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Company Background

IFGL Refractories Ltd (IFGL), promoted in 1989 by Mr S.K. Bajoria of Kolkata produces specialized refractories and operating systems for steel industry, in technical collaboration with Krosaki Harima Corporation, Japan, subsidiary of Nippon Steel. It has its manufacturing facilities at Kalunga, Odisha and Kandla SEZ, Gujarat. IFGL has expanded its product basket, markets, customer base and manufacturing footprints globally through several strategic acquisitions over the last decade. It’s 100% subsidiaries viz. EI Ceramics, USA, Hofmann Ceramics, Germany and Monocon, UK (which has a subsidiary in China) help IFGL serve respective local markets or exports. In August 2017, IFGL completed reverse merger with its subsidiary IFGL Exports Ltd (IEL).

Investment Rationale

Top line improvement with better product mix

* During Q2FY22, consolidated net sales of IFGL witnessed a growth of ~25.9% to ~Rs 3.1 bn on the back of favourable demand traction from its key end user industry of steel, better product mix and improved realisation. Realisation witnessed improvement driven by price negotiations with clients in order to pass on input cost escalations. Of late, raw material (RM) prices are on increasing trend. Thus, further increase in realisation will be in alignment with any upward movement in input cost. A ~30% y-o-y top line growth to ~Rs 5.8 bn was achieved in H1FY22.

* During the Quarter, performance of IFGL’s 100% overseas subsidiaries witnessed significant improvement led by gradual economic recovery in the respective countries. EI Ceramics, USA delivered a revenue growth of 13% to ~USD 4.4 mn, Monocon, UK reported growth of ~5% to GBP 7.1 mn while Hofmann Ceramics, Germany reported a growth of ~55% to EURO 1.98 mn. They remained profitable at PAT levels as well. With visibility of sustainable demand, better capacity utilisation and established clientele, management expects them to deliver better results, going forward. On a standalone basis, IFGL’s revenue was Rs 3,098 mn in Q2FY22 vis-à-vis Rs 2,462 mn in Q2FY21 driven by higher domestic demand.

* The Company is witnessing sustainable demand for refractories and expects the same momentum to continue. Going forward, we expect IFGL’s top line to grow at a CAGR of ~12.6% over FY21-24E respectively driven by buoyancy in steel demand which is expected to grow by ~3.4% to 1,896 mn tn globally and ~11.7% to 111.4 mn tn over FY20-22E in India supported by GoI’s thrust on infrastructure development.

Better product mix and improved realisation to help maintain margins

* EBITDA Margin during Q2FY22 witnessed a moderation of ~398 bps y-o-y to 11.9% driven by RM availability issues and incessant increase in RM costs which, as a percentage of sales, grew by ~406 bps y-o-y to ~48.5%. Further, continued shortage of containers at port with delays in delivery of both finished goods and RM shipments and increasing cost of ocean freight rates resulted in decline in margins. Going forward, despite cost headwinds, we expect EBITDA Margin to remain in the range of ~12-13% driven by a) better product mix, b) higher volumes with ramping up of new capacities, c) better realisation and d) cost optimization efforts being undertaken by the Company. EBITDA margin also dropped by ~200 bps y-o-y to 11.9% in H1FY22.

* As per amendments by Finance Act 2021, Goodwill on amalgamation is no longer a depreciable asset and depreciation on goodwill is not allowable expenditure effective April 1, 2020. Thus, unamortised value of goodwill of ~Rs 1,335 mn arising out of merger of IFGL with IFGL Exports in 2017 can no longer be amortised and is proposed to be written off against securities premium subject to approval from NCLT. The Management expects to receive NCLT approval in next 6-9 months and till then they will continue to amortise goodwill. However, we have completely written off the un-amortised value of goodwill against securities premium in FY23E for fair representation of assets and liabilities of the Company.

* During Q2FY22, PAT stood at ~200 mn, witnessing de-growth of mere ~3.1% y-o-y with PAT margins at ~6.46% v/s ~8.38% in Q2FY21. Interest cost increased by ~16.5% y-o-y to ~Rs 9.9 mn with increase in working capital requirement.

Enhanced capacity to drive volumes

* IFGL is undergoing a brownfield capex for production of Monolithic and Precast Shapes at Kandla unit in a phased manner of which Phase-I of 12,000 tons/pa capacity was completed in Q4FY20. Further, Phase-II entailing a similar capacity is expected to be commissioned by H2FY22 with a further cost of ~Rs 100 mn. This expansion will boost profitability as margins at Kandla are better than consolidated margins due to SEZ benefits and freight cost advantage on exports because of proximity with customers in Europe and Middle East, resulting in lower transit time.

* IFGL is also undergoing a greenfield capex at Visakhapatnam in a phased manner. It has acquired 10 acres of freehold land for the production of new products including monolithic and special precast shapes. Phase-I was completed in Q2FY22 involving a capacity of ~48,000 tons p.a. at a cost of ~Rs 300 mn. The Company plans to ramp up the capacity by 25%/50%/75% over FY23-25E, sequentially. Further, capex of ~Rs 200 mn is envisaged for Phase-II expansion which is slated to be completed by FY23E. Also, Capex of ~Rs 100 mn is envisaged towards maintenance and de-bottlenecking activities at the Odisha Plant by H1FY23.

* IFGL has a strong balance sheet with gross debt of Rs 0.7 bn and cash & cash equivalents of ~Rs 2.73 bn resulting in a net cash of ~Rs 2.03 bn at the end of H1FY22 coupled with strong free cash flow visibility. Thus, overall liquidity position is expected to remain strong driven by healthy net worth and low reliance on external debt.

Valuation

We have valued the stock on the basis of EV/EBITDA of 7x of FY24E EBITDA method of relative valuation on the back of buoyancy in steel demand leading to better demand visibility for refractories. We recommend a “BUY” on the stock with a target price of Rs 475 (~73% upside) in 18 months.

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