Agarwal Industrial Corporation Ltd – Profitable Microcap with high growth potential in infrastructure space

I have recently taken a position in this company after a reasonable amount of research. Sharing the same here in a summary form; forgive me as a lot of this might already be covered in previous comments but I am summarizing everything for the sake of being comprehensive.

The company basically has 2 divisions:

1. Trading bitumen (some value added products but negligible hence ignored)
2. Transporting bitumen (ships only; we will ignore trucks as revenue is minor)

Other minor divisions (1 petrol pump, wind power) are being ignored due to irrelevance and no significant plans for future expansion.

Bitumen Division

• Bitumen Market Size & Growth – Demand
  • The market is estimated at 9 million tones / year in volume terms and growing at 8-9%
    • USD 3.6B market at 0.4 USD / KG price point (assumed based on trends)
  • The demand is 99% from road building alone; rest can be ignored
  • The road construction is at an all time high and budget allocation is increasing further
  • Besides the need for new roads, proper road maintenance also requires bitumen
  • There was some conversation about switching from Tar roads to Cement roads due to longer durability; however, due to safety concerns (cement roads have higher friction and heat up more and can cause tires to burst) the general trend remains towards tar roads (source: industry conversations)

Conclusion 1: Industry is not too large at 3.6B USD but is promising from a growth perspective.

• Bitumen Market Size & Growth – Supply
  • There are two sources of bitumen for India – local refineries and importing
    • Local Refineries
      • PSU companies like Indian Oil Corporation, HPCL, BPCL are producing about 5-5.5 MTPA with no plans to expand production (Management claim and experts in the industry)
      • In fact, there seems to be a push towards further reduction due to refinery economics (more on that later if interested)
    • Importing
      • The demand supply gap is being full filled via imported bitumen and since the locally produced bitumen is contracting / stable the growth on import segment would imply
        • Market volume growth = 9M x 8% = 0.72M
        • Import growth = 0.72M / 3.5M = 20.6%

Conclusion 2: Volume growth for AIC sub-segment is great at 21%

• Bitumen Importers – Porter Analysis
  • Rivalry: According to exim data there are 103 entities that import bitumen to India. The largest 3 players control only 20% of the trade. Score: Low
  • Barriers to Entry: Bitumen can be imported in bulk or in drums; While the former is cheaper (was unable to quantify the difference) at scale it requires specialized equipment and scale to handle, however drums are more easily handled and transported. This allows even smaller players to enter. Score: Low
    • However, due to the size of the industry (only 3.6B USD) there is no temptation for a large player to enter and disrupt the market
  • Substitutes: None; required for roads, and roads are required in India. Some talk around Bio-bitumen exists but doesn’t seem like a major threat in the near future Score: High
  • Power of suppliers: Suppliers are large refineries in the middle east and can decide who to sell and who not to; so supply uncertainty exists (one of the reasons for AIC to invest in their own ships); however, like in all industries, large consistent buyers will have an edge in negotiations Score: Low
  • Power of customers: Customers are road building companies (EPCs); While they have a number of people to buy from they require two things: Score: Medium
    • Supply reliability: Economic returns from an infra project is heavily dependent on timely completion and releasing working capital; any delay in getting bitumen can cost the company heavily
    • Payment support: Since EPC companies are either directly or indirectly dependent on the govt. to release payments; delays in such disbursement can cause cash crunch for the EPC and on those occasions they need support from their suppliers

Conclusion 3: The industry is NOT attractive structurally besides the growth rate

• AIC Bitumen Division Advantages
  • They are the biggest importers to Bitumen into India with a 13% market share (volume) among the importing sub-segment of the market with a volume CAGR of 40%+ over the last 5 years (basis exim data).
  • They have built cost advantages and agility by setting up extensive physical infrastructure in the form of warehouse (across the country), a fleet of trucks. This allows them to process and handle imported bitumen quickly and cheaply to their customers making them reliable partners while still being profitable. (Management claim; cannot quantify)
  • They also have a strong balance sheet and cash position to extend credit to their customers when required while still ensuring reasonable terms (Debtor days have come down from 129 in FY17 to 37 in FY22)
  • To ensure suppliers full fill the orders to them they have also integrated backward to shipping industry where they focus purely on ships that can carry bitumen for them.

Conclusion 4: Major differentiator here is scale, cost and a strong balance sheet

• AIC Bitumen Division – Thesis:
  • This market is too small for any major large investment; hence while small traders might keep entering and exiting, AIC can continue to capitalize on being the largest.
  • The import segment of the industry is looking to boom with stalled growth in domestic supply and a constant increasing in demand from new roads (India priority)
  • The only differentiator in the industry is scale, cost and reliability; all of which being the biggest player in the Industry, AIC is to benefit from
  • Management has demonstrated a history of performance and the ability to navigate the industry (source Screener segment data)
    

Shipping Division

I cut some corners in the study of this division.

• The company entered this segment to ensure suppliers cannot redirect their shipments to others and they have visibility on their supply immediately after dispatch from the suppliers port.
• But they found that they were often able to utilize their ships more profitably on other routes. Hence although it started as a support business they are trying to set up this an independent revenue center which is contributing significantly to their bottom line.
• How much can this business grow? I am not sure, however the shipping industry is large and they have only 8 ships so far which they claim only covers 25% of their own annual demand
• Hence I have assumed that AIC can afford to go up to 32 ships without significant risks to their margins (if they are unable to gather demand for their ships, they can just use it to full fill their own demand and treat it like a cost center).
• However, since Bitumen demand is rising and these ships are equipped to transport Bitumen in particular, the demand for them should grow as well.
• The management is very particular about only buying when they get a good deal to ensure good ROI. With their past 10Y ROE averaging at 17%, I tend to believe them.
• However, if I were to assume even a 5% nominal growth in the shipping EBIT and a 20% growth in Bitumen (industry growth) the company will still comfortable at 15% EPS growth. But I expect this growth to be more.

If someone can come up with a better analysis here, I would love to hear it. Specially from the supply side on how many such ships are there already and if the major players have plans for more.

Concluding Remark

As I mentioned at the start, I am invested so I guess keep that under consideration when you read this. I have stitched this together through both primary and secondar research but if you find any mistakes or inconsistencies, please do point them out (you might end up saving me some money :P)

I think the company is poised for growth in both their divisions and the industry structure will benefit them in particular. Disciplined execution is something these guys have demonstrated with consistent growth and ROE metrics. Thus at a PE of 10-11 and a 10Y growth of 35-40% in both Revenue and Profit seems like a good buy.

PS – Why Local refineries are avoiding Bitumen production?

As promised here is what I understand of the tradeoff:

• When crude oil goes to fractional distillation a bunch of products are created. The output is decided basis the input crude. Generally ‘heavy’ crude creates Bitumen but it also creates Fuel Oil. This is not very clean for consumption (high sulfur content) and thus does not command a good price.
• Hence reduce the amount of Fuel Oil they create, they conduct a process call Hydrodesulfurization (HDS) to reduce the sulfur content and make the Fuel Oil sellable. However, the resultant liquid is then too impure to be used for Bitumen production
• For the refineries however, this trade off is worth it as the overall payoff from selling the excess Fuel Oil more than makes up the loss in revenue from sale of bitumen