Ratnamani Metals & Tubes Ltd: The Bright Spot Amongst The Greys!

Ratnamani Metals & Tubes is a leading metal tube and pipe manufacturer that caters to over 19+ industries globally. It specializes in stainless steel, carbon steel, and exotic alloys tubes and pipes.

Ratnamani is,

Business Model:

Before you read any further, let me quickly explain the differences between a pipe and a tube.

Ratnamani’s Business Segments:

Stainless Steel (SS) & Exotic Alloys:

Products in the Stainless Steel (SS) segment:

Carbon Steel (CS):

Products in the Carbon Steel (CS) segment:

Business Strategy:

Ratnamani’s business is heavily reliant on the capital expenditure plans of its customers. Since significant capital expenditure in these sectors occurs (on an average) every 2-4 years (timelines may change due to the macroenvironment), Ratnamani’s revenues tend to be lumpy and are entirely dependent on them winning the underlying contracts.

What is important to note here is the quantum of expenditure that these end user industries set aside specifically for pipes and tubes:

Ratnamani has a three-pronged strategy for growing its business:

Customer Base:

Competitive Advantages & Economic Moats enjoyed by Ratnamani:

Moderate Customer Switching Costs

A Pipes and Tubes Supplier needs to be ‘approved’ by the customer or sometimes by the EPC which undertakes the construction (capex) work. These approval processes involve the customer (or EPC) visiting and auditing the facilities and products, and generally takes over 5 years.

Due to the intense scrutiny applied by the customer, they tend to not switch suppliers based on cost, provided quality remains high.

In tubes, the criticality associated with failure is exceedingly high (nuclear, API, defense, aerospace), and hence, customers tend to stick to their high-quality trusted supplier.

Hence, the players in the industry that cater to the larger reputed customers enjoy moderate customer stickiness.

Vertical Integration

In 2016, Ratnamani embarked on a new journey by deciding to set up a hot extrusion facility that would produce mother hollow pipes (backward integration) and would allow for extrusion from up to 10” inch mother hollow pipes.  This exercise will enable backward integration into mother hollow pipes as well as forward integration into value-added pipes and tubes of Stainless Steel, Nickel Alloys, and Inconel etc. It also undertakes inner and outer coating of pipes and tubes thereby reducing commissioning time for the end-customer (forward integration).

This integration puts the company on par with global leaders like Sandvik, Sumitomo, and Salzgitter.

Product-Market Fit

Ratnamani’s product portfolio, especially in the high-margin SS segment is entirely ‘made-to-order’ as per the needs of the customer. This approach of catering to the precise needs of the customer results in higher customer satisfaction and better Product-Market fit.

The company has a domestic market share of over 40% in stainless steel tubes for niche applications.

The CS segment generally tends to have more standardized requirements.

It also undertakes setting up of ‘Mobile Plants’ near the end user’s location which can be set up and dismantled quickly. This helps reduce transportation costs and commissioning time. Generally, these mobile plants are set up for water distribution projects, pipes for potable water, and drainage infrastructure.

Location Advantage

The company’s manufacturing facilities at Kutch, Indrad, and Chhatral, in the state of Gujarat allow for easy connectivity with the ports of Kandla and Mundra, thereby helping lower transportation costs. The company enjoys lower transportation costs than its peers (lower by about 1.5% – 2.5%).

Risks Faced by Ratnamani:

Performance Linked to Capex Initiatives

Ratnamani’s performance is strongly linked to the capex requirements and initiatives of its end customers. Generally, over 80% of demand is reliant on new projects. Hence, it is imperative for the company to have a strong sales network to ensure that it builds long-term relationships with customers thereby boosting opportunities for new contracts. This focus on developing a strong sales team is evident from their efforts to continuously add representatives in new geographies as well as partner with local leading suppliers.

The company has had a few years of flatlined growth due to the lack of / deferral of projects by Oil & Gas companies which are their largest customers.

Raw Material Risk

HR Coil (key raw material) supply in India was largely monopolized in the hands of Jindal Stainless due to high anti-dumping duty placed on imports for the same. However, the government has relaxed the duty considerably to enhance the competitiveness of HR Coil prices. This move is favorable for Ratnamani as it will help lower the supplier’s power and increase Ratnamani and its peers bargaining power.

Ratnamani does not face excessive margin pressure due to raw material risk as the business is based on a ‘conversion’ basis (fixed profit) as well as the company’s approach of booking raw material on a back-to-back basis when an order is received. However, the past two quarters have seen an exceptional surge in steel prices (jumping to INR 55,000 per ton from INR 38,000 per ton), molybdenum, and nickel prices. This large increase in input prices has forced customers (and EPCs) to delay parts of their orders.

Working Capital Risk

The Metal Pipes and Tubes industry is characterized by high working capital requirements. This comes about largely due to the chunky nature of contracts which are executed over a period of a few quarters resulting in high inventory buildup (buildup for 4-5 months) and high working capital days (between 150-200 days on an average).

These large working capital requirements also pose as an entry barrier to new entrants.

Substitution Risk

The application of metal tubes and pipes is in environments which are subject to extreme temperatures and pressures thereby rendering other substitutes such as plastic pipes entirely useless. Substitution Risk is near negligible in the core end-user industries.

Product Mix Risk

The growth in the high margin SS segment has been lower than the growth in low margin CS segment since 2012. Since 2014, CS revenues have been higher than that of SS revenues, leading to margin compression.

Margin Profile: SS Margin (SS Segment) > ERW Margin (CS Segment) > Helical SAW Margin (CS Segment)

Competitive Risk

Ratnamani does face competition from domestic as well as global (mainly Chinese, Japanese, and European) competitors.

Its key domestic competitors are:

Ratnamani has been relatively insulated from local competitors in the SS segment due to their strong relationships with customers. The CS segment is largely commoditized with low product differentiation which leads to margin compression in lean years due to oversupply.

Under the ‘Make in India’ directive, the government has aimed to boost domestic manufacturing through initiatives such as the ‘Purchase Preference Local Content’ (PPLC) policy for the Oil & Gas sector. The PPLC policy allows Class 1 local suppliers to win public sector contracts even if they quote rates 20% higher than the lowest bid.

Class 1 local supplier is one whose goods contain a minimum of 50% raw material that is sourced locally. Ratnamani would fall under this category in the eyes of an EPC due to it sourcing over 70% of its raw materials domestically, also, Ratnamani tends to be the L1 bidder for most of the projects (L1 means the Lowest Bidder).

Ratnamani is also looking towards the government to impose anti-dumping duty on cheap poor quality Chinese imports that are used in lower value projects.

Opportunities:

As we have seen, the opportunities for the company are contingent on their end-user customers following through on their capital expenditure plans. Thus, the scope of these opportunities keeps changing annually.

Includes Domestic Order of INR 594 Crs in CS segment received on 12th April 2021.

Financials:

Financially, the company’s minimal debt burden (BV D/E of 10%, MV D/E of 2.2%) and healthy cash balance is likely to provide operational flexibility and help maintain a strong liquidity position. The company has stood out in terms of its performance despite a poor macro environment over the past few years.

The company generates a very small portion of its revenues (~1% of revenue) through energy generation via Wind Mills.

Valuation:

It seems to me that the capex cycle for most of their customers has already begun and I expect to see healthy revenue growth over the next 2-3 years. However, post that period, I believe that the capex cycle (significant capex) will undergo a slowdown for the next 1-2 years before reviving again. I expect Ratnamani’s revenues to be mildly cyclical due to exposure to the Oil & Gas industry and allied sectors, partly offset by increasing revenues due to market share gains (as a result of import substitution).

I expect operating margins to improve gradually over the course of the next few years due to high margin SS segment making a comeback. Terminal year margins will be 14%.

Sales to Capital ratio will start to improve as new capacity utilization increases, eventually reaching 1.6

Terminal Year Cost of Capital stands at 8.52% with ROIC at 10.52%

Based on my narrative and understanding, Ratnamani’s intrinsic value stands at INR 1044.73 per share (base case) and INR 1279.58 per share (bull case).

Conclusion:

At the current price of INR 1922 per share, I do not find Ratnamani Metals & Tubes particularly attractive from a valuation perspective, yet, I do like the company fundamentally.

At the end of the day, the sole intent of investing is to generate wealth, and Ratnamani has done just that!

Ratnamani Metals & Tubes and APL Apollo have been the outperformers in this sector!

To me, Ratnamani Metals & Tubes is the bright spot amongst the greys!

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