IFGL Refractories Ltd.

Transcription

1 January 5, 2018 IFGL Refractories Ltd. Solid, stable, ready for a steely growth CMP INR 309 Target INR 403 Initiating Coverage - BUY Key Share Data Face Value (INR) 10.0 Equity Capital (INR Mn) Market Cap (INR Mn) 11, Week High/Low (INR) 354/294 1 month Avg. Daily Volume (BSE) 9,905 BSE Code NSE Code Reuters Code Bloomberg Code Shareholding Pattern (Post Amalgamation) 5% 23% 72% Key Financials (INR Million) IFGLEXPOR IFGLRF:NS Promoter FII/MF IFGLRF:IN Puiblic & Other Source: Company Particulars FY17 FY18E FY19E FY20E Net Sales 7, , , ,822.9 Growth (%) 6.8% 6.2% 9.6% 10.2% EBITDA , , ,385.0 PAT Growth (%) 5.3% 1.3% 26.1% 24.5% EPS (INR) BVPS (INR) Key Financials Ratios Particulars FY17 FY18E FY19E FY20E P/E (x) P/BVPS (x) Mcap/Sales (x) EV/EBITDA (x) ROCE (%) 6.7% 6.6% 7.7% 9.0% ROE (%) 8.2% 6.4% 7.7% 8.8% EBITDA Mar (%) 12.3% 13.0% 13.6% 14.1% PAT Mar (%) 5.8% 5.5% 6.3% 7.2% Debt - Equity (x) Analysts: Nikhil Saboo Tel No: ; Mobile: nikhil.saboo@skpmoneywise.com Anik Das Tel No: ; Mobile: anik.das@skpmoneywise.com 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 of Japan, a subsidiary of Nippon Steel Corporation. IFGL has expanded its reach and product basket through several strategic acquisitions over the last decade and has manufacturing plants located in India, China, Europe and America. It has recently completed its reverse merger with its subsidiary IFGL Exports Ltd (IEL). Investment Rationale Favourable export demand Demand for refractories from European steel mills is expected to be better going forward due to gradual pick up in steel production (steel demand in European region including UK is expected to grow by 2.1% to mtpa in CY18) and improving macro situation (as is visible from the pick-up in GDP numbers). Since European region accounts for ~70% of IFGL s exports from domestic operations and ~48% of revenues on a consolidated basis (including overseas subsidiaries net sales), we expect IFGL to benefit from improving demand situation in Europe. Strategic Kandla location resulting in better margins IFGL s Kandla plant is strategically located in Gujarat s SEZ for better proximity with export customers in Europe and Middle East. It helps in reducing freight cost due to lower transit time, resulting in lower receivable cycle, alongwith benefits like income tax exemption, tax savings on domestically procured raw materials and no duty on imported raw materials. Collectively, its is a substantial saving as reflected in FY17 EBITDA margins at 26.6% for IEL vs 10.1% for IFGL standalone. Incremental capacity to drive volumes IFGL is in the midst of capacity expansion at Kandla unit from 1,60,000 pieces/year to 2,40,000 pieces/year at an investment of Rs 10 crores which is expected to get commissioned by FY19E. This expansion will be a game changer for IFGL as margins at Kandla is double of consolidated margins due to SEZ benefits and freight advantage on exports. We expect volumes & EBITDA at Kandla unit to more than double by FY20E. Exports from standalone operations (~35% share) should be substituted by Kandla gradually, improving margins at the standalone entity as it supplies more in the domestic market. Acquisitions led to expansion of product mix IFGL has increased its presence in overseas market through several acquisitions in the past few years, aimed at enriching product mix, access to new technologies, new markets and new customers. All subsidiaries are profitable and self-sufficient to fund their capex and maintenance requirement and have reported consistent performance. Every plant of the company's international subsidiary is dedicated for the local needs of steel industry except the Chinese plant. Merger of IFGL with IFGL exports (IEL) to rationalize costs With a view to rationalize cost and improve overall margins, IFGL has recently completed a reverse merger with IEL. Following the merger, IFGL s 51% shareholding in IEL gets cancelled and to that extent profitability of merged IEL improved. Also, merger has been accounted following purchase method, resulting in Rs 267 crores as goodwill, which is to be amortised over a period of 10 years. Strong free cash flow generation and low leverage IFGL s EBITDA margins deteriorated significantly from 14.5% in FY14 to 12.7% in FY17 due to 1) under utilization of capacities (slow down across steel industry) and 2) lower realisations. Margins are expected to improve gradually as revenues from Kandla unit picks up. Going forward, increase in volume, prices and cost control measures are likely to expand margins despite increase in costs. We expect IFGL s consolidated EBITDA margins to improve to 14%+ by FY20E. IFGL has a strong balance sheet with gross debt of Rs 0.8 bn and cash & cash equivalents of ~Rs 0.7 bn resulting in a net debt of ~Rs 0.1 bn at the end of FY17. D/E stands at an attractive level of 0.1x and is expected to improve further as no incremental capex is planned in near term. Valuation IFGL is well positioned to capitalize on the recovery in steel production in key markets of US/Europe/India (aided by regulatory support and demand revival) coupled with operationally sound high-quality global assets and a solid balance sheet with strong free cash flow visibility. We have valued the stock on the basis of P/E of 15x of FY20E EPS adjusted for goodwill write-off and recommend a BUY on the stock with a target price of Rs 403/ (~30% upside) in 18 months. SKP Securities Ltd Page 1 of 22

2 Industry Snapshot Refractories are produced from non-metallic minerals and are used in internal lining of industrial furnaces and posses capability to withstand heat and pressure. Refractories are mainly of two types shaped and unshaped (monolithics), used mainly by the steel industry as a consumable in the internal linings of furnaces, kilns, reactors and other vessels for holding and transporting metal and slag. It is also used in glass, cement, petrochemicals, non-ferrous metals, thermal power plants, ceramic industry, etc. Shaped refractories are characterized by fixed shapes with most common being rectangular brick. Brick shapes may be divided into two standard shapes and special shapes. Standard shapes have dimensions that are used by most refractory manufacturers and are applicable to kilns and furnaces of same type. Special shapes are customized for particular kilns and furnaces. Shaped refractories are always machine-pressed and possess high uniformity in properties. Unshaped refractories are without a definite form and are only given shape upon application. They form jointless lining and are better known as monolithic refractories. Raw materials used to manufacture refractories are broadly classified into clay and nonclay. Clay refractories consist of naturally occurring alumina silicate like fireclay, flint clay, flint brick and high alumina, used to produce bricks and insulating refractories. Non-clay refractories are made from non-clay materials and are classified into basic (made in the form of bricks from magnesia, dolomite, chrome etc), extra high alumina, mullite (made from kyanite, bauxite, alumina), silicon carbide and zircon. Exhibit: Share of refractories by form & raw materials Refractory share by form Refractory share by raw material Unshaped, 45% Shaped, 5 5% Non Clay, 35% Clay, 65% Applications of refractories - Largely used in steel industry for furnace lining: Applications of refractory materials are found in lining of plants that carry out thermal processes such as melting, firing, heat treatment, heat recovery systems, heat insulation and in transportation vessels. Steel industry accounts for ~60% of refractory consumption globally and ~75% in the domestic market. In non-metallurgical industries (cement, glass, nonferrous), refractories are mostly installed on fired heaters, hydrogen reformers, cracking furnaces, incinerators, utility boilers, air heaters, ducting, stacks, etc. Non-ferrous industries like copper and aluminium require high performance refractories in several equipments like anode baking furnaces, induction furnaces, reduction pots, slag cleaning surfaces etc. Glass industry also requires refractories in refiner, regenerator, dog-house and ports of furnace. SKP Securities Ltd Page 2 of 22

3 Exhibit: Sector wise refractories demand Sector wise refractories demand - Global Others, 10% Sector wise refractories demand - India Non- Ferrous, 6% Glass, 3% Non- Ferrous, 15 % Cement, 12% Non- Metallic, 15% Steel, 60% Steel, 75% Source: RHI, SKP Research Global refractory market estimated at ~USD 45 bn; expected to grow ~3% CAGR: Global refractories market valued at USD 45 bn in 2016 is expected to reach USD 53 billion by 2021, witnessing CAGR of 5%. In terms of tonnage, the global market was at 42.5 million metric tons per annum (mtpa) in 2016 and is expected to post a substantial growth over the next 2-3 years. China enjoys ~50% of global refractory market and is expected to maintain that. Growing forward, with rebound in global steel sector along with strengthening economic conditions, we expect volume of refractories consumed to rise in the U.S., Western Europe, and Japan. Exhibit: Global Refractories Market size $45.09 Bn $53.08 Bn Growing at CAGR of 3.32% >60% 42.5 Mn MT 15kg/tonne Iron & Steel to contribute in Product-Demand in Volume Terms Source: Industry, SKP Research Size of Refractories Market in 2016 Average consumption of Refractories per tonne in crude steel Domestic refractory industry - Strong growth within process flow: According to various industry studies, Indian refractories market is estimated at ~Rs 70 bn with production of 1.2 mtpa in FY17 on an installed base of 2 mtpa (~60% capacity utilization, accounting for a mere ~3% of global refractories market by volume). In India, the refractory industry is fragmented with more than 150 players, of which, 15 to 16 are major players while the remaining are small private players. Although the average consumption of refractories has fallen from 19 kg per tonne of steel about five years ago to kg on an average, the scope for growth is good in case of established refractory players with strong product portfolios in the steel flow control segment and catering to customised requirements of steel companies. SKP Securities Ltd Page 3 of 22

4 This will be led by the thin castings segment, which is at ~15% of the current refractory market, growing at ~50%, wherein players like VIL, ORL and IFGL have a strong competitive advantage. The slump in the global steel market and a surge in imported finished steel products have led to an oversupply of refractories and refractory minerals in India. Domestic producers also have to contend with competition from low cost raw materials, particularly from China. Exhibit: Indian refractory industry SWOT analysis Strengths Weaknesses Opportunities Threats - Increasing preference for quality & service (complete solution provider) - Global parentage of established players - Declining consumption per ton of refractory for steel companies - Low pricing power - Raw material dependence on China - Increasing production of primary producers with BOF set up - Import substitution of monolithic - Technological advancement among steel players - Steel under penetration in India - Tighter working capital during slowing steel cycle - Competition from Chinese players - Any possible disruption in Raw Material Imports from China Source: SKP Research Refractory industry - Raw materials sourcing: The industry is largely dependent on imports for key raw materials like high grade alumina, bauxite, magnesite, silicon carbide, etc. Raw material accounts for 50% of total production costs and roughly 70% of global magnesite deposits are located in China, North Korea and Russia. Magnesia products are mainly imported from China, because India does not have magnesite of high enough purity to make refractory bricks products, which only a handful of Indian companies make. Also, other raw materials are imported from China, as quality of domestically produced raw materials does not meet the standards required by the steel industry. Similarly, the availability of high quality refractory clays is limited, while kyanite, sillimanite and alusite remain unavailable from Indian suppliers. SKP Securities Ltd Page 4 of 22

5 Demand Drivers: Indian refractory sector is well placed to reap the benefits arising because of: (a) steady rebound of global steel demand (b) sizeable growth potential as per capita consumption of steel at 60 kg is a meagre one fourth of world s average (217 kg) and one tenth of China s average (447 kg); (c) the National Steel Policy devised to enhance India s steel capacity 2.5x to 300 mtpa by 2030; and (d) shift of steel production in favour of primary steel makers with increasing quality, services and customised refractory needs to ensure maximum safety, quality and productivity. Exhibit: Grow ing Opportunities in India a positive Automotive Capital Goods Infrastructure Airports Railw ays Oil-Gas Pow er Rural India The Automotive industry is forecasted to grow in size by USD 74 billion in 2015 to USD billion by 2026 The capital goods sector accounts for 11% of steel consumption w hich is expected to increase to 14/15% by and has the potential to increase in tonnage & market share The infrastructure sector accounts for 9% of steel consumption w hich is expected to increase to 11% by Estimated steel consumption in airport building is likely to grow more than 20% over next few years Crisil estimated that the railw ays sector could create business opportunities w orth USD billion Oil and gas amongst major end-user segment accounted for ~34.4% of primary energy consumption in FY16 The government targets capacity addition of 100 GW under the 13th FiveYear Plan ( ) Rural India is expected to reach per capita consumption of kg to 14 kg for finished steel by 2020 Exhibit: World Steel Utilization levels improving 76% 74% 72% 70% 68% 66% 64% 72% 72% 69% 69% 71% Source: WSA, SKP Research Capacity Utilization (%) 70% 70% 68% 70% May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 71% 73% 74% 72% 74% 1 73% 73% 74% 73% Exhibit: Favorable Government Policies aiding Indian Steel Exhibit: New Steel Policy 2017 Reduction in Customs Duty on Plant & Equipment Targets to achieve 300MT of Steel Making by % FDI through automatic route in Indian Steel Increase per capita Steel Consumption to 160Kgs from current level of 60Kg by 2030 Increased focus and budgetary allocation towards R&D & Innovation Entire Demand of High grade automotive steel, electrical steel, special steels and alloys to be met DOMESTICALLY Make in India and preference to Locally produced Steel in Projects To facilitate R&D in the sector via setting up Steel Research and Technology Mission of India (SRTMI)Projects Imposition of CVD for 5 years on import of certain Stainless steel products will boost domestic production. Adoption of energy efficient technologies in the MSME steel sector to improve productivity SKP Securities Ltd Page 5 of 22

6 The strongest driving factor will be growing per capita consumption of steel, which is currently abysmally low compared to the global benchmark. Consequently, the refractory industry is bound to be a big beneficiary of the expected huge uptick in the steel industry. Within sub-segments, the 10 mtpa thin cast market, which constitutes ~15% of the industry, is expected to grow at the fastest clip of ~50%, riding capacity expansion plans of players and dynamics of the steel industry favoring this segment. India has lagged other major steel producing countries in terms of intensity of steel use in overall economic activities or per capita consumption of steel despite clocking a robust production growth. Exhibit: India hugely under penetrated in steel despite rising consumption (Kg) (In tonne) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 CAGR (%) (FY08-16) China % S. Korea % Japan % USA % Russia % Germany % India % World (average) % Source: WSA, SKP Research Global steel demand to remain positive in CY17 The World Steel Association expects demand for steel to grow by 1.6% y-o-y in CY18 while steel demand in China is expected to remain flat. Overall, steel demand will get boost from higher demand in USA, India, Middel East and Africa. We believe that increased demand from these countries will lead to higher steel production which will drive demand for refectories, benefiting existing players like IFGL. Exhibit: Global Steel Production Grow th Figures in Mn MT 5.2% 3.8% 13.5% 0.4% 4.1% 7.4% 14.4% 13.3% % European Union Other Europe CIS North America South America Africa Middle East Asia Ex India India Jan-Oct 2016 Jan-Oct 2017 Domestic refractory demand to come back: Over the last few years, domestic refractory industry has been witnessing muted consumption growth (due to a fall in per tonne consumption for steel making on account of technological advances) and faces strong import pressure with one fourth of the market being serviced by net imports (mainly from cheap supplies from China which accounts for two thirds of refractory imports in India). Demand for refractories in China is anticipated to SKP Securities Ltd Page 6 of 22

7 drop to 21.4 mtpa (including export) by 2020, of which refractory for steel will hit about 10.5 mtpa as Chinese steel manufacturers have closed down ~150 mtpa of steel plants capacity through consolidation. We expect industry growth to pick up due to scope for higher steel production (backed by higher infra spend and expansion in per capita steel consumption) and lessen dumping from the Chinese players. Recently, India and U.S have imposed antidumping duties on the imports from China. Consolidation to intensify in the refractory industry; paves way for price recovery and margin improvements: The refractory industry is capital intensive in nature and is characterized by closely guarded technology. The competitive environment and global excess capacities in refractory production paves the way for a consolidation within the refractories industry in the medium to long term. Especially in China, the world s largest refractories market, the industry is highly fragmented with more than 2,000 manufacturers. In accordance with the directive of the Chinese government, local producers are sounding out their options for mergers. This directive provides for a consolidation to roughly five companies of international size in the coming years and will also put pressure on refractory producers outside of China to consolidate. With expectations of increased demand of refractory in future and no new capacity addition in pipeline, the gains of incremental volumes are expected to accrue to existing players. Exhibit: Refractory Companies Deal History Year Acquirer Target Stake(%) Deal Size (Rs Mn) EV/EBITDA (x) 2004 Sarvesh Refractroies Raasi Refractories 55% x 2005 Calderys, France ACE Refractories (from ICICI VF) 99% x 2005 IFGL Refractories Ltd Monocon International Refractories Ltd, UK 100% x 2008 IFGL Refractories Ltd Hofmann Ceramic GmbH,Germany 96% x 2010 IFGL Refractories Ltd EI Ceramics 100% RHI AG Austria Orient Refractories Ltd 70% x 2016 RHI AG Austria Magnesita Refratários S.A 45% x Source: Industry, SKP Research Replacement trend in steel industry driving demand Refractory application and consumption favour replacement dynamics for 70% of the business, leading to non-cyclical growth. Steel making requires maximum amount of refractories (10-15 kg/tonne) with replacement requirement ranging from 20 minutes to 2 months. Steel industry demands complete refractory management and services driven solutions from refractory makers. While cement industry is the next big user with annual replacement requirement, non-ferrous and glass industries have longer replacement cycles. Exhibit: Refractory consumption dynam ics across user industries Key Industry Application Replacem ent Per tonne consumption Refractory requirements Steel BF(BOF, EAF,Casting Ladles, Induction Furnaces, Pellet rotary Kilns 20 minutes to 2 months Global avg Kgs. India avg - 15 Kgs Consumable product ( Systems and solutions for complete refractory management) Cement Kilns Annually 1 Kgs Glass Glass Furnace Upto 10 years 4 Kgs Non(Ferrous) Converters 1-10 years Aluminium - 6 Kgs, Copper - 3 Kgs Investment Goods (Longer replacement cycles, Customized solutions based on the specific requirements of various industrial production processes, complete lining concepts) Source: RHI PPT, SKP Research SKP Securities Ltd Page 7 of 22

8 Exhibit: Key Milestones 1970 Indo Flogates founded (Jointly promoted by Flogates Limited of UK ) Started manufacturing facilities with slide gate refractories and systems for teeming of steel IFGL Refractories Founded Collaboration with Harima Corp., Japan 1999 Company Profile IFGL Refractories Ltd (IFGL), incorporated in 1989, is the flagship company of S.K. Bajoria group, engaged in manufacturing of specialized refractories and operating systems for the steel industry, having technical collaboration with Krosaki Harima Corporation of Japan (KHC), a subsidiary of Nippon Steel Corporation. IFGL offers total solutions for refractory for flow control in steel teeming and continuous casting of steel. With focus on export markets, IFGL had set up a subsidiary named IFGL exports Ltd (IEL) in 2012 at Kandla, Gujarat which is engaged in manufacturing of iso-statically pressed continuous casting refractories with focus on exp. IFGL hold 51% stake in IEL followed by 20% stake held by KHC. With a view to rationalize cost and improve overall margins, IFGL has recently completed a reverse merger with IEL. Following the merger, IFGL s 51% shareholding in IEL gets cancelled and to that extent profitability of merged IEL improved. Also, merger has been accounted following purchase method, resulting in Rs 267 crores as goodwill, which is to be amortised over a period of 10 years. Purchase of stake from Vesuvius. Indo Flogates merged with IFGL Refractories Acquired Monocon group at a cost of 9.5mn pounds with its plants located in Brazil, Taiwan, China, UK and USA Acquired Goricon group in at a cost of 1.1mn pounds and later merged it with Monocon Hoffman ceramics was acquired at a cost of 7mn euros for getting entry into foundries for supply of consumables Acquired EI Ceramics which has similar product basket as IFGL s domestic operations but provided access to key markets in Americas. Subsidiary IFGL Exports started operations in FY13 (May 2012) with a capacity of 80k pcs/year and achieved sales volumes of ~64k pcs in FY14. Announced reversed merger of IFGL Export with IFGL announced (expected to complete by FY17-end) in 1:1 share swap ratio. IFGL has completed a reversed merger with IEL. Following the merger, IFGL s 51% shareholding in IEL gets cancelled and to that extent profitability of merged IEL improve. Source: Company,SKP Research Exhibit: Corporate Structure IFGL Refractories Limited (formerly IFGL Exports Limited) Cr Equity Shares with a Face Value of Rs. 10 each 100% IFGL Worldwide Holdings Limited Plants at Kalunga, Orissa, India + Plant at Kandla SEZ, Kandla, Gujarat, India (earlier held 51% equity; now 100% owned) 100% 100% 100% Monocon Group Hofmann Ceramic EI Ceramics UK / USA / China Germany USA Source: Company,SKP Research SKP Securities Ltd Page 8 of 22

9 Exhibit : IFGL - Business Mix Parameter Revenue contribution (FY17) Revenue contribution (FY19E) Geographic presence Market position Refractory 100% 100% Domestic and export markets Export markets: US, Europe, China, Czech Republic, Germany. ~77% of the total revenue is largely driven by sales from overseas customer. ~33% of the total RM is imported. ~7% of the total revenue is driven by import trading (reporting losses). End market and top clients Key competitors Demand drivers Margin drivers Plant Location: ~65% of the total domestic manufactured good is driven by integrated steel players (ISP). Mainly used in steel, cement, glass manufacturing and other non-ferrous industries like copper, aluminium, etc. Orient Refractories, Vesuvius India,OCL Refractory. Growth in steel and cement industries to boost refractory demand. Dependent on raw material imported from China. Increasing contribution from silica bricks and concast to boost margins. IFGL has low traded goods portion in sales and hence has highest gross margins in the industry. The company has 8 manufacturing plants strategically located across the globe - India, China, Europe and America. IFGL's plants cater to domestic demand especially in East India, where major steel plants are located. Most of the key customers lie within distance of KM from the IFGL s manufacturing site, which gives the company logistical advantage. On the other hand, its Kandla facility is closer to the port in an SEZ, which would cater to the export market. Exhibit: IFGL plants in India Capacity and freight differential for exports IFGL- Kalunga (Plant), Orissa In Pcs IFGL- Kandla (Plant), Gujarat In Pcs Continuous casting ref.(pcs/yr) Continuous casting ref.(pcs/yr) Slide gate ref. (pcs/yr) Slide gate ref. (pcs/yr) NA Purge plugs, cast products (pcs/yr) Purge plugs, cast products (pcs/yr) NA Unshaped (tpa) Unshaped (tpa) NA Distance from port 400Kms Distance from port 50Kms Plant set-up date 1990 Plant set-up date 2012 Region-wise Revenue Mix: IFGL operates in four geographical segments India, Europe, Asia ex-india and America. It enjoys a strong presence in export markets such as Brazil, China, Czech Republic, Germany, UK and USA. IFGL's standalone operations accounts for ~40% of its consolidated revenue, while sales from overseas customers account for ~50% of the standalone operations through its plant at Kalunga, Orissa and Europe accounts for ~65% of sales from overseas customers. Overall, overseas market accounted for ~77% of the IFGL's consolidated revenue. SKP Securities Ltd Page 9 of 22

10 Exhibit: Revenue Mix (%)- Consolidated 100% 80% 60% 40% 20% 0% 24% 25% 23% 23% 24% 24% 10% 8% 7% 8% 12% 12% 38% 39% 51% 48% 41% 41% 24% 25% 19% 21% 23% 23% FY12 FY13 FY14 FY15 FY16 FY17 Source: Com pany, SKP Research Strong Clientele: India Europe Asia Ex India America The Company has got its plants spread across the Europe, USA, China, Latin America and India. Apart from domestic steel majors like Jindal Steel, Adhunik, JSW Steel, Bushan Steel, SAIL and Tata Steel, it supplies its products to the renowned steel maker Arcelor Mittal and steel companies in Australia, New-Zealand and Middle East etc. SKP Securities Ltd Page 10 of 22

11 Investment Rationale Strategically located Kandla unit providing flexibility of supplying in export markets; Capacity expansion to drive volume growth IFGL s Kandla plant (an SEZ) is strategically located in Gujarat which in close proximity to export customers (European region & Middle East) which helps in reducing freight cost (lower transit time) resulting in lower receibalbe cycle along with other benefits like income tax exemption, tax savings on domestic procured raw materials and no duty on imported raw materials. The Kandla plant started operations in FY13, specializing in continuous casting product line with focus on exports to European markets, having production capacity of 80,000 pieces/year (achieved sales volumes of ~76,000 pcs in FY17). The steel demand in European Union is expected to grow by 1.4% to mtpa in CY18, reflecting good demand for specialized refractory products which augurs well for IFGL. IFGL is in the midst of increasing the capacity of continuous casting refractories by 1,60,000 pieces/year (in phase-1 and phase-2) at its Kandla plant with an investment of ~Rs 160 mn, funded through internal accruals, to cater to export market. With this capacity augmentation plan, the capacity of the Kandla plant will go up from 80,000 pieces/year to 2,40,000 pieces/year by the end of FY19E. Phase-1 capacity of 80,000 pieces/year is already commissioned in FY17 while phase-2 expansion is expected to get commissioned by FY19E. Post expansion we expect the company to achieve utilization levels of 80%-85% levels with sales volume to reach 2,16,000 pieces by FY19E. We note that, IFGL s Kandla unit has shown sharp jump in its operating profitability in FY17 (EBITDA margin of ~26% vis-a-vis consolidated margin of ~12.7%) within fifth year of company s operations which demonstrates superior management quality and expertise in the refractory business. Exhibit: Capacity expansion planned at Kandla Exhibit: Sales volumes at Kandla to double in 3 years Capacity In Pcs Sales Volumes (pcs) FY16 FY17 FY18E FY19E FY17 FY18E FY19E FY20E Orissa plant located nearer to customer site; plant to cater domestic demand IFGL has its main manufacturing unit situated at Exhibit: Domestic operations - Locational advantage Kalunga, Orissa which is the Plant Distance (In KM) industrial belt of easten India. SAIL Rourkela Steel Plant <10 KM These plants cater to the SAIL Bhilai Steel Plant 400 KM domestic demand especially SAIL Bokaro Steel Plant 250 KM in East India, where major SAIL Durgapur Steel Plant 350 KM steel plants are located. Most of the key customers lie Jindal Steel and Power 150 KM within distance of less than 400 KM from the IFGL s manufacturing site, which gives the company logistical advantage. SKP Securities Ltd Page 11 of 22

12 IFGL s flagship plant at Orissa (standalone operations) is expected to capture increasing domestic demand and gradually reducing the share of sales from overseas customers in total sales as sales from overseas customer will continue to get shifted to Kandla unit in coming years. The freed up capacity at Odisha plant will allow for capitalizing domestic steel sector growth as the integrated steel capacity coming on stream to drive volume for shaped refectories segment. IFGL is currently running at near full utilization levels for continuous casting refractories at its Orissa plant and has an opportunity to increase its utilization in other shaped products like slide gate refractories, purge plugs and cast products. Also, utilization in unshaped refractories is expected to improve. Lower share of sales from overseas customers would result in savings on freight coupled with higher utilization lead to lower fixed costs. Domestic steel production is shifting to large steel mills, thereby improving demand outlook for organised refractory producers. We see good demand visibility in the domestic market as steel production is expected to pick up, led mainly by higher volumes from large steel mills. IFGL derives ~65% of its domestic revenue from large steel mills and is expected to be a key beneficiary of the gradual shift in domestic steel production to large steel mills. IFGL has shown revenue CAGR of ~8% at its standalone operations during FY13-17 led by better pricing, weak rupee benefitting sales from overseas customers revenue and improvement in capacity utilization, but we expect revenue CAGR of ~5.2% during FY17-20E on account of limited room for higher volumes (particularly in continuous casting refractories segment which is almost completely utilized), reduced share of sales from overseas customers going forward and low pricing power due to increased competition. Exhibit: Exports share in total standalone sales to reduce Exhibit: Capacity utilization at Orissa to improve 120% Capacity Utilisation (%) 100% 80% 60% 52% 51% 57% 105% 70% 72% 68% 68% 70% 73% 75% 78% 80% 85% 35% 0% FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E 50% 46% 42% 40% 38% 35% 40% 20% 48% 49% 43% 50% 54% 58% 60% 62% 65% 0% FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Domestic Source: Com pany, SKP Research Exports Acquisitions led to expansion of product mix IFGL has increased its presence in overseas market through several acquisitions in the past few years, aimed at enriching product mix, access to new technologies, new markets and new customers. All subsidiaries are profitable and self-sufficient to fund their capex & maintenance requirement and have reported consistent performance. Every plant of the company's international subsidiary is dedicated for the local needs of steel industry except the Chinese plant. The company does not cater to the local Chinese market, but is predominately works as an export base for raw material of refractories.the Indian plant also buys some raw material from China through this subsidiary. SKP Securities Ltd Page 12 of 22

13 Exhibit: Snapshot of overseas acquisitions Company Acquired Year of acquisition IFGL acquired Monocon group in 2005 at a cost of 9.5 mn Pounds (Rs 560 mn) with its plants located in Brazil, Taiwan, China, UK and USA. Monocon group provided IFGL with wide range product basket (from Lances, Darts, Monolithics & Castables) and also gave access to key large steel plants in Europe of steelmakers like Corus & Arcelor Mittal. IFGL acquired Goricon group in 2006 at a cost of 1.1 mn Pounds (Rs 70 mn) and later merged it with Monocon as the companies had similar products and were competitors of each other. Hoffman ceramics was acquired in 2008 at a cost of 7 mn Euros for getting entry into foundries for supply of consumables. FGL bought EI Ceramics in 2010 which has similar product basket as IFGL s domestic operations but provided access to key markets in US. IFGL acquired EI Ceramics with an eye on future expansion as it had space to increase capacity by ~3x. IFGL also acquired CUSC international in US (later merged with EI) which was providing ancillary services to EI including processing of raw materials, warehousing & packaging. Purchase Cost (Rs mn) Monocon Group Plant Locations UK, US, China Products Markets Comments Refractory darts, lances, monolithics UK, Europe, China Services key customers in Europe like TATA steel UK, Arcelor. Brazil plant closed and Taiwan plat shifted to China. Goricon Group UK, US Darts, lances and ladle Powder Europe Merged into Monocon Hoffman Ceramics Germany Refractory ceramics like filters, feeders etc Europe Supplies consumables to foundries EI Ceramics Ohio, US Continuous casting refractories US, Canada, Mexico Acquired to gain traction in America market Source: Industry, SKP Research Overseas subsidiaries have seen steady improvements over the years and remain self sustaining IFGL has faced several challenges in managing the profitability and operations of its overseas acquisitions due to global economic crisis in CY08 which impacted steel production in US & Europe very severely. The slowdown resulted in removal of competition from refractory players in EU & US and aggressive cost control measures helped the industry to sail through bad times. Both Monocon and Hoffman group had EBITDA loss in FY09 but management efforts into consolidation of key group entities (Goricon was merged with Monocon) and closure of certain unviable facilities (Taiwan, Brazil plants of Monocon were closed, Czech plant of Hoffman was closed) coupled with recovery in demand has led to gradual improvement in profitability of company s subsidiaries. Demand for refractories from European steel mills is expected to be better going forward due to gradual pick up in steel production and improving macro situation (as is visible from the pick-up in GDP numbers). Since Europe (including UK) accounts for ~70% of IFGL s sales from overseas customers from domestic operations and ~48% of revenues on a consolidated basis (including overseas subsidiaries net sales), we expect IFGL to benefit from improving demand situation in Europe. SKP Securities Ltd Page 13 of 22

14 Exhibit: Revenue trend for overseas subs Rs Mn We note that Monocon group s profitability has improved substantially during FY11-17 with EBITDA CAGR of ~12% and improvement in margins/roce to 8.6%/10% in FY17. Hoffman group has also returned to profits although margins remain low. IFGL s acquisition in US of EI Ceramics in 2010 has been rewarding and the company has performed consistently well post acquisition and achieved PAT CAGR of ~11% during FY Since EI Ceramics enjoys the best margins (~16%) among IFGL s overseas subsidiaries, increase in share of earnings from EI Ceramics is expected to lead to margin improvement for IFGL at a consolidated level Exhibit: EBITDA margin has show n improvement 20.0% 15.0% 10.0% 5.0% 0.0% FY % FY14 FY15 FY16 FY17 FY13 FY14 5.1% 5.1% 16.2% 9.1% 4.9% 15.7% 8.4% 9.0% 10.5% FY15 4.9% 10.4% FY % FY17 8.6% 10.4% EI Ceramics Monocon Group Hoffmann Ceramics EI Ceramics Monocon Group Hoffmann Ceramics Sustainable competitive strength of IFGL s refractory business with many entry barriers IFGL possesses sustainable competitive strengths in refractory business which it has conscientiously developed over a decade. Refractory business has significant entry barriers which new entrants find challenging to break; ensuring the availability of incremental business pie to existing players, of which only ~4-5 players with meaningful size exist in worldwide. Industry s competitive strength is driven by huge entry barriers in the form of: High initial capital outlay and low turnover potential for a new entrant: Setting up new refractory capacities are not only capital intensive but also provides very low turnover potential with asset turnover well below 1x. Moreover, working capital requirements are high in addition to high probability of rejection in early stages of product manufacturing. Acceptability of refractories is the major entry barrier: Refractories being a low-cost element in overall steel production costs, pricing is not a differentiating factor. It stated that consistent supply is the most important entry barrier, as refractories have a critical role in steel production. It takes years for its products to get an entry because steel players refrain from changing their refractory suppliers frequently. IFGL has positioned itself as an alternative to global players like Vesuvius/RHI, as steel players source refractories from three-four players in order to avoid dependability on a single/few players. Relationship oriented Industry: The industry is marked by a relationship and referral based model. A new entrant has to prove the quality of its products by supplying to a steel manufacturer and then get referral and word-of-mouth publicity from the manufacturer. The entire process often takes several years, as the steel manufacturers are not inclined to try out a new supplier. SKP Securities Ltd Page 14 of 22

15 Commodity Prices to remain stable Alumina, Zirconia and Resin constitute close to half of the raw martial cost and a quarter of the sale value; together with other raw materials the ratio of raw material to sales stood at ~47-50% during FY Raw martial prices are off the mean as the expectation of proximity of commodity super-cycle driven by China remains distant. We expect the raw material trend in the ratio to remain constant as the prices globally have normalised and also due to local sourcing of raw materials. We believe the raw material to sales ratio to reach to 46% of sales by FY20E. Benefits of safeguard duties to flow in India and U.S have recently imposed anti-dumping duties on the imports from China. We believe that, this move is positive for IFGL, as the full benefits of antidumping duty will accrue in FY18E, leading to a pickup in order inflow. Despite, the weak FY17, IFGL was able to generate strong cash flow, and we expect the momentum to continue going ahead. Growth ahead with limited incremental capex IFGL has invested well in its global assets and it expects that, growth in the coming years would be contributed by brownfield expansions at Kandla unit, improvement in steel consumption globally, higher capacity utilisation and operating leverage at its subsidiary, Hofmann Ceramics (expansion via debottlenecking) and increase in market share. Expansion in Gujarat is likely to come at the cost of Rs mn, while its annual maintenance capex would be in the range of Rs mn. On track to increase market share IFGL has achieved strong revenue CAGR in the last decade (higher than steel production growth) led by acquisitions across the globe and change in product mix. IFGL was able to increase its market share from 0.1% in FY05 to 0.5% in FY16, in the global refractory market of ~USD25 bn. Given its scale of operations and presence in key markets, we believe that, there is huge room for IFGL to increase its market share in the years to come. Assuming global refractory market remains constant, every 10 bps increase in IFGL market share would lead to incremental revenue of USD 25 mn. Exhibit: Market Share (Domestic) Company Market Share (%) Supply to Integrated steel mills Vesuvius India Ltd 10% 95%+ Orient Refractories (RHI) 7% 10%-15% IFGL Refractories (incl. IEL) 6% 65%+ Tata Refractories 16% NA Calderys 10% NA OCL 7% NA Comments Leading supplier with wide product basket, strong customer relationships with large mills. Has developed a niche with mini steel mills Mainly into flow control shaped refractories, good relationship with large mills Largely into bricks supplies (Commodity refractories) Supply largely to non-ferrous producers, strong in bricks and monolithics Source: SKP Research SKP Securities Ltd Page 15 of 22

16 Strong Financial performance: Consolidated top-line to grow at a CAGR of ~8.7% over FY17-20E on higher Volumes The company has managed a reasonable top-line growth over the last 7 years (despite lower capacity utilizations in the steel sector and de-stocking of inventories by steel manufacturers) backed by strategic investments, foray into new geographies, increased product portfolio and healthier industrial relationships. We expect IFGL to witness a turnaround following an improvement in volumes backed by recent capacity expansions, cyclical uptrend in the steel industry and continuation of anti dumping duty on Chinese imports and assumed realizations improvement in FY18E, FY19E & FY20E. Driven by an increase in capacity utilisation, IFGL s revenues are expected to grow at ~8.7% CAGR over FY17-19E to Rs 9.8 bn. Exhibit: Expect revenue CAGR of ~8.7% during FY17-20E led by pick-up in sales volume FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Revenue (Rs Mn) Growth (%) EBITDA margins to trend upwards On the back of an improvement in capacity utilisation, we expect IFGL to enjoy economies of scale. Steps taken by the company to control costs are expected to aid in expanding operating margins from current levels. Going forward, in the next couple of years, margins are expected to improve gradually as revenues from Kandla picks up. Also, increase in volume, prices coupled with costs control measures are likely to aid in expansion of margins despite increase in costs. Exhibit: EBITDA CAGR of ~14% during FY17-20E % 12.2% 9.3% 14.5% 11.7% 10.6% 12.3% 13.0% 13.6% 14.1% 20.0% 15.0% 10.0% FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E 5.0% 0.0% EBITDA (Rs Mn) EBITDA Margin% SKP Securities Ltd Page 16 of 22

17 Earnings to grow 1.6x aided by better product mix and lower interest outgo Net profit is expected to improve by ~1.6x on account of proactively managing production schedules, cost control initiatives across facilities and strategically located Kandla unit providing flexibility of supplying in export markets. Factoring in the above, we expect IFGL to report PAT of Rs 448 mn in FY18E, Rs 564 mn in FY19E & Rs 702 mn in FY20E. In FY17, there was reduction in PAT as financials were restated to account for Ind-AS and the merger resulted in ~Rs 2.7 bn goodwill to be amortised over a period of 10 years, sharp increase in networth and drop in return ratios on account of the same. Exhibit: PAT CAGR of ~17% during FY17-20E % % % 8.1% 6.8% 5.8% 5.8% 5.5% PAT PAT Margin% 6.3% % FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E % 8.0% 6.0% 4.0% 2.0% 0.0% Strong free cash flow generation ahead with limited capex; Net cash status augurs well for company IFGL has high quality assets and expects incremental revenue of Rs bn to Rs 10 bn from its existing operations, assuming ~80-85% utilization versus ~55-60% now. The company is expected to maintain capex of Rs mn which is a minimal outgo for debottlenecking the manufacturing facilities; allowing for faster ramp-up of production. As a result, we see a strong free cash flow generation in the coming years. Due to the slowdown in the steel industry, its debtor days have increased. Despite this, the company has been able to generate return ratios of 8-9% in FY17. Better working capital management led to a reduction in debt levels for the company. IFGL boasts of a strong balance sheet with gross debt of Rs 0.8 bn and cash & cash equivalents of ~Rs 0.7 bn resulting in a net debt of ~Rs 0.1 bn at the end of FY17. D/E stands at an attractive level of 0.1x and is expected to improve further as no incremental capex is planned in near term. Exhibit: Strong free cash flow generation Exhibit: Gross debt & Debt/Equity Ratio FY FY FY FY FY FY FY FY18E 1194 FY19E 1762 FY20E FY FY12 FY FY14 FY FY FY FY18E FY19E FY20E FCF (Rs Mn) Gross Debt (Rs Mn) D/E Ratio (x) SKP Securities Ltd Page 17 of 22

18 Valuations IFGL is well positioned to capitalize on the recovery in steel production in key markets of US/Europe/India (aided by regulatory support & demand revival) coupled with operationally sound high-quality global assets, improvement in operational efficiencies, increased share of higher-margin subsidiary and a strong balance sheet with free cash flow visibility. Given the above factors, visibility of margins expansion and strong clientele augurs well for IFGL. We have valued the stock on the basis of P/E of 15x of FY20E EPS adjusted for goodwill write-off and recommend a BUY on the stock with a target price of Rs 403/ (~30% upside) in 18 months. Exhibit: Valuation Charts 28.0 Rolling forward P/E(x) chart Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Fwd P/EPS Mean P/EPS P/EPS+1sd P/EPS-1sd Risks & Concerns Sharp slowdown in steel industry leading to lower volumes: Like any other refractory company, IFGL s fortunes depend on the steel industry and any slowdown in global economy may hamper the steel industry s growth and IFGL s volume growth would be more vulnerable. Sharp slowdown in the steel industry (vs expectations of recovery) in coming years could lead to lower capacity utilization and lower than expected volumes. Dependent on raw material sourcing through imports: The industry is dependent on imports of key raw materials like high grade alumina, bauxite, magnesia, silicon carbide etc. China is the major supplier and has imposed heavy taxes on export of raw materials of refractories. This has resulted in sharp increase in imported raw material costs. IFGL sources ~52% of its raw materials through imports and remains exposed to increase in costs which can impact its margins. Currency Fluctuation We believe that steady weakening of Rupee over the past couple of years has been favourable to the industry as well as for IFGL due to better import substitution and higher realizations on exports negated only to a partial extent by higher import costs for raw materials. IFGL has 80% of its revenues coming from overseas on a consolidated basis. On a standalone basis, approximately 58% of the revenues (FY14) came from overseas customerss. Company s revenues remain exposed to sharp appreciation of Rupee against foreign currencies. SKP Securities Ltd Page 18 of 22