20 October 2011 Initiating Coverage | Sector: Metals

Rain Commodities

Strong cashflow

Robust demand

Secured inputs

Sitting pretty
Pavas Pethia (Pavas.Pethia@MotilalOswal.com); +91 22 3982 5413 Sanjay Jain (SanjayJain@MotilalOswal.com) / Tushar Chaudhari (Tushar.Chaudhari@MotilalOswal.com)

Rain Commodities

Rain Commodities: Sitting pretty

Page No. Summary .............................................................................................................. 3 CPC business in a sweet spot .............................................................................. 5 Operating margins to remain robust ................................................................... 6 Strong cash flows to help deleverage balance sheet ........................................ 10 Worst is behind in cement business .................................................................. 12 Valuations compelling; deserves re-rating ....................................................... 13 Key risks ............................................................................................................ 14 Company description ......................................................................................... 15 Corporate restructuring: separating carbon and cement operations .............. 19 Financials and valuation .................................................................................... 20

20 October 2011

Initiating Coverage Sector: Metals

Rain Commodities
BSE SENSEX S&P CNX

16,748

5,038

CMP: INR29
Sitting pretty

TP: INR68

Buy

Strong operating margins, robust demand, compelling valuations

Bloomberg Equity Shares (m) 52-Week Range 1,6,12 Rel. Perf. (%) M.Cap. (INR b) M.Cap. (USD m) RCOL IN 354.2 42/25 5/6/6 10.3 208

Y/E Dec 2011E 2012E 2013E 53.5 10.7 4.9 13.8 -24.3 69.3 2.1 0.4 0.6 2.9 19.9 17.0 21.0 51.8 10.7 4.9 13.9 0.3 82.0 2.1 0.4 0.5 2.4 16.9 17.0 20.3

Sales (INR b) 54.5 EBITDA (INR b) 13.0 NP (INR b) EPS (INR) EPS Gr. (%) BV/Sh. (INR) P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) RoE (%) RoCE (%) RoIC (%) 6.5 18.3 95.6 56.5 1.6 0.5 0.7 2.8 32.3 22.5 25.4

RCOL's carbon business is in a sweet spot between aluminum smelters and oil refineries Increasing aluminum production is leading to strong demand for calcined petroleum coke (CPC) Difficulty in raw material sourcing is acting as an entry barrier for new players despite reasonable margins Strong cash flows to help deleverage balance sheet Cement margins improving with better market discipline and declining pace of capacity addition Recent announcement that RCOL's board will consider buyback proposal highlights attractive valuation and robust operating cashflows We initiate coverage with a Buy and a target price of INR68 - 134% upside

CPC business in a sweet spot RCOL's carbon business is in a sweet spot between aluminum smelters and oil refineries. Merchant calciners like RCOL are making reasonable conversion margins, as green petroleum coke (GPC) does not contribute meaningfully to refineries' revenues and CPC does not contribute substantially to smelters' costs. At the same time, it is difficult for a new player to enter this business because sourcing raw material is a challenge. Operating margins to remain robust We expect operating margins to remain robust (27.2% in last 14 quarters) due to the following: Strong CPC demand driven by growing aluminum production: Aluminum smelting, which constitutes 83% of CPC demand has grown at a CAGR of 6% in the last 10 years. This has resulted in strong demand for CPC, which is used as consumable carbon anode (0.4/t of Al) in smelting process. The current growth rate in aluminum production will lead to demand for an additional 5.5mtpa of CPC by CY15. Consolidation in CPC industry: The top-5 calciners account for 50% of the global capacity (ex China). Major players will continue to focus on profitability and margins, given their high leverage and industry consolidation. Strategically located CPC operations: Three-fourths of RCOL's CPC capacity is in the US. The country is a net exporter of GPC due to large sweet crude refining. Three of RCOL's seven CPC facilities in the US are located next to refineries, giving them easy access to the key input, GPC. Raw material security through long-term contracts: RCOL's US operations are backed by long-term supply agreements with refiners. Its Indian operations also receive ~25% of their requirement via US relations. RCOL receives over 90% of its supplies from refiners with whom it has a relationship of more than five years.

Shareholding pattern % (Jun-11)

Others 23.1 Promoters 42.4

Foreign 16.9 Domestic Inst, 17.6

Stock performance
Rain Commodities Sensex - Rebased 42 37 32 27 22 Jul-11 Jan-11 Oct-10 Apr-11 Oct-11

20 October 2011

Rain Commodities

Strong cash flows to help deleverage balance sheet We expect RCOL to generate operating cash flows of USD367m over CY11-13. This along with cash balance of USD80m at the end of CY10 is more than sufficient to take care of its scheduled debt repayment of USD180m(including 1HCY11) and capex of USD62m for US WHRB energy projects in the next three years. Net debt to equity ratio is likely to come down to 0.5x in CY13 from 2x in CY10. Worst is behind in cement business After substantial margin contraction in CY10, cement producers are exercising better market discipline. As the pace of capacity addition slows down in South India, we expect margin pressure to ease. RCOL's cement margins have improved from INR366/ton in CY10 to INR1,011/ton in 1HCY11. Buyback proposal highlights attractive valuation RCOL recently announced that the board of directors in the meeting to be held on 25th October 2011 will consider the proposal to buy back the equity shares of the company. The buyback proposal highlights that the company trades at an attractive valuation and robust operating cashflows are more than sufficient for its debt repayment. Valuations compelling; deserves re-rating We believe that the strong cash flows of the carbon business are sustainable, given RCOL's robust business model, favorable demand scenario and relative security of inputs. Valuations are compelling; we expect the stock to get re-rated, as the balance sheet gets deleveraged and direct equity returns in the form of dividends/buy-back are stepped up. We initiate coverage with a Buy recommendation and a target price of INR68. We value RCOL's carbon operations (CPC, energy and pet coke trading) at an EV of 4x CY12E EBITDA (Implies EV/ton of USD293/ton) and cement operations at an EV of 5x CY12E EBITDA (Implies EV/ton of USD65/ton).

CPC comparative valuations

Deals/ Companies Oxbow - GLC Rain - CII PCIC-Oxbow Goa Carbon Year 2007 2007 2010 Valuation based on FY11 numbers EV/Ton 384.9 328.4 914.1 157.7 EV/EBITDA (x) 9.2 8.0 Remarks

Favorable supply agrrement and above industry average operating margins Low operating margin ~7.9% (FY11) as compared to RCOL's CPC business operating margin of 24.3% (CY10) Source: Company/MOSL

Comparative Valuations: Midcap

RATING CMP MCAP (INR) (USD M) FY11 EPS (INR) FY12E FY13E 37.1 49.9 15.4 61.6 13.7 48.1 9.2 18.3 20.2 56.0 55.9 18.8 70.7 19.9 59.4 7.0 13.8 21.1 P/E (x) FY12E FY13E 13.0 2.2 8.1 4.9 3.9 6.8 10.5 1.6 2.4 8.6 2.0 6.7 4.3 2.7 5.5 13.8 2.1 2.3 EV/EBITDA (x) FY12E FY13E 14.4 3.0 9.3 1.7 5.8 8.8 7.4 2.8 2.5 9.6 3.5 6.6 0.9 4.8 8.0 7.9 2.9 2.3 P/BV (x) FY12E FY13E 1.3 1.2 0.5 0.4 0.5 0.5 0.8 0.7 0.6 0.5 1.0 0.9 0.6 0.6 0.5 0.4 0.3 0.3 Source: MOSL

Monnet Ispat Neutral 484 697 43.7 Godawari Buy 111 78 27.0 Sarda Energy Neutral 125 95 19.1 Tata Sponge Buy 302 104 65.8 Adhunik Metaliks Buy 53 144 14.9 Bhushan Steel Neutral 327 1,554 44.9 Jai Balaji Buy 97 137 12.2 Rain Commodities* Buy 29 208 9.3 Prakash Industries Buy 49 145 19.9 CMP=current market price; * CY reporting * Rain Com. follows calendar year reporting, CY11 and CY12 figures

are quoted in place of FY12 and FY13 respectively

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Rain Commodities

CPC business in a sweet spot

RCOL's carbon business is in a sweet spot between aluminum smelters and oil refineries. Merchant calciners like RCOL are making reasonable conversion margins, as green petroleum coke (GPC) does not contribute meaningfully to refineries' revenues and calcined petroleum coke (CPC) does not contribute substantially to smelters' costs. It is difficult for a new player to enter this business because sourcing raw material is a challenge.

GPC contributes less than 3% to the refiner's overall revenue; similarly, CPC contributes 7% of the total cost of production of aluminum

Insignificant contribution of GPC/CPC to refineries' revenues/smelters' costs GPC contributes less than 3% to the refiner's overall revenue and needs to be extracted through further processing of residual fuel. Similarly, CPC contributes 7% of the total cost of production of aluminum. Aluminum smelters are more concerned with the quality of CPC than its cost, as inferior quality results in higher energy consumption. In order to adhere to consistent quality and assured supply smelters prefer merchant calciners as captive production is exposed to varying availability and quality of raw material. Most of the industry participants including the two largest calciners RCOL and Oxbow are based on merchant caclining model.
CPC industry participants
Aluminium Smelter 9%

CPC as percentage of aluminum production cost

10% 8% 6% 4% 2% FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Refinery 25%

Merchant Calciner 66%

Source: MOSL

Source: Company

The supply of CPC is constrained by limited availability of key raw material, GPC

Constrained raw material availability a significant entry barrier Currently, the supply of CPC is constrained by limited availability of key raw material, green petroleum coke (GPC). Though it is a conversion business, consolidation in the industry and bargaining power of CPC producers due to limited supply of CPC ensures reasonable margins. It is difficult for a new player to enter this business because sourcing raw material is a challenge.

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Operating margins to remain robust

We expect operating margins for RCOL's CPC business to remain robust (27.2% in last 14 quarters) due to the following: (1) strong CPC demand driven by growing aluminum production, (2) consolidation in CPC industry, (3) strategically located CPC operations, and (4) raw material security through long-term contracts.

Aluminum smelting, which constitutes 83% of CPC demand, has grown at a CAGR of 6% in the last 10 years, driving CPC demand

1. Strong CPC demand driven by growing aluminum production Aluminum smelting, which constitutes 83% of CPC demand, has grown at a CAGR of 6% in the last 10 years. The growth in aluminum smelting has been led by China, whose overall share has increased from 12% to 40% during the last decade. This has resulted in strong demand for CPC, which is used as a consumable carbon anode (0.4t/t of Al) in the smelting process. After aluminum, the titanium-dioxide industry is the other major consumer of CPC. It is also consumed as a recarburizer in graphite electrode and other industrial uses. The current growth rate in aluminum production will result in additional demand of 5.5mtpa of CPC by CY15. China and India, due to their population, industrialization, and economic growth, would be strong drivers for aluminum demand.
Rising aluminum production fuelling CPC demand
TiO2 Others

CPC by end use

Aluminium

44
5%

million tons

12%

39 33 28 22

83%

Source: Company

Source: IAI/MOSL

Aluminum production growth led by Asia

2001 2010 16.1

m tons

4.7 1.7 5.2 North America 2.3 2.0 Latin America 2.2

5.2 3.9

3.8 3.7

4.3 2.3 2.1 Oceania 3.4 China

Source: IAI/MOSL

1.4 Africa

Western Europe

Asia (ex China)

Eastern Europe

2011E

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

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Increasing demand from smelters has led to higher realization and better margins

Increasing demand from smelters has led to higher realization and better margins. CPC prices and margins lag demand by a couple of months due to semi-annual price resets in CPC sales contracts. Current prices are set with a view of the next six months' demand. Though the world economy nosedived in the second half of CY08, realizations continued to be higher, as prices were negotiated in the first half of CY08. Similarly, despite recovery in aluminum production in the second half of CY09, price realizations and margins started to improve from 3QCY10. With current aluminum production touching an all-time high, we expect better margins and realizations, going forward. We believe that EBITDA margins of ~USD100/ton (USD80/ton in CY10; USD132/ton in 1HCY11) are sustainable.
Aluminum quarterly production v/s RCOL's CPC realization and EBITDA (USD/ton)
Al Prod. Wolrd - RHS 600 450 300 150 0 1QCY8 2QCY8 3QCY8 4QCY8 1QCY9 2QCY9 3QCY9 4QCY9 1QCY10 2QCY10 3QCY10 4QCY10 1QCY11
220 Alcoa

CPC Realization

CPC EBITDA 11.4 10.6 9.7 8.9 8.0

Source: Company/MOSL

The CPC industry is fairly consolidated, with the top-5 calciners accounting for 50% of the global capacity (ex China)

2. Consolidation in CPC industry The CPC industry is fairly consolidated, with the top-5 calciners accounting for 50% of the global capacity (ex China). The top-2 calciners, RCOL and Oxbow have large debt, courtesy Rain-CII and Oxbow-GLC leveraged buyouts in 2007. Given the high leverage and fair amount of consolidation, the large players have been focusing on margins and profitability which is expected to continue going forward. Merchant calciners like RCOL are reluctant to increase capacity utilization at the cost of margins. Any increase in utilization will lead to higher prices of GPC, a scarce commodity, thereby impacting margins.

Top-10 CPC producers (ex China and Russia)

2,495 2,422

Thousand tons

1,493 1,076 600 500 498 355 350 300 240 GoaCarbon

Rain CII

Conoco Phillips

Petrocoque

PCIC

BP

RTA

Manyar Group

Oxbow

Alba

Source: Company/MOSL

Bsid

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Rain Commodities

Major consolidation moves in CPC industry since 2007

Deal Oxbow acquisition of Great Lakes Carbon (GLC) Year 2007 Capacity MTPA 2.12 Remarks Oxbow acquired GLC by outbidding RCOL. Oxbow paid ~USD385/ton for the GLC acquisition. RCOL sold its 20% stake in GLC to Oxbow and received termination fees of ~USD15m from GLC in accordance with the terms of an earlier agreement between RCOL and GLC. RCOL acquired CII Carbon, USA at an aggregate purchase price of USD622.3m (USD328/ton, EV/EBITDA of 9.2x). RCOL has ~INR19b of goodwill on account of CII Carbon acquisition. Oxbow acquired 40.82% stake in PCIC for USD920/ton. PCIC enjoys superior operating margins compared to other calciners. It had assured GPC supply due to the agreement with Kuwait Petroleum Company (KPC) for 475,000-485,000 tons/year. Source: Company/MOSL

RCOL acquisition CII Carbon

2007

1.89

Oxbow acquisition of Petroleum Coke Industry Corporation (PCIC)

2010

0.35

Three-fourths of RCOL's 2.5mtpa CPC capacity is in the US, a net exporter of GPC

3. Strategically located CPC operations GPC a major input for CPC production is a by-product of sweet crude refining. The US has large sweet crude refining operations, making it a net exporter of GPC. Apart from US, China is the only other major region which is long on GPC. US has roughly one-fifth of the world's refining capacity and accounts for half the GPC production (ex China) worldwide. Three-fourths of RCOL's 2.5mtpa CPC capacity is in the US. Three of RCOL's seven CPC facilities in the US are located next to refineries, giving them easy access to GPC. All its seven facilities are also close to captive river terminals. This enables RCOL to reduce logistics costs and offset the high maintenance costs of old plants.
Petroleum coke production in 2008
USA, 19% RoW, 16% UK, 2%

Total Refining Capacity in 2009

ROW, 40%

China, 10%

Mexico, 2% Canada, 4%

Canada, 2% Saudi Arabia, 2% Italy, 3% Germany, 3%

Former USSR, 9% Japan, 5% India, 4% Korea, 3%

Brazil, 3% India, 4% Japan, 1% Russia, 1% China, 10%

Source: United Nations

USA, 57%

Source: IEA key world statistics

GPC production worldwide has been unable to match demand, resulting in a tight supply market

GPC production worldwide has been unable to match demand, resulting in a tight supply market. This is mainly due to the shift towards sour crude refining, whose residual petroleum is unsuitable for GPC production. The shift towards sour crude is on account of increasing sweet-sour spread and limited availability of sweet crude. About 70% of the world's remaining oil reserves consist of heavy, high sulfur "sour" crude. Increasing sweet-sour spread results in better margins in sour crude refining. Sweet-sour spread has been increasing, especially since 2005, as countries adopted stricter environmental norms, raising cleaner fuel prices (in this case, sweet crude with low metal and sulfur content). The spread declined to pre-2005 levels in 2009 due to sudden drop in crude demand in the backdrop of severe recession. However the spread has been increasing since 2010 except for brief slump recently on current economic turmoil. The margins so far has been favoring sour crude refining limiting availability for GPC.
8

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With limited GPC availability, the industry is forced to substitute anode grade coke with NTAC

GPC supply-demand dynamics is not taken into account while deciding on the type of crude (sweet or sour) to be refined, as GPC contributes less than 3% of total refinery revenues. With limited GPC availability, the industry is forced to substitute anode grade coke with non-traditional anode coke (NTAC) to make up for the shortfall. NTAC is produced by blending high quality (low sulfur and metal) anode coke with inferior petroleum coke. Up to 20% of blending can be done using NTAC, with reasonable quality of final aluminum product.
Increasing sweet-sour spread (USD/barrel )
10.0 7.5 5.0 2.5 0.0 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Sweet-Sour Bloomberg index spread

Source: Bloomberg

RCOL's US operations are backed by long-term supply agreements with refiners

4. Raw material security through long-term contracts RCOL's US operations are backed by long-term supply agreements with refiners. Its Indian operations also receive ~25% of their requirement via US relations. RCOL gets over 90% of its supplies from refiners with whom it has a relationship of more than five years. It has right of first refusal over Conoco Phillips' worldwide GPC production minus its internal consumption till 2015. Given its multi-year relationships with refineries, RCOL is better placed than its competitors in terms of raw material security.
Long-term supply agreements
Major Suppliers ConocoPhillips Company Sinopec International Motiva Enterprise ExxonMobil Corporation Kuwait Petroleum Corporation Pertamina TCP Marathon Ashland Petroleum HUSKY KOCH CY 2010 % of Sourcing 32 17 12 7 5 5 4 4 3 2 Years of relationship Over Over Over Over Over Over Over Over Over Over 15 years 5 years 35 years 25 years 10 years 10 years 10 years 15 years 10 years 5 years Source: Company

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Strong cash flows to help deleverage balance sheet

CPC production is likely to remain flat at 1.9m tons in CY11 and CY12 due to constrained supply of GPC. Despite lack of volume growth, we expect RCOL to generate operating cash flows of USD367m in the next three years, which is more than sufficient to take care of its scheduled debt repayment of USD180m and capex of USD62m for US WHRB energy projects.

RCOL's CPC production is likely to remain flat at 1.9m tons in CY11 and CY12 due to constrained supply of GPC

Production to remain flat in CY11 and CY12 CPC production is likely to remain flat at 1.9m tons in CY11 and CY12 due to constrained supply of GPC, though RCOL will have some idle capacities. Currently, one kiln at Moundsville, West Virginia facility is not operational despite sufficient demand due to lack of GPC. Any volume growth can only be achieved through enhanced raw material availability. RCOL is trying to source more GPC from China, which is long on green coke. Recently it entered into one year supply agreement with Sinopec, China to supply ~.2mt of GPC. If similar breakthroughs can be achieved for larger volume and duration then production at US operations can be ramped, as supply from China can substitute GPC sourcing from the US for Indian operations. Expect operating cash flows of USD367m in next three years Despite lack of volume growth, we expect RCOL to generate operating cash flows of USD367m in the next three years. This is more than sufficient to take care of its scheduled debt repayment of USD180m and capex of USD62m for US WHRB energy project. In the next three years, we expect deleveraging to continue and debt-equity to decline to 0.5x. This is significantly below the debt-equity of 10x in 2007, immediately after the acquisition of CII Carbon. Post the refinancing of USD400m debt in November 2010, RCOL is comfortable in terms of its debt repayment schedule.
Declining debt to equity ratio (x)

We expect RCOL to generate operating cash flows of USD367m in the next three years, more than sufficient to take care of its scheduled debt repayment

10.0

4.2 2.3 2.0 1.3

0.8 CY12E

0.5 CY13E

CY07

CY08

CY09

CY10

CY11

Source: Company/MOSL

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Scheduled repayments
Period USD million 6M ending December 2011 11 2012 26 2013 122 2014 11 Later Years 480

Current debt profile (USD million)

Term debt profile as on June 30, 2011 Senior Bank Debt External Commercial Borrowings Senior Secured Notes High Yield Fixed rate Junior Subordinated notes Other Debt Sales tax deferment Total Gross Debt Debt 45 139 400 16 17 13 21 651 Profile Libor+350bp Libor+300bp 8.00% 11.13% 10% 10.66% 0% 6.61% Source: Company/MOSL

Comfortable in terms of debt repayment schedule post recent debt refinancing RCOL raised USD400m through 8% Senior Secured Notes (due in 2018) in November 2010. It used part of the amount raised to retire USD219m 11.125% Senior Secured Notes (due in 2015), with redemption premium and transaction fees amounting to USD35m. It also repaid ~USD105m low cost debt (LIBOR+353) as a precondition by lenders to issue new bonds. Taking redemption premium, transaction fees and current LIBOR into account, the company did not benefit financially from the refinancing (annual savings of USD2.4m against USD35m paid for redemption and fees). The major benefit from the refinancing was longer tenor debt (due in 2018 against 2015 for earlier notes) being issued on non-recourse basis (not on parent's books).

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Worst is behind in cement business

After substantial margin contraction in CY10, cement producers are exercising better market discipline. As the pace of capacity addition slows down in South India, we expect margin pressure to ease. RCOL's cement margins have improved from INR366/ton in CY10 to INR1,011/ton in 1HCY11.

Pricing discipline leading to margin recovery According to our cement analyst, "Cement demand is muted, especially in South India. However, experiences of cash losses have made the industry participants rational in their pricing approach. We believe that the worst pricing scenario is behind us. We expect prices to remain volatile, driven by seasonality and production behavior. However, we do not expect prices to correct as much as in 1HFY11. The pace of capacity addition in South India will slow down, as only 10-12mt of new capacity will commence operations over the next 18 months (v/s 30mt commissioning operations in the last 18 months). Current pricing discipline adopted by most of the producers is allowing for better margins and as the pace of capacity addition slows, margins and utilization should improve".
Cement prices improving in South on market discipline (INR/50kg)
330 290 250 210 170 Mar-06 Mar-07 Jun-06 Dec-06 Mar-08 Jun-07 Dec-07 Mar-09 Jun-08 Dec-08 Mar-10 Jun-09 Dec-09 Dec-10 Mar-11 Jun-10 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Jun-11

Source: MOSL

We believe that the worst is over for RCOL's cement business

Expect gradual recovery in pricing and utilization While we do not expect a sharp improvement in demand-supply equilibrium, we believe that the worst is over for RCOL's cement business. Current pricing discipline has resulted in lower utilization but with higher margins. This coupled with start of commercial operations of fly ash and packing plant should support margins, going forward. However, we have assumed lower margins than 1HCY11 for the rest of the year (INR893/ton for 6MCY11 and INR893/ton for CY12, against INR1,011/ton in 1HCY11 and INR341/ton in CY10) to account for coal price hike, seasonality and further capacity addition. We expect gradual recovery in pricing and utilization from CY12.

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Valuations compelling; deserves re-rating

We believe that the strong cash flows of the carbon business are sustainable, given RCOL's robust business model, favorable demand scenario and relative security of inputs. Valuations are compelling; we expect the stock to get rerated, as the balance sheet gets deleveraged and direct equity returns in the form of dividends/buy-back are stepped up. Recent announcement by the company that the board will consider buy-back once again implies compelling valuations and strong operating cash flows. We initiate coverage with a Buy recommendation and a target price of INR68. We value RCOL's carbon operations (CPC, energy and pet coke trading) at an EV of 4x CY12E EBITDA (USD293/ton) and cement operations at an EV of 5x CY12E EBITDA (USD65/ton).

RCOL will get re-rated, as the balance sheet gets deleveraged and direct equity returns are stepped up

Significant improvement in business prospects We believe that the strong cash flows from the carbon business are sustainable, given RCOL's robust business model, favorable demand scenario and relative security of inputs. The cement business is also witnessing a turnaround with better market discipline. Overall operating environment for both the carbon and cement businesses has improved substantially. Lack of growth, uncertain demand scenario due to recession and high leverage had led to a de-rating. However, we now expect stock to get re-rated, as the balance sheet gets deleveraged and direct equity returns (dividends/buy-back) are stepped up. Buyback proposal highlights attractive valuation RCOL recently announced that the board of directors in the meeting to be held on 25th October 2011 will consider the proposal to buy back the equity shares of the company. The buy back proposal highlights that the company trades at an attractive valuation and robust operating cashflows are more than sufficient for its debt repayment. Buy with a target price of INR68 - 134% upside The stock trades at 2.1x CY12E EPS, 0.4x CY12E BV, and at an EV of 2.9x CY12E EBITDA. We believe that current valuations are compelling. We value RCOL's carbon operations (CPC, energy and pet coke trading) at an EV of 4x CY12E EBITDA (Implies EV/ton of USD293/ton) and cement operations at an EV of 5x CY12E EBITDA (Implies EV/ton of USD65/ton). Buy with a target price of INR68 - 134% upside.

Robust operating cashflows are more than sufficient for its debt repayment

CPC comparative valuations

Deals/ Companies Oxbow - GLC Rain - CII PCIC-Oxbow Goa Carbon Year 2007 2007 2010 Valuation based on FY11 numbers EV/Ton 384.9 328.4 914.1 157.7 EV/EBITDA (x) 9.2 8.0 Remarks

Favorable supply agrrement and above industry average operating margins Low operating margin ~ 7.9% (FY11) as compared to RCOL's CPC business operating margin of 24.3% (CY10) Source: Company/MOSL

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Key risks
Overdependence on aluminum industry RCOL derives ~90% of its CPC revenues from sales of carbon anode to aluminum smelters. The aluminum industry is cyclical in nature, with demand-supply governed by a variety of factors, especially the economic wellbeing of the world as a whole. With its current debtequity at 1.6x and significant debt service obligations in the next couple of years, RCOL will be financially constrained in case of a major downturn in the aluminum industry. External sourcing of key raw material GPC is the main component and primary cost in CPC manufacturing. It is a by-product of oil refining and is not produced with a view to meet the requirements of aluminum or titanium dioxide manufacturers. With continuous shift towards sour crude refining, external sourcing of GPC could pose a serious threat to its operations. However, owing to its longterm relationships with suppliers, RCOL has not witnessed any major raw material shortfall so far. Substitutes/replacements Current aluminum smelting is known for large greenhouse emissions and high energy consumption. Considerable research has been done to explore alternative production processes that could lower energy consumption and greenhouse emissions. Until now, there is no known economically feasible substitute for carbon anode. There has been some progress on inert anode technology, but IEA reports that the ultimate technical feasibility of inert anodes is not yet proven, despite 25 years of research. More fundamental research on the materials is needed and anode rate of less than five millimeters per year has to be attained. The following table provides an overview of the technological status of inert anodes for the aluminum industry.
Technological status: Inert anodes
Inert Anodes Technology Stage 2003-15 R&D 2015-2030 2030-50 Demonstration Commercial Source: IEA Technology perspectives, 2008

Although there is always the threat of technological advances in the smelting process, the transition to new technology will be gradual.

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Company description
Rain Commodities (RCOL) is one of the largest calciners in the world, with a capacity of 2.5mtpa contributing to 81% (CPC, Power and Pet. Coke) of revenue courtesy LBO of CII (USA) in 2007. It has its CPC capacity located in North America (1.89mtpa), India (0.6mtpa) and China (0.02mtpa). It has cogeneration capacity of 125 MW in energy (Power and Steam). It also has cement operations (3.5mtpa) in South India attributing to balance 19% revenues. It has recently restructured its operations into separate CPC and Cement operations with aim to list entire CPC business in US to unlock value at appropriate time.
RCOL: CY10 revenue break-up
Pet Coke 3% Cement 19%

CPC (Including Energy) 78%

Source: Company/MOSL

RCOL: Growth timeline

1998
Began calcining operations in Visakhapatnam with a capacity of 0.3 MTPA

2005 2006

Doubles CPC capacity

Acquires 20% stake in Great Lakes Carbon

2007

Divest GLC stake in favour of Oxbow Corporation after losing out in a biddingwar. Acquires CII Carbon USA with CPC capacity of 1.895 MTPA in leveraged Buy Out

2008

Completed Brownfiled Cement Expansion of 1.5MTPA. Total cement capacity

increased to 3.16 MTPA

Entered Chinese CPC industry with acquistion of small CPC plant with capacity of

2009

20,000 TPA
Startey fly ash handling and cement packing unit in Bellary, Karnataka. Improved fly

2011

ash blend ratio to increase cement capacity to 3.5 MTPA

2012-13

Setting up two waste heat recovery plant with 70MW capacity in USA.

Source: Company/MOSL

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RCOL: World wide operations

Source: Company/MOSL

CPC operations RCOL has facilities spread across USA, India and China. Three of the US CPC facilities are strategically located adjacent to oil refinery. At one of these locations, it also supplies steam to the refinery. It also owns three vessel loading terminals at the Chalmette, Gramercy and Lake Charles facilities. Its Visakhapatnam facility enjoys logistical benefits, as it is a port city. RCOL's China facility is a strategic move to get a foothold in one of largest markets of CPC.

RCOL: CPC production facilities

Facility Moundsville, West Virginia Lake Charles, Louisiana Robinson, Illinois Chalmette, Louisiana Gramercy, Louisiana Norco, Louisiana Purvis, Mississippi Visakhapatnam, India ZXTTCL, China Annual Capacity 420,000 400,000 315,000 230,000 230,000 230,000 70,000 600,000 20,000 Commission Date 1957 1979 1958 1968 1972 1965 1959 1998 Co-generation Ability Yes No No Yes Yes Yes No Yes No Number of kilns 2 2 2 1 1 1 1 2 Source: Company/MOSL

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RCOL production facilities (Vizag Plant)

Rotary Kiln I Rotary Kiln II

Conveyor Belt

Waste Heat Recovery Plant

Control Room

Storage Facility

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RCOL: Major CPC customers

Customer Concentration for CPC business Percentage of CY09 Sales

CVG Venalum 11 Alcan 9 Alouette 8 BHP Billiton 7 Dubal 6 Hydro 6 Nalco 5 Century 5 Dupont 4 Noranda Aluminum 3 Total 64 Source: Company/MOSL

RCOL is planning to set up two more waste heat recovery plants in existing CPC plants in the US in a phased manner at Lake Charles-Louisiana and Robinson-Illinois, with an aggregate capacity of 70MW. The projected capex for these two projects together is ~USD125m. Execution work for the Lake Charles plant has already started and is likely to be completed by December 2012. RCOL derives more than 90% of its CPC revenues from sale of anode grade CPC to aluminum producers. Its customers are located throughout the world. In particular, the Group derives a significant portion of revenues from North America, South America, Middle East, South Africa, India and Europe. Cement operations RCOL has a fly ash handling and cement packing unit at Bellary. It has a contract with Karnataka Power Corporation Limited (KPCL) for exclusive supply up to 0.4m ton per annum of fly ash to RCOL till 2021. Improved fly ash blend ratio has resulted in increase in the total production capacity from 3.1m tons to 3.5m tons of cement per annum. It sells mainly to retail customers in Andhra Pradesh, Karnataka and Tamil Nadu under the brand name, Priya Cement. RCOL has recently invested ~INR120.5m to acquire Birla Cement and Industries, which controls limestone mining leases in the state of Andhra Pradesh. Birla Cement and Industries has now become a wholly-owned subsidiary of the company.

RCOL group cement capacity

Facility Annual Capacity (mtpa) 1.0 2.2

Nalgonda, India Kurnool, India

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Corporate restructuring: separating carbon and cement operations

Before the CII Carbon acquisition in 2007, the group's cement and calcining operations were under two different companies - Rain Commodities and Rain Calcining, respectively. Both these companies were merged to leverage the combined balance sheet for the CII Carbon acquisition. Now, the company has again undergone restructuring to separate carbon and cement operations under different subsidiaries. The cement operations, which were part of the parent company (RCOL), have been moved to Rain Cements Limited (formerly Rain CII Carbon India Limited), a 100% subsidiary. The Indian CPC business has been moved to Rain CII (Vizag) Limited (RCCVL), step down 100% subsidiary of Rain Commodities USA Limited (RCUSA). There is still 12.2% crossholding of Rain Cements Limited in RCCVL. Its US CPC business, Rain CII Carbon LLC, also became part of RCUSA through the step down subsidiary. The restructuring exercise was carried out so as to have freedom to look out for strategic investment in both CPC and cement operations, as well as to pursue organic and inorganic growth, separately. Shareholders continue to hold same control over various businesses after restructuring.
Current group structure

RCOL

100% RCUSA 61% of Pet. coke trading (RGS) 100%

100% Rain Cements 3.5 MTPA Cement

CPC Holdings

12.2%

87.8%

RCC (Vizag) 0.6 MTPA CPC, 50MW Power

100%

RCC LLC 1.895 MTPA CPC, 75MW Power and Steam

100%

ZXTTC China 0.02 MTPA CPC Source: Company/MOSL

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Financials and valuation

Income Statement (Consolidated)
Y/E December Net sales Change (%) Total Expenses EBITDA % of Net Sales Depn. & Amortization EBIT Net Interest Other income PBT before EO EO income PBT after EO Tax Rate (%) Reported PAT Minority interests Adjusted PAT Change (%) 2009 36,435 -20.1 27,359 9,076 24.9 1,227 7,850 2,260 44 5,634 513 6,147 1,714 27.9 4,433 -5.2 4,068 -9.3 2010 37,557 3.1 30,056 7,501 20.0 1,157 6,344 1,896 179 4,627 -1,249 3,378 951 28.2 2,427 19.5 3,305 -18.8 2011E 54,467 45.0 41,484 12,983 23.8 1,146 11,838 2,139 189 9,888 9,888 3,341 33.8 6,547 82 6,465 95.6 2012E 53,535 -1.7 42,821 10,714 20.0 1,221 9,493 2,078 244 7,660 7,660 2,721 35.5 4,938 47 4,891 -24.3

(INR Million)
2013E 51,845 -3.2 41,176 10,669 20.6 1,303 9,366 1,916 228 7,678 7,678 2,726 35.5 4,952 47 4,905 0.3

Balance Sheet
Y/E December Share Capital Reserves Share holders funds Loans Secured Unsecured Defferred tax liability (net) Capital Employed Gross Block Less: Accum. Deprn. Net Fixed Assets Capital WIP Investments Curr. Assets Inventories Sundry Debtors Cash and Bank Loans and Advances Curr. Liability & Prov. Sundry Creditors Other Liabilities & Prov. Net Current Assets Application of Funds E: MOSL Estimates 2009 708 11,396 12,104 30,312 17,859 12,453 2,260 44,697 37,453 3,294 34,159 233 307 13,777 4,771 4,479 3,057 1,470 3,779 2,661 1,118 9,998 44,697 2010 708 13,225 13,934 31,781 29,341 2,440 2,173 47,947 36,692 4,308 32,384 561 16 19,391 7,452 5,616 3,639 2,684 4,404 3,526 878 14,987 47,947 2011E 708 19,311 20,019 30,298 27,858 2,440 2,173 52,631 36,812 5,454 31,358 1,391 16 25,483 11,341 6,858 4,600 2,684 5,617 4,739 878 19,866 52,631 2012E 708 23,822 24,530 29,082 26,642 2,440 2,173 55,974 36,812 6,675 30,137 2,361 16 28,995 11,147 6,741 8,424 2,684 5,536 4,658 878 23,460 55,974

(INR Million)
2013E 708 28,347 29,056 23,617 21,177 2,440 2,173 55,081 39,562 7,978 31,584 561 16 28,309 10,795 6,528 8,302 2,684 5,389 4,510 878 22,920 55,081

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Financials and valuation

Ratios
Y/E December Basic (INR) EPS Cash EPS BV/Share DPS Payout (%) Valuation (x) P/E Cash P/E P/BV EV/Sales EV/EBITDA Dividend Yield (%) Return Ratios (%) EBITDA Margins Net Profit Margins RoE RoCE RoIC Working Capital Ratios Fixed Asset Turnover (x) Asset Turnover (x) Debtor (Days) Inventory (Days) Creditors (Days) Leverage Ratio (x) Current Ratio Interest Cover Ratio Debt/Equity 2009 11.5 15.0 34.2 0.7 6.9 2010 9.3 12.6 39.3 0.9 15.7 2011E 18.3 21.5 56.5 1.0 5.8 2012E 13.8 17.3 69.3 1.0 7.7

(INR Million)
2013E 13.9 17.5 82.0 1.0 7.7

2.5 1.9 0.8 1.0 4.1 2.6

3.1 2.3 0.7 1.0 5.1 3.2

1.6 1.3 0.5 0.7 2.8 3.4

2.1 1.7 0.4 0.6 2.9 3.4

2.1 1.7 0.4 0.5 2.4 3.4

24.9 11.2 33.6 17.6 19.1

20.0 8.8 23.7 13.2 14.5

23.8 11.9 32.3 22.5 25.4

20.0 9.1 19.9 17.0 21.0

20.6 9.5 16.9 17.0 20.3

1.0 0.8 45 48 27

1.0 0.8 55 72 34

1.5 1.0 46 76 32

1.5 1.0 46 76 32

1.3 0.9 46 76 32

3.6 3.5 2.3

4.4 3.3 2.0

4.5 5.5 1.3

5.2 4.6 0.8

5.3 4.9 0.5

Cash Flows Statement

Y/E December Pre-tax profit Depreciation (Inc)/Dec in Wkg. Cap. Tax paid Other operating activities CF from Op. Activity (Inc)/Dec in FA + CWIP (Pur)/Sale of Investments CF from Inv. Activity Debt raised/(repaid) Dividend (incl. tax) CF from Fin. Activity (Inc)/Dec in Cash Add: opening Balance Closing Balance E: MOSL Estimates 2009 6,147 1,129 2,724 -1,693 -376 7,931 849 -39 811 -7,511 -307 -7,817 924 2,359 3,057 2010 3,378 1,014 -4,407 -753 -438 -1,207 434 291 725 1,469 -380 1,089 608 3,057 3,639 2011E 9,888 1,146 -3,918 -3,341 3,775 -951 -951 -1,483 -380 -1,863 962 3,639 4,600 2012E 7,660 1,221 230 -2,721 6,390 -970 -970 -1,216 -380 -1,596 3,824 4,600 8,424

(INR Million)
2013E 7,678 1,303 418 -2,726 6,673 -950 -950 -5,465 -380 -5,845 -122 8,424 8,302

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Disclosures
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Disclosure of Interest Statement 1. Analyst ownership of the stock 2. Group/Directors ownership of the stock 3. Broking relationship with company covered 4. Investment Banking relationship with company covered

Rain Commodities No No No No

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