APL Apollo Tubes has just made a recent life time high. So I thought why not have a look at the fundamentals. From the look of things the numbers look too good to be true, that is from the growth prespective. The company is into steel tubes manufacturing.
I had visited their factory in Hosur a year and a half ago. Here are a few things i can recollect from the discussions and observations made in the plant
Pro’s
Their plant in Hosur is equipped with the latest state of the art machinery for manufacturing of tubes.
The pace with which they gave all the clearances for installation of new equipment was pretty amazing. Decision making was really good and thethey werequality conscious and not necessarily price conscious.( They had only asked the top 3 companies in India to quote for the project and were interested in all additional accessories and fetaures)
They had equipment in place for manufacturing pipes across all the major required diameters and thickness available.
Good locational advantage to service the markets as logistical advantages play a huge role in the steel business due to the low margins and the high cost of transportation.
Cons
1)They had indicated to me that they procure the raw material from JSW and their major competitor in the organized space is one of the group companies of JSW. ( This really put me off as JSW then will always have the pricing power over them butsomehow APL apollo tubes has a better standing in certain markets than JSW)
Due to the aformentioned reasons there is always an inherent risk on margins which are already very low in the Steel processing industry.
Hope this helps.
DISC : I am not invested in this stock and am not tracking it.
(This is the note I’d written for someone when I started buying this in Aug 2014)
Though this is operating in the commoditized steel tubes segment, I was drawn to this story (started buying in Aug 2014) for the following reasons -
Share of organized players in the ERW tubes segment is under 50%, other than APL none of the other large players have expanded since 2010-11 due to this either being a peripheral segment for them or them being saddled with debt. Volume growth at 20% looks probable over the next 3-4 years even without an immediate uptick in the business cycle
Looks like a good proxy for the India infra urbanization story without excessive reliance on any single segment
Since the product differentiation is low the key to success in this segment could emerge from relative scale advantages. PAT margin, interest cost & freight out expenditure are all in the 2.5-3% range which place APL at a significant advantage due to a hygienic debt levels, improving operating cash flow & working capital and distributed production
Appears to be the only player with the ability to quickly launch customized products for niche applications due to the ability to get closer to end customers, which in turn is due to their evolving direct marketing model
The stock was being priced as a cyclical commodity play, my evaluation told me that the quality of the business is better what it appears to be at first glance with emerging advantages that have the potential to cement APL’s dominance in the segment
Real world events that could trigger a virtuous cycle from where we are -
Volume growth in the 18-20% range backed up by capacity addition in the same range. Capex to be funded (approx 100 Cr each announced for 2016 and 2017) mostly from internal accruals since OCF is very likely to be 100 Cr+ every year here on, long term debt to see a reduction
WC which has been trending down over the past 5 years continues to improve due to better receivables management, evolving distribution model (share from direct marketing to increase) & interest rates coming down. Interest as % of sales coming down from the current 2.4% to add to bottom line and improve ROE
Effect of new product launches (door frames, color coded pipes & exports) to enhance product portfolio and improve realizations
BTL marketing efforts to enhance repeat business and channel stickiness
Demand environment getting better over the medium term due to Govt infra spending from FY17 onward
Latest interview by the CEO confirms that (1), (3) and (4) are well underway and that (2) and (5) are expected to play out over the medium term. However for a business of this nature I would demand a higher margin of safety, at CMP the 1 year forward P/E is 11.5 for the consolidated business and I believe the risk reward is in favor of investors
Negatives I can highlight (current scenario) -
Some fuzzy accounting till Q3 FY2016 - they had a local auditor and were amortizing BTL expenses instead of charging to P&L. Set right after they changed auditor to Deloitte, 17 Cr was charged off in Q3
No control over pricing, commodity nature of the business may not ever change. Fall in HRC prices will mean inventory writedowns, reduced EBITDA margins with return ratios going for a toss
Competitors now starting to expand, Surya Roshni is doing a capex which may introduce the element of competition which was missing for the past 3-4 years
No big margin of safety at CMP, market cap of 2300 Cr with FY17 PAT expected to be 150-160 Cr
Market acceptance of color coded pipes hasn’t been great so far, management has been transparent about this though
The company has a high tax rate at 35%. This could reduce after GST. Also management talked about direct forming technology which would lead to saving of material by 7-8%. In a high volume low margin business this could make a big difference in cash flows.
I am a bit curious on why this business has received so little attention on this forum though the stock has run up almost 3X in the past 2 years, primarily driven by earnings growth with some re rating thrown in.
I am sure some folks would’ve seen this business and stayed away for certain reasons, would help if those reasons get highlighted here. One of my hypothesis when I invested was that the possibility of accelerated re rating looks low, I just want to see if I turned out to be correct for the right reasons.
One reason may be that this is not a long term compounder type of business. It is a commodity type cyclical business, where one has to be right both at entry and exit.
Agree that this is a commodity business to a good extent, however it is not cyclical. Any business that can grow volumes at 20%+ over a 7-8 yr period cannot be termed cyclical IMO, the sector by itself goes through cycles but this specific business has a long runway from here.
Unless one looks at the industry map and understands what each player in the ERW pipes segment is upto it is very tough to see why this business merits an investment. I stumbled onto this while I was trying to analyze Ratnamani Metals and Tubes, in the process of understanding the competitive landscape I managed to see the tailwind this specific business will have over the next 5-6 years.
Do take a detailed look at this, a superficial look will only highlight the negatives. The mini virtuous cycle underway right now has the potential to take the stock to the next orbit (5000 Cr+ market cap), specific reasons listed in my post above. However I would demand a margin of safety much higher than what’s in the current price.
Disclaimer: This position constitutes almost 20% of my equity portfolio, I have every incentive to sell this story to every boarder here!
I have seen this term (long term compounder) thrown around on this forum a lot. It appears to me that favorite stocks on this forum are the ones that have already done well in the past and people hope that it will continue to do well in future.
A turnaround story or a re-rating story does not evoke the kind of enthusiasm that at steady compounder does. On this forum past performance is an indicator of future performance.
Looking at the products it makes, it does appear to be a cyclical story but the product is gaining wider acceptance and company is also introducing innovative products that are finding more uses and presumably replacing other materials. All this leads to a cycle that is long enough to make this a secular story.
Just like you, I stepped on this company when I was researching Ratnamani. I initially brushed off this company just looking at the debt (and missed a major part of the re-rating), what caught my attention is the low level of receivables. This company is selling it’s products like hot cakes. I was initially skeptical of how far the product can go but looking at the receivable numbers, I have no doubt that products are gaining market share over other competing materials and company is having no trouble selling them.
One question I still have is the rate of expansion. They are chewing more than they can swallow. I hope they don’t choke on that. Company’s products needs some convincing and that needs a strong marketing and distribution. I am yet to convince myself if company has the ability to scale up their marketing to sell all the stuff that will start coming out their new factories over the next 2-3 years.
Do you expect the stock to be rerated from current levels? Companies like these never trade at more that 20 PE ratio no matter what their EPS growth rate is. I think the rerating part is done at this valuation. Growth in volumes is the only driver of future returns. I only hope they don’t stumble in a big way and stock gets rerated in the other direction.
The company is doubling capacity in the next couple of years. I dont think a significant rerating is required for earning a good return in this company. In its conc call management said it is targeting to gain market share from current 12-13% to 20-25% due to GST, better marketing and distribution. Its the only player in this segment to have a pan india presence. Also management feels it will improve margins to 10% from 8% currently due to implementation of new technology.
ERW pipes is a 30,000 Cr market annually which will grow at a 5-8% rate depending on how well the broader economy does. APL last FY did a topline of 4200 Cr, hence the length of the runway is long given the competitive situation in this segment. What struck me was the fact that they have had virtually no competition over the past 3-4 years. Surya Roshni is busy with their electricals business (only recently have they announced intention to increase capacity for the pipes business), Tata Steel pipes section capacity has been at 550K MT since 2011 though they do the highest realization per MT. All others have smaller capacity and have more important business segments they have to focus on. In short when it came to incremental business expansion APL has been a monopoly for the past 3-4 years.
In a business where product differentiation is low due to commoditization the only moat possible can come from distribution, cost due to relative scale advantages. APL is more than 2x the size of the nearest organized player and this gap will only go up as they expand and sell more. In terms of the judgement this is an amazing management that has caught on to the possible opportunity and executed amazingly well.
In terms of execution capability they have proven multiple times that they can do organic/inorganic expansion and run the show efficiently. The absolute level of debt has been the same for some time now, relative debt levels will continue to come down since incremental capex will be driven by internal accruals. This year they will do 200 Cr capex, OCF will be in excess of this number since PAT is likely to be 140 Cr+. Purely from earnings expansion this should at 2x CMP in 3 years time, one need not even bank on re rating from here.
In terms of where this business should trade, the quality is far higher than it appears at first sight. Unless one takes the effort to understand why this companies has grown volumes at this pace, understands the competitive landscape he will never be convinced about this company. My sense is this will trade at 20+ PE from here, on a forward basis maybe at 18.
As per latest presentation they are significantly ramping up their distribution, sales team will be 2x from here in 3-4 years. They are doing exactly what I would do if I were to run the company to, logically I do not see any inconsistencies.
Of course given the lack of control on pricing and the way HRC prices can move in a quarter, one had to demand a higher margin of safety primarily through a lower acquisition price. Current price is close to being fair but nowhere close to being expensive.
Appreciate your detailed explanation.
With manufacturing industry in general and steel industry i particular, dumping from China is a constant threat. My assumption is china will be dumping raw products like coils and sheets rather than finished products like hollow tubes and pipes due to higher freight costs and that these are finished products that have to made to order. If it is true, then cheap raw materials from China will actually be beneficial to converter companies like APL. What’s your take on this, is China dumping a threat or a boon?
Chinese dumping of HRC’s has been a threat after the 2014 commodity meltdown. Prior to that landed cost + logistics cost was prohibiting imports but after the $ value of HRC’s fell below the domestic cost of production pricing in the domestic market fell accordingly. This is why the PAT number for 2015 and H1FY16 was pretty muted for the company due to inventory losses. This is where the company’s good inventory management saved them, if they were running an inventory holding period of 60 days instead of the 35 days the fall in steel prices would’ve hurt the bottom line even more. After steel prices stabilized and import duty was imposed the inventory losses have vanished and the PAT has been in excess of 30 Cr every Q from Q3 FY16 onward.
The interesting thing is that the company has started importing HRC as well, this you can see from the latest annual report. Once they have the production and distribution engines firing, adding suppliers is relatively far easier. Looks like the company will import HRC if it has to as long as it makes good commercial sense.
Overall Chinese imports are a threat from a margin point of view since inventory losses will hurt if pricing moves downward suddenly. For a converter company the biggest problem is the instantaneous pass through in pricing which they have no control on. So how this worked in the past is -
If steel prices trend down, realizations dip accordingly, margin down due to inventory losses
If steel prices trend up, realizations go up, margin may improve temporarily for a Q or two
So if volumes were to go up by 25% in a year, depending on how steel pricing moves the top line and bottom line will adjust accordingly
These impacts will be transient in nature though, longer term advantages for this company come from relative scale advantages, distributed production leading to lower logistics cost & BTL marketing which enhances trade channel stickiness. That is what the investment hypothesis will need to be based on for a long term investor. The thesis here is actually very simple!
Inventory loss is not my biggest concern. As you said, these are transient factors and the real story is in volume growth. I would be worried about inventory loss in an inventory-heavy business like jewelry but not here. I guess prices won’t continue to drop, and in fact, if prices drop volumes will pick up as hollow steel tubes are replacing other materials like PVC, brick and mortar, wood, aluminium etc.
Outside in India, I have seen hollow steel tubes are extensively used as structural materials mainly because of ease of construction, design, and low labor efforts needed compared to other materials in structural projects. As these factors become important in India, the product should sell well. It does look like a product whose time has come with a global precedent.
The pace at which they are adding capacity, they expect competitors to catch up so they want to have a first mover advantages by raising capacity, building a distribution network and establishing a brand. I have seen some companies stumble when they followed similar strategy but so far APL has done well.
@zygo23554 There was a major capital infusion in 2008 and again in 2009 when share capital went up from 3 cr to 20 cr and reserves went up from 12 cr to 145 cr via conversion of warrants. This was just before the TN plant was started. Do you know who infused the capital and at what valuation?
Thanks for providing the link.
Given the high debt levels of the company and reluctance of the banks to fund steel sector, do you think this company will have problem rolling over it’s debt in near term as much of the debt is short term? I couldn’t find information on how many of the promoter shares are pledged. If the company is unable to refinance the debt, these could be offloaded on the market. Any views on this issue?
No shares pledged by promoter as per annual report
I see minimal risk of a short term liquidity crunch. In fact the company has been able to stay steady over the past 2 years when commodity prices were getting hammered and the banking sector was under severe pressure to clean up NPA, I think the worst period is already past. If anything the credit rating will only improve from here, relative debt levels (D/E) will stay steady at worst and get better if you go by the base case scenario.
Disclosure: I am biased in favor of the company, please read all my posts with this perspective.
