GRP Management Q&A: Aug 2011

Management Q&A

Discussion Transcript provided by ValuePickr member who traveled to AGM and met the Management. Prefers anonymity, doing the quiet work! Minor edits after talking with the member for some details and better readability. Please note the free-flowing discussion meant some specifics/details could not be asked in exactly the same flow. We will try and get the missed ones answered as soon as we can – Editor

1. WHAT WOULD YOU SAY IS GUJARAT RUBBER RECLAIM’S CORE COMPETENCY?

It would be wrong to assume any one thing as our core competency. We have the best technology and machines (in-house manufacture). Also our quality and our processes. We are approved vendors for 6 of top 10 tyre manufacturers in the world. We have a strong sourcing network with more than 190 active suppliers. Some of them are exclusive suppliers of scrap.  Also we have 100% yield of our products which makes us one of the most efficient players. The last non-working day in the company was 4 years back which is a record for our industry!

2. WHAT ARE YOUR KEY RAW MATERIALS? ANY RISK TO THE SAME?

There are 3 types of scrap. Whole tyre scrap, Side tyre scrap & Tube scrap. Each has different proportions of raw materials. There is no shortage of raw material as more than 75% of demand in tyre industry is from replacement market. Indian tyre industry has an annual demand of 10-11 lakh tonnes. That’s a replacement market of 7-8 lakh tonnes. All that scrap is available to players from the Reclaims industry. This is about 4-5x the total production of reclaim rubber industry in India.

There are alternate uses of scrap tyres – in the cement industry (for generating heat for clinker)- and is a risk, as that can increases scrap prices. But this is dangerous for environment as this releases sulphur in the environment and is legally, not above board.

3. WHAT ARE THE GENERAL USES OF RECLAIM RUBBER?

Reclaim rubber can be used in any kind of rubber application except high speed tyres. Higher the vehicle speed, lesser the use of reclaim rubber in the vehicle’s tyres. Reclaim rubber finds highest use ~35% in bicycle tyres. In CVs and passenger tyres the usage is ~4%. And ~8% in OTR’s (Off-the-Road like Earthmoving Equipement, etc.) due to lesser speed. Usage varies in conveyer belts. Since Reclaim rubber is black in colour, it is not used in gloves & condoms. Overall Reclaim rubber usage is roughly 8% of the Indian rubber industry.

4. PRODUCT SEGMENTS & CONTRIBUTION. NATURAL RUBBER RECLAIM AND SYNTHETIC RUBBER RECLAIMS ARE GRRPL’S TWO MAIN SEGMENTS. IN SYNTHETIC RUBBER RECLAIMS YOU HAVE BUTYL, EPDM, NITRILE, LATEX.

Kindly throw some light on the end-user industry for synthetic rubber reclaims and the demand-supply situation -both domestic and exports. Who are your customers? What kind of margins are prevalent in synthetic rubber reclaims? What kind of revenue contribution is coming from synthetic rubber reclaims today? Is Butyl reclaims contributing the most within synthetic rubber reclaims? Which is the most promising, and why?

Synthetic Rubber reclaims find application in Inner Tubes, Tyre Inner liner, Adhesives, sound dampners, molded parts.

How is the RM procurement situation in synthetic rubber reclaims? How have you secured your RM supplies on this front?

We produce synthetic reclaim from synthetic scrap and natural rubber reclaim from natural rubber scrap.The sourcing for butyl and other synthetic reclaims is through the same scrap-supply chain.

5.  DOES RADIALISATION HAVE ANY EFFECT ON YOUR PROCESSES?

Yes, it does affect us as there is more steel in radial tyres which needs to be extracted. We have been working on our processes over time and we are now able to process the radial tyres efficiently, as well. This infact should work in our favour as small scale companies will take some time to catch up on this aspect.

6.  HOW ARE THE PRICES OF RECLAIM RUBBER, SCRAP RUBBER & NATURAL RUBBER CONNECTED?

Reclaim rubber prices are not linked to natural rubber prices. They usually used to trade between 35% to 40% of natural rubber prices but that correlation no longer exists due to tremendous increase in the natural rubber prices. But the increase in the natural rubber prices has given us tremendous boost in terms of growth as more and more industries are trying to increase the reclaim percentage in the usage.

7. EXPORTS – GEOGRAPHIES AND CONTRIBUTION

What is the exports sales contribution currently? Kindly provide the Geographical spread – how much from Europe, US and other markets. How much of export sales is booked in Euros and how much in US$? Do you have higher margins from Export sales?

Most of our Export Sales (80%) are from Europe. We do not engage in hedging as we do not have any competency there.

8. COMPETITION –DOMESTIC AND EXPORT MARKETS. IN THE DOMESTIC MARKET YOU HAVE BALAJI RUBBER (36000 MTPA) AND ELGI RUBBER AS THE MAIN COMPETITORS. ELGI RUBBER WITH ACQUISITION OF NETHERLANDS BASED RUBBER RESOURCES (42000 MTPA). BOTH COMPANIES ALSO SEEM TO HAVE COMPETENCIES IN BUTYL RUBBER RECLAIMS.

Both the companies are good. But the market is big for everybody as Indian market itself is growing by 15% every year. Also regarding the company ELGI rubber recently acquired, we had looked at the same company 2 years back. But we were not satisfied with South Africa plant and decided not to go ahead with the purchase after the due diligence. The expense of 2 Cr in 2009 AR was written off for the same.

Who are your major competitors in the Export markets? How big is the overall Reclaim rubber market, and what is the Industry rate of growth? How is Gujarat Reclaim competitively placed today – Is GRRPL growing faster than the Industry growth and grabbing market share from Competitors. If yes, why? What are your competitive advantages?

Overall the reclaim rubber market would be growing at ~15% for next few years as there is sudden rise in the natural rubber prices leading to increased demand. But only the existing approved vendors can take advantage of the same as there is 3 years period before you can get approval as a vendor with major customers like Bridgestone, Michelin. We are growing faster than competitors because of our quality & approvals with 6 of the top 10 tyre manufacturers worldwide.

How strong is Chinese competition? In terms of capacities, how much bigger are they compared to GRRPL? Does GRRPL have any advantages in terms of the Product mix today vis-à-vis Chinese competition? What is the price differential, if any, between Chinese and GRRPL products to OEMs.

N.A.

How is the demand supply situation generally? If you had the full 80,000 MTPA capacities today, would you be able to sell comfortably? Are you aware of competitors expanding capacities aggressively? Is it likely that the demand-supply situation will get skewed with volatility in European and US economy?

The demand is extremely robust due to increase in the natural rubber prices. Yes, if we had 80,000 MTPA capacity available for production today, we should be able to sell that. Competition is always there, but our quality and customer relationship is superior.

9. GROWTH – OUTLOOK. YOU HAVE RECENTLY EXPANDED CAPACITY TO 60000 MTPA AFTER 3 YEARS OF CONSOLIDATION. THERE IS ALSO EXPANSION WORK OF 10000 MTPA ONGOING FOR THE ERODE FACILITY, WHICH MIGHT TAKE CAPACITIES TO 70000 MTPA BY FY12. 1QFY12 SALES GREW AT A HEALTHY 31% AND PAT GREW AT 47% OVER THE LAST YEAR QUARTER. YOU HAD GUIDED FOR A 30% GROWTH CAGR FOR NEXT FEW YEARS.

Kindly comment on the current outlook and plans. What is the sense that you have got from your customers, especially Exports? What is your order book size at the moment? Have you noticed any slowdown in orderbook in Q2? If Export demand sees a decline, what are the plans to counter this risk? Can domestic market absorb additional sales? How do you see margins playing out for the rest of the yearFY12?

Our capacity expansion plans are 70,000 MTPA by FY12E & 80,000 MTPA by FY13E. We generally are able to use the full capacity in the year following the capacity enhancement. We don’t work on orderbook basis as it is continuous supply. Till now we are seeing robust demand in exports markets. We should be able to touch 420 Cr at full capacity. Steady state operating margins will be ~18% . 1QFY12 margins were exceptional, there will be wage revision impact in current quarter.

10. ERODE –MANUFACTURING PLANT ON 12.5 ACRES. MOTT MACDONALD, THE GLOBAL ENGINEERING AND DEVELOPMENT CONSULTANCY HAS BEEN APPOINTED AS EPCM CONSULTANTS FOR THIS PLANT.

The stakes seem to be very high for this plant! Kindly tell us a little more on what is planned and what kind of sophistication/productivity efficiencies is this likely to bring? What kind of capacities are planned at this facility in total? What is the timeline for the first phase of expansion? Is this facility going to be dedicated for Butyl reclaims as reported in the press, or this will be multi-product?

This is our first foray outside of West, our home region. Mott MacDonald would help us keep a tight control over execution. Our machines can be interchangeably used for both types of reclaims. All our plants have that facility. After this expansion we should be hitting 80,000 MTPA by Dec 2012. It generally takes 12 months to build up the capacity. Currently utilities work is going on at the Erode plant.

11. THERMOPLASTICS FORAY. REPORTEDLY, THIS IS A VERY EXCITING SPACE AND HAS HUGE POTENTIAL. KINDLY SHARE THE DEVELOPMENTS IN THIS SPACE? ANY MAJOR SUCCESSES? HOW MUCH DOES THIS CONTRIBUTE TO REVENUES TODAY?

This is a part of our process only. This is not a new segment. We get the thermoplastic straps from the scrap only as impurities and are trying to sell the same. So it is mentioned as different segment.

12. CUSTOMER SEGMENTS – GRRPL PRODUCTS ARE APPROVED AT 7 OF THE TOP 12 TYRE COMPANIES IN THE WORLD AND 4 OF THE TOP 10 NON-TYRE RUBBER MAKERS GLOBALLY.

Kindly share recent customer successes and or deeper penetration into existing accounts. Have more marquee names been added to the list?
Given the focus on synthetic reclaim rubber are we seeing more penetration in that segment? Who are your top customers in this segment?
How much does your top 3 customers contribute to Sales? Does any one customer contribute more than 10% of Sales?

N.A.

13. INVESTOR RELATIONS –COMMUNICATION. GRRPL NEEDS TO IMPROVE COMMUNICATION WITH THE INVESTOR COMMUNITY AT LARGE. THE WEBSITE DOES NOT PROVIDE EVEN THE ANNUAL REPORTS.

With the company growing in size and stature, are we going to see a more proactive IR at GRRPL. Can we expect regular Analyst Calls & Presentations form the company updating investors on its successes, opportunities and challenges ahead?

We have been very busy catering to the expansions underway. We will try to update our website and revive the newsletters.


Disclosure(s)

Donald Francis: No Holdings in the Company; ;
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Ajanta Pharma

Background

Ajanta Pharma ranks among the Top 50 Pharmaceutical companies in India (IMS ORG MAT March 2012) with sales growing at 27% CAGR over FY06-12.  More than 2000 Medical Representatives strength.

The company has one of the highest R&D spends among pharma companies of similar size, spending ~ 6.5% of Sales on R&D and has invested in over 200 skilled personnel with a 35000 sq feet dedicated R&D facility for working on API synthesis and finished formulations.
The Company operates 4 manufacturing facilities in India, 3 for formulations and 1 for APIs (for captive consumption). Another formulation manufacturing facility is located in Mauritius through its 100% subsidiary. The manufacturing facility at Paithan, Maharashtra is approved by USFDA, UKMHRA, WHO Geneva (pre qualification).

Main Products/Segments

Main Generic Brands:

  • Ophthalmology (Olopat, Diflucor, Zaha, Unibrom, Nepaflam)
  • Dermatology (Melacare, Pacroma, Salicia KT, Sunstop)
  • Cardiology (Atorfit CV, Met XL, Rosufit)
  • Anti-Malarials (Artefan – Artemether & Lumefentrine)
  • Gastroenterology (Lafutax – Lafutidine)
  • Male Erectile Dysfunction (Kamagra – Sildenafil Citrate)
In the Dermatology segment, the company ranks 18th and has 34 generic brands – with 4 leading brands and more than 10 first-time products. In the Opthalmalogy segment, the company is ranked 7th and has 30 generic brands – with 9 leading brands and more than 16 first-time products in India.  In the Cardiology segment, the company ranks 31st and has 51 generic brands – with 3 leading brands and more than 6 first-time products in India.

Main Markets/Customers

  • Mainly three segments – Dermatology (32% FY07-11 sales CAGR), Cardiology (24% FY07-11 sales CAGR) and Ophthalmology (23% FY07-11 sales CAGR).
  • 75% of Domestic Revenues come from top 3 segments of Ophthalmology, Dermatology and Cardiac. Balance 25% come from new segments like Orthopedics, Gastro Intestinal and the Institutional segment.
  • Sales are mostly from a prescription-based model as the company moved decisively in reducing its exposure to tender based sales (0% from last 3 years). Institutional Sales comprise some 20% of Sales (governed by rate contracts for Ajanta’s brands). Direct Sales force has gone up from 600 to 2000+ in last 3 years. Country-wide C&F Agents network caters to the domestic market.
  • ~60% of Sales from Exports : of which ~50% from Asia, ~30% from Africa, and rest from Latin America; No sales from US and EU currently. Present in around 25 countries in Africa, South East Asia, Middle East, Central Asia and Latin America. Each country is treated as a different market. 1 distributor for each country. With around 1300+ brand registrations across countries filed, the company also has another 1300 or so brands under approval to ensure future growth.

Bullish Viewpoints

  • Consistent Growth – Ajanta Pharma has had a great run over the last 10 Years. Sales have grown at 21% CAGR growing from 100 Cr in 2003 to 605 Cr in 2012 and Net Profits have ramped up much faster at a CAGR of 46% to 66Cr in 2012. Consolidated record is even better.
  • Margin Expansions – Operating margins touched ~21% and Net Margins crossed 11% for the first time in FY2012. The company has been consistently recording higher margins over the last many years moving up from 14% Operating margin and 5% Net margin levels in FYO6. This may be attributed to increasing “brand” value, gradual shift in business model(s), and operating scale efficiencies.
  • Strong Product Pipeline – Ajanta Pharma invests ~6.5% of Sales in R&D. It has over 1300 product registrations in different countries and a pending registration (filed) pipeline of over 1300 products. For the last few years, the company has been introducing more than 20 new products every year in the domestic market, many of them first-of-its kind in India.
  • Prescription-Sales shift – Ajanta Pharma has successfully transitioned to a prescription-sales model, from the earlier dependence on sales to government and institutions – which were lower-margin tender based business. The company has heavily invested in increasing its field force to over 2000 Medical representatives. Expansion of doctor base, coupled with increased prescription rate has led to significant gain in market share and improved ranking during the year (FY12 within Top 50, compared to 63 in FY11).
  • Direct-Sales led model – Interestingly, Ajanta Pharma has been relying on a direct-sales led model rather than a distributor led model, even in overseas markets. More than 90% of export sales reportedly are through the direct marketing network, with only 10% coming from distributors.
  • Focused therapeutic markets – The company follows a very country-specific and product-specific model. For example, it sells its Anti-malarial and specialty range of products in African markets, while in South East Asian markets cardiology, ophthalmology and dermatology products are sold. Similarly for Latin American market, the company sells cough syrup dosages predominantly. Thus rather than dumping all products to marketing team, selective penetration is attempted depending upon the demand for that particular market.
  • Backward Integration for API facilities -Ajanta Pharma invested in a state-of-the-art API (Active Pharmaceutical Ingredient) facility in Waluj, Aurangabad in FY10. While the company mainly depends on Chinese supplies for its API needs, this facility is critical in its objective of launching new first-time products in the country. In-house capabilities on this front enables it to maintain product confidentiality in the innovation and trial phases where API supplies may be unavailable/scarce. The facility is being used primarily for captive consumption.
  • Heavy investments in Capex – In the last 4 years Ajanta Pharma has spent upwards of 200 Cr in Capital expenditure, which has paid off handsomely, so far – upgrading the USFDA approved Paithan facility, setting up an API facility in Waluj, a newfully equipped R&D center in Mumbai and Warehousing infrastructure. It also acquired a formulations facility in Aurangabad to cater to semi-regulated markets. With the current and foreseen growth levels, the company envisages capacity peaking in next 2 years. The company has planned two separate manufacturing facilities – one for regulated markets & another for domestic & emerging export markets to be completed in 24 months with an investment of ~400 Cr. Funding through new debt, apart from internal accruals.
  • Improved Subsidiary Performance – Subsidiaries have started adding to the fizz – contributing 72 Cr (~12%) to the topline and 11 Cr (~17%) to the bottomline. Performance of its subsidiary in Mauritius has been excellent and the step down subsidiary in Philippines has also been able to improve its performance substantially making profit for the first time. US and UK subsidiaries continue to assist in regulatory work for product registrations in those countries.
  • Entry into developed markets – The company has made excellent progress on this front since FY10, when it first started filing ANDAs (Abbreviated New Drug Application) in the US Market. It has received approvals for the first 2 products and filed another 7 in FY12. The first 2 products are expected to be launched in 1QFY13. Management has guided for a ~$2.5-5 million annual sales from these mid-size product segments.
  • Strong Balance Sheet – With long term borrowings at 75 Cr and short-term borrowings of 87 Cr, the total debt-to equity stands at 0.6x. Long term debt-to-equity is at 0.28x which leaves plenty of room for further leveraging. The company is in a position to fund its growth plans comfortably.
  • Consistently increasing Dividends – Dividend Payout is low at ~13% of Earnings in FY12. But to its credit the company has been consistently increasing dividends over the last 5 years. Dividends went up from 2.93 Cr in FY08 to 8.78 Cr in FY12, at an impressive 31% CAGR.

Bearish Viewpoints

  • Likelihood of Abbreviated New Drug Application (ANDA) filing fees going up – Establishment of Generic Drug User Fee Rates for Fiscal Year 2012 has revised the rates of ANDA filings. This is likely to see a significant escalation in expenses and may cause the company to pursue a more moderate ANDA filing strategy.
  • Higher Working Capital requirements – Working Capital/Sales has seen a significant jump in FY12 over FY11 – reversing the earlier trend. Working Capital by Sales is over 25% of Sales as compared to ~20% of Sales in FY11. This is attributable to the big jump in Inventory and Sundry Debtors – both going up by over 25% from FY11 levels. This might exert downward pressure on margins going forward.
  • Aggressive Expansion Plans – The company has indicated expansion plans entailing 400 Cr over next 2 years. This is a huge jump over the average spend of ~50 Cr per year over the last 4 years. This will mean stretching the balance sheet from the current comfortable levels, entail higher interest costs, and exert further pressure on margins.
  • High Exports contribution – With over 60% of Sales, coming from ROW exports any changes in the regulatory/political environments of these countries may impact revenue prospects
  • Forex fluctuations -Forex volatility remains a significant risk to be managed in light of over 60% of Sales coming from Exports.

Barriers to entry

  • Strong Brands –  Company’s leading brands listed in top 5 sub-therapeutic segments of
    • Ophthalmology (IMS Rank 7, Industry  ~800 Cr)- Olopat, Unibrom, Diflucor, Zaha and Nepaflam
    • Dermatology (IMS Rank 18, Industry ~2600 Cr) – Melacare, Pacroma, Salicia KT
    • Cardiology (IMS Rank 31, Industry ~5300 Cr ) – Atorfit CV, Met XL
  • Strong Direct Sales model – Over 2000 direct sales people to increase doctor reach and prescription sales. Going by the gain in market share and improved rankings, this model (invested in over the years), is working to the company’s advantage.
  • Lower Tax rates – The company’s locations continue to operate under MAT. Besides it also avails of R&D tax deductions (150%). Overall the tax rate is around 15-16%.

Interesting Viewpoints

  • Ajanta Pharma has received 2 Abbreviated New Drug Application (ANDA) approvals for Risperidone & Levetiracetam from the USFDA in FY12. It has also filed for another 7 ANDAs during FY12, taking the total ANDA Portfolio to 9. The company received its first product approval by USFDA in a record 16 months of filing the ANDAs.
  • Keppra® (Levetiracetam) 2011 net sales: € 966 millions by UCB Pharma Inc – the original patent holder.
  • Ajanta Pharma is expecting $2 -$2.5 million of annual revenue from both these products and is likely to launch both products that received approval in the first half of FY’13.
  • The company has guided to file 5-6 ANDAs every year with the USFDA, and to build up a portfolio of 20-25 products in the next 3-4 years in the U.S. market for potential contribution to its top line.
  • The company continues to launch new products in the market in different therapeutic segments. During FY12 the company launched 25 new products out of which 13 were first time in the country. (FY11 23 new products launched).

Disclosure(s)

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


Ajanta Pharma Management Q&A: July, 2012

Management Q&A

1. AJANTA PHARMA HAS HAD A GREAT RUN OVER THE LAST FEW YEARS. SALES HAVE DOUBLED IN LAST 5 YEARS TO OVER 600 CR WHILE NET PROFITS HAVE GONE UP MORE THAN 3 TIMES TO OVER 66 CR

Kindly take us through the journey and key success factors. Kindly explain Ajanta Pharma’s business model segments. Kindly explain how the company decided to concentrate on “Prescription-Sales” led business model.

Although we started operations way back in 1973, what you are seeing today – the seeds for this was really sown in the conscious choice we started exercising almost a decade back in 2002-03 – when we decided to concentrate on the Generics Formulations business with a 3 pronged focus – 1. Branded 2. Specialty 3. Innovative

We decided we will play in the branded generics space. We will not go for everything – we will have different basket for different markets -specialty segments. We will focus on country specific disease profiles. And we will bring innovative first-time products to the market.

The Innovative plank focuses on 2 aspects of delivery for the patient 1. Convenience 2. Compliance. For e.g we were the first to introduce  Met-XL  – a single dose BP drug. Similarly we have introduced several opthalmology products for the first time as eye-drops (which hitherto could only be taken orally with attendant acidity and gastric side effects). The convenience aspect encourages both doctors and patients to ensure better “compliance” to prescribed medicines.

How long did this process take? What were the main challenges on the way and how did the company manage these?

As mentioned before, this has taken us almost 10 years to reach where we are today. It has been a slow, careful and calibrated approach. In 2002-3 we were slightly negative on P&L or just break even. We could write-off accumulated losses only in 2005 (we were in a position to do it earlier also) since RBI permissions for the same were received only in that year.

We made a conscious decision to move away from low-margin tender-based sales. We invested in R&D and gradually built up the direct sales force.  In the last 3 years Direct Sales force has climbed up from 600-1300-2000.

Is it true that currently Tender based Sales constitute less than 20% of Sales?

For the last 3 years Tender-based sales contribution has been zero. We do have some institutional sales but those are based on rate contracts and for our Branded Generics products.

What is the current direct sales force size? And the distribution network?

We rely on a country-wide C&F Agents network, with our 2000+ direct sales force.

2. PRODUCT SEGMENTS

Kindly explain major product segments and their contribution to Revenues.

Cardiology, Dermatology  and Ophthalmology are our existing specialty segments. Orthopedics, ENT and Gastro Intestinal (GI) are the new Specialty segments that we have entered. As per IMS 2011, we are ranked No. 7 in Indian Opthalmology Industry valued at ~800 Cr. In Dermatology we are ranked 18th (Industry ~2600 Cr), and in Cardiology segment we are ranked 31st (Industry ~5300 Cr).

75% of Domestic Revenues come from our top 3 segments of Ophthalmology, Dermatology and Cardiac. Balance 25% come from new segments like Orthopedics, Gastro Intestinal and the Institutional segment

How has the company managed to produce Top 5 Generic brands in the Derma, Opthalmalogy and Cardiac segments?

Ajanta Pharma has leadership in many sub-therapeutic segments across specialties. We have been able to consistently move up the IMS rankings. This year we have been ranked 50th overall in terms of Sales in Indian market. This is because of our strategic focus, innovative product portfolio and leadership in many sub-therapeutic segments. We introduced many first to market products providing patient convenience & compliance.

In Opthalmology the company has totally 30 brands. 9 are leading brands with top 5 IMS ranking. Of these more than 16 products were first-time launch in India. Similarly in Dermatology we have some 34 brands. Leading brands are 4, with more than 10 First-time launch products in India. In Cardiology total brands are 51. leading brands are 3 with more than 6 first-time launch products in India.

Apart from the R&D skills, what does it take on the Marketing PUSH side?

New specialty segments, new product launches, brand building exercises and consistent investment in expanding quality direct sales force. In the last 3 years the sales force has gone up form 600 to 1300 to 2000. That is the main investment on the Marketing side.

Kindly take us through how your R&D spends and Marketing Overheads spend have looked over the years – as you made the transition majorly to the Prescription-Sales model?

We have one of the highest R&D spends among pharma companies of similar size. we spend 6.5% of Sales on R&D. We have invested in over 200 skilled personell with a 35000 sq feet dedicated facility.
Marketing spends will also be in a similar range.

How do you go about maintaining/augmenting market share of the top generic brands in domestic markets?

We have dedicated divisions responsible for each segment. They are responsible for chalking out individual programs in a very dynamic environment.

3. ROW EXPORT SALES. EXPORT SALES CONTRIBUTE MORE THAN 60% OF SALES.

Kindly explain the business model adopted in your ROW markets.

We are present in around 25 countries in Africa, South East Asia, Middle East, Central Asia and Latin America. Each country is treated as a different market. We have 1 distributor we go with for each country. With around 1300+ brand registrations across countries filed, we also have another 1300 or so brands under approval to ensure future growth.

The company has a policy of targeting select geographies for export of select products? How do you go about identifying such target markets? What are the criteria used?

We study the country specific disease profile, dissect what’s missing – again from the convenience & compliance angles. As explained above, this is a result of a detailed formalised market study.

What’s the revenue mix there between prescription-sales and tender-based sales there?

No Tender based sales.

How many employees in ROW markets? And in your experience is this better than the distributor-led model? Why?

We have a distributor in each country. We have some 300 direct sales force in RoW markets.

What’s the company’s hedging policy? How does it plan to manage the volatility ion Forex?

We do not hedge except for the natural hedging available by way of Foreign Currency loans.

4. USFDA AND ANDA APPROVALS. THIS IS A BIG SHIFT IN STRATEGY FOR THE COMPANY. TILL NOW THE COMPANY’S SUCCESS WAS ATTRIBUTABLE MAJORLY TO SUCCESS IN DOMESTIC AND ROW EXPORTS.

2 ANDA Approvals in 16 months. And 7 more filed in 2012. Kindly explain the segments these 2 products are launched for. What is the annual market size? How many companies with the same approvals?

Please understand the US market foray for what it is. We have deliberately not gone after blockbuster drugs. The market sizes for these products are small. You should see this as another means for us to diversify our geographical reach and open up additional revenue streams from new markets . We have had good success in RoW markets, and we do have some product advantages, but competition is not far behind!

While this is no doubt a very big achievement for the company, how long will this segment take before significant contributions come in? What kind of revenues can be expected from this segment in FY13?

Revenue contributions will not be significant, any time soon. You see today RoW markets contribute ~US$ 70 Mn. Even if we take a product basket of 10 approved ANDAs with a $4 Mn annual average business, it will add upto some $40 Mn. That itself will take some doing.

Kindly explain the Distribution/Sales model adopted by the company in US. What kind of partnerships have you struck? How does the company plan to ramp up sales in US market? What will it take for significant business to be derived – and by when?

The US is just another market for us. We have appointed 1 local distributor who will take care of Sales & Marketing efforts. We will not looking to have our own set up there.

What are the costs involved per ANDA filing? There are reports that additionally GDUFA fess are going to be levied which will make it very costly ($30,000 -$150,000) ? Kindly explain the impact of these and at what levels are these fees envisaged for FY13?

Yes, there are significant costs and may have a big impact on future plans. You see whatever has already been filed has been processed under existing fee structures. For any future filings, we will need to take account the new fee structures and its impact. We will have to assess fresh if it makes sense!

Why is the company focusing on developed markets? Isn’t the Indian and ROW markets large and lucrative enough? Why not push new products through well-established distribution channels in India/RoW, rather than push new products through new sales channels in US/Europe?

As explained before, RoW and Domestic markets will continue to be focus areas. Alongside we will always be looking to open up new markets and additional revenue streams for the company.

5. R&D SPEND. R&D SPENDS HAVE BEEN RAMPED UP OVER THE LAST FEW YEARS. FY13 SPEND AT 37 CR IS ~56% OF NET PROFITS.

Kindly explain your company’s R&D Philosophy and the sustainability of spends at such levels.

R%D spends at some 6-7% of Sales is something that we will continue to invest in. Regulations are becoming more and more stringent. The Approval/Registration process is getting extended. Our Focus is to remain ahead – in our specialty segments.

Many of your products are first-time launch in India. Kindly explain to us the philosophy of the company behind this strategy? What percentage is first-time products vs overall product launches in a year? Do all your first time products enjoy a 6-month or more kind of window before other competitors catch up?

The ‘Convenience” & “Compliance” focus as explained before is the mainstay of our specialty or innovative products business. The many first-to-market innovative products are based on a mix of Release profile, convenient dosages, combinations and/or new off-patented molecules.

Yes our first-time products do enjoy atleast a 6month first-mover window of opportunity to consolidate our branding. In many cases this goes upto almost a year.

Would you say this first-time product focus is an USP for Ajanta Pharma that differentiates it from other similar size branded generics manufacturers?

Yes Specialty Products is our USP and our strength. We will continue to build on our strengths. In keeping with the philosophy, the next 2 years Product Pipeline is ready, today. This rich new product pipeline should propel future growth.

6. PRODUCTION CAPACITY. CAPEX. THE COMPANY RECENTLY ANNOUNCED 400 CR CAPEX FUNDING REQUIREMENT IN NEXT 2 YEARS.THIS IS A BIG 4X KIND OF JUMP IN ANNUAL CAPEX FIGURES.

Isn’t this a very aggressive move? What are the current capacity utilisation levels? What are the underlying business/market assumptions that would require such a jump in Capex? Is there any link with the US market Foray?

We have 5 manufacturing facilities. 3 are formulation facilities in Aurangabad and 1 formulation facility in Mauritius for African countries. And 1 API facility in Aurangabad. Our Paithan formulation facility is one of the best in the country and approved by USFDA, MHRA, WHO Geneva and MOH of many other countries.

Yes, you are right about the jump from our normal Capex levels. There are good reasons for the move now. You see currently some 30% of our production is outsourced. At the rate we are growing, within 2 years it would have meant 50% of our production being outsourced.

We thought about it and decided we cannot take that risk – for the kind of specialty/innovative products we are in. We need a certain degree of control over Timing, Launch readiness, Quality. Besides that 50% of outsourced manufacturing when brought in-house will allow us greater operational efficiencies.

Also it will help us streamline product segmentation. Today we have only 1 plant that is USFDA/MHRA/WHO approved, and that already is working at 75% capacity utilisation levels as it caters to other markets as well. We are looking to dedicate this 1 plant exclusively for developed markets. Approvals for a separate new plant usually takes 24 months.

This will mean is we can switch other production in this plant, plus the outsourced portion, to the new plant/or other plants.

Does this mean you will stop outsourcing altogether?

Well, some 20% to 30% outsourcing may continue.

Is funding secured with the $55 Mn ECB and Internal accruals? What will be the order of Maintenance Capex needed over FY13 and FY14?

Yes, this ECB Loan comes with a 2 year moratorium and 4 year repayment period terms. Maintenance Capex will vary from 20-30 Cr and can go-upto 50 Cr depending on the specifics/de-bottlenecking, etc.

Post ECB, the company will have US$ receivables and payables in US$ as well, how much of a natural hedge will this bring in? Will there be major changes to existing hedging policy?

Yes, we probably have to re-look at our Hedging Policy.

7. WORKING CAPITAL. WORKING CAPITAL HAS GONE UP SIGNIFICANTLY TO OVER 25% OF SALES COMPARED TO EARLIER 20%. DEBTORS AND INVENTORY HAVE BOTH GONE UP BY OVER 25%.

What is the outlook for the next 2-3 years? As the company operates at a larger scale, will this keep going up? What are the company’s targets on this front?

Inventory levels went up this year due to some specific Raw Material situation. We should be able to revert to our normal 20% levels as Inventory Days. Debtor Days will probably remain at 25% levels.

8. MARGINS & PROFITABILITY. MARGINS AND PROFITABILITY HAVE MADE BIG UPWARD STRIDES IN THE LAST FEW YEARS. FROM ABOUT 6% LEVELS IN FY08, NET MARGINS HAVE CROSSED 11% IN FY12. OPERATING MARGINS HAVE TOUCHED ~21%

What are the key success factors? Where do you see margins stabilising? What is a sustainable level for the next 2-3 years? Why?

Yes in terms of EBITDA improvements that we have seen over the last few years, we have probably peaked. That pace will slow down, we may register small 100 bps kind of improvements. We certainly hope to be able to sustain at these levels.

9. WHERE DO WE GO FROM HERE? WHAT IS THE NEXT LEVEL FOR THE COMPANY?

Post completion of planned Capex (400 Cr) what is target revenue mix and target margins from different geographies (FY14-FY17)?  Where do you see the company in the next 5 years? What are the major milestones on that road and what are the major challenges?

We have our internal targets, for sure. We are here today because of what we started doing say 3 years back. We will be in a different (better) position 3 years into the future. The idea is to focus on our strengths, keep persevering in our goals, ensure that we make progress and not slip back or fall down from where we are – in spite of all the dynamic changes in the environment.

We want to be CONSISTENT, keep growing at a steady pace. We want to keep growing above industry average with improved profitability.

In 5 years time, what % of revenue will come from the US and ROW Exports, and what % from domestic?

Domestic will continue to be ~37-40% contribution levels. US contribution will be bigger.

10. LONG TERM VISION

Kindly elaborate on the long term vision and the strategic directions the company will be setting goals for itself.

You see 4 years back we were ranked 163 among Pharma companies in India as per the IMS MAT Survey. In 2012, we have made it to the 50th.

We will continue to focus on our main Segments. In Optha we are number 7 currently, our aim is to reach No. 2 position there. Similarly in Derma we are at No 14, we can considerably improve on that.

Which among dermatology, cardiology, ophthamology or other segment are the thrust/focus areas for the company? Where does the company see maximum potential for growth?

In India, the Basket approach works better. Doctors give priority or preference to a company with a larger basket of products in their segment. A cardiologist for example, will prefer an MNC company with say 5-10 products than say an Ajanta Pharma with say only 2 products.

Dermatology, Ophthalmology and Cardiac are focus areas for the company. In Ophthalmology the Industry has grown at a 5yr CAGR of 17%, and we have managed to grow at 23% CAGR over last 5 years. Similarly Cardiology Industry segment has grown at a 5yr CAGR of 17% and we have grown at a 24% CAGR. Dermatology Industry has grown at a 5 yr CAGR of 18%, while we have managed to grow at a much healthier 32% CAGR.

There is enough growth potential in all the 3 segments and we are constantly working to increase our product basket in these segments. The new sub segments like Orthopedics, Gastro, etc also have good potential.

Is the company thinking of partnering any bigger MNC company to scale up?

The segments that we operate in are niche segments. Small market size. Some of the new segments are even smaller. Bigger MNCs are not really interested in segments of these sizes, because even a 10% share of that market is pretty small for them.

Is the company looking for collaboration/partnerships for US market? How do you plan to cater to competition from larger Indian peers in US (5-10 years span, strategy)

This is still too far away to comment anything at this stage. we will see as things develop and our penetration increases.

Given the increased generic penetration levels in next 5 years, where do you see margins stabilising in 5 years time from now?

Fortunately we are not in the mass market volume segments like the Anti-Infectives/antibiotics (we were a late entrant) where it has become ultra-competitive fragmented – just too many players.

Can’t really say what will happen 5 years from now. If Rupee goes to 80 or 30 to the US$! Or other dynamic shifts in the environment. Having said that, in the face of normal competitive activity we should be able to hold our own and sustain at these levels – given that we operate in Specialty niche segments.

11. RISKS. GOING FORWARD, WHAT ARE THE MAJOR CHALLENGES & RISKS FOR THE COMPANY?

There are many sectors coming under the Competition Commission lenses. Any chances of Pharma sector coming under its purview?

Regulatory RISK is the possibly the biggest risk the industry/company faces. Regulation and compliance norms are getting stricter and tougher. There are many forces at work. The industry on its part has been trying to engage and work with the Government – to come out with a comprehensive National Drug Policy, now for a number of years.

What are the other challenges before the company?

Forex Management is another one. Volatility in either direction is a concern and is a dynamic challenge that we have to gear up to face.

Changing consumer patterns is also a bigger challenge for companies like us. There is much more awareness and access to information on the part of consumers. We need to be able to understand and harness these shifts in consumer patterns.

12. CONSISTENT PROMOTER BUYING. THERE HAS BEEN CONSISTENT BUYING BY PROMOTERS FROM OPEN MARKET FROM OCT 2011. PROMOTER STAKE HAS CONSEQUENTLY GONE UP TO ~70% IN Q4FY12 FORM ~66% IN Q2FY12. THE BUYING HAS BEEN SUSTAINED IN Q1FY13 TOO!

Would you like to make any comment on this? There seems to be a hurry to race to 75% stake by Promoters. Do you find the company undervalued at current levels? Are there any major events unfolding in near future??

There are no external factors at play. This is part of a natural scheme of things.The Promoters believe in the prospects of the company. And yes, they find it undervalued. They have been enhancing stake in the company from time to time.

Also pledged shares have again gone up. From 200,000 shares pledged in Q2FY12 to 550,000 in Q3FY12. Please comment.

That is only by way of financing the additional share purchases.

Disclosure(s)

Atul Sethi: No Holdings in the Company; ;
Ayush Mittal: 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, 2012

Management Q&A

1. POST-EXPANSION PRODUCTION CAPACITY OF 276,000 BY FY2015. SINCE WE TALKED LAST TIME IN JULY 2011, BKT’S AMBITIONS HAVE GROWN MULTI-FOLD. THERE IS FURTHER CAPACITY EXPANSION OF 30,000 MT WITH AN OUTLAY OF 400 CR. THERE IS A NEW MIXING PLANT FOR 100 CR, AND A TOWNSHIP ~ANOTHER 100 CR. 600 CR OUTLAY IN ADDITIONAL PLANS IN A YEARS TIME.

You seem to be in a hurry to consolidate your position. It looks like your FY12 performance and developments/feedback from the Market has fired more ambition for BKT. Is this a sign of a more confident/more aggressive Management?

It’s been a natural normal advancement in our plans. You know that we were making small quantities of OTR Radial in FY12 from existing plants. We received very encouraging feedback from the OEMs. That led us to fast-tracking some of the plans on that front. We also saw that the Captive Power plant which we were putting up at Bhuj could now have full utilisation with this additional plant (in earlier case, we would have had to sell spare power to the Grid).

The other important aspect we were dealing with was about attracting and retaining talent. The plant is 30 Km away from Bhuj City – with no good educational facilities, etc. We realised an Integrated Township will go a long way in help addressing these.

What are the risks according to you?

Unforeseen demand crash! That’s the only risk so far as we can see.

2. FUNDING FOR ADDITIONAL CAPEX OUTLAY OF 600 CR. ON 31ST MAR FY12, LONG TERM DEBT POSITION STOOD AT ~900 CR. YOU HAVE MENTIONED ANOTHER $100 MN FUNDING TIED UP AT LIBOR+320 BPS.

You must be looking to draw this soon. Long-Term Debt to Equity would cross 1.4x, probably for the first time. There is also Short Term borrowings of ~750 Cr. Is the company comfortable with these figures?

Yes the new 500 Cr Loan will take the total debt to about 2100 Cr. If you take out the Working Capital borrowings, long term debt would still be at ~1.3x. We are comfortable with that, even if that figure goes up to 1.4x we are okay.

In FY13 you will be spending ~800 Cr in Capex. Do you envisage a consolidation phase in FY14 and FY15, or further capex/borrowings are pretty much the order?

There will be 600-700 Cr capex in FY13 and the balance 500-600 Cr in FY14. Any fresh Capex will not be needed before FY16.

Also you should note that we have about 280 acres of land in Bhuj. Currently we have utilised only about 125 acres. Further Capex will be at lower levels.

3. SIGNS OF A SLOWDOWN IN KEY EUROPEAN MARKETS. YOU HAVE MENTIONED SEEING A SLOWDOWN IN EU REGION IN THE FIRST 2 MONTHS. YOU HAVE ALSO MENTIONED SLUGGISH OEM DEMAND.

How are you factoring this in? To maintain its position in the EU market, BKT may have to further reduce its price advantage of 20%?

That was a general statement acknowledging the state of the economy. We are growing. We have a good visibility.

Paring prices at this stage will be an aggressive move, and not warranted. We have no such plans. We would rather be conservative.

While Rupee depreciation effect on RM may be neutralised by US$ sales, this must be queering the pitch for Euro zone sales booked in Euros. Your RM import bill is probably 15-20% higher vis-a-vis major competitors in EU. Isn’t the competitive advantage degrading fast for your comfort?

Actually no such thing. All our imports are in US$. The competitors also have to import in US$. As far as the Euro is concerned we had average realisations of Rs 63-64 to the Euro. In FY13, the average realisation is ~Rs 70 to the Euro, so we are in a better position.

All our pricing is in US$ or the Euro. Rupee has nothing to do. If we managed very well when Rupee was at 39 to the dollar, we should be able to manage much better at current levels.

We have a natural competitive hedge in Europe. With a falling Euro their imports starts going up; becomes uncompetitive for the bigger players. Yes if Euro-US$ PARITY, if that happens, we might face problems with a falling Euro as realisations will be going down. But that doesn’t seem to be happening at the moment. US $ remains strong with $ at 0.81 Euro.

In FY12 we had 40% revenue growth. 20% of this was driven by volume growth. We had taken a 6-7% price hike, so the balance is all from currency growth.

How are you looking to mitigate these effects? You have mentioned the US market making up for some of the loss from EU. Will we see a major drive to increase penetration in the US market and RoW markets?

See in 2007 we had US Sales of $15 Mn. That contributed 6-7% of our sales. In 5 years we are at 100Mn in US sales which is now ~25% of Sales. This is a natural progression. As we have more capacities, we will penetrate more markets.

4. GUIDANCE FOR FY13 AT 160,000-165,000 MT. THIS IS AGAIN BASICALLY A 20% GROWTH IN VOLUME TERMS, SIMILAR TO FY12. HOWEVER THE COMPANY HAD REGISTERED A 40% GROWTH IN SALES IN FY12 BY VIRTUE OF PRICE HIKES AND A BETTER PRODUCT MIX.

FY13 may turn out to be very different? Rubber prices have corrected by some 20% in last 6 months and are expected to correct even further as mentioned by you.

Yes we may have to pass on some price reduction benefits later in the year, depending on the competitive activity. So far we have not seen any such moves. There is also the lag effect. Earlier Inventory was of 4-5 months. So this may become relevant only in subsequent quarters.

We remain confident of a revenue growth of 38-40% depending on the currency.

Where do you see price realisations stabilising in FY13? Is it correct to assume that price hikes are less likely? Better product mix may drive up realisations a bit? By how much?

Yes Price hikes are not on in the current scenario. Better realisations from Product Mix will start reflecting from next financial year. This year the new plant will only contribute probably 10-15000 MT of OTR radials and some from our existing plants – which may not be significant.

5. MARGINS & PROFITABILITY

Where do you see Operating margins stabilising for the next 2-3 years?

We are pretty comfortably placed for FY13. In the coming years too we should be able to operate within our historical range 18-21% EBITDA levels.

In a depreciating rupee scenario, do you foresee the revised Schedule VI norms for Forex accounting taking a further toll on margins?

No it works to our advantage. We are a net Forex earner.

The currency fluctuations occur because we book Sales at the Customs rate when goods go out of the factory, and realisations happen at the forward contract rate. This difference was earlier attributable to Sales but now need to be recognised as Forex gains/loss in Other Income (as per Schedule VI norms).

On the other hand, the Mixing Plant at Bhuj is supposed to bring in efficiencies and savings on transportation & logistics costs. There is also a co-generation plant contributing to power savings. What order of savings is this likely to bring in?

There should be a differential of 2-3%.

Interest cost capitalisation benefits for this phase of Capex may be over soon? That will see a spurt in interest costs and exert further pressure on Net margins. Where do you see Net Margins stabilising at?

Today we have access to funds at pretty low costs. Our net cost of borrowing was only 3%. Working Capital borrowings are at 2%. We also take advantage of buyers credit.

The next tranche of loan is also at low cost 3.2 +3m Libor which is 0.45, so 3.65% or so. In FY13, the interest costs will be applicable only for half year. In FY14, interest costs for the full year will be ~60-70 Cr.

We should be able to main PAT at 9-10% levels.

Could you explain 3m/6m Libor terms?

Basically refers to the interest payment cycles. 6 month Libor would mean interest payments are due every 6 months, which are at 0.75%. 3 month Libor is at 0.45% with interest payments due every quarter.

This seems like a big advantage. Not many companies are able to manage finance costs at these levels, are they?

Actually everyone should be able to access funds at 3.5%+ Libor. So that translates to 4.25% to atmost 5% costs.

But yes, smaller loan amounts probably come at a higher cost.

6. 30,000 METRIC TONNES OF LARGE AND ULTRA-LARGE SPECIALTY OTR TYRES

Kindly tell us a little more on what this means for the company in the coming years? Are you looking at expanding the presence in this segment in a big way?

OTR -all steel radial is a technology advancement. Just like it moved from cross-ply to normal radials (Nylon cords), now the technology has moved to all steel radials.

The total demand is ~$13-14 Bn globally, growing at 4-5%. Of this $4Bn is Agri demand. The balance $8-10 Bn is non-Agri – mostly Industrial, Mining, Construction – what we call OTR (Off the Road) And these require large and ultra-large specialty OTR tyres.

As you are aware our current mix is 33% OTR, 63% Agri. So this is very big incremental opportunity for us. The results of our initial attempts have been very encouraging. We should be able to encash on that.

We had a 3.5% market share 5 yrs back. We are at 5-6% market share currently. We should get to a 10% market share by 2020 or before.

This will start contributing from FY14? What kind of realisations are possible in this segment?

These will start contributing from FY15. 30000 MT should get us a topline of 750 Cr, or [email protected]

What is the total size of the land available at Bhuj facility? And how much of this will have been utilised by the new plant, mixing facility and Township?

as mentioned before, total area is 280 Cr. We are using up only 125 acres for all above.

In the interim, Agri segment remains the biggest segment for BKT. How is BKT’s Agri business affected by recession, monsoons?

Recession affects the OEM segment first. As you are aware our business model caters mainly to the Replacement market. In recession people stop buying new equipment, but they continue operating old equipment – for that they need replacement tyres!

Also Agri/Food business is recession proof. It is evergreen whether it is US, EU or rest of the globe. Someone has to produce, right? Certain countries like Israel are not monsoon dependent. Drip-Irrigation is very advanced.

We are not dependent on the Indian market for Agri segment.

7. ORDER BOOK POSITION. FOR THE LAST FEW QUARTERS WE HAVE BEEN NOTICING THE COMPANY MAINTAINING AN ORDER BOOK POSITION OF ~65000 MT OR ABOUT 5-6 MONTHS OF SALES AT THE CURRENT RUN RATE OF 12000 MT A MONTH.

Do you see this changing in the coming years in view of overall demand slow-down and capacities being ramped up at the same time?

It is a good thing if we can serve the customers in time. Order book may come down in future form the 4-5 months order book levels currently, as customers look to pare their inventory levels.

But there is a basic 45-60 days shipment time for EU/US as it goes by Sea. So customers have to book atleast 3 months in Advance taking into account the transit time.

Only someone like Michelin attempts Just-in-Time delivery models with company owned warehouses.

Why can’t BKT adopt similar models?

We have chosen to go the distributor route. In our case the Distributors play that role of warehousing.

We can chose to knock of a 15% expense difference that is attributable to the distributor-led sales model. We can also set up just in time, with company owned warehouses, but then we will end up competing with our distributors. We find no incremental gains in doing so.

8. OUTLOOK FOR RUBBER PRICES IN FY13. LAST YEAR WHEN WE TALKED ABOUT THE SPIRALING RUBBER PRICES, YOU HAD ATTRIBUTED SPECULATIVE INTEREST AS THE MAIN REASON DRIVING UP PRICES, AND NOT DEMAND-SUPPLY GAPS.

What are the reasons for the downtrend this year? Is it true that there is surplus production of rubber in Thailand?

The surplus production is actually across the globe. 2004-05 had seen lots of new rubber plantations coming up. It takes 6-7 years for these to mature. This has now come into the market only from this year.

Prices are expected to fall lower. We have cut our inventory levels down to 2 months (from earlier 5 months).

9. FOREX MANAGEMENT

US Sales currently act as a natural hedge for the raw material imports. You have guided for a 20% volume growth in FY13. Do you expect US Sales increase, say from 25% of Sales to 30% of Sales to be able to compensate?

It is not only US sales. Anywhere other than EU, it is US$ Sales for us.

Or this will need hedging on the US $ front too, apart from hedging the Euro?

Not necessary for Sales. We might require some hedging, only to the extent of the loan repayments.

The ECB repayments are starting in FY15, that will need to be factored in? What is the repayment period?

If Rupee depreciates significantly from here, we might need to hedge on this front.

10. SUSTAINABILITY OF COMPETITIVE EDGE. THE LARGE VARIETIES-LOW VOLUME NATURE OF THE OHT MARKET MAKE IT UNATTRACTIVE FOR NEW PLAYERS TO ENTER THIS MARKET, INCLUDING MAINSTREAM TYRE MAJORS.

When we talked about players like Alliance with similar cost advantages as BKT, you had clearly identified the ability to maintain a large no SKUs as BKT’s competitive edge. That Alliance is the closest and they will take atleast 5 years to catch up to offer any serious challenge to BKT. Has this position changed, or are you still sanguine on this front?

Alliance has a 45000 MTPA facility in Israel. They also have 30-35000 MTPA production in Chennai. Further progress in Chennai is reportedly halted due to labour problems. They have acquired some land in Jagedia near Bharuch. Israel is a high cost location so they dont get much advantage from there. So they are still 4-5 years away from catching up.

They acquired GPX which gets produce from China. The GPX acquiaition gives them the distribution access. But it’s not really a marketing challenge, it is still a manufacturing challenge. Getting to the right no of SKUs is key.

Price differential of 30-35% in FY09 with OHT majors in US and EU markets is eroding steadily. In FY11 this was down to 25%. And in FY12 we hear this is down to only a 20% differential. Will this be sustainable beyond FY15, and Why?

Well the price differential is still in the range of 25-30%. BKT is now a brand in its own right. It may come down to 20-25% in the next 5-7 years. The erosion cannot be more than 4-5%.

Promotional expenses would be up then, on the flip side?

Yes, but that’s only incremental in nature.

11. MAJOR CHALLENGES BEFORE THE COMPANY. RM AND FOREX FLUCTUATIONS ARE DYNAMIC CHALLENGES THAT BKT HAS TO FACE UP TO AND IS DOING A VERY COMMENDABLE JOB.

Is it correct to say Resources, Labour and Training are the bigger challenges before the company?

Resources – not an issue anymore. We have access to easily available funding at very good terms.

Labour and Training are issues. The ramp up happens slowly. That is the main reason our production capacity can only be ramped up to 30000 MT in a year or so. We have very good long term agreements signed with the labour force.

What is the size of the Labour force needed for the Bhuj facility? And how are you coping with these challenges?

Ultimately we will be needing about 3000 strong workforce there. We are building that up gradually in tune with the demand situation.

When you say long term agreements, kindly explain?

We have long term settlement agreements at all 3 locations. They are of 4-5 years duration.

12. CHRYS CAPITAL EXIT

Chrys Capital off-loaded its entire stke of 9.59% in BKT recently. It is surprising that a long-standing investor in BKT chose to exit at a time like this. Would you please comment on the circumstances and timing of this exit?

Chrys Capital invested in us from 2005. It is already 7 years. The fund that invested had a term of 5 years and it had already taken 2 extensions. Under its terms it could not get a 3rd extension, hence the exit.

Why would they choose to exit, just when the benefits of the expansions are about to kick in?

Also you may know Ashish Dhawan is exiting Chrys Capital to set up his own. He offered the investment to be liquidated rather than being taken over by new team which they accepted under the conditions.

You are also aware that bulk of it was taken up by 3 fund houses. Franklin Templeton, HDFC and BNP. Franklin Templeton took up the biggest chunk.


Disclosure(s)

Ayush Mittal: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
: ; ;
: ; ;

Oriental Carbon & Chemicals

Background

Oriental Carbon & Chemicals , belonging to JP Goenka Group of companies, is one of the market leaders in the production of Insoluble Sulphur for the Tyre and Rubber industry around the world. 

It has state of the art manufacturing facilities in India at Dharuhera (Harayana) and at Mundra (Gujarat). Apart from Insoluble Sulfur OCCL also manufacture Sulphuric Acid and Oleums in the chemical complex at Dharuhera. 

Starting in 1994 with modest capacities of 3000 mt per annum capacity, The production capacity of Insoluble Sulphur now stands at 22,000 Mt per annum.


Main Products/Segments

Oriental Carbon & Chemicals enjoys a dominant market position in the domestic market by virtue of being the only local manufacturer of Insoluble Sulphur in the country.

The company also reportedly enjoys a favourable market position as the ‘Second Alternate Supplier’ in the global industry, which is dominated by Flexsys of USA.

The other products manufatured are Sulphuric Acid & Oleum which constitute less than 10% of the Sales Mix. Insoluble Sulpher contributed 90.65% of Sales in FY12.

Exports constitute ~64% of Sales in FY12.


Main Markets/Customers

Insoluble Sulphur is a key ingredient for vulcanisation of rubber and is mainly consumed by the Radial Tyre Industry. Increased Radialisation of tyres in domestic market is favourable for the company.

Strong customer base comprises major tyre companies in the world like Continental AG, Goodyear, Bridgestone, Pirelli, Kumho Tyres etc. for exports and Apollo Tyres, Bridgestone, JK Tyres, MRF Tyres, Ceat Tyres, Goodyear India, etc. in the domestic market.


Bullish Viewpoints

  • 2nd Alternate Supplier – Solutia remains the market leader with 70-80% market share. Oriental Carbon commands 8-10% market share. Shikoku Japan caters to mostly Japan & Korean markets. Chinese production is consumed in-country. That leaves Oriental Carbon in a “preferred” alternate supplier position for Europe and RoW markets. (No US presence at the moment).
  • Long Term Relationships – Most tyre majors view the relationship with OCCL as strategic in nature. The co-operation therefore extends to commercial and technological terms framed to be mutually beneficial, with a long term perspective.
  • Excellent Track record – While 5yr Sales CAGR is a healthy 25%, Net profits have galloped away at an astonishing 73% 5yr CAGR. This is on the back of Operating Margins moving up from 14-15% levels to ~30% levels in last 2 years. Please read the Oriental Carbon Management Q&A to read why this looks sustainable.
  • Higher Grade products – The company has been making investments in manufacturing of tailor made grades of Insoluble Sulphur, which command a premium over conventional grades of Insoluble Sulphur as the European markets are witnessing a shift from conventional to value-added grades of Insoluble Sulphur. The value-added grades provide economies and more flexibility in production to the tyre majors.
  • Consistently growing Exports – Exports have climbed up from ~46 Cr in FY08 to over 140 Cr in FY12 at a ~32% CAGR. This establishes growing acceptance with Tyre majors worldwide.
  • Comfortable Debt position – Long Term debt stood at 116 Cr in FY12. At a comfortable debt-to-equity ratio of 0.77x the company seems well-placed to fund its growth requirements in the near to medium term.
  • Aggressive Capex – The company has doubled capacities by completing an 11,000 MTPA green-field expansion at Mundra SEZ taking the total capacity to ~22,500 MTPA. This was completed at a cost of ~120 Cr. It has lined up another 11,000 MTPA expansion at the same premises, which will be taken up on better demand visibility.
  • Lower tax rates – The Mundra Facility enjoys MAT credit at 18% rates. The effective tax rate may come down to 20-22% for the company as production from the Mundra facility takes off. The company can offset the 18% MAT credit against overall tax liability for the company.

Bearish Viewpoints

  • Cyclical nature of the business – The demand of Insoluble Sulpher is essentially derived from demand for tyres in vehicles which remains cyclical and depends heavily on economic conditions.
  • Direct linkage of Raw material to Margins – High correlation of operating margins to raw material volatility. The time lag is 3-6 months for RM price volatilty pass-on.
  • Slowing demand situation in Europe – The company mentions some slack in demand from Europe which it hopes will be offset from demand uptake from other markets.
  • Aggressive Capex – The company has just finished doubling its capacity to 22,500 MTPA and is working at 60-70% capacity utilisation levels. It has also plans for aggressively expanding another 11,000 MTPA in 2 phases of 5500 MTPA. In view of the slowdown in demand, further expansion may have to be put on hold for longer than the company anticipates ( ~6m).
  • Slower growth in FY13 – Q1FY13 results point to a better performance on the Operating Margins front. But Sales growth is tapering off at barely 18% (FY13 Sales growth at 36%). This result is a cause for concern and may be pointing to lower volume growth of only 10-15%. This is because Rupee depreciation benefits of last 6 months (lag effect) would have contributed significantly to the volume growth of 18% for the quarter.

Barriers to entry

  • Small market size. Estimated to be ~250,000 MTPA
  • Closely guarded technology. Market Leader Solutia dominates with 70-80% market share. Only 4-5 players globally.
  • Long Term relationships with most tyre majors – preferred alternate supplier.
  • Capital intensive nature of the business
  • Long time required for getting approvals from the tyre majors, more than 2 years.
  • The tyre majors need a minimal assured supply of 2500-5000 MT for them to even consider switching vendors. Small tyre customers usually do not bet on a new vendor unless a tyre major has first approved.

Interesting Viewpoints

  • Next opportunity from US market – The company has been pursuing some tyre majors for penetrating the US market. The next big growth will come from the company’s success on that front
  • Big beneficiary of rupee depreciation – Exports contributed ~64% of Sales in FY12. Imports for FY12 ~14% of Sales (RM, CG, Spares & traded goods).

Disclosure(s)

Donald Francis: No Holdings in the Company;


Oriental Carbon Management Q&A: July 2012

Management Q&A

  1. ORIENTAL CARBON & CHEMICALS HAS TAKEN SOME RAPID STRIDES OVER THE LAST 5 YEARS. SALES HAVE GROWN AT A 25% CAGR WHILE NET PROFITS HAVE GROWN AT AN AMAZING 73% CAGR. ALSO THE COMPANY HAS BEEN OPERATING AT A DIFFERENT LEVEL SINCE FY 2010. OPERATING MARGINS HAVE JUMPED FROM 14-16% LEVELS TO 30% PLUS LEVELS IN LAST 2 YEARS.

Kindly share the journey. The business started picking some momentum around 2005-6. What were the catalysts?

You see in 2006 we had doubled our capacity to ~6000 MT from earlier 3000 MT. There was the EOU unit benefit and economies of scale kicking in.

The company entered a different trajectory from 2010, as margins moved dramatically upwards. What changed in the market dynamics? What have you done differently in the last few years?

Well actually the different trajectory started from 2009 itself. 2008-9 was a bad year because of huge increases in RM Sulpher prices. But it wasn’t a bad year for Oriental Carbon!

You see Insoluble Sulpher market is dominated by Flexisys. They set the pricing terms. They had different pricing policies for different regions – US, Euro, and Others. The Euro-Dollar volatility also used to lead to anamolies, which Flexisys could not correct dynamically. This was going on for last 7-8 years. The huge increase in RM in 2008 resulted in big anamolies, and Flexisys had to do something to smooth out these. This they did finally by resorting to a quarterly Dollar pricing policy on a global basis – with an adjustment range for RM (Sulpher) fluctuations.

Oriental Carbon also followed suit, and started entering into similar quarterly pricing agreements with customers instead of annual agreements. This allowed flexibility to pass on the raw material price increase.

So economies of scale with capacities doubling & continuous de-bottlenecking, benefits from the EOU status, and these changes in the pricing policy resulted in significant improvement in the profitability.

  1. INSOLUBLE SULPHER IS TODAY THE MAIN PRODUCT SEGMENT AND TYRE MAJORS ARE THE MAIN CUSTOMERS. FLEXISYS (USA) IS REPUTED TO BE THE DOMINANT SUPPLIER WORLDWIDE. APART FROM ORIENTAL CARBON, OTHER PLAYERS KNOWN SHIKOKU (JAPAN) & SINORGCHEM (CHINA).

Kindly tell us more on the market Opportunity. What is the total size of the market- Domestic & Exports? What is Flexisys market share and what is yours? What are the growth drivers – both in India & in Export markets.

This is a niche market and there are no industry-published figures. We can only provide some estimates.

As per our data, the total market is ~225,000 MT per annum. Solutia controls 70-80% of this market. Oriental Carbon caters to about 8-10%. Shikoku, Japan goes neck & neck with Oriental Carbon. We believe they have a capacity of 17-18000 MTPA.

Insoluble Sulpher is mostly used by the Tyre Industry. Increased Radialisation is the main demand driver.  A shift in preference for value added grades is being seen as these offer ease of handling and more production flexibility to the Customer.

How big are the Chinese & Japanese competitors. Do you enjoy any competitive advantages over the other Asian players?

Chinese capacity is reportedly 35,000 MTPA. Sinorgchem, a new entrant, is also reportedly putting up a new plant of 15,000 MTPA capacity. The first phase of 5000 MTPA is supposed to come up in 2012-13.

The Chinese capacity is at present completely consumed in-country. Shikoku is serving Japan and Korea mostly. In Europe, for example Oriental Carbon is the only competitor to Solutia.

How do you match up in quality to say market leader Solutia?

OCCL Insoluble Sulpher grades substantially match that of the larger players like Solutia.

  1. ENTRY BARRIERS. COMPETITIVE ADVANTAGES.

Kindly tell us more about the nature of this market? Why is one company Flexysis having such a dominant market share? Why has it not attracted more investment and more players? What are the entry barriers?

As explained before, the total market size is small. The technology is closely guarded. No tyre major is interested in shifting vendors or entertaining new vendors unless you can supply in sizeable quantity – atleast 2500-5000 MT. The approval process is also very lengthy and costly.

The risk/reward situation does not warrant much fresh investment.

Oriental Carbon has been in Insoluble Sulpher business since 1994! But Business Performance has become noticeable only since last 2 years, Why?

There is also the history of the company that you have to consider. Carbon Black was the main business. This business gradually became a commodity business. We recognised Insoluble Sulpher as the business of the future, but were struggling to put up required capacity till 2000. We decided to divest the Carbon Black business altogether only after the new capacity was up.

Solutia has reportedly announced plans of 50000 MTPA expansion in Thailand. How does this development impact OCCL? When will this new capacity likely to come on-stream?

We don’t see anything changing materially. It is in market leaders interest to maintain price levels. If the pricing reduces by 1$ we are affected to the tune of $20,000, but they may then be staring at a $200,000 impact.

Having said that, we also need to be careful of not altering the current balance. We can grow at a calibrated pace.

How is Oriental Carbon placed today? Will it be able to sustain its competitive advantages? Why?

We are reasonably well placed. Any new plant needs fresh approvals which is lengthy & time-consuming. For a new line (in existing plant) a competitor needed 1 full year for approvals.

This is also a very capital intensive business. Asset Turnover is generally in the range of 1:1. Rupee depreciation etc may take it to 1:2 at most. For us to get a payback in 3-4 years time, the business needs ~25-30% margins, at the minimum.

We hope to be able to maintain that due to the reasons mentioned before – Limited Market size, closely guarded technology, lengthy approval process, etc. discouraging fresh investments.

  1. CUSTOMERS. REVENUE CONTRIBUTION FROM TOP CUSTOMERS.

You have been mentioning OCCL getting preferred alternate supplier status. Can you elaborate on that.

As mentioned before, in certain geographies like EU we are the only other supplier capable of servicing the tyre majors. So we have relationships going back a number of years.

Do you have long term contracts with any of the majors? What is the normal contract duration?

Yes. we have very long term arrangements with some of our customers. No formal contracts, but s mentioned before strong relationships and understandings that extend to both commercial and technological aspects.

Kindly share recent customer successes and or deeper penetration into existing accounts. Have more marquee names been added to the list?

Continental AG, Goodyear, Bridgestone, Pirelli are some of our big customers. In the domestic market we have MRF, Apollo, JK tyres and some more.

How much does your top 3 customers contribute to Sales? Does any one customer contribute more than 10% of Sales?

TBD

What kind of approval process do you have to go through with your major customers? Do you have to take plant-specific approvals? Is the new Mundra Facility approved for all your customers?

Approval process varies from customer to customer. Any plant in a new location has to ofcourse go through fresh approvals. The Mundra plant is approved. The new line at Mundra plant will have to go through the process, but will take less time.

Are there any majors that you are persuing currently that may lead to increased sales?

We have been pursuing Michelin for some time now. Its under process.

  1. CAPEX. INSTALLED CAPACITY HAS GONE UPTO 22500 MTPA. YOU HAVE BEEN MENTIONING CAPACITY BEING PRE-SOLD. YOU HAD ALSO BEEN MENTIONING LAND AVAILABILITY FOR THE NEXT 11000 MTPA EXPANSION.

Looks like, demand was far outstripping supply. Please tell us a little more on the demand situation you saw in FY11 and FY12. How is the demand outlook looking now with double the capacity?

Demand situation warranted that we expand quickly. Yes capacities were pre-sold as per arrangements with our customers. We are working at something like 75% capacity utilisation at the moment. The Phase 1 expansion of 5500 MT is working at full capacity and the phase 2 5500 MT expansion is at 25-30% utilisation levels.

What is the total Capex cost for the 11000 MTPA incurred in Mundra Phase I & II expansions? And how much will be needed for the next 11000 MTPA expansion?

The total capex for 11000 MTPa was ~120 Cr. The next 11000 expansion is in the same premises (already acquired) will cost less due to spreading of fixed costs.

The latest AR mentions slowing growth possibility in Euro Zone. Have any major customers cut back on plans? What are the plans for the next expansion?

The last 11000 MTPA expansion was pre-sold. We have agreements in place. But customers have their own process of demand-slack allocations. So plans may be deferred by 3-6 months. Most of these customers have geographically diverse plants. Demand slack in one region may be compensated by pick up in another.

Can some slack be taken up by the domestic market?

Yes. but only of the order of 200-300 MT

  1. EXPORTS. EXPORTS TODAY CONSTITUTE ~60+% OF TOTAL SALES UP FROM 40% LEVELS IN FY 2001. EXPORT GEOGRAPHIES & CONTRIBUTIONS.

Kindly provide the Geographical spread – how much from Europe, US and other markets. How much of export sales is booked in Euros and how much in US$? Any other currencies

Most of our sales come from Europe and RoW (Rest of the World) Market. We do not have any significant presence in the US. In terms of currency breakup, roughly 60% Euro and 40% in US$ sales.

Do you have higher margins from Export sales?

Slightly higher margins in Export Sales.

What kind of hedging policy is followed by the company? US $ Hedges seemed to be order of 50 lakhs only and same for Euros. Loan positions are left unhedged. Do we see changes coming in due to increased volatility, or will this policy remain largely unchanged?

We hedge our Sales for protecting margins. Typically 3-6 months rolling basis. US $ Loans are left unhedged as that provides some natural hedge.

If you have been hedging on a regular basis, why have we not seen better performance in FY12?

That’s also because of the 3-6 month lag effect. You will see some impact in coming quarters.

What is the sense that you have got from your Export customers? What is your order book size at the moment? Have you noticed any slowdown in order book already?

We have covered this before. There is some delay in allocations by 3-6 months. We will defer the next expansion phase accordingly.

If Export demand sees a decline, what are the plans to counter this risk? Can domestic market absorb additional sales? Can you penetrate deeper into customer accounts from the US, if say Euro Zone slows down?

As mentioned before most customers have geographically diversified plants. There are plants in Indonesia, Korea, South Africa where demand pick-up can compensate. Middle East is also another important and promising market.

  1. RAW MATERIALS. SULPHER AND NAPATHANIC OIL ARE THE MAJOR RAW MATERIALS. RM/SALES USUALLY IS IN THE 30-35% RANGE. BUT HAD SHOT UPTO 45% IN FY09. LAST 2 YEARS HAVE BEEN BENIGN WITH RM AT 26-28% OF SALES. 1QFY12 HAS SEEN RM SHOOT UP SIGNIFICANTLY TO 35% OF SALES

Kindly explain the overall raw material linkages and demand supply situation. If crude prices soften, will that see prices of Napathanic Oil & Sulpher both easing off?

RM procurement is on SPOT basis. There is no real direct correlation with crude prices. What happened in 2008 for example to Sulpher prices -was pure speculative in nature.

As you are aware prior to 2009 we had annual contracts, but subsequently we work on a quarterly pricing structure with customers, with RM price revisions being of a pass-on nature.

Kindly explain the nature of RM procurement. Do you have agreements with leading suppliers, how does it work? In most years we see a mix of local purchase and imports. Some years we have seen no imports? Imported RM in FY12 is ~19% compared to ~14% in FY11. Kindly comment.

We procure from both domestic and international suppliers. Realtionships are strategic in nature.

Would you say there is a direct linkage of raw material prices to operating margins?

Yes, there is a direct correlation to margins.

  1. POWER & FUEL COSTS. POWER IS THE SECOND BIGGEST COST COMPONENT FOR THE COMPANY.

Power costs have gone up to ~13% of Sales from ~10% levels a year or two back. Kindly explain.

That is because in Dharuhera plant we had some advantage from steam co-generation from the Sulphuric Acid plant, which isn’t there in the Mundra plant.

However this will stabilise as Mundra facility works at peak capacities. We draw quality power at Mundra with lower costs.

  1. WORKING CAPITAL. FY11 HAS SEEN WORKING CAPITAL/SALES CLIMBING UP TO ~40%. MOSTLY BECAUSE OF DEBTOR DAYS GOING UP BY A SIGNIFICANT 20% IN FY11 (OVER THE 40% INCREASE IN FY10 OVER FY09). IN FY12 WORKING CAP/SALES IS BACK TO ABOUT 34% OF SALES.

Kindly explain the sales cycle – What kind of debtor days do you have for International & domestic sales? What kind of Inventories do you normally need to hold on the RM front, especially Sulpher?

Debtor days and Inventories are actually at normal levels. The year end picture looks skewed as most of the investment in assets were towards the the 2nd half of the year. This year we should see reversal to normal levels, as capacity utilisation goes up.

Why have we seen big jumps in FY10 & FY11, followed by some cooling off in FY12? What according to you is a sustainable level for the next 2-3 years? And Why? Please comment.

Basically the same reason as above. You will see better figures for FY2013.

  1. MARGINS & PROFITABILITY. FY10 AND FY11 HAS SEEN OPERATING MARGINS AT 30% PLUS FOR THE FIRST TIME. REALISATIONS HAS MOVED UP FROM ~RS 70/KG IN FY07/08 TO ~RS 95/KG IN FY09 AND RS 100/KG FOR FY11 & FY12. IN FY12 REALISATIONS HAVE CLIMBED TO RS. 116/KG.

Is it correct to say that because of Sulpher prices going through the roof ion 2008-09, operating margins in FY09 were subdued. Otherwise OCCL had started getting higher realisations from FY09, and margins were actually on an upswing since then, not FY10.

Yes, we have covered this before.

Is it correct to say that FY12 higher realisations are entirely due to the Rupee depreciation effect?

That’s not entirely correct. We have forward covers and there is the 3-6 months lag effect.

Export Realisation came in at Rs 113/kg, while overall realisation is at ~Rs 116/kg. It also looks like you had better realisations in the domestic market in FY12 than in exports? Is that correct? Does the domestic market work on Import-Parity basis?

Domestic realisations are slightly lower actually. Perhaps the figures you used included that of Sulphuric Acid as well.

International prices of Insoluble Sulpher are quoted at $2200-2600 per Tonne? OCCL seems to be billing at ~5-10% discount to the lower range. Are there any chances of improving $-realisations? Why?

No. we have been billing at this $2200 -2600 range only. You might have taken an average Rupee-US Dollar conversion rate for the entire year – that would be misleading.

The Rupee has depreciated by ~22% against US$ and some 10% against the Euro in FY12, but OCCL has not really been able to ride the benefits all the way. What are the main reasons for this? Were there any losses on Forex account due to hedging?

We have covered this before. The actual impact will be seen in FY13 because of the lag effect.

What kind of realization levels are possible in FY13 & FY14? If rupee remains at current levels, do we see margins reverting to 30%+ levels? At what levels do you see Operating margins sustaining for the next 2-3 years?

Yes, we should see a reversal to higher operating margins. If rupee remains higher, margins should be better ~ 30% range.

  1. VALUE-ADDED PRODUCTS. INSOLUBLE SULPHER HIGH STABLE AND HIGH DISPERSION GRADES. SUPPLIES OF HIGH STABLE GRADE STARTED IN FY 2009 ON A REGULAR BASIS. HIGH DISPERSION GRADES HAVE BEEN APPROVED BY SOME TYRE MAJORS.

Please tell us a little more on higher grade Insoluble Sulpher market and the demand for it. What are the advantages? Are margins superior and by how much? Is the demand shift trend more in export markets?

Well Oriental carbon clearly is a follower. Whatever quality grades are required by the customer, we try to match that quality. We interact and collaborate on technology aspects with the customer. Our customers help us in moving up the value chain as we are the 2nd alternate supplier for them. Offering higher grade products is a continuous process, and usually comes with better margins.

What is the contribution of High Stable, High Dispersion grades in better price realizations for the last 1-2 years? What is the revenue mix currently in Insoluble Sulpher segment from High Stable grades?

TBD

2011 & 12 Annual reports mention Company is currently working on development of pre-dispersed Insoluble Sulphur. Is this another value-added grade? Any other new products/grades in the R&D pipeline.

TBD

What kind of R&D Set-up do you need to maintain? Is this sufficient for the current needs, or will it need sustained higher investment?

TBD

  1. CHEMICALS PRODUCT SEGMENTS – SULPHURIC ACID & OLEUM

Kindly tell us a little more on these product segment markets, demand/supply and raw material linkages. Is it true that the domestic market moves with the whims of the main supplier – Hindustan Zinc?

Sulphuric Acid market in India is dominated by Hindustan Zinc. This is a by product for Hind Zinc. The demand for Sulphuric Acid is dependent on industrial activity and therefore cyclical in nature. Since they produce a certain quantity anyways (unlinked to demand cycles) they have to dispose it off anyways! Sometimes demand situation is so bad, that people are paid to take away Sulphuric Acid in Tankers.

In such situations, the industry margins become negative. The last 2-3 years margins have been positive and stable. Though it reduced quite a bit in FY12

Chemicals segment contributes just 10-12% in Revenues but in bad years have the potential to drag down margins drastically? Why would you continue with such volatile segments? How much is the cost saving from Steam, generated from the Sulphuric Acid plant, in percentage terms?

We have been continuing with the Sulphuric Acid segment, as it generates steam which is used by the Plant at Dharuhera. The savings from steam generation is significant and makes that segment viable.

FY11 & 12 were benign for the Chemicals segment – with 14% plus EBIT margins? But FY12 EBIT levels were down to 5%. What is the outlook for FY13?

This year should be better

Any plans of divesting this segment altogether?

No

  1. MEDIUM TERM OUTLOOK

Given the 22500 MTPA capacity, what is the capacity utilisation and Volume targets in the medium Term?

75% capacity utilisation. We should continue to grow at current levels. The volume growth may be limited to 10-15% if the demand slack continues.

How is the overall market growing in the medium to long term?

India is a high potential market and should more than double by 2020. Global market also is growing steadily. Medium term outlook is good and we expect good margins.

What rates do you see the domestic market growing? Will it be able to absorb higher levels of supply in the medium term?

Domestic market is growing at about 15% on an annual basis. It can take about 7500-800 MTPA. Chinese market currently is at 35000 MTPA, so there is huge scope for growth in India.

  1. TAX IMPACT FOR FY13 ONWARDS

Please indicate the applicable tax rate for FY13? Will Mundra SEZ facility get any MAT credit? Does that mean in FY13 11000 MTPA production/sales will get MAT credit at 18% rates while the rest will be taxed at full rate?

Effective tax rate will be lower at 20-22%. This is because of the Mundra facility which as an SEZ gets MAT credit at 18% which can be off-set against the overall tax liability. As the share of production in Mundra facility goes up, effective tax rate will come down.

Where do you see Net Margins stabilizing at for the next 2-3 years?

Operating margins should expand but we are not banking on the same and going conservative in our plans. Net margins should also expand due to  better operating margins and Lower tax. However there is the impact of higher debt servicing costs. Net margins may be slightly lower in FY13.

  1. SCHRADER DUNCAN ACQUISITION.ORIENTAL CARBON HOLDS 12.58% IN SCHRADER DUNCAN, A LISTED ENTITY.

Kindly explain the rationale-Why was the stake in Schrader bought in Oriental Carbon?. It looks like an unrelated business with poor return ratios and was earlier making losses? What is the situation now? Since OCCL has divested businesses in the past, what are the plans for the Schrader now?

This was a JV company where we had 25% ownership. The foreign parent company was getting sold and hence in the course of re-structuring they wanted to sell the Indian arm as well. Pneumatic area has good potential. The price was good and the issue with the company were more of structural nature (like high salary due to expats). We knew we can correct them. By selling the property worth 40 Cr, we could bring down the debt and the company should turn profitable.

What is the current status?

It has already started turning around. We have some plans for expanding the business.

  1. DIVIDEND POLICY

Please indicate the dividend policy followed by the company. While dividend amounts have increased over the years, it has not kept pace with the increase in earnings. Payouts have fallen from ~47% in FY03 to 11% in FY11. And has increased somewhat in FY12.

If you see the last 5 years, we have generally been increasing dividends. In FY12 again we have increased dividends. 

If you consider the Dividend Tax component, Payouts have increased to over 19% in FY12. We intend to maintain payout ratios at 20% or so.

  1. PLEDGING OF SHARES. 254514 SHARES PLEDGED

Although this is under 5% of promoter shareholding in the company, this has been continuing for a number of years. Please explain the circumstances for the same and why is this not being paid off & revoked.

The pledging was for some corporate loan taken from bank. Shares were given as an additional security.

  1. MAJOR OPPORTUNITIES & CHALLENGES

Where does Oriental Carbon see itself in the next 5 years? Can we see Oriental Carbon reach 500 Cr Sales, by when? What are the major challenges before the company and where are the big opportunities?

Yes 500 Cr is possible and should happen after the expansion of the next 11000 MT capacity. The next big opportunity would come from penetrating the US Market.


Disclosure(s)

Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 6 months;
Donald Francis: No Holdings in the Company; ;
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