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  • 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

    [email protected]

    Manoj Bahety, CFA

    +91 22 6623 3362

    [email protected]

  • 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.

    (Click here for

    video clip)

  • 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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    (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

    [email protected]

    Manoj Bahety, CFA

    +91 22 6623 3362

    [email protected]

    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

  • 29

    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

  • 33

    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

    36

    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

  • 37

    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