Piping hot

On a balmy winter morning in early 2010, it was work as usual for Vimal Katta as he strode into his office located on the relatively busy Naranpura Char Rasta road in Ahmedabad. No sooner did he plonk down in his chair that the finance director of Ratnamani Metals & Tubes got a call on his landline. The inquisitive voice on the other end sought to know more about the company and its business, and a few minutes into the conversation, Katta realised that this was not a routine sales enquiry but a business call of a different kind. As it turned out, the person on the other end was calling from Nalanda Capital, the Singapore-based boutique investment firm of Pulak Prasad, who earned his spurs during his previous stint with Warburg Pincus.

To jog your memory, it was Prasad who fetched a near six-time killing for Warburg on its initial investment of $292 million in Bharti Airtel, which is today the largest telecom player in the country with over 200 million subscribers and over 28% market share at the end of January 2014. Prasad quit the New York-based private equity major in 2006 to float his own firm, raising over $400 million from investors. Since then, Nalanda, or rather, Prasad, has been investing in publicly listed companies, especially mid caps, which make the cut based on the following investing tenets: a company should enjoy high return ratios, should have a good management with a proven track record and a robust business model.

It’s not surprising then, that Katta got the call. Because Ratnamani Metals, despite being in the unsexy commoditised business of manufacturing stainless steel and carbon steel pipes for petroleum, power and other infra sectors, is one hell of an efficiently run company. With a turnover of over Rs 1,200 crore, it’s the smallest player in the industry but also the most profitable. As expected, a team flew down from Singapore for a closer interaction with the management, seeking details about its vision and plan, key customers and competitors. The team visit was soon followed by a personal visit by none other than Prasad, who wanted a first-hand account of what Ratnamani was all about. Satisfied with what it saw and heard, Nalanda eventually went on to own a significant minority stake in the company, which today has a market cap of over Rs 700 crore. From a little over 1% stake four years back, Nalanda currently owns an 11% stake in the company.

Small is beautiful- Graphic

So, what exactly is it about Ratnamani that has enamoured Prasad? Because barring Kenneth Andrade, the star mid-cap fund manager from IDFC Mutual Fund, no other fund manager seems to have an exposure to the stock.

 League of its own

Sitting in his modest office, Ratnamani Metals promoter Prakash Sanghvi is counting his blessings that he is not facing the same pangs that his peers in the business are currently feeling. More than Lady Luck, it is Sanghvi’s prudent streak that is now helping the company tide the slowdown that seems to have permeated to every corner of the economy, especially the core industries. 

To begin with, Ratnamani Metals started out as a manufacturer of stainless steel tubes in October 1985 and gradually diversified into carbon steel in 1994. But it was during the boom-bust cycle of FY05-FY08 that the company really came into its own, and thanks to a reality check, managed to stay the course through the subsequent slowdown. “We had a good time back then, as the whole petroleum sector was going through a boom phase and crude prices kept hitting new highs. It was around this time that we started adding more capacity in the carbon steel segment, even as the other domestic players were far more aggressive in their approach,” reflects the 58-year-old.

Blowing hot, blowing cold- Graphic

What appeared to be a recipe for success soon turned out to be a disaster for the pipeline industry. The global contagion took the wind out of effervescent crude prices, forcing global majors in the petroleum sector, the biggest demand driver for pipelines, to shelve their expansion plans. The net effect: the domestic pipe industry was left grappling with overcapacity, which was compounded by the fact that a lot of it was funded by leverage, taking a heavy toll on the bottomline. But that’s not the case with Ratnamani. “Unlike my bigger brothers in the business, Welspun, Jindal Saw and the likes, my capacity is still minuscule and is not hurting,” points out Sanghvi. The reason is not difficult to fathom, as with a stainless steel capacity of 27,000 metric tonne (20,000 for welded pipes and 7,000 for seamless pipes) and 350,000 tonne of carbon steel, Ratnamani today is small in an industry that has over 8 million tonne capacity. “Unlike others, who are either pure stainless steel or carbon steel players, we have an equal split between both segments. Also, in the carbon steel segment, the capacity is split across four product lines,” points out Sanghvi. The four products are: LSAW (longitudinal submerged arc welded) 40,000 tonne; ERW (electric resistance welded) 70,000 tonne; HSAW (helical submerged arc welded pipes) 180,000 tonne; and CSAW (circumferential submerged arc welded) 60,000 tonne.

While the company did not resort to costly borrowings to fund its expansion, a drop in utilisation rates, thanks to weak demand, has taken a toll on return ratios. While the going was good, ROE went from 29% in FY05 to 59% in FY07, but after the 2008 crisis, it slipped to 21% in FY11. Putting the decline in context, Katta explains, “Low margin carbon steel pipe segments such as line pipes and ERW have not given the returns one would have expected.”

After the crisis, the company exercised greater prudence. “We have consciously turned conservative, concentrating on only those segments where we see good potential for growth. We are now focusing on the stainless segment and high-value products to ensure that returns stay healthy,” mentions Katta. Between FY10 and FY13, even as revenues doubled, the return ratio (ROE) moved up from 21% to 23%. This is largely because the bulk of operating profits are flowing down to the bottomline, thanks to a manageable debt of around Rs 136 crore and minimal inventory. “The weighted average cost of our borrowings is just around 9%,” he adds. 

Future tense- Graphic

But more importantly, the company does not hoard raw materials unless there is a clear visibility on orders. “We don’t speculate because we are in a business that is largely of a made-to-order nature. We book materials as and when the order is ready to be executed,” says Sanghvi. That approach has ensured that the company enjoys the best operating margins of around 20% compared with its rivals. The difference is stark if we consider that big brother Welspun Corporation — five times Ratnamani’s size — enjoys 9% margins.

Talking about what is helping the firm cope with the slowdown, Sanghvi points out, “We sell highly customised niche high value-added products. For instance, we are one of the few manufacturers in the world who make long tubes, up to 36 m in length, for the oil and gas and petrochemical industry. We are the only makers of titanium welded steel tubes [which do not get corroded] in India selling to desalination and UMPP power plants located along the shores.” Keeping that in mind, the firm is in the last stage of its capex expansion that will increase its stainless steel capacity to 29,000 tonne by June of the next fiscal year.

 Future tense

While Ratnamani appears to be sitting pretty compared with other players, it continues to face the same challenges that the industry faces — lack of clear growth opportunities. Though there are no analysts tracking the stock, rating agency Care in a report on the pipeline sector portrays a rosy picture of what lies ahead. Care Research estimates global and domestic SAW pipe demand for Indian manufacturers (excluding replacement demand) at 16 million tonne ($19.45 billion) over the next five years from the oil and gas sector alone. Demand from the replacement market is likely to be 10.4 million tonne over the next five years, since most of the pipes laid during the 1960s and 1970s in the US and other developed nations will need replacement. 

So far so good, but the reality is that orders are hard to come by, thanks to the controversy over natural gas pricing, and the delayed construction in other user industries such as power, because of environment issues. In terms of exports orders, there is not enough demand. Barring FY12, where revenues bumped up 50% y-o-y, Ratnamani has seen growth decline in FY10, FY11 and FY13. However, the company’s management feels that there is light at the end of the tunnel. “We have an order book of around Rs 778 crore, of which Rs 221 crore comprise exports and Rs 557 crore are domestic orders. We should end the year at around Rs 1,300 crore,” points out Katta. Of the current order book, #250 crore will be converted into sales by end-FY14 and the balance Rs 528 crore will be carried forward into the new fiscal year.

But going ahead, the visibility of new orders is far from clear. Though Sanghvi is bullish on Reliance’s publicly stated plans of investing over Rs 50,000 crore in the oil and gas business — that is expected to translate into a big order opportunity — the controversy over gas pricing remains a big overhang over the proposed expansion. Besides, the power industry, yet another big client for pipelines, is in a rut, something Sanghvi concurs with. “A lot will depend on whether our customers are in a position to tie up their financial closure and pick up materials.” The bigger worry for Sanghvi is that if the domestic scenario deteriorates further post the general elections, the effect will be felt in the exports market as well. “Increasing footprint in global market takes time, but once global clients realise that there is no domestic market for you back home, they can really start arm-twisting you, and that’s not a good situation for the pipeline industry,” he opines.

So it’s not surprising that against such a backdrop, Ratnamani is not under the active coverage of brokerages, what with the stock ending nearly flat in CY13. Also, its relatively smaller industry presence, small market capitalisation and poor liquidity do not make the cut for domestic fund managers. “While it is no doubt an efficient player and does not have leverage issues, unless the overall business environment really improves, there is nothing much that Ratnamani can achieve in the current conditions,” points out a fund manager on the condition of anonymity. But that’s something Sanghvi is ready to live with. “I am not obsessed with growth but rather with profitable growth.” If one were to consider that while the topline has grown just one-fold over FY10-FY13, profits have gone from Rs 82 crore to Rs 136 crore, Sanghvi is not far from the truth.

Though estimates are not available, if one were to extrapolate the average 18% growth in profit between FY10 and FY13 to FY14, the stock is trading at around 4.45 times estimated earnings per share of Rs 34.38 (Rs 29.14 in FY13). Considering that the stock price has been flat in CY13, there is more to see on the upside than the downside. If indeed Ratnamani were to live up to its tagline — “prosperity through performance” — then investors have nothing to really worry about.