors is a subsidiary of Zaveri Savla Consultants LLP. This article has been written to share our thoughts on the company under assessment. In now ways, this is an investment advice of any sort. An investor is supposed to do their own research about the company and base his buy/sell decision on the same.