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Evolved and ready to Re-rate

We initiate on IFGL Refractories Ltd. (IFGL), a highly undervalued business in the booming refractory sector, with a TP of Rs585 (~109% upside) and BUY. After drastic improvement in the existing business through addition of products and customers, business from new Vizag plant (new products), recovery in subsidiary business and robust steel demand is expected to double its EBITDA by FY23/FY24. Internal cost optimization, higher utilisation of existing plants, benefit of favourable location at Vizag plant should sustainably elevate margins. Along with best-in-industry cash flow generation, FCF yield and payouts, improvement in return ratios due to one-time writeoff of amortisation and superior earnings can drive strong re-rating for IFGL.

* Business transformation to drive revenue growth: IFGL is expected to deliver strong earnings growth with Consolidated EBITDA to double to Rs1.9-2bn (in FY23E/FY24E) vs Rs0.9-1bn range for last 3-4 years. This is led by addition of customer especially mini mills (10-11% of the revenue now as compared to no presence before), recruitment of industry veterans from peers at key positions, market share gains in domestic refractory business and favourable demand scenario from both domestic and global steel industry. We expect improved performance by IFGL’s overseas subsidiaries on recovery in demand in EU and USA along with higher acceptability of products sold by Hoffman. Additionally, location benefits of new plant in south and product additions (precast at Vizag) should help IFGL achieve revenue growth of at least 12% CAGR over FY21-FY24E.

* Structural initiatives to lift margins: Optimum utilisation at Kalunga and Kandla along with internal cost optimization measures were some of the reasons for high margins in FY21, factors that should continue to hold.. The newly commissioned Vizag capacity has cost benefits due to technical modernisation and savings on freight as IFGL had no presence in south India before. Although, sea freight inflation and shortage of raw materials from China has eroded their margins. However in medium term, we expect margins to rebound on pass on of this input cost inflation. Therefore, we expect margins to improve to a sustainable level of at least 14% vs. 5- year historical avg. of 12%.

* Writeoff of amortisation to magnify return ratios; ready to re-rate: IFGL has traditionally traded at large discount to MNC refractory peers (Orient Refractories and Vesuvius) mainly due to low return ratios which in turn were impacted due to large goodwill on the books. We see the discount narrowing led by one-time writeoff of pending goodwill amortisation and earnings growth aiding return ratios. IFGL has maintained Net cash for the last 3 years, thereby financing expansions through internal accruals as also ensuring higher returns to shareholders (FY21 dividend yield 5.8%). IFGL’s cash flow generation is also very efficient due to tight working capital cycle leading to OCF/Cash PAT > 1 for last 5years. Despite such compelling financials, IFGL currently trades at 4.1x FY23E EV/EBITDA vs 14-17x for peers. We believe that the stock certainly qualifies for a re-rating.

* Valuation & Risks: We value the overseas subsidiary business at 4.2x Sept’23E EV/EBITDA, which is 40% discount to its global peers and domestic business at 10.2x Sept’23E EV/EBITDA which is 40% discount to leading domestic peer to arrive at the fair value of Rs585/share. At CMP of Rs292, stock trades at 3.9x FY23E EV/EBITDA. Key risks: RM cost risk impacted by sea freight inflation, change in management.

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