AIA Engineering Ltd - Stock Valuation and Financial Performance

AiA Engineering reported flat sales over previous year with volume decline by 3% and realization growth of 6%. Low mining activity, delay in capacity addition are few reasons for poor volumes. FY22 also is expected to be subdued year due to i) Canada’s anti dumping ban on AiA Engineering ii) Delay in capacity addition iii) low mining activity. 

Our Opinion: AIA Engineering is a manufacturer of high chrome mill internal products used by cement, mining and utility industries It caters to 90% requirement of the domestic cement sector, and 30% of global cement sector. It is continuously adding capacity and expected to add another 20-25% in next 2-3 years. AIA Engineering trades at higher price versus our MRP. Niche player with high margin and ROCE are the reason why it trades at high prices. We are positive on the company and await better price before recommendation.

Maintains volume guidance

AIA reiterated its guidance of incremental volumes of ~125000 metric tons by FY18E as management focuses on gaining market share gains and new market penetration.

Capacity expansion as planned

AIA is on track to complete its planned capacity expansion of 80000 metric tons by 3QFY16 and 100000 metric tons by end of FY17. This will take total capacity to 440k tons by FY17 (capex would be ~Rs 5600 Cr).

Mining slowdown to hurt

Global commodity meltdown has led to decline in mining activity, driving miners to cut inventory for grinding media. This will put pressure on near term volumes.

Margins under pressure

Management will resort to discounted pricing in order to gain market share and penetrate newer markets. This along with low volumes will have a significant impact on margins. Management expects to maintain margins in the range of 21-22% as against 30% seen in 2Q16.

Valuation impact

Accounting for the low volumes and margin decline, we have reduced our valuation to Rs. 916 as against Rs. 1100 earlier. Our new MRP factors in earnings growth of 15%  CAGR over next 5 years primarily through from market share gains. We will revise our valuation if the realization per ton falls beyond estimates and volume growth doesn’t cover fixed costs comfortably.

What should investors do?

AIA is India’s largest and world’s second largest manufacturer of impact, abrasion and wear resistant, high chrome mill internals (HCMI), used primarily in cement, mining and thermal utility industries. The company services the replacement demand of these industries and the original equipment manufacturer (OEM) requirement for new capacities added.

Thus, as long as mines continue to operate, AIA will have business. Operating in an oligopoly market, it stands to gain immensely once mining activity recovers. Shift to ferrochrome grinding media will add incremental revenues.

While we continue to believe in AIA’s robust business model, we would like a higher discount given the fact that commodity cycles last longer (sometimes as long as a decade). Ensuring higher margin of safety and buying at lower levels will ensure we are compensated for higher risk from volatility in earnings power.