Description

Introduction
Maithan Alloys (est. 1995) is a manufacturer of Manganese (Mn) alloys, which is used to create hardened steel (in turn used to create rock crushers, cement mixers). It operates three plants in India across different states (in total producing~225kT pa) and has recently acquired a fourth (50kT pa but not currently active). It is owned (~75%) and run by S.C Agarwalla (founder) and his two sons who have delivered truly exceptional results over a decade.

Industry and Demand-Supply Dynamics
Mn alloy manufacturers serve the steel industry and therefore their demand follows the steel industry’s cyclicality. Even though their customers (domestic and foreign steel companies) are much larger than them and Mn alloy is a commodity, manufacturer can pass on increases in the raw material cost because Mn is a small but critical component in the manufacture of steel (Mn comprises ~1.5% of all steel manufactured) as can be seen by comparing the spreads in Mn alloys and Steel. India is currently the largest exporter of Mn alloy in the world (providing 25% of global imports), having grown at a 10-
year CAGR of ~5% (vs global steel growth of ~1%). Despite structural disadvantages, India is one of the lowest-cost suppliers of Mn alloys, delivering prices ~10% cheaper than the global median.

Key among these disadvantages is the reliance on expensive energy. Mn alloy production is extremely electricity intensive (needed to melt the raw materials). Power comprises 30-60% of the direct costs and is the cause of volatility in gross margins (Maithan’s margin tends to vary between 20%-30%). Roughly 3/4ths of India’s electricity is generated from coal, one of the most expensive sources of electricity.

This handicap is one faced by most of the smaller, unlisted, Mn alloy producers in India (~80 in total) which cannot afford a captive power plant (Maithan owns 3 windmills). Maithan is the largest producer of Manganese Alloys in India and one of the cheapest in the world. Comparing it to its closest listed peers (but note the differences in product and diversification) we can see many areas of outperformance and advantage over the last decade (Indian companies follow a March year-end).

In both revenue and profit, Maithan is larger than its peers, Indian Metals and Ferro Alloys and Nava Limited (Note: Nava’s consolidated results include foreign mining and power operations). This achievement is made even more impressive by the fact that it has utilized as much or less assets while also delivering a higher margin which helps it achieve exceptionally high RoCE.

It also appears to show a greater degree of financial prudence, avoiding expensive acquisitions (there is a lack of goodwill) carrying the largest net cash position whilst still delivering 15-25% RoE. Over the last ~5 years, many of the smaller ferro alloy businesses have gone bankrupt due to excessive leverage and power price fluctuations. This allowed better capitalized players to acquire assets at rock-bottom prices (eg: Vedanta, Tata Steel, Maithan Alloys).

Recent Developments
Prior to the recent war, Ukraine was the second largest producer of Mn alloys and able to do so at a slightly lower prices than India. Although global data for 2022 is not available, reports cite that their production has been cut to a third of previous levels. This likely drove the resulting price jump in FY22 and FY23 which benefited Indian players.

An exceptionally hot summer in early ‘23 drove increased demand for electricity across India. The supply of coal was unable to expand fast enough, and electricity prices rose across the country by up to ~50% (in Andhra Pradesh) in the current year. This led to the reduced production of many Mn alloy plants across the country, including two of Maithan’s. Similar events took place twice before, in 2012 and 2002. Shortly after both events, prices normalized, and operations resumed.

Company and Leadership
Maithan reached its current maximum capacity (137 MVA = ~226’000 MT) in 2013, although it took ~2 years for production to ramp up. Since then, they have always operated at ~90%+ capacity, producing ~226 MT / year.

This has allowed it to consistently deliver very high asset turnovers and meet the demand for high-grade Mn alloy. Maithan imports almost all their manganese because high grade material is not available in India and their geographic position allows them to easily import large quantities. This commitment to quality has made Maithan the preferred supplier of the largest steel companies in India, who have been their clients for over 7 years (100% retention domestically, 75% overall). They have seen greater attrition internationally, as prices are more affected by volatile shipping costs and hence management keeps a diversified geographic base and low customer concentration (<10%).

Perhaps because almost the entirety of their wealth is deployed in the business, Maithan’s management follows a prudent business strategy in day-to-day operations and longer-term projects: they keep few raw materials on hand, enough to deliver on the 3-to-6-month order book and they only invest in additional plants when the current factories have been operating at near maximum capacity for a few years. Similarly, management raises its dividend only when it is confident that it will not have to reduce it, usually after capacity has expanded and achieved consistently high utilization.

By doing this, they have consistently (over 20 years) delivered super-normal RoCE and RoEs (20%+ and 15%+) by avoiding expensive acquisitions, tightly managing net working capital, and building a rock-solid balance sheet. They have stated that their first preference for the use of the excess cash on hand is to acquire or build new facilities. If they are unable to do so over the next 2-3 years, management has indicated that they will return funds to shareholders.

Recent Developments
In FY22, some of the excess cash was used to acquire Impex Metal and Ferro Alloys (IMFAL) through the insolvency process. Maithan paid INR ~1’400 Mn to acquire and refit the plant in Andhra Pradesh. IMFAL has a capacity of ~50MT which should yield a Revenue and EBIT of INR ~4’000 Mn and INR ~500 Mn per annum (~30% yield). Shortly after work on the plant was completed, electricity prices in Andhra Pradesh increased dramatically and the plant was shut down.

Valuation and Variant View
At 90%+ capacity, Maithan earns an average (excluding the boom years of FY22 and FY23) Revenue and EBIT of INR ~18’000 Mn and INR ~2’800 Mn (~16% EBIT margin). The current share price (INR 995) implies an Enterprise Value (EV) of INR 9’142 Mn, which equates to a normalized EBIT yield of ~30% (3.2x EV / EBIT) and a multiple of 1.1x book value. On average the business has traded at ~4.2x normalized EBIT and ~1.5x book value.

Steel has been the building product of choice for >200 years and Mn alloy is a critical ingredient to make hardened steel for infrastructure and heavy machinery. One can therefore be confident of continued demand for the product, absent of any risk of disruption, over the long term. A yield of ~30%, considering this, is incredibly attractive.

In other words, on a per share basis, for INR ~1000, incoming investors get ~700 of excess cash, thus paying only INR 300 (around book value) for a business which delivers INR ~100 / share (excluding IMFAL)

Why does this opportunity exist?
The most critical reason relates to the shareholding – the management own ~75% of the stock outstanding of a US$ 300 Mn company. This leaves just US$ 75 Mn of free float market capitalization available. With only US$ ~500 k of daily traded volume any block of even US$ 1-2 Mn would dramatically shift the price. This is unfortunate for institutional investors because it is rare to find such capable management whose interests are so closely aligned with shareholders.

The next factor relates to the nature of the industry and recent developments. Steel is a cyclical industry and Retail investors are wary of exiting at a downturn in the cycle. I do not believe they adequately appreciate the criticality of manganese to steel production which affords Mn players a more stable business than its customers. They are also wary of recent developments, including the abnormal pricing and plant shutdown in Andhra Pradesh. For the long-term (>3 year) investor, these are transient developments that have only a marginal impact on the total profit the business will earn over the next ~100 years.

Upside not currently priced in
The large amount of excess cash provides downside protection and offers investors the chance to benefit from further smart investment by management: many smaller ferro-alloy players carry debt heavy balance sheets and will be feeling the crunch due to heightened electricity prices. Should plants become available in the near term at attractive prices, management will be able to further consolidate and benefit from their existing economies of scale.

The current price also does not reflect any benefit from operations at IMFAL resuming, even though history has shown time again that local government work to reduce electricity prices in short order: in addition to being large employers in the state, the amount of local taxes and duties generated serve to incentivize them. Operations resuming at IMFAL could increase output, Revenue and EBIT by ~25% and is not priced in.

The market also over-estimates the time and extent to which prices for ferro alloys will correct. With US$ 440 Bn of damage already done, Ukraine’s need for hardened steel is likely to consume all its domestic capacity for many years. Although Mn alloy prices have already started reducing from their peak, it could be possible that prices remain elevated for many years as the efforts to rebuild Ukraine takes longer than currently expected.

Conclusion and Final Recommendation
In conclusion, Maithan is an exceptional business run by prudent manager-owners currently available at a price that offers substantial downside protection, a highly profitable business at a throwaway valuation (50-60 paise on the Rupee) and unpriced upside that could lead to IRRs >50%. Purchase of the common stock at the current price is recommended.

“Heads I win, Tails I don’t lose much”

Catalyst