Rajratan Global Wire business background

Introduction
• Rajratan is the second largest bead wire manufacturer in Asia (Excluding China). Bead wire is a critical component in all types of tyres. It holds the tyre to the rim while resisting inflated pressure. 84% of this company’s revenue is from Bead wires.
• Rajratan manufactures High Carbon Steel wires too. 13% of the revenue comes from this segment.
• It has got two manufacturing units located in Indore (Management claims that it is deal for Pan India Supplies) and Ratchaburi, Thailand located near to customers and ports (Ideal for Exports). It’s Thailand Capacity increased from 26000 TPA to 34800 TPA. It also added 8000 sq metres of warehousing capacity. It appointed a consultant to plug organisational gaps and build a stronger team.
Why Thailand as a manufacturing hub for the Tyre Industry?
Thailand is Asia’s largest tyre manufacturing hub. Rajratan is the only manufacturer of bead wires in Thailand. Thailand is emerging as the world’s largest tyre manufacturing base. 37% of global raw rubber supply is from Thailand leading to significantly lower prices for raw materials. US tariffs on Chinese tyres is a booster shot for Thailand Tyre Industry. There are large investments made by global tyre players in Thailand. Thai Tyre market is estimated to grow $3 billion by 2022. This means that around 12-14% growth is expected per year in Thailand till 2022.
• Almost all major tyre manufacturers (including Indian) are clients of this company.
• Positive Sectoral Outlook:
Around Rs.51,000 Crores Investments in Tyre Industry;
Anti-Dumping Duties on Chinese Tyre Imports to India;
Trebling of Indian Automotive Industry size to around Rs.16 – 18 lakh Crores by 2026 (Contributing to almost 12% of GDP) and Increasing Export value to more than US$ 80 billion (Around Rs.5,40,000 crores ) according to Automotive Mission Plan, 2026.
• Sticky Customers: 85% of revenue generated from customers of >5 years.
• Rajratan grew at 3x Industrial growth rate during 2018-19 while also is soon going to achieve 72000-tonne capacity from 36000 capacity couple of years back. This capacity expansion has led to enhanced customer confidence and retention.
• Equity at Rs. 10 Face Value is Rs.4.35 Crores. 63.5% of shares owned by Promoters.
• RoCE for Rajratan is around 19 for FY19 compared to 16 in FY18. The current EBITDA margin is 10.98%. This is depended upon steel prices.
• It reduced Debt Costs from 11.5% in FY15 to 9% in FY19. Interest Coverage ratio went up from 1.35 in FY15 to a healthy 4.15 in FY19.
Competitors
One of the Competitors in India Shutdown around Feb 2019. They had a debt of around Rs.250 crore. They had a capacity of 8000-9000 tonne per year for tyre bead wire. This will create an opportunity for higher growth and pricing power in the coming 2 years. (It takes around 2 years for any new capacity to come alive).

Other competitors in India are Tata Steel and Aarti Steels. Presently, both are running in full capacity. Foreign competitors are primarily from Malaysia, Vietnam and China. Possibility for new competitors is low because the learning curve is too long for this industry.

Raw Materials
The major raw material is Steel. Last year, the cost of Steel increased by around 25%. Rajratan purchases steel on a monthly basis. Increase in Raw Material cost is passed around to the customers in the next quarter.

Pricing Power
It is estimated that around 3% of a tyre’s manufacturing cost is Bead wires. Due to this, pricing is not a major issue for suppliers. It is quality that matters for suppliers.

• Past Performance
  Rajratan registered a growth of 41% in Revenue which included 22% Volume Growth over FY18. EPS increased by 56% over FY18. Rajratan had charged all interest expenses to Profit & Loss Statements in last year.

It was asked by one of the participants about why despite a price hike and volume hike, the sales across all quarters in FY18-19 were flat. Management didn’t have a proper answer then and told that it will be clarified later to the questioner later. Management had also said that Rajratan had compromised growth in India up till 2015 for survival and they turned around their Thai operations during this period. This led to an increase in revenue from them. Investments in Thailand happened in 2009, and it took 4 to 5 years to become profitable. (CARE rating says it got profitable after 6 years.)

Entry Barriers
Entry Barriers in this industry are quite high. Management expects that there will be further consolidation in the industry. Bead wire has a very long approval cycle. It takes around 10 years to get approval in Japan. Tata Steel is yet to get approval. Rajratan is in the process of getting approvals from new customers. Yokohama has already approved Rajratan as its supplier. Michelin may approve Rajratan in a few years.

Creating a greenfield capacity won’t be viable for new companies. It costs $1000/tonne/year for new capacity addition according to claims of Rajratan management (Almost Rs.70000 per tonne). In comparison, Rajratan is able to add the same capacity at Rs.14,000/tonne due to its existing working plants. Minimum 25000 – 30000 tonnes per annum is required for breakeven capacity, and it will cost Rs.150-200 Crores for the same. In such a scenario, according to management during concall, RoCE shall be less than 10% which makes it not viable for new players to enter. The ability for Rajratan to add capacity at low cost remains key for its competitiveness. Learning Curve is too long in this industry which shall effectively become another entry barrier.

Customers always prefer to have their suppliers to be near to their locations for ensuring consistent and regular supplies. This also enables to keep the logistics costs lesser for the suppliers. However, it may not be viable for suppliers to keep plants near to those customers with low volume requirements.
Without a big benefit, customers like MRF do not have an incentive to switch. It will take 2-3 years to ensure quality.
Market Size

• Indian Market has a cumulative capacity of 120000 tonnes. It is unknown whether this capacity is exclusive of the shutdown capacity by Rajratan’s competitor.
• Thailand Market size is around 95000 tonnes. They mainly import from Malaysia, Vietnam and China. In this, around 70000 tonnes is from Trucks and Buses Radials (TBR).
• Rajratan claims a market share of 40% of bead wire market share in India.
  Capacity Expansion
  Rajaratnam expects the capacity to be doubled to 72000 tonnes by next quarter. In this, the bead wire capacity shall be 60000 tonnes. Around Rs.20 Crores of Capex remains to be invested out of the total Rs.50 Crore marked for doubling capacity. Roughly, this amounts to around Rs.1 Crore required for expanding capacity by 720 tonnes for Rajratan. It’s around Rs.14,000 per tonne.
  In Thailand, no additional capex is required. Total Capacity of Rajratan (India + Thailand) after expansion becomes 106800 TPA.

In FY21, Rajaratnam expects peak level production in India to be around 65000 tonnes out of a total capacity of 72000 tonnes total proposed capacity in India.

• Future Projections by Management
  Management is fairly confident of 20% - 30% growth in volume for next 2 years with an EBITDA margin of 12% - 12.5% (Compared to 11% this year). Competitor Shutdown in India shall be a significant catalyst in India due to the vacuum of 8000-9000 tonnes in capacity. Major capex of around Rs.25000 crores – Rs.30000 crores is done by tyre companies (around extra Rs.20000 crores in the next 5 years). Even then, the tyre industry is operating at 70%-80% capacity utilization. This should be another big catalyst for growth. According to Industry estimates, Indian auto markets shall be growing at 12% up till 2026. Management expects debt to go up by Rs.10 -15 Crores in the immediate future for remaining capex. However, later, debt will come down.

Rajratan shall also be developing new products, expanding to other growing markets and sourcing business from new tyre companies investing in the servicing markets. These shall be the growth drivers beyond the next couple of years.

Sales Volume Breakup as heard and understood from Concall.
Volume (Tonnes)
Sales INDIA THAILAND
Q4 FY19 11021 7000
FY19 40019 25186
FY18 33105 22274
Share of Purchase from Rajratan by Customers for bead wire
Apollo MRF CEAT BKC Bridgestone
50% 50% 70% 80% 80%
Customer Concentration: Around 80% of revenue comes from the top 5 customers. (MRF accounts for 25% of sales in that).
Working Capital may not be able to be reduced beyond a level.

My Thoughts

• Rajratan offers solid visibility in growth for the next 3 years of at least 10%-12% (Claims of up to 30% growth by Management).
• Moats in terms of Learning Curve and Switching Costs. High Entry Barriers exist in business. Consolidation in the industry should occur. New suppliers are always looked at with suspicion by customers and it will take time to gain trust. Pricing Power is with the Seller. Price of Bead Wires is just 3% of Cost of Tyre for Customers. It is quality that matters for customers. Increase in raw material cost should not affect this company wildly.
• Rajratan holds around 40% market share for bead wires in India. Going beyond 50-60% will be quite difficult. Rajratan should look at geographical expansion for new markets.
• Logistics cost shall be a problem for exporting to far places in big quantities. Also, new greenfield plants shall be costlier than increasing existing capacity. It will be interesting to see what management does to overcome the dilemma.
• I do not see any existential problems for this company for the next 5 years. However, without new products or new geographies or low-cost capacity additions, sustainable high growth period will be impossible.
• As per my rough calculations(after swallowing management guidance in numbers), Net Profit should be somewhere around Rs.50-60 Crores for FY21-22 which makes it a doubling candidate in market cap by then based on current P/E. Based on basic DCF done in a piece of paper (It doesn’t matter whether we use fancy excel or a piece of paper as long as logic is the same), I believe current price after in 3 years discounted terms could be anywhere between 720 to 1500 (i.e. Intrinsic Value having 5% downside to up to 100% upside from current price).

Key Risk Analysis:

1. This stock is a small cap stock. We should expect liquidity troubles.
2. I do not see any existential problems for this company for the next 5 years. However, without new products or new geographies or low-cost capacity additions, sustainable high growth period will be impossible.
3. Any levels of auto slowdown should affect this company
4. I have written this article with a biased attitude in favour of the management.