Vesuvius India, which produces refractory products used by steel plants, appears to be a smart way to gain exposure to the Indian ferrous metals space. The company has the potential to grow sales and earnings to more than justify its valuation, given its vast product mix, strong financials and a growing domestic steel production base to cater to.

The company's stock (Rs.381) is valued at 14.6 times the trailing 12 month earnings, which is at a premium to peers in the space. The premium is warranted, given the higher operating margins and realisations Vesuvius enjoys compared to peers such as Tata Refractories, IFGL Refractories and OCL India. The company's valuation is also much lower than the 26 times FY11 earnings valuation ascribed to competitor, Tata Refractories, when a majority stake was acquired in it in June 2011 by a Japanese firm.

Vesuvius India produces refractory products which are used in the steel, cement and glass industries. The refractory lining on furnaces and other industrial machinery is required to provide heat and corrosion resistance to machinery operating at high temperatures. It is crucial in improving blast-furnace efficiency. Through two units in Vizag and Kolkata, the company produces a broad range of refractory products for the domestic market. Fifty five per cent of Vesuvius India is owned by Cookson UK. Cookson specialises in supplying products globally (sales in 2010 of $4 billion) to the steel and electronics space. Access to the parent group's product line expertise allows Vesuvius to compete effectively against peers such as Ace Caldersys and Tata Refractories, which have a similar backing.

CLOCK-WORK GROWTH

The last five years have seen prolific domestic steel consumption, which has grown at a compounded 9.5 per cent. Vesuvius capitalised on the growing domestic market. Since CY2006, the company's sales and profits have grown at a compounded rate of 12 and 16 per cent respectively to Rs 440 crore and Rs 49 crore in CY10 (also the company's financial year). With an accelerated pace of capacity additions in steel and the likelihood of shorter replacement cycles for refractory products, the pace of growth may improve, going forward.

In the nine months ended September 2011, Vesuvius has seen sales and net profits rise by 22 and 19 per cent respectively to Rs 392 crore and Rs 42 crore compared to the same period a year ago. Domestic steel production grew by 5.3 per cent during the same period. Steel producers expected to add 35-40 per cent more capacity to the existing base over the next three years.

This gives Vesuvius India a growing market to cater to. Also working in the company's favour is the shortening duration between blast furnace relining. This is necessitated by measures to keep soaring energy and raw material costs under check. The installation of larger blast furnaces may also work in favour of Vesuvius. In a bid to ramp up output, the company recently doubled capacity at its larger Kolkata unit. The company is a zero-debt entity and is using internal accruals to fund its expansion plans. Vesuvius has enjoyed better realisations on their refractory products compared to peers such as OCL and IFGL, not to mention better operating margins (17-20 per cent) as well.

RISKS

The company's growth prospects are strongly tied to the steel cycle. Increasing domestic capacity could provide more players for Vesuvius to cater to. Any delays in steel capacity additions could hurt Vesuvius' growth. The company's raw material requirements include alumina, bauxite, silicon carbide and cement. Both bauxite and alumina prices have shown signs of cooling off over the last three months as prices are down by roughly 20 per cent over the last few months. Silicon carbide prices have remained stiff through the second quarter. The company has managed to maintain margins , despite volatile raw material costs.

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