VESUVIUS INDIA LTD

Revising to Accumulate

Analyst Rajiv Bharati

rajiv.bharati@destimoney.com 022-6788-5803

July 4, 2013

Vesuvius India Ltd ACCUMULATE with 10% upside

ACCUMULATE
TARGET : `402 CMP : `365

Key Data Ticker (Bloomberg) NSE Code BSE Code Sector Industry Face Value (`) Book Value per share (`) Dividend Yield (%) 52 Week Range (`) Market Cap. (` mn.) VI VESUVIUS 520113 Refractory Other Industrial Goods 10 169 1.2% 310-390 7,409

(In ` mn) Net Sales EBITDA EBITDA Margin EPS (`) EV/Sales EV/EBITDA P/E (x) Price Performance Absolute Relative

CY11 5,403 887 16.4% 25.0 1.2 7.5 14.6 CY10 53.0% 35.0%

CY12 5,623 955 17.0% 27.5 1.2 7.0 13.3 CY11 -6.5% 18.2%

CY13E 6,143 1,063 17.3% 31.2 1.1 6.3 11.7 CY12 7.7% -20.0%

CY14E 6,850 1,185 17.3% 34.8 1.0 5.6 10.5 YTD 9.1% 10.3%

Shareholding Pattern as on 31 Mar 2013

Mar-13 Promoters FII DII Bodies Corporate Others Total 55.6% 10.7% 14.8% 3.3% 15.6% 100% Dec-12 55.6% 10.5% 14.8% 3.2% 15.9% 100% Sep-12 55.6% 10.4% 15.7% 3.3% 15.0% 100% Jun-12 55.6% 10.4% 16.0% 3.2% 14.8% 100%

Relative Stock Performance (Jul12=100)

120 110 100 90 80 Jul-12 Sep-12 Nov-12 Vesuvius Jan-13 Mar-13 May-13 Jun-13 NIFTY

Source: Company, Bloomberg, Destimoney Research

Weaker trends on topline and rising raw material cost remains cause of concern
Vesuvius India Limited has consistently edged out competition by its technological leadership position in its product and services portfolio even in the current weak demand scenario. It leverages its parents leadership in flow control systems and isostatically pressed refractories, filters, feeding systems and fused silica crucibles. Despite representing a fraction (1%-3%) of the customers total production cost in steel manufacturing, it seem to get squeezed during slack demand period. The current phase represents a similar period which is further impacted by excess capacity globally. Vesuvius recorded fourth consecutive quarter of low single digit YoY growth preceded by robust performance of over 15% growth in the past. During Q1CY13, its revenue grew by 4.56% to `1,444 mn. On an annual basis the company witnessed drop (-1%) in volumes in the consistently performing monolithic category. Cost control measures and lower growth in relatively lower margin unshaped refractory (monolithics) resulted in restoration of margin profile during the prevailing lean period. In Q1CY13, Vesuvius recorded smart operating margin of 20.2% and net margin of 12.2%. Vesuvius dependence on imported raw material has risen in past few years which could be detrimental in the prevailing sharply depreciating rupee regime. In CY12, imported raw material forms 22.4% of gross sales as against 20.1% in CY11. Vesuvius is strongly placed against its peer companies based on its better asset utilization (fixed asset turnover of 2.8 vs 1.0 for peers). Strong balance sheet, zero debt and steady cash generation justifies the premium valuation it commands vis--vis its peers. Considering its high dependence on steel industry, we expect the current lean patch to impact its performance for a couple of more quarters. Recent push by the govt to fast track the pending projects and clearing bottlenecks is a heartening sign for revival of demand. We remain cautious towards pickup in infrastructure and construction activity in the economy and hence revise our rating on VESUVIUS LTD to ACCUMULATE and a target price of `402 per share.

Cost control has been key in maintaining the margin profile

Quarterly Performance
P a rt ic u la rs ( ` mn ) Net Sales Other Op. Income Total Income Total Expenditure Operating Profit Other Income EBITDA Depreciation EBIT Interest EBT Tax PAT Margins(%) OPM NPM (incl. Extraordinaty Items)
Source: Company

Q1CY13 1,444.4 1.4 1,445.8 1,153.4 292.4 9.8 302.2 41.0 261.2 (0.2) 261.4 84.8 176.6 20.2% 12.2%

Q1CY12 1,381.4 12.6 1,394.0 1,186.8 207.2 4.2 211.4 40.2 171.2 2.0 169.2 55.6 113.6 14.9% 8.1%

% Change 4.6% 3.7% -2.8% 41.1% 43.0% 2.0% 52.6% 54.5% 52.5% 55.5%

Q4CY12 1,535.1 0.3 1,535.4 1,238.7 296.7 7.1 303.8 41.1 262.7 5.5 257.2 85.5 171.7 19.3% 11.2%

% Change -5.9% -5.8% -6.9% -1.4% 38.0% -0.5% -0.2% -0.6% 1.6% -0.8% 2.9%

CY12 5,623.4 5,623.4 4,668.2 955.2 35.2 990.4 163.5 826.9 0.6 826.3 268.7 557.6 17.0% 9.9%

Low single digit YoY topline growth in the fourth consecutive quarter is worrisome for Vesuvius which continue to feel the pressure of slowing demand from construction and infrastructure sector and delay in capex from corporates.

Vesuvius topline growth shadows GDP particularly industrial metals, reflecting disappointing performance in the recent past
Vesuvius annual sales growth closely follows GDP growth rate which implies further stress on topline
44% 33% 22% 11% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 12% 9% 6% 3% 0% 0% -20% Dec-08 Dec Dec-09 Dec Dec-10 Dec Jun-11 Jun Dec-11 Dec Jun-12 Jun Jun-08 Jun Jun-09 Jun Jun-10 Jun Dec-12 Dec

Quarterly growth sales growth is highly correlated with IIP (metals) growth
60% 40% 20%

Vesuvius annual sales growth (LHS) India GDP Growth (RHS)

India Steel Production Growth (LHS)

Vesuvius Quarterly Sales Growth (YoY)

IIP (metals) YoY growth

Source: Company, Bloomberg, CSO

Vesuvius, which derives 70%-75% of its demand from steel sector, which in turn is dependent on manufacturing and construction activity in the economy, has been witnessing the slowdown in the demand and investment driving activities in the economy. The economy is struggling to get back to its high growth ways amidst challenging global macroeconomic scenario. This is further accentuated by slow moving clearances in infrastructure projects domestically.

Deteriorated steel sector outlook does not infuse much confidence

Steel industry globally is reeling with overcapacity which was built in response to the growing demand on the back of the macroeconomic stimulus measures taken by central banks all over. Currently the world steel capacity stands at 2 bn MT while the consumption stands at 1.45 bn MT. China with over 160 mn MT capacity surplus is a major overhang on the Asian steel demand-supply scenario. Pressure on profitability of Steel companies is detrimental to OEMs like Vesuvius. Steel majors are struggling to manage the high raw material cost domestically due to restriction on mining and limited ability to pass on the higher cost due to subdued demand from end-user industries. The margin pressure is higher on producers with no captive mining. Despite softening of Iron ore prices globally, domestic prices are still ruling high due to regulatory intervention in various states, which in long term bode well for the industry but will be deterrent in the short-to-medium term. Meanwhile, NMDC has shifted to import price parity for selling iron ore to domestic players thereby acerbating the already challenging scenario.

as Asian countries continue to produce at reasonable clip as other markets stem supply by reducing production
Geography wise steel production trend
1 tonne of steel = 12 kg of Refractories
EU (in mn MT)
220 180

North America (in mn MT)

150 120 90 60 2000 2003 2006 2009 2012

140 100 2000 2003 2006 2009 2012 1200

Asia & Oceania (in mn MT) India (in mn MT)

800 400 0 2000 2003 2006 2009 2012

89 64 39 14

South America (in mn MT)

51 44 37 30 2000 2003 2006 2009 2012 34 28 22 2000 2003 2006 2009 40

2000

2003

2006

2009

2012

Africa & ME (in mn MT)

2012

Source: Steel Statistical Yearbook-2012

which might put pressure on margins across the value chain

World Steel Association forecasts output to grow by 2.9% in 2013 following 1.2% growth in 2012. Chinas growing steel output in the face of dwindling demand domestically has resulted in flooding of Chinese steel in global market, thereby bringing the prices down. World crude steel production
Rank 1 2 3 4 5 6 7 8 9 10 Country China Japan Russia US India South Korea Germany Ukraine Brazil Turkey YoY growth in Jan-May 2013 9.60% 1.25% 1.12% -7.15% 5.24% -5.65% -0.64% -2.36% -3.10% -4.06% YoY growth in 2012 3.73% -0.33% 2.71% 2.73% 6.25% 1.24% -3.67% -6.85% -1.37% 5.22% Production (mn MT) 2012 708.8 107.2 70.6 88.6 76.7 69.3 42.7 32.9 34.7 35.9 585 Sep-12 Aug-12 Apr-12 Dec-12 May-12 Mar-12 Nov-12 Feb-13 Feb-12 Oct-12 Jan-12 Jun-12 Jan-13 Jul-12 765 720 675 630

World Steel Prices in $ per Tonne (Hot Rolled Coil)

Four of the five top producers by volume has seen positive growth in first five months of CY13, which could further pressurize margins as supply increase
Source: World Steel Association, Steel Statistical Yearbook-2012, Bloomberg

Micro-structural changes in raw material has resulted in lower refractory consumption per unit of final product manufacturing over the years
Refractory used in Kg per Ton over the years has come down Innovation in raw material engineering of refractories has resulted in creation of more resistant refractory varieties which require lower maintenance. It has also reduced in the amount of refractory consumption for each unit of steel produced. Vesuvius Plc (Parent) has been in forefront in adopting such technological changes.
1980s Steel Industry 2000s Glass Industry

36

24

12

Global Refractory Market (by volume in mn MT)

56 42 28 14 0 2011 Source: Industry Data 2016

Global Refractory Market (by value in $bn)

56 42 28 14 0 2011 2016

Volatility in the forex market might also have a bearing on margins

Managing the dependence on imported raw material will remain a challenge

28% 21% 14% 7% 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Rising proportion of imported raw material as percentage of gross sales in the current forex situation will be a stress on bottom-line

Sharp depreciation in rupee

60 58 55 53 50 Nov-12 Dec-12 Sep-12 Feb-13 Oct-12 Jun-12 May-13 Mar-13 Aug-12 Apr-13 Jun-13 Jan-13 Jul-12

Imported RM as % of Gross Sales Source: Company, Bloomberg

` per $

Management indicated companys policy of not pushing to increase exports or develop new markets, as it is taken care by associate companies, hence Vesuvius stands exposed to the forex fluctuations in the current volatile environment. Exports of raw material from China are subject to restrictions such as various forms of supplimentary fees and taxes, export quota, and auctioning of export liceses to domestic bidders only. None of these are levied on exports of finished products hence making it impossible for other producers to compete against Chinese counterparts. Recent sharp depreciation in Indian Rupee has given protection to domestic manufacturers against cheaper imports especially from China.

10

Although being cash generative across cycles, Vesuvius has been conservative in paying dividends despite having strong balance sheet
Book value per share has grown smartly
200 150 100 50 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 40 30 20 10 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2012

...and so has cash per share

Book Value Per Share

Cash per Share

Royalty payments continue to remain close to historical levels

3.4% 2.8% 2.2% 1.6% 1.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

while the company has been conservative in dividend payout

42.0% 34.0% 26.0% 18.0% 10.0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Royalty % of Net Sales Source: Company, Destimoney Research

Dividend Payout %

11

Firmly placed against competitors hence commands premium valuation

Operating Margin
32% 24% 16% 8% 0% 2008 IFGL 2009 OCL 2010 2011 2012 Vesuvius 50% 38% 25% 13% 0% 2008 IFGL 2009 OCL

ROE
48% 36% 24% 12% 0% 2010 2011 2012 Vesuvius 2008 IFGL 2009 OCL

ROCE

2010

2011

2012 Vesuvius

Orient Abrasives

Orient Abrasives

Orient Abrasives

Fixed Asset Turnover

3.4 2.7 2.0 1.3 0.6 2008 IFGL 2009 OCL 2010 2011 2012 Vesuvius 1.8 1.4 1.0 0.6 0.2 2008 IFGL

EV/Sales
8.0 6.5 5.0 3.5 2.0 2009 OCL 2010 2011 2012 Vesuvius 2008 IFGL

EV/EBITDA

2009 OCL

2010

2011

2012 Vesuvius

Orient Abrasives

Orient Abrasives

Orient Abrasives

Source: Company, Ace Equity, Destimoney Research

12

Government efforts to shore up the economy seem a heartening sign for the sector

Fast-tracking 23 projects estimated to generate 23000 MW, stalled on fuel linkage ground 1600 km power transmission line in central India

Dispute Resolution Bill to have fast-track mechanism to resolve PPP disputes `231 bn Mumbai metro line-3 project

` 8,454 mn iron ore handling project at Vishakhapatnam `380 bn project under PMGSY to connect 82 naxal affected districts

13

We revise our rating to ACCUMULATE with a target price of `402 per share

Considering its high dependence on steel industry, we expect the current lean patch to impact its performance for a couple of more quarters. Recent push by the govt to fast track the pending projects and clearing bottlenecks is a heartening sign for revival of demand. The stock is trading at 11.7 and 10.5 times its CY13E and CY14E earnings. We revise our rating on VESUVIUS LTD to ACCUMULATE and a target price of `402 per share.

Relative Stock Performance (Jul12=100)

120 110 100 90 80 Jul-12 Sep-12 Nov-12 Vesuvius Jan-13 Mar-13 May-13 Jun-13 NIFTY

CY11 EPS (`) CEPS (`) P/E (x) P/B (x) ROE ROCE EV/EBIDTA (x) 25.0 32.2 14.6 2.5 17.0% 24.3% 7.5

CY12 27.5 35.5 13.3 2.2 16.2% 22.6% 7.0

CY13E 31.2 40.0 11.7 1.9 16.1% 22.1% 6.3

CY14E 34.8 44.6 10.5 1.6 15.6% 21.5% 5.6

Source: Destimoney Research, Bloomberg

14

Financial Summary

(In ` m n) Net Sales Operating expense EBIDTA Depreciation EBIT Interest EBT Other Income PBT Tax

CY11 5,403 4,515 887 147 741 6 735 47 781 275

CY12 5,623 4,668 955 164 792 1 791 35 826 269

CY13E 6,143 5,081 1,063 179 884 884 61 946 312 634

CY14E 6,850 5,665 1,185 199 986 986 69 1,055 348 707

(In ` m n) Liabilities Equity Share Capital Reserves & Surplus Deferred Tax Liability Current Liabilities (CL) Long Term Provisions Total

CY11

CY12

CY13E

CY14E

203 2,778 64 1,118 62 4,224

203 3,230 76 1,027 68 4,603

203 3,743 76 1,126 68 5,215

203 4,315 76 1,255 68 5,917

Assets Total Fixed Assets Current Assets (CA) Total 1,523 2,701 4,224 1,564 3,040 4,603 1,384 3,831 5,215 1,484 4,433 5,917

PAT Margins Sales Growth % Operating Margin % Net Margin %

506

558

22.8% 16.4% 9.4%

4.1% 17.0% 9.9%

9.2% 17.3% 10.3%

11.5% 17.3% 10.3%

Source: Company, Destimoney Research

15

Key risks & challenges

Fluctuations in raw material and energy cost. Delay in capacity addition may result in performance below our expectation. Being directly pegged to Steel sector, any downward fluctuation in demand will directly impact the refractory business. Poor negotiation power of the industry as a whole. Refractory makers gets squeezed between raw material suppliers and steel makers. Pressure from cheaper refractory imports from China. Hiring and retaining skilled manpower Adverse political or regulatory developments Fluctuation in exchange rate.

16

Destimoney Securities Private Limited

6th Floor, " A" Wing , Tech-Web Centre, New Link Road, Oshiwara , Near Behram Baug, Jogeshwari (West), Mumbai - 400102

Disclaimer: In the preparation of the material contained in this document, Destimoney* has used information that is publicly available, as also data developed in-house. Some of the material used in the document may have been obtained from members/persons other than Destimoney and which may have been made available to Destimoney. Information gathered & material used in this document is believed to be from reliable sources. Destimoney has not independently verified all the information and opinions given in this material. Accordingly, no representation or warranty, express or implied, is made as to the accuracy, authenticity, completeness or fairness of the information and opinions contained in this material. For data reference to any third party in this material no such party will assume any liability for the same. Destimoney does not in any way through this material solicit or offer for purchase or sale of any financial services, commodities, products dealt in this material. Destimoney and any of its officers, directors, personnel and employees, shall not be liable for any loss or damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, as also any loss of profit in any way arising from the use of this material in any manner. The recipient alone shall be fully responsible, and/or liable for any decision taken on the basis of this material. All recipients of this material before dealing and/or transacting in any of the products advised, opined or referred to in this material shall make their own investigation, seek appropriate professional advice and make their own independent decision. This information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject Destimoney or its affiliates to any registration requirement within such jurisdiction or country. This information does not constitute an offer to sell or a solicitation of an offer to buy any financial products to any person in any jurisdiction where it is unlawful to make such an offer or solicitation. No part of this material may be duplicated in whole or in part in any form and / or redistributed without the prior written consent of Destimoney. This material is strictly confidential to the recipient and should not be reproduced or disseminated to anyone else. Names such as Teji Mandi, Maal Lav, Maal Le or similar others for market calls and products are merely names coined internally and are not universally defined, and shall not be construed to be indicative of past or potential performance. Recipients of research reports shall always independently verify reliability and suitability of the reports and opinions before investing. *"Destimoney" means any company using the name Destimoney as part of its name.

17