BUY Kirloskar Ferrous Metals Initiating Coverage 4 ... · Castings products of KFIL: KFIL’s foundries, located at Hospet (Koppal plant, Karnataka) and Solapur (Maharashtra) are

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Well casted at an inflection point We initiate coverage on Kirloskar Ferrous (KFIL) with a Buy and TP of Rs155 (56% upside). KFIL features i) a well invested asset base with spare capacity of 50%/25% in Castings/Pig Iron, ii) increasing share of high-margin casting business, iii) cost efficiencies from upcoming low-payback projects, iv) an enviable track record of converting cash profits to cash flows (5Y/10Y AOCF/CP ratio of 1x/0.9x) and v) strong earnings growth led by higher volumes and operating leverage, buttressed by a low D/E of 0.3x. Exciting future growth prospects await KFIL’s castings business which boasts of i) a strong product profile and customer relationships, ii) sustainable competitive strengths and iii) satisfactory demand visibility. We expect an impressive EBITDA/PAT CAGR of 28%/29% during FY17-20E driven by castings volume CAGR of 19% coupled with cost efficiencies. Finally, we believe that it merits rerating based on an attractive cash flow yield of 11.4%/15.9% (FY19E/20E).

� Hard yards covered in castings, strong growth underway: KFIL has alreadycompleted the augmentation of the value-added business of castings in the pastfew years and has invested heavily in i) increasing capacity by 50% to ~133ktpa, ii)adding machining facilities which fetch superior margins, iii) innovation and R&Dto reduce new product development cycle time from eight months to two months– a game changer achievement and iv) acquiring several marquee customersacross various segments. With its castings business having i) sustainable competitive strengths in a fragmented industry, ii) servicing steadily growing sectors like auto, tractor and diesel engines and iii) having well invested asset base with 50% spare capacity, KFIL is set to achieve a quantum leap in its castings volumes/turnover with CAGR of 19%/21% over FY17-20E and increase castings share in overall turnover to 51% by FY20E (from ~44% in FY18E).

� Pig iron business being made robust with meaningful cost improvement projects: KFIL has taken several steps to reduce its foundry grade pig iron business’vulnerability to the vagaries of commodity cycles (which too have become shorterand erratic in the recent past). Cost benefits are likely to accrue from H2FY18 from steps already implemented, such as i) BF-1 upgradation in FY17 and ii) coke sourcingthrough conversion arrangement at domestic third-party locations vs. imports. Big ticket cost improvement projects like i) installation of PCI system to replace ~80kgs of coke with low cost coal and ii) setting up of 200ktpa coke oven with 15 MW WHR CPP are likely soon and will improve the cost metrics of PI business materially from FY20E. Weexpect profitability of pig iron business to improve sharply, led by i) cost savings from low-payback projects, ii) higher volumes and iii) better spreads.

� Splendid combo of consistent cash flows, low D/E and spare capacity: KFILsports a solid combination of i) consistent cash flows with enviable track record ofconverting cash profits to cash flows (5Y/10Y AOCF/CP ratio of 1x/0.9x), ii) low D/Eof 0.3x and iii) well invested asset base with spare capacity of 50%/25% inCastings/Pig Iron. Additionally, KFIL is part of a pedigreed group run by highlyexperienced management professionals and scores highly on our corporategovernance framework. We expect sustainable improvement in return ratios led byimprovement in asset turnover and higher margins (driven by cost efficiency, better spreads and operating leverage) leading to attractive ROE of 25% in FY20E.

� Valuation and risks – Earnings at an inflection point, re-rating scope strong:We expect EBITDA/PAT CAGR of 28%/29% during FY17-20E, led by volume CAGRof 19% in the castings business coupled with cost efficiencies and operatingleverage leading to higher margins and strong improvement in return ratios. Wesee strong scope for re-rating and value KFIL using our conservative five-yearAOCF/EV yield methodology to arrive at a TP of Rs155, upside of ~56%. Key risksare lower volumes and raw material volatility. Currently, the stock has noinstitutional sell side coverage.

Target Price Rs155 Key Data

Bloomberg Code KKF IN

CMP* Rs99.4 Curr Shares O/S (mn) 137.3

Diluted Shares O/S(mn) 137.3

Upside 55.9% Mkt Cap (Rsbn/USDmn) 13.6/211.7

Price Performance (%)* 52 Wk H / L (Rs) 112/65.5

1M 6M 1Yr 5 Year H / L (Rs) 112/15

KKF IN 24.2 0.3 35.1 Daily Vol. (3M NSE Avg.) 244607

Nifty (3.1) 5.3 23.5

*as on 1 December 2017; Source: Bloomberg, Centrum Research

Shareholding pattern (%) *

Sep-17 Jun-17 Mar-17 Dec-16

Promoter 59.6 59.6 59.6 59.5

FIIs 0.6 0.6 0.6 0.5

DIIs 2.6 1.8 1.8 1.8

Others 37.2 38.0 38.0 38.2

Source: BSE, * as on 1 December 2017

Well invested asset base with spare capacity

Source: Centrum Research

Strong volume growth in castings underway

Source: Centrum Research Estimates

Sharp uptick in per tonne profitability in store


Abhisar Jain, CFA, [email protected], 91 22 42159928

Y/E Mar(Rs mn) Rev YoY (%) EBITDA EBITDA (%) PAT YoY (%) EPS (Rs) RoE (%) RoCE (%) P/E (x) EV/EBITDA (x)

FY16 11,139 (18.4) 1,509 13.6 578 17.4 4.2 12.2 11.0 12.5 5.5

FY17 11,337 1.8 1,756 15.5 907 56.9 6.6 16.9 14.0 11.4 6.3

FY18E 15,793 39.3 1,352 8.6 465 (48.7) 3.4 7.8 7.5 29.3 11.1

FY19E 17,086 8.2 2,467 14.4 1,179 153.5 8.6 17.9 14.6 11.6 6.3

FY20E 18,049 5.6 3,730 20.7 1,953 65.7 14.2 25.4 20.2 7.0 4.2


133000

390000

65892

291273

67108 98727

50%

25%

0%

50%

100%

0

500000

Castings Pig Iron

Tonne

Capacity Production

Spare Capacity Spare Capacity % - RHS

60396 57257 5666165892

8200097000

110000

45% 42% 42%49%

61%72%

81%

2.8% -5.2% -1.0%

16.3%24.4%

18.3%13.4%

-20%

0%

20%

40%

60%

80%

100%

0

20000

40000

60000

80000

100000

120000

FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Volumes (Tonne) Utilisation - % YoY % - RHS

14428

15067

17126

14971

17137

19310

3969

4361

5497

3481

5821 8419

34.8

41.445.8 44.1

47.7 51.2

0

12

24

36

48

60

0

5000

10000

15000

20000

25000

FY15 FY16 FY17 FY18E FY19E FY20E

Rs/t

Gross Profit/t Blended EBITDA/t

Castings Share - % (RHS)

Metals BUY

Initiating Coverage 4 December 2017

INDIA

Kirloskar Ferrous

2 Kirloskar Ferrous

Table of Contents

Hard yards covered in castings, strong growth underway ................................................. 3

Leading castings producer with strong relationships in a growing industry ................................................ 3

Investment in building capacity and capability of castings division already done ..................................... 6

Strong volume growth in store, better product mix and economies of scale to enhance margins & profitability ........................................................................................................................................................................ 10

Pig iron business being made robust with meaningful cost improvement projects ...... 12

Foundry grade pig iron business with limited competition ............................................................................. 12

Spread contraction in last 12-18m hurt earnings, but recovery underway ................................................. 13

Third party coke manufacturing tie-up to reduce costs .................................................................................... 14

Low-payback backward integration projects being planned, cost metrics likely to improve significantly by FY20E .................................................................................................................................................... 15

Splendid combo of consistent cash flows, low debt/equity and spare capacity ............. 16

Spare capacity of 50%/25% in castings/pig iron businesses ............................................................................ 16

Asset turnover at a multi-year low, set to improve with higher utilisation ................................................. 16

Low leverage gives flexibility to pursue investment projects for cost savings and growth .................. 18

KFIL continues to pursue iron ore mines in Karnataka auctions and looking for attractive bidding price ..................................................................................................................................................................................... 18

Financial Analysis – Earnings at an inflection point .......................................................... 19

Revenue growth to be aided by solid volume growth in castings segment .............................................. 19

EBITDA margins to trend upwards, driven by increasing share of high margin castings and cost saving initiatives .............................................................................................................................................................. 19

Return ratios should inch higher with major uptick in FY20E .......................................................................... 20

Strong dividend payout track record ....................................................................................................................... 20

Key Assumptions and Sensitivity ....................................................................................... 21

Valuation – Strong scope for re-rating, Initiate with Buy and TP of Rs155 ..................... 22

AOCF/EV valuation – 40% premium ascribed to historical AOCF/EV yield .................................................. 22

EV/EBITDA valuation – 25% premium ascribed to historical EV/EBITDA ...................................................... 22

KFIL trading at attractive adjusted cash flow yield, leaving scope for re-rating ........................................ 23

Key risks to our thesis .......................................................................................................... 25

Company Background ......................................................................................................... 26

Corporate governance check – highlighting the finer points .......................................... 27

Independent directors’ representation on the board – KFIL has good balance ........................................ 27

Independent directors’ profile and compensation analysis ............................................................................. 28

Promoter group compensation analysis – as good as it gets .......................................................................... 29

Contingent liability ......................................................................................................................................................... 30

Related party transaction – clean history ................................................................................................................ 31

Auditor pedigree ............................................................................................................................................................. 31

Annexure – Indian Foundry (Castings) Industry ................................................................ 33

Financials - Historical ........................................................................................................... 37

Financials .............................................................................................................................. 38

3 Kirloskar Ferrous

Hard yards covered in castings, strong growth underway

Leading castings producer with strong relationships in a growing industry

KFIL’s pig iron business is forward-integrated into castings which is expected to account for ~44% of its overall sales in FY18E. Castings is the value added business in KFIL’s basket and the company has invested massively in both asset and capability development which has provided the base for a quantum leap in the castings division’s volumes/turnover with CAGR of 19%/21% expected over FY17-20E through higher utilisation of its existing world class asset base. We expect the share of castings business in overall turnover of KFIL to reach ~51% by FY20E

KFIL is a leading castings producer in India and possesses niche capabilities with production of grey iron and spheroidal graphite iron castings - key components for automobile, tractor and diesel engine OEMs. KFIL has made substantial investments in its castings business in the past two decades and painstakingly developed strong capabilities, giving it a substantial edge over competitors. KFIL also possesses strong customer relationships in a steadily-growing industry and has a well-invested asset base with significant spare capacity that provides a solid platform for strong growth. We discuss KFIL’s castings business in detail below (including industry snapshot) and then discuss the capabilities of KFIL in next section which gives us confidence in the company’s growth potential.

� Castings products of KFIL: KFIL’s foundries, located at Hospet (Koppal plant, Karnataka) andSolapur (Maharashtra) are equipped to produce Grey Iron & S.G Iron Castings for a variety ofapplications such as cylinder blocks, cylinder heads and different types of housings required byautomobile, tractor, and diesel engine Industries. A large share of production consists ofcomponents developed for the automotive sector, which includes trucks, agriculture and roadconstruction machinery, industrial and marine engines, among others. The parts manufacturedinclude engine blocks, heads, housings and components for brakes, transmission systems andaxles. KFIL has the capacity of 133 ktpa in castings in its two plants.

Exhibit 1: Cylinder blocks Exhibit 2: Cylinder heads

Source: Centrum Research Source: Centrum Research

Exhibit 3: Tractor housings Exhibit 4: SG castings & others


4 Kirloskar Ferrous

� Marquee client base across auto, tractors, engines and other segments: In automobiles, KFILservices mainly the commercial vehicle (CV) segment and has a well-diversified client base,comprising all leading OEM’s. Within tractors, the company supplies to all large players and hasbeen successful in adding new customers. In the non-auto segment, KFIL services few engineproducers and construction equipment manufacturing companies.

Exhibit 5: KFIL FY17 castings sales by customer segments Exhibit 6: KFIL FY17 casting sales by product segments


� Domestic castings industry growing at ~5% CAGR: Within this industry whose total productionstood at 11.4 MT in FY17, grey iron castings account for ~70% of the overall market (~8 MT). Theproduction CAGR in the industry for total castings/grey iron castings was at 5%/5.6% over FY14-17. As per various industry sources including snippets offered by the Institute of IndianFoundrymen (IIF), the industry is well poised for much stronger growth in the next five years, driven by higher demand.

Exhibit 7: Castings production in India Exhibit 8: Castings production in India - CAGR trend

Source: IIF, Centrum Research Source: IIF, Centrum Research

47.0%

43.0%

10.0%

Auto

Tractor

Diesel Engines

13.0%

22.0%

32.0%

33.0%

Cylindrical Head

Cylindrical Block

Housings

W/J Block/SG Castings

0

2

4

6

8

10

12

14

FY07 FY10 FY12 FY17

MT

Grey Cast Iron Spheroidal Graphite Iron Malleable Steel Non-Ferrous

7.2 7.4

10.0

11.4

5.6%

3.0%

4.9%5.0%

2.6%

4.7%

0%

1%

2%

3%

4%

5%

6%

3Y (FY14-17) 5Y (FY12-17) 10Y (FY07-17)

Grey Iron Castings Total

5 Kirloskar Ferrous

� Competition largely fragmented; KFIL servicing the Grey cast iron market: KFIL has thecapability of producing several niche products within this segment. As per our industry analysis, KFIL’s addressable market within grey cast iron castings is ~3 MT and the company currently holds a market share of ~3%. The castings industry is considerably fragmented and does not have thepresence of very big players. Foundries generally cater to specific requirements of somecustomers and do not possess scale or the capability to service needs of diverse customers. Keycompetitors of KFIL are Nelcast, DCM Engineering, Menon & Menon, Ghatge Patil, Neosym,Steelcast and Amtek foundry. KFIL has wider and deeper capabilities than its competitors in the greyiron castings segment as per our industry and competition deep dive analysis.

� Castings business has several entry barriers: Some key entry barriers are:-

� Long and complex new product development time – Each casting is unique in nature andneeds to be developed on designs given by clients. The time taken for new product developmentplays a crucial role in procuring an order and successfully executing it within a giventimeframe. The new product development time is between 8 to 18 months for the industry ingeneral.

� Need for technology, innovation and continuous R&D– There is constant need for investing in R&D (as high as ~1% of revenues), innovation in operational efficiencies for getting the desired output and strong technology support for designing and manufacturing customised products.

� Long customer approval time and relationships – New customer acquisition is a longdrawn out process, involving a lengthy procedure for approval of both the productionfacilities and soft skills related to technology, and product development. Customers also tendto have sticky and long-term relationships with their suppliers and don’t change vendorsfrequently.

� High rejection rate, need for high quality, customised products dissuades marginalplayers – The industry suffers from high rejection rate (8-9% on an average) due to thecomplexity of product design and production, as customers look for quality. Moreimportantly, client needs customised products to suit their requirements and hence designand quality are vital. This keeps marginal players out of the game as it is uneconomical forthem.

6 Kirloskar Ferrous

Investment in building capacity and capability of castings division already done

KFIL has made huge strides in not only building up capacity in its castings division but also in developing niche capabilities that give it an edge over competitors and paves way for strong volume growth in the coming years. We discuss these in detail below:-

� Impressive capacity build-up by KFIL in castings division: KFIL has made significant investments in its castings division over the past 10 years and built up a strong production base at Solapur and Hospet (Koppal) plants. The company acquired the Solapur plant in 2008 and subsequently set up a new line of 40 ktpa at the plant while abandoning the old lines completely. At its Koppal plant, KFIL set up the new line in FY13-14 with a capacity of 48 ktpa at a competitive capex. The new lines are highly robotized and efficient. KFIL has also invested in setting up machining facilities at Solapur and more recently at Koppal, providing strong value addition.

Exhibit 9: Capacity build-up in castings


� Focus on increasing sales of higher margin machined castings: KFIL is also focussed on increasing the sales of machined castings, which adds substantial value and fetches much higher margins. While non-machined castings fetch a realisation of ~Rs80/kgs, machined castings fetch an additional Rs40-50/kg and the company makes EBITDA margins of ~40% on the additional realisations. KFIL is currently doing machining jobs of ~10% of its overall casting volumes but intends to spend further on building more machining facilities for value addition. Machining capabilities also attract more customers who want highly value added machined castings. The payback on the investment done for machining is 4-5 years and currently the company is procuring more orders for machining work.

Exhibit 10: Machining facilities in castings division of KFIL

Source: Centrum Research, *Koppal capacity of machining is on ballpark basis

45,000 45,000

93,000

40000 40000

4000048000

-

20,000

40,000

60,000

80,000

1,00,000

1,20,000

1,40,000

FY06 FY08 FY09 FY14 FY17

Tonne/year

Koppal Solapur New Line Solapur Koppal New Line

45000

95000

133000

24000

48000 48000

48000 48000

24000

0

20000

40000

60000

80000

100000

120000

140000

FY08 FY14 FY18

Nos

Solapur - Heads Solapur - Blocks Koppal*

7 Kirloskar Ferrous

� Game-changing achievement of reduction in new product development cycle time from eight to two months: A key determinant of capability in castings production is new product development cycle time and KFIL has in FY17 achieved a big breakthrough in reducing this from as high as eight months earlier to less than two months now. The new product development cycle involves developing the requisite design for castings (after getting the initial design in 2D/3D form from the customer), developing the toolings design for manufacturing of casting (core and moulds making), producing initial samples and procuring customer approval on samples before the product can be sent for production. KFIL earlier took seven to eight months to do the job as the design of toolings, which was outsourced, itself took four to five months. Now this is done in-house within two weeks and other processes have also been streamlined. As a result of reduced new product development cycle time, KFIL can now develop ~15 new products annually versus 4-5 products earlier. This resulted in new customer acquisitions and more orders and was a game changer for the company from FY17 (Refer exhibit 11 for key benefits).

Exhibit 11: Game changing improvement in new product development cycle time


� Efforts underway to reduce cycle time further to one month: KFIL is currently working to adopt the new technology of 3D printing which could further reduce new product development cycle time to ~1m. We believe that if successful, this will help the company further in growing volumes strongly and add to its competitive advantage.

� Improved product quality and delivery time: KFIL has also made substantive progress in improving product quality over time by reducing rejection rates and creating better fettling facilities. KFIL’s Solapur facility has rejection rate of only 5% - lowest in the industry - and rejections rates on a whole for the company stands at 7-8%. The company has given the delivery mechanism special importance focussing sharply on customer requirements. This will help retain customers over long periods of time.

� Significant increase in new customer additions & strong geographical presence: KFIL has been able to develop a diversified customer base with several new customer additions over the past two years and also increase its geographical presence in the past five years along with the build-up in volumes from Solapur plants. Customer diversification has been increasing constantly and KFIL has added several new customers in the past few years.

8

2

1

0

1

2

3

4

5

6

7

8

9

Till FY16 From FY17 Likely from FY19-20E

No. of months

Key benefits of cycle time reduction:

� More product developments annually� Flexibility to target and develop products for more customers� Better utilisation of spare capacity in castings� Strong Competitive edge over peers

8 Kirloskar Ferrous

� Strong focus on R&D capability: KFIL has spent ~Rs115mn on R&D in the past two years, which amounts to ~0.5% of sales and ~2% of overall other expenses. The benefits of R&D, as per company’s annual report, has been in the following areas:

� Reduction of new product development cycle time.

� Acquiring of capability of developing critical castings.

� Improved quality and consistency.

� Initiation of prototype casting development through core 3D printing technology.

� Higher productivity through changes in designs of moulds/patterns.

Exhibit 12: R&D spend of KFIL


� Setting up a 10MW solar power plant at Solapur to reduce power cost: KFIL is currently setting up this plant at a capex of ~Rs500mn at its Solapur castings facility for captive use, which is likely to get commissioned by Q4FY18E. The operational cost of solar power is likely to be less than Rs2/unit and should cater to ~50% of the Solapur plant’s power requirement. The power cost at Solapur plant is currently north of Rs7/unit; our rough estimates suggest cost savings of ~Rs88mn/Rs61mn at EBITDA/PBT level from solar CPP from FY19E and thus translate to a payback of ~5 years from the project.

Exhibit 13: Significant power cost savings form Solar CPP

EBITDA Level PBT Level

Solar CPP Capacity (MW) 10 10

PLF - % 20 20

Power Production (mn units) 17.5 17.5

Cost/unit (Rs/unit) 2 3.5

Power Purchase Cost (Rs/unit) 7 7

Power cost savings (Rs/unit) 5 3.5

Total Savings (Rs mn) 88 61


70.4

43.7

0.6

0.4

2.3

1.5

0.0

0.5

1.0

1.5

2.0

2.5

0

10

20

30

40

50

60

70

80

FY16 FY17

Rs mn

R&D Spend - LHS as % of sales as % of other expenses

9 Kirloskar Ferrous

� Large investments already in place; monetisation of the same in store: As discussed in detail in the current section already, KFIL has made large investments in castings and with crucial capabilities such as quicker new product development time and marquee customer relationships already in place, the stage is set for monetisation of the existing robust asset base through higher capacity utilisation. We expect KFIL to sweat its asset base in castings; note that capacity utilisation at its Koppal/Solapur plant stood at just 44%/62% in FY17, thereby leaving large room for growth. We expect investments in castings business to be focussed incrementally on machining for the next 2-3 years and hence the capex in this business should be limited to ~Rs250-300mn/year.

Exhibit 14: Investments in castings business

Investments done in Castings Business over last 5 years

Set-up of new line (48000 ktpa) at Koppal in FY14

Set-up of new machine shop at Solapur in FY14

Set-up of new machine shop at Koppal in FY18

Set-up of fettling facilities in Solapur in FY17

Investment in R&D to reduce new product development cycle time and improve product quality


Exhibit 15: Enough room for capacity utilisation improvement going ahead


93000

40000

133000

41192

24700

6589244%

62%

50%

0%

10%

20%

30%

40%

50%

60%

70%

0

20000

40000

60000

80000

100000

120000

140000

Koppal Solapur Total

Tonne/yr

Capacity Volumes Utilisation - RHS

10 Kirloskar Ferrous

Strong volume growth in store, better product mix and economies of scale to enhance margins & profitability

KFIL has come a long way in the castings business by developing key competencies over time and simultaneously increasing capacities (as explained in detail already in previous sections) and we expect strong volume growth, driven by increased mining of existing customers as well as acquisition of new customers. We also expect better product mix and economies of scale to augment margins, culminating in strong earnings growth from the castings business.

� We expect castings volume CAGR of 18.6% during FY17-20E: We expect KFIL to clock impressive volume CAGR of 18.6% in castings division during FY17-20E with total volumes growing to 110kt by FY20E (versus 66kt in FY17). Revenue growth is likely to increase at a fast clip led by better product mix (increased share of special castings and machined castings) and sales should rise to Rs9.2bn in FY20E (~1.8x of FY17 levels of Rs5.2bn).

Exhibit 16: Castings volumes up-trend Exhibit 17: Revenue growth to remain solid

Source: Centrum Research Estimates Source: Centrum Research Estimates

� Focus on cost optimisation, higher share of machined castings and economies of scale to augment castings margins: The castings business enjoys a high gross profit/t and we expect this to improve as share of castings in the overall mix increases to 51% by FY20E (Refer exhibits 18 & 19). We expect strong margin tailwinds for the castings business for KFIL because of i) a sharp increase in volumes providing economies of scale, ii) higher share of machined castings that fetch substantially higher margins and iii) focus on cost optimisation through set-up of captive power plant at Solapur, and other cost saving exercises.

Exhibit 18: Castings gross profit/t trend Exhibit 19: KFIL gross profit/t to move up led by higher share of castings


60396 57257 5666165892

82000

97000110000

45% 42% 42%49%

61%72%

81%

2.8% -5.2% -1.0%

16.3%24.4%

18.3% 13.4%

-20%

0%

20%

40%

60%

80%

100%

0

20000

40000

60000

80000

100000

120000


Volumes (Tonne) Utilisation - % YoY % - RHS

4,600 4,745 4,607

5,191 6,970

8,148

9,240

4.1%3.1%

-2.9%

12.7%

34.3%

16.9%13.4%

-5%

5%

15%

25%

35%

1,000

3,000

5,000

7,000

9,000

11,000


Sales (Rs mn) YoY % - RHS

40,000

45,000

50,000

55,000

60,000

65,000


Rs/t

12971

14428

15067

17126

14971

17137

19310

37.334.8

41.445.8 44.1

47.751.2

0

10

20

30

40

50

60

10000

12000

14000

16000

18000

20000


KFIL - Gross Profit/t (Rs) Castings - % Share - RHS


� Growing volumes of industry & key clients => Higher volumes for KFIL castings division: Analysis of sales volume data of CV and tractor industry indicates that i) CV industry is showing steady single digit growth in last few years but market shares of M&M and VECV have been inching up, and ii) tractor industry sales growth is on fast track coupled with increase in market share of Mahindra brand of tractors. KFIL is set to witness strong volume growth with increase in volumes of existing clients with whom the company enjoys a long term relationship coupled with acquisition of new clients.

Exhibit 20: CV industry volume trend Exhibit 21: Market share of KFIL’s clients increasing

Source: SIAM, Centrum Research, *YTD nos annualised Source: SIAM, Centrum Research

Exhibit 22: Tractor industry volume trend Exhibit 23: Market share trend in tractor industry

Source: SIAM, Centrum Research, *YTD nos annualised Source: SIAM, Centrum Research

873258

709776

701014

788828

822495

832232

0

2,00,000

4,00,000

6,00,000

8,00,000

10,00,000

FY13

FY14

FY15

FY16

FY17

YTDFY18A*

Nos

M&HCV LCV Total CV

55.950.8

47.945.4 44.4 43.5

20.525.5 25.1 24.8 25.1 26.6

7.511.4

14.9 17.8 17.6 17.5

5.4 5.5 6.0 6.6 7.1 6.80

10

20

30

40

50

60

FY13 FY14 FY15 FY16 FY17 YTDFY18

%

Tata Motors M&M

Ashok Leyland Volvo Eicher (VECV)

527737

634151

551463

493764

582844

676099

20.2%

-13.0% -10.5%

18.0%16.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

300000

400000

500000

600000

700000

FY13

FY14

FY15

FY16

FY17

YTDFY18A

Nos

Tractor Domestic Sales YoY - %

40.2 40.6 40.1 40.9 42.6

25.0 24.7 24.4 23.020.5

11.7 10.7 10.4 10.3 10.8

9.7 10.3 12.0 11.9 11.9

0

10

20

30

40

50


%

M&M TAFE Escorts Sonalika


Pig iron business being made robust with meaningful cost improvement projects

Foundry grade pig iron business with limited competition

KFIL produces foundry grade pig iron (FGPI) through its two blast furnaces (MBF1 & 2) and has an installed capacity of 3.9 lakh tpa. KFIL consumes ~15% of pig iron in-house in its castings division and sells the remaining in the merchant market to various foundries through an extensive pan-India dealer network. The FGPI business is characterised by lower competition, higher prices and better margins as compared to steel grade pig iron (SGPI) but remains exposed to cyclical movements in raw material and product prices.

� Pig iron demand-supply remains largely balanced: Pig iron market in India is characterised by supplies from a large number of small producers and demand is generally driven by i) foundries (for making of castings for various end-user industries) and ii) steel producers (as feed into SMS/induction furnaces to form appropriate metallic mix) for making finished steel. Pig iron is usually of two types: steel grade (SGPI) and foundry grade (FGPI) and is manufactured and supplied by various producers having mini blast furnaces in the secondary steel sector. Large producers account for only 10% of the market and include mainly the PSU’s like SAIL & RINL. The pig iron market in India has been passing through a subdued phase with flattish consumption for the last three years, but the market remains largely balanced as supply too has not increased and remains flattish at ~9.5 MT annually.

Exhibit 24: Pig iron demand-supply

FY13 FY14 FY15 FY16 FY17 YTDFY18

Production for Sale 6.9 8.0 9.7 9.2 9.5 5.4

Production growth % 27.9 15.7 21.9 (4.8) 2.4 (2.9)

Import 0.0 0.0 0.0 0.0 0.0 0.0

Exports 0.4 0.9 0.5 0.3 0.4 0.3

Exports as % of production 6.0 11.9 5.6 3.2 4.1 5.7

Net Exports 0.4 0.9 0.5 0.3 0.4 0.3

Consumption 6.5 7.1 9.1 9.0 9.1 5.1

Consumption growth % 30.7 9.4 27.4 (0.4) 0.5 (3.1)

Source: Joint planning commission, Centrum Research

� Foundry grade pig iron less competitive, fetches better prices and margins: While the foundry grade pig iron (FGPI) market is less than 20% of overall pig iron market, the number of producers in foundry grade market is limited, as manufacturing of foundry grade requires keeping sulphur and phosphorous at a lower level and also needs better quality iron ore. While foundry grade pig iron is also a commodity like steel grade pig iron, but limited competition in FGPI enables it to fetch better prices and margins compared to steel grade pig iron.

� Upgradation of MBF1 in FY17 => reduced coke consumption, higher capacity: KFIL has completed a crucial upgrade of its mini blast furnace 1 (MBF1) in FY17 at a capex of ~Rs400mn. The upgradation was aimed at i) increasing the working volume of the furnace to 300m3 resulting in an increase of MBF1 capacity by ~30ktpa, ii) reducing the coke rate through better operational working and iii) paving the way for future installation of pulverised coal injection plant for both MBF1 & 2. The MBF1 has been re-blown at a higher capacity since Jan’17. KFIL’s overall pig iron manufacturing capacity has increased to 1100 tpd (3.9 lakh tpa) and company is also looking to upgrade MBF-2 in due course, post which the capacity would increase to 1250 tpd (4.25 lakh tpa). The company expects the capex for upgradation of MBF2 to be between Rs400 and 500mn.


Spread contraction in last 12-18m hurt earnings, but recovery underway

KFIL’s pig iron business has seen substantial spread contraction in the past 12 to 18 months due to a sharp increase in coke/coking coal prices, which was not accompanied by a commensurate increase in pig iron prices. However, raw material prices have recently started stabilising at lower levels, while pig iron prices are showing resilience and hence spread recovery is underway. Additionally, KFIL has already initiated several cost reduction measures for reducing the volatility in spreads of the pig iron business. We expect gross profit/t for KFIL’s pig iron business to improve from H2FY18 from the distress levels of H1FY18.

� Large increase in coke prices has hurt spreads in last 12-18 months: Coke prices have more than doubled in the last 18 months on account of supply disruptions in coking coal; this led to a sharp squeeze in the difference between pig iron and coke prices, as pig iron prices in the domestic market couldn’t mirror similar gains (refer Exhibit 25 & 26). In the last few months, coke prices have softened 25% from the peak while pig iron has remained steady to marginally positive, thereby brightening the spread situation.

Exhibit 25: Coke & coking coal prices have more than doubled in last 18m

Exhibit 26: Difference between pig iron and coke prices reduced, squeezed spreads

Source: Steelmint, Centrum Research Source: Steelmint, Centrum Research

� Spreads have bottomed out, improvements underway aided by cost improvement initiatives: Pig iron spreads have been under pressure in the past one year and have been trending well below their long-term average. We see improvements in spreads already underway and expect the same to further improve. However, we remain conservative in our assumptions for improvement in gross profit/t of pig iron business and have factored in gross profit/t of Rs3984/5657 in FY19E/20E as compared to the last five-year average of ~Rs6200/t. Moreover, a major portion of our recovery assumptions is based on several cost improvement initiatives that KFIL is taking (explained in detail in the next section) and not purely on market related improvement in spreads. Improvement in gross profit/t from current distressed levels would help KFIL see its profitability in pig iron business stabilising by Q4FY18E, in our view.

Exhibit 27: KFIL’s pig iron gross profit/t trend – we expect recovery but remain conservative


0

100

200

300

400

May-15

Jul-15

Sep-15

Nov-15

Jan-16

Mar-16

May-16

Jul-16

Sep-16

Nov-16

Jan-17

Mar-17

May-17

Jul-17

Sep-17

Nov-17

US$/t

Coke (Met Coke 64% China - CNF India)

Coking Coal (HCC 8% Ash - CNF India)

Sharp increase seen in last 12-18 months 4000

8000

12000

16000

20000

5000

10000

15000

20000

25000

30000

May-15

Jul-15

Sep-15

Nov-15

Jan-16

Mar-16

May-16

Jul-16

Sep-16

Nov-16

Jan-17

Mar-17

May-17

Jul-17

Sep-17

Nov-17

Rs/t

Rs/t

Pig Iron (Foundry Grade - Ex Kharagpur)Met Coke import landed (from China)Spread (PI - 0.7x Coke)

6223

5023

6846

63696713

2809

3984

5657

2,000

3,000

4,000

5,000

6,000

7,000

8,000

FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E

Rs/t


Third party coke manufacturing tie-up to reduce costs

KFIL has been procuring coke mainly through imports till now and was thus getting adversely impacted by the increase in international coke prices. But the company is likely to have tied up with two domestic coke manufacturers for a third party conversion of coking coal into coke exclusively for KFIL, at a fixed conversion cost. This arrangement is likely to yield substantial cost savings of ~Rs1570/t of coke and ~Rs300mn annually at the current coking coal and coke prices as per our estimates.

� Coke manufacturing being done at third party coke plants: KFIL is likely to have tied up with two third party plants in Karnataka and Tamil Nadu for exclusive third-party conversion of coking coal into coke. The volume tie-up is for a quantity of ~10,000 tonne/month with each supplier and the agreed conversion cost is approx. Rs2000/t. KFIL is targeting savings on coke procurement through this arrangement while the producers are looking for fixed return on their capacities without taking on commodity price movement risk.

� Coke cost reduction of ~Rs1570/t vs. imports at current prices: Our calculations on potential cost savings and workings on comparison of landed cost of coke from third party arrangement vs. imports indicates a saving of ~Rs1570/t on coke landed cost for KFIL (Exhibit 28, 29 & 30 below). We note that savings on coke are dynamic in nature and dependent on the prevailing prices of coking coal and imported coke. This translates to ~Rs1100/t in savings on pig iron manufacturing, implying annual savings of ~Rs300mn at current prices. We believe KFIL can realise a significant portion of this despite volatility in both coking coal and coke prices and this would help the company to manage its spreads in the pig iron business better. The coke supply arrangements with suppliers can be terminated at short notice if it becomes non-remunerative for KFIL.

Exhibit 28: 3rd party coke landed cost for KFIL Exhibit 29: Imported coke landed cost for KFIL

Hard Coking Coal Aus - CNF India – US$/t 195

Import Duty (2.5%) – US$/t 4.9

Port Charges – US$/t 5

Ex-Port Coking Coal Price US$/t 205

USD/INR 65

Ex-Port Coking Coal Price Rs/t 13,317

Internal Freight (Port to 3rd Party Coke Plants) – Rs/t 1,000

Coking Coal Landed Cost at 3rd Party – Rs/t 14,317

Coking coal reqd. for conversion to coke 1.42

Total Coking Coal Cost for making 1 tonne of Coke – Rs/t 20,330

Conversion Charges paid to 3rd party – Rs/t 2,000

Freight from 3rd party plant to KFIL plant – Rs/t 550

Landed cost of Coke at KFIL plant – Rs/t (A) 22,880

Met Coke 64% China - CNF India – US$/t 315

Import Duty (5%) – US$/t 15.8

Anti-dumping duty – US$/t 25

Port Charges – US$/t 5

Ex-Port Coking Coal Price US$/t 361

USD/INR 65

Ex-Port Coking Coal Price Rs/t 23,449

Freight from port to KFIL plant – Rs/t 1,000

Landed cost of Coke at KFIL plant – (B) 24,449


Exhibit 30: Coke savings snapshot

Price differential of imported coke vs 3rd party converted coke (B-A) - (Rs/t) 1,569

Coke reqd/t of Pig Iron 0.72

Savings per tonne of Pig Iron (Rs/t) 1,130

Coke quantity tied up on annual basis 2,40,000

Likely quantity received (80%) 1,92,000

Annual Savings (Rs mn) 301



Low-payback backward integration projects being planned, cost metrics likely to improve significantly by FY20E

KFIL is in a strong position to pursue backward integration projects with a low payback in its pig iron business thereby making the business more robust across cycles. These projects will address the issue of sourcing of coke and are likely to improve the cost metrics significantly.-

� Installation of Pulverised Coal Injection for full pig iron capacity => 80kg of cheap coal to replace high cost coke: KFIL is likely to install a pulverised coal injection unit for its mini blast furnaces (MBFs) at a capex outlay of ~Rs350mn. PCI set-up allows MBFs to charge 80kg of low-cost pulverised coal for production of hot metal thereby replacing high-cost coke to that extent. As KFIL has upgraded one of its MBFs and is also looking at upgrading another soon, installation of PCI is the next natural step in the value chain and would help the company in realising crucial savings. We estimate a cost differential of US$120/t on a normalised basis between pulverised coal and coke. We also estimate annual savings of ~Rs240mn for KFIL’s pig iron production of ~380 ktpa in FY20E, on replacement of 80kg of coke with low cost coal. We expect the PCI investment announcement before FY18E-end and commissioning before FY19-end thereby resulting in savings from FY20E. The payback for this capex is likely to be less than two years.

Exhibit 31: PCI project savings snapshot

Coke Replacement by PCI 80 Kgs

Total Coke Replaced/yr 30,600

Cost Difference (US$/t) 120

USD/INR 65

Cost Difference (Rs/t) 7,800

Total Savings/yr (Rs mn) 239


� Set-up of 200 ktpa coke oven with associated WHR CPP of 15MW: KFIL is likely to set up captive coke oven batteries with a capacity of 200ktpa, along with associated waste heat recovery CPP of 15MW at a total capex of ~Rs2.5bn at its Koppal plant. It has already acquired requisite land of ~80 acres adjacent to its plant and has taken EC and pollution clearances for the project. This project will provide ~75% of its coke requirement and low cost power generated from WHR CPP can be utilised in the castings business that currently sources power at a very high rate of ~Rs6.5/unit. We expect material savings on an overall basis (refer exhibit 32) from the project and a payback of less than four years.

Exhibit 32: Coke & WHR power project savings snapshot

Coke Making Waste Heat Power Generation

Savings on Captive Conversion v/s Third Party Conversion (US$/t)

15 Captive WHR Power 15 MW

Coke Capacity (tonne) 200000 Net PLF 80%

Coke Savings (US$ mn) 3 Power Generated (mn units) 105

USD/INR 65 Power Savings (Rs/unit) 5

Coke Savings (Rs mn) 195 Power Savings (Rs mn) 525

Total Coke+Power Savings (Rs mn) 720


Exhibit 33: Capex likely to be undertaken – Likely earnings accretion & payback period

Project Project Type Project Size Capex to be incurred

by KFIL (Rs mn)

Likely Savings/Additional EBITDA (Rs mn)

Likely Payback

PCI for BF Operational efficiency NA 350 240 <2 yrs

Coke BOOT route + WHR CPP Backward integration Coke - 200 ktpa, WHR CPP - 15 MW

2500 720 <4 yrs



Splendid combo of consistent cash flows, low debt/equity and spare capacity

Spare capacity of 50%/25% in castings/pig iron businesses

KFIL has spare capacity of 50%/25% in castings/pig iron as both businesses are well endowed with substantial investments made in the past few years. Castings has spare capacity at both Solapur and Koppal plants and with reduction in new product development cycle time already achieved, both plants are likely to see better utilisation. KFIL has focussed on building its capabilities in the past few years and has set itself up strongly for volume growth from FY18E onwards. We believe that volume growth will be strong in the years ahead as existing assets get better utilised. This will be driven by i) long-standing, vital customer relationships and quicker product development in castings, and ii) higher operational efficiency of blast furnaces for pig iron.

Exhibit 34: Snapshot of capacity and utilisations in KFIL’s castings/pig iron businesses


Asset turnover at a multi-year low, set to improve with higher utilisation

KFIL has been allocating capital in the past five years to projects on forward integration (increase in castings capacity for value addition and higher profitability) and operational efficiency (upgradation of blast furnace for cost savings and expansion). While the gross block has expanded by ~70% (over FY13-17), volumes and turnover have remained largely flat. Asset turnover in FY17 was at a multi-year low of 1.2x (versus 1.9x in FY13) and we see improvement in asset turnover led by higher utilisation of the existing solid asset base.

Exhibit 35: Revenue/Gross block trend


133000

390000

65892

291273

6710898727

50%

25%

0%

10%

20%

30%

40%

50%

60%

0

100000

200000

300000

400000

500000

Castings Pig Iron

Tonne

Capacity Production Spare Capacity - RHS Spare Capacity - RHS

1.9

1.5

1.6

1.21.2

1.5 1.5

1.3

1.0

1.2

1.4

1.6

1.8

2.0

0

4000

8000

12000

16000

20000


Rs mn

Revenues Gross Block Rev/GB (x) - RHS


Strong conversion of cash profit into adjusted operating cash flows (excl. interest) => hallmark of a well-run business

We believe that one of the key signals of prudent capital management is conversion of cash profits (CP) into adjusted operating cash flows (AOCF=OCF-Interest). KFIL boasts of an enviable track record of conversion of cash profits to cash flows (5Y/10Y AOCF/CP ratio of 1x/0.9x). This in turn has resulted in greater flexibility to undertake capex and reduce debt. We expect KFIL to continue to convert majority of its cash profits into cash flows going forward.

Exhibit 36: AOCF/CP trend


Working capital management remains sound

KFIL’s integrated business is not working capital-intensive and the management has done a good job in controlling inventories to below 40 days. Debtor days for the pig iron business have remained low as KFIL sells specialised foundry grade on favourable terms to various markets through a strong dealer network. As per industry standards, debtors for the castings business is between 60-70 days and supplies are to long-standing customers. Creditors are between 40-60 days for sourcing of coke depending on negotiations while iron ore is procured from e-auctions in Karnataka on bidding and cash payment. On an overall basis, KFIL’s working capital management remains sound with cash conversion cycle maintained at ~30 days on an average in the past (FY11-17 average); we expect the same to remain at 40 days in FY19E/20E.

Exhibit 37: Cash conversion cycle trend


0.8

1.1

1.3

0.9

0.7 0.6

1.00.9

0.5

0.7

0.9

1.1

1.3

1.5

0

500

1000

1500

2000

2500

3000


Rs mn

Cash Profit AOCF AOCF/CP (x) - RHS

33 32

24

31

50

45

40 40

0

10

20

30

40

50

60

-80

-60

-40

-20

0

20

40

60

80


Days

Days

Inventory Debtors Creditors Cash Conversion Cycle - RHS


Low leverage gives flexibility to pursue investment projects for cost savings and growth

KFIL boasts of a strong balance sheet with low Net Debt (incl. acceptances)/Equity ratio of 0.3x. Despite investing for growth in the past few years, the company has continuously repaid its debt and reduced leverage. KFIL currently does not have any long-term debt and existing debt is only for working capital. Strong balance sheet with low leverage coupled with strong cash flow generation gives KFIL enormous flexibility to pursue growth as well as backward integration projects which will help make its operations more rewarding across cycles.

Exhibit 38: Consistent debt reduction has led to low leverage


KFIL continues to pursue iron ore mines in Karnataka auctions and looking for attractive bidding price

Apart from pursuing backward integration projects for coke sourcing, KFIL is also actively looking to acquire iron ore mines in the ongoing auctions in Karnataka. KFIL currently buys iron ore from e-auctions in Karnataka but aspires to have their own captive mine for long term, dedicated sourcing. While the bidding so far in mine auctions has been too aggressive and well above the threshold levels from an economic point of view, KFIL would remain a key participant in upcoming mine auctions and looks to procure the iron ore mines at much better bidding prices which provides both savings on a per tonne basis and captive feed for long term.

17021896

1327

1082969

2946 2947 2487 1721 1762

0.70.7

0.5

0.30.3

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0

500

1000

1500

2000

2500

3000

3500


Rs mn

Net Debt Net Debt (Incl. acceptances) Net Debt/Equity (x) - RHS


Financial Analysis – Earnings at an inflection point

Revenue growth to be aided by solid volume growth in castings segment

We expect net sales CAGR of 16.8% for KFIL during FY17-20E. This would be led by strong volume CAGR of 18.6% from the castings segment. We estimate the share of value added castings business to reach ~51% of overall revenues by FY20E from ~44% in FY18E. With spare capacity being available in pig iron division also, we expect pig iron volume CAGR of 9.5% during FY17-20E.

Exhibit 39: Revenue CAGR of 16.8% during FY17-20E Exhibit 40: Strong volume CAGR of ~19% in Castings


EBITDA margins to trend upwards, driven by increasing share of high margin castings and cost saving initiatives

We expect strong pick-up in KFIL’s EBITDA from FY19E led by higher volumes, superior product mix and better spreads. We expect an EBITDA CAGR of 28% during FY17-20E. KFIL’s blended EBITDA/t has been improving between FY15 and FY17 and we expect this to improve materially to ~Rs8400/t by FY20E led by higher share of castings which fetches higher margins. We expect gross profit/t to improve smartly to Rs19300/t (versus ~Rs15000/t currently) led by i) cost savings through backward integration projects, ii) higher contribution of castings and iii) overall better spreads in pig iron.

Exhibit 41: EBITDA CAGR of 28% during FY16-19E Exhibit 42: Blended EBITDA/tonne to improve materially


13651

11139 11337

1579317086

18049

10.8

-18.4

1.8

39.3

8.2 5.6

-40

-20

0

20

40

60

0

5000

10000

15000

20000


Net Sales - Rs mn YoY Growth - % (RHS)

318 289 253306 327 333

5757

66

8297 110

0

100

200

300

400

500

FY15 FY16 FY17 FY18E FY19E FY20Ekt

Pig Iron Castings

CAGR FY17-20ECastings - 18.6%Pig Iron - 9.5%

1490 1509 1756 1352 2467 3730

10.9

13.615.5

8.6

14.4

20.7

0

5

10

15

20

25

0

1000

2000

3000

4000


EBITDA - Rs mn Margin - % (RHS)

14428

15067

17126

14971

17137

19310

3969

4361

5497

3481

5821

8419

34.8

41.445.8 44.1

47.751.2

0

10

20

30

40

50

60

0

5000

10000

15000

20000

25000


Rs/t

Gross Profit/t Blended EBITDA/t Castings Share - % (RHS)


Return ratios should inch higher with major uptick in FY20E

KFIL’s return ratios have remained subdued on account of front loaded investments and low asset turnover due to low utilisation. However, this is set to change sustainably and with meaningful contribution from spare capacity in value-added business of castings coming in progressively by FY20E, we expect material jump in ROE/ROCE by FY20E. We forecast ROE/ROCE (post tax) to be at ~25%/20% in FY20E.

The DuPont analysis of ROE shows that the improvement is well distributed between key metrics:-

� Profit margins – This is expected to improve materially (to double digits) by FY20E led by i) higher share of high margin value-added castings, ii) cost improvement projects in pig iron business coupled with captive power facilities for castings and iii) operating leverage from higher volumes.

� Asset Turnover – We expect substantial sweating of assets despite incremental capital getting invested in backward integration projects (like coke oven and CPP which don’t fetch additional sales), and hence an increase in return ratios.

� Leverage – The leverage for KFIL remain low with no long-term debt and we expect the company to largely maintain this situation through internal accruals. Hence, leverage is expected to play a bare minimum role in improvement of ROE’s and hence ROE improvement is not borrowed from increased leverage which is again a positive sign.

Exhibit 43: Return ratios to inch up Exhibit 44: DuPont analysis


Profit Margin - % 3.6 5.2 8.0 2.9 6.9 10.8

Asset Turnover (Net Sales/Assets) - x

1.4 1.2 1.2 1.5 1.4 1.3

Financial Leverage (Assets/Equity) - x

2.2 1.9 1.7 1.8 1.9 1.8

ROE - % 11.2 12.2 16.9 7.8 17.9 25.4


Strong dividend payout track record

KFIL has maintained a good record of dividend payout of ~30% of PAT. We note that the company has carefully calibrated its cash flows and allocated them appropriately over time to i) dividends, ii) debt repayments and iii) new project investments as part of capex. We expect strong dividend payout to be maintained. We also note that promoters of KFIL do not draw any salary from the company (except board sitting fees) and instead realise money as general shareholders by way of dividends. This is positive for all shareholders (refer to details in Corporate governance section on page 27).

Exhibit 45: Dividend payout


11.212.2

16.9

7.8

17.9

25.4

10.4 11.0

14.0

7.5

14.6

19.9

5

10

15

20

25

30


%

ROE ROCE (post tax)

1.2 1.2

1.8

0.8

2.1

3.635%

30%

26%25% 25% 25%

3% 2% 2%1%

2%4%

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


Dividend (Rs/Sh) - LHS Payout - % Div Yield - % (RHS)


Key Assumptions and Sensitivity

Exhibit 46: Key Assumptions


Revenue (Rs mn)

Pig Iron 7,174 8,437 6,231 5,889 8,423 8,498 8,325

Castings 4,600 4,745 4,607 5,191 6,970 8,148 9,240

Sales Volumes (kt)

Pig Iron 2,75,692 3,18,023 2,89,485 2,53,495 3,06,300 3,26,850 3,33,000

Castings 60,396 57,257 56,661 65,892 82,000 97,000 1,10,000

Net Sales Realisations (Rs/t)

Pig Iron 26,021 26,528 21,525 23,231 27,500 26,000 25,000

Castings 76,170 82,864 81,303 78,786 85,000 84,000 84,000

Gross Profit (Rs/t)

Pig Iron 5,023 6,846 6,369 6,713 2,809 3,984 5,657

Castings 49,251 56,543 59,502 57,186 60,399 61,460 60,640

KFIL - Total 12,971 14,428 15,067 17,126 14,971 17,137 19,310


Exhibit 47: Earnings sensitivity to castings volumes & realisations (+1% change)

1% Chg EBITDA PAT

Castings FY19E FY20E FY19E FY20E

Volume 2.0 1.5 2.9 2.0

Realisations 3.1 2.4 4.5 3.1


Exhibit 48: Earnings sensitivity to RM costs (+1% change)

1% Chg EBITDA PAT

RM Costs FY19E FY20E FY19E FY20E

Iron Ore (1.1) (0.7) (1.6) (0.9)

Coke (2.2) (1.3) (3.2) (1.7)



Valuation – Strong scope for re-rating, Initiate with Buy and TP of Rs155

The KFIL stock has remained sideways in the last six months on account of pressure on gross profit/t which has kept earnings subdued, despite better product mix through higher castings sales. We see scope of re-rating led by earnings recovery and market appreciating the full potential of KFIL’s well-invested asset base in due course as utilisation picks-up and share of value-added castings business increases. We value KFIL on our differentiated AOCF/EV methodology as well as conventional EV/EBITDA and initiate with a Buy rating and a TP of Rs155. At our TP, stock would be valued at 10.9x FY20E P/E and 6.2x FY20E EV/EBITDA. We ascribe a premium to historical multiples and specify key reasons for the same below.

AOCF/EV valuation – 40% premium ascribed to historical AOCF/EV yield

For AOCF/EV based valuation, we note that five year average AOCF/EV yield stands at 9.2% for KFIL. We ascribe a 40% premium to this average for arriving at the target EV/AOCF multiple, which, in turn, is used for deriving the target EV. We arrive at a target AOCF/EV yield of 5.5% for KFIL, and hence, the implied EV/AOCF multiple of 18.1x. We use average AOCF over FY16-20E of Rs1337mn and 18.1x EV/AOCF multiple to arrive at our target EV and our TP of Rs155 (Exhibit 49). We note that FY20E AOCF of Rs2465mn is substantially higher than our 5 year average used for valuation and hence our valuation methodology builds in sufficient margin of safety.

EV/EBITDA valuation – 25% premium ascribed to historical EV/EBITDA

For EV/EBITDA based valuation, we use our FY20E EBITDA estimates and ascribe EV/EBITDA multiple of 6.5x (25% premium to last 5 year average EV/EBITDA multiple of 5.2x). From this methodology we get a fair value of Rs155/share (Exhibit 50).

Exhibit 49: AOCF/EV based valuation Exhibit 50: EV/EBITDA based valuation

9.2

40%

5.5

5 Year avg. AOCF/EV Yield - % - FY13-17

Premium assigned

Target AOCF/EV Yield - %

Implied EV/5 yr AOCF Multiple (x) 18.1

5 yr AOCF (Rs mn) - FY16-20E 1,337

EV (Rs mn) 24,216

Less: Net Debt (incl. acceptances) – FY20E (3,251)

Fair value mkt cap 20,964

No. of shares (mn) 137.3

Fair Value/share (Rs) 155

(Rs mn) Mar'20E

3,730

5.2

25%

EBITDA

Historical EV/EBITDA avg. (FY13-17)

Premium assigned

Ascribed EV/EBITDA (x) 6.5

EV 24,242

Less: Net Debt (incl. acceptances) (3,251)

Fair value mkt cap 20,991

No. of shares (mn) 137.3

Fair Value/share (Rs) 155


We believe that the premium assigned to the multiple is justified on account of the following reasons:

� Margin expansion (on sustainable basis) led by increase in value-added castings business and operating improvements: KFIL’s EBITDA/t profile is expected to enter a new territory overFY19-20E led by increased contribution from the high-margin castings business and significantimprovements in operational parameters as well as captive integration of coke and power. Thisimprovement is sustainable in nature (and not cyclical driven) due to structural change in thebusiness profile of the company led by higher share of value added business of castings and longterm cost efficiency projects.

� Front-end capex fully factored in EV while positive cash flows impact expected to remain back-ended into FY20-21: As discussed in detail in the investment rationale and financialssection, full capex on likely backward integration projects for pig iron business factored in by us islikely to be spent by H1FY20E and this would contribute to earnings largely from H2FY20E. Wenote that AOCF would trend materially higher from FY20E onwards due to sharp up-tick inearnings from both divisions with full benefits of both volume growth and cost savings.


� Increase in return ratios with efficient capital management: KFIL’s return ratios are expected to see sharp improvement by FY20E led by efficient capital management coupled with sustainable increase in share of high-margin castings business. Return ratio profile is expected to improve sustainably for KFIL and merits a multiple re-rating.

� Undiscovered and under-owned at Institutional level: We believe that the stock has largely remained undiscovered and out of the radar of institutional investors and its capability in the castings segment has not been recognised; this could be one of the reasons for its lower valuations in the past. We see scope for re-rating once profitability improves and KFIL’s capabilities get recognised. We thus believe that premium to historical valuations is justified on account of superior fundamentals, future growth opportunity, and strong management capabilities.

KFIL trading at attractive adjusted cash flow yield, leaving scope for re-rating

We have plotted KFIL’s AOCF yield on corresponding year’s enterprise value. KFIL’s cash flow yield stands at attractive levels of 11.4%/15.9% on FY19E/20E basis, leaving strong scope for re-rating.

Exhibit 51: KFIL trades at attractive adjusted cash flow yield


11.4

18.4

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Exhibit 52: 1 year forward EV/EBITDA chart Exhibit 53: 1 year forward P/E chart

Source: Bloomberg, Centrum Research Estimates Source: Bloomberg, Centrum Research Estimates

Exhibit 54: Peer comparison – Historical Financials

Company Net Sales (Rs mn) EBITDA (Rs mn) PAT (Rs mn) EBITDA Margin % PAT Margin %

FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17

Kirloskar Ferrous 13,651 11,139 11,337 1,490 1,509 1,756 493 578 907 10.9 13.6 15.5 3.6 5.2 8.0

Nelcast 5,449 5,607 5,746 460 643 640 219 319 340 8.4 11.5 11.1 4.0 5.7 5.9

Jayaswal Neco Industries 30,243 26,326 25,162 3,593 2,628 2,800 3 (936) (4,593) 11.9 10.0 11.1 0.0 (3.6) (18.3)

Steelcast 791 1,370 1,343 0 263 154 (185) 1 24 (0.1) 19.2 11.5 (23.4) 0.1 1.8

Alicon Castalloy 7,136 7,489 7,728 709 769 868 198 222 262 9.9 10.3 11.2 2.8 3.0 3.4

Precision Camshafts 5,144 4,381 4,430 1,374 1,192 1,006 476 549 609 26.7 27.2 22.7 9.3 12.5 13.7

Company CAGR 15-17 (%) ROE % Div Yield % P/E (x) EV/EBITDA (x)

Revenue EBITDA PAT FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17

Kirloskar Ferrous (8.9) 8.6 35.7 11.2 12.2 16.9 2.5 2.4 2.3 13.9 12.5 11.4 5.5 5.5 6.4

Nelcast 2.7 18.0 24.4 8.0 10.9 10.7 2.1 1.4 1.5 12.7 14.4 14.9 7.1 7.8 8.2

Jayaswal Neco Industries (8.8) (11.7) NM 0.0 (4.3) (24.4) 0.0 0.0 0.0 NM (5.5) (1.1) 13.4 16.8 15.5

Steelcast 30.3 NM NM NM NM 3.2 - - - (3.7) 670.2 59.9 NM 3.3 8.2

Alicon Castalloy 4.1 10.6 14.9 16.9 16.3 16.4 1.1 1.3 0.9 11.4 16.1 16.6 5.5 6.8 7.6

Precision Camshafts (7.2) (14.5) 13.0 23.1 14.7 11.5 - 0.7 1.1 - 23.6 22.9 - 10.7 11.2

Source: Bloomberg, Centrum Research

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Mean + Std Dev Mean - Std Dev

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Mean + Std Dev Mean - Std Dev


Key risks to our thesis

� Margin pressure due to higher competition from peers: The domestic castings (foundry) industry is fragmented and has unutilised capacity. Though demand outlook is good and the business is characterised by product positioning and client relationships, thus limiting competition-related margin pressures, a sudden increase in activity from some players with low utilisation could pose a potential risk to margins.

� Client concentration: KFIL has large exposures to some of its big clients and is exposed to risks associated with any issues in the volume trajectories of its large clients. However, the company has been able to increase its client base significantly in last few years and has been reducing this risk over time.

� High volatility in raw material prices: KFIL’s key raw materials are iron ore, scrap, coke and coking coal which have witnessed sharp fluctuations in the past. The raw material price fluctuations are not easily passed on to customers and any major volatility in raw material prices would impact gross margins and profitability.

� Foreign exchange fluctuations: KFIL imports its key raw materials like coking coal/coke and has to prudently manage its foreign exchange risk on the same. The company has been entering into forward covers for hedging and has incurred forex related costs both on account of losses as well as premium on contracts. The forex related costs have been brought under control through prudent management over the last few years but risk to earnings could potentially arise again.

Exhibit 55: KFIL forex gain/loss trend

(Rs mn) FY12 FY13 FY14 FY15 FY16 FY17

Forex gains (in other inc.) 0 0 0 2 0 2

Forex loss (in other exp) 178 137 1 0 0 0

PBT 557 624 580 718 853 1,216

PBT (excl. forex gain/loss) 735 761 580 716 853 1,214


� Transition of auto industry to electric vehicles over long term: Over the longer term, it is expected that a major portion of automobile industry might move towards electric vehicles that will not need internal combustion engines. Some of KFIL’s products find applications in engines of the CV industry and could see the impact of transition to EV in long term. However, we believe that EV transition would first be felt in passenger vehicles rather than CVs and KFIL doesn’t have any exposure to passenger vehicles segment currently. Also, we believe that EV transition could be a very long process stretching to 15-20 years and threat of the same in next ten years in KFIL’s segments remains low.


Exhibit 56: Shareholding pattern (%)

Sep-17 Jun-17 Mar-17 Dec-16

Promoter 59.6 59.6 59.6 59.5

FIIs 0.6 0.6 0.6 0.5

DIIs 2.6 1.8 1.8 1.8

Others 37.2 38.0 38.0 38.2

Source: BSE

Company Background

KFIL is an initiation of Kirloskar Oil Engines Limited (KOEL) and Shivaji Works Limited (SWL). Incorporated in 1991, the flagship company of the Kirloskar Group, KFIL was formed with an objective of manufacturing high quality Pig Iron and thin walled quality grey iron castings to cater to the growing demand in industry sectors such as Tractors, Automotives and Diesel Engines.

It has 2 manufacturing plants at Koppal and Solapur in Karnataka and Maharashtra respectively.

KFIL has unique capability of producing a range of products that includes Grey Iron castings upto 300 kg single piece weight, S.G. Iron castings upto 120 Kg single piece weight and in Pig Iron grade includes Foundry Grade, S.G. Iron Grade & Basic Grade.

The commercial production of Pig Iron commenced from Mini Blast Furnace I in 1994. In due course, the commercial production of Grey Iron Castings commenced in 1995 along with Mini Blast Furnace II. For effective utilization of waste gas from MBF, two Power plants of 3.5 MW each were commissioned in 1994 and in 1997 respectively. In the year 2007, KFIL acquired Solapur foundry from Kirloskar Oil Engines Limited.

Exhibit 57: KFIL product profile

Product Name Capacity (TPA) Location

Pig Iron 390,000 Koppal, Hospet, Karnataka

Castings 93,000 Koppal, Hospet, Karnataka

Castings 40,000 Solapur, Maharashtra


Exhibit 58: Key management personnel

Name Position Profile

Mr. Atul C. Kirloskar Chairman

Mr. Atul Chandrakant Kirloskar began his career with erstwhile Kirloskar Cummins Limited in the year 1978, where he started as a trainee. On 1 November 1984, he was appointed as the Executive Vice President of Kirloskar Oil Engines Limited (KOEL). He was co-opted on the Board of KOEL on 6 August 1985, wherein he took over as the Managing Director. In 1988, he became the Vice Chairman of KOEL and held the position till 25 July 1998 when he was appointed as Chairman of KOEL. He was appointed as Managing Director of KOEL with effect from 31 March 2010 and was appointed as Executive Chairman of KOEL with effect from 26 January 2012. He is the past President of Maharashtra Chamber of Commerce, Industries and Agriculture (MCCIA), Pune and past Chairman of CII National Committee of Defence. He was appointed as a Director of the Company on 10 August 1992. He is the Chairman of the Company.

Mr. Rahul C. Kirloskar Vice Chairman

Mr. Rahul Chandrakant Kirloskar is qualified as B.S. (Mechanical Engineering) from USA. He has been with the Kirloskar Group of Companies for more than 25 years at senior levels in different capacities. He has also been Chairman of the CII Pune Zonal Council as well as CII Maharashtra Council. He was appointed as Director of the Company on 28 October 2013. He is the Vice Chairman of the Company.

Mr. R. V. Gumaste Managing Director

Mr. Ravindranath Venkatesh Gumaste holds a bachelor’s degree in Metallurgical Engineering from Karnataka Regional Engineering College, Surathkal. Soon after graduating, he joined Kirloskar Oil Engines Limited in July 1981. In 1993, he joined Kirloskar Ferrous Industries Limited and later rose to become the SBU Chief for the pig iron business in 1998. In view of his pioneering efforts and initiatives to improve the performance of the Company, such as cost reduction drive on all fronts, improvement in the production process, increasing the productivity of foundry operations and quality of output, negotiating for reduction in raw material prices, improvement for market share of castings, etc. he was appointed as Executive Director of the Company with effect from 25 July 2002 and further as the Managing Director of the Company with effect from 1 July 2003.

Source: Company


Corporate governance check – highlighting the finer points

Independent directors’ representation on the board – KFIL has good balance

The strong representation of independent directors on the board ensures that decisions are made in all fairness and in the best interest of all the shareholders, thereby gaining shareholders’ trust. KFIL has maintained good balance of independent directors’ representation on the board with a share of ~60% on an average over the last six years.

Exhibit 59: Representation of Independent and promoter directors on companies board

FY12 FY13 FY14 FY15 FY16 FY17

Kirloskar Ferrous

- Total Strength 8 8 9 11 10 9

- Promoter 1 1 2 2 2 2

- Executive 1 1 1 1 1 1

- Non Executive & Non Independent 1 1 1 1 1 1

- Independent 5 5 5 7 6 5

- % share of Promoter 12.5 12.5 22.2 18.2 20.0 22.2

- % share of Executive Director 12.5 12.5 11.1 9.1 10.0 11.1

- % share of independent 62.5 62.5 55.6 63.6 60.0 55.6

Nelcast


- Promoter

- Executive 3 3 2 2 2 2

- Non Executive & Non Independent 0 0 1 1 1 1



- % share of Executive 42.9 50.0 33.3 33.3 33.3 33.3


Jayaswal Neco


- Promoter 3 3 3 3 3 3

- Executive 1 1 1 2 2 2

- Non Executive & Non Independent



- % share of Executive Director 11.1 12.5 12.5 16.7 16.7 16.7




Independent directors’ profile and compensation analysis

We find that KFIL has appointed IDs from diverse backgrounds and focused on domain experts in castings and pig iron industries. The attendance record of IDs of KFIL is 100%, which is a good sign. The compensation of IDs appears to be on the higher side but is fair and in line with normal industry practice, in our view, as it also depends on the value addition provided by IDs. One notable trait in IDs profile is the absence of their representation on any other prominent companies’ boards.

Exhibit 60: Independent directors profile and compensation

Independent Director Name

No. of directorship in other public ltd

cos

Name of other companies in which director

FY17 Compensation

(Rs mn)

As % to FY17 PBT

FY17 Board meeting

attendance (%)

Kirloskar Ferrous

Mr. A R Jamenis 0 1.5 0.1 100.0

Mr. B S Govind 0

0.8 0.1 100.0

Mr. R Sampath Kumar 1

1.4 0.1 100.0

Mrs. Nalini Venkatesh 0

1.1 0.1 100.0

Mr. Y S Bhave* 0 0.2 0.0 100.0

Nelcast

Mr. D Sesha Reddy 0

0.2 0.0 100.0

Mr. R Mohan Reddy 1 Lokesh Machines 0.2 0.0 100.0

Mr. A Balasubramaniam 1 Butterfly Gandhimati 0.1 0.0 100.0

Jayaswal Neco

Mr. B.K. Agrawal 2 Manaksia Industries, Reliance Chemotex Industries Ltd

0.2 0.0 100.0

Mr. S. N. Singh 0

0.1 0.0 100.0

Mr. D. K. Sahni 0

0.1 0.0 50.0

Mrs. Raji Nathani 0

0.1 0.0 75.0

Mr. Arvind Iyer 0

0.1 0.0 75.0

Mr. M M Vyas

0.0 0.0 0.0

Mr. Bharat Pal Singh 0 0.0 0.0 0.0

Source: Centrum Research; * Inducted during Jan'17


Promoter group compensation analysis – as good as it gets

KFIL performs extremely well on promoter group compensation, as the promoters have chosen not to take any salary from the company (except drawing board sitting fees). The promoters (Kirloskars) serve as Chairman and Vice Chairman on the board but draw only Rs1.4mn as compensation (board sitting fees) and are instead choosing to realise money by way of dividends. This trait is extremely positive for minority shareholders, in our view.

Exhibit 61: Promoter group compensation summary *

(Rs mn) FY12 FY13 FY14 FY15 FY16 FY17 FY15-17 Total

Kirloskar Ferrous

- Promoter Directors 0.4 0.3 0.7 0.9 1.0 1.4 3.2

- Mr. Atul C Kirloskar (Chairman) 0.4 0.3 0.4 0.4 0.5 0.7

- Mr. Rahul C Kirloskar (Vice Chairman)

0.3 0.4 0.5 0.7

- Executive Directors 16.3 21.4 27.1 30.1 34.6 44.2 108.9

- Mr. R V Gumaste (MD) 16.3 21.4 27.1 30.1 34.6 44.2

- Total Promoter Directors 0.4 0.3 0.7 0.9 1.0 1.4 3.2

- % share of PBT 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Nelcast


- Mr. P Deepak (MD) 19.0 8.3 11.1 11.2 12.1 12.1


- WTD 10.3 15.6 16.5 9.6 8.0 7.4


- % share of PBT 2.8 4.0 3.1 3.8 2.6 2.5 2.8

Jayaswal Neco


- Mr. Basant Lall Shaw (Chairman) 0.0 0.0 0.0 0.1 0.1 0.1

- Mr. Arbind Jayaswal (MD) 5.3 5.0 6.7 11.9 12.7 12.7

- Mr. Ramesh Jayaswal (Jt MD) 5.2 5.0 6.7 11.9 12.7 12.7


- Mr. P K Bharadwaj (ED & CFO) 2.6 2.8 3.8 4.4 4.6 5.1

- Mr. Megh Pal Singh (ED Steel)

2.0 5.8 6.2


- % share of PBT 1.2 2.1 1.2 13.7 2.3 0.5 1.3

Source: Centrum Research, * % share considered positive even when PBT is negative to show the absolute picture


Contingent liability

In our analysis, we have not encountered any potential contingent liabilities which could materially change the structure of the financials or pose a significant risk to KFIL’s net worth. It mainly consists of tax related matters and bills discounting which are not sizeable in nature.

Exhibit 62: Contingent liability trend

(Rs mn) FY12 FY13 FY14 FY15 FY16 FY17

Kirloskar Ferrous

- Taxation related matters 144 73 234 216 269 288

- Central Excise & Customs 23 6 19 16 16 15

- Service Tax 34 11 30 30 54 34

- Income tax 88 51 179 103 133 174

- Sales Tax 0 5 5 66 65 65

- Others 2 2 2 180 227 165

- Bill Discounting 0 0 0 178 225 143

- Provident Fund Matters 0 0 0 0 0 19

- Labour Matters 2 2 2 2 2 4

- Bank Gaurantee 0 0 0 0 0 0

- Interest on Electricity tax 1 1 0 0 0 0

- Total 146 75 236 397 496 453

- % share of Net Worth 3.8 1.9 5.5 8.7 10.1 7.8

Net Worth 3,802 4,067 4,264 4,550 4,920 5,826

Nelcast

- For Taxation related 0 0 0 36 41 55

- Central Excise & Customs 0 0 0 33 38 52

- Sales Tax 0 0 0 3 3 3

- Others 21 1 24 19 0 10

- Bank Gaurantee 21 1 24 19 0 10

- Total 21 1 24 55 41 65


Net Worth 2,427 2,516 2,670 2,816 3,051 3,297

Jayaswal Neco

- Taxation related matters 857 1,408 1,520 1,296 1,337 987

- Excise & service tax 272 283 273 280 155 60

- Sales Tax 297 422 407 248 154 131

- Customs duty 79 81 83 87 10 19

- Other disputed demands 168 580 716 657 994 743

- third party claims 41 42 42 24 24 35

- Others 6,003 7,560 6,865 3,480 1,874 1,973

- Bill Discounting 1,432 1,255 1,841 1,971 974 884

- Letters of Credit 4,163 5,817 4,516 1,030 600 732

- Gaurantee (Banks & Corp) 408 488 508 478 300 358

- Total 6,861 8,968 8,385 4,776 3,211 2,960


Net Worth 12,276 18,063 21,237 22,179 20,977 16,373



Related party transaction – clean history

KFIL does not have any related party transactions except for the small rent paid.

Exhibit 63: Related party transaction details

Particulars (Rs mn) FY12 FY13 FY14 FY15 FY16 FY17

Kirloskar Ferrous

Building rent paid 1 1 1 1 1 1

Rent deposit receivable 0 0 0 0 0 0

Others 0 0 0 0 0 0

Nelcast

Amount of Investment during the year 50 50 60 50 20

Closing Balance 155 205 255 315 365 385

Others

Jayaswal Neco

Commission/Rent/Interest 9 37 56 59 68 95

Purchase of assets 3,137 4,121 7,681 1

Sale of Assets 0 0 0 0 0 1

Sale of Goods and services 1,347 1,379 1,160 1,167 609 483

Purchase of Goods & Services 558 2,170 1,279 735 484 574

Current borrowings-Inter corporate deposits taken 94 785 156 72 48 15

Current borrowings-Inter corporate deposits repaid 0 219 1,095 106 33 51


Auditor pedigree

KFIL has changed its auditor in 2015 to Kirtane & Pandit LLP from P G Bhagwat who was the auditor for more than ten years. Kirtane & Pandit LLP is the auditor for Aarti Industries, Force Motors, Garware Polyester, Maharashtra Scooters and a few others. It has a long and trusted track record of auditing companies across various industries.

Exhibit 64: Auditor details

Auditor Name Type Other Companies Audited by the auditor Auditor for the company since

Auditor Fees - FY17 (Rs mn)

As % to PBT

Kirloskar Ferrous Kirtane & Pandit LLP Statutory Aarti Industries, Force Motors, Garware Polyester, Maharashtra Scooters, few more

2015 3.6 0.3

Nelcast Reddy A V & Co Statutory NA 2016 1.5 0.3

Jayaswal Neco Chaturvedi & Shah Statutory Bajaj Hindustan, CG Power, Cox & Kings, Dewan Housing, Eros Int, Jet Airways, Reliance Industries, Reliance Ind Infra

>10 years 1.5 0.3



Exhibit 65: Quarterly financials

Particulars (Rs mn) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18

Net Sales (incl. op. income) 2,678 2,474 2,997 2,898 2,241 3,201 3,340 4,005

Cost of Raw Materials consumed 1476 1150 1360 1455 1029 2023 2111 2607

Staff Cost 195 178 185 187 182 173 184 193

Other Operational expenses 671 779 774 767 676 769 884 872

Operating Profit (Core EBITDA) 336 368 677 489 356 236 161 332

Depreciation 110 114 119 118 117 104 125 113

EBIT 225 254 558 371 238 132 36 219

Interest 55 52 44 24 45 22 31 69

Other Revenue/Income 4 6 34 4 5 14 10 5

Other Exceptional Items 0 0 0 0 0 0 0 0

Profit Before Tax 174 208 548 351 198 123 15 156

Tax 53 78 170 125 27 -9 3 47

Tax rate (%) 30.6 37.6 31.0 35.5 13.7 -7.5 20.6 30.2

Profit After Tax 121 130 378 226 171 133 12 109

Growth (%)

Net Sales (20.4) (23.3) (1.1) (2.1) (16.3) 29.4 11.4 38.2

EBITDA (15.3) 39.6 78.4 11.6 5.9 (35.7) (76.2) (32.1)

PAT (23.8) 814.5 146.8 24.1 41.5 2.1 (96.7) (51.9)

Margin (%)

EBITDA 12.5 14.9 22.6 16.9 15.9 7.4 4.8 8.3

EBIT 8.4 10.3 18.6 12.8 10.6 4.1 1.1 5.5

PAT 4.5 5.2 12.6 7.8 7.6 4.1 0.4 2.7

Sales Volumes (tonne)

Pig Iron Merchant 74,589 59,173 72,419 69,414 39,355 72,307 66,186 72,605

Castings 13,032 15,138 17,002 17,448 14,992 16,450 18,139 20,438

Net Sales (Rs mn)


Castings 1,054 1,205 1,331 1,375 1,170 1,310 1,451 1,733

Others 84 70 55 60 70 80 87 287

Realisations (Rs/t)


Castings 80,878 79,601 78,285 78,777 78,042 79,635 79,999 84,769



Annexure – Indian Foundry (Castings) Industry

About metal castings & foundry

A foundry is a factory that produces metal castings. Metals are cast into shapes by melting them into a liquid, pouring the metal in a mould, and removing the mould material or casting after the metal has solidified as it cools. The most common metals processed are aluminium and cast iron. However, other metals, such as bronze, brass, steel, magnesium, and zinc, are also used to produce castings in foundries. In this process, parts of desired shapes and sizes can be formed. Metal castings have several applications across industries in Auto, Tractor, Railways, Machine tools, Sanitary, Pipe Fittings, Defence, Aerospace, Earth Moving, Textile, Cement, Electrical, Power machinery, Pumps / Valves, Wind turbile generators etc.

Casting is the process from which solid metal shapes (castings) are produced by filling voids in moulds with liquid metal. The basic steps involved in making castings are patternmaking, molding, melting and pouring, shakeout and cleaning, heat treating, and inspection. The key raw materials used for making castings are pig iron (hot metal), scrap (industrial), sand

Manufacturing Process

The manufacturing processes of castings must be executed with maximum accuracy, performance and quality, thus ensuring the final customer´s satisfaction.

Exhibit 66: Metal casting manufacturing process

Source: Industry, Centrum Research


The steel castings processes may be different across foundries, but the manufacturing process applied in major foundries follows the following steps:

1. Project and design

The starting point for the procedure for making castings is the order received from the client. Initially it is necessary to study the feeding and filling system of the pieces to be built, and make the necessary patterns and core boxes. Studies and computer simulations of steel castings solidification are made to ensure the highest quality of the goods to be obtained during the process. The construction of the patterns and core boxes, tools used for making sand molds and sand cores, where the liquid steel is poured until solidification, is subcontracted to qualified modelers.

2. Moulding and core-making section

The sand molds are made in the respecting molding facilities. Core making section is an auxiliary molding section, and is the part of the process where sand cores are made using the core boxes. The sand is prepared in the mills and dumped on casting patterns for compaction and compression, shaping the future piece sand mold. Once the sand mold is compacted, the casting pattern is separated and reused for making new sand molds. The manufactured cores done in the coremaking section are placed inside the sand molds in order to determine the inner shape of the work piece. The next step is the union and closing of the sand molds, and finally the molds are moved to the storage area where the melted steel is poured into the molds.

3. Melting and casting

For obtaining the liquid steel the scraps and ferroalloys are melted in electric induction furnaces of medium frequency placed in the melting section. Cupola furnaces are also used for this process. After the melting process, the steel is downloaded to the ladle, and finally the liquid steel is poured into the sand molds deposited in the casting zone. After the solidification of the steel, the solid piece (as cast) is obtained. This solid piece (as cast) must be submitted to the subsequent processes to reach the design and final shape desired by the customer.

4. Demoulding (Shake out)

Demoulding of the castings is produced with the separation of the molding sand (containing sand) of the casting good, operation that is performed by a vibrating shake-out system.

As a result of this two parts are separated:

- The casting good, which will follow the rest of the manufacturing processes, - and on the other part , the sand, that be used for recycling.

Demoulded steel (as cast) goods are ready for shot-blasting.

5. Shot-blasting

The solid pieces/goods (as cast) are collected in a basket which is subsequently introduced into a shot-blasting machine , where the rest of sand that still remain attached to the casting is removed by projecting steel granules.

6. Fettling

After the shot- blasting process the goods are prepared for the next step, the sleves-feeder cutting process, removing the entries and the channels designed from the feeding system of the good. Cutting operations: air-gaz cutting, arc-air electrodes cutting, manipulators for feeders breaking . The solid piece/good (as cast) part is subjected to special heat treatments, in order to achieve the mechanical properties of strength, hardness and toughness. Once the heat treatment is finished, the goods pass to the deburring processes. In this process are performed the operations to remove existing burrs on the work piece.

7. Quality control and inspection

All casting processes are subjected to specific quality control procedures and inspection.

8. Machining

The whole manufacturing process of steel casting ends with the machining of the castings to obtain the final dimensions and tolerances required by the customer. The main machining operations are turning, milling, drilling and balancing.


Global Foundry Industry scenario

As per 50th World casting Census published by Modern Castings USA, world casting production reached 104.1 MT, slightly above 103.7 MT produced in 2014 and 103 MT in 2013 with a marginal growth of ~0.4 % from 2014 to 2015. It is the 6th year in a row the market has expanded after global recession from 2008-09. China accounts for 44% of the total casting production in the World and India & USA combined account ~20% of total Production.

The total number of casting units in the world is ~47000, down from 48164 in 2010. As global casting production had increased in the last five years, the decrease in plants indicates metal castings businesses are consolidating and becoming more efficient.

Domestic Foundry Industry

The Indian foundry industry manufacturers metal cast components for applications in Auto, Tractor, Railways, Machine tools, Sanitary, Pipe Fittings, Defence, Aerospace, Earth Moving, Textile, Cement, Electrical, Power machinery, Pumps / Valves, Wind turbine generators etc. Foundry Industry has a turnover of ~US$19 bn with export of ~US$2.5 bn. However, grey iron castings have the major share of ~68% of total castings produced.

Major Foundry Clusters – There are ~1500 units are having International Quality Accreditation. Several large foundries are modern & globally competitive. Many foundries use cupolas using LAM Coke. However, these are gradually shifting to Induction Melting. India has many foundry clusters and each cluster is known for its products and end-use markets. The major foundry clusters are located in Batala, Jalandhar, Ludhiana, Agra, Pune, Kolhapur, Sholapur, Rajkot, Ahmedabad, Belgaum, Coimbatore, Chennai, Hyderabad, Chennai, etc. The Coimbatore cluster is famous for pump-sets castings, the Kolhapur and the Belgaum clusters for automotive castings and the Rajkot cluster for diesel engine castings, Howrah cluster for sanitary castings etc.

Manpower - The total manpower in Foundry Sector is approx. 500000 directly & 1500000 indirectly. The foundry sector is highly labour intensive & currently generates employment for 2 Million directly & indirectly mainly from socially & economically weaker sections of society.

Role in Manufacturing Sector - The new manufacturing policy envisages the increase in the share of manufacturing in the GDP to 25% from current 15% & to create 100 Million additional jobs in next 10 years. Since all engineering & other sectors use metal castings in their manufacturing, the role of foundry industry to support manufacturing is very vital. It is not possible to achieve the above goal without the sustainable corresponding growth of the foundry sector.


Domestic castings industry growing at ~5% CAGR

Domestic casting industry’s total production stood at 11.4 MT in FY17 with grey iron castings accounting for ~70% of the overall market (~8 MT). The production CAGR in the industry for total castings/grey iron castings was at 5%/5.6% over FY14-17. As per various industry sources including snippets offered by the Institute of Indian Foundrymen (IIF), the industry is well poised for much stronger growth in the next five years, driven by higher demand.

Exhibit 67: Castings production in India Exhibit 68: Castings production in India - CAGR trend

(MT) FY13 FY14 FY15 FY16 FY17

Grey Cast Iron 6.3 6.7 6.8 7.4 7.9

Spheroidal Graphite Iron 1.0 1.0 1.1 1.2 1.2

Malleable 0.1 0.1 0.1 0.1 0.1

Steel 1.2 1.1 1.0 0.9 1.0

Non-Ferrous 0.9 1.0 1.1 1.3 1.2

Total (MT) 9.3 9.8 10.0 10.8 11.4


Castings demand is well-spread across several sectors with auto sector contributing to one-third of the total demand. Other sectors which drive the demand are sanitary, agriculture machinery, pipes & fittings, railways, pumps, valves, diesel engines and others. The castings industry size in India is ~US$19bn and exports are substantial at ~US$2.5bn but have remained stagnant while imports are restricted to below US$1bn.

Exhibit 69: Castings export and import trend in India Exhibit 70: Sector-wise castings demand in India


5.6%

3.0%

4.9%5.0%

2.6%

4.7%

0%

1%

2%

3%

4%

5%

6%

3Y (FY14-17) 5Y (FY12-17) 10Y (FY07-17)

Grey Iron Castings Total

2572 26182729

25032366

1013 927 946 926 962

0

500

1,000

1,500

2,000

2,500

3,000


Exports (USD mn) Imports (USD mn)

Auto, 32%

Agriculture Machinery,

7%

Sanitary, 8%

Pipes & Fittings, 7%Railways, 6%

Power, 6%

Industrial Machinery,

6%

Pumps , 5%

Valves, 5%

Diesel Engines, 3%

Others, 15%


Financials - Historical

Exhibit 71: Income Statement

Y/E Mar(Rs mn) FY11 FY12 FY13 FY14 FY15

Revenues 10,898 10,897 11,981 12,322 13,651

Materials cost 7,685 7,117 7,540 7,962 8,236

% of revenues 70.5 65.3 62.9 64.6 60.3

Employee cost 331 428 512 496 652

% of revenues 3.0 3.9 4.3 4.0 4.8

Others 1,892 2,419 2,847 2,748 3,273

% of revenues 17.4 22.2 23.8 22.3 24.0

EBITDA 990 933 1,083 1,116 1,490

EBITDA margin (%) 9.1 8.6 9.0 9.1 10.9

Depreciation & Amortisation 270 292 332 338 504

EBIT 720 641 751 778 985

Interest expenses 41 105 152 229 298

PBT from operations 678 536 599 549 687

Other income 40 21 25 31 31

Exceptional items (1) 0 0 0 0

PBT 717 557 624 580 718

Taxes 235 186 233 181 226

Effective tax rate (%) 32.8 33.4 37.4 31.3 31.4

Reported PAT 482 371 391 398 493

Adjusted PAT 481 371 391 398 493


Exhibit 72: Key Ratios

Y/E Mar FY11 FY12 FY13 FY14 FY15

Growth Ratio (%)

Revenue 35.0 (0.0) 10.0 2.8 10.8

EBITDA 7.5 (5.8) 16.2 3.0 33.5

Adjusted PAT (2.4) (23.0) 5.4 1.9 23.7

Margin Ratios (%)

EBITDA 9.1 8.6 9.0 9.1 10.9

PBT from operations 6.2 4.9 5.0 4.5 5.0

Adjusted PAT 4.4 3.4 3.3 3.2 3.6

Return Ratios (%)

ROE 14.0 10.0 9.9 9.6 11.2

ROCE 13.4 10.1 8.8 8.5 10.4

ROIC 13.3 10.1 8.7 8.3 10.2

Turnover Ratios (days)

Gross block turnover ratio (x) 2.2 2.0 1.9 1.7 1.6

Debtors 45 54 47 56 47

Inventory 53 44 47 48 32

Creditors 86 69 61 73 55

Cash conversion cycle 12 28 33 32 24

Solvency Ratio (x)

Net debt-equity (0.1) 0.1 0.4 0.4 0.3

Debt-equity 0.0 0.1 0.4 0.4 0.3

Interest coverage ratio 0.1 0.2 0.2 0.3 0.3

Gross debt/EBITDA 0.0 0.6 1.6 1.7 0.9

Current Ratio 1.1 1.1 1.0 0.9 0.9

Per share Ratios (Rs)

Adjusted EPS 3.5 2.7 2.8 2.9 3.6

BVPS 26.1 27.7 29.6 31.1 33.1

CEPS 5.5 4.8 5.3 5.4 7.3

DPS 1.5 1.5 1.2 1.2 1.2

Dividend payout % 41.9 54.4 43.9 43.1 34.8

Valuation (x)*

P/E (adjusted) 9.3 8.9 9.3 7.1 13.9

P/BV 1.2 0.9 0.9 0.7 1.5

EV/EBITDA 4.3 4.0 4.8 4.1 5.4

Dividend yield % 4.5 6.1 4.7 6.1 2.5

5 Yr Avg AOCF/EV yield % 14.2 12.2 8.4 12.1 8.8


Exhibit 73: Balance Sheet


Equity Share Capital 687 687 687 687 687

Reserves & surplus 2,904 3,115 3,380 3,578 3,864

Shareholders' fund 3,591 3,802 4,067 4,264 4,550

Total Debt 0 550 1,702 1,896 1,327

Def tax liab. (net) 380 421 515 642 731

Total Liabilities 3,970 4,772 6,283 6,802 6,608

Gross Block 5,004 6,038 6,363 8,408 8,797

Less: Acc. Depreciation 2,116 2,400 2,679 2,945 3,378

Net Block 2,888 3,638 3,684 5,464 5,419

Capital WIP 703 214 1,198 227 313

Net Fixed Assets 3,591 3,852 4,882 5,691 5,731

Investments 0 0 0 0 0

Inventories 1,590 1,304 1,548 1,623 1,183

Sundry debtors 1,347 1,598 1,532 1,903 1,765

Cash 184 136 146 115 101

Loans & Advances 329 653 773 580 491

Other assets 43 2 3 4 7

Total Current Asset 3,492 3,693 4,001 4,225 3,547

Trade payables 2,565 2,061 1,998 2,456 2,043

Other current Liab. 273 435 347 414 359

Provisions 275 277 255 243 268

Net Current Assets 379 920 1,402 1,111 877

Total Assets 3,970 4,772 6,283 6,802 6,608


Exhibit 74: Cash Flow


Operating profit bef working capital changes

1,024 952 1,127 1,121 1,536

Changes in working capital (23) (620) (235) 77 206

Cash flow from operations 749 191 742 1,074 1,609

Adj. OCF (OCF - Interest) 707 86 590 845 1,311

Net Capex (480) (540) (1,589) (864) (584)

Adj. FCF 1,187 626 2,179 1,709 1,895

Cash flow from investments (470) (532) (1,580) (854) (566)

Cash flow from financing (261) 290 848 (251) (1,057)

Net change in cash 18 (52) 10 (31) (14)



Financials

Exhibit 75: Income Statement

Y/E Mar(Rs mn) FY16 FY17 FY18E FY19E FY20E

Revenues 11,139 11,337 15,793 17,086 18,049

Materials cost 5,924 5,867 9,980 9,822 9,495

% of revenues 53.2 51.8 63.2 57.5 52.6

Employee cost 709 731 819 918 1,028

% of revenues 6.4 6.5 5.2 5.4 5.7

Others 2,997 2,983 3,642 3,879 3,797

% of revenues 26.9 26.3 23.1 22.7 21.0

EBITDA 1,509 1,756 1,352 2,467 3,730

EBITDA margin (%) 13.6 15.5 8.6 14.4 20.7

Depreciation & Amortisation 444 459 518 557 662

EBIT 1,066 1,297 833 1,910 3,067

Interest expenses 235 137 199 227 245

PBT from operations 831 1,160 634 1,684 2,822

Other income 22 56 50 50 50

Exceptional items 0 0 0 0 0

PBT 853 1,216 684 1,734 2,872

Taxes 275 309 219 555 919

Effective tax rate (%) 32.2 25.4 32.0 32.0 32.0

Reported PAT 578 907 465 1,179 1,953

Adjusted PAT 578 907 465 1,179 1,953


Exhibit 76: Key Ratios

Y/E Mar FY16 FY17 FY18E FY19E FY20E

Growth Ratio (%)

Revenue (18.4) 1.8 39.3 8.2 5.6

EBITDA 1.3 16.3 (23.0) 82.5 51.2

Adjusted PAT 17.4 56.9 (48.7) 153.5 65.7

Margin Ratios (%)

EBITDA 13.6 15.5 8.6 14.4 20.7

PBT from operations 7.5 10.2 4.0 9.9 15.6

Adjusted PAT 5.2 8.0 2.9 6.9 10.8

Return Ratios (%)

ROE 12.2 16.9 7.8 17.9 25.4

ROCE 11.0 14.0 7.5 14.6 19.9

ROIC 10.9 13.6 7.2 14.5 20.2

Turnover Ratios (days)

Gross block turnover ratio (x) 1.2 1.2 1.5 1.5 1.4

Debtors 46 63 60 55 55

Inventory 30 39 40 40 40

Creditors 45 53 55 55 55

Cash conversion cycle 31 50 45 40 40

Solvency Ratio (x)

Net debt-equity 0.2 0.1 0.2 0.3 0.2

Debt-equity 0.2 0.2 0.2 0.3 0.3

Interest coverage ratio 0.2 0.1 0.2 0.1 0.1

Gross debt/EBITDA 0.7 0.6 1.1 0.8 0.6

Current Ratio 1.0 1.2 1.1 1.0 1.1

Per share Ratios (Rs)

Adjusted EPS 4.2 6.6 3.4 8.6 14.2

BVPS 35.8 42.4 44.8 50.9 61.0

CEPS 7.4 9.9 7.2 12.6 19.0

DPS 1.2 1.8 0.8 2.1 3.6

Dividend payout % 29.7 26.5 25.0 25.0 25.0

Valuation (x)*

P/E (adjusted) 12.5 11.4 29.3 11.6 7.0

P/BV 1.5 1.8 2.2 2..0 1.6

EV/EBITDA 5.5 6.3 11.1 6.3 4.2

Dividend yield % 2.4 2.3 0.9 2.2 3.6

5 Yr Avg AOCF/EV yield % 9.1 8.2 6.2 7.1 8.6


Exhibit 77: Balance Sheet


Equity Share Capital 687 687 687 687 687

Reserves & surplus 4,234 5,139 5,468 6,303 7,684

Shareholders' fund 4,920 5,826 6,155 6,989 8,371

Total Debt 1,082 969 1,469 2,069 2,269

Def tax liab. (net) 789 805 805 805 805

Total Liabilities 6,792 7,600 8,429 9,863 11,444

Gross Block 9,303 9,802 10,802 11,602 13,802

Less: Acc. Depreciation 3,801 4,060 4,578 5,135 5,798

Net Block 5,502 5,742 6,223 6,466 8,004

Capital WIP 81 189 189 1,389 1,189

Net Fixed Assets 5,583 5,930 6,412 7,855 9,193

Investments 0 0 0 0 0

Inventories 930 1,219 1,731 1,872 1,978

Sundry debtors 1,394 1,960 2,596 2,575 2,720

Cash 60 123 160 233 377

Loans & Advances 591 481 649 702 742

Other assets 8 9 9 9 9

Total Current Asset 2,983 3,791 5,145 5,391 5,826

Trade payables 1,368 1,638 2,380 2,575 2,720

Other current Liab. 337 430 649 702 742

Provisions 69 54 100 107 112

Net Current Assets 1,209 1,669 2,016 2,007 2,252

Total Assets 6,792 7,600 8,429 9,863 11,444


Exhibit 78: Cash Flow


Operating profit bef working capital changes

1,520 1,763 1,352 2,467 3,730

Changes in working capital (178) (481) (310) 82 (100)

Cash flow from operations 1,161 1,038 823 1,994 2,710

Adj. OCF (OCF - Interest) 926 901 623 1,768 2,465

Net Capex (335) (737) (1,000) (2,000) (2,000)

Adj. FCF 1,262 1,638 1,623 3,768 4,465

Cash flow from investments (324) (700) (1,000) (2,000) (2,000)

Cash flow from financing (891) (269) 215 79 (566)

Net change in cash (53) 69 37 73 144



Appendix A

Disclaimer

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KFIL price chart

Source: Bloomberg, Centrum Research

0

20

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60

80

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Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17

Kirloskar Ferrous Industries Ltd


Disclosure of Interest Statement

1 Business activities of Centrum Broking Limited (CBL)

Centrum Broking Limited (hereinafter referred to as “CBL”) is a registered member of NSE (Cash, F&O

and Currency Derivatives Segments), MCX-SX (Currency Derivatives Segment) and BSE (Cash

segment), Depository Participant of CDSL and a SEBI registered Portfolio Manager.

2 Details of Disciplinary History of CBL CBL has not been debarred/ suspended by SEBI or any other regulatory authority from accessing /dealing in securities market.

3 Registration status of CBL: CBL is registered with SEBI as a Research Analyst (SEBI Registration No. INH000001469)

KFIL

4 Whether Research analyst’s or relatives’ have any financial interest in the subject company and nature of such financial interest No

5 Whether Research analyst or relatives have actual / beneficial ownership of 1% or more in securities of the subject company at

the end of the month immediately preceding the date of publication of the document. No

6 Whether the research analyst or his relatives has any other material conflict of interest

No

7 Whether research analyst has received any compensation from the subject company in the past 12 months and nature of

products / services for which such compensation is received No

8 Whether the Research Analyst has received any compensation or any other benefits from the subject company or third party in

connection with the research report No

9 Whether Research Analysts has served as an officer, director or employee of the subject company No

10 Whether the Research Analyst has been engaged in market making activity of the subject company. No

Rating Criteria

Rating Market cap < Rs20bn Market cap > Rs20bn but < 100bn Market cap > Rs100bn

Buy Upside > 20% Upside > 15% Upside > 10%

Hold Upside between -20% to +20% Upside between -15% to +15% Upside between -10% to +10%

Sell Downside > 20% Downside > 15% Downside > 10%

Member (NSE and BSE)

Regn No.:

CAPITAL MARKET SEBI REGN. NO.: BSE: INB011454239 CAPITAL MARKET SEBI REGN. NO.: NSE: INB231454233 DERIVATIVES SEBI REGN. NO.: NSE: INF231454233

(TRADING & CLEARING MEMBER) CURRENCY DERIVATIVES: MCX-SX INE261454230

CURRENCY DERIVATIVES:NSE (TM & SCM) – NSE 231454233

Depository Participant (DP) CDSL DP ID: 120 – 12200

SEBI REGD NO. : CDSL : IN-DP-CDSL-661-2012

PORTFOLIO MANAGER

SEBI REGN NO.: INP000004383

Website: www.centrum.co.in Investor Grievance Email ID: [email protected]

Compliance Officer Details:

Kavita Ravichandran

(022) 4215 9842; Email ID: [email protected]

Centrum Broking Ltd. (CIN :U67120MH1994PLC078125)

Registered Office Address

Bombay Mutual Building ,

2nd Floor,

Dr. D. N. Road, Fort, Mumbai - 400 001

Corporate Office & Correspondence Address

Centrum House

6th Floor, CST Road, Near Vidya Nagari Marg, Kalina,

Santacruz (E), Mumbai 400 098.

Tel: (022) 4215 9000

BUY Kirloskar Ferrous Metals Initiating Coverage 4 ... · Castings products of KFIL: KFIL’s foundries, located at Hospet (Koppal plant, Karnataka) and Solapur (Maharashtra) are

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