ArunaGiri N

Moat is a mighty subject in the investment space. Quite understandably, any discussion around that is likely to be an animated one. The reason why it raises mercury in much of the debates is because it is so intangible and yet so powerful in its effect on financials and cash flow. While it is a highly debatable subject, in some cases such as consumer brands, moats are more obvious. But the flip side is, when it is more obvious, less is the opportunity for investors as it gets fully priced. Less-obvious moats are where one can spot hidden gems.

Some of the less obvious moats are: a) an industrial brand distributed by a vast dealer network to a diversified user base; highly critical product (by quality requirements), yet very low value in relation to the end product price; businesses which have a high proportion of replacement demand, are precision-intensive, or research-driven manufacturing with superior operational scale and efficiency.

Electroplating and surface treatment chemicals is one such business that possesses hidden moats because of the presence of a large number of unorganised and small-scale user industries in the buying value chain. Relative to the end product cost, though plating is a low-cost process, it is highly critical for the anti-corrosive property of the final product. This rare blend of a diversified small-scale industrial user base and high criticality has been the key for Grauer & Weil (GWIL) to build a powerful industrial brand (Growel) in this segment. Through its long operating history of over six decades since 1957, Growel has not only become a trend-setter in the general metal-finishing industry but has also emerged as a formidable player in electroplating and specialty chemicals.

Supremacy In Surface Treatment

Electroplating and surface treatment is a very competitive industry with innumerable players trying to get a slice of the growing domestic market, which even prominent global players, such as Atotech, a subsidiary of French oil major Total, are aiming at. In 2016, Atotech was acquired by the Carlyle group for over $3.2 billion, signifying the importance of this industry for large private equity players. In spite of the strong presence of global players, GWIL has continued to lead the industry with a formidable share of over 40% in the domestic electroplating market. This could be possible because the company could build a powerful story in this space by its sheer single-minded focus on quality and innovation and by building a vast and loyal distribution network over a six-decade long period. 

In fact, the genesis of the company goes back to 1957, when it was founded in Bombay by the Mores family in collaboration with Grauer & Weil, UK. Subsequently, the management control changed completely to the Mores. Currently, the third generation of the family, that is, Umesh More and his son Niraj More, run the business with support of a professional CEO, Vinod Haritwal.

Surface treatment chemicals constitutes over 60% of the overall revenue and is the cash cow of the company, which has built a durable competitive advantage in the specialty chemicals business over time through its Growel franchise. As a result, the economics of this part of the business is extremely attractive with a superior margin profile and high return metrics driven by high fixed turns and robust free cash-flow generation. Based on company’s annual reports, if one looks at the segment results for the past five years, the return on capital employed (RoCE) for the chemicals business has been consistently hovering over 100%. This level of return is mouth-watering by any standard. High asset turn (over five times) and a healthy margin are the reasons for such superior return in the chemicals business. 

One of the reasons why the company could build such a strong franchise among its customers is its ability to stay focused on bringing differentiation in its core business. GWIL is one of the few companies worldwide that is into the entire value chain of electroplating, that is, projects (plating equipment) and servicing. This enables the company to take a solution-centric approach to customers, and coupled with the constant look-out for latest technology, keeps it ahead of competition. For example, the company recently signed a technology and licence-transfer agreement with Herbert Schmidt for the manufacture and sale of the German company’s entire range of products for plating on plastics on an exclusive basis in India. This will help the company to consolidate its leadership in providing solutions for surface treatment on a wide variety of substrates. So is the company’s envied entry into aerospace industry with the recent AS9100 aerospace certification from the BSI group. This has enabled them to explore business with Rolls Royce and Boeing. This break-through in global aviation space will help the company in scaling up its exports significantly in the coming years.

The Challenge

While the specialty chemicals business has a spectacular economics (moat), it suffers from lacklustre growth as it is a proxy to broader manufacturing growth in the economy. As a result, the best one can expect is an ‘in-line’ growth with the IIP index (around 6-7% annual growth). While the business throws substantial free-cash flow, growth has been a drag. Given the low capacity utilisation of 60% in the chemicals business, more capex can hardly help in addressing the growth challenge. Here is where the company’s recent diversification assumes significance.

Venturing Out

Where the story gets interesting is how the management plans to use the steadily growing free-cash flow (FCF) from the specialty chemicals business into new businesses, so as to unlock long-term value. The company generates close to Rs.650 million of free cash-flow every year from its chemicals business. This is where the company’s free-hold land parcel of about 13 acres (including three acres in Chembur) comes into the picture. It will play a pivotal role in bumping up profits in the future. Further, the new capacity expansion in the paints business (revenue expected to double from Rs.1 billion over the next two years) will be a key growth trigger for revenue and profit.

Hence, the development of the land parcel is a key component of the company’s growth strategy as well. The company will look at retail, and infotech parks to unlock value from the land. This division already runs the famous Growel 101 mall, built and developed on 10 acres of land parcel in Kandivali, a western suburb in Mumbai. There is headroom for doubling the built-up space in the mall from the existing 250,000 square feet to 500,000 square feet in the coming years. The company generates close to Rs.300 million of annual lease revenue from this. Similar plans are on cards for the three-acre parcel in Chembur as well. While the chemicals business provides revenue predictability with single-digit growth, the new property and paints businesses will provide a fillip to growth and profitability. This combination has the potential to unlock value substantially for investors.

Worth The Price

Overall, GWIL is a high-quality business with growing free-cash flow, given that its current FCF yield is 6.5% of its market cap of Rs.12 billion. It is a zero-debt company with a net surplus cash of about Rs.1.13 billion, coupled with high double-digit operating margin and superior return ratios in the mid-20s. 

Rarely would one get a quality business at a cheap valuation, but GWIL is an exception. On a FCF-based intrinsic valuation, that is, net present value of conservative future cash flow estimates, it is available at 50% discount to its intrinsic worth. The company’s current market cap is nearly half its intrinsic value of over Rs.20 billion. 

Alternatively, if one takes into account just the land parcel, the development potential of the 13-acre land (including the Growel mall) itself is double the current market cap. Whichever way one looks at it, at the current valuation, there is a substantial margin of safety in the stock which holds the potential for a significant re-rating.

The writer and clients of his firm have a position in the stock