RÜTGERS is far less exposed to aluminum with approximately 17% of revenues sold to the aluminum industry and hence will not be impacted to the same degree as CPC. One avenue for increased profitability is management’s expectation that EBITDA margins for the chemicals division will normalize around 10 -12%, currently at ~8%.
Margins and business performance. RÜTGERS’ cost structure is very similar to the calcining business, where the operator earns a stable margin for sourcing and refining coal tar, and is able to pass-through input cost changes to the customer. Earnings have been extremely stable for the business, ranging from 11%-12% EBITDA margin historically before falling to 10% in 2013. On a per ton basis the company has expanded its margin from €88/t to €120/t from 2009-2012 on back of: i) increasing chemicals prices (chemicals prices are based off fuel oil prices as oil based production is most prevalent in the industry, whereas RÜTGERS is able to use coal tar derived hydrocarbons as its primary input), ii) higher primary distillation utilization rates through improved logistics and flexibility to shift volumes to higher production areas; and iii) higher chemical capacity utilization through outsourcing of raw materials.
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In terms of the businesses acquired, Rain does not actively manage operations and functions as a holding company. While Jagan Mohan Reddy has been in the calcining industry for nearly two decades, management teams of CII Carbon and RÜTGERS were retained to manage operations. On the company’s conference calls, all three operators are available to answer questions on their respective businesses. Historically Rain has not used stock -options or share-based compensation to incentivize management (limiting dilution and short-term focused decision making), but does have a cash bonus program.
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Aluminum and Energy Prices. The relationship between aluminum prices and oil prices is not an obvious one, however energy accounts for ~25% of aluminum generation cost and carbon for another ~15%. Both these inputs are impacted by natural resource prices ranging from natural gas and coal to CPC and pitch. The recent pullback in aluminum prices, which have fallen 25% over the last two years while energy costs have remained stable, has put significant margin pressure on smelters. Though aluminum prices are not central to the investment thesis, several factors provide comfort of limited downside from current levels: i) in China, the largest aluminum production globally, it is estimated that approximately 35% of smelters will end up losing money in 2013; ii) the resilience in production is explained by fixed overhead costs of ~US$200-250/ton to be incurred by smelters even if they were to temporarily shut-down their facility making operating at breakeven or small losses the more economical option; iii) there have been closures of approximately 1-1.5 mln ton capacity of high-cost smelters in China that were offset by new plants coming online in the Middle East.
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The Industrial Revolution began as the development of iron making and the use of refined coal triggered the invention of machine-based manufacturing of textiles ("Industrial Revolution," n.d.)....
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Rain reports its financial results under ‘Carbon’ segment (CPC and coal tar distilling excluding chemicals), Chemicals segment, and Cement segment, making it difficult to interpret the individual business unit performance within the carbon segment. However based on benchmark commodity prices and management comments, I believe it’s the CPC business that is suffering in 2013 (discussion below). Going forward monitoring the performance of the individual segments will become increasingly cumbersome as prior year comparisons will no longer be available.