Manjushree Technopak Management Q&A: Sep, 2010

Management Q&A

1. WE HAVE SPOKEN AFTER THE EXCELLENT 1ST QR RESULTS. CONGRATULATIONS, AGAIN!

How does it look from here? Have you added any new clients? Tupperware??

Thanks. Business outlook remains good. Tupperware is an existing client, it has been with us for over a year now. GSK consumer division is a significant new client we have added, for which we have set up additional dedicated capacity.

2. EXTENDED MONSOON HAS DAMPENED BEVERAGE SALES IN Q2 IN NORTH INDIA. THE 20-25% GROWTH FIGURES ARE DOWN TO SINGLE DIGITS, AS PER NEWS REPORTS.

How does Q2 look for Manjushree? Is it also badly affected?

Yes, North India sales is badly affected. But there has not been that much effect in the South. As you are aware, Q1& Q4 are Manjushree’s best quarters while Q2 and Q3 are slightly dull. To that extent sales will be lower in Q2. But nothing out of the ordinary has happened in Q2 for MAnjushree.

3. OF LATE MEDIA ACTIVITY HAS PICKED UP. SHRI VIMAL KEDIA HAS BEEN ON SEVERAL CHANNELS. THERE WAS A BUSINESS INDIA ARTICLE TOO. WE HAVE HEARD A FIGURE OF 200 CR FOR EXPANSION PROJECTS.

Seasoned investors are speculating that perhaps Manjushree will be looking to raise funds through the equity route, and is beefing up its profile in the media. Tell us more on the expansion plans. How will this be funded?

You know how Media exposure plays out. A set of good results, one channel interviews you, then others also get interested in the story. Nothing more than that, we certainly are not thinking of diluting equity in the near future.

The 200 Cr expansion figure is spread out over the next 3 years. One thing is certain, the industry we are in calls for continuous investments in capacity. you have to keep pace with your customers growth, if you cant business will go elsewhere. Rs. 60 Cr capital expenditure is planned for FY11, while Rs. 80 Cr is envisaged for FY12. Funding will be through debt and internal accruals. Our Balance sheet can be leveraged for that.

Of the Rs.60 Cr capital expenditure in FY11, half will go towards plant & machinery and the other half towards land & building.

4. AMCOR PLASTICS, THE GLOBAL RIGID PLASTICS PACKAGING MAJOR HAS SET UP MANUFACTURING IN PUNE. ALCAN, KLOCKNER, PENTAPLAST, CAN PACK, BOSCH PACKAGING ARE ALSO GETTING ACTIVE IN INDIA.

What is the level of competition activity? Isn’t Amcor Plastics, a big threat? Are the other players ramping up on capacity?

Amcor Plastics is one of 3 players in PET Preforms. But we have not seen them augmenting capacity in a big way. Perhaps Indian market is still not a focus area for the Australian major.

Among the domestic competition Futura and Sunrise, again we have not seen any significant augmentation in capacity. By the end of the year we will be far ahead of competition.

5. LETS SHIFT FOCUS TO MARGINS AND PROFITABILITY. OPERATING MARGINS HAVE JUMPED TO 19% (16% FY09).

Is this sustainable? What are the contributing factors? Is preforms jobworks going up the main reason?

What you are seeing here is simple economies of scale. With higher volumes, our fixed costs are getting spread over a larger base. Operating margins should be sustainable at these levels. Even without jobworks, we would have seen margins trending higher.

6. NET MARGINS HAVE NOT MOVED UP! 7.08% (7.09% FY09)

Depreciation costs have gone up to 7% (4.5% FY09) of Sales, and Interest costs have climbed to 2% (1% FY09). what is the picture likely for FY11?

We expect to record higher net margins for FY11 on the back of increasing Operating margins, which will be offset to an extent by the higher depreciation (increased capex) and interest cost ( increased debt).

7. WORKING CAPITAL HAS SEEN A BIG SURGE. WORKING CAPITAL/SALES IS AT 35% (21% FY09 AND ROUGHLY THE AVERAGE IN PREVIOUS YEARS)

Debtor days has gone up by 20% to 66 days (55 in FY09). Inventory Days is more or less at same levels at 64 days (67 in FY09). Payables days has shot up to 30 days (12 in FY09). Whats the likely trend in FY11?

Our debtor days are normally around that 2 months figure. Sometimes it may go up or down by 5 days. Inventory days will also be similar. 1 month Payables days is likely.

8. PREFORMS CAPACITY IS ROUGHLY 22000 MTPA. CONTAINERS CAPACITY IS 7000 MTPA.

You have announced capacity enhancement upto 36000 MTPA in FY11. How much will be Preforms and in Containers?

Preforms capacity will go up by ~5000 MTPA, and containers by ~2000 MTPA.

9. MOVING ON TO THE EXCELLENT QUARTERLY RESULTS. NET MARGINS AT 9.2%!!

While Depreciation and Finance costs have gone up, there is improvement in all other expense fronts/Sales – raw material, power & fuel, employee costs, other manufacturing sales & administration. Is this sustainable??

We touched on this before. We are reaping the benefits of economies of scale. yes we expect net margins to settle down at slightly higher levels than the past 2 years. We may see a drop of 500 basis points from Q2 levels, at 8.5% or so.

10. DIVIDEND PAYOUTS HAVE SLIPPED FROM 18% TO 13% IN FY10

Your dividend policy seems to be stuck at 10% of FV. One would expect dividends to keep some pace with the increase in earnings.

Well, at this stage of our growth, our business requires all the funds that we can plough back in the business. We believe our shareholders are reaping a greater return from the business results and stock performance. Having said that, yes we should see higher dividend payouts in future.


Disclosure(s)

Donald Francis: Less than 5% of Portfolio in the Company; Holding for more than 1 year;
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Mayur Uniquoters

Company Background

 

Mayur Uniquoters, a PU and PVC synthetic leather (artificial leather) manufacturer, was established in 1992 by S.K. Poddar, an industry veteran trader in PVC Leather line.

It has 3 manufacturing facilities at Jaipur with an installed capacity of about 1.2 million linear meters/month, from where the company manufactures a wide range of premium products for Footwear, Apparel, Luggage, Furniture, Leather Goods, Upholstery and Automotive Industries. 

Chemicals (~64%), Knitted Fabrics (~16%), Other fabrics (~14%), Release paper (~6% which is reusable) are the main raw materials. 

 

Mayur Uniquoters concentrates mainly on 3 segments. Footwear (55%), Auto (25%), Furnishing (10%). Others bring up the balance 10%. Exports (10% of Sales in FY2010) is spread among above segments. Automotive OEM exports have begun in FY11 to GM & Chrysler. Other international OEMs like BMW, Mercedes and Ford have put Mayur Uniquoters on the approved vendor list, and orders are awaited.

Major customers include Bata, Liberty and Action in Footwear and Maruti, Tata Motors, GM in Automotive segments. Recent breakthroughs include international OEM customers such as Chrysler & GM in US.


Growth Snapshot

We can’t just look at a series of past growth rates and assume that they will predict the future – if investing were that easy, money managers would be paid much less, and this stock analysis would be much shorter. It’s critical to investigate the Sources of a company’s growth.
Variable FY07 FY08 FY09 FY10 FY11
Sales Turnover (Rs. Cr.) 71.70 97.81 123.13 176.15 269.14
Sales Growth Year on Year 36.18 27.50 43.20 50.87
3yr Average Sales Growth 35.62 40.52
3yr Sales CAGR 31.76 35.12 46.99
5yr Average Sales growth 39.44
5yr Sales CAGR 39.17
Profit After Tax (PAT) (Rs. Cr.) 2.65 5.11 6.06 16.22 25.27
Adjusted EPS 4.90 9.45 11.20 29.98 46.71
EPS Growth Year on Year 92.83 18.59 167.66 55.80
3yr Average EPS growth 93.03 80.68
3yr EPS CAGR 51.22 78.16 104.20
5yr Average EPS growth 83.72
5yr EPS CAGR 75.73

 

Mayur Uniquoters has made steady progress over last 5 years. The company has roughly tripled its sales to reach Rs.176 cr in FY10 and EPS has gone up roughly 6x in the same period. Sales have grown at ~30 percent CAGR while EPS on an adjusted basis has grown at over 57 percent CAGR.

Sources of Growth

1. Mayur Uniquoters dominates the PU/PVC Synthetic Leather Market. The customer list straddles all the major footwear brands and major automotive OEMs in India, the main segments the company concentrates on. At 1.2 million meters/month they enjoy some economies of scale, as the nearest competitor has only about half the capacity.

2. Special products for Automotive OEMs in Europe and USA, which satisfies world class quality standards for synthetic leather. Investments in Analytical Labs (for raw material quality inspection) and special plant & machinery enabled them to develop the artificial leather for GM, Chrysler and Ford in USA and Mercedes Benz and BMW in Europe. As per the company, this type of material has been developed for the first time in India, and no other leather cloth company has been able to develop such products.

3. Large variety of products  – Mayur Uniquoters has developed nearly 400 different varieties of synthetic leather to offer for diverse requirements, while the nearest competitor can offer only about 50 varieties.

4. Three main segments contribute to the Sales mix. Footwear (55%), Auto (25%), Furnishing (10%). Others bring up the balance 10%. Exports (10% of Sales in FY2010) is spread among above segments. The company reportedly supplies 75% of Bata India’s requirements. 


Profitability Snapshot

Profitability is the second, and in many ways, the most crucial, part of our Analysis framework. How much profit is the company generating relative to the amount of money invested in the business – the returns? This is the real key to separating a great company from average ones -the higher that return, the more attractive that business. Net profit Margins and comparing cash flow from operations to reported earnings per share are good ways to get a rough idea of the company’s profitability (because cash flow from Operations represents real profits!). But neither account for the amount of capital that’s tied up in the business, and that’s something we cant ignore. We need to know how much economic profit the company is able to generate per dollar/rupee of capital employed because it will have more excess profits to re-invest which will give it an advantage over less-efficient competitors.
Variable FY07 FY08 FY09 FY10 FY11
Operating Profit Margin 9.51 11.18 10.39 16.13 16.05
Net Profit Margin 4.00 5.66 5.27 9.85 10.17
Fixed Asset Turnover 4.16 4.23 5.08 7.12 7.94
Asset Turnover 2.19 2.72 3.13 3.55 3.61
Return on Assets 8.75 15.40 16.46 34.91 36.73
Financial Leverage 1.56 1.37 1.27 1.10 1.13
Return on Equity 13.61 21.12 20.93 38.57 41.42
Return on Capital Employed 17.01 27.64 29.20 57.21 57.20
Debtor Days 92.60 82.52 68.41 56.79 46.39
Inventory Days 61.07 36.20 28.77 28.71 27.86
Cash from Operating Activities (Rs. Cr.)
Operating Cash Flow to Sales
Capital Expenditure 6.11 3.25 2.50 13.93
Free Cash Flow
Free Cash Flow to Sales
Equity Dividend (Rs. Cr.) 0.75 1.00 1.91 2.71 5.42
Dividend per share 1.50 1.92 3.53 5.01 10.02
Adjusted DPS 1.39 1.85 3.53 5.01 10.02
Dividend Growth Year on Year 33.33 91.00 41.88 100.00
3yr DPS CAGR 59.58 64.62 68.45
5yr DPS CAGR 63.96
Dividend Payout 28.30 19.57 31.52 16.71 21.45

This is as pretty a picture as you can find – with a caveat. This achievement is on a very small base, and typical risks associated with small companies of this size, apply. Please see Bearish Viewpoints in our stock story section, for the overall picture.

On the margins front, Operating Profit Margin (OPM) has remained between 10-11% for the most part, in the last 5 years. Only in FY10, operating margins have seen a big jump to over 16%. This is on the back of a ~1% drop in raw material prices, and a big 3% drop in Selling, General & Administrative (SG&A) costs, and other efficiencies achieved on power & fuel costs (as a percentage of Sales, see Common size P&L statement below) in FY10.

The Net Profit Margin (NPM) record is far better, showing a somewhat steadier climb form 4.5% to ~10% in FY10. this is on the back of a steadily reducing interest burden and debtors and inventory levels. Its great to see debtor days consistently coming down from ~96 days in FY06 to ~56 days in FY10. Similarly Inventory days have halved from ~57 days in FY05 to ~28 days in FY10. This is a great record in working capital management for a company as small as Mayur Uniquoters and speaks a lot about the Management focus on operational efficiency.

It is also great to see a steady rise in Asset Turnover – rising from ~2x in FY06 to over 3.55 in FY10. Few manufacturing companies manage such a steady rise – tells me that capacity expansions have been judiciously planned and executed, in tune with rising demand. This coupled with the rising net profit margins have ensured that Return on Assets (RoA) climbed from ~9% in FY06 to over 16% in FY09. In FY10 RoA climbed to ~35% on the back of doubling of net profit margins. We can think of ROA as a measure of efficiency. Companies with high ROAs are better at translating Assets into Profits.

The rising net profit margins and asset turnover (with a gradually declining Financial Leverage) has ensured Return on Equity (RoE) has climbed from ~14% to over 20% till FY09. In FY10 RoE has jumped to ~39% on the back of almost doubling of net profit margins. RoE is a good measure of overall profitability as it measures the efficiency with which a company uses shareholders’ equity. We can think of it as measuring profits per rupee of shareholders’ capital. The Return on Capital employed record is similar going up from 18% in FY06 to ~29% in FY09, before jumping to over 57% in FY10.

The company has an even better track record in steadily increasing Operating Cash flows. Operating Cash flow/Sales more than tripled from ~4% in FY06 to over 13% in FY10. The Free Cash Flow (FCF) record is even better recording almost a 6x increase from ~2% in FY06 to ~12% in FY10. Free Cash flow at over 10% of Sales for a manufacturing company that has grown sales at a ~30% 5yr CAGR is a very rare achievement. It needs to be noted that Capital Expenditure (Capex) of some 15 Cr is slated for FY11 on a backward integration project. Further Capex of another 8-10 Cr will be needed for capacity expansions, sooner than later. If these are not exceeded, the Cash on balance sheet and the healthy cash flows are perhaps adequate to fund the upcoming capex requirements.

And when we find a company with a high RoE and high FCF combination, it is said to be in a sweet spot, and reason to track this company as a potentially excellent business to invest in, but at the right valuation.

Also one must not forget the consistent dividend payment track record. Dividend payments have been steadily rising to register a 5yr DPS CAGR of over 52%. Again a good record for a company of Mayur Uniquoters size.

For Mayur Uniquoters FY10 has been a year of stupendous achievement. We may argue that till FY09 the performance was not exemplary and one may not have taken much notice, it is only FY10 performance that has made us sit up – Will the high OPM & NPM margins be sustainable? The odds are on, to that settling down at slightly lower levels, perhaps.

An objective look back at this profitability analysis tells us that softening raw material prices played only a small part, and it is the operational efficiency improvements on most fronts that has propelled the company to greater heights.


Common size P&L Statement

Can we dig deeper to see what else we can understand about how this company makes money? A good way is to look at the common size profit and loss statement. Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of Sales.
Variable FY07 FY08 FY09 FY10 FY11
Common Size Sales 100.00 100.00 100.00 100.00 100.00
Common Size Raw Material 78.84 77.63 74.15 72.96 74.13
Common Size Power & Fuel 1.24 1.10 1.14 0.93 0.65
Common Size Employee Cost 4.11 3.44 3.37 3.11 2.50
Common Size COGS 81.90 80.46 77.09 75.85 76.68
Gross Profit Margin 18.10 19.54 22.91 24.15 23.32
Common Size Depreciation 2.29 1.54 1.38 1.32 1.08
Common Size Interest Cost 1.81 1.30 1.13 0.81 0.75
Common Size SG&A 10.32 8.66 11.17 8.41 7.81
Operating Profit Margin 9.51 11.18 10.39 16.13 16.05

This section has got covered mostly in the profitability analysis, as we looked for reasons behind the good performance.

Raw material prices seem to have softened over the last 4 years, when seen as a percentage of Sales. Power and Fuel costs have also come down. As per the Annual Report FY10, online embossing process improvement led to reducing 1 complete process in the chain with significant power savings. Employee productivity seems to be improving over the years as employee costs as a percentage of Sales has been gradually coming down. Selling, General & Administration expenses have also come down as a percentage of Sales.

This common size P&L statement points to a company getting more efficient over the years. We have also seen earlier in the profitability analysis consistent improvement in working capital management as the company has steadily brought down debtor days and inventory days.

is Mayur Uniquoters becoming a more efficient company, as it is growing? The track record of last 5 years certainly points to a strong management focused on improving operational efficiencies.


Financial Health Snapshot

Once we have figured out how fast (and why) a company has grown and how profitable it is, we need to look at its financial health. Even the most beautiful home needs a solid foundation, after all.
Variable FY07 FY08 FY09 FY10 FY11
Financial Leverage 1.56 1.37 1.27 1.10 1.13
Debt to Assets 0.36 0.27 0.21 0.09 0.11
Debt to Equity 0.56 0.37 0.27 0.10 0.13
Interest Coverage 4.29 7.84 8.27 19.84 21.16
Interest Cost to Total Debt 11.10 13.03 16.56 30.39 23.91
Current Ratio 1.88 1.56 1.66 1.82 1.99
Quick Ratio 1.32 1.24 1.34 1.52 1.60
Cash to Assets 3.76 13.29 15.65 42.14 33.19

Mayur Uniquoters Financial Heath track record is the best testimony perhaps, for the company.

Any which way you look at it, this is a great record. Debt to Equity has steadily been decreasing over the years. From 0.64x in FY06 it is practically debt free in FY10 at 0.10x. Financial Leverage and Debt to Assets mirror the same trends. Interest Coverage has been steadily rising over the years from 4x in FY06 to ~20x in FY10, and thus its unlikely that it will run into difficulty in meeting debt liabilities if earnings should fall unexpectedly.

Liquidity measures like Current ratio and Quick ratio are comfortable, showing that the company is able to source enough cash to meet near-term liabilities. Cash to Assets has steadily risen over the years and is at a very high 42% of Assets. The company plans to utilise the cash for the announced backward integration plans of setting up a knitting fabric plant (a key raw material) in FY11. 

The only blip that shows up is a high Finance cost to Total debt of over 30% in FY10. This is a sudden rise on account of high bank charges (~35 lakhs) and other finance charges (36 lakhs) adding to the ~60 lakhs interest cost. It is possible that the Total debt was reduced (4.41 Cr in FY10 from 7.85 Cr in FY09) at the fag end of the year, leading to the higher charges. 

Overall the picture that emerges is, Mayur Uniquoters has a strong clean balance sheet and is in a very comfortable situation, on the financial front. Again the record speaks highly of Management excellence.

Vinati Organics

Company Background

Vinati Organics Limited was promoted by first generation entrepreneur Vinod Saraf in 1989 to manufacture specialty organic chemicals. Vinati is a niche player but has already achieved global recognition and size.

  • Iso Butyl Benzene (IBB) – the primary raw material for the popular painkiller Ibuprofen. It is the largest manufacturer with a 14,000 TPA manufacturing facility and has ~ 60% global market share
  • ATBS (2-Acrylamido 2-methylpropaneargest manufasulfonic Acid) – It is the 2nd largest manufacturer with a 12,000 TPA capacity and a 25% global market share. Vinati has broken into the exclusive club of ATBS manufacturers. There are only three other manufacturers of ATBS globally viz. Lubrizol (USA) ~14000 TPA, Toagosei (Japan) ~8000 TPA and a Chinese company with small capacity of ~2000 TPA.

Domestic market for its products is small, the Company exports bulk of its products to USA, Europe, Australia, Middle East and China. Export contribution in FY 2010 is ~75%. In FY 2010 IBB contributed 54%, ATBS contributed 44% while Others contribute 2% of the Sales mix. Contribution from ATBS has been steadily growing over the years and in 1Q FY 2011 ATBS has already overtaken IBB, contributing ~57% to the Sales mix.

Main customer segments:

  • IBB – is the primary raw material for the popular painkiller Ibuprofen – supplied directly to Ibuprofen manufacturers like BASF (largest Ibuprofen manufacturer), Shashun Chemicals, Biocause (China) the other large scale Ibuprofen manufacturers.
  • ATBS, Na-ATBS and other derivatives that the Company makes are specialty monomers having wide applications mainly in acrylic fibre manufacturing, adhesives, and personal care products. These are supplied to polymer manufacturers who then sell the polymers to users through their distribution channels. Direct sales of ATBS are only to acrylic fiber industry.
  • Some of the key clients are BASF, AkzoNobel, Ciba, Perrigo, Rohm & Haas, Clariant, NALCO, Shasun Chemicals

As per the company, New Applications like Enhanced Oil Recovery & Water Treatment hold substantial potential for growth of ATBS and global demand is expected to go up 2-3 fold.


Growth Snapshot

We can’t just look at a series of past growth rates and assume that they will predict the future – if investing were that easy, money managers would be paid much less, and this stock analysis would be much shorter. It’s critical to investigate the Sources of a company’s growth.
Variable FY06 FY07 FY08 FY09 FY10
Sales Turnover (Rs. Cr.) 65.20 90.46 161.36 203.47 238.44
Sales Growth Year on Year 43.07 78.34 30.19 21.65
3yr Average Sales Growth 50.53 43.39
3yr Sales CAGR 59.73 52.37 25.85
5yr Average Sales growth 43.31
5yr Sales CAGR 41.78
Profit After Tax (PAT) (Rs. Cr.) 1.95 3.51 15.20 25.13 40.04
Adjusted EPS 0.40 0.71 3.08 5.09 8.11
EPS Growth Year on Year 80.00 333.05 65.33 59.33
3yr Average EPS growth 159.46 152.57
3yr EPS CAGR 179.19 167.57 62.30
5yr Average EPS growth 134.43
5yr EPS CAGR 112.87

Vinati Organics has made rapid progress over the last 5 years. The 5yr CAGR growth record is impressive- Sales have grown at over 40% annually, while EPS has grown at an astonishing 112%. What is behind this impressive growth?

Sources of Growth

Vinati Organic’s story has been primarily an export-led growth with strategic capacity build-up in carefully chosen product niches. Capacity so far has been expanded judiciously in tandem with market success and demand growth.

  • IBB was the key growth driver initially – may be muted from here on

In FY06 Vinati’s IBB capacity was 10,000 TPA which was increased to 14000 TPA by FY08. In FY07 it had signed up a long term 5yr deal (till 2011) with BASF that required BASF (the largest Ibuprofen manufacturer) to source majority of its IBB requirements from Vinati. As per the company monthly selling price of IBB is adjusted based on monthly world prices of key raw materials and USD/INR exchange rate, thus minimizing the Company’s risk exposure. By FY2008, Vinati was manufacturing 60% of the global IBB requirements. IBB is a mature product and worldwide growth is now projected at 3-5%. Since FY08, there has been no expansion in IBB capacity.

  • Growth kicker from ATBS

Vinati is one among 3 players worldwide to have access to ATBS manufacturing technology (protected by patents) and it is the 2nd largest manufacturer with 12000 TPA capacity. ATBS capacity in FY06 was 3000 TPA, which was expanded to 5000 TPA in FY08 and further enhanced to 10000 TPA by FY09. Current expansion announced to 18000 TPA, to be completed by May 2011, will make it the largest manufacturer in the world. ATBS capacity had trebled in last 5 yrs, and by FY12 slated to go up 6x in seven years! As per the company ATBS contracts have a quarterly pass-on of key raw material and USD/INR exchange rate exposure. Currently ATBS contributes 57% to the Sales mix.

  • Backward Integration/by-products/power co-generation

In FY10, Vinati has also completed a backward integration project for one key ingredient of ATBS, Isobutylene (IB) with a installed capacity of 12000 MT. This project was completed in June 2010 and will start contributing to the bottomline in FY11 as this finds captive use and import replacement demand in IB domestic market . Keeping in mind the increased energy consumption arising because of new facilities and expanded capacities, Vinati decided to setup a captive 6MW co-generation plant. The 6MW co-generation plant (coal based) is expected to be operational by end of FY11. Besides, a Diacetone Acrylamide (DAAM) plant of 1,000 MT capacity is being commissioned and a lot of capacity expansions are on the anvil: expanding the capacity of ATBS plant from 10,000 MT to 18,000 MT; of TBA plant from 300 MT to 900 MT; of ATFE capacity from 1,000 MT to 3,500 MT. Majority of the expansion program is to be completed by FY11 and would require an approximate capex of Rs. 120 Cr, as announced by the company.

  • Frenetic pace of expansion – cause for some concern

Annual Report FY2010 had announced a capital expenditure outlay of 77 Cr. But this has been been enhanced now to 120 Cr, as announced earlier and re-iterated in this August 2010 Analyst Meet . This will be funded through a mix of debt and internal accruals as announced by the company. Admittedly as per this conference call, the company is already operating at 90-95% ATBS capacity, but the frenetic pace of expansion carries significant execution and market risks. Company’s current debt burden is ~60 Crs. If these plans have to be funded, the company may have to take on sizeable debt exposure as cash flow accruals are around ~30 Crs. Debt/Equity levels may climb higher to 1.5 or so.


Profitability Snapshot

Profitability is the second, and in many ways, the most crucial, part of our Analysis framework. How much profit is the company generating relative to the amount of money invested in the business – the returns? This is the real key to separating a great company from average ones -the higher that return, the more attractive that business. Net profit Margins and comparing cash flow from operations to reported earnings per share are good ways to get a rough idea of the company’s profitability (because cash flow from Operations represents real profits!). But neither account for the amount of capital that’s tied up in the business, and that’s something we cant ignore. We need to know how much economic profit the company is able to generate per dollar/rupee of capital employed because it will have more excess profits to re-invest which will give it an advantage over less-efficient competitors.
Variable FY06 FY07 FY08 FY09 FY10
Operating Profit Margin 10.11 10.14 17.30 17.38 22.74
Net Profit Margin 3.40 4.28 10.39 13.19 17.28
Fixed Asset Turnover 1.56 2.28 3.58 4.26 2.91
Asset Turnover 1.15 1.48 1.90 1.64 1.43
Return on Assets 3.91 6.31 19.75 21.69 24.67
Financial Leverage 1.82 1.86 1.80 1.79 1.64
Return on Equity 7.14 11.74 35.63 38.72 40.37
Return on Capital Employed 8.43 13.49 34.32 30.36 34.63
Debtor Days 84.39 87.64 55.05 53.50 56.49
Inventory Days 68.39 48.95 42.00 32.87 43.37
Cash from Operating Activities (Rs. Cr.)
Operating Cash Flow to Sales
Capital Expenditure 3.25 17.07 39.61 34.80
Free Cash Flow
Free Cash Flow to Sales
Equity Dividend (Rs. Cr.) 0.66 0.79 1.97 2.47 4.94
Dividend per share 0.20 0.24 0.40 0.50 1.00
Adjusted DPS 0.13 0.16 0.40 0.50 1.00
Dividend Growth Year on Year 19.70 149.37 25.38 100.00
3yr DPS CAGR 72.77 76.82 58.35
5yr DPS CAGR 65.40
Dividend Payout 33.85 22.51 12.96 9.83 12.34

 

Vinati Organics 5yr profitabilty snapshot looks impressive. However, this achievement is on a very small base, and typical risks associated with small companies of this size, apply. Please see Bearish Viewpoints in our stock story section, for the overall picture.

On the margins front, Operating Profit Margin (OPM) has steadily improved year on year to reach ~23% in FY10 from just about 10% in FY06. In FY10, operating margins have seen a big jump by over 5%. This is on the back of an unusually good year for IBB (20-25% margins). This will probably be hard to sustain in FY11 as IBB margins (usually 15-20%) have started to get hit because of increased supply from new competitors like IOL with a 6000 TPA IBB capacity. The falling margins may be compensated by somewhat higher margins (usually 20-25%) enjoyed by ATBS, its increasing contribution to sales mix, and the backward integration benefits from IB.

The Net Profit Margin (NPM) record is better, showing a steady climb form 3.4% to over 17% in FY10. This is on the back of a steadily reducing interest burden and debtors and inventory levels. Its great to see debtor days coming down from ~84 days in FY06 to ~56 days in FY10. Similarly Inventory days have come down from ~68 days in FY06 to ~43 days in FY10. This is good working capital management and confirms the Management focus on operational efficiency. Net margins may lower a bit from current levels in FY11 due to higher depreciation and interest costs incurred in the year consequent with the pressure on Operating margins.

Although Asset Turnover has declined gradually over the last 3 years due to rapid capacity expansions, the rising net profit margins have ensured that Return on Assets (RoA) climbed from ~4% in FY06 to over 24% in FY10. We can think of ROA as a measure of efficiency. Companies with high ROAs are better at translating Assets into Profits.

The rising net profit margins and asset turnover (with a gradually declining Financial Leverage) has ensured Return on Equity (RoE) has climbed from ~7% to over 40% by FY10. RoE is a good measure of overall profitability as it measures the efficiency with which a company uses shareholders’ equity. We can think of it as measuring profits per rupee of shareholders’ capital. The Return on Capital employed record is similar going up from 8% in FY06 to over 34% in FY10.

Although cash flows has improved substantially from FY06 levels, the company does not have a good a record on Operating Cash flows which has mostly lagged behind Net profits, even if increasing over the years. The company is also far from recording any Free Cash Flow (FCF) as business growth has necessitated continuous capacity expansion. It needs to be noted that Capital Expenditure (Capex) of some 120 Cr is slated for FY11 on several expansion projects. This is roughly 3x the capital expenditure incurred in earlier years, and carries execution risks and much higher debt exposure.

Dividend payments have been steadily rising to register a 5yr DPS CAGR of over 65%. Vinati Organics is a good dividend payer with a consistent track record – infact dividend per share doubled in FY10 over FY09.


Common size P&L Statement

Can we dig deeper to see what else we can understand about how this company makes money? A good way is to look at the common size profit and loss statement. Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of Sales.
Variable FY06 FY07 FY08 FY09 FY10
Common Size Sales 100.00 100.00 100.00 100.00 100.00
Common Size Raw Material 66.40 66.58 65.76 63.70 59.52
Common Size Power & Fuel 3.33 3.91 3.68 3.99 5.18
Common Size Employee Cost 7.22 6.17 4.24 4.64 4.96
Common Size COGS 73.43 74.61 71.97 70.29 68.60
Gross Profit Margin 26.57 25.39 28.03 29.71 31.40
Common Size Depreciation 4.15 3.30 2.00 1.71 2.13
Common Size Interest Cost 2.16 2.40 2.23 1.73 1.91
Common Size SG&A 13.51 14.61 12.01 12.04 10.87
Operating Profit Margin 10.11 10.14 17.30 17.38 22.74

Raw material as a percentage of Sales has been coming down over the years with good reductions in FY09 & FY10 which has helped boost Operating Margins. The company claims its long term contracts terms allow it to pass on raw material price escalations to the customers after a time lag. For IBB it can resort to monthly price revisions, whereas for ATBS it can pass on revisions after a quarter.

Power and fuel costs had ranged from 3-4%, but has risen sharply in FY10 to over 5%. The company seems to be seized of this as it has announced plans to set up a 6MW co-generation plant. Interest and Depreciation costs played within a 2% range for last 3 years or so. This is due to see a jump up in FY11.

Selling & General Administration overhead costs have seen a gradual declining trend from ~14% to about 11% in FY10. This is a good trend as the company is able to probably leverage its existing customer relationships and has better visibility in its market.

The increased depreciation & interest costs in FY11 may be a bit of a dampner to the overall picture. However the record points to a focused management that seems to be knowing & running its business well. It has made significant improvements in managing overhead costs. The raw material price revision clauses protect it from big surprises and it has initiated steps to bring power & fuel costs back in line.


Financial Health Snapshot

Once we have figured out how fast (and why) a company has grown and how profitable it is, we need to look at its financial health. Even the most beautiful home needs a solid foundation, after all.
Variable FY06 FY07 FY08 FY09 FY10
Financial Leverage 1.82 1.86 1.80 1.79 1.64
Debt to Assets 0.45 0.46 0.45 0.44 0.39
Debt to Equity 0.82 0.86 0.80 0.79 0.64
Interest Coverage 3.39 3.81 8.10 10.69 12.72
Interest Cost to Total Debt 5.51 7.67 9.51 6.46 7.00
Current Ratio 2.12 2.26 2.54 2.79 3.60
Quick Ratio 1.47 1.72 1.87 2.11 2.59
Cash to Assets 2.77 1.58 1.78 1.63 1.10

 

Vinati Organics financial health over the last 5 years presents a decent picture.

Debt to Equity has been decreasing gradually over the years from 0.82x in FY06 to 0.64x in FY10. Financial Leverage and Debt to Assets mirror the same trends. Interest Coverage has been steadily rising over the years from ~3x in FY06 to ~12x in FY10, and thus its unlikely that it will run into difficulty in meeting debt liabilities if earnings should fall unexpectedly.

Liquidity measures like Current ratio and Quick ratio are comfortable, showing that the company is able to source enough cash to meet near-term liabilities. Cash to Assets position has however been declining and is pretty thin at ~1% of assets in FY10.

Overall it emerges that Vinati Organics has a decent balance sheet and is in a comfortable situation, on the financial front. It should be able to leverage its balance sheet to part finance its aggressive capital expenditure plans in FY11. This is the first time in last 6 years that Debt to Equity may shoot up over 1x and may touch ~1.5x. How well it executes its plans and its ability to manage the higher debt-exposure, remains to be seen.