Your Questions March 2018

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By IE&M Research

I bought 500 shares of Kirloskar Ferrous Industries Ltd. on someone’s recommendations very recently when it was trading at Rs100. Now there is a drastic fall and I’m losing on this buy. Although I don’t mind keeping it in my portfolio for longer period but there should be some logic behind it. Right now I find none. Can you please guide me? – Satish Kumavat, Jaipur

First of all you should not buy just because somebody is suggesting. This way you’ll reach nowhere and only lose your hard earned money very fast, ultimately you’ll be soon out of the markets. Secondly, you should be very clear before buying a stock whether you are buying for long term or just for trading purposes. This will reduce smoothen half of your dilemma. In fact, these days the hot topic is the electric vehicle. It is nowhere seen to the extent that it can damage the industry, yet if it catches on, it will certainly impact many companies making the conventional engines irrelevant. This could be one reason why investors are not very enthusiastic about this scrip since Kirloskar Ferrous’ entire casting business predominantly caters to large engine components. But since the government policy regarding this is still not very clear you should not worry much. Rather the worrying aspect is management’s conservative approach towards pursuing growth opportunities as the significant portion of earnings growth in the last 5 years is because of backward integration and improvement in processes.

Kirloskar Ferrous is largest integrated manufacturers of foundry grade pig iron. Being a part of the widely respected Pune-based Kirloskar group the company has several advantages over its peers. The company is the only Indian manufacturer of Euro-VI castings, a segment that requires an immense amount of time and resources to have a breakthrough with the customer and get the product quality right. The management is trying hard to reduce rejection rates in the Euro-VI casting business from the current 5-10% to the industry average of 3-5%. If they succeed there will be enough room for supernormal earnings growth. The most important aspect is, the dependence on Tractors has significantly reduced over the years. Tractors contributed to more than 60% of the castings volumes prior to FY14 which now stands at only one-third of the business. The company has successfully diversified into other heavy automobile categories. It has also commercialized its Euro-VI castings catering to the requirements of Daimler and Hino.

Kirloskar Ferrous has two business segments – Pig Iron manufacturing plant in Hospet with a capacity of 390,000 MTPA and Ferrous Casting plant in Hospet and Solapur with a combined capacity of 150,000 MTPA. The company has setup hot blast stove which helps to reduce the consumption of coke, a highly volatile input. The company’s casting plant at Hospet houses two-third of the total casting capacity, and enjoys the benefit of backward integration in the form of ready availability of molten pig iron and captive power generation capacity of 11.5 MW.

Casting business has exhibited lackluster growth in the past for two reasons. Firstly, the castings unit was initially setup to cater to tractors. The volumes and capacity utilization was hence linked to the tractor cycle. Secondly, over the last 5 years, the company has been investing lots of time and resources in developing a large Euro-VI casting for MHCV engines catering to the export market. This is an extremely challenging business to crack, given the stringent quality requirements of these components, which finally find their application in engines. The rejection rates are quite high in this segment. While the global average rejection rates in Euro-VI castings are 3-5%, the rejection rates are as high as 15-20% in the initial period of commercialization. This stretches the product development/learning cycle making the entire process both time and capital intensive. Having invested considerable amount of resources in developing these specialized castings, today Kirloskar Ferrous is the only company in India to make Euro-VI castings.

Kirloskar Ferrous’ gross margins are directly proportional to the castings volume. The realizations from castings have been steadily inching upwards in the recent quarters coupled with improving volumes. The company has added three new clients in FY18. The management is also in advance talks with a few other clients, and if it materializes the Kirloskar Ferrous’ castings capacity utilization will go up to 80% plus. Another lever for earnings growth is the scope to reduce the rejection rates.

To catch up the new technology Kirloskar Ferrous is now exploring to set up a coke oven battery to convert the coking coal into coke. The company is also exploring to bid for iron ore mines to keep itself immune to price volatility. With only working capital debt of Rs840 million and a debt-equity ratio of less than 0.2x, the company has ample scope to improve its profitability. At present with 80% utilization of pig iron business and 75% utilization of casting business, the company is expected to record a topline of around Rs 19 billion and EBITDA of Rs Rs.3.9 billion. As the current enterprise value is around Rs14.5 billion, the stock is available at an EV/EBITDA of 4x as against industry peers of 9-13x. The company has consistently had a dividend payout of more than 30% over the past 5 years. Our suggestion to you is – be invested. However when it goes up you can reduce your holding after booking some profit because this is a long term story.

About the author: IE&M Team

Indian Economy & Market is an Indian media and information platform producing data-backed news and analysis on all the vital elements at the intersection of the economy, stock markets, mutual fund, insurance, commodities, currency, technology, startups and business.

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