Discovering New Moats as we continue our journey with Rain Industries Ltd.

March 24, 2018 | Stock Talk

Few moats are like an iceberg, what meets the eye and lies before us is tiny compared to what lies beneath it.

Our Undervalued Metal Proxy turns into a proxy to the U.S. Growth, Protectionism and Electric Vehicle Revolution

As a stock picker, time and again you get humbled by extraordinary return you make by discovering new moats in your investment idea which you never thought it existed at the time you made your primary investment thesis.

At the time of investing in Rain Industries Ltd., our thesis was that the aluminium cycle seemed to be turning around promising to be in a good shape in the coming years. Instead of investing directly in any aluminium company, where the supply side disruptions were very few and far between, we decided to play on a company which manufactures essential material (CPC & CTP) used in the production process and whose industry had gone through supply side rationalization. It was further supported by huge entry barriers and no substitutes for the products.

At the time of investing, we didn’t know that this undervalued bet has such enormous potential upside and would turn out to be one of the best investments for us.

Rain, being a global company is actually affected by lot of factors and happenings across the world and global aluminum cycle turning was just tip of the ice berg.

Slowly, our analysis on the same gave us an idea that the Chinese cutting down production in Aluminium and calcining is actually causing a structural change globally. The fundamentals of the industry is slowly changing and leading to benefit the global industry ex. of China. This actually acted as a long term game changer for the global aluminium industry leading to more production outside China.

Further, our analysis gave us an idea that it’s a seller’s market for CPC and CTP as there is huge demand but insufficient supply of CPC and CTP. We believed that the supply side challenges (CPC and CTP) and the structural change in the raw material industry are expected to persist for a longer period of time than the aluminium cycle. The cyclical nature got reduced to a large extent or at least has extended the carbon materials cycle.

The better understanding of industry and business made our investment thesis stronger and allowed us to increase allocation to this company which proved to be fruitful for us.

But a string of few unexpected events happened which are putting the company in a sweet spot of earnings where multiple triggers are helping it improve the cash flows and consolidate its position as the world leader of these carbon materials.

Donald Trump unexpectedly winning the election and staying true to his words of supporting the aluminum industry by protectionist measures and also reducing theCorporate Tax in the U.S., where substantial operations of this company are located, was one such event. The improved earnings gave company a change to refinance its debt at a substantially lower cost and do interest savings,and all of that played in our stride.

This has also paved way for us to indirectly play on the Boom in Electric Vehicles which is transforming Aluminium demand and benefit from the protectionism measures taken by Donald Trump.

The report aims to highlight on how Rain Industries will benefit and would be ahead of its peers:

Spur in Electric Vehicles Demand
Trump’s Tariff Policy
Increase in GPC prices put rain better placed than its competitors
Corporate Tax cut in U.S.
Interest Savings

Huge Demand of Electric Vehicles to transform Aluminium Demand

According to CRU, share of electric vehicles would account for 30% of the global vehicle fleet by 2030 from a share of 4% in 2017.

Usage of aluminium in automobile designs is going up substantially owing to its lightweight and ability to be energy efficient that comply with stricter pollution norms being followed around the world especially the large economies. The aluminium electric vehicle in total is 187 kg lighter than the steel electric vehicle.

Electric vehicles use 25-27% more aluminium than the typical internal combustion engine car today. This assumes 160kg of aluminium per vehicle is used in internal combustion engines today.

All major automakers have already started the shift since last year with major US automakers making their major selling cars with high aluminum content.

The greater adoption of electric vehicles, which uses more metal than conventional vehicles, will have positive consequences for aluminium producers.

Demand for aluminium will also rise on account of infrastructure needs for serving EVs, since aluminium is commonly used as housing material for EVs charging stations. This lightweight metal will also have its share in the construction of assembly plants of batteries and vehicles.

Today’s SUV Tomorrow’s SUV

Aluminium Consumption It can be inferred from the above graph that the usage of aluminium in cars in the coming years will increase significantly. As a result, production of aluminium will increase.

According to European Aluminium, the average European car currently uses around 150 kg of aluminium (2016 data). This is expected to increase to 200 kg by 2025.

In USA, the average content in cars will increase from 180 kg in 2016 to around 235 kg in 2025.

The uptick in aluminium demand is expected to continue for quite some time as new facilities producing aluminium parts and batteries for EV segment will enter the market to meet the increasing demand.

Hence, primary aluminium producers have great potential upside. This ensures the demand for Carbon Products.

Trump’s Tariff Policy

In one of our earlier updates on Rain Industries Ltd., we highlighted on how Donald Trump’s victory in U.S. elections would benefit Rain Industries Ltd.

Again, Trump’s policy on Aluminium and Steel sector which is causing ramifications across the globe proves to be very beneficial for Rain Industries Ltd.

Trump has expressed to put sweeping tariff of 10% on Aluminium and focus on import substitution. The goal is to make the domestic metal industry stronger and incentivize U.S. companies to buy aluminum from U.S. producers.

With increase in capacity utilization in Aluminium Industry in U.S., the demand for Carbon Products (CPC and CTP) will directly increase.

Rain Industries Ltd. has majority of its plants in U.S. It is very well placed in terms of location and cost and any increase in demand can be easily fulfilled by Rain. Distribution cost would also be saved. It may yield better realization for the company.

Rain is the best placed Calciner in the world in the rising low sulphur GPC(key raw material for CPC) prices as Rain being the Lowest Cost Producer due to the best raw material management and Capex done in the past years to process low quality raw materials too

Technological Advantage

Low sulphur GPC is the major raw material for manufacturing CPC and it is scarcely available in the market.The recent spike in GPCprices has increased the price of cost of raw material for many calciners. High sulphur GPC (cheaper than low sulphur GPC) is abundantly available in the U.S..Rain has its CPC plants in the U.S. which has a technology called SO2 Scrubbing. It removes SO2 from high sulphur GPC, thus allowing its use in manufacturing of CPC. This enables Rain to be on the lowest curve in the industry.

India CPC Blending Strategy

The management is proactive in understanding the industry and takes appropriate action timely. In 2016, U.S. production was sluggish and the aluminium smelting was shifting to countries with lower cost of operations such as India and the Middle East. The basis of the India CPC blending strategy is to ship CPC product from US plants, and blend it with the Indian produced CPC product for re-sale in India and the Middle East markets. This blending plan helps the company to maintain the production volumes in the U.S. and meet the growing demand of emerging Aluminium markets.

Competitors shutting down CTP plants

Koopers, the largest producer of CTP has shut 7 out of 11 CTP plants in the recent past. This benefitted Rain to gain market share in CTP and become the largest producer of CTP globally.

Cut in Corporate Tax rate in U.S.

There is a cut in corporate tax rate in U.S. from 35% to 21%. There would be lower tax trends in the coming quarters. This will boost the bottom-line.

Refinancing of Debt would be rewarding

The company expects to save ~$25-30 million on interest expense due to refinancing. This comes to be ~Rs. 35-40 crores in each quarter. This will further enhance the bottom line.

Conclusion

Niveshaay has been able and will continue to play these upsides in the investment thesis.

Not getting swayed by the hostile reactions of other nations, Trump stands to maintain status quo on its tariff policy. This will further increase the demand for Rain’s products in the US and hence reduce its transport cost as currently it has to move its materials elsewhere in the world. Also we get a chance to participate in the upcoming Electric Vehicle Revolution by taking indirect exposure in the transforming Aluminium Demand linked to the electric vehicles.

Further, aluminium is gaining market share to other metals in a lot of industries including Construction, Automobiles, Packaging and Aerospace, and we believe Aluminium volumes are more important than the prices.

Overall, we believe that Rain Industries Ltd. still has ample headroom to grow and we continue to maintain a positive outlook on the company.

For more details about the company, refer the following links Rain Industries Ltd. Detailed Report Rain Industries Ltd. Q3 CY2017 Update Rain Industries Ltd Q4 CY2017 Update