Prime Stock recommendation: A proxy play on the private capex theme
Capital goods & infrastructure company stocks are over-heated due to the government-backed capex push. So here is a proxy!
N V Chandrachoodamani
Chandrachoodamani started his capital market career in mid 2000s with Equity Intelligence India and then worked with several capital market Intermediaries in various roles over the last 15 years. Most of his career experience has been in equity research and PMS. Most recently, he was with MOAT, a PMS firm. He is a graduate in mathematics, a post graduate in finance, and holds a CFP certification. LinkedIn|Twitter
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8 thoughts on “Prime Stock recommendation: A proxy play on the private capex theme”
Hi Chandra,
Even in the current weak market condition, is it a good time to buy this stock?
Thanks.
Sir, when markets are weak, you can buy in phases.
Hi,
I would want to understand the following:
1. How Vesuvius did perform well in the last 1/3 years compared to RHI? What really worked for them?
2. Any data available regarding % of revenue coming from small steel mills and large integrated plants? Higher portion of revenue coming from large integrated players (likely in case of Vesuvius) will protect them from china dumping.
3. What is % exports to related parties?
4. If China dumping continues, exports will be muted going forward which is one of the key drivers for the company.
5. What is the RM dependency on China (% of RM imported from China). Has RHI diversified its sourcing mix in the last few years?
6. Looks like acquisitions did not work out and RHI overpaid.
“The impairment is primarily due to a weaker market environment in export geographies where demand has fallen significantly. Weaker demand is further exacerbated by strategic decisions to step away from low value customers and from restricted markets. Despite the realisation of synergies post”-acquisition, the expected profitability of the acquired entity has been rationalised to reflect the rebasing of benefit schemes and a higher rate of inflation in local market costs which cannot be passed to customers. The above underlying impacts are expected to persist over the near and medium term, which has led to the downward revision of cash flow expectations underlying the valuation of the acquired entity”
Welcome your query sir,
Let me try to address all your queries to the best possible extent
On VESIVIUS, I was also looking at whether its valuations are reasonable. It appears like low liquidity was driving the rally and pushing up valuations, can’t find any other reason. It also didn’t have any corp. action/ equity dilution event like RHI to add equity supply to market and put a check on stock price rally
Coming to specifics of RHI,
1. % share of large mills: If I remember right, large mills contribute majorly to revenues, especially after acquisition and consolidation of Hi-tech and Dalmia. Pl refer to Page 11 of Q1 earnings call transcript, link below
https://www.bseindia.com/xml-data/corpfiling/AttachHis/4462a93f-81cc-4ec7-9179-95235617e274.pdf
2. Overall exports are only 10% of consolidated revenue and was at 9% in Q1 due to slowdown.
Exports are largely to fellow subsidiary and there are purchases of raw material as well (RHI group is backward integrated as well). This is likely to go up in future also as the parent wants to make India a key sourcing base.
Meanwhile, parent’s backward integration provides RHIM with flexibility in sourcing based on how China factor plays out.
Currently China is the major source of raw material.
Even in acquired assets, raw material sourcing synergies will play a key role in improving their efficiencies as well as margins.
3. On dumping by China, this is definitely a concern. As mentioned in the report, the re-set of global supply chain is a long-term process and we are seeing Govt. supporting industries with duties as well. This re-set of supply chain could incrementally favour local players, that’s the best guess to take at this point of time.
Otherwise, this remains a valid concern.
4. On acquisitions, it may be too early to say whether they worked or not. Anyhow, it’s good to see pro-active checks on impairment, write-offs while strengthening balance sheet through QIP. Since you have quoted the reason for “impairment” provisioning from Annual Report, it was based on the scenario at the end of FY24.
But Q1FY25 numbers, especially margins, have actually taken the market by surprise. Even though supply disruptions from China helped with some pricing power, the consolidated margins paint a healthy picture. It seems like the steel industry is also recovering currently post China stimulus.
So, the context itself is changing with China’s slowdown a year earlier Vs China Stimulus now and we will have to view its prospects on that basis
Hope this clarifies
Pl feel free to write to us again if the explanation is not satisfactory
Thank you
Hi ,
am holding this Co from Rs.350 around per share, it went up to Rs.800 and now trading at Rs.600 but its peers such as IFGL doubled its share price. Now, commodity cycle is going through headwinds, they have done capex and debt and depreciation are there. How do you value future prospects as EBITA omits cost of capital and depreciation ?
Welcome your query sir,
You are right that peers like IFGL and Vesuvius doubled or more
RHI was in consolidation and acquisition more. Meanwhile, there is not much debt, just some 300-320 Cr net debt as they did a 900 Cr QIP in FY24
As mentioned, RHIM has been consolidating its presence in India. Now they want to increase market share, increase exports and improve capacity utilization and efficiency of acquired assets. All these are earnings accretive
I don’t rule out your apprehension about commodity cycle and threat of Chinese imports
But India is the only large market that is offering growth with more capacity additions being planned in steel, cement, glass, chemicals, etc.
RHIM appears like one entity that will be able to utilize this opportunity well, if its eyeing 40% share of this market. Again I also don’t rule out import substitutes, dumping from Asia, etc, but the trend that deserves a benefit of doubt is “localisation of supply chains”
On valuation, higher depreciation and interest costs due to acquisitions are compressing PAT of RHIM unlike its peers IFGL and Vesuvius. Meanwhile, the capex is almost done with and depreciation is a non-cash cost
(RHIM’s depreciation is 4X that of Vesuvius or 3X that of IFGL for 2X size)
So EBIDTA – taxes will be actual cash flows (unless working capital increase, interest cost will be much lower next year), but higher depreciation will make profit appear a tad lower.
Hence used EV/EBIDTA as a metric
Ultimately, sum of the present value of future cash flows is the actual value of a business.
It gives a clear sense of pay-back period for an acquirer of this Co, hypothetically.
Of course, we would have been happy to take the stock for reco. at a lower multiple of say 15-16X, but current market doesn’t offer that scope.
Hope this clarifies
Thank You
Thank you for the recommendation, However, I am still not able to understand the strong conviction on earning potential despite the not so good parameters. Can you please help? The PE ratio is well above the median pe and industry PE but you have said it is due to the one time exceptional item and the exceptional items are impairments due to their subsidiaries, how is it a favourable aspect. The Company is not generating any Free cash flow and has been heavily investing in Capex. The company also does not have any retained earnings in the past 5 years. Can you please help to understand on the rationale on this recommendaion at this valuation?
Welcome your observations sir,
As given in the financials table in the report, PE ratio excluding exceptional items was 40 times.
You might have seen higher interest cost and depreciation also compressing net profit
In these kinds of sectors, during unusual increase in capex, EV/EBIDTA is a better measure. Because capex is already incurred, and depreciation is already charged. Depreciation is a non-cash item and its impact on profitability is high in early years
On cash flows, it appears negative on account of acquisitions. Operating cash flow is positive and should improve as RHIM streamlines its acquired assets. Now, major acquisitions are all over and focus will be on profitable growth
We will be watching for EBIDTA to Operating cash flow conversion closely from this first half of FY25
Meanwhile, if the Co. delivers as per the strategic plan it has laid out (mentioned in detail in report) comprising market share gains, export share increase and higher utilization of assets, all these are earnings accretive factors – means profit growth will outpace revenue growth
Hope this clarifies
Thank you
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