Maithan Alloys | A Multi-bagger in the Making

Maithan Alloys Ltd is engaged in the production of manganese alloys. It mainly produces Ferro Silicon and Silica Manganese. 


COMPANY OVERVIEW

Ferro alloy refers to various alloys of iron with a high proportion of one or more other elements such as manganese, aluminium, or silicon. They are used in the production of steel and alloys. The alloys impart distinctive qualities to steel and cast iron or serve important functions during production and are, therefore, closely associated with the iron and steel industry, the leading consumer of ferro alloys. They mainly enhance steel strength, durability, anti-corrosion and anti-stain properties and acts as de-oxidant in steel.


  • Ferro Manganese - An alloy of iron and manganese: Used in steel products wherein silicon content needs to be controlled at low levels, Used in flat steel, manganese-rich steel and stainless-steel manufacturing

  • Silicon Manganese - An alloy of silicon and manganese: Cost-effective blend of silicon and manganese, Consumed in all steel products. Used in higher quantities in 200 series stainless steel, alloy steel and manganese steel

  • Ferro Silicon - An alloy of iron and silicon: Silicon acts as a steel oxidant, used primarily in special steels and in small quantities in mild steel, Revenue is evenly spread between domestic and export with major export to Asia pacific except China



The most important raw material for Maithan Alloys Ltd is Manganese ore. They import manganese ore mainly from Africa and Australia apart from minor local procurement. Procurement of raw material is one key risk identified as it is in the hands of a very few suppliers which can disrupt the supply of raw material at any point of time.


I've taken some great points from https://forum.valuepickr.com/t/maithan-alloys-ltd/1036/208 (mentioned by Saurabh Kumar) for my analysis. He has done a fantastic research on the business. Highly recommend to check that out.


Key Points

  • Maithan Alloys chose to manufacture niche low carbon/low phosphorus grades that would hypothetically move the slowest, unlike other alloy makers who work in commodity grades that move the fastest. But by doing so it creates relatively good competence for itself.

  • Most companies first secure their resource needs through direct mine ownership. Maithan Alloys refrained from securing their resource needs through direct mine ownership and thus remained asset-light, liberated itself from being tied down to a singular ore source, worked with various mine owners, mobilized the best resource mix and enjoyed the best trade terms.

  • Most alloy companies would have invested in captive power generation capacity and reduced production costs. Over the years Maithan Alloys emphasized more on its core competence of making a superior end-product.

  • Maithan Alloys has always been able to derive operational efficiencies by keeping capacity utilization to optimum levels, the latest figure being 95% CU in FY19.



MANAGEMENT

The company is led by Mr. S C Agarwalla and his two sons – Mr. Subodh Agarwalla and Mr. Sudhanshu Agarwalla. Both sons seem to have decent education background from prestigious universities and have been totally involved in business with Mr. S C Agarwalla. We have performed a background check on the management and we did not find any case of fraud associated with them.


The salary structure of the management is more on the variable side and is heavily linked to performance of the business which is reassuring. Although, we did find the salary structure to be bit on a higher side than compared to peers but it was not alarming.



VALUATION

We are yet to understand why the company is so heavily undervalued by the investing community. For starters, let us compare what our valuation models give the fair value of the company vs what the investing community is valuing them at:

Disclosure: We bought the company when it came into our radar back in 2016 for a little extra premium over our fair value and sold a good portion in Feb 2018 when the premium became too high to sustain. We still hold the stock and are trying to accumulate around Rs. 350 as of 1st April 2020.


The BLUE line represents the market price of the share over 10 years and the YELLOW line indicates the lower side of the fair value range at which we are most comfortable at buying the stock. As you see, this stock was highly undervalued till 2016 after which it zoomed from Rs. 40 to Rs. 1000 in just 4 years. Why such a sudden realisation?!



FINANCIAL OVERVIEW

Asset Structure represents the break up of asset side of the balance sheet. We notice that the company 'Investments' shot up in FY 2018 and FY19. This is mainly because the company has around Rs. 600 cr left idle to invest for further expansion of the business. They are currently looking for opportunities and are also planing to start production of 'Chrome Alloys'. It has been assured during recent con-call that this amount will be declared as dividend if suitable investment opportunities are not found in next 8-10 months.


We always follow the practise of dividing reported revenues of the company into 2 parts, one being Core Earnings which is coming through core operations of the business and the other being Other Income which comes through non-core activities like dividend income, gain from forward contracts, interest income etc. Here, we are very skeptical as well as conservative of including Other income into our valuation numbers. We are not saying that companies have high other income are bad, we are just saying that most of other income (except interest income and other income) are non-scalable and non-sustainable and are more prone to manipulation. Maithan Alloys is reporting around 90% core earnings which is excellent.


  • MANIPULATION CHECK

If you notice 'Cash Generated from Operations / Operating income' which essentially checks whether company is actually generating cash over reported PNL or not. Here, Maithan Alloys is mostly reporting it as 1 which is an excellent number and tells us that the probability of manipulation is low You can manipulate PNL but it's very difficult to manipulate the cash flow statement. Please note that this is just a glimpse of a broader check we perform to determine whether the company is engaged in manipulation or not.


Maithan Alloys have 13% of total assets as contingent liabilities which is little bit on the higher side. Although, we have checked and noted that their contingencies rarely turn into losses from them. Moving forward to Return on Assets (normalised), which is a number which we calculate using our own formulated methods we see that the RAO has increased recently in FY19 and FY18 suggesting we are in the upward cycle of this cyclical industry. Even the profit margins have been improving mainly on account of lower employee cost % and raw material cost %. Expecting the margins to normalise and come down to about ~15%. Debt / Equity is negligible now. 


The company mainly incurs variable cost as compared to fixed costs which assures us that although the company might face losses at bad times (like today - Coronavirus) but the company can to an extent cut down on their expenses. One key concern is that the margins being thin, it increases the probability of the company facing losses during bad times.


All in all, we like the company as it meets our stringent set of criteria of being a quality business with a quality management. It is a good bargain at prevailing prices and we are actively monitoring the stock for the long term.



Summary

The Good - The company has built a strong hold in the niche business domain of ferro alloys and now is a market leader in their product. They have operational advantage over their competitors and is capable of taking hits better than the competitors. They are currently having excess cash waiting to be deployed for business expansion.


The Bad - Company is still into cyclical business having highly volatile margins. When the tide turns, it would be the strongest who survives. Low profit margins won't give cushion during bad times. Threat of increasing competition from Malaysia and Indonesia is there. Suppliers are concentrated and Maithan Alloys is dependent on them.



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