Stock review : An under-researched, niche, small-cap play

This call has been updated to a BUY on Dec 6, 2022 with a buy price of Rs 629

A lot goes into making that piece of gold jewellery you see at your jewellers’. Or even the copper that goes into your two-and four-wheelers. The first step starts with mining these metal and mineral ores. The next is to crush the ore lumps into desired sizes and processing them in mills to extract the metal or mineral. 

This involves a lot of machinery such as crushers, screens and other mineral processing equipment. In mill equipment, there’s a critical component that protects the equipment to ensure longer life, reduce noise as well as downtime, and improve safety. 

That component is mill liners, which are critical consumables used in the mill equipment to withstand the abrasion. Given its criticality, you may think that the space would have plenty of suppliers. But – even globally – there really aren’t that many players.

One of them is an Indian small-cap company, which is the second largest player in polymer-based mill liner industry globally and the 5^th largest in the overall mill liner space. In this report, we review this company – Tega Industries.

The company

Tega Industries is a manufacturer and distributor of critical consumable products used in the mining, metal and mineral beneficiation and bulk solids handling industries. It was listed in December 2021 and has a market cap of Rs 3,700 crore, which makes it a small-cap stock. 

It is a 79% percent promoter-held company, and presently has low liquidity in the market.

The company is based out of Kolkata with 3 plants in India and others in Chile, South Africa and Australia – regions that have high metal and mineral assets. The company’s sales expanded by 14.3% annually in the last 3 years and net profits by 52%. The success of a breakthrough product called DynamPrime (launched in FY-18, and explained further below in this report) pushed its profits and margin trajectory northwards. 

Positives

#1 Less prone to mining capex cycles

As a supplier to the mining industry, one might think that Tega Industries’ prospects are linked to capex cycles of metals. This is not entirely the case. 

• First, Tega Industries' products are linked to the operating expenses incurred by metal and mining and bulk solid handling companies. Roughly, the consumables it produces account for about 6-8% of operating expenses of mills, depending on the size of such mills. According to the company, over the lifecycle of a mill, after-market spend is generally 3 times the upfront capex and liners account for one such critical spend. Hence, the company’s business is not tied fully to capex in the mining sector.
• Second, the nature of industries that use Tega Industries' consumables are also fairly steady by way of their production. Close to two-third of the company’s end users (in terms of revenue) come from gold and copper, where production has remained steady (with copper’s prospects said to remain bright as a result of EV and renewable energy thrust). About 15% comes from iron ore mills and the rest from titanium, platinum silver, cement (and aggregates) industries. 
• Third and very importantly, liners have become critical components as ore grades have declined over the years, especially in the copper and gold industries. Therefore, superior quality of consumables (such as liners) is a must for the higher beneficiation requirements. For example, copper grades in an operating mine can be 0.5% to 1%. That means you would be able to extract just about 5 kg of copper from a tonne (1000 kg) of ore. This is even worse for gold as its grades are even lower. Thus, these metals would increasingly need larger equipment and superior consumables to handle extraction efficiently. This will also likely keep the margins for these critical consumables reasonably high. 

#2 Breakthrough product

Tega Industries makes mill liners and cross sells other products (other than mill lines) used in mills. The mill liners, which are the primary products, are typically classified into metal mill liners, rubber liners and hybrid (composite). In 2018, the company launched DynaPrime, a composite mill liner made of steel and rubber and targeted at larger mineral processing sites that used the traditional metal mill liners. 

This product has provided a breakthrough both in terms of growth and margins for the company, taking off well in Chile, US, Canada and Europe. It is in trial runs in various other regions. 

This product will increase the present opportunity in the mill liner space, as mining companies will likely try to replace their metal liners with this product given its advantages. The liner increases throughput and productivity of the machine, has statedly higher shelf life (by 50%), reduces downtime as well as energy costs. It is also lower in weight and has improved safety features. 

This product generated revenue of 27.5% CAGR for Tega Industries in the three years ending FY22 and also helped gain 2-2.5% market share in the metal mill liner industry. Tega Industries expects to comfortably grow this segment at 25% CAGR over the next 3-4 years. As the replacement for this product is anywhere between 4 months to 18 months (based on the nature of the mill), the replacement demand will likely remain healthy. 

While a single product success may not be sustainable, Tega Industries has stated that it is in the process of patenting 4 more products. With a 36-member research team, newer product launches may be necessary for this company to retain its market share and margins. 

#3 High moat and margins

The industry opportunity in mill liners is not high at $1.8billion in 2021 (of which more than half is metal liners, which is the target market for DynaPrime). However, the market itself can expand as companies shift to higher quality liners as well as replace them more often as ore grades deteriorate with time. The players in this space are not too many with the top 5 accounting for about 50% of the market share.

Tega Industries is among the top 5 in the mill liner market where a majority of mills are SAG (semi autogenous) mills, which are typically large mills and where Tega Industries has an edge. Tega Industries, along with competitors Metso-Outotec and Weir compete in the mill liners in the SAG mill category.

Tega Industries is at present the only company producing hybrid mill liners for SAG mills with 9.5-12.5-meter diameter range. And as degrading ores mean that one needs larger mills, Tega Industries presently has potential to gain market share, especially with the DynaPrime product.

Realisations from DynaPrime is stated to be 35% higher than traditional metallic liners due to its superior performance. This appears to have buttressed Tega’s operating margins at around 18-23% overall for the company in the last 4 years (average OPM was 10.3% between FY-15 to FY-18).

#4 Global footprint and capacity expansion

As the business of mining is more a global activity than local to India, Tega Industries has rightly expanded its footprint across key mining regions of Chile, South Africa and Australia. For the first half of FY-23 revenue from South America expanded 31% YoY while Africa grew 14%, Asia-Pac 43%, EMR region 80%, India 37% and a decline by 7% in North America. Overall, close to 85-90% revenue is from overseas markets. 

It has done this by setting up capacities in key regions, to service various markets. The capacity expansion has been undertaken without resorting to high debt levels. Debt equity ratio as of September 2022 stood at 0.25. 

Of course, the company can add to capacity over the next couple of years. The company already spent Rs 57 crore this fiscal from internal accrual on capex. While the remaining quarters may see muted addition on this front, FY-24 and FY-25 could once again see it upping the game as it focuses on capacity expansion in Chile. Latin American countries boast of 40% of global copper production and hence there is need for the company to expand capacity in the region.

It plans to double capacities there over the next 3-4 years. While this can lead to a spike in the overall debt levels, earlier debt levels and quantum of potential capex suggest that the company may not see debt jump sharply.

Challenges

#1 Not immune to supply chain challenges and logistics

As a niche player in this segment, Tega Industries is confronted with supply chain challenges and high freight costs for exports. This was particularly bad for the June 2022 quarter when long working capital days as well as freight costs hurt margins. Working capital days has since eased to about 140 days from 170 days and freight costs are off their peaks, resulting in improved margins. 

Price hikes, while not impossible, are eased in and not drastic. For example, of the 20% revenue growth in the September quarter (over a year ago) – 18% was volume growth while 2% was attributed to price increase. In addition, exchange impact too can hurt although the company does try to hedge where needed.  

#2 Product concentration

Tega Industries has a well-diversified product portfolio of over 55 products installed at 450 sites across 70 countries globally. 75% of its sales is also replacement demand with a high level of customer stickiness. It also has a healthy mix of mill liner and non-mill liner products at 60:40 respectively for the first half of FY-23. 

However, with the mill liner product of DynaPrime catching the mill market fancy, the product alone accounted for 22% of total sales for the first half of FY-23. With this product set to grow at a fast pace, the company’s revenue might get concentrated on this single product. While the non-mill liner products in Australia have rebounded post Covid and can help in revenue contribution, we do think that Tega Industries would need to prove its mettle in coming up with more high-end products. It has stated that it has filed patents for 4 more products. But the time-to-market on these can be prolonged as trial runs and market interest is not easy to catch in such industries.

# 3 Geopolitical tensions

Tega Industries gets almost 90% of its revenue from overseas markets. The location of the mines globally is also largely in developing nations, subjecting them to geopolitical tension and economic stress. This can lend a shade of risk at all times to its highly lucrative business.

Valuations

Tega Industries is at 27 times its trailing 12-month earnings at Rs 579. This is at a discount to most other capital goods and engineering plays, especially considering the superior OPM and ROE (ROE was 18% as of September 2022 from 16% In March 2022). Its orders as of September 2022 at Rs 345 crore is about 1.25 times the September quarter revenue; healthy for a consumable product.

However, there is a large factor that currently acts as a deterrent to investing in this small-cap stock – which is low float. Domestic institutional investor holding has slowly increased from 7.5% in December 2021 to 10.9% as of September 2022. 

While the turnover on the NSE ranges from several lakhs to crores, the trades are quite erratic causing large price swings. On the BSE, the turnover is extremely low and can get to even Rs 2-4 lakh on some days. You have to be on guard and avoid transactions through BSE.

This is a high-risk stock and has ALL the challenges that a company of this size with a niche product can face. It is therefore not for those looking for steady compounders. If you decide to take exposure now, do so only in tranches.

Disclosures and Disclaimers

The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (hereinafter referred to as the Regulations).

1. PrimeInvestor Financial Research Pvt Ltd is a SEBI-Registered Research Analyst having SEBI registration number INH200008653. PrimeInvestor Financial Research Pvt Ltd, the research entity, is engaged in providing research services and information on personal financial products. This Research Report (called Report) is prepared and distributed by PrimeInvestor Financial Research Pvt Ltd with brand name PrimeInvestor.

2. PrimeInvestor Financial Research Pvt Ltd, its partners, employees, directors or agents, do not have any material adverse disciplinary history as on the date of publication of this report. 

3.  I, Vidya Bala, author/s and the name/s in this report, hereby certify that all of the views expressed in this research report accurately reflect my/our views about the subject issuer(s) or securities. I/We also certify that no part of my/our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. I/we or my/our relative or PrimeInvestor Financial Research Pvt Ltd do not have any financial interest in the subject company. I/we or my/our relative or PrimeInvestor Financial Research Pvt Ltd do not have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. I/we or my/our relative or PrimeInvestor Financial Research Pvt Ltd do not have any material conflict of interest. I/we have not served as director / officer, etc. in the subject company in the last 12-month period.

4.  I, Vidya Bala, do not hold this stock as part of my investment portfolio. I/ analysts in the Company have not traded in the subject stock thirty days preceding this research report and will not trade within five days of publication of the research report as required by regulations.

5.  PrimeInvestor Financial Research Pvt Ltd has not received any compensation from the subject company in the past twelve months. PrimeInvestor Financial Research Pvt Ltd has not been engaged in market making activity for the subject company.

6.  In the last 12-month period ending on the last day of the month immediately preceding the date of publication of this research report, PrimeInvestor Financial Research Pvt Ltd has not received compensation or other benefits from the subject company of this research report or any other third-party in connection with this report.

General Disclosures & Disclaimers