Ador Fontech Management Q&A: Mar 2011

Management Q&A

1.  ADOR FONTECH HAS HAD A DECENT RUN OVER THE LAST DECADE. RECENTLY THE COMPANY ACHIEVED A TURNOVER OF OVER 150 CR WITH EXCELLENT MARGINS AND RETURNS. 

Congratulations! Kindly take us through the Journey and key success factors

Let me give you a backgrounder on the company and its business first. Ador Fontech has been in this business since Dec 1979. We are like Doctors to industrial machinery. With a salesforce of over 150 we service the entire infrastructure sector in India, for repairs. Cement, Steel, Mining Plants and Refineries.

We provide the Services necessary for resurfacing, refurbishing and repair of industrial machinery. We manufacture much of the consumables required and have partnerships (many are exclusive distributorship agreements) for some special consumables that are not economical to manufacture (market size small).

Let’s take the Mining industry – say Coal or Iron Ore. Typical equipment used are Dumpers and Drag Lines which can be of BEML, Caterpillar or Komatsu make. Each have different levels of wear & tear. Its like Cars from Fiat & BMW (latter may need very little maintenance).

Now why go for refurbishments? While refurbishments are gone in to extend life, Cost and Availability play a big hand. Sometimes maybe custom components are required, or very old components, or the technology may have changed meanwhile.  Sometimes availability is like 6months/1 year. This proves very expensive for customer. So he may go for a temporary solution/ or a permanent solution too.

The repair service industry is small. Let’s take Cement industry – people know each other. They go by Testimonials. They know our capabilities. For particular type of critical jobs, they will come to us. This is a knowhow-based, specialised skills niche industry. We maintain a big Documentation and Training Center (Cumulative Knowledge base of Case Studies).

What are the future plans? Where does the company see itself in the next few years? What are the key success factors and what are the challenges that lie ahead?

The infrastructure sector in India, say Cement or Steel is miniscule, when you compare with any developed economy standards, say US or China. Plants are small and fragmented. Let’s take power boilers. We have from 22 to 62, 100, 200, moving upto 770 MW, whereas the Developed world works with 1000 or 1200 MW boilers.
You can afford a shutdown of small boiler for days. But a large scale boiler you cannot afford a shutdown for even a few hours. the losses will be enormous. So, with larger equipment is associated Superior quality. Downtime is small. Losses are large.
The numbers involved changes quite a bit. It all depends on how Industry shape in India changes, and how fast. It is no more economical to put up a 15 Mn Tonnes Steel Plant. Everybody talks about setting up a 150 Mn Tonnes Steel plant! And in an environment of slower growth, everyone defers Maintenance!
Training people and retaining people are the big challenges. In our industry its a new Learning every time. The machine may be same 2 year old, but the situation (wear & tear) is completely different.

2.  ADOR FONTECH IS IN A BUSINESS THAT IS NOT CAPITAL INTENSIVE. YOUR AVERAGE CAPEX HAS BEEN IN THE RANGE OF 1-3 CR OVER THE LAST FEW YEARS. HOWEVER FY11 HAS SEEN MAJOR CAPEX BEING INVESTED IN THE COMPANY ~12 CR

Kindly explain the reasons for this major investment in a single year? Are we seeing a shift in gears with the company adopting a more aggressive gameplan form here on?

We had like a small “clinic” in Nagpur. We have now converted that into a Hospital. We are spotting an increasing trend of “outsourcing” repair services in the industry as opposed to maintaining big in-house repair services teams.

We have increased the capacity by some 4x times. Earlier we could service small shafts, gears, impellers. Now we can service bigger components like Cement Kilns. new specialisations have been added. Emphasis is on more value-adds.

3.  YOUR TRACK RECORD ON THE MARGINS FRONT IS EXEMPLARY. WE DON’T FIND MANY BUSINESSES THAT CAN BOAST OF IMPROVING MARGINS ALMOST 2X IN 5 YEARS. OPERATING MARGINS HAVE GONE UPTO ~20% FROM 12% IN FY07, AND NET MARGINS HAVE IMPROVED FROM 6.4% IN FY07 TO ~13% IN FY11

Kindly take us through the dynamics of your business, and what makes this kind of a performance possible?

The answer is simple. The business profile and mix has changed over the years. Earlier we were doing mostly Trading. Increasingly we have been Manufacturing our own consumables. And now there is an increasing component of Services.

What is the contribution of Services segment currently?

Well, it should be about 12-13% of overall revenues.

In view of your recent Services capacity expansion, is it fair to say Margins uptrend looks set to continue?

In a “Normal” environment, Yes. We have metal prices and imports volatility to contend with also.

With a 4x increase in Service capacity, are we going to see a corresponding increase in Service segment revenues? By when?
(TBD)

4.      “LIFE ENHANCEMENT OF INDUSTRIAL COMPONENTS”. THIS IS A NICHE SEGMENT THAT ADOR HAS BEEN SERVICING OVER THE YEARS.

Kindly educate us on the Total Market size in India and the nature of competition that you face.

Repair Services is roughly a 450 Cr Annual market in India currently. Competition is from a few other organised players.

Is it true that effectively this is a Duopoly. Ador Fontech and EWAC are the only two players?

There are effectively 3 players. EWAC Alloys (235 Cr), Ador Fontech (150 Cr), and Diffusion (60 Cr). EWAC is 100% L&T owned – Production by EWAC and Marketing by L&T. Diffusion is a Nagpur based player, breakaway group from L&T.

What about players like Esab and Ador Welding? Are they not competing in the same market?

Esab and Ador Welding cater to the “Fabrication” services market (new). We are into “Repair” Services for old equipment. There is some overlap sometimes, but very little.

Is it true that EWAC enjoys operating Margins in the range of 24-25%? Why are they doing a better job than Ador Fontech? Will Ador eventually catch up on the margins front?

When you are comparing EWAC with Ador Fontech, you are not comparing Apples to Apples. EWAC did not have any Marketing overheads on its books – everything was taken care of by L&T. Also their volumes are bigger. But from this year onwards, Marketing will also be completely be with EWAC. So a better timeframe to compare will be 1 or 2 years down the line.

5.  EXCLUSIVE DISTRIBUTOR RELATIONSHIPS – SULZER METCO, ALLOY STEEL INTERNATIONAL, DELLERO STELLITE, EWM, MICROTHERM, PROTECTOR, CEPRO, CEA, GASFLUX, YORK AND EUROMATE PRODUCTS IN INDIA

Kindly give us an idea of the role these exclusive distributor relationships play in the sustainability of your business. Which are your top 3 relationships, and what is the current contribution form your top 3 product relationships?

Partner relationships help us move up the technology curve to High-End repair services. Low-end repair service is commoditised. There is no money, too many players to service.

With Sulzer Metco we have a relationship going back some 26 years. We are their Agents and also stock & sell their consumables and spares in India. We also sell & service Sulzer Metco equipment. They are the specialists in Plasma spray or thermal spray solutions – used for Turbines/Engine components.

Dellero Stellite is another partner we are working with for some 18+ years. They are specialists for Cobalt & Nickel Alloys used in high temperature applications like Engine Valves.

EWM, manufacturers of High-tech welding machines is another partner with a relationship that goes back some 7-8 years. These are needed in higher quality fast welding applications.

Please give us an idea of Revenue/Sales contribution from top 3 Partners

(TBD)

What does an EWAC do for say Sulzer Metco products? Are there equally effective alternate sources?

Yes, there are multiple vendors for most applications.

6.  ENTRY BARRIERS. SUSTAINABILITY OF COMPETITIVE ADVANTAGE

Kindly educate us on the Entry Barriers? Do you think these are strong enough to help you sustain your competitive edge for a number of years, and why?

You may like to see it like this. If you are a senior person and need some cardiac intervention/repair, you will go to a Specialist for the job. You will not bargain!

So, for some specialised jobs, proprietary technology remains with you, for some time. You are usually the first choice. And if the number of such jobs are small, no one else is likely to jump in.

Our entrenched customer relationships help. Our partner relationships help, they act like our extended Sales Team.

What kind of certifications, if any are necessary before one can service industrial reclamation projects?

Certain certifications that we have from BHEL, WRI (Welding Research Institute) add value. Nuclear Power Corporation has recently approved us.

7.  POWER, SHIPPING, MINING AND OTHER CORE SECTORS AND ENGINEERING INDUSTRIES. THE CANVAS IS HUGE, ESPECIALLY IF WE LONG AT THE LONG TERM GROWTH PROSPECTS OF THESE SECTORS IN INDIA

Which are your top sectors? Are you strategically aiming at developing expertise in certain core sectors? Kindly educate us more on the company’s vision for the long term.

Cement, Steel, Mining and Refineries are top sectors. The nature of industrial components are similar – boilers, turbines, kilns, gears, shafts, etc. But, sizes are changing. And volumes are changing too!

8.  THE COMPANY’S TRACK RECORD HAS BEEN EXEMPLARY ON MARGINS AND PROFITS. THE SAME CANNOT BE SAID HOWEVER OF THE TRACK RECORD ON SALES PERFORMANCE.

While everyone agrees that Ador Fontech is a well managed company, Investors also feel the company has been too risk averse? That your are over-selective in choosing contracts to participate in? What can otherwise explain the pretty average record on the sales front?

(TBD)

Considering that this is effectively a duopoly in your niche, could you not have grown faster?

(TBD)

9.  CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

Who are your top customers/ What contribution comes from your top 3 customers?

(TBD)

10.  RISKS FROM EXCLUSIVE DISTRIBUTOR RELATIONSHIPS

What is the company’s views on risks from exclusive relationships. What can change the nature of the relationships? Some of the players have India presence, why will they not think of setting up their own service organizations.

The market size is currently too small.

11.  RAW MATERIALS – WIRES, METAL STRIPS & FLUXES, WEAR PLATES

Kindly explain the process followed on raw material management front? Are there any constraints/challenges on the sourcing front and price volatility faced, etc.

We do not normally face challenges on sourcing.

12.  IMPORTS. HEDGING POLICIES

Ador Fontech has a sizeable Import Bill. ~35 Cr in FY11 or almost 25% of Sales. Kindly explain how do you manage the risks on the currency fronts. What kind of hedging policies are followed by the company?

We do not do any Hedging. But are open to look at it.

13.  SALES DISTRIBUTION & SERVICE NETWORK. TENDER BASED BUSINESS

Kindly explain your sales and service network in place. How do you go about securing and managing business from customers? How much of the business is from tendered business?

As mentioned before we have a salesforce of over 150 trained people. They are in the field and in touch with major customer segments on a regular basis.

Significant portion is tendered business.

14.   PACE OF TECHNOLOGY CHANGES. KEEPING PACE

Kindly explain how the company manages to stay on top of technological challenges? What kind of a R&D set up does the company maintain and nurture?

We have a big Documentation and Training Center for continuously building on the metallurgy and wear & tear knowhow base. We have a team to continuosly look at quality improvement solutions.

15.   LOW PROMOTER HOLDING. WHILE PROMOTER HAS BEEN GOING UP FROM 24% IN 2007 TO OVER 35% IN 2011, THIS IS STILL VERY LOW COMPARED TO OTHER GROUP COMPANIES. ADOR WELDING HAS ALWAYS HAD PROMOTER HOLDING ABOVE 50-55%.

Kindly comment on the relatively low promoter holding in this company. Is this lack of confidence in growth prospects earlier? And has this changed for the better considering there has been a steady acquisition over the last few years.

All I can say is this is there because of historical reasons.

16.  DIVIDENDS. DIVIDEND POLICY. PAYOUTS

Kindly elaborate on the dividend policy followed by the company. Why is the company not doling out higher payouts considering the excellent profitability and low capex/funding requirements?

No, we do not have a dividend policy.

17.  CHALLENGES BEFORE THE COMPANY

Kindly elaborate on the main challenges faced by the company in view of the huge opportunities that lie ahead. When can we see Ador Fontech touching 500 Crs in revenues?

Good Question. 500 Cr in turnover – is that a prime objective at this point? No, keeping a healthy bottom line, is. But we do keep looking at Opportunities.

Disclosure(s)

Manu Dev: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
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