RefractoryRefractory
June 24, 2014June 24, 2014
G a i n i n g g r a v i t a sG a i n i n g g r a v i t a s
Edelweiss Securities LimitedShradha Sheth
+91 22 6623 3308
Manoj Bahety, CFA
+91 22 6623 3362
We are delighted to initiate on the Refractory sector under our mid-cap series, Banyan. Banyan signifies Growth Without
Maintenance and under the series we endeavour to present stocks not widely covered owing to low management access
/liquidity, but which possess robust long-term fundamentals and structural drivers. Considering the low management
access and long-term structural drivers, we will not release regular maintenance updates on the said stocks.
Our selection framework is differentiated in this series and not clouded by valuations alone. Some of the important
attributes of stocks under the series are:
1. Good corporate governance history.
2. Healthy balance sheet with robust cash flows.
3. May have low liquidity.
4. Low or no management access.
5. Not widely covered.
6. Low institutional holding.
Our latest initiations under the Banyan Series are Orient Refractories (ORL) and Vesuvius India (VIL). The companies, by
virtue of their dominant positions in the high growth and profitable steel flow control segment, are domestic market
leaders. A vibrant product portfolio in conjunction with technology prowess renders them the preferred suppliers to large
integrated steel players right from the capacity formulation stage.
We perceive humungous growth opportunity in the domestic steel industry predominantly stemming from Indias
aspiration to become the second largest producer globally from the current No.4 and the huge under penetration at mere
one fourth the world average and one tenth Chinas. Also, increasing shift of production towards large integrated steel
producers with customised refractory requirements will favour players like VIL and ORL who are equipped with strong
product portfolios underpinned by illustrious global parentage. Moreover, being leading players in the fast growing steel
flow control segment, these companies are in a sweet spot to reap the benefits therein. Hence, with expected uptick in
steel demand and eventual capacity uptick, we estimate ORL and VIL to clock 20% and 16% earnings CAGR over FY14-16E
and CY13-15E, respectively. These companies are also blessed with robust financial metricshigh return ratios (average
core RoCE of ~45%, RoE of ~26%)and are cash rich with net cash per shareORL and VIL at INR1.5 (2% of current market
cap) as on FY14 and INR52 (8% of current market cap) as on CY13, respectively. We initiate coverage with BUY
recommendations on ORL and VIL with target prices of INR115 and INR870, implying upsides of 55% and 32%, respectively.
As always, we await your valuable feedback.
Regards
Nischal Maheshwari
Co-Head Institutional Equities & Head Research
1
Edelweiss Securities Limited
Refractory
Executive Summary
We perceive humungous growth potential in Indias refractory
industry. Our optimism is firmly entrenched in our
expectation of an uptick in cyclical driverssteel consumption
and eventually investment cycleover the medium term.
Further, structural drivers will also work their magic over the
long term as: (a) Indias steel industry is at an inflection point
being the fourth largest and aspiring to be the second largest,
with per capita consumption of 57kg, mere one fourth of
worlds average (217kg) and one tenth of Chinas average (447kg); (b) the
National Steel Policy, which has been devised to spur Indias steel capacity 3x
to 300mtpa by 2025-26E; and (c) shift in steel production favouring primary
steel makers with customised refractory needs bodes well for the industry.
Large scale infrastructure expansion plans and target to raise per capita steel
consumption portend unprecedented growth potential in the Indian steel
industry over the next 10 years. Hence, the expected uptick in steel
consumption and eventually investment cycle are bound to spur the
refractory industry.
Vibrant product portfolios with technology expertise riding global parentage
render companies like Orient Refractories (ORL) and Vesuvius India (VIL), the
preferred suppliers to integrated steel players right from the capacity
formulation stage. ORL and VIL are expected to clock 20% and 16% CAGR in
earnings over FY14-16E and CY13-15E, respectively. We initiate coverage with
BUY recommendations on ORL and VIL with target prices of INR115 and
INR870, implying upsides of 55% and 32%, respectively.
Secular drivers: Infra boost, National Steel Policy to spur demand
China, which contributed a mere 15% to global crude steel production in 2000, currently
contributes 45% led by huge investment scale up in the country over the past 14-15 years.
The Indian steel industry is at a similar juncturecurrently, it contributes a mere 4.8% to
global steel production. However, humungous infrastructure expansion plans under the
Twelfth Five Year Plan (2012-17) at USD1tn (10% of GDP versus 5% of GDP in Tenth Five
Year Plan) and the National Steel Policys target to enhance the countrys steel capacity 3x
to 300mt and raise per capita steel consumption are bound to armour India to become the
worlds second largest steel producer. Moreover, demand for higher quality and customised
refractory requirements with shift in steel production in favour of primary steel makers
provides a structural opportunity to players with established product portfolios. Also, the
thin casting market at 10mtpa, which is ~15% of the refractory industry, has the potential to
grow 50% in absolute terms based on the dynamics of the industry. Additionally, massive
capital outlay in steel is expected to propel huge structural opportunity for the refractory
industry. Global steel majors making India a manufacturing hub offers further
unprecedented growth opportunity.
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2
Edelweiss Securities Limited
Refractory
Cyclical drivers: Booming steel demand a potent growth driver
Uptick in the steel industry is a lynchpin of the refractory industry. Steel demand grew a
modest 0.5% in FY14 compared to 2.0% in FY13. Cumulatively, FY13-14 steel demand surge
was amongst the weakest since FY81. Interestingly, historical data analysis indicates that
India has never faced more than two continuous years of slow steel demand, and more
importantly, there has typically been a sharp double-digit rebound after a period of sharp
slowdown. Though we are currently forecasting 6% demand growth over FY15-16, if
demand follows historical precedents, our demand numbers will be on the lower side. In
fact, progress on stalled/half-completed projects alone would be enough for steel and
thereby refractory demand to surge in years 1 and 2 (FY15-16E). Post that, a new
investment cycle would be necessary for the demand to sustain.
Vibrant product portfolios, tech expertise lend competitive advantage
ORL and VIL have carved a niche with dominant positions in the refractories market,
anchored by their vibrant product portfolios along with technology expertise. VIL commands
a robust ~33% market share in the most profitable steel flow control segment. Strong global
parentage provides expertise and global processes to this company which new players find
difficult to replicate. ORL commands a robust ~33% market share in the overall steel flow
control segment and is a dominant player among smaller domestic steel companies. Global
parent RHI provides it the muscle to approach bigger steel mills to garner higher market
share.
Robust financial metrics
The industry has strong financial metrics: (1) high return ratios (average core RoCE of ~45%,
RoE of ~26%); and (2) strong cash rich companies with net cash per shareORL and VIL at
INR1.5/share (2% of current market cap) as on FY14 and INR52/share (8% of current market
cap) as on CY13, respectively. With robust cash flow generation, we expect ORLs cash per
share to be augmented 4x over FY14-16E to INR6 in CY15E (8% of current market cap) and
VILs 2x over CY13-15E to INR104 in CY15E (16% of current market cap).
Outlook and valuations: Strong investment case; initiating with BUY
ORL and VIL will be strong beneficiaries of the uptick in the investment cycle and thereby
the steel industry in India. This, in conjunction with strong product portfolios, will derive
huge benefits of growing per capita consumption of steel in the country. ORL and VIL are
trading at 12x FY16E and 15x CY15E EPS respectively, at a discount of up to ~25% to VILs
historical higher band valuations of 20x. We initiate coverage with BUY on ORL and VIL
valuing them at P/E of 18x FY16E and 20x CY15E earnings, to arrive at target prices of
INR115 and INR870, implying upside of 55% and 32%, respectively.
3
Edelweiss Securities Limited
Refractory
Contents
Executive summary .................................................................................................................. 1
At a glance ............................................................................................................................... 4
Refractory: Structural opportunity - Flow edge ....................................................................... 5
Indian steel sector: Humungous potential to benefit refractory sector ........................... 5
National Steel Policy: Landmark development ................................................................. 7
XII Five Year Plan to spur infrastructure spending............................................................ 7
China could lose steam given overcapacity issues and restructuring ............................... 8
Adoption of advanced technology to boost growth ......................................................... 8
Customised refractory requirements to spur industry ..................................................... 9
Replacement trend in steel industry driving demand ...................................................... 9
Import substitution to drive monolithic manufacturing ................................................. 10
Cyclically, steel consumption in India at historic low ..................................................... 10
Refractory industry: Overview ............................................................................................... 11
Steady long-term financials.................................................................................................... 18
Companies (Initiating Coverage)
Orient Refractories ................................................................................................................ 21
Vesuvius India ........................................................................................................................ 45
4
Edelweiss Securities Limited
Refractory
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5 Edelweiss Securities Limited
Refractory
Refractory: Structural opportunity - Flow edge Demand drivers: Structurally and cyclically well poised: The Indian refractory sector enjoys advantages of: (a) humungous opportunity in the countrys steel industry, which is at an inflection point as it is the fourth largest producer of steel globally, harbouring aspirations of becoming the second largest over the next few years; (b) sizeable growth potential as per capita consumption of steel at 57kg is a meagre one fourth of worlds average (217kg) and one tenth of Chinas average (447kg); (c) the National Steel Policy devised to enhance Indias steel capacity 3x to 300mtpa by 2025-26; and (d) shift of steel production in favour of primary steel makers with increasing quality, services and customised refractory needs to ensure maximum safety, quality and productivity. Indian steel sector: Humungous potential to benefit refractory sector The Indian steel industry is estimated at USD57bn as at FY14 and is the fourth largest in the world in terms of volume, accounting for ~4.8% of global steel production. Drawing on the East-wards shift of the global steel industry and the countrys growth metrics, the domestic steel sector is expected to clock 7% CAGR in capacity till FY17E to 124mt. Strongest driving factor will be the growing per capita consumption of steel, which is currently abysmally low compared to the global benchmark. Consequently, the refractory industry is bound to be a big beneficiary of the expected huge uptick in the steel industry. Within sub-segments, the 10mtpa thin cast market, which constitutes ~15% of the industry, is expected to grow at the fastest clip of ~50%, riding capacity expansion plans of players and dynamics of the steel industry favouring this segment. This will favour players like Vesuvius India (VIL) and Orient Refractories (ORL), which are concentrated in the segment in terms of product positioning, and enable them to outperform steel industry growth. India is currently the fourth largest producer of crude steel in the world and harbours aspirations of becoming the second largest by 2015-16. In 2012, the countrys per capita steel consumption was a meagre 57kg against the world average of 217kg and Chinas 477kg. This indicates high potential for increase in per capita steel consumption and potential unprecedented expansion of the steel industry.
Drawing on the East-wards shift of the global steel industry and the countrys growth metrics, the domestic steel sector is expected to clock 7% CAGR in capacity till FY17E to 124mt
Indias steel industry at an inflection point being the fourth largest producer globally and aspiring to be the second largest over the next few years
Continuous casting refractories
6
Edelweiss Securities Limited
Refractory
Chart 1: Country-wise per capita consumption of steel
Source: Ministry of Steel (MoS)
India has lagged other major steel producing countries in terms of intensity of steel use in
overall economic activities (i.e., per unit of GDP) or per capita consumption of steel despite
clocking a robust 8% per annum production growth over the past five years. Improvement in
both these factors can further spur growth.
Table 1: India hugely under penetrated in steel despite rising consumption (kg)
Source: MoS
Chinas dominance in steel is apparent from its share in global crude steel output. Today, it
produces ~48% of global steel output compared to 15% in 2000; the jump was led by huge
investment scale up in the country over the past 14-15 years. The Indian steel industry is at
a similar juncturecurrently, it contributes a mere 4.8% to global steel production.
However, humungous infrastructure expansion plans under the Twelfth Five Year Plan
(2012-17) at USD1tn (10% of GDP versus 5% of GDP in Tenth Five Year Plan) and the
National Steel Policys target to enhance the countrys steel capacity 3x to 300mt and raise
per capita steel consumption are bound to armour India to become the worlds largest steel
producer, which will, in turn, be strong drivers of the refractory industry.
0
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520
780
1,040
1,300
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Ind
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Wo
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(kg
s)
Countries 2005 2006 2007 2008 2009 2010 (P)CAGR (%)
(2005-10)
China 266 287 320 327 409 427 12.4
S. Korea 982 1,043 1,144 1,211 936 1,077 1.5
Japan 602 620 637 612 416 503 (3.0)
USA 357 401 359 324 193 258 (7.1)
Russia 205 246 286 252 178 256 5.7
Ukraine 118 143 174 150 87 121 (0.1)
Germany 428 476 518 514 343 441 0.0
India 37 41 46 45 48 52 7.8
World (average) 174 188 199 194 181 203 3.7
Indias per capita steel
consumption is at a meagre 57kg,
one-fourth of the world average of
217kg and one-tenth of Chinas
477kg
Huge investment boom in China
has seen its steel output rising to
~48% of global output from a
mere ~15% in 2000;
Indian steel industry is at a
similar juncture - currently
contributes a mere ~4.8% to
global steel production
7
Edelweiss Securities Limited
Refractory
Chart 2: Chinas giant leap in global steel industry in past decade and half
Source: MoS
The key ongoing steel projects in India will take its total steel capacity from about 104mtpa
currently to 124mtpa over the next two years.
Table 2: IndiaAbout 20mt capacity will get commissioned over next two years
Source: Companies
National Steel Policy: Landmark development
The National Steel Policy 2012 was devised with an objective of enhancing Indias crude
steel capacity 3x by 2026 to 300mtpa by attracting investments from both domestic and
foreign players, and facilitating speedy implementation of new plants. The basis of this was
~9-10% annual growth. Even assuming slow GDP CAGR of ~6-8% over FY14-26, India will
require ~180-225mt crude steel capacity by that year. This implies that even assuming the
base case of a 7% steel demand CAGR, India will need to set up 75mtpa of additional crude
steel capacity over the next 12 years to be self sufficient. This is over and above the 20mtpa
of projects in progress. Assuming that the cost of setting up a new greenfield plant is about
USD1,000/t, the country will need USD75bn of investments in new steel capacity over the
next 12 years. The Ministry of Steel has been proactive in facilitating the establishment of
new plants and evaluating ideas such as setting up of new capacity as special purpose
vehicles.
XII Five Year Plan to spur infrastructure spending
Infrastructure spending in the XII Five Year Plan at USD1tn is estimated to be 6x that spent
in the X Plan (USD140bn) and twice that in XI Plan (USD400bn). Allocation to infrastructure
China
15%
Japan
12%
India
3%
Other Asia
11%
EU (27)
22%Other
Europe
2%
CIS
11%
NAFTA
16%
Africa
2%
Middle
East
1%
Central
and South
America
5%
Company Capacity expansion (mt) Status
SAIL 8.0 Expected commisioning over FY15-16
Tata Steel 3.0 Target commisioning over FY15
JSW Steel 1.7 Target commisioning over FY15-16
RINL 3.3 Nearing completion
Bhushan steel 2.5 Started trial runs
JSPL 1.6 Started trial runs
Total 20.1
China
42%
Japan
8%
India
5%
Other Asia
11%
EU (27)
12%
Other
Europe
2%
CIS
7%
NAFTA
8%
Africa
1%
Middle
East
1%
Central
and South
America
3%
National steel policy targets to
enhance the countrys steel
capacity by 3x over FY14-26 to
300mtpa assuming ~9-10% annual
growth
Even assuming slow GDP CAGR of
~6-8% over FY14-26, India will
require ~190-235mt crude steel
capacity by that year
8
Edelweiss Securities Limited
Refractory
spending will increase from 5% of GDP in X Five Year Plan to ~10% of GDP in the XII Five Year
Plan. A rough estimate of incremental demand for steel in the country works out
approximately to 40mt in infrastructure alone. Currently, the domestic steel industrys
capacity is at ~100mtpa. The XII Five Year Plan (2012-17) envisages steel sector, which is
considered the backbone of the industrial sector, touching 142.3mt capacity by 2017.
China could lose steam given overcapacity issues and restructuring
China is undoubtedly a lynchpin of the global steel industry. According to the World Steel
Association, global steel production grew 3.5% in 2013 versus 1,607mt in 2012, with China
growing 9.9% to 779mt; global production, excluding China, was flat at 828mt. Growth came
primarily from Asia, the Middle East and India, whilst crude steel production in the
European Union, South America and NAFTA dipped compared to 2012. While steel output
has stagnated at roughly 361mt since 2010 in advanced economies, it has risen by some
175mt to approximately 1.25bt in emerging markets during the same period, primarily
attributable to the ongoing rapid development of steel output in China. The average
increase in volume by approximately 15% in this period has led to overcapacity of ~250mt
across the world.
In China, the new government is trying to restructure the steel industry and shift growth
from infrastructure driven investment (long products) to domestic consumption (flat steel)
driven investments by means of structural reforms. Excess capacities, which are estimated
at roughly 30% for the steel industry, will be reduced and production of higher-grade,
knowledge-based products will be promoted. An action plan was introduced in July 2013 to
restrict production and decommission production capacities in heavy industry and serves as
a signal to Chinese industry to increase its adaptability. Hence, Chinas metrics become
critical to Indias growth and profitability with production rebalance towards India in the
emerging economies.
Adoption of advanced technology to boost growth
While refractories represent a relatively small proportion of the input costs of customers
(e.g., less than 1% for a steel producer), their performance is critical in their production
processes. Therefore, customers demand high quality and consistent products for these
most demanding applications to ensure maximum safety, quality and productivity. This,
along with growing drive for adoption of high technology products by steel companies to be
competitive with global companies, will drive strong growth of refractory players with
established technology. The Ministry of Steel has directed major PSUs to form
collaborations to develop the necessary technology for production of high-grade steel to
meet domestic demand and reduce reliance on imports. Steel Authority of India (SAIL) and
Rashtriya Ispat Nigam (RINL) have been asked to sign memorandums of understanding
(MoU) or joint venture agreements for development of technology for high-grade steel.
Indian steel makers rank relatively low on the special steel front compared to their
counterparts in Japan or South Korea, which is to their disadvantage as India has free trade
pacts with these countries. Hence, to efficiently compete, most players are trying to
improvise their mix.
Restructuring of steel industry by
the Chinese government to lead to
reduction of excess ~30% steel
capacity in turn making it critical to
Indias growth and profitability
Most Indian steel players are trying
to efficiently compete by
improving their product mix
9
Edelweiss Securities Limited
Refractory
Customised refractory requirements to spur industry
Domestic steel production has been steadily shifting towards primary producers with large
furnaces and multiple plants. Expected growth rate of primary producers, accounting for
~56% of overall steel production by FY16E, is higher at 9% CAGR over FY13-16E versus 6%
for the entire industry. With customised refractory needs of primary steel producers, we
expect more business in favour of established players like VIL and ORL. Primary producers
generally prefer long-term relationships with large refractory players (compared to smaller
producers) to receive post installation services as well as long-term repairs and maintenance
services in addition to high quality technologically driven products.
We expect players like VIL and ORL to register higher growth due to requirements of bigger
producers:
Adoption of higher priced, more advanced, but lower volume refractories by steel
makers.
Focus on extensive maintenance of furnace by steel producers to extend the life of
their furnace rather than opting for complete realigning. This has built a case for low-
cost forms like gunning mixers by taking business away from higher-cost bricks
manufacturers.
The emphasis is shifting from mere cost cutting and longer lasting goods to custom-
designed solutions for both new installations and for major maintenance-repair
assignments.
Replacement trend in steel industry driving demand
Refractory application and consumption favour replacement dynamics for 70% of the
business, leading to non-cyclical growth. Steel making requires maximum amount of
refractories (10-15kg/tonne) with replacement requirement ranging from 20 minutes to 2
months. Steel industry demands complete refractory management and services driven
solutions from refractory makers. While cement industry is the next big user with annual
replacement requirement, non-ferrous and glass industries have longer replacement cycles.
Table 3: Refractory consumption dynamics across industries
Source: RHI
Key industry Application Replacement Per ton consumption Refractory requirements
BF-BOF, EAF, Casting 20 minutes to 2 Global avg - 10-15Kgs. Consumable product - Systems and solutions for complete
Ladles, Induction
Furnaces,
months India avg - 15 Kgs refractory management
Pellet rotary Kilns
Investment goods - Longer replacement cycles, Customized
solutions based on the specific requirements of various
industrial
production processes, complete lining concepts
Glass Glass furnace upto 10 years 4kgs
Aluminium - 6 Kgs,
Copper - 3 Kgs
Steel
Cement Kilns Annually 1 kgs
Non ferrous Converter 1-10 years
Steady shift in steel production
towards large integrated producers
with customised refractory
requirements will lead to strong
growth for established players like
VIL and ORL
10
Edelweiss Securities Limited
Refractory
Import substitution to drive monolithic manufacturing
The domestic refractory industry faces competition from imports (especially from China).
Imports as a percentage of production stood at ~39% in FY11, thereby keeping domestic
refractory producers capacity utilisation subdued. With sharp depreciation in INR since
FY11, we believe the industry dynamics have turned in favour of domestic producers who
are in a better position to replace imports (as landed costs have increased). We also note
that monolithics and others constitute between 35-50% (2-3 lakh tpa on an average) of
overall imports into India and can be easily replaced by domestic producers like VI who are
focusing increasingly on bolstering production in this segment.
Chart 3: Imports keeping production under check
Source: MoS
Cyclically, steel consumption in India at historic low
FY14 steel demand grew a modest 0.5% after growing 2% in FY13. Cumulatively, FY12-14
steel demand growth was one of the weakest since FY81 (FY90-92 was previous weakest
period). Also, growth has remained extremely low in the refractory industry over the past
two-three years due to pressure on steel consumption and production, lack of growth-
oriented policies and economic slowdown. Historical analysis indicates that after a period of
sharp slowdown, demand bounces back with double-digit growth rates. We are currently
forecasting ~6% demand growth for FY15-16, but if history is repeated, our demand
numbers could turn out to be on the lower side. Also, steel has seen limited capacity
additions and higher demand will have to be met via restart of shut capacities. Thereby,
with a strong pick up in infrastructure requirements, strong capacity will have to be laid.
While the issues triggering weak demand are well documented, there is a general perception
that without restart of the investment cycle, materials sector demand is unlikely to revive.
However, we believe, a sharp pick up in the investment cycle is not necessary for pick up in
steel demand. As per historical trend, after periods of weak steel demand growth, in the
following years of sharp pick-up in demand, overall GDP does not increase much, it is just that
the industrial/construction share of GDP increases and reverts to the long-term average. In our
view, new projects do not need to start for any demand pick up. Progress on stalled/half-
completed projects alone would be enough for spurt in steel demand in years 1 and 2 (FY15-
16E). Post that, a new investment cycle would be required for the demand to sustain.
0.0
18.0
36.0
54.0
72.0
90.0
0
300,000
600,000
900,000
1,200,000
1,500,000
2007-08 2008-09 2009-10 2010-11
(%)
(to
ns)
Total Production (Tonnes) Import (Tonnes) % of Total Production
Domestic manufacturing by players
like VIL and ORL in monolithics can
lead to import substitution in this
segment which constitutes ~35-
50% of overall refractory imports
FY14 steel demand grew a modest
0.5% after growing 2% in FY13.
Cumulatively, FY12-14 steel
demand growth was one of the
weakest since FY81 (FY90-92 was
previous weakest period).
Progress on stalled/half-completed
projects alone would be enough
for spurt in steel demand in years 1
and 2 (FY15-16E). Post that, a new
investment cycle would be
required for the demand to
sustain.
11
Edelweiss Securities Limited
Refractory
Refractory industry: Overview
Global refractory market at ~USD25bn; expected to post ~3.5% CAGR
According to various industry studies, global refractories market size is ~USD25bn with
production of 41.5MT in CY12. According to industry estimates, the global refractories
industry is expected to clock 3.5% CAGR during CY13-16 and grow to 46MT with a market
value of USD29bn. China accounted for ~70% of the market by volume and ~60% by value in
CY12, whereas India accounted for ~3% of the global refractories market by volume.
Chart 4: Global refractory industryOn the rise
Source: Industry, Edelweiss research
Indian refractory industry: Strong growth within process flow
According to various industry studies, Indian refractories market size is INR50bn with
production of 1.28MT in FY12 on an installed base of 2mtpa, ~60% utilisation and
accounting for a mere ~3% of the global refractories market by volume. Although the
average consumption of refractories has fallen from 19kg per tonne of steel about five years
ago to 12-13kg on an average for the steel industry as a whole, the scope for growth is good
in case of established refractory players with strong product portfolios in the steel flow
control segment and catering to customised requirements of steel companies. This will be
led by the thin castings segment, which is at ~15% of the current refractory market and
growing at ~50%, wherein players like VIL, ORL and IFGL have a strong competitive
advantage.
Refractories are non-metallic materials characterised by extremely high melting points,
rendering them suitable to be used as heat-resisting barriers. They are primarily of two
typesshaped and unshaped (monolithics)and are used predominantly by the steel
industry as a consumable product in internal linings of furnaces, kilns, reactors and other
vessels for holding and transporting metal and slag. The steel industry accounts for ~60% of
refractory consumption globally and ~75% in the domestic market.
21.6
23.4
25.2
27.0
28.8
30.6
37.8
39.6
41.4
43.2
45.0
46.8
CY12 CY16E
(US
D b
n)
(MT
)
Volume (MT) Value (USD bn)
Indian refractory industry with
production of 1.28MT is under
utilised
However thin castings segment,
which is at ~15% of the current
refractory market is growing at
~50%, wherein players like VIL, ORL
and IFGL have a strong competitive
advantage
12
Edelweiss Securities Limited
Refractory
Chart 5: GlobalSector-wise refractory demand Chart 6: IndiaSector-wise refractory demand
Source: Industry, Edelweiss research
Steel flow control process chart
Different areas of the steel manufacturing process are exposed to diverse temperatures,
slag and sulphur gases. Refractory selection for the lining of a furnace is invariably built
upon a combination of material qualities and brick size to maximise performance. Steel
industry uses refractory for diverse applications in blast furnaces, coke ovens, torpedo ladles
and secondary refining ladles.
Fig. 1: Consumption of refractories in steel making process
Source: Magnesita
Steel
60%Non
metallic
(Cement,
Glass)
15%
Non
ferrous
(Aluminiu
m, copper,
zinc, silver)
15%
Others
(paper,
petrochem
icals)
10%
Steel
75%
Cement
12%
Non
ferrous
(Aluminiu
m, copper,
zinc, silver)
6%
Glass
3%Others
4%
13
Edelweiss Securities Limited
Refractory
Fig. 2: Consumption of refractories in steel making process
Source: RHI
Types of refractories
Shaped refractories are characterised by fixed shapes with the most common form being
rectangular brick. Brick shapes may be divided into twostandard shapes and special
shapes. Standard shapes have dimensions that are conformed to by most refractory
manufacturers and are generally applicable to kilns and furnaces of the same type. Special
shapes are specifically made for particular kilns and furnaces. Shaped refractories are almost
always machine-pressed and possess high uniformity in properties. Unshaped refractories
are without a definite form and are only given shape upon application. They form jointless
lining and are better known as monolithic refractories. They are manufactured in powder
14
Edelweiss Securities Limited
Refractory
form as granular material and known as plastic refractories, ramming mixes, castables,
gunning mixes, fettling mixes and mortars.
The raw material used to manufacture refractories is broadly classified into clay and non-
clay. Clay refractories consist of naturally occurring alumina silicate like fire clay, flint clay,
flint brick and high alumina and are used to produce bricks and insulating refractories. Non-
clay refractories are made from non-clay material and are further classified into basic (made
in form of bricks from magnesia, dolomite, chrome etc), extra high alumina, mullite (made
from kyanite, bauxite, alumina), silicon carbide and zircon.
There has been a gradual shift from shaped to unshaped refractories for higher
performance and ease of use and from clay to non-clay refractories due to flexibility of
manufacturing from a variety of raw materials and ease of use.
Chart 7: Share of refractories by form Chart 8: Share of refractories by raw materials
Source: Industry, Edelweiss research
Chart 9: Indian refractory market break up
Source: Industry, Edelweiss research
Shaped
55%
Unshaped
45%
Flow
control/special
refractories
15%
Basic bricks
24%
Blast furnace
20%
Balance (Shaped
and others)
41%
Non Clay
35%
Clay
65%
15 Edelweiss Securities Limited
Refractory
Global competitive intensity VIs parent, Vesuvius PLC, is a leading refractory manufacturer with global market share of ~10%. Global refractory industry is highly fragmented and dominated by local players in each country. Vesuvius PLC and RHI have manufacturing locations around the world and enjoy leadership in technology and innovation. Chart 10: Global market share of players
Source: Magnesita
Competitive intensity in India Chart 11: Indian refractory market share
Source: Industry, Edelweiss research
Note: RHI includes combined sales of ORL, RHI Clasil and RHI Pvt Ltd
IFGL refractorys numbers are standalone numbers
Vesuvius Plc10%
RHI9%
Magnesita5%
Segment players (Saint Gobain,
Calderys)10%
Regional players (Shingawa,
Krosaki,ANH)16%
Small local players
13%
Chinese players37%
RHI India21%
TRL Krosaki17%
Vesuvius India12%
OCL India8%
IFGL Refractories
7%
Calderys India11%
Dalmia Bharat1%
Balance 23%
Parent Vesuvius Plc is a global market leader in the overall refractory industry as well as enjoys pole position in the critical molten flow control segment
16 Edelweiss Securities Limited
Refractory
Chart 12: IndiaSteel flow control market share
Source: Industry, Edelweiss research
Note: Financials of IFGL are on standalone basis
Financials of OCL India are of the refractory division
VIL (largest player in steel flow control in India): Strongest position in steel flow control in India as well as globally in steel flow control segment, which is a high margin process for players. RHI (No. 2 player globally and recently acquired Orient Refractory in India): is half the size of VIL in steel flow control business globally. In India, it has a strong foothold in silica bricks which is a process before steel flow and Chinese compete in this area. Orient Refractory (acquired by RHI): It caters to small steel plants and has a low cost advantage in steel flow control and is primarily into recycling materials. Controlling stake of 70% by RHI will help Orient now procure turnkey projects from large steel companies. IFGL Refractory: It is the No. 3 player in steel flow control in India, but does not have the entire range of products in comparison to VI and it admits to not being able to compete with VIL in many areas because of certain patents which give the latter the first mover advantage. Also, IFGL has almost 50% sales coming from exports. TRL Krosaki: It is strong in bricks/monolithics. Sinoref (Chinese player): The company focuses on the bricks space.
Orient Refractories
33%
Vesuvius India33%
IFGL Refractories
20%
OCL India14%
Vesuvius India and Orient Refractories are leaders in the high growth and profitable steel flow control segment in India
17
Edelweiss Securities Limited
Refractory
Fig. 3: Indian refractory industrySWOT analysis
Source: Industry, Edelweiss research
SWOT analysis
Strengths
Increasing preference for quality, service,
complete solution provider
Global parentage of established players
Opportunities
Increasing production of primary producers wih BOF
set up ,
Import substituiton of monolithics,
Technological advancement among steel players, steel underpenetration in India,
National Steel Policy of India to increase capacity
by 2.5-3x
Threats
Tight working capital during slowing steel cycle
Competition from Chinese players
Imports from China
Weaknesses
Declining consumption per ton of refractory for steel
companies
Low pricing power
Raw material dependence on China
18 Edelweiss Securities Limited
Refractory
Steady long-term financials
Revenue growth: ORL and VIL have posted non-cyclical growth ORLs revenues posted healthy double-digit revenue growth with 19% CAGR over the longer tenure (ten year term - FY04-14) outperforming the industry over a long tenure. It has outperformed VIL by an average 3-4% over across the time periods. It has outperformed IFGL over 8 year and 10 year time period in revenue growth by 5%. Going forward, with cyclical uptick in industry, we expect growth to accelerate for both ORL and VIL. Table 4: Sales CAGR over the years
Source: Company
Table 5: EBIT CAGR over the years
Source: Company
Note: Financials of IFGL are on standalone basis
Financials of OCL India are of the refractory division
As can be seen ORL and VIL have grown profitably over long term cycles. ORL registered 18% CAGR over ten years and VIL registered 14% CAGR over the same time period in EBIT.
Recent industry stake sales Global refractory producers have been entering the Indian market and three major deals have been completed in the past five years. We take a closer look at these deals including an analysis of valuations and premiums. However, we note that Vesuvius PLC has not increased its stake in VI from current 55.6% for more than 10 years. Deal 1: Krosaki Harima buys 51% in Tata Refractories (@25x forward P/E, high band premium) Krosaki Harima (Japanese refractories producer) bought 51% stake in Tata Refractories (from Tata Steel) in April 2011 at high premium valuation of INR11.3bn, valuing at ~25x forward P/E. Tata Refractories was a non-listed company, but valuations ascribed by Krosaki Harima imply ~32% premium to VIs 10-year high-end multiples. Deal 2: RHI buys ~70% in Orient Refractories (@14x forward P/E, average band)
CY13/FY14(INR mn)
1 yeargrowth
(%)3 year
CAGR (%)5 year
CAGR (%)8 year
CAGR (%)10 year
CAGR (%)Vesuvius India 6,023 6.7 10.7 11.1 13.5 16.2 Orient refractories 4,035 11.5 14.2 13.9 17.9 18.5
IFGL refractories 3,274 7.0 15.8 14.4 12.2 13.4 OCL India 3,176 4.0 2.7 0.6 5.3 9.0
CY13/FY14(INR mn)
1 yeargrowth
(%)3 year
CAGR (%)5 year
CAGR (%)8 year
CAGR (%)10 year
CAGR (%)Vesuvius India 990 20.0 9.8 15.0 10.6 13.5 Orient refractories 750 22.0 20.0 12.5 20.8 18.0 IFGL refractories 395 34.0 38.0 9.0 6.0 11.0 OCL India 154 (18.2) (5.1) (14.4) (4.4) 6.2
ORL and VIL have posted non- cyclical sales CAGR of 19% and 16% over last 10 years and EBIT CAGR of 18% and 14% respectively over the same time period
19
Edelweiss Securities Limited
Refractory
The RHI Group of Austria, second largest refractory producers in the world, bought a stake
in Orient Refractories in January 2013 at ~14x P/E by offering ~INR43/share (~16% premium
to January 15, 2013, closing price of INR37/share) for 43.6% stake of promoters and later
made an open offer for 26% additional stake at the same price in April 2013, taking its total
stake to ~70% and controlling the company. RHIs stake purchase was at mid band of VIs
15-year average.
Deal 3: Calderys buys out ACE Refractories from ICICI PE fund (@28x forward P/E, high
band premium)
Calderys, part of Imerys of France (one of the largest monolithic refractory producers in the
world), bought full stake in ACE Refractories in August 2007 (earlier part of ACC and bought
by ICICI Venture Capital PE in 2005) at a high valuation of 28x P/E for a market value of
~INR5.5bn.
20
Edelweiss Securities Limited
Refractory
CCoommppaanniieess
Edelweiss Research is also available on www.edelresearch.com,
Bloomberg EDEL , Thomson First Call, Reuters and Factset.
Edelweiss Securities Limited
Global refractory major RHIs (No.2) strong focus on emerging markets
and profitability was vindicated by its acquisition of 69.6% in Orient
Refractories (ORL), a leading player in Indias profitable steel flow control
segment. ORL clocked strong non-cyclical 19% sales and 18% EBIT CAGR
along with 17% EBIT margin and average RoE of 45% over FY04-14.
Considering 27% gross block expansion, robust fixed asset turnover of
over 6x, ~60% unoccupied land and parents robust portfolio approach
which will expand clientele, the company is well placed to capitalise the
parents target of doubling ORLs sales to tap the emerging markets
opportunity and make it an exports hub. With leading position in steel
flow control segment fortified by parent RHI, we value ORL at 18x FY16E
EPS, 10% discount to Vesuvius India (VIL). Initiate with BUY.
India shinning: RHI tapping local opportunity; exports hub focus
RHI is targeting 70% contribution from emerging markets (57% currently) and aims to
double India revenue over next four years, generating ~20% CAGR. By virtue of being a
leading player in the steel flow control segment in India among smaller steel mills, ORL is
geared to capture bigger turnkey orders, leveraging its global parentage. The ORL
acquisition provides RHI to tap the growing domestic market as well as make India an
exports lynchpin, leading to 21% CAGR in ORLs sales over FY14-16E.
Unutilised land to capitalise on steel opportunity
ORLs plant stands on a 30 acres land parcel, which is 60% unutilised. With 27% gross
block expansion over the past two years, further 74% expansion is estimated over next
two years led by parents plan to capitalise on domestic steel and outsourcing
opportunity. ORL has generated strong core fixed asset turnover at an average 6x.
Outlook and valuations: Robust spurt; initiate with BUY
We expect core RoCE to catapult 940bps over FY14-16E to 76% on improved utilisation
and higher growth in steel flow control segment, leading to 20% earnings CAGR over
the period. Considering unutilised land (60%) available to leverage the steel cycle
uptick and expanding clientele riding parents support, we assign target of 18x P/E on
FY16E EPS and arrive at a target price of INR115. Initiate coverage with BUY.
INITIATING COVERAGE
ORIENT REFRACTORIES Flow glow: Leveraging India growth
story
EDELWEISS RATINGS
Absolute Rating BUY
Investment Characteristics Value
MARKET DATA (R: ORRE.BO, B: ORIENT IN)
CMP : INR 75
Target Price : INR 115
52-week range (INR) : 85 / 22
Share in issue (mn) : 120.1
M cap (INR bn/USD mn) : 9 / 149
Avg. Daily Vol. BSE/NSE (000) : 65.5
SHARE HOLDING PATTERN (%)
Current Q1FY14 Q4FY13
Promoters *
69.6 69.6 69.6
MF's, FI's & BKs 0.0 0.0 0.0
FII's 0.4 0.0 0.2
Others 29.9 30.3 30.2
* Promoters pledged shares
(% of share in issue)
: NIL
PRICE PERFORMANCE (%)
Sensex Stock Stock over
Sensex
1 month 3.3 1.2 (2.1)
3 months 15.4 43.1 27.7
12 months 33.7 155.7 122.0
Shradha Sheth
+91 22 6623 3308
Manoj Bahety, CFA
+91 22 6623 3362
India Equity Research| Refractory
June 24, 2014
(Click on image
to view video)
Financials
Year to December FY13 FY14 FY15E FY16E
Net revenues (INR mn) 3,619 4,035 4,691 5,886
EBITDA (INR mn) 690 792 884 1,141
Core profit (INR mn) 432 528 584 763
Diluted shares (mn) 120 120 120 120
EPS (INR) 3.4 4.4 4.9 6.4
P/E (x) 21.8 17.1 15.5 11.8
EV/EBITDA (x) 13.0 11.2 9.7 7.2
ROAE (%) 48.7 44.0 37.2 37.5
Refractory
22
Edelweiss Securities Limited
Investment Rationale
Strong, consistent performance outpacing peers
Historically, ORL has registered consistent growth and outpaced peers on revenue and
margin front, drawing on its low-cost model and strong position in the steel flow control
segment. The company has outperformed the steel industry growth in the shaped segment,
which witnessed ~127% (18% CAGR) surge in volumes during FY06-11. This is as compared
to steel industry growth of 52% (9% CAGR) over the same period.
Market leader in ladle and tundish management system coupled with lower costs with
strong positioning among small steel mills have driven the companys growth ahead of
industry. Revenue and earnings growth of the company at 19% and 18% CAGR over past 10
years respectively, also remained non-cyclical in nature in spite of being dependent on the
highly cyclical steel industry. During FY09-14 however, the companys revenue and PAT
growth trajectory was impacted (14% and 11% CAGR respectively) by slowdown in domestic
steel investment cycle. Nevertheless, the ORLs relative outperformance to peers continued.
Table 1: Performance through cycles
Source: Company
Chart 1: ORL has outperformed domestic refractory players on shaped volumes
Source: Industry, Edelweiss research
Note: 2006 figures are rebased to 100
1 year 3 year 5 year 8 year 10 year
Growth (%) CAGR (%) CAGR (%) CAGR (%) CAGR (%)
Sales 4,035 11.5 22.0 18.0 21.0 19.0
EBIT 796 22.0 20.0 12.5 21.0 18.0
FY14 (INR mn)
0
50
100
150
200
250
FY06 FY07 FY08 FY09 FY10 FY11
Crude Steel Production (mt) VI (Shaped) in pcs
ORL(Shaped) in pcs IFGL(Shaped) in pcs
Outperformed steel industry
with 18% CAGR in shaped sales
volume during FY06-11 versus
9% CAGR logged by the steel
industry led by pole position in
steel flow control segment
Isostatically pressed continuous
casting refractories
23
Edelweiss Securities Limited
Orient Refractories
Chart 2: Strong volume trajectory ahead
Source: Company, Edelweiss research
Going forward, strong focus by the parent on India, ORLs portfolio approach and industry
leadership position will help continue its outperformance to steel industry and peers with
overall net manufactured sales CAGR of 21% over FY14-16E.
Strategising for strong inclusive growth
Portfolio approach to drive big client additions
Leveraging parent, RHIs brand: This far, ORL has been successfully sourcing contracts from
the small steel mills and currently derives 70% of revenues from them. Around 70% of the
companys sales are supplied to the medium and small steelmakers including Bhushan Steel,
Sunflag, Mukund and Jai Balaji, among others. The company also caters to big steel players
like SAIL, RINL, etc., which contribute to 20-25% of sales. With RHI acquiring 69.6% stake in
ORL, the latter will be able leverage parents brand in procuring large turnkey orders from
large steel companies, resulting strong volume growth.
Led by unlisted business serving unshaped refractory requirements: RHI AG has unlisted
entities (RHI Clasil and RHI Private Limited) which meet bricks and linings requirement of
clients. This, we believe, will further support ORLs portfolio in seeking large turnkey
projects from steel companies. As such, the steel flow control product and services will be
catered to by ORL, while the unlisted entities would meet requirements of the unshaped
(bricks) refractories of the steel companies.
Going forward, the Indian steel industry will gain from new plant commissioning and better
utilisations. This will bolster ORLs volumes as they get increased business from larger steel
companies with the parent support.
ORL has seen a surge in new orders for its products, post getting acquired by RHI in 2013.
This has also enhanced revenue visibility in the quarters to come. This complementary
approach parent will leverage on ORLs strong product portfolio while ORL will optimise
parents brand and other businesses (bricks in refractories) leading to strong volume
0
8,000
16,000
24,000
32,000
40,000
FY
06
FY
07
FY
08
FY
09
FY
10
FY
11
FY
12
FY
13
FY
14
FY
15
E
FY
16
E
(to
ns)
Shaped Unshaped
Shaped FY06-13:19%CAGR
Unshaped FY06-13:-2%CAGR
Shaped FY14-16E:21%CAGR
Unshaped FY14-16E:16%CAGR
Strong product positioning in
ladle and tundish management
led by lower costs along with
parents portfolio approach will
help in sourcing large turnkey
contracts
Tundish system
Refractory
24
Edelweiss Securities Limited
visibility for ORL. Overall, we expect ORL to log revenue CAGR of 21% over FY14-16 with
26% YoY growth in FY16.
Plant concept to beef up exports for ORL
In 2013, weak capacity utilization, low growth rates in Europe, led to RHI resolving with
closure of one of its largest sites in Europe (Duisburg, Germany) to ensure better utilisation
with corresponding reduction in fixed costs. RHI started working on the plant concept
wherein it adjusted production capacities and has been trying to consolidate 33 world-wide
plants in its bid to stay competitive in the long term. The parent is focused on staying
competitive and reduce lead time, owing to which production has been moved to low-cost
countries alongside increasing localisation. Hence, the parent has been outsourcing
manufacturing from low-cost countries. Going by this strategy, we expect India operations
to attract higher attention. Also, the parents strong focus on steel flow control globally with
complementary assets of ORL, is expected to lead to strong exports opportunity for ORL.
With RHI acquiring 69.6% in ORL, as at end April 2013, will enable the latter in attaining its
goal of growth with profitability. On the other hand, RHI will be able to further cement its
number-two position in the flow control business riding on ORLs strong product portfolio
and low-cost manufacturing units. Thus, ORLs exports are expected to receive a strong leg-
up since the parent would use India as a significant hub for exports to Asia and the Middle
East.
ORLs exports have increased at 19% CAGR in the past two years. Going ahead, we expect
the same to register robust 25%CAGR over the next two years, led by strong intent of parent
to outsource global manufacturing.
Emerging markets: Revenue share to rise to 70% by 2020E
Asia currently represents ~65% of global steel production, but accounts for mere 18% of
RHIs revenue.
In the groups global scheme of things, emerging markets are its strong focus areas where it
envisages robust growth and sales over the long term. Hence, the group has set the target of
increasing contribution from 57% of the group sales currently to greater than 70% of its sales
by 2020. With Indias per capita steel consumption less than 57kgs, there exists huge pent-
up demand in India in comparison to China, where per capita consumption is ~477kgs while
the world average is 217kgs. RHI strives to participate in the catching-up process in the high-
growth region of India. In line with this, RHI acquired 69.6% in ORL thereby enabling the
former to consistently implement its growth strategy in the emerging markets and
additionally help strengthen its number-two position in the flow control business. Company
invested Euro 50mn towards acquiring 70% stake in ORL, India.
Focusing on growth regions and expanding the local production in India, Brazil and Russia
are part of the RHI Groups strategy to be cost competitive and leverage on the high growth
in emerging markets. This will help the company continue to surpass market growth.
Strong beneficiary of
consolidation (closure of a big
site in Germany last year) in
manufacturing at parents end
leading to production moving
to lower cost destinations and
strong exports for ORL India
Plans afoot to enhance
emerging markets sales 1.2x
with strong focus to double
sales in India led by ORL
acquisition
25
Edelweiss Securities Limited
Orient Refractories
ORLs contribution to increase: ~2% to > 3% of global turnover
With the parents focus on India, it third most important market, will result in strong growth
opportunity for ORL. Currently, ORL India contributes ~2% of the global turnover. However,
owing to a fast expanding manufacturing portfolio, capacity, parents support, portfolio
approach and strong R&D set up, ORLs share will increase by more than 50% to ~3% plus at
the parents end over next four years as the company intends to tap not only the growing
domestic market, but also use India as a significant hub for exports to Asia and Middle East.
Parent has set aside a target of internally doubling turnover of ORL India over next five years
to INR8bn, which itself would be a ~20%CAGR over the next 4 years by tapping synergies on
the sales side.
RHI to leverage ORLs strengths
Parent to leverage strong position of ORL in steel flow control segment
RHI is the second largest player in overall globally (with overall 9% market share) and second
largest in the critical steel flow control segment. While the parent is strong in the steel
segment (63% of overall sales), ~16% and 47% of its overall business constitutes steel flow
control and linings, respectively. The parents sales in the most critical steel flow control is
Euro290mn, representing ~16% of sales. Parent wants to further beef up its No.2 position
in the flow control segment globally and has set the target of achieving 1.4x growth
trajectory to Euro400mn by 2020. Acquisition of ORL in India was a strategic step in that
direction. ORL, with its technology and innovation, enjoys leadership position in ladle and
tundish management system within the steel flow control process; it commands a strong
~30% market share in the critical process of steel flow control.
With strong positioning of ORL in steel flow control segment in India, parent plans to
leverage this asset. Thereby strong focus of the parent in steel control and emerging
markets will lead to strong growth for ORL in both domestic and export sales.
Chart 3: RHIGlobal sales break up
Source: Company
Steel flow
control
17%
Lining
46%
Industrial
division
35%
Raw materials
2%
CY13
RHIs India vision: Double
ORLs sales over next 4 years
leading to 20% CAGR
RHIs target: Increasing sales in
profitable steel flow control
segment by 1.4x to EUR400mn
by 2020
Target of strengthening No. 2
position globally in steel flow
control further fortified by
acquisition of ORL in India
Refractory
26
Edelweiss Securities Limited
Capitalise growth with 60% unutilised land, strong fixed asset turn
Following high capacity utilisation of ~99% in FY11 in shaped refractories segment, ORL
undertook capex of INR180mn in the past three years (27% expansion on FY12 gross block)
to gear up for growth. As a result, the company enhanced capacity towards higher-value
shaped refractories. The current plant at Bhiwadi, Rajasthan is a 30 acre land parcel. Even
with the current capacity expansion, this land is still 60% unoccupied. This, because all
expansion happened at the existing plant with low fixed costs and company has generated
strong core fixed asset turnover of ~6x historically. Going forward, in attaining we have
assumed further capex of INR380mn (further 74% expansion) to attain parents target of
doubling revenues.
Going forward, following capacity expansion, we have assumed 22% CAGR in net
manufacturing sales over FY14-16E (versus 15% CAGR during FY08-14) and 13% CAGR in
traded sales over FY14-16E (versus 19% CAGR during FY08-14).
Chart 4: Gross block expansion of 27% over FY12-14; further 74% expected
Source: Company, Edelweiss research
Strong volume boost to sustain high margin
Industry leading position in steel flow control coupled with low-cost advantage allows ORL
to enjoy superior margin in the refractory industry versus peers. The companys gross
margin stood at ~46.8% in FY14 (average of 45% in past three years). Its manufacturing
margin stood at ~51% (average of 49% over past three years) and traded margin at ~15% in
FY14 (average of 9% over past two years). Within overall sales, 73% were shaped and
balance 12% unshaped sales under manufactured sales. Traded goods contribute 15% to
overall sales. The company generated overall average EBITDA margin of 19% in past two
years.
Going forward, with the portfolio approach of the parent and increasing capacity utilisation
from FY16E, we expect strong 22% net sales CAGR over FY14-16E. As a result we expect
gross and operating margins to be maintained at 46.2% and 19.4% respectively, over FY14-
16E. This is despite strong business from RHI (parents group companies) which may lead to
dilution of margins. Ergo, we expect 20% CAGR in operating profit over FY14-16E.
4.0
4.8
5.6
6.4
7.2
8.0
0
200
400
600
800
1,000
FY12 FY13 FY14E FY15E FY16E
(X)
(IN
R m
n)
Gross block Core Fixed Asset turn
Having increased gross block by
27%, we expect further ~74%
jump with huge unutilised land,
60% unoccupied; generated
strong fixed asset turnover of
6x historically
27
Edelweiss Securities Limited
Orient Refractories
Chart 5: Increasing manufacturing sales trajectory to maintian high margins
Source: Company, Edelweiss research
0.0
5.0
10.0
15.0
20.0
25.0
0
1,200
2,400
3,600
4,800
6,000
FY12 FY13 FY14 FY15E FY16E
(%)
(IN
R m
n)
Manufactured sales (INR mn) EBITDA margin (%)
Strong manufacturing sales
trajectory at 22%CAGR to lead
to high margin sustenance at
19.4% over FY14-16E
Refractory
28
Edelweiss Securities Limited
Valuation
ORL, the second largest refractory player globally, is cyclically well positioned with strong
demand drivers available for the steel industry. Structurally also, the company is well poised
owing to emerging markets, integrated portfolio approach of the parent, strengthening
position in the profitable steel flow control process segment and a strong product portfolio
in India. Strong gross block addition (27% over FY12-14), with further ~74% addition
expected, India being a strong focus area of the parent with a target to double turnover for
ORL, will be catalysts allowing the company to post 21% sales and 20% earnings CAGR over
FY14-16E. Strong focus of the parent to tap both domestic and exports growth, along with
focus on growing market share in the steel flow control segment led by the acquisition of
ORL will result in narrowing of discount to the market leader, Vesuvius India (VIL).
We expect the company register free cash flow (FCF) over the next two years of INR1bn
(versus INR820mn in past three years). Hence, we expect net cash to get augmented by 4x to
INR6/share in FY16E (8% of current market cap).
At current market price, ORL is trading at 15.5x FY15E and 11.8x FY16E EPS. The company
has limited history since it was acquired by RHI in FY13 and demerged from Orient Abrasives.
ORL has outperformed its domestic and global peers in terms of growth, margins and return
ratios and has been able to maintain non-cyclical sales CAGR of 19% and EBIT CAGR of 18%
(average 17% EBIT margin) over past 10 years. RoE was an average 46% over FY13-14 due to
high core fixed asset turn and strong profitability ratios. With expected strong sales and
earnings CAGR of ~21% and 20% respectively, over FY14-16E, we expect ORL to trade at
mere ~10% discount to the market leader in steel flow control VIL, going ahead. Hence, we
initiate coverage on the stock with a BUY recommendation and target price of INR115,
based on 18x FY16E EPS and 10% discount to VILs target valuation.
We believe the stock is a re-rating candidate given its consistent track record, beneficiary of
parents strong focus on India, strong returns profile and huge beneficiary of uptick in the
domestic steel industry.
Trading at 11.7x FY16E EPS, we
believe ORL is a re-rating
candidate given its consistent
track record outperforming
industry, lead position in
profitable steel flow control
segment further fortified by
parents strong focus on India
and sturdy returns profile
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Edelweiss Securities Limited
Orient Refractories
Key Risks
Delay in recovery in key segment
Slowdown in steel sales momentum can impact our sales growth projections since its the
biggest driver for ORLs revenues.
Dependent on raw material sourcing through imports
The industry is dependent on imports of key raw materials like high grade alumina, bauxite,
magnesite, silicon carbide, etc. China is a major supplier of imports and has imposed heavy
taxes on export of raw material of refractories. This has resulted in sharp increase in
imported raw material costs. Imports constitute ~11% of net sales. This also includes
currency headwinds on ~25% of raw material costs which are imported. Also, the company
exports ~16% of sales, making it a net exporter.
Increase in royalty rate
Currently, royalty, trademark and service fees, as a percentage of overall sales, stand at
mere INR 1.75lakh, whereas some others have received an average 1.3-1.7% of net sales for
in case of Vesuvius India. Any increase in the same could pose a risk.
Intensifying competition
International players like Vesuvius Plc. which have a strong leadership position in steel flow
control process globally, Krosaki Harima which bought 51% in Tata Refractories, Calderys,
part of Imerys of France which acquired ACE Refractories are all setting up base in India
through the acquisition route. This will heighten competition in the refractories industry
going ahead.
Refractory
30 Edelweiss Securities Limited
Company Description
Fig. 1: ORLEvolution
Source: Company
About ORL The RHI Group holds about 69.6% of ORL India share capital and is the second largest player globally in the design, engineering, manufacture and delivery of refractory products,
systems and services for high-technology industrial applications. ORL is now part of the RHI Group of Austria, globally the number two player in the design, engineering, manufacture and delivery of refractory products, systems and services for high-technology industrial applications. The parent clocked revenues of Euro1.75bn and EBIT of Euro111mn, as of CY13. In India, ORL is the second largest player in the steel flow control process segment, with market share of ~30%. ORL's product range includes:
Isostatically pressed continuous casting refractories
Slide gate plates
Nozzles and well blocks
Tundish nozzles
Bottom purging refractories and top purging lances
Slag arresting darts
Basic spray mass for tundish working lining
Castables
Strong technological prowess and rich product portfolio enables the company to partner with a steel company right from the capacity formulation stage. It has a technology licence agreement with parent, but pays meager royalty and technical fees of INR1.75lakh. The company clocked 85% of overall gross sales from manufactured sales in FY14. Within overall sales, 74% comprise shaped and balance 11% unshaped. ORL also generated 15% of overall revenue from trading of refractories.
1985Bhiwadi plant started commercial productionof refractories
2007Expanded unshaped capacity from 17,000 to 23,000 MT
2008Expanded shaped capacity from 9,000 to 16,000MT and unshapedto 28,000MT
Mar-13RHI aquired 43.6% of Orient refractoriesfrom the ex-promoters and further made anopen offer to acquire.
ORL is a leading player in steel flow segment in refractories market in India in laddle and tundish management
31
Edelweiss Securities Limited
Orient Refractories
The company also exports 16% of its sales to its customers in Europe, Middle East and South
East Asia.
ORL has just one plant at Bhiwadi with total capacity of 44,000MT, which operated at full
capacity utilisation in FY13. Hence, the company has undertaken 27% capacity expansion. It
also has an outsourced arrangement for its unshaped refractories from Salem.
Chart 6: Shaped refractories and capacity utilisation
Source: Company
ORLs exposure to the steel flow control segment is ~65-70% of sales.
Chart 7: Unshaped refractories and capacity utilisation
Source: Company
0.0
24.0
48.0
72.0
96.0
120.0
0
3,600
7,200
10,800
14,400
18,000
FY08 FY09 FY10 FY11
(%)
(to
ns)
Installed capacity (in tons) Sales qty (in tons) Capacity utilization (%)
0.0
24.0
48.0
72.0
96.0
120.0
0
6,000
12,000
18,000
24,000
30,000
FY08 FY09 FY10 FY11
(%)
(to
ns)
Installed capacity (in tons) Sales qty (in tons) Capacity utilization (%)
Shaped refractories account for
major ~73% of gross sales
Refractory
32
Edelweiss Securities Limited
Chart 8: ORLBusiness mix
Chart 9: Overall sales mix
Chart 10: Traded sales mix
Source: Company, Edelweiss research
Manufactured
85%
Traded
15%
FY14
Manufactured
(Shaped)
74%
Manufactured
(Unshaped)
11%
Traded
15%
FY14
Traded
(Shaped)
78%
Traded
(Unshaped)
22%
FY14
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Edelweiss Securities Limited
Orient Refractories
Manufacturing facilities
The company has a well-balanced product portfolio of refractories shaped refractories
capacity is 16,000 tonnes/year and unshaped (monolithics) capacity is 28,000 tonnes/year.
ORLs factory at Bhiwadi houses its manufactured capacity. Shaped segment accounted for
~74% revenue share with ~11% coming from unshaped segment and remaining 15% from
trading activity in FY14.
ORL has ~30 acres of land which is only ~40% occupied and hence additional capex will be
incurred here.
Table 2: Production unit
Source:Company
Diversified product portfolio
ORL has been expanding capacity through organic route. The company enhanced capacity
1.8x in FY08 in shaped refractories in view of the burgeoning demand from 9,000 tonnes in
FY07 to 16,000 tonnes in FY08. Even in unshaped segment, capacity was expanded 1.6x
from 17,200 tonnes in FY06 to 28,000 tonnes in FY08.
Chart 11: Sales break up
Source: Company, Edelweiss research
Factory Products Capacity Refractory type
Continuous
casting
refractories,
sl ide gate
Shaped at 16,000
tonnes/year;
equipment,
porus plugs,
inner nozzles,
machine parts -
shaped
refractories
unshaped at 28,000
tonnes/year
Salem - arrangement Monolithics Unshaped
Bhiwadi Shaped and unshaped
0
1,400
2,800
4,200
5,600
7,000
FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E
(IN
R m
n)
Manufactured Traded
Manufacturing will be on an
uptrend with 22% CAGR in
sales versus 13% CAGR in
traded sales over FY14-16E, led
by capacity addition and high
fixed asset turn
Refractory
34
Edelweiss Securities Limited
Over past two years (FY12-14), manufacturing revenues logged CAGR of 16% versus 15%
registered by traded. Going forward, we estimate 22% CAGR in manufacturing and 13%
CAGR in trading over FY14-16, led by 27% gross block expansion in past three years and
further ~63% expected over next two years.
Chart 12: Sales break up
Source: Company, Edelweiss research
Chart 13: Export sales trend
Source: Company, Edelweiss research
Exports posted 19% CAGR during FY12-14. Going ahead, we have assumed 25% CAGR in
export sales over FY14-16E. The parent is laying focus on growing exports.
0
1,400
2,800
4,200
5,600
7,000
FY12 FY13 FY14E FY15E FY16E
(IN
R m
n)
Domestic Exports
14.0
14.7
15.4
16.1
16.8
17.5
0
240
480
720
960
1,200
FY12 FY13 FY14E FY15E FY16E
(%)
(IN
R m
n)
Exports % of revenues
Exports constitute 16% of net
sales; having posted 19% CAGR
over FY12-14, we estimate 25%
CAGR over FY14-16E
35
Edelweiss Securities Limited
Orient Refractories
RHI Group (Global)
The RHI group of Austria is the leading global supplier in molten metal flow engineering with
revenue of Euro1.75bn (as of CY13) and operating margin at 14.9%.
The second largest player in the refractory industry, RHI has been in existence since 1834
and produces more than 1.7mn tonnes of refractory products per year. The company has
two main divisions (steel and industrials).
RHI develops refractories under two product segments: steel under Interstop brand for steel
flow control, Didier for lining, and refractories for glass industry under Monofrax and Refel
brands.
Europe is the largest market accounting for 36% of the groups revenues; steel is the major
division, representing 63% of sales. The balance 35% of industrial is broken up into 12%
cement, 11% non-ferrous, and 8% glass.
RHI has 33 production sites, >160 international technical experts at customer locations, and
70 sales and service sites, together employing over 8,000 personnel and serving more than
10,000 customers from the steel, cement, nonferrous metals, glass, energy and chemical
industries in nearly all countries of the world.
Some key customers of steel business include ArcelorMittal, Severstal, etc. Some key
customers of the Industrial division are Cemex, Holcim, Lafarge in cement division, Ardagh
Glass, Corning, Vitro in glass division and Glencore, Bhp Billiton, Rio Tinto in the non-ferrous
division.
Segments
Steel
In a challenging market, sales volume of the division declined by ~5% YoY to 1,187,000
tonnes in CY13 due to weak business in Europe and the Middle East. In contrast, revenues
were maintained nearly constant at 1,097.5mn (1,112.7mn in the previous year) due to
initial consolidation of the 69.6% share in the Indian company, ORL, which was acquired
towards late April, and improvements in product mix.
Industrial
Sales volume of the division dropped by ~7% YoY to 439,000 tons due to a decline in the
number of construction projects in the business unit environment, energy, chemicals and
decreasing volume in the cement business unit. The decline in revenues from 673.9mn in
2012 to 619.0mn in 2013 was primarily attributable to weak demand in the business units
of glass and environment, energy, chemicals and to non-recurrence of delivery of a major
project in the ferrochrome segment in the previous year.
RHI Group of Austria is second
largest global supplier in
refractories with revenue of
EUR1.7bn (as of CY13), 9%
market share and strong 14.9%
operating margin
Refractory
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Edelweiss Securities Limited
Chart 14: RHIs sales by region
Source: RHI
Chart 15: RHIs sales break up
Source: RHI
Innovation: A key success factor
The groups investment in research and development (R&D) during CY13 amounted to
Euro20mn, representing 1% of group revenue.
RHI has ~1,500 patents granted with 25 new filed during the year 2013. The company
has more than 160 international experts in its global R&D team. Banking on a strong
global R&D network, the parent intends to considerably strengthen its innovation
capabilities in Asia Pacific, to cater to the regions customers.
Globally, incremental stress is being laid on R&D. Research focuses on four strategic areas:
substitution of raw materials, energy efficiency, functional products and recycling.
Innovation at RHI extends from the product level to all business processes and involves all
employees. To underline the importance of innovation, the RHI Group has set up a separate
Western europe
29%
USA &Canada
13%Australia &
Japan
1%
CIS
5%Eastern europe
7%
Middle east &
Africa
13%
South America
& Mexico
14%
Asia
18%
CY13
Steel flow
control
17%
Lining
46%
Industrial
division
35%
Raw materials
2%
CY13
Parents R&D expenses were at
EUR20mn in CY13 and stood at
1% of sales
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Edelweiss Securities Limited
Orient Refractories
innovation and IP management department in 2013, which reports directly to the CEO of
the group.
Primary objectives of RHI group over medium term include:
Revenue target of the group for 2020 has been set at 3bn from 1.75bn in 2013,
increasing at 8% CAGR/EBIT margin of 12% (throughout the economic cycle) from
6.3% in CY13.
The RHI group has pursued a clearly defined strategy for several years based on
expanding market presence in emerging markets by increasing contribution from
emerging markets from 56% to >70%. To attain this, the company has internally set
a target to double ORLs turnover by next 4 years, increasing at ~20% CAGR. After
USA and Germany, India has become the third most important market for the RHI
Group and will continue to gain importance in ensuing years.
The company wants to grow profitably and strengthen its number two position in
the flow control segment by increasing sales from Euro290mn to >Euro400mn.
The company has set the target to grow profitably and ORLs acquisition is seen by
the group to attain its target. The transaction enables RHI to consistently
implement its growth strategy in emerging markets and additionally strengthen its
number two position in the flow control business.
Refractory
38
Edelweiss Securities Limited
Financial Outlook
Revenue to post 21% CAGR over FY14-16E led by parents support
Historically, ORL has outpaced the steel industry in terms of sales growth over the years,
owing to its leading position (second after leader VIL) in the profitable steel flow control
process. As a result, shaped manufacturing volumes have risen at 18% CAGR in the shaped
segment over FY06-11. This is as compared to steel industry growing by 9% CAGR over the
same period.
Increasing capacity, parents focus to grow sales in steel flow control segment, double sales
in India, expanding client portfolio from small steel mills to bigger steel mills will drive
strong sales growth in the shaped sales segment. As a result, we expect 22% CAGR in
manufacturing sales over FY14-16, which will lead to overall net sales CAGR of 21% over the
period versus 17% CAGR during FY12-14. Meanwhile, steel industry production is estimated
to increase at 6% CAGR over the period.
Chart 16: Strong sales trajectory ahead with strong focus by parent
Source: Company, Edelweiss research
Manufacturing trajectory better than traded
We anticipate the company to post strong growth riding on capacity expansion of INR180mn
(27% expansion of FY12 gross block). Also, led by strong focus of parent to double ORLs
turnover, we expect further capex of ~63% over FY14-16E at INR380mn. The company has
historically generated average core fixed asset turn at over 6x plus, which we expect over
the next two years. We have assumed 22% CAGR in manufacturing sales over FY14-16E. Also,
with growing manufacturing sales, traded sales trajectory will be lower at 13% CAGR over
FY14-16E. Therefore, stronger manufacturing will support higher margins as well going
forward.
0
1,400
2,800
4,200
5,600
7,000
FY12 FY13 FY14 FY15E FY16E
(IN
R m
n)
Refractories (Shaped) Refractories (Unshaped) Traded
Parents portfolio approach
with increased business from
big steel mills will result in net
sales posting 21% CAGR over
FY14-16E versus 17% CAGR in
past two years
Capex and high core fixed asset
turn to drive manufacturing
sales at 22% CAGR versus 13%
CAGR in traded sales over
FY14-16E
39
Edelweiss Securities Limited
Orient Refractories
Chart 17: 22% CAGR in manufactured sales versus 13% CAGR in traded sales
Source: Company, Edelweiss research
Strong volumes in shaped segment to support margin at ~19%
We believe EBITDA margin is likely to sustain at current levels of ~19%, led by increasing
capacity utilisation, strong volume growth and thrust by management to grow steel flow
control. While the portfolio approach of parent may dilute margin as the company will be
generating sales from parents unlisted entities like RHI Clasil and RHI Pvt Ltd too, we expect
the strong volume uptick to sustain margins. Hence based on our expectation of strong
trajectory in shaped refractories volumes, operatin