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August 28, 2017 | PM Securities
Business Summary & Our take:
Established in 1992 Gravita india’s core business is recycling of batteries into usable lead. Gravita India currently has 13 manufacturing facilities (6 in India, 7 in international Markets) and presence in 50 + countries. The Chairman Dr M P Agarwal and his son Mr Rajat Agarwal – Managing Director have over 25 years of experience in the lead recycling industry. Gravita India is engaged in the following business verticals:
Business Verticals:
1) Lead Recycling (~90% of FY17 revenues) : Involves collection of scrap batteries, crushing, smelting & recycling. The major challenge in this business is collection of scrap, which Gravita has addressed well enough by far spread distribution of collection centres.
2) Aluminium Recycling (~7% of FY17 revenues) : Relatively a new vertical started operations from FY15. As of FY17 had a Gravita had a capacity of 6000 MTPA which is expected to double this financial year.
3) PET Recycling ( <1% of FY17 revenues) : A recent addition to the verticals, currently at a very nascent stage. The company is currently trying to learn and strengthen the collection process of PET scrap. Although with a capacity of 3600 TPA IN FY17 & expected to be 14400 MTPA by end of FY18 this vertical is expected to contribute Rs 30 Crs. to the FY18E top-line of Rs. 933 crs.
4) Turnkey Solutions ( 1.2% of FY17 revenues) : This vertical is involved in selling of smelters & allied recycling equipment pertaining to lead recycling processes.
Our Take
Lead industry has immense demand and hence sales is not a major concern but collection of scrap is. Gravita seems to have gathered expertise on the rather tough collection part of the business. Gravita operates on a fixed margin basis, whereby lead pricing doesn’t impact the business if hedged on a daily basis, which was not the case until FY16 resulting in reduced profitability. Managements decision to create daily hedge shall ensure no correlation of profitability with lead pricing. With excess capacities in the lead vertical and concurrent expansions in lead & Other verticals we envisage an expected revenue of Rs.933.59 Crs.(FY18E) & Rs1303.63 Crs. (FY19E) ie. 42% & 40% y-o-y growth respectively and Net Profit of Rs.55.66 Crs.(FY18E) & Rs.90.93 Crs.(FY19E) ie. 83.48% & 63.38% y-o-y growth respectively. At the CMP of Rs. 112.5 the stock trades at 9.8x FY19 Earnings. With no demand constraint & low Lead price to earnings delta we believe that Gravita is not a conventional commodity linked stock and re-rating of the stock is on the cards. We recommend to BUY the stock. We assign a P/E multiple of 11x FY19E EPS of Rs. 13.27 thus arriving at a target price of Rs.146 in 12-18 months.
Investment Highlights
1) Low demand constraint:
Majorly lead is consumed in the battery industry from autos to telecom and power all of which are witnessing high demand potential in the domestic markets. Also, in the international markets aggressive shift from fossil fuels to electricity as a source of energy is aiding the lead demand. As the management suggests they do not face any constraint of demand and suggest that selling is the easiest part of their business activity requiring less endeavour.
2) Daily Hedging Policy: After facing headwinds due to lead price fluctuations Gravita India has drafted a hedging policy from june 2016 to ensure daily hedging of Lead prices. This policy change shall ensure low delta of profitability with lead prices thus hiving off the commodity price risk and securing margins. Typically Base lead sells at 96 % of LME, refined lead 102 % of LME & Lead alloys at 107 % of LME thus leaving the hedge marginally imperfect although this should not have a sizeable impact on profitability.
3) Expected EBITDA Margin Expansion by 150-250bps: With a shift towards higher margin non-core business of PET & Aluminium expansion a subtle improvement in margins is expected. However, ramp up in production of lead from ~33000 tonnes in FY17 to expected 55000 tonnes in FY18E shall aid better margins due to sticky fixed costs.
4) Robust collection structure : Gravita requires ~1.7units of scrap to produce 1 unit of lead and collection of scrap is the biggest challenge in the lead recycling industry. Gravita has a global network and systems I'm place with collection centres places across geographies ensuring sourcing of scrap from the small aggregators. This is a massive barrier for entry in the industry
5) Unlocking of new opportunities: The recently inaugurated Chitoor plant with 12000 MTPA capacity (Phase 1) & additional 12000 MTPA capacity (Phase 2) is in proximity with the Indian battery manufacturing giants like Amaraja besides others this may open up further possibility of acquisition of these customers.
Key Risks:
Customer concentration: Trafigura & Luminous 2 key customers of Gravita constitute 25% & 20% of gravita’s top-line respectively.
Overpromise : Management has a history of over promising on capacity expansions should the planned expansion lag it may pose a risk to already subdued cashflows. However we have accounted for this in our estimates to an extent.
Deviation is absolute estimates: On account of dependence of revenues on lead prices estimates of absolutes might fluctuate, however the margins are fixed so profitability wont be impacted.
Forex Gains/loss : Gravita imports & exports both scrap and lead to over 50 countries thus resulting in probable forex risks.
Political risks: Gravita operates in 5 countries including india any disruption in political health of these shall pose a risk.
Business Overview
Process:
Lead recycling involves collection of batteries, crushing, separation of plastic and lead scrap, refining of plastics and lead scraps. Refining of lead includes smelting before it is treated for impurities. Although gravita has a lead refining capacity of 113419 MTPA its smelting capacity is only ~80000 MTPA. Assuming a best case scenario of 80% capacity utilisation gravita can only produce upto 64000 MTPA although the refining capacity is much higher. An alternative route to utilise this additional refining capacity is sourcing smelted lead sludge instead of batteries but this is a very low margin business and management prefers to stick to the battery route.
Financials
Disclaimer
This document has been prepared and compiled from reliable sources. While utmost care has been taken to ensure that the facts stated are accurate and opinions given are fair and reasonable, neither the Company nor any of its Directors, Officers or Employees shall in any way be responsible for the contents. The Company, its Directors, Officers or Employees may have a position or may otherwise be interested in the investment referred in this document. This is not an offer or solicitation to buy, sell or dispose off any securities mentioned in this document.
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