Strong Growth Prospects, Reasonable Valuation

Gravita is one of Asia’s leading recycling companies, non-ferrous secondary metals producers and one of India’s largest lead metal companies. Headquartered in Jaipur and incorporated in 1992, it recycles used lead in acid-batteries, cable scrap/other lead scrap, aluminium scrap and plastic, etc, from its facilities in the growth centres of Asia, Africa and Central America. Its products are sold in more than 59 countries and it has supplied more than 60 recycling projects across the world. Its global scrap collection network allows it to buy scrap at competitive prices. It has four verticals: lead, aluminium, plastics and recycling projects. Lead is the biggest revenue contributor, with 85% revenue share as of FY21-22.

The lead segment reported revenue growth of 52% to Rs1,870 crore year-on-year (y-o-y); aluminium segment revenue jumped 117% to Rs207 crore; plastics segment revenue jumped 70% to Rs131 crore; and recycling project revenue was up by 64% y-o-y to Rs6 crore, as of FY21-22. Overseas business contributed around 36% of the revenue but 75% to net profit in FY21-22 with just 31% of the capital employed. It has 12 recycling plants, more than 1,400 touch points with 215,000MT (metric tonnes) production capacity of which 34% is overseas capacity. Its present capacity utilisation is at 66%. It has an order-book of more than 60,000MT.

Gravita started its operations in 1994 by commercialising lead plant in Jaipur. Its first overseas recycling plant was established in 2001 in Sri Lanka. Thereafter, in 2007, another recycling plant was set up in Ghana. In 2010, the company was listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). In 2013, it started manufacturing of value-added products at the Jaipur plant. In 2015, it diversified into plastic recycling and then in aluminium recycling in 2016. In 2019, the company expanded its plastics and aluminium recycling facilities in Africa. Then, in 2021, the company established a new recycling plant at Mundra Port and it has recently ventured into rubber recycling.

At present, the company is sourcing raw materials (battery scrap) from overseas into India which leads to higher logistics costs and, therefore, dilutes a lot of value for the company. But it is hopeful of higher sourcing from the domestic market itself. However, scrap is cheaper in the overseas market than in India  which leads to higher profitability in the overseas plants. Also, the company enjoys certain benefits in its overseas plants. For example, Ghana and Senegal plants enjoy import duty exemption into the European Union (EU). Therefore, the company enjoys some additional benefits while selling to EU or US. Further, Gravita does not pay any tax in most overseas geographies.

The rubber recycling is currently serving company’s own requirement and is acting as backward integration. The three products from rubber recycling are: carbon, iron and pyrolysis oil which are used in its smelting process. At present, the company is creating capacity to these for its own captive consumption. It will look for some value-added products from rubber in future while adding additional capacities.

Out of the total 12 facilities, seven are in Asia, six in India and one in Sri Lanka. It has four existing facilities in Africa with one upcoming facility. It has one facility in America (Nicaragua) as well. It has an international procurement network of 29 own yards, more than 1,400 touch points with scrap collection of more than 180,000MT. Geographically, it has scrap collection capacity of more than 110,000MT in Asia, Africa 50,000MT, America 13,000MT and Europe 7,000MT. Of the total 29 yards, 24 are in Africa. Its customer network outside Asia is diversified in terms of delivered recycled products with 19,000MT in the Middle East, 11,000MT in America and 10,000MT in Europe.

Gravita has increased its lead capacity from 112,819MTPA in FY18-19 to more than 168,000MTPA as of H1FY22-23. Its aluminium capacity has gone up from 13,200MTPA to 22,000MTPA. The company has spent Rs220 crore from FY18-19 to H1FY22-23 towards capital expenditure (capex). Its existing facilities are running at around 67% capacity utilisation. The overall capacity will further increase from 213,719MTPA to 425,000MTPA according to its vision 2026 that envisages new recycling verticals including those for rubber, copper, paper, e-waste and lithium. It wants to reduce the share lead from 83% at the end of Q2FY22-23 to 75% by 2026, while growing (lead segment) at 15% to 20% annually. Its overseas business is the major profitability driver contributing 62% of the net profit in Q2FY22-23 with just 38% of the revenue in Q2FY22-23.

Industry

Lead is a malleable, grey and lustrous metal with high density and low melting point. Due to its anti-corrosive and anti-radioactive properties, it is extremely useful in certain industries such as batteries and pigments. It is also used in galvanising, soldering, sound-proofing, roofing and cable-sheathing. Around 85% of lead is used by batteries industry globally and, in India, 5% to 6% of lead is used by cable industry. It is used in vehicle batteries due to large power to weight ratio. The global lead-acid battery market is estimated around US$38bn (billion) to US$42bn of which around 66% comprises automotive demand and the rest 29% is industrial demand. The Indian lead-acid battery market is around Rs36,500 crore. The major battery players include Amara Raja and Exide. It is a highly recyclable metal especially in batteries as almost 99% of the lead-acid batteries are recyclable while only 71% of the steel cans can be recycled. As a thumb rule, one tonne of battery scrap yields around 0.6 tonne of lead.

Its competitors include: Chloride Metals Ltd, Pondy Oxides & Chemicals Ltd and NILE Ltd. Chloride Metals is the recycling arm of Exide Batteries and has more than 354,000MTPA lead recycling capacity. Pondy Oxides and NILE operate in Tamil Nadu and Andhra Pradesh having 132,000MTPA and 107,000MTPA lead recycling capacity, respectively. But the operating profit of these companies is 5% to 7% whereas Gravita has consistently had operating margins of around 7% to 10%. Earnings before interest, taxes, depreciation and amortisation (EBITDA) per metric tonne of lead have increased significantly due to higher prices in domestic markets. EBITDA per MT for lead was around Rs19,214, for aluminium at Rs15,852 and for plastic at Rs11,265. In terms of volume, lead had the highest volume with 31,060MT in Q2FY22-23, aluminium and plastic had volume of 4,331MT and 4,123MT, respectively. The management expects EBITDA margin in lead to decline to around Rs17,000.

Risks

The company faces the usual financial risks such as credit, liquidity and market risks. The credit risks exposure arises from loans, trade receivables and other financial instruments which are measured using credit ratings. Brickwork, whose licence has now been cancelled by the Securities and Exchange Board of India (SEBI), has assigned BWR A (stable) ratings for its bank loan facilities of Rs257.33 crore. The company faces commodity price risks. It hedges lead on the Multi Commodity Exchange (MCX) in India to protect from adverse price changes. But for other metals, like aluminium, it is not able to hedge as it deals with aluminium alloys which are not currently available on the exchanges. It has requested MCX to register aluminium alloys which may take six to nine months. Also, plastic cannot be hedged as it comes in various forms and grades and is not available on the exchanges.

The battery management regulations may change market dynamics in the near future. The company is hopeful that the new battery management regulation which asks battery manufacturers/OEMs to collect batteries using regional networks will be beneficial. It believes that, eventually, smaller companies will not be able to execute the collection process and, therefore, will buy certificates from recycling companies such as Gravita. The recycling companies can sell volume certificates to battery manufacturers. These certificates will have a value and will be regulated on a portal. The larger companies will be able to have partnership with recyclers and have their tolling arrangements; but smaller player may rely on certificates. But implementation of these regulations may take time. 

Gravita will face competitive risk as the process of smelting is not very complex and is replicated by many smaller players and, in a scenario of implementation of these regulations, the market may grow wherein such smaller players may also gain market share at the expense of larger players like Gravita. But the management believes that the number of players will reduce significantly and unorganised players will not be able to compete as their current tax benefit will vanish. The management believes that after consolidation there will be around 20 players. It also believes that Gravita will outperform the industry growth due to its pan-India presence. But 20 is also a very large number.

Financial Snapshot

Sales have witnessed compounded annual growth rate (CAGR) of 21.5% in the past five years. Its operating profit margin has expanded with volume growth and has risen to 10% and the management expects that margins will sustain around these levels. The net profit margin has also expanded substantially in line with operating profit margin. The margin will expand with the rise in volume and value-added products.

Quarterly Performance

Gravita’s Q2FY22-23 volume grew by 17% y-o-y which led to sales growth of 25% y-o-y. On sequential basis, volume of lead grew by 26%, battery aluminium and plastic grew by 31% and 11%, respectively. The per tonne profitability (EBITDA) for lead and plastic increased by 23% and 13%, respectively,  y-o-y but aluminium saw a decline of 6%. Domestic scrap collection for Indian plants increased by 47% in Q2FY22-23 compared to 39% in Q1FY22-23. Revenue from value-added products was around 42% of total revenue as of H1FY22-23. Operating profit margin was flat y-o-y at 9%, whereas net profit margin dipped a little by 50bps (basis points) to 6.6% y-o-y. The company faced increasing cost pressure across major raw materials but was able to protect its margin to certain extent. Out of the Rs45 crore net profit, 62% was from overseas business.

The company reduced its debt by around Rs90 crore in H1FY22-23, but will be borrowing around Rs300 crore to Rs400 crore in future to meet capex requirements. Its return ratios have improved significantly and inventory days are expected to reduce as and when import of scrap is reduced. There is a very high volatility of stocks and debtors which affects free cash-flows.

Management 

Dr MP Agarwal is the chairman. He is aged about 88 years and has MBBS and MD degrees. After retiring as a director of department of medical & health, government of Rajasthan, in 1992, he engaged himself in the business of lead manufacturing with his son Rajat Agarwal who is the managing director, with an annual remuneration of around Rs1.2 crore. He is in an engineering graduate from MNIT Jaipur and has more than 30 years of experience. He holds more around 47.87% of stake in the company. Yogesh Malhotra is the CEO (chief executive officer) and a whole-time director. He is a mechanical engineering graduate from MREC, Jaipur, and MBA from National University of Singapore. He has more than 29 years of experience in Asia-Pacific markets. He has previously worked at Blue Star, Castrol and Eurochem, etc. His annual remuneration is around Rs3.5 crore. The compensation of key managerial personnel (KMP) as a percentage of net profit is around 3.6% which is very reasonable.

Business Outlook

Gravita’s step-down subsidiary has recently started aluminium recycling plant at Senegal having an annual capacity of 4,000MTPA. The company has made investment of Rs3.5 crore on the plant through internal accruals. According to the management, this project will lead to additional revenue of Rs60 crore with gross margin of 20%. Another step-down subsidiary at Ghana has started plastic recycling plant whose annual capacity is 1,200MTPA in phase-1. This will increase to 2,700MTPA in phase-2. For this, Rs1.9 crore have been invested from internal accruals. It has similar plastics recycling plant facilities in Senegal, Mozambique and India. This is in line with company’s vision of replicating recycling business in different geographies. Gravita has incurred capex of Rs44 crore in H1FY22-23 and the capex for H2FY22-23 is expected around Rs30 crore-Rs35 crore.

The domestic scrap collection has grown by 39% and 47% y-o-y in the first two quarters of FY22-23. The management believes that, with redefining battery waste management rules, extended provisions and stricter implementation of goods and services tax (GST), scrap availability will increase. Though the company has achieved volume growth of around 17% in Q2FY22-23, it is well below the target volume growth of 25% set by the company itself. According to the management, the reason for this low growth was issues in Sri Lanka and delay in expansion. The Sri Lanka plant was not working at its full capacity and some expansion which was earlier estimated to start production in Q2FY22-23 got pushed to Q3FY22-23. But the management has not changed its future outlook and expects 20% to 30% volume y-o-y up to 2026. On a CAGR basis, in the next three years, it expects 25% volume growth, taking into account capacity expansion. Gross margin will sustain around 20% but may increase if the contribution from aluminium and plastics increases.

Gravita has increased its lead capacity from 159,000MT to 168,000MT in H1FY22-23. The management is confident of reaching total capacity of 425,000MT by 2026 including existing and new planned verticals. The maximum payback period for new projects is around three years and RoCE of 25%. It estimates a capex of Rs75 crore to Rs80 crore per year up to 2026. Additionally, Rs70 crore to Rs80 crore for existing verticals and Rs200 crore to Rs250 crore will be spent on new verticals in the next three years till 2026. A major part of the capex will be funded through internal accruals and around Rs300 crore to Rs400 crore will be funded from additional debt. The management estimates spending of around Rs1,300 crore for capex till 2026.

It has been able to bring down its net working capital cycles from 95 days in March 2022 to 80 days by September 2022. This was on the back of higher availability of domestic scrap, lower imports which led to reduction in transit inventory and also retail scrap collection from original equipment manufacturers (OEMs) which has zero working capital requirement. The company aims to reduce this cycle to 65 days by March 2026. 

The company is hopeful of increasing domestic scrap from OEMs where it does not need to pay for the scrap. The scrap comes from the retail automobile sector. As soon as it gets more volume, working capital requirement is going to drop significantly. It will then replace imported scrap. In future, Indian battery manufacturers will manage battery market like in the US and the EU but similar to these geographies the recycling will be done through partners like Gravita.

Gravita’s management is not only betting on higher volume growth on account of industry growth but also on the shift from unorganised to organised players. It believes that even if the industry growth is flat for few years, the organised segment will grow by 2x-3x in the next few years and, therefore, its 2026 capacity expansion plans will be timely. By 2026, its capacity will increase to 425,000MT from 215,000MT at the end of Q2FY22-23 of which lead will be around 70% to 75%. It has an order-book of 60,000MT of which around 80% to 85% is of lead and some part is of aluminium and plastics as well. These orders are from OEMs and traders like Trafigura, Glencore and others. Leading investor Ashish Kacholia holds around 1.96% stake as of September 2022 and Abu Dhabi Investment Authority (sovereign wealth fund) bought 0.8% stake at around Rs332 per share, in October 2022.

Valuation 

The business of Gravita is environment-friendly and fits in with the ESG (environment, social and governance) investment narrative. This business has high returns on capital but has low gross margin of 20%, operating margins around 10% and net profit around 5% to 6%. So, it has to depend on continuous volume expansion to propel earnings growth. The present regulatory environment changes are strong tailwinds and, therefore, must be watched carefully. Gravita is currently available at a market-capitalisation of around Rs3,000 crore. As per consensus estimates, its FY23-24 net profit is estimated at Rs210 crore implying that the company is trading at price-to-earnings ratio (P/E) of 14.8x its FY23-24 estimated profits. Considering the high returns and the long runway ahead, the growth prospects are, perhaps, not fully discounted.