PI Industries Management Q&A: Sep, 2013

Management Q&A

1. AGRI INPUTS

1.1 OSHEEN – DINOTEFURAN INSECTICIDE

Kindly educate us on OSHEEN product, USPs, advantage over competitive products,etc.

As you are aware Osheen is a 3rd generation systemic insecticide invented in Japan by Mitsui Chemicals Agro Group (MCAG).  PI Industries has registered and developed OSHEEN for the Indian market, in collaboration with Mitsui, Japan.

OSHEEN has been trusted as a most reliable solution to effectively manage the Brown Plant Hoppers in Rice for number of years in the leading Rice growing countries. It has also been tested and recommended by leading agriculture research institutes of Govt. of India on Rice crop and Cotton crop.

You are known for registering/introducing in-licensed products only after proper gap analysis. Is it correct to say OSHEEN is a uniquely positioned product, just like Nominee Gold was?

Yes of course. OSHEEN has been introduced through due process – has unique advantages of longer control period and better coverage. Because of its unique mode of action OSHEEN effectively controls the target pests which are not controlled by other molecules.

So what additional benefits does it bring when compared to other competing Insecticides?

OSHEEN has fast action due to which target pests stop damaging the crop after coming into contact of OSHEEN and start dying within few hours. It has systemic action and quickly gets absorbed into the plant, effectively killing the target pests present in the different parts of plant and provides longer and effective control on targets pests. OSHEEN has trans laminar action due to which spray done on the upper surface of the leaves gets translocated to the lower surface and controls the target insects hiding on the lower side of leaf.

But then it must be a more costlier product?

See you must realise for Farmers its not about a BRAND. For him the only thing that matters is cost of application/acre, and there OSHEEN delivers much better than many competing products.

So there has been enough efforts on farmer education?

Yes.

What about Data Protection? How many years will it have an uninterrupted run?

Well it has the usual 3 year data protection as per Indian laws. Post that a generic me-too source may be eligible to apply – depends on how good the product is. Even with a good product, effectively it will be 4-5 years before any effective competition emerges.

Any co-marketing efforts already on?

That will come later. First OSHEEN needs to be seen to be delivering the goods.

1.2 NOMINEE GOLD

Kindly update us more on Nominee Gold. You had allowed co-marketing of the brand with other MNC/innovative agrichem partners? What are the results?

As you are aware we had enetered into reciprocal co-marketing arrangements for Nominee Gold with a few MNC players. That allowed us access to some of their brands for co-marketing by us. We entered into these realtionships after due evaluation for optimising product portfolio in certain markets to offer complimentary product baskets. Results have been encouraging so far.

But you have also extended co-marketing to Rallis & Dhanuka too? Aren’t you diluting the BRAND if its available from everyone? What’s the deal there?

Again we evaluate these things from a relationship perspective too. They have reasonably big distribution network in certain regions and It ensures our presence in those markets.

You had mentioned last time if PI were to try and cover the whole market it would take us 10 years. Co-marketing would allow us to increase visibility and allow us faster coverage in 4-5 years? How far has that played out? How much additional sales has been generated for the product through co-marketing?

Should be 15 – 20%

Rice Herbicide penetration was mentioned last time at 5% levels? Where is that now?

It should be ~8-9% of total rice acreage.

So there is growth possibility definitely for next 4-5 years?

Much more than 4-5 years of good growth.

Now that Data Protection for Nominee Gold is over, what about emerging competition?

That was over last year itself. Few Companies have applied. It will take time before we see effective products on ground.

1.3 IN-LICENSED VS GENERIC IN-HOUSE PRODUCTS

In-licensed vs Generic products. Is the current ratio still 60:40?

It is about 65:35 right now

You had mentioned that this ratio will rapidly change, by now you had predicted 80:20 actually; going upto 90:10 eventually

That’s true, but take into account last year. Because of the pretty bad last year, we got behind. We should be there in the next one or two years.

You launched 2 in-licensed new products. Kindly educate us about In-licensed Pipeline vs Competition. What’s the process? How do you keep abreast/ahead?

We have ~8-9 products in development pipeline and several others at negotiation table. This is a continuous process and our Competitive Intelligence mechanisms giving us inputs long before products are actually out in the market. Our process cannot depend on assessment of pipeline of others. As you are aware, we have very strong in-house gap-analysis MIS culled from all over the country for prioritising our pipeline.

What’s the price/revenue mechanism with In-licensing Innovators?

It’s based on simple long term purchase contracts. We purchase the Raw Material – active ingredients or formulated product.

What’s the pricing strategy for new generation in-licensed products?

As mentioned before, end of the day the farmer has to see lower of application/acre and therefore, your product price proposition should be attractive for him.

There are quite a few new breed of competing products like Round Up and others. What kind of threats do you see for your product lines?

We think there is room for all to grow. We focus on identifying a gap and providing better yield/productivity for the farmer.

What kind of impact do you see of the Food Security Bill? Is that a positive?

This to my view should drive food production, productivity and yields have to go up substantially. Farmers will get incentivised. If Farmer is happy, we will be happy.

You have lot of exposure to the Rice crop. First through Nominee Gold and now Osheen. Have you seen much of Hybrid Rice? Is that growing rapidly? What’s the potential?

Yes this is true. However, Osheen is also doing well in cotton.  Also we have several other products in fruit, vegetables and other field crops.  Hybrid seed is rising and so is the research seed.  Next wave of growth in seed may come from corn.

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2. CUSTOM SYNTHESIS (CSM)

For the first time we have seen CSM overtake the Agri segment. Revenue Contribution in FY13 was 55:45 CSM:Agri. How long before this scales to 65:35? Strategically, is this a great development?

It’s certainly good to see CSM scaling up the way it has done in the last 2-3 years. However for us it is important to be able to grow both segments equally well. For two reasons:

1. This gives us a neatly de-risked/balanced business model
2. Agri segment – the domestic opportunity is huge. It’s a very low-capital intensive business. Given the strength of our model and the strength of the agri-business sector in India, this segment is poised for 30-40% kind of growths over the next 3-5 years horizon. This segment provides us the CASH to fund the scaling up of the CSM business.

Give us a sense of the split between Long term contract vs annual contracts  in CSM?

~60% is in Long Term contracts while roughly 40% get negotiated annually.

And the Long Term Contracts are all guaranteed off-takes model?

Yes, Take or Pay.

You have cited deliberately not expanding $300 Mn order book (static for 2 years) – for flexibility in accommodating higher value/volume molecules that had some visibility.

That’s right. Keeping the Order Book at an optimum level gives us the flexibility to balance investments required for sewing in long term contracts for say 10 years. Accordingly you need to invest in plant for tapping new opportunities.

So any success there?

That is what you are seeing today. The ramp up is from that success. We had promised 30% but we grew by 60%, isn’t it. This is happening because we have retained the flexibility.

14 molecules in Commercial stage. Please give us a sense of the longevity of Molecules – new vs old?

Both old and new molecules. Some have been there for long. Some have dropped off to be replaced by new molecules. That is why you need the Pipeline.

Pipeline of 28 molecules. With a 40-45% success rate you hope to see 10-12 going to commercial success? Is it right to say you have pipeline that provides visibility for next 4-5 years?

As you know Pipeline keeps getting refined on a continual basis. We have a robust Pipeline is what I can say.

Please give us a sense of existing Customers. How many in Commercial stage and how many at R&D/Pilot stages?

8-9 Customers at Commercial stage (14 molecules). Rest in R&D/Pilot stages

Please share with us the Competitive scenario currently? You used to be single, 2nd or 3rd alternate supplier. Is that still valid?

Yes there are no more than 2-3 suppliers. We continue to be the dominant supplier for many of our customers.

How is the geographical spread between customers – US, EU & Japan?

It’s more or less balanced.

What’s the typical commercial life-cycle for a CSM molecule? How much of useful patented life is left for commercialisation, typically? What’s the payback period?

We assume a typical 4-5 year payback. Which means it will need to be replaced with a new one. But in actual practice it turns out much longer usually 10+years.

Any new competition from domestic markets? Or all are overseas competitors?

Given the products we are in, all competition is mostly from developed markets.

Recently we have seen players like Hikal stating they have partnered with agrochem innovators for CSM? Kindly comment.

No comments.

Give us a break-up of Commercial Molecules – agri/pharma/fine-chem? Where is the Focus?

Currently 80-90% is from Agrichem. Focus is on balancing the Portfolio.

Is it right to say Pharma molecules have higher margins?

Yes. Higher EBIDTA margins but not necessarily high ROI because the investments are huge.

Pharma CRAMs players like DIvi’s have 30-35% EBITDA margins. PI Industries EBITDA margins are much lower. Kindly comment.

Yes Divi’s Labs has EBITDA margins of 30-35%, but Asset Turns <2. PI has EBITDA margins of 20-25% with Asset Turns 2.5 to 3.Things should be seen in that context.

You have today ~600 Cr coming from 14 CSM molecules. Is that ~40-45 Cr per molecule?

(Laughs). Well different molecules have got added at different stages. They come in different sizes. Having said that it’s not so skewed also as say 2 molecules contributing 500 Cr and rest 12 contributing 100 Cr.

Sony-PI/Update?

Nothing new to report.

Why are your R&D expenses so low compared to other players?

If you are engaged in innovation research/ANDAs your R&D costs will of course be at higher levels. We on the other hand are involved with process research where costs are much less.

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3. JAMBUSAR

We are starting to see good contributions from Jambusar. But project is delayed by 2 to 2.5 yrs?

All delays are attributable to delays in getting pollution clearances and the Environmental Clearances.

Given the 10 yr tax concessions already underway, is there a focus to ramp up subsequent phases?

Of course. We are already doing erection work for next phase.

First phase took 2 to 2.5 years. What’s the timeline for commercialisation of next phases?

May be 9 – 12 months.

Sterling SEZ progress. Would you say there are any risks to progress?

None at all. As you are aware Gujarat is a very progressive state. Everything is progressing normally.

We have already reached 90% utilisation at some 100-120 Cr. What happens to Asset Turn targets of 2-2.25x?

(Sighs). One must look at the total investment versus investment for Phase1 and then compute Asset Turns. Our existing Asset Turns are greater than 2.5x. Going forward you will see these numbers. Projects will come/being negotiated with these figures in mind.

What are you Long Term Debt goals. Do you intend to become Debt free in future? Interest Costs will continue to be low

Yes, that’s the goal. Interest costs will be low.

With Free Cash flows flowing in, are there inorganic moves being planned?

Yes, we are investigating.

We were visiting companies across Gujarat and came across your Panoli facility. We couldn’t help notice the severe smell/pollution?

We are not in the Perfume Industry, you know. (Laughs, from all around).

Did you notice it all along the highway? or only along our plant. This is a common feature across the belt.

So aren’t these things monitored by any Agency?

Let me state that India is at least 10 -15 years ahead of China in this aspect. We have been having very stringent norms since the last 15 years.

Gujarat Government has evolved even more stringent norms. There is online monitoring of air stream and water streams.

So how significant are the Pollution control/Environment Management Risks for your business?

We are at risk only if a) we are not adhering to Norms b) not investing to manage pollution/effluent levels. Environment Management is the largest component of our Costs.

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Disclosure(s)

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

SHRIRAM CITY UNION FINANCE

Background

Shriram City Union Finance (Shriram City) established in 1986, is part of the nearly four decade-old Shriram Group, and has its origins from the needs of the Chit Funds customers. The company started operations with truck financing. In October 29, 1988, the company became a public limited company and renamed as Shriram Hire Purchase Finance Ltd. In March 1990, City Union Bank Ltd. acquired shareholding 200,000 shares at par. Consequently, the name of the company was changed to Shriram City Union Finance Ltd. The company registered as a deposit taking asset financing NBFC with RBI and went public in 1994.

Prior to 2002, the company was exclusively engaged in transport finance with special emphasis on financing pre-owned commercial vehicles to small road transport operators. In 2002, the company discontinued the truck financing business (except for trucks > 10 year old) as that business was consolidated in its sister concern (viz. Shriram Transport Finance Ltd) and started as a separate business unit in year 2002 as Shriram City Union Finance Ltd.  Listed on BSE in 2003.

Today Shriram City offerings comprise finance for Two Wheelers and Three Wheelers, Four Wheeler Finance (both new and pre-owned passenger and commercial vehicles), Personal Loans, Small Business Loans, and Loan against Gold. This has made Shriram City the only NBFC to offer such a wide range of products under one roof.

Vision: Serving the under-served. Creating value at the bottom of the pyramid.


Main Products/Segments

  • Niche Diversified Product Portfolio
As on Sep 2013 MSME Loans Gold Loans 2 Wh Loans Auto Loans Personal Loans
Inception Dec 2005 Oct 2006 Dec 2002 Dec 2005 Jan 2006
% Loan Book  49% 22% 15% 10% 4%
Avg Yield 18-22% 14-18% 24-26% 22-24% 24-27%
Avg Ticket size 700,000 40,000 35,000 150,000 75,000
Avg Loan to Value NA 55% 70% 60% NA
Branches offering  493 (1021)  714 (1021)  832 (1021)  359 (1021)  396 (1021)
Gross NPA  1.4%  1.6%  3.8%  3.7%  4.8%
Net NPA  0.3%  1.4%  0.8%  0.4%  0.0%

Source: Company, CRISIL

  • Branch Network – 1021 Total branches, 724 Owned Branches, 297 Shared Locations
  • Geographic Concentration – AP [48%], TN [32%], MH [9%], KN [2%], OTHERS [9%]
  • Group Customer Base – ~4 Mn Chit Fund customers; 95% of MSME customers referred by Shriram Chits

Main Markets/Customers

  • Strong Positioning for the Niche Addressable Under-penetrated Market – primarily the Self-Employed – without formal credit history and/or future cash flow signature – primarily feeding-off the Chit Business and concentrated in AP, TN, MH – hugely scalable – completely protected (?) market – may continue to grow nicely
    • MSME Loans, Gold Loans, 2 Wh Loans and Personal Loans
  • A piece of the MSME Non-Chit action – primarily concentrated in North India – primarily leveraging regular credit worthy customers with credit history and adequate documents – Max 1 Cr loans – Avg Ticket size 20-25 lakhs – may see cautious growth – as this is untested market/untested models
  • Nascent Niche presence in the under-penetrated Housing Finance segment – focusing on Tier 2 & Tier 3 Cities and the under-banked – Avg ticket size 10 lakhs – insignificant currently, but growing rapidly – may become significant within 4-5 years

Bullish Viewpoints

As on Sep 2013/ Jan 2014 SCUF SCUF
(Dec ’13)
SHTF Chola Sundaram MMFS Bajaj Finance
Size (AUM) 15800  14937 49700 19000 17600 27900 17100 Small
Years in Business
(Effectively)
28 (11) 28 (11) 35 36 60 23 27 SHTF, MMFS have also grown AUM fast
Capital Adequacy 23.3%  24.26% 19.9% 17.1% 17.7% 19.1% 20.9% Industry best
3Yr Earnings CAGR  45%  45%  19%  74%  20%  39%  58% Robust
Cost to Income 37%  38.68% 26% 50% 37% 33% 45% Industry Median
Cost of Funds 12.6%  11.74 9.8% 10.6% 10.6% 9.9% 10.3% Industry Highest
Margins 11.2%  12.35% 7.0% 7.6% 8.4% 9.4% 12.1% One of Industry highest
Yield 22.1%  21.19% 16.3% 15.4% 17.7% 16.4% 20.7% Industry best by far
 RoA  3.2%  3.36%  2.9%  2%  3%  3.4%  3.6% One of Industry highest
 P/B  2.2  1.8  1.5  2.4  3.05  1.6
 P/E  12.7  10.37  10.6  15.14  14.35  11.24
  • Huge under-penetration in Target customer base – With only 9-10% penetration of the ~4Mn Shriram Chit Customer base, there is huge headroom to grow in its niche with virtually no competition
  • Improving Product Mix – With Gold Loan share coming down (expected to stay within ~20-25%), Product Mix decisively tilting towards higher tenure, higher yields
  • Strong Growth Drivers – Deeper Product Penetration into existing branches especially in high-yielding MSME, 2wheeler and Personal Loans will keep driving growth.
  • Dominant position in MSME Loans – As per a Frost & Sullivan study SCUF share in overall MSME Loans disbursals in FY11 was a dominant 53%. Shriram City concentrates on ticket sizes comprising Very Small Loans (sub Rs. 1 Lac), Small Loans (Rs. 1 Lac – Rs. 10 Lacs) and Medium Loans (Rs. 10 Lacs – Rs. 50 Lacs), with the bulk of its MSME book constituting Small Loans – 42% market share as per 2013 AR.
  • High Capital Adequacy – With the recent Capital Infusion, CAR at ~23% is the highest in the industry. Tier I Capital is at a comfortable~18%. This should be adequate to fund growth for next few years
  • High growth trajectory -While FY14E AUM growth will be muted – partly due to Loan Book recast and partly due to disruption in normal business in AP due to Telengana protests, next 2-3 years could see 25% CAGR growth
  • High Yields look sustainable – SCUF has the highest yield among similar NBFCs at ~22%. Given improving Product mix, yields likely to stay high
  • Operating Costs likely to come down – SCUF Cost to Income ratios had been climbing up mostly due to Employee expenses shooting up over last 3 years – from ~6% of Expenses in FY11 to over 13% in FY13. This was largely due to integration of Shriram Chit Employees into its fold (From ~3000 to just over 19000 in 2QFY14). With the process getting completed and conservative branch expansion targets hereon, this is likely to stabilise and head downwards in next 2-3 years
  • Valuations – Given the strong positioning in its niche, SCUF appears to be trading at reasonably attractive 2.2x P/B valuations (CMP 1030)

Bearish Viewpoints

  • Concentration of business in AP & TN – 80% of business currently comes from these 2 states with AP (48%) and TN (32%). Any disturbances and/or policy change in the key states could impact business significantly. The ongoing Telengana issue and protests had seen disruption in normal business activity and had affected disbursements to MSME customers. The impending bifurcation of AP and likely protests means SCUF remains vulnerable to disruptions again – and that may impact growth
  • Asset Quality seemingly deteriorating (Advancing recognition Norms)
SCUF SHTF Chola Sundaram MMFS Bajaj Finance
GNPA 2.4 3.2 1.0 1.0 3.0 1.5
Recognition Norm 150d 180d  180d 120d 150d 90d
  • SCUF’s NPA’s are on the higher side. This should also be seen from the context of significant share of Gold Loans (with low NPAs) in Loan Book. However to be fair, Recognition norm at 150d is conservative and keeping ahead of RBI stipulations/timeline.
  • Advancing Recognition Norms/Standards Asset Provisioning may be raised – As per Usha Thorat Committee DRAFT Guidelines, NBFCs may have to move to 120-day NPA recognition norm from April 1, 2014 and 90-day norm from April 1, 2015. Also Standard Asset provisioning may be raised to 0.40% from 0.25% effective March 31, 2014. This may lead to higher costs on provisioning impacting earnings. Eventual write-offs though could be lower (nature of customers/business). As per Management, in the entire 28 years history actual delinquency is <1-1.5%.
  • Gold Loan remains a significant portion of Loan Book. Gold price volatility may impact growth possibilities

Barriers to entry

  • Chit Model – 90% of the current business/addressable market is mostly insulated from competition. For its target segments a Shriram Chit customer will go out of the group only if SCUF is unable to meet the customer requirement
  • Strong Brand Equity – “Shriram Brand” has high brand equity within its target segment – leading to low spend on advertising in both existing and new geographies

Interesting Viewpoints

  • Leveraging/Piggy-Riding on parent/group – Shriram City Union completely leverages the groups strengths – Customers, Database, home-grown systems and processes for the self-employed, and IT systems. Expansion to newer geographies can be incrementally calibrated by piggy-riding on group ecos-system and branch network, with minimal capital outlay
  • Regulator view of NBFCs turning favourable? – Even 2 years back regulatory risk may have been cited as a key risk for NBFC businesses. However of late RBI is seen to be shifting its hawkish stance (as evidenced in say the recent Comprehensive Financial Services for Small Businesses and Low Income Households Report chaired by Nachiket Mor, Central Board Member, RBI) and acknowledging the key role and value-added contribution that NBFCs could make towards financial inclusion in India. Also recent 23 Jan 2014 Speech Non-Banking Finance Companies: Game Changers, by P. Vijaya Bhaskar, Executive Director, RBI
  • Only 7% of MSMEs seek external sources of credit, the rest managing with self-financing or with funding from informal sources. MSMEs have a total finance demand of Rs. 32.5 trillion, of which only 36% is widely considered as addressable by financial institutions. The remaining 64%, ordinarily considered unviable because of inadequate/poor credit profiles, preference for debt from informal sources, reliance on self-financing etc. presents a rich potential for NBFCs if adequate safeguards can be built in to protect asset quality[Source: Ministry of Micro, Small and Medium Enterprises, Company AR, MSME FInance in India IFC Report]
  • Shriram City for the most part caters to the Micro Enterprises segment. Their research indicates that in the event of the GDP growing between 4% – 5%, the MSME sector should see a long term growth of between 15% – 20%. [Source Company AR]
  • Shriram City Housing Finance – Incorporated as a fully owned subsidiary in Nov 2010. Currently 76.5% owned by Shriram City and 23.5% by Valiant partners. Focusing on Tier 2&3 cities and the under-banked with average ticket size of 10 lakhs, this business is at a nascent stage with Asset size of ~340 Cr as on Sep 2013. Growing rapidly with disbursements crossing ~215 Cr in Sep 2013 up from 40 Cr in Sep 2012 – a building block being laid for future disproportionate growth?

Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months