Poly Medicure Management Q&A: July 2011

Management Q&A

1. POLY MEDICURE HAS HAD A NICE RUN OVER THE LAST DECADE. SALES AND PROFITS HAVE GROWN AT OVER 25% CAGR. THAT’S A DECENT ACHIEVEMENT. CONGRATULATIONS!

What are the future plans? Where does the company see itself in the next few years? We have recently heard the company talking of a 300-400 Cr turnover goal – by 2013. That’s like a 30-50% plus CAGR for next 2 years. Kindly explain the reasons behind this optimism/aggression.

We have been able to grow at a 25% CAGR over the long term as noted by you. We have had a few significant successes in the last year – getting USFDA approval for our Faridabad facility, introducing Safety IV Cannulae product- these developments are likely to help us leverage new contracts and increase order flows. We should be able to register a 30% CAGR comfortably for next 2 years.

2.     SAFETY DEVICES MARKET IS REPUTED TO BE A $1BN CURRENT MARKET. A 5% MARKET SHARE IS WHAT IS BEING AIMED AT BY POLY MEDICURE IN THE NEXT 2-3 YEARS, OR $50MN FROM SAFETY DEVICES ALONE.

You have successfully defended patent infringement suits by B. Braun (Safety IV Cannulae products) in the recent past –both in Indian & German courts. What is the current status? Does this make Poly Medicure only the second player in the world after Braun to manufacture this product for developed markets? How many players and how is the competition in this segment. How has the company seized the opportunity in Safety IV Cannulae devices? Any major wins in outsourced contracts?

Yes we were successful in defending the patent infringement suits by B. Braun. So far there has been no further developments, and we have been shipping this product as planned. Globally there are 5-6 players. B. Braun is the market leader and holds 50-60% market share.
We are ramping up production capacities and will be able to start shipping this product in bulk by Q3/Q4 FY12.

3.     USFDA APPROVAL RECEIVED FOR FARIDABAD PLANT IN DEC 2010

Kindly explain the significance of this development for Poly Medicure’s plans for the developed markets. How has the company benefited from this in FY11? Will FY12 see the company extracting the most of this opportunity.

As you are aware USFDA approval was received in Dec 2010. This is a significant development coupled with our Safety IV Cannulae product development. In the US Market, safety feature is a must. We have started exports to US in small numbers in FY12, the full benefit of this will be available to us in FY13.
For the US market we are introducing a number of safety products including Safety IV Cannulae, Safety Catheters, Safety Blood Collection Holders, among others.

4.     PRODUCT SEGMENTS. SAFETY DEVICES, BLOOD BAGS, OTHERS

Kindly give us an idea of the revenue contribution & margins from major product segments. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why?

IV Cannulae contributes ~45% of Sales today. IV Sets, Blood Bags, Catheters, Blood Transfusion Sets contribute another 20-25% Sales. Balance 30% comes from a variety of other small products. Margin contributions vary in the range of 18-25%.
All segments are growing strongly. Safety devices should see a spurt in the next 2 years as contribution from this segment is expected to go up from 7-8% to 15%.

5.     BLOOD BAGS SEGMENT.

Recently we saw an announcement by the company on a contract for supply of single Blood Bags for total consideration of INR 12.93 Cr from Ministry of Health & Family Welfare. Please share the significance of this order, does it open up this segment for major growth for Poly Medicure?

Blood Bags segment has been a steady growing segment for us in the last few years. Yes this is a major order from National Aids Control organisation (NACO), and the single largest order so far in this segment. Sales for this segment so driven by Govt. Tender supplies or to Hospitals which is License based.

6.     CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

Who are your top Customers? How much do your top 5 customers contribute in revenues? Does any customer contribute more than 10% of Sales?

International OEMs are some of the top customers. Top 5 customers contribute 30-35% of our Revenues. Sales are evenly distributed and no single customer accounts for more than 10% of Sales.

7.     EXPORT MARKETS. SALES & MARKETING. OUTSOURCED MANUFACTURING FOR OEMS.

Exports contributed some 58% of Sales in FY10. Kindly explain your sales & marketing set-up for developed markets. What contribution is expected from outsourced manufacturing contracts? Are margin contributions likely to be much higher in outsourced contracts for Safety IV Cannualae. What is the split between Europe and US markets currently, and what is the picture for next 2-3 years?

In most countries medical kits supplies are a Tender driven business. In overseas markets we go through distributors. 50% of the supplies are for OEMs and 50% under Poly Medicure brand. There isn’t much difference in margins.
Europe accounts for ~45% of exports. US market supplies have started in a small way which should go up significantly in the next 2 years.

How about the domestic market? Is your sales process any different here?

As mentioned before, this is mostly a Tender driven business in India. Roughly 60% of our domestic sales comes from Tenders, which is addressed by our direct sales force. The sales force also addresses major hospitals in Metros. About 15% of additional sales come from Direct Sales and the rest comes through distributors.

8.     PRODUCT PRICING. SAFETY IV CANNULAE

Kindly give us a sense of product pricing on IV Cannulae vs Safety IV Cannulae and the margin contributions.

Well a IV Cannulae from Poly medicure typically sells for Rs 5 or 5.5 and a Safety IV Cannulae we can sell at Rs.17, though the addition raw material cost is hardly 50 paisa to a rupee. B. Braun sells the Safety IV Cannulae at Rs. 45-50. (They can provide finer guage of needles for kids & babies). Internationally too, the prices are in the same range.

9.     MARGINS & PROFITABILTY. SUSTAINABILITY

After a dismal FY08 and FY09, Poly Medicure registered an Operating margin of over 22% and Net Margin of over 12% in FY10. This was sustained, infact marginally improved in FY11. Return on Equity (28%) and Return on Capital Employed (25%) are back to robust levels for the last 2 years. How sustainable are these going forward? Are margins and profitability on an upward trend consider significance of new product segment and volumes coming from there?

Margins shopuld show an uptrend considering volume increases and other cost-cutting measures undertaken by us including waste recycling. 30% growth in earnings is a given.

10.  FOREX DERIVATIVES CONTRACTS – FY08 AND FY09 SAW THE COMPANY TAKING A HIT ON ACCOUNT OF DERIVATIVE CONTRACTS ENTERED INTO BY THE COMPANY TO HEDGE THE RISK OF CHANGES IN FOREIGN CURRENCY EXCHANGE RATE ON FUTURE EXPORT SALES AGAINST EXISTING LONG TERM CONTRACTS.

Outstanding as at March 31, 2010 for hedging currency related risk aggregate to Rs. 118.54 Cr (Previous year Rs. 197.73 Cr). What is the current position on this front? How much of a risk does this currently pose? When will these contracts finally be over?

There are 3 outstanding contracts, out of which one will expire in Sep 2012, and another 2 will restart from Oct 2012, but for only a year. We continue to hedge these using simple 1 year forwards. Having learnt our lessons, we monitor these movements very strictly. We don’t think there is any major risk from these.

11.  CAPITAL EXPENDITURE. TO GROW SALES, POLY MEDICURE NEEDS TO CONTINUALLY INVEST IN CAPACITY EXPANSION. WE HAVE HEARD OF INVESTMENTS OF RS.100 CRS IN CAPACITY EXPANSION.

What is the current capacity? How much was the capital expenditure incurred in FY11 and what is the expected ramp up in the next 2-3 years?

25 Cr has been invested in FY11 towards new building and machinery. Another 25-30 Cr is being invested in FY2012 towards increasing automation. Balance 40 Cr is looked to be invested in the Jaipur SEZ at an appropriate time.

12.  DEBT POSITION. FUNDING

FY11 debt stood at 40 Crs. What is the current debt position? How much additional debt is likely to be taken to fund current capacity expansions?

Debt levels including working capital will remain at similar levels in FY12.

13. EUROPE AS A MARKET. EURO AS A CURRENCY. RISKS

How much of company’s sales comes from Europe. And is this booked in Euros or US$? Given the serious economic environment in Europe currently and the attendant risks both on the market and the currency, what is the sense that you are getting from your customers, and what has been the impact, if any? What steps are being taken to mitigate these risks?

As mentioned before 45% of Exports are from Europe. Roughly 15% of such sales are booked in Euros, and the balance is all booked in US$.
Our existing customers in Europe are large players and we have a long relationship with them. We haven’t got any sense of slowdown in business from them, so far. Yes, Euro as a currency has been fluctuating a lot. We hedge our Euro Sales on simple 1 year forward contracts.
Any new players we are booking sales on 100% advance basis.

14.  MANUFACTURING FACILITIES BEYOND INDIA. THE COMPANY HAS BEEN TRYING TO SET UP A MANUFACTURING FACILITY IN SOUTH AMERICA FOR SOME TIME NOW. ANNOUNCEMENTS HAVE BEEN MADE A FEW TIMES, BUT NOTHING HAS FRUCTIFIED SO FAR.

Besides manufacturing facilities in India, you already have a manufacturing facility in Egypt and another in China. There seems to be a focus in the company for locating manufacturing close to important markets, but the contribution has been negligible so far? How has been the experience managing these facilities and what has been the progress? When will these contribute significantly to topline and bottomline?

The Egypt JV is a different type of project where we provide consultancy, machinery and some of our products on a 10% markup/commission basis. So that’s an entirely different project.
The Chinese facility is expected to break even in FY12. But more importantly it has been a great source of RM sourcing for us -from China, and neighbouring regions. The savings on the sourcing side has been ~20%.

Why is the South American presence so important? Is it for the Brazil market or catering to US market?

Well we have been looking to acquire a manufacturing facility in these markets. Brazil can be a very important market to gain access to. If we get some manufacturing facility in Europe at a reasonable price, we are open to that too.

15. OVERSEAS ACQUISITION.WE HAVE BEEN HEARING OF AN ACQUISITION IN TEH RANGE OF $20-30 MN FROM TIME TO TIME.

What is the focus here? Is it to acquire a manufacturing facility or a sales & marketing set-up in developed markets?

Nothing has materialised so far. We are keen on acquiring a manufacturing facility close to developed markets where we can draw synergies form our production facilities, at the same time get increased market access for our products.

16. COMPETITION. PLEASE TELL US MORE ON THE COMPETITION YOU FACE FROM BITH DOMESTIC AND MNC PLAYERS IN THIS MEDICAL KITS & ACCESSORIES BUSINESS.

Hindustan Syringes are the biggest players in our niche, but only 10% of our product lines co-incide, as they concentrate mostly on syringes, which we do not manufacture. Then there is Eastern Medikit who compete directly with us on the whole product range, but they have poor financials. Besides them there is the Romsons group which has 6 brothers operating different facilities. Effectively we are the 2nd largest player in this segment.

MNC presence is small. There is a MNC player Bechtel Dickinson who have set up an ultra-modern plant in Manesar, Haryana. The plant set-up cost is 3x ours of comparable capacity. They cannot compete head-on with us and restrict themselves to the high-value niche segment.

17. RAW MATERIALS. RISKS

Raw Material is ~40% of Sales. With a rising crude prices scenario, raw material prices must be a cause for strain. Kindly explain how the company manages raw material price volatility risks.

As you mentioned raw materials is some 40% of Sales, and so far we have been able to manage the volatility without significant impact.

18. TAX BENEFIT WITHDRAWALS. IMPACT ON MARGINS.

Effective tax rate for the company in FY10 and FY11 was under 10%. Now with the withdrawls in the benefits, what is the likely tax rate for FY12, and how significant will be the impact on net margins and growth? Any impact on Jaipur SEZ plans also because of the SEZ Tax exemptions being withdrawn too?

Yes, there will be significant impact on account of this. We are hopeful of minimising the impact through higher depreciation in our accounting and the margin expansion that is likley to accrue form the new products.

19. SHAREHOLDING PATTERN

Company has 48% in promoter holdings and then about 37% by persons holding more than 1% (few bodies have been holding since several years). Please throw some light on the shareholding pattern. Are some of these parties part of promoter group?

Most of these are people known to the Promoter group – not part of the promoter group. These people are long term shareholders. When our share price was in the RS 10-15 range, they have not exited and now that they know the company is on an inflection point, they are unlikely to exit their holdings.

20.  MAJOR OPPORTUNITIES & CHALLENGES

Where does Poly Medicure see itself in the next 5 years? What is the size of the opportunity in its niche? Can we see Poly Medicure reach 1000 Cr Sales, by when? What are the major challenges before the company and where are the big opportunities?

Well we are on course to register a 25%-30% growth for the next few years. The significant developments in FY11 should see us win major contracts from OEM suppliers and increase our presence in developed markets like the US. So this growth itself should take us to 600 Cr in the next 5 years. Any Acquisition that we do is likely to add to that and help us in reaching the Rs 1000 Cr mark.
The main challenges are in scaling up to meet the growth in demand. Funding is not an issue, but Labour orientation and skills training is a major challenge. We are also trying to increase automation in our factories to help on this front.

Disclosure(s)

Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 2 years;
Donald Francis: No Holdings in the Company; ;
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Mayur Uniquoters

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 1.4 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.


Main Products/Segments

Mayur concentrates mainly on 3 segments. Footwear (55%), Auto (25%), Furnishing (10%). Others bring up the balance 10%.

Exports (~20% of Sales in FY2011) is spread among above segments.


Main Markets/Customers

Automotive OEM exports have begun in FY11 to Chrysler and Ford. Other international OEMs like GM, BMW, Toyota, and Mercedes have put Mayur Uniquoters on the approved vendor list, and orders are awaited.

Major customers in India include Bata, Liberty and Action in Footwear and Maruti, Tata Motors, GM in Automotive segments.

Opportunity size

Synthetic Leather production in India is estimated at ~2000 Cr annually. Add to this another 700 Cr Chinese Imports coming into India annually (which has been coming down in share over the years). Unorganised sector accounts for roughly 50% of the market.  And balance 50% is catered to by some 15 players in the organized sector. Of these 5-6 are bigger players, the rest are much smaller players. On the Auto OEM exports front, each of the 6-7 big OEMs like GM, Ford, Toyota, Daimler, BMW, Chrysler have synthetic leather buys in excess of 500-600 Cr each year for developed markets like Europe and US, that adds another 3000-4000 Cr annual market. [Source: Company]

As per the company, Mayur Uniquoters has an annual market size of 4000-5000 Cr opportunity before it.

Competition

Competition in domestic market comes from Jasch Industries, Fenoplast, Royal Vinyl Cushions and Polynova. Mayur caters only to the organised players in the market and is thus less vulnerable to competitive pressures from unorganised sector and cheap Chinese imports.

It faces strong competition in International Auto OEM markets, where it aims to scale up significantly in the next 2-3 years. Mayur Uniquoters has unfurled a new Vision statement in 2011.

” To be a preferred supplier of Artificial Leather to the leading Automotive OEMs in the world “


Bullish Viewpoints

  • High Profitability and Returns – This is a rare small company consistently growing Free Cash Flow/Sales (FY10 FCF/Sales 11.59%). And then you couple this with a consistently increasing RoE and RoCE (FY10 RoE ~38%, RoCE ~57%). A company with a high RoE and high Free Cash Flow combination is said to be in a sweet spot. While high RoE tells us its a company that can earn a high return on its shareholders money, high Free Cash Flow enables us to separate it out as a business that is a net producer of Capital – from a business that is a net user of Capital – one that spends more than it brings in. This Profitability analysis throws more light on how this company is showing consistently good all round improvement.
  • Big Opportunity size – A 4000-5000 Cr annual market size is the scale of the opportunity before Mayur Uniquoters. Given its Profitability, strong Balance Sheet, Free Cash Flows and dominant competitive position, Mayur Uniquoters is in a strong position to scale up and address the Opportunities before it.
  • Focus on Margins – Mayur Uniquoters operates in a very competitive market but has consciously chosen to concentrate on segments that need to be more quality conscious such as Footwear, Automotive (upholstery), and Furnishings, ensuring better margins for the company. They have been slowly trying to exit low-margin segments/customers and even whole markets (UAE, e.g.). Economics of scale have kicked in with fixed costs getting spread over increasing volumes. Also product mix has been changing for the better with higher value added products leading to better realisations.
  • Automotive OEM exports driver for quality growth – As per the company the margins are  2-3x in OEM exports. It is steadily becoming a focus area for the company in its bid to improve margins. They are targeting the US market, and specifically Germany in Europe. Since FY11 start when they made a breakthrough in Chrysler & Ford, Exports have now grown to 48 Cr, or almost 3x in a single year.  As per the company, US alone has a demand for 2.5 million meters/month. The company has guided for a 55% growth in Exports for FY12 on the back of new capacity coming on-stream slowly.
  • Backward Integration – Knitted fabrics constitute ~16% of raw materials – an ingredient where consistency in quality is key to finished product quality. In order to retain a degree of control over consistency in meeting export quality requirements, the company is planning on investing Rs. 15-18 Cr in a knitting facility that will produce 800K meters/month.
  • Capacity expansion – 35,000 sq.mt land has been acquired. Land Conversion is completed and environmental clearances have been received. The knitting facility will be started here. New capacities are being added ~0.5 million linear meters/month at existing facilities, taking total capacity upto ~1.9 million linear meters/month by Q2FY12
  • Automotive Replacement market is promising – According to the company during last automotive crisis, it got good business from the replacement market which helped it avert any significant impact of auto sector cyclicality.  With so many vehicles coming out every year and the need to replace the upholstery once in ~3-4 years, the company is of the view that replacement market in India could surpass the OEM market within 2 to 3 years.
  • Good dividend paying track record – Mayur Uniquoters has been a consistent dividend payer. The dividends have also been steadily rising consistent with earnings growth. This Profitability Snapshotshows 5yr DPS CAGR at ~64% – big achievement for a small company.

Bearish Viewpoints

  • Hugely competitive and fragmented market – Lot of low-quality synthetic leather is being dumped into India by Chinese manufacturers. The synthetic leather industry has been following up with the government for levying anti-dumping duty.
  • Capacity expansion not keeping pace – The company is in the process of adding fresh capacities by installing another coating line by Q2 FY12 that will take capacities to 1.9 million linear meters/month (up from 1.4 million linear meters/month). However this additional capacity will only become fully available by Q2FY13. Company has deliberately been slow in adding capacities and admittedly this is now hurting the company’s immediate growth prospects. The company has guided for ~25% growth in Sales for FY12, after stupendous 44% and 48% Sales growths registered in the last 2 years.
  • Sustainability of Margins – FY10 profitability was a stupendous achievement for the company. Operating Profit Margin (OPM) had remained between 10-11% till FY09, but saw a big jump to over 16% in FY10.  Net Profit Margin (NPM) also hovered between 4-6%, but climbed steeply to ~10% in FY10. Will the high OPM & NPM margins be sustainable? To its credit the company has sustained both operating and net margins at these levels in FY11.
  • Raw material price volatility – The company’s performance may be sensitive to raw material price volatility as raw materials constitute 70%-80% of Net Sales . The common size P&L statement shows the last 5 years have seen raw material costs hovering between 73% to 79% of sales.  The company maintains it has no bargaining power with its much bigger suppliers. But it tracks price changes meticulously and keeps its major customers informed and thus is able to pass on raw material price increases to most of its quality-conscious customers.
  • The company has been penalised by SEBI vide its order dated 11 Feb 2009 for violating SAST regulations. The company maintains that while SAST regulation violations were committed on 3 occasions in 1997, 1998 and 2002 unknowingly when the company promoters redistributed ownership within the family (but did not announce an open offer for the same as required by SAST), they did not gain anything from this nor did it cause any loss to investors. Considering that SAST regulation violation carries a maximum penalty of 5 lakhs, the order for Rs.50,000 penalty seems to acknowledge this. The violations came to light when the company made one open offer to acquire 10 lakh shares in May 2006 to regularlise the past transactions. Roughly 4 lakh shares were finally offered even though offer price Rs. 44 was higher than prevailing market price of Rs. 36.

Barriers to entry

  • Customer relationships  – strong lock-ins exist with major customers. For e.g. its supplies nearly 75% of Bata’s requirements.
  • Long approval time – Its not easy to break into supply relationships and get on approved vendor lists with the majors. As an example, it took Mayur 3-4 years of running after International Automotive OEMS before they got on to the approved vendor list recently.
  • Economies of scale – The nearest competitor has only about half the installed capacity at 0.7 million linear meters/month.
  • Large variety of products  – Mayur Uniquoter has developed nearly 400 different varieties of synthetic leather to offer for diverse requirements, while the nearest competitor can offer only about 50 varieties.

Interesting Viewpoints

  • Many leading Automotive OEMs like GM, BMW, Daimler now have Mayur Uniquoters on their approved vendor list. Orders received from Ford & Chrysler, and the company has started supplies in FY11 and scaled this up significantly.As per the company the margins are 2-3x in OEM exports. Ford, Toyota and GM relationships will be leveraged as Mayur puts up additional capacity. But again they will be going slow in first stabilising the processes for optimum efficiency and quality. It will take a full year, till Q2FY13, before they stabilise and run the new coating line continuously on 24 hour, 3 shifts basis.
  • Other than Mayur Uniquoters, no Indian synthetic leather manufacturer has been able to penetrate the International automotive OEM market. There are only 2 players from Asia in this market and that includes Mayur Uniquoters. There is a Canadian manufacturer who has set up plants in China who is another big player. A US based player shut down recently. It’s not a very crowded market, as per the company!
  • Ability to pass on Price increases – Interestingly a factor that has worked for Mayur Uniquoters in the last few years is the gradually increasing input prices, which in its industry they have generally been been able to pass on with a time lag. (a 5%-10% increase in our products make a difference of hardly 1%-2% in the end product price, as per the company)
  • Induction of Professional Management into the company is a significant & bold step by the company. Mr Ramdas Acharya Sr VP (Technical) and Dr. V K Khanna Sr VP (Operations) have joined the company recently. Mr Khannna brings over 30 years of experience in Quality control. Mr Acharya brings over 30 years rich experience in R&D and Production in synthetic leather and related business for automotive OEMs in the US

Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years


Mayur Uniquoters Management Q&A: Jun, 2011

Management Q&A

1.     MAYUR UNIQUOTERS HAS MADE RAPID PROGRESS OVER LAST 5 YEARS. SALES HAVE GROWN AT A CAGR OF ALMOST 40% TO TOUCH 270 CR WHILE EPS HAS GROWN AT AN AMAZING 75% CAGR. CONGRATULATIONS!

Kindly share with us this journey and the key factors responsible for such an impressive growth performance. What have been the main drivers of this growth?

You need to understand that Synthetic or Artificial Leather today is everywhere – quality has improved tremendously in the last few years – in design, texture, colour matching, tensile strength, abrasion tolerance, etc. Daily use products like footwear, ladies bags, furnishings, upholstery, and automotive seats are using artificial leather predominantly. You will be surprised to know that 90% of leather used in footwear and furnishings today is artificial leather. Even in Leather products – say a leather sofa -the main seating area & backseat is pure leather, the sides and bottoms use matching colour artificial leather. In leather shoes you may see inners and sockings using artificial leather. Genuine Leather has become prohibitively costly. The synthetic leather industry has been helped by market forces at work!
There are 3 or 4 main contributing factors.
Firstly economics of scale have kicked in with our fixed costs getting spread over increasing volumes. Secondly product mix has been changing for the better with higher value added products leading to better realisations. The third factor that has worked for us in the last few years is the gradually increasing input prices, which in our industry we have generally been been able to pass on with a time lag. (a 5%-10% increase in our products make a difference of hardly 1%-2% in the end product price)
Delivering consistent quality, ability to scale up in tune with customer demands while maintaining solid financial discipline has helped us leverage on our best customer relationships. Today the business/customer is very savvy, appreciative of their best vendors and the marriage is usually very strong, as they cannot afford to expose their production lines to inconsistent quality. Is it in any wonder that bulk of the business goes to their best vendors? Our nearest competitor does roughly about 50% of our business levels.
We have also done lot of market development work especially in Southern market. This has included right from introducing the customer to new product design & innovations to helping them with sourcing the right technology (machines) and raw material partners.

2.     IF THE GROWTH TRAJECTORY HAS BEEN AMAZING, THE QUALITY OF THE GROWTH ACHIEVED IN WHAT MUST BE A DIFFICULT INDUSTRY, HAS MADE EVERYONE SIT UP AND TAKE NOTICE. THERE HAS BEEN A MAJOR SHIFT IN THE QUALITY OF EARNINGS OVER THE LAST 2-3 YEARS. WORKING CAPITAL/SALES AT 14-15% IS ALMOST HALVED FROM EARLIER LEVELS. OPM (16%) AND NPM (10%) HAVE JUMPED UP BY 5-6% IN THE LAST 2 YEARS AND SEEM TO HAVE STABILIZED AT THESE LEVELS.

This is not just economics of scale at work. Mayur Uniquoters has clearly shifted gears and is operating at a different level today. Kindly share the key changes that have happened over the last 2-3 years in the company. What changes have you effected in your business model to bring about this focus on improvement in operational efficiency?

I would again say the factors cited above are responsible. Also new product development and innovations have helped us move up the value chain with better price realisations. We have also consciously been moving the customer/segment mix and volumes towards higher margin segments like automotive replacement market and automotive exports.

3.    SALES GROWTH VS PRODUCTION GROWTH. WHILE PRODUCTION IN FY11 HAS GROWN BY ~18%, SALES HAVE GROWN ALMOST 3X BY ~53%.

This is an exceptional performance, which needs to be properly understood. You have mentioned higher input cost, better price realisation, value additions as factors. Kindly elaborate on the extent of contribution from each of these factors.

Well last year was another extraordinary year. Higher input costs to the extent of 18-20% is what we mainly benefited from to see such an order of Sales performance. If we see similar escalation again this year, I am not sure all our customer segments can absorb another such steep hike in rapid succession. Volume off-takes and Margins could well be effected.
This year so far it has been okay but this is a key risk and we have to see how the situation develops for the rest of the year. We are hopeful that the situation will moderate soon.

4.     PRODUCT SEGMENTS AND CONTRIBUTIONS

Kindly give us an idea of the revenue contribution & margins from major product segments. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why?

There are 5-6 main segments. Footwear, Furnishings, Automotive OEM, Automotive replacement market, and Automotive Exports. We are trying to open up a new segment in Automotive OEM Exports Replacement market.
The philosophy of the company has been to achieve growth more from new segments that allow us to leverage our consistent quality, ability to innovate and demonstrate better value-addition to our customers, and get better realisations. In doing this we also are spreading the risk across segments. Eventually we are trying to see that no segment has more than 25% revenue contribution. Margins are more or less the same across most segments.
All segments are growing well and the potential is good. Automotive OEM exports and Automotive exports replacement market will see increasing focus. But this will take time – We have slowly leveraged on the Chrysler relationship which has grown multifold. Quality requirements are stringent and rejections carry the risk of considerable penalties.

5.     CUSTOMER SEGMENTS

Kindly share with us the quality of business and the level of business with your major customers. How much do your top 3 customers contribute to revenues? Is there any single customer contributing more than 10% of Sales?

The 80:20 rule applies to us, as in most businesses. 20% of our customers get us 80% of the business. No single customer accounts for more than 4-5% of our revenues.

6.     EXPORT SEGMENT HAS ALMOST TRIPLED FROM ~17 CR IN FY10 TO OVER 48 CR IN FY11. YOU WERE ALREADY SUPPLYING TO FORD & CHRYSLER. THE COMPANY IS EXPECTING TO START SUPPLYING TO GM & TOYOTA. BMW & MERCEDES APPROVAL PROCESS IS ON.

Kindly share with us your successes and plans on the exports front. What will it mean to have GM as a customer? What is the scale of opportunity with a customer like GM? Do you enjoy superior margins there?

As I mentioned Chrysler relationship is growing stronger. They have increasing confidence in us. Two new programs with Chrysler will start later this year. They have again called us to US to discuss participation in another new program. They are very happy with the quality we have been able to consistently deliver. 80% of current OEM exports are to Chrysler and 20% to Ford.
Ford, Toyota. GM relationships will be leveraged as we put up additional capacity. But again we will be going slow in first stabilising the processes for optimum efficiency and quality. It will take us a full year before we stabilise and run the new coating line continuously on 24 hour 3 shifts basis.

The vision of the company now states “to be a preferred supplier of artificial leather to the leading automotive OEMS in the world”. So has the focus decisively changed towards automotive exports? What is the kind of growth that is expected from automotive exports segment?

Each of these 6-7 big automotive OEMs have annual artificial leather buys in excess of 500-600 Crs today in the developed markets like US and Europe. Our estimates tell us that this is a 3000-4000 Cr market across US & Europe.
We should be able to get 500 Cr -1000 Cr business from automotive OEM exports and Exports replacement market eventually. But this is a slow climb, it takes 2 years of constant engagement to break in for these majors to even entertain us. We also need to strengthen the organisation to scale up to meet the challenges thrown up by these opportunities in front of us.

What will be the effect on the product mix as footwear segment used to contribute some 55% of sales and was a significant counter against cyclicality of auto sector?

As mentioned before we would like revenue contributions to be no more than 25% eventually from any segment. Risks get spread across segments – not just auto sector cyclicality. And as mentioned before automotive replacement market is big and is getting bigger by the day as new vehicles get added every year. In the next few years the replacement market will be much bigger than the OEM market. If you recall in the FY09 auto recession we were not really affected.

7.    SALES & MARKETING SETUP & PROCESSES FOR DIFFERENT SEGMENTS. EXPORT AGENTS

Kindly explain your sales and marketing processes & set-up for the different segments.

We have Agents in developed markets on retainer basis for the automotive OEM exports. Even  in India we work through Agents for some major OEMs like Mercedez Benz.

For the Auto OEM segment, once product approval is received from say GM, who places the order on Mayur Uniquoters – GM, or their Car Seats vendor/assembler? Who do you supply to? How is price negotiation done and by whom?

Once an OEM like Chrysler selects us for a Program (say a new model), it instructs its leading automotive seat vendors to procure from Mayur Uniquoters. The price baseline is fixed by Chrysler. The seat vendor then contacts us and places orders. Some negotiation around the baseline is inevitable.

8.   INDUCTING PROFESSIONALS IN SENIOR MANAGEMENT CAPACITY. MR. RAMDAS U ACHARYA SENIOR VP (TECHNICAL) AND DR. V K KHANNA SENIOR VP (OPERATIONS).

This is a very welcome step. Kindly comment on the significance.  Should we take this as a signal of the confidence Management has in the scalability of this business?

Definitely Yes. A couple of years back we would not have been able to even afford to have such experienced professionals on board. Mr Khannna brings over 30 years of experience in Quality control. Mr Acharya brings over 30 years rich experience in R&D and Production in synthetic leather and related business for automotive OEMs in the US.

They are critical cogs in our plans to build scalabilty in the organization teams/processes to be able to address major opportunities before us. If we have to meet stringent export market norms with any consistency, our Operations and Quality processes need to be strengthened. Similarly R&D efforts will need significant  bolstering to offer new product development and innovations for attracting new business from customers.

Given Mr Ramdas Acharya’s extensive experience with different product lines for auto OEMs in developed markets, is there hint of product diversifications in the coming future, or settting up JVs for the same?

[ValuePickr: Sorry we missed asking this directly in the informal discussion flow. Mr Acharya is recruited directly from the US market after pursuing for 3 years we were told. His rich experience in Automotive OEM synthetic leather market and contacts with industry players will be very useful for opening up new opportunities – Automotive exports replacement market could be one such initiative, we were given to understand. Mr S K Poddar categorically told us that within 2 years the company would like to be in a situation where most of the day-to-day operations are run by professional management and the Owner-Management (Mr S K Poddar, his son Manav Poddar, and son-in-law Arun Poddar) devote only 10% of their time in day-to-day operations and are free to spend their time on strategic areas.]

9.   THE PU/PVC SYNTHETIC LEATHER MARKET. THE SIZE OF THE OPPORTUNITY BEFORE MAYUR UNIQUOTERS.

What is the size of the current market being addressed? Where do you see the company 5 years from today? What are the major challenges to reach there?

Let’s look at the Indian market first. Our internal estimates show current synthetic leather production in India caters to roughly ~2000 Cr. Another 700 Cr is met by way of Chinese Imports. 50% of the market probably is catered to by the unorganized sector. And balance 50% is catered to by some 15 players in the organized sector. Of these 5-6 are bigger players, the rest are much smaller players. Our nearest competitor has less than 50% of our capacity.

About the automotive OEM export market we talked at length before. We reckon that US and European synthetic leather market together is worth not less than 3000-4000 Cr annually.

We should definitely double our Sales in next 5 years!

[ValuePickr: Management likes to talk very conservative. Mr S K Poddar was quoted in this Dec 2010 CNBC interview of doing Rs.48-49 EPS in FY12. They achieved that (Rs. 46 EPS) in FY11 itself. When reminded of this by us, Mr S K Poddar laughed and said we believe in under-promising! Today we have a much greater responsibility as more people like you and analysts have started talking to us regularly. Let our performance do the talking for us!]

10.   PU/PVC SYNTHETIC LEATHER MARKET WOULD SEEM TO BE A LOW-BARRIER-TO-ENTRY MARKET. BUT YOUR DOMINANT PERFORMANCE SEEMS TO BE TELLING A DIFFERENT STORY.

What is the level of competition you face today both domestically and in exports. Who are these players? Would you continue to enjoy a sustainable competitive edge, and why?

Domestically as I mentioned there are about 5-6 bigger players in the organized sector. The customers in the organized sector also like to deal with these bigger players for reasons as mentioned before. Jasch Industries, Polynova, Royal Cushion Vinyl, Fenoplast are some of these players. Our nearest competitor has roughly ~50% of our capacity.

Other than Mayur Uniquoters, no Indian synthetic leather manufacturer has been able to penetrate automotive OEM export market. There are only 2 players from Asia in this market and that includes Mayur Uniquoters. There is a Canadian manufacturer who has set up plants in China who is another big player. A US based player shut down recently. It’s not a very crowded market!

If Mayur Uniquoters is a leading vendor with major customers today, it is for a reason. A certain financial strength and stability is needed to be able to invest in supplying bulk order quantities. Backed up by consistent quality and the ability and willingness to engage customers with new product ideas and innovations. We have developed more than 500 product varieties and are continuously adding to this. Our capacity utilization rates are the highest in the industry. While we derive roughly 4.5-4.75 linear lakh meters/month from one coating line I would hazard a guess that most others are not deriving more than 3-3.5 lakh linear meters/month. We invest continuously in machine and process upgradation. A small example – a leather roll changeover that used to take 45 minutes earlier, today takes less than 5 minutes! 

11.   CAPITAL EXPENDITURE. GROSS BLOCK ADDITIONS IN LAST 5 YEARS IS ~25 CR, BULK OF IT SOME 10 CR ADDED IN FY11. CAPITAL WORK IN PROGRESS WAS SOME 3CR. IN THE SAME TIME SALES HAVE INCREASED BY ~200 CR.

No wonder Fixed Asset Turnover has doubled form 4x to ~8x in last 5 years. Again maximum improvements have come in last 2 years.

As mentioned before, one thing you need to appreciate is that Sales growth has not been led by volume growth as much as by better price realizations (value additions and higher input prices). Having said that, once a coating line stabilizes, our utilization is very high – at 100% levels -24 hours, 3 shifts a day.

This looks almost like an asset-light business model? What’s going on? Is this sustainable ~8x fixed asset turnover for a manufacturing business?

You should also recognize that some our assets are very well depreciated. The first coating line is almost 15 years old and still going strong. The good part is much of the parts can be periodically replaced/upgraded and we have been doing that. Once this 4th coating line starts, we will be able to shut off this 1st line for a few days and carry out some upgrades. Please take into account with new investments of some 50 Crs being made over the next 3 years, these figures may/will temper down.

Please share the company’s philosophy, processes, and how you have gone about implementing such extraordinary productivity and efficiency improvements.

Well the answer to that is our Hunger. And the Ambition. Who sets the benchmarks here? We set them –right? There are no cut off –figures! We are a process industry. Seemingly small but continual investments in processes upgradation is a Mantra with us. If you ask me, if I were to grade us where we are today from where we would like to be I would say we are operating at 60% efficiency!
 

[ValuePickr: Mr VK Khanna and Ramdas Acharya had also joined us by now. Mr Khanna chipped in saying while CMD’s assessment is at 60% , my own assessment is that we are at 40% today!! There is a lot to do and achieve. We are hoping that the next plant that we are coming up with will be a quantum jump over our efforts today. Next time when you visit we would like to showcase to you a world-class facility. Let’s see.]

12.   BACKWARD INTEGRATION.  KNITTED FABRICS UNIT INCURRING 15-18 CR CAPEX

Has this been completed? Is this only for captive use for the exports segment or for generating additional sales as well? What kind of capex will be required going forward?

The land has been acquired. Unfortunately it has taken us 9 months to get the land converted for Industrial use. Construction has started now.

This investment in knitted fabrics is necessitated because of the quality issues being faced by us especially for export markets. We wanted to have this key raw material under our control. Initially much of this will be for captive use, but we also see increasing possibilities of opening up a new market segment for us!

Knitted fabrics has much wider ranging applications than synthetic leather. This market in India alone is a 50,000 Cr annual market! That will bring its own challenges, but show me a business today that does not have intense competition. There are no easy lunches. We are quite sure if there is an opportunity, we will find our own way, albeit gradually.

How much was the expense incurred in Knitted fabrics RM as a percentage of Sales? What will be the contribution towards margin expansion, if any, on account of this?

[ValuePickr: Sorry we missed asking this directly in the informal discussion flow. Will get this answered for you, soon]

13.   RAW MATERIALS – CHEMICALS, KNITTED FABRICS, OTHER FABRICS

RM constitutes some 70-75% of Sales. Kindly explain how the company manages raw material price volatility risks. Are you able to pass on price increases? What is the process with auto OEMs? How often have you resorted to price increases in FY11? What is the outlook for FY12?

Our suppliers are some of the biggest players in the world. They set the prices based on the demand equation and crude situation. We are completely dependent and vulnerable to RM price hikes. The good part though is that we are generally able to pass on the price hikes to our customers. For some of them we have regular price escalation clauses in the agreements. While for some of them we need to go back and negotiate. As mentioned before in our industry we are usually able to pass on with a time lag. (a 5%-10% increase in our products make a difference of hardly 1%-2% in the end product price).

If it is a gradual hike, usually price increases have worked for us in enabling higher sales. But as mentioned before I am not sure if we see another 18-20% hike in input prices again this year on the back of last year, something has to snap – not all our customers can absorb/pass on such steep hikes!

14.    FOREX RISKS. YOUR RM IMPORTS WERE ROUGHLY 69 CR WHILE EXPORTS CONTRIBUTED ROUGHLY ~48 CR IN FY11.

This picture may substantially change with rising exports in FY12. Will the natural hedge between imports & exports be maintained? What are the measures the company is taking to mitigate risks on this front?

The natural hedge works for us. At the moment we do not see an issue here.

Disclosure(s)

Nagabrahma: More than 5% of Portfolio in the Company; Holding for more than 1 year;
Nitin Jagtap: No Holdings in the Company; ;
Manish Kulkarni: No Holdings in the Company; ;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months;

Balkrishna Industries Management Q&A: July, 2011

Management Q&A

Balkrishna Industries operates in the specialty tyres segment – Off-Highway Tyres. Pneumatic tyres for special applications for agriculture, construction, earthmoving industry, material handling, forestry, lawn and garden, and All-Terrain-Vehicles (ATV). It has an amazing run and track record in the last 10 years – as it built up a global brand, exports 90% of its produce and enjoys a 4% global market share. In the last 10 years sales have grown at a ~28% CAGR while EPS has grown at over 41% CAGR!

Read this Balkrishna Industries stock story to know why it made it easily to our shortlist of promising mid-cap stocks – that our in-depth process for hand-picked stock-picks throws up.

There are a few questions that came up during our detailed analysis on Balkrishna Industries, its prospects, and risks as we see it. (of course that is entirely based on published sources and without the benefit of a meeting/interview with Management).

We put forward these questions to Balkrishna Industries Management with a request for a meeting/visit to its premises. We met the CFO Mr B K Bansal and spent more than 2 hours with him trying to understand the business opportunities and challenges ahead.


Questions for Balkrishna Industries Management

1.     POST-EXPANSION ACHIEVABLE PRODUCTION CAPACITY OF ~230,000 MTPA. AGRICULTURAL TIRES (65%), OTR TIRES (29%), OTHERS (6%).

Please explain to us the current demand-supply situation in Agricultural Tires, and OTR Tires segments. Is demand running far ahead of supplies? What makes for this aggressive expansion of over 80% from current levels? How have you planned for increasing Sales in tandem, or is that a given? What are the risks according to you?

Let me first set the context. The Off-highway Tires business is about $11 Bn globally which is growing at 4-5% annually. We have been growing sales at 25-30% annually for the last 10 years. So obviously we are taking away market share from the more established players. Our current global market share is ~4%.

We have grown sales in FY11 over 40%. If we had the capacities we could have sold much more. There are no doubts in our mind that we can increase sales in tandem with increase in capacities. We have invested in increasing our distribution reach and penetrating deeper in existing markets. We don’t think there are any risks on that front.

2.     PREMIUM PRODUCTS. AGRI RADIAL AND OTR RADIALS. BKT IS THE LARGEST MANUFACTURER OF FULL RANGE OF RADIAL TRACTOR TIRES FROM ASIA.

How much of the post-expansion capacity is planned for premium products like Agri Radials and OTR Radials? What is the revenue contribution from Premium products currently and is there going to be increasing focus on premium segments?

Radial/Non-radial products is roughly 30:70 in our Sales mix today and is likely to go upto 40:60 with increased capacities being available. There is little higher contribution from Radials segment but not by very much.

3.     OFF-TAKE FROM GLOBAL MAJORS LIKE MICHELIN AND VREDESTEIN CURRENTLY FORMS 6% OF TOTAL SALES.

With large capacities available from BKT especially in premium segments, do you foresee greater interest from Global majors in increasing off-takes from BKT. We know that OEM market margins are lower than the Replacement market, but how are the margins in the Off-take segment?

There is lot of interest from global majors to increase off-takes from players like Vredestein, Trelleborg, Nokian. The margins are also better. However we are not very interested in pursuing that as we believe BKT is a good brand we would rather invest in increasing our market share. We have had offers for a JV from Vredestein too – the enticement is access to more markets through their network and better technology. We have not taken these up as we feel we can handle Technology and we know how to market our products from the experience gained in the last 10 years.

We maintain a certain level of engagement with these players as there are a few things that we do learn form them from time to time. The engagement levels will remain same at some 5-6% of total sales, unlikely to touch something like 10-12% levels.

4.     INDIAN MARKET SHARE CURRENTLY FORMS 11% OF SALES AND MOST OF IT COMES FROM OTR SALES. THE INDIAN EARTHMOVING AND CONSTRUCTION EQUIPMENT INDUSTRY IS MEANWHILE EXPECTED TO GROW FIVE FOLD FROM USD 2.3 BILLION TO USD 12 –13 BILLION BY 2015.

Would we see an increasing focus on the Indian OTR tires segment once you do not have any constraints on the capacity front? Who are the existing players in this market –same Michelin, Titan, or there are others? What are their market shares, and how far behind is BKT.

In the Indian market we have chosen to concentrate mainly on the OTR Earthmoving and construction equipment segment. We are not present in the Agri-Tires segment and unlikely to pursue it.

You see in India agricultural tractor use is usually of less than 50 HP. In the developed markets tractors use go as high as 200 HP. They use different equipment for different seasons, even different crops. The Agri tires mix is pretty diverse.

The OTR segment in India comprises some 11% of our Sales. Yes there will be a higher focus from us on this segment and OTR segment sales in India should go up to 20% levels from here with the increased capacities. We do not face international competition here, but its mostly MRF and Apollo.

5.     GLOBAL COMPETITION. MICHELIN. TITAN. OTHER PLAYERS LIKE ALLIANCE FROM DEVELOPING MARKETS HAVING SIMILAR ADVANTAGES AS BKT HAVE EMERGED ON THE SCENE TOO.

Michelin 2008 Investor Presentation listed BKT as serious competition in Europe and showed BKT’s share as 3%. Kindly explain what has changed in the last few years. Do you still enjoy the 30% price differential? If there is a demand-supply mismatch situation, the bigger players also must have invested in creating larger capacities?

In Europe BKT has grown much stronger in the last few years and commands 9-10% market share. Price differential has narrowed to something like 25%.

Mehensarias (Alliance Tires) have a strong technical background, they have the Capital backing them up, the benefit of the BKT experience till 2005/6, and have lined up substantial capacities by now, and may well replicate most of the advantages that BKT today enjoys. How closely do you track local competition? Any changes in tactics/plans to tackle this emerging threat.

Yes they are strong players. And yes they should be able to replicate most of the advantanges that we enjoy, eventually.

They invested in a 30000 MTPA capacity in Chennai for Phase I. There were some issues and a strike, and they have deferred the deciaion ton invest for the planned Phase II expansion of another 30000 MTPA. they are looking for a new location. Their Israel facility has ~40000 MTPA capacity.

They way we look at this is simple. It has taken us 10 years to reach where were today. Anyone striving to reach our levels has to go through the same process, they may be able to do it faster but it will still take them 8-10 years. It takes atleast 3 years to stabilise production and reach peak capacity utilisation levels. The 90,000 MTPA capacity we have coming onstream next year will still take us 3 years to reach peak levels, or roughly 30000 MTPA each year. There is no magic formula or shortcuts.

From ground zero, it will take anyone 5 years to reach peak utilisation levels from a 90000 MTPA capacity installation!

So, BKT will have a unchallenged run for the next 5 years, atleast?

That’s right the next 5 years should see an unchallenged run, at the least. And other than Alliance we aren’t aware of any other player wanting to take on this complex niche, which has seen exits from several big players.

The new entrants in a bid to capture greater market share faster may resort to undercutting? Is that not a real threat?

That risk is probably very remote. The market is big and there is enough room for new players to sprout and thrive without resorting to undercutting other small players. Its only when BKT gets to the size of say 25% market share that perhaps this may become a real threat for us.

If it’s possible, kindly share why Mahensarias (who now run Alliance Tires) had to split from the Poddars in 2006. They were actually running the show in BKT till then. To the Poddars’ credit though, BKT has done exceedingly well in the last 5 years since the split.

Well the MD’s brother-in-law was Mr Mahensaria. Mahensaria held 5% in the company and 10% through Promoter Holdings. The Poddars didn’t have a second generation to run the company and thus Mahensarias played the Executive role. To be fair the strong foundation for BKT’s success today was laid by the Mahensarias when they ran this company till 2006, and they had done a very good job. Then the Poddar 3rd generation came along and were ready, naturally they wanted to take back control. The Mahensarias understood and accepted this situation graciously. The parting was perfectly amicable. Today Mr Arvind Poddar is assisted by his son and nephew in running the show at BKT.

There was no non-compete agreement as it was made clear by the Mahensarias that this is the only business that they knew how to run, and it was made clear that they will be attempting to start building a business from scratch.

Its good that they now have secured funding. Both sides are still on very good terms. There is no reason for under-cutting and killing each other, when the market is ripe and low hanging fruits are still available.

6.     EUROPE AND AMERICAN MARKETS. FAST GROWING ECONOMIES SUCH AS BRAZIL, ARGENTINA, COLOMBIA, COSTA RICA

Tell us a little more on the penetration that you are making in your fastest growing markets, especially the Americas. Which of these markets will provide you most of the sales growth? Are you able to get similar margins form the South American growing markets?

BKT had initially focused on European markets and is gradually increasing its presence in Americas, which is our fastest growing market, and that is mostly the US. South American markets are also seeing increasing presence but they are smaller markets. Margins are more or less the same.

7.     IN FY11 BKT REGISTERED AN IMPRESSIVE 40% PLUS GROWTH IN SALES, BUT SUFFERED AN 11% DEGROWTH ON PAT FRONT DUE TO THE REVERSAL IN RAW MATERIALS PRICING.

How do you see FY12 panning out? You mentioned order booking of 5 months in the last Conference call. Are you protected on the margins front in booked orders?  At what levels 18-20%? What is a sustainable level for the full year?

Yes on the booked orders we are protected on the margins front at 18-20% OPM levels.We have seen Price peaks at $6400/tonne, then it corrected somewhat to $5100 levels. Since the last 2 months prices are stabilising at $3500-4000 range. Our understanding is that it will settle lower at $3000+ levels.

How do you do this forecasting or reach an understanding on what levels are likely? Is it that demand supply gaps have narrowed with increased production this year?

Well no such thing as demand supply gap. If that was the reason we should have seen at least some people complaining that rubber is not available the quantity they want. In this whole hullabaloo we did not come across a single situation like that – it was always available at a certain price. It was purely speculative plays!

So far as we can make out and understand from those who track these markets well, rubber prices are expected to stabilise at lower levels this year.

If prices are expected to soften in coming months, how are you booking your current orders?

Well we have not seen anyone rolling back prices since the last time hikes were announced. Neither have we.

8.     FINANCIAL STRENGTH. BKT HAS ALWAYS MAINTAINED PRUDENT DEBT LEVELS IN THE RANGE OF 0.7X TO 1.3X. CAPEX FOR FY12 OF ~700 CR IS GOING TO BE A BIGGER BURDEN ON THE BALANCE SHEET THIS YEAR.

We may see Debt-to-Equity levels touching 1.5x or so. Please tell us a little more on the financing costs. Working Capital/ Sales has risen to over 32% of Sales, and is likely to go further up as inventory levels go higher. Is Working Capital also financed in foreign currency? What will be the overall financing cost? Will it be lower than your traditional 4-5%?

The current debt is about 600 Cr. Of the 700 Cr we will be spending about 500 Cr this year and 200 Cr will be used in FY13. So I think we will still be within D/E levels of 1.3x. Yes Working Capital finance is also in foreign currency now. Our overall financing cost will be around 2%

9.     EUROPEAN ECONOMY IS TROUBLED. THE CURRENT BAILOUT TO GREECE MAY NOT BE ENOUGH AND THERE ARE FEARS THIS MAY LEAD TO MORE SUCH BAILOUTS FOR GREECE AND THE OTHER COUNTRIES LIKE IRELAND, SPAIN TOO. THE EURO AS A CURRENCY IS UNDER TREMENDOUS PRESSURE. BKT DERIVES ~47% OF REVENUES FROM EUROPE.

What are BKT’s views on the risks from this front and what are its plans to mitigate these risks?

Well these fears have been around for last 3 years or so. we hear them all the time but from customers on the ground we have heard no such fears -they expect business as usual. If there is some turmoil, the Agri-Tires situation (65%) will probably be okay because farming & food business will still carry on. The OTR segment may see some pressures.

The Euro currency front is a cause for concern say if it corrects to being equivalent to dollar levels. We can’t do much on that except the simple 1 year forward contracts that we take to hedge for upto a year ahead.

10.EXPORTS ACCOUNT FOR ~90% OF SALES. MORE THAN 70% EXPORTS ARE TO DEVELOPED  MARKETS.

How soon will emerging economies together account for something like 40-50% of Sales? What are BKTs views on entering the Chinese market?

In the post expansion situation of 230,000 MTPA capacity the export dependence on developed markets will continue. The mix may change – Europe may come down to 40% levels from 47% and US market may increase to 30% from 23% currently. Some Other markets may inch up to 4-5%.

Post the 2015 expansion, there may be a higher tilt to emerging economies. Chinese market has established players -but they operate solely within China. We have no plans of entering that market.

11.SUSTAINABLE COMPETITIVE ADVANTAGE. WE HAVE SEEN BKT HOLDING ITS ADVANTAGE THROUGH THE LAST 10 YEARS AND GROWING MORE THAN 10X IN THE SAME TIME IN SIZE.

What are the reasons you have continued to enjoy competitive advantages and have not faced serious threats from emerging or bigger players?

As you know our niche is known by its characteristics as a low volume-large varieties market. The approach needed for production and servicing this niche is completely different from the mainstream high volume commercial tire production market. It needs completely different processes, a completely different factory and a different set of people.

The business is very SKU driven. The larger the number of SKUs that you can manage the larger business you can attract. The reason is because our customer businesses need to run a very tight ship because of the low volumes and large varieties. They will always prefer to deal with a vendor who can support all their requirement sunder one roof, rather than deal with multiple vendors.

For the bigger players, the OHT segment is very small, less than 10% of their business. But if they have to grow this smaller segment profitably, they would have to shift a considerable focus away from their main commercial tire business. Many big players with OHT presence have chosen to exit from the niche.

If we look at tractor tyres in India we see mostly MRF or Goodyear. Why has MRF for example not found it profitable to compete with you in exports for Agricultural tires? It’s not that MRF or Apollo or any of the tire biggies in India aren’t aware that BKT operates at something like 2x their margins and returns!

True, these players have been making some noises from time to time but they have all been running small OHT operations, and the size continues to remain small. For them to scale up the OHT segment would mean a considerable shift of focus from their main bread & butter business, for reasons as explained before. They have been unable/unwilling to take those steps.

Why has no one from the mainstream tire industry ventured out in off-highway tires in a big way despite clearly seeing a decade long growth story unfolding before them?

Exactly the same reasons.

And for the first time there is hint of serious competition coming from players like Alliance who seem to be capable of replicating the same advantages as BKT. Why do you think you will retain sustainable competitive advantages for the next 5 years?

The number of SKUs that we have built and are managing. Its not that you can turn on a switch and you have a set. Each SKU takes its own process and time, endurance testing and the like which varies from product to product. It will take anyone atleast 8-10 years to reach here.

Like most businesses isn’t it true of your business too that 80% of the business comes from 20% of the products? So what prevents a competitor from fast-tracking on the most important SKUs and Alliance for example could be well are of those characteristics.

Well no such luck! Our business is spread more or less evenly across the whole SKU range. The more the number of SKUs we have, the more business we can attract.

In other words, is it fair to surmise that having large number of SKUs is your actual moat – or main competitive advantage today?

It is!

12.MANUFACTURING PLANTS & AUTOMATION

The modern automated plant at Chopanki (60000 MTPA) is reportedly delivering 110 TPD at 75-80% utilization. Both the plants are functioning on three shifts per day on a 7 day week. But your Bhiwadi plant (60000 MTPA) is over 18 years old and reportedly still delivers about 135-140 TPD close to 100% achievable capacity. Is this true??

 Actually the Bhiwadi plant was acquired from Govind Rubber a subsidiary -which makes bicycle tires in 2001. They had 2 plants one of which was lying idle. That plant was acquired by us and the whole set up was revamped. So its like a 10 yr old plant today. Our Walud plant is the oldest.

This is an amazing record and speaks well of Management’s ability to maintain its plants and progressive de-bottlenecking. It also indicates maneuverability and the expertise of the company to implement a complex manufacturing process and switching it flexibily to accommodate client specific requests.

Both Bhiwadi and Chopanki plants are exactly similar. They have similar levels of automation or manual interventions. The Chopanki plant is new and as mentioned before will need progressive de-bottlenecking to reach peak utilisation levels.

13. MOULD DIVISION MERGER. BKT REPORTEDLY HAS 500-600 MOULDS USED FOR VARIOUS APPLICATIONS IN VARYING SIZES AND DESIGNS LAID IN THESE TWO PLANTS, ALL MANUFACTURED AT BKT’S MOULD MANUFACTURING PLANT AT DOMBIVALI, MAHARASHTRA. THIS DIVISION IS NOW BEING MERGED WITH BKT?

Kindly tell us a bit more on the advantages of having your own mould manufacturing plant. And why this decision now to merge it with BKT?

We had acquired a plant that basically had land. We thought this land could be best used for expanding our mould making facility in BKT moulds which was adjacent. Thus BKT Moulds was merged with BKT. 

14.DIVIDEND POLICY. BKT USED TO BE PAYING ABOVE 20% OF EARNINGS AS DIVIDEND TO SHAREHOLDERS. THIS HAS BEEN GRADUALLY COMING DOWN AND HAS SEEN DRASTIC CUTS IN THE LAST 2 YEARS. FY10 DIVIDEND PAYOUT WAS AT 6.48% AND FY11 IS EVEN LOWER

Can you please clarify the Managements thinking on this front? What kind of dividends can we expect in the future?

We do not have a Dividend policy written down. But we are clear that we will pay dividends – we must maintain our uninterrupted dividend paying record. The quantum of dividends paid got reduced yes, during the last credit squeeze, liquidity was very tight. We reckoned that we could better utilise the proceeds by paying lesser dividends and consequent taxes, which otherwise we would have had to raise from the market.

We have taken into consideration views on Dividends from several Investor groups, and in happier times we will try and restore some balance there.

15. $1 BN IN SALES?

What are the important milestones on the way? With a Sales target of 130000- 135000 MTPA for FY12 we are probably doing ~2300-2400 Cr in Sales?

No actually we should do better at some 2700 Crs. We have locked in orders booked at higher realisations.

With 230,000 MTPA achievable capacity from 2HFY13, what kind of Sales is probable in FY13? 3000-3500 Crs?

FY13 would probably see ~30,000 MTPA additional capacity coming onstream. So yes Sales could be in that range.

What kind of market share will this transalate to for BKT? When will we see BKT claiming a 10% market share in the global off-highway tires market?

$ 1 Bn will happen by 2015. The global market by then would be close to $12 Bn by then and a 10% market share will translate to over a Bn$ sales.

16. CHALLENGES AHEAD. WE HAVE TRIED TO COVER THE ISSUES BEFORE THE COMPANY AS WE SEE IT FROM OUR LIMITED UNDERSTANDING OF BKT AND THE INDUSTRY.

Please elaborate on the main challenges before the company as it is scaling up in a big way and trying to address the huge opportunities before it.

Well we see the Challenges mainly on 3 fronts.

First Execution Challenges – and this includes resources, labour, training, handling multi-locational issues while executing on-time. Second challenge is handling the RM situation well, and lastly there are challenges on the Currency front like we discussed before.

So Marketing is not a challenge?

No, Marketing is NOT a challenge!


Disclosure(s)

Nagabrahma: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
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