20 August 2019

AIA Engineering Stock Analysis

AIA Engineering stock has delivered multibagger returns over the last five years. The company has healthy return ratios and has exhibited strong growth despite the slow economic growth globally. AIA Engineering operates in the grinding mill internal market on a global level, serving the Cement, Mining, Thermal Power and Aggregate industries. The mining industry is the major source of revenue for the company. Exports contribute 76% of the company’s revenues.

Industry & Product

AIA Engineering designs, manufactures and markets consumable wear parts (mill internals) which are used in the process of Grinding and Crushing. Due to impact, abrasion and corrosion, there is wear & tear on these parts and they wear away. The company makes these consumables in high chrome metallurgy which offers wear resistance and longer wear life. High chrome is 40% more expensive than forged grind media. AIA Engineering and Magotteaux have a 80% market share of the industry.
The estimated annual consumption of grinding media for the mining segment is 2.5 million tons. Only 20% of the consumption demand is met from high chrome while the balance consumption is met from the conventional forged components. The company caters to four major metal ore types – Iron, Platinum, Gold and Copper. The company plans to tap it’s existing customer base for it’s new product – Mill Linings. This product has a global demand of 300,000 ton annually. Although the company has a presence in the cement and power industry, it doesn’t expect much growth from sales to these industries in the near future.

Management

The company’s Managing Director Bhadresh Shah has built the company from scratch. Earlier, AIA was in a joint venture with Magotteaux till the early 2000’s.
The promoters hold a 58.47% stake in the company (vs 61.65% on 31 March 2018). FII holding is 21.81% and DII holding is 14.8%. The stock is held by many funds and the retail holding is just ~ 5%.

Company Fundamentals

The company has a current capacity of 340,000 tons per annum but the management has undertaken a CapEx to increase this capacity to 440,000 tons per annum. However, this CapEx plan has been delayed by three years because of financial issues being faced by an important equipment supplier. The company also plans to invest Rs 100 Crores in wind mills to mitigate the risks associated with power costs.
Over the last 5 years, the consolidated revenue has grown at a CAGR of 8.11% while the net profit has grown at a CAGR of 9.47%. Volatility in raw material prices make the margins volatile (refer the graph).
Metal Scarp and Ferro Chrome are the major raw materials of the company. A 1% move in the raw material prices can have a Rs 25 Crore impact on the company’s bottomline. The EBITDA margins spiked between FY15 and FY17, however the management expects the EBITDA margins to sustain in the early 20’s.

Analysis

Molycop is the largest producer of forged grinding balls. The company has a capacity of 1.7 Million tonnes and sales of nearly 1.1 Million tonnes. Molycop was sold for $1.6 Billion in 2016. AIA Engineering with a lower capacity and overall market share has a valuation upwards of $2 Billion.AIA Engineering’s direct competitor, Magotteaux, spends $6 Million on R&D annually, but AIA spends no amount on R&D. Because of lower employee costs and overall cost of production, AIA Engineering enjoys higher margins than it’s peers.
As it is a replacement product and makes up a small cost for the consumers, high chrome enjoys recurring demand. The company incurred Rs 785 Crores of capital expenditure in the last 5 years and this was met from internal accruals. The company had Rs 1,143 Crores in current investments and Rs 208 Crores in cash and bank balance.This made up roughly 9% of the market cap of the company. Further, the company has a 75% stake in a listed company – Welcast Steel Ltd. The company makes raw material purchases from Welcast.

Ratio Analysis

AIA Engineering has to maintain a quarter worth of inventory for its customers. The inventory days has increased from 68 in FY16 to 93 in FY19. This has resulted in a sharp increase in the working capital requirement.
The working capital includes the liquid fund investments. Readers should note that the above numbers on working capital look distorted because of these investments.

AIA Engineering Stock Analysis

AIA Engineering’s average realisation per unit is ~ Rs 102,000 per ton (+/- 5%). The management expects incremental volume growth of 50,000 TPA from the mining industry over the next 2 years. FY15 to FY18 was a tough year for the mining industry because of low commodity prices.
Even if the realisation per ton doesn’t improve, there is room for the company to clock revenues of ~ Rs 3,400 Crores by FY21. At 18% PAT margin, the company would make a profit of ~ Rs 600 Crores. However, if the company is able to push up realisation to ~ Rs 105,000 per ton and maintain PAT margin at ~ 20%, then the profit would be ~ Rs 700 Crores.
The company is facing a law suit of $60 Million (~ Rs 420 Crores) and has been spending upwards of Rs 10 Crores towards legal expenses every year. If the law suit materializes, then it would cost the company almost a year’s worth of profits. This could hit the AIA Engineering stock price for the short term.

Long Term Investment

AIA Engineering stock trades at a PE of 30x its FY19 earnings. For a company that caters to cyclical industries like Mining and Cement, this valuation is quite rich. From the current market cap of Rs 15,560 Crores the prospective returns over the next 3 years are not much. The AIA Engineering stock has usually traded at fair valuations of above 20 PE, primarily because the company has sustained a high ROCE over time.
The AIA Engineering stock is part of our watchlist and we would be interested to buy if the stock price corrects to fair valuations. Long term investors can also consider buying on dips.

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