Pre engineered buildings: Proxy to Infra

You might have seen this concept bounce around twitter and telegram for a few weeks, This blog will try to delve deeper into this sector aided by tailwinds of value migration from traditional building structures to PEB or Pre engineered buildings. We will keep it simply by explaining PEB, its advantages which are aiding its growth, industry overview and growth, key metrics to track and a brief of the key players involved.

What are Pre Engineered buildings?

Chat GPT answers it as

These are structures designed and fabricated in a factory before being transported to the site for assembly. These buildings use a standardized framework, typically made of steel, which is prefabricated and pre-assembled in components like columns, beams, and rafters, and then transported to the construction site.

To simplify it, these are steel/ metal structures which are manufactured in a factory and all that needs to be done is to assemble them on site. Think of them as Legos, but meant for actual buildings and warehouses.

These are some examples of how they look. Now, if there is a value migration taking place, we have to look at it in two ways. First, why? What advantage does PEB hold that other steel structures don't? Second, if they actually do hold an advantage, how can we be certain that a value migration is actually taking place? We will look at the advantages of PEB and then the industry growth.

Advantages of Pre engineered building

1. Faster efficiency: Since they are premade in a factory, all the customer has to do is assemble them on site. Hence, the time taken to set up the building will be much faster and could be around 50% of the original construction time.

2. Flexibility: PEBs can be customized based on the client's specific requirements, including size, shape, and structural specifications. Their design is flexible, allowing for modifications and expansions.

3. Cost effective:Pre-engineered buildings are often more economical due to reduced construction time, lower labour costs, minimal waste, and less need for heavy machinery on site. Standardized components also contribute to cost savings. They actually cost 40-50% lower than a traditional building. This means that the energy/power taken, manpower needed, etc., is considerably lower for PEB structures.

4. Lightweight Construction: Most conventional structures are made of steel, bricks, sand, cement, concrete, etc. However, PEB are made of steel, which makes them lightweight yet strong, which reduces the load on foundations and can lower overall structural costs.

5. Energy Efficiency: These buildings can be designed with energy-efficient materials, insulation, and ventilation systems, helping to reduce energy consumption and operating costs. Moreover, PEB type structures are said to suit the climate of India, and hence adoption of PEB has an inherent advantage in India.

Industry overview

Size of the industry

Currently, the Industry size of PEB is estimated to be around 600-8000 crores. PEB construction is primarily popular in manufacturing buildings such as warehouses and factories and has a negligible presence in infrastructure and residential. However, it is expected to grow its market share in infrastructure from 5-7% to 10% in the next five years. Meanwhile, it holds a 13-15% share in manufacturing and is expected to reach around 20% in the next five years. According to industry leaders and their promoters, residential is a section that will come up later in the growth trajectory, as the adoption of PEB in this segment will take time.

The PEB industry is estimated to continue doing well in terms of growth.

Growth expectations

All the industry players have been growing a CAGR of 30%+ in the past few years. India recently overtook to report the fastest growth in the PEB industry in the world at 9.5%, beating China's 8.5%. Hence, we can be pretty certain that the industry is growing, that there is a value migration taking place, and that the growth rates should continue for some time. Moreover, the West has a higher rate of PEB usage where we are not even close to it. Hence, we expect to catch up to that % of PEB usage. 

Unorganised vs organised

Unorganised industry takes up about 60% of the whole sector, while the top 6 players in the organised space take up a mere 11.6% The organised players have inherent advantages of the unorganised players and hence are expected to take their market share over time.

End users

Where are these buildings used? this will give us an idea of why are there such strong tailwinds in the business

• Warehousing and Logistics: PEBs are widely used in warehouses, logistics parks, and storage facilities due to their quick construction time and cost-effectiveness.

• Manufacturing Industries: PEBs are extensively used in industrial manufacturing plants for automobile production, electronics, and heavy industries. Their modular design, ease of expansion, and cost advantages make them ideal for industrial setups​. This will be a big leg of growth and cash cow as India keeps investing in manufacturing.

• Infrastructure Projects: PEBs are used in public infrastructure like railway stations, airports (for hangars and terminal buildings), and toll plazas. The government’s focus on infrastructure development has increased the demand for such structures​. Moreover, themes like Data center and renewables which will be going through massive capex will be the end users of PEB.

• Commercial Buildings: Shopping malls, office buildings, and retail complexes also utilize PEBs, especially as developers seek faster construction timelines and more flexible design solutions​.

  
  

Risks

Before I get into the companies and key metrics, it is very necessary to understand the risks behind these businesses as there are many. Barring the obvious that the business is cyclical (what isn't?), lets look at other sector specific risks that need to be looked at.

• Steel price fluctuations: It became pretty clear that steel is probably the biggest expense for the companies. About 60-75% of the revenue goes into raw material costs. Hence, there can be a big inventory loss, and the company will be susceptible to uncertainty with respect to steel pricing.

• Cut throat:These businesses have low OPM and gross margins, the competition is cutthroat, and there is little to no differentiation. Hence, they do not have a lot of control over pricing and will suffer when the demand dies down. Using Porter's five forces, I would say that this industry can face a pricing war, which is basically a race to the bottom. Why? Little to no differentiation in terms of product, relatively low capex required to set up, and suppliers and buyers holding power. Hence, we should be wary of such businesses in downturns as they can make return ratios lower than the cost of capital and face cash crunches, which leads me to my next point.

• Working capital: The business will have high working capital needs owing to its industry structure. Provided that the industry has razor sharp margins and that working capital is needed, the success will largely boil down to its internal effiecency in terms of costs and time. That will be very important. Unfortunately, I could not find the relevant data to compare businesses in this aspect, but please ping me if you all do.

Key metrics to track

• Order book: Its an order book driven book, and we can gauge the revenue of the business and the demand in the indutry by looking at the order book. Hence, it is very important to look at the direction of order book.

• Gross margins and PAT margins: How do we know if a business is in our desired direction of internal efficiency? Of course, there is more alpha in visiting the factory and understanding the upstream chain of efficiency, but a simple way to do it is by looking at the margins. It is important to look at how the business is fairing in terms of its cost control and efficiency, and hence, this becomes important. For example, look at the PAT margins of Pennar Industries (one of the leaders of this industry and invested by yours truly), and you will see that the direction has been towards the right side. Why did it happen? The business started focusing on winding up the below-average businesses and focusing on high-margin products and geographies.

• Geography: The west is an established market in terms of PEB. The US industry is about 8 billion dollars and is much better in terms of market conditions for these guys to thrive. For example, Ascent (a subsidary of Pennar) has PAT margins which are about 400-500 bps points higher than the Indian business, and hence we should look at how the domestic companies are foraying in the international markets.

• Asset turns and working capital days: Again, I can not emphasise enough supreme internal efficiencies when a sector can be brutal. Working capital days and asset turns are key to track: how debt and interest costs will be, the cash flow of the business (which is very important here) and return ratios. Pennar Industries has a working capital day of 74 days, with the aim to reduce it to 72 in the coming quarters and 60 soon.

Business analysis

I would have loved to analyse the listed players using the metrics discused above, however since this is an emerging industry: we do not have a lot of data points and companies that I can cover comprehensively. Hence, I will be discussing three businesses: Pennar industries, Bansal roofing and Interarch industries.

Pennar industries.

Pennar industries is one of the few listed players in this segment who is a leader as well. Previously, they dealt with multiple business lines and suffered losses and capital misallocation, which did not allow them to grow at their best. However, the management recognised this mistake and has started to wind down these low-margin, low-return businesses and instead focus on a select few, which includes PEB, CDW tubes, white goods, etc.

These industries are fast growing and have a better margin profile, which is why you will notice that the company has increased its PAT margins exponentially.

Pennar is currently winding down their low margin businesses which is why we do not see a lot of revenue growth, as the incremental revenue growth from the focused segments is being negated by the other ones. However, this is only a transitionary period and hence not something to worry for too long.

The business has walked the talk well have reduced their working capital days and maintain good asset turns. Moreover, they are moving towards their PAT margin guidance of 5%, which should be reached in a few quarters.

Talking specifically about the PEB business, the business currently stands at an order book of 800 crores, up 30% YoY. This is an excellent indicator of the growth the industry holds. Moreover, their current capacity for PEB is about 72 crores a month, but after a capex, which is going live in a quarter or two, the capacity will go up to 88-100 crores per month. This is a significant jump. The largest company in India in the PEB segment has a PAT margin exceeding 11%, and hence, with size and cost optimisation, Pennar Industries has a significant leeway ahead in terms of margin expansion.

Pennar has done tremendously well in the US (Ascent) as the order book stands at 52 million dollars, which was 45 million dollars last year. US business has a huge TAM as the market is exponentially bigger than India's, and the margins PEB companies get there are better as well; hence, US business has played a crucial role in the turnaround of Pennar. Ascent is also increasing its production capacity, and this will mostly be done by the end of the financial year. This production capacity will nearly double the capacity of Ascent.

In terms of valuations, I think it is fairly valued owing to its PAT growth and the growth that its capacity expansion will fuel. Moreover, strategically exiting the worst business segments and working towards internal efficiencies helps the business survive downturns and hence increase its terminal value. However, I would not consider a PE between 18 and 22 to be its exit PE. 

On the other hand, Pennar's exposure to 4-5 business segments could pose challenges. This diversity can make the business more difficult to predict and potentially more vulnerable to changes in infrastructural spending in India, economic slowdowns in the US, or downturns in the end industries it operates in.

Bansal roofing

Bansal roofing is a microcap that is in the PEB industry. I learned about it from a friend's video (Smart sync service on the same company) and tried to dig deeper and find any information I could.

The business, too, is expanding its capacity in the PEB segment and is expected to 2.5x its revenue from 100 crores to 250 crores in 2-3 years. The business primarily operated in roofing products but is switching aggressively to PEB. The share of revenue coming from PEB has been consistent, increasing from 11% in FY23 to 30% in FY24. With the capex, it is expected to increase further.

If you look at its income statement, it might look like the business hasn't grown much, but that's not true. Its tonnage has increased significantly, but the drop in steel prices has caused the revenue to look subdued. This is a live case study on how these businesses are susceptible to raw material price fluctuations.

Currently, the business has 2 units, where the first unit is rented out while the other unit is being used for operations. The Unit 2 is going through the expansion which will help the business increase its revenue from 100 to 250 crores.

The business has limited info available and hence should be looked at with caution. We need information on checking if the execution of the capex is intact. Moreover, 90% of its revenue comes from Gujarat which can be a problem in the future as a capex slow down in Gujarat will affect the income of the business.

Moreover, I find the valuations to be quite expensive at the moment as its trading around 40 PE. This gives the business 1x PEG which is good but the quality of business should matter as well and that would mean that the exit PE should be around 20. Hence, in my opinion, i find it expensive.

I am trying to get in touch with the promoters through a common connection, if I am able to set up a meeting with them: I will surely share my notes and try to understand the business better.

Interarch industries

Interarch industries is a recently listed business which has the second biggest integrated PEB capacity at 161,000 MTPA. It is also the only listed business which is solely present in the PEB segment. The business has a good sized order book at 1200 crores (its revenue was 1300 crores in FY24.)

With further expansions planned, the company is planning to increase its installed capacity to 200,000 MTPA.

They have been in the industry for 40 years and have marquee clients such as Reliance Industries, Birla Group, Asian Paints, Tata Motors, and more. 

The company aims to grow at twice the pace of the industry growth and hence aims for 20%+ growth. They have been guided to double their revenue growth in 3-4 years. 

The business has a superior PAT margin of about 7%, which is impressive. However, despite of having the second largest capacity, they are the third largest in terms of PEB turnover. This means that the asset turnovers are lower compared to its competitors. Another strong advantage that company posseses is that its balance sheet is strong as its a net cash company which is great for any company but more for capital good cash intensive businesses.

The business lacks detailed information as it is recently listed, but as they do more calls, I will cover this business on my Twitter account.

The business, too, faces key risks from the same sources: a slowdown in spending and working capital management.

I hope this blog was worth the time; thank you.

Citations

“India Prefabricated Buildings Market Size: Mordor Intelligence.” Prefabricated Building Market in India - Size, Share & Industry Analysis, www.mordorintelligence.com/industry-reports/india-prefabricated-buildings-industry. Accessed 19 Sept. 2024.

“Pre-Engineered for Success: Tracking Growth of PEB Steel Buildings in India.” NBM Media Pvt. Ltd., www.mgsarchitecture.in/building-materials-products/precast-peb/250-pre-engineered-for-success-tracking-growth-of-peb-steel-buildings-in-india.html. Accessed 19 Sept. 2024.

R, Maria. “India: The Fastest Growing Market in Peb.” India’s #1 Magazine on Infrastructure, Construction Equipment Industry, www.nbmcw.com/interviews/india-the-fastest-growing-market-in-peb.html. Accessed 19 Sept. 2024.

Arora, Ishmohit. Top 7 Emerging Themes for 2025, SOIC, www.youtube.com/watch?v=spd7g32drt8&t=726s. Accessed 19 Sept. 2024.

Bajaj, Dhruv. The Next Big Investable Trend: Pre-Engineered Buildings | Smart Sync Services, Smart Sync Services, www.youtube.com/watch?v=R8ois8XmVOk&t=123s. Accessed 19 Sept. 2024.