SG Mart: Disrupting the steel industry

Disclaimer: not invested

Indian building material companies such as steel, copper, cement, etc., are expanding significantly to meet the rising demand backed by government spending on capex. The current steel industry capacity is 120 Mn tonnes and is expected to reach 300 Mn tonnes by 2030. These steel companies rely on distributors who act as wholesalers and help carry forward the finished product to smaller companies, which are irrelevant to the size of someone like TATA Steel. However, a problem arose when producers' capacity increased, but these distributors' capacity to take the delivery did not. According to management, the biggest distributor does 25000 tons per month. Do you see the ridiculous gap between the producer's capacity and the distributors? These producers would be forced to deal with thousands of distributors.

This is where SG mart comes in. It aims to become the one stop distributor for these companies which is capable of handling the capacity that they are producing.

About the business

SG Mart is essentially a trader that connects manufacturers to smaller businesses all around India that sells steel products from the producers to SME businesses. Due to their rich parentage in the steel industry (SG mart is a venture of the APL Apollo family) they decided to focus first on the steel sector and expand into other materials if this business model was successful. Some of their product offerings:

Currently, the company has three business segments.

1. B2B trading: The company trades long and flat steel products, buying directly from the steel producers and distributing them in the market. They started 6-7 months ago and do 60,000 to 70,000 tons of volumes monthly. This means they are already the biggest distributors and are also the largest zinc trader as of Q1 FY25. The company buys directly from JSW Steel, NMDC Steel, Jindal Steel and Power, SAIL, and some imports, which ensures enough raw material supply to power their business. The margins here will be 1.5-2%, which makes sense as it's essentially trading and very competitive. The company buys the steel on credit and sells in cash, as steel is primarily a cash-and-carry business. The key here is working capital days, or how fast you sell your inventory, and for them, it's 10 days, which is remarkable. There are multiple advantages to this that I will get to later.

2. B2B service centers : A network of service centres processes upstream steel and then sells it semi-finished. According to management, there are no pan-India service centre businesses, and all of them are fragmented and unorganised. That is why the company is foraying into this industry. These service centres allow them to take orders from auto companies, consumer durables, etc., as they prefer finished steel products. Currently, the company has two service centres, which are doing 10,000 to 12,000 tons per month, and two other service centres are being set up and should be operational by Q2 FY25 results. A fifth service centre is being set up in Dubai, and these centres should combine 30,000 to 40,000 tons of finished products per month. They aim to set up 15 new service centres by Q1 FY26 and 100+ centres By FY30, which allows them to can penetrate deeper into smaller cities. The working capital days are a bit high and vary between 15-25 days which is fine as it's compensated by the margins being made, which are 4-5%. Capex per service centre is 25 crores and 15 crores for working capital. Thus, a 40 crore investment is needed for a service centre, which profits should fund as the business keeps growing. These service centres can act as warehouses for metal trading and B2C distribution, which helps with costs, delivery time, and inventory management. 

3. B2C distribution : To take advantage of the existing network the group has created owing to its enormous success in the tubes sector and formalizing it, SG mart aims to do the same for other sub-sectors such as angle channels, rebars, welding rods, etc. According to the management, they have visibility of 3-4L crores in this market, and hence, it is a high growth opportunity area in which they have an inherent advantage. They aggregate the demand from distributors and, against that, do tie-ups with manufacturers, and we bridge the gap between the SME manufacturer and an SME trader. This business began around July-August and currently does 30,000 tonnes of monthly volumes. The working capital days here are 15-20 days, and the margins vary depending on the private label but are generally between 2-4%. They will not deal in steel pipes because that is a different distribution business set for APL Apollo. 

Now that we understand the business, lets get to the thesis and key risks

Thesis

1. HUGE TAM: It goes without saying that the primary reason for my thesis is built on the existing industry structure. The B2B marketplace penetration in India is at 1%, while it is at 20% for countries like China and the USA. As India gears up to strengthen its position to become a global manufacturing hub, the other parts of the value chain must also catch up, and SG Mart is doing exactly that. The potential market they can address is remarkably high; the sky is the limit. From my understanding, the trading sector is ripe for disruption. SG Mart seems to be the ideal option with its scale, expertise, and synergy, created amongst its vertical and business groups. Moreover, the TAM below is just for the steel products; if the company succeeds in this sector, it can expand into other building materials and do well there, too.

2. Promoter history: SG mart is probably backed by one of the best-suited promoter groups with respect to what the business requires. They have created immense wealth, established leadership and have a good experience in the steel industry. They have put up 350 crores and raised 900 more from other investors, which shows skin in the game and the capital to make the company big. APL Apollo has also given SG Mart the right to use the APL Apollo brand for non-steel pipe products (free of charge). Additionally, the company has the advantage of leveraging the scale and distribution power of APL Apollo.

3. Strong unit economics and economies of scale: All their business segments have a very good working capital cycle, which allows them to ramp up the growth at minimal investment. Hence, their ROC shoots up. The ROCE for all three businesses ranges around 35-40%, which is very impressive. The ability to churn inventory fast will be the absolute key to success here. It allows increasing turnover and high return ratios and negates the risk of inventory losses. Steel is a commodity product, so its price keeps fluctuating, which can result in inventory losses/ gains. SG mart tackles this buy selling under ten days, which means that they do not let price change influence their business as prices are reviewed once a month or so, and by then, the transaction will be done. Clients are billed directly to manufacturers (billed to ship contracts), which reduces the inventory days to a minimal level for SG Mart. The company maintains inventory days of 5-6 days, barring CTL HR Coil products, which have inventory days of 15 days. The inventory holding period is expected to remain low at an average of 10-15 days, which will assist in mitigating the inventory price risk to a certain extent. Receivable days are comfortable at less than ten days, reducing any significant debtor risk.

   Further, there is no dealer concentration, with top customers forming 5.3% of total revenue in fiscal 2024. The number of dealers has increased from 110 on September 30, 2023, to 224 on June 30, 2024. As SG mart is the biggest player already, they can buy in bulk and get a discount, which can be forwarded to customers. It allows them to maintain their leadership, increase their market share, and make much money. It is essentially a product that is hard to differentiate (commonly defined as a commodity); hence, the main factors of differentiation will be price and time taken to deliver.

4. Strong balance sheet: The business has a lot of cash in hand, and from the management's commentary, the direction looks the same. The company does not plan on having any debt except maybe a 1000 crore or so short-term debt when they reach a topline of 50,000 crores. Moreover, their business model does not need a lot of capital investment, and hence, the gross block and depreciation will be low. Essentially, the EBITDA margins will more or less also be the PBT margins as there is not much to deduct.

5. High growth guidance: A combination of the three points above translate to high growth. The company whose FY24 revenue and PAT stands at 2680 crores and 61 crores PAT (some of it is coming from interest payment as the money raised is in deposits which will be used as when needed to fuel growth) is guiding for 7000/8000 crores of topline in FY25 with margins to be 2.5-3% which translates to 1.3 million tons of steel, to 12000-13000 crores in FY26 and 50,000 crores in FY30! The idea is to reach 7-8 million tons of volume by FY30 and whats surprising is that it still doesn't translate to a significant market share (which means a long way to go)

   
   

Risks

1. Highly competitive: As mentioned above, the key advantage they have is scale and their existing distribution network. What worries me is that that is not a strong enough differentiator for me which is why I would expect the industry to become intensively more competetive and hence force companies to fight for profits. My concern is what stops other giants from venturing into trading? They too will possess the same advantages and hence can compete against SG mart. Competitive intensity must be tracked closely. Rising competition would mean deteriorating return ratios, margins and worsening working capital cycle which essentially means that the triggers of growth are gone.

2. Foreign exchange rates: The working capital days ensure thst volatility of steel prices does not affect the business much. However, they import around 20% of its products, which means it is also susceptible to any adverse movement in foreign exchange rates.

People have raised concerns of related party transaction or conflict of interest amongst the companies in the group, I am not so worried as I have not seen much of it and moreover, objectively it is better to be associated with the APL group and benfit from their brand power and image. Its not a big matter of concern for me at the moment.

Technicals and valuations.

I would not pay give much weightage to the technicals as it seems to be too volatile,owing to its float. However, we can see that it is on the bearish side but has been consolidating a bit. Let us see how the future goes.

On the valuation front, it is currently at a PE of 53.5 might seem optically high but the growth guidance and the probability of achieving that growth makes the company at a decent valuation to purchase. I would not rely on just my words and hence would urge everyone to study the business independently.

This marks the end of the blog, I hope it was helpful and provided good insights about the business. Do share and subscribe if you find the content worth your time!

Sources

• Q1FY25 presentation

• Q1 FY25 Concall

• FY24 Annual report

• SG Mart - Sales Note." Arihant Capital, http://www.arihantcapital.co.in/research/Insti/SG%20Mart%20-%20Sales%20Note.pdf. Accessed 17 Oct. 2024.