Kaveri Seed Company Management Q&A: Feb, 2013

Management Q&A

  1. KAVERI COTTON MARKET PRESENCE

KAVERI COTTON MARKET PRESENCE

2012 (lakh pkts)

2013E (lakh pkts)

2014E (lakh pkts)

Andhra Pradesh 5 16
Maharashtra & MP 5 13
Gujarat 1 2
Punjab, TN, Karnataka 7 10
Total 18 41 50

If Kaveri is to do a 20-25% increase over last year, you should be doing ~50 lakh packets in 2014E. Where will that growth come from?

Most of the growth will have to come from AP & Maharashtra. We introduced our hybrids early in AP, so we have some advantages there. In Maharshtra, the competition is more.

  1. KAVERI PENETRATION STRATEGY

KAVERI ANDHRA PRADESH PENETRATION STRATEGY?
TELENGANA(10 districts) COASTAL(9 districts) RAYALSEEMA(4 districts)
Dominance 2013 2014E 2013 2014E 2013 2014E
Nuziveedu 1 1 all equal all
Mahyco 4 2 all equal all
Kaveri 2 3 1 1 all equal all
Azith 3 4
Ankur
Total (90 lakh packets) 60 lakh packets 22-23 lakh packets 5-7 lakh packets

Is it right to say Jadoo Hybrid has seen very good acceptance in Coastal areas, post Neelam cyclone; earlier the response was mixed?  Apart from good yield, makes for easy plucking (just a finger tap is enough), a leading non-Kaveri distributor told us.

Jadoo has shown good acceptance almost everywhere – not just Coastal AP. Adilabad district is the only one where Jadoo has not done well. Even in Telengana Jadoo has done well esp. in Khammam & Mehboob Nagar districts. Also in Medak district.

Jadoo plant is tall with strong stem. Ball-to-Ball distance is less. Jadoo has shown some tolerance to Sucking Pest. The best part about Jadoo is its higher yield. The plant rejuvinates and gives a second yield which is 30% of the first.

3. 2014E – INVENTORY PICTURE /OVERALL

2.5 Cr packets nventory carry-over from 2012; 4.5 Cr packets New Production. 7 Cr packets Total. Expected 2014E Total Sales 3.6 Cr packets (10% less than 2013). Carry-over of 3.5 Cr packets.

Yes, there will be carry-over of inventory this year.

Only 30-35% sales Advance basis; 60-65% Sales PUSH Sales?

The advance we receive is 30-35% of Sales. Credit Sales is not more than 5-10%

Impact on Kaveri Seeds?

We didn’t have any unsold inventory last year. Marketing Expenses will be higher, as everyone will resort to aggressive marketing.

Lower performing brands – for them it is a matter of do or die – survival??

Yes. Those who carry over inventory for the second year running may find it tough to survive.

Risk of Advance payment Terms changing to Cash basis??

Not for the better-performing hybrids.

What if this was to continue for 1 more year?

You see the RISK is totally based on the demand for your hybrid. If there is demand for your hybrid, you can sell it after 2 years too. But if there is low demand, then you will have a tough time selling it ever!

4. 2014E – INVENTORY PICTURE /BIG 5

Mahyco and Ajith seem to have managed to scale up production levels – from ground vacated by smaller players?

2013 2014E
Nuziveedu 100
Mahyco 20
Kaveri 40
Azith 15

Mahyco had done 25-30 lakh packets last year. Azith had also done 25-35 lakh packets. Ankur had done almost 30-35 lakh packets. Monsanto Emergent had done 15-20 lakhs. Vibha had done 15-20 lakhs. Tulasi has done 15-17 lakhs. And there are also Mahyco types that do well! In the North, DCM Shriram did very well ~20-25 lakh packets.

Most bigger players are reported to have scaled up production 2x-3x? Most have to lose out??

Its going to be an extremely competitive season. Those with better performing hybrids will do better.

One view is Mahyco most well-placed to capture back lost ground? market share? What farmers paid Rs 2000 last year, they will get at Rs 930 this year.

The other view is that those who paid Rs 2000 last year did not benefit. Mahyco should be able to do 20% more than last year.

Why will Kaveri even maintain existing Sales? On such a high base?

We should do atleast 20% more. Yes we had more than doubled our Sales last year. But that also means our base of satisfied farmers is much bigger. We have atleast 3x more satisfied farmers. Our hybrid Jadoo has done extremely well. 70% of our Sales is driven by Jadoo. No competitor has one single hybrid accounting for such a high proportion of Sales. Nuziveedu’s Banni & Mallika together reportedly contribute around 50-55 lakh packets.

What Sales Promotion activities have you planned?

As we have indicated before we expect intense competition, this year. Kaveri will be using local-language advertisements in regional media for the first-time. We are ready with the Advertisements.

What about dealer/distributor incentives like Foreign travels?

These have been going on. We want a situation where the farmer should ASK for our product. So we will focus more on PULL for our product(s) than PUSH sales, though that too has its role.

Margin pressures?

We think we will be able to maintain margins. Normally we would have seen an increase in margins on higher volumes. But because of the intense competitive activity there will be higher spend on sales promotion.

5. CONTRACT FARMING – CHALLENGES/ MAINTAINABILITY/ SCALABILITY

The overall land available for contract farming isn’t expanding; it can only be reducing for several reasons. Producing at even 20% more each year, seems a very big challenge to keep managing?

Its not entirely true that the land available is reducing. There are new areas that have taken up contract farming. For Cotton, the entire production area about 130,000 acres is in AP (70%) and Karnataka, Gujarat & Maharashtra (30%).

We have 75-80% of our production in Gadwal (Mahboobnagar district) & Nandhyal (Kurnool district) in AP which are higher yield regions. We also procure from Eluru region from West Godavari district.

Challenge seems to be to hold on to contracts/relationships. Once you scale down, scaling up may be much more difficult/costly.

Farmer’s incentive is Yield. Having a higher yield reduces cost of production. The other way is to commit more money to the farmer.

6. PRODUCTION -OVERESTIMATION RISKS

There seems to big risks of Inventory Carry-over?

There might be some who are carrying inventory over from last year. For players like us who had near-zero inventory last year, it is not a big risk. 

But the bigger longer-term risk seems, if one were forced to cancel/scale down contract farming relationship size

Yes, there are challenges here, but it’s not impossible (to scale back). You must remember Kaveri has scaled up in the last 2-3 years from nowhere. Good higher-yield hybrids play their part too, as production costs are less for the farmer.

Is it possible someone is off the mark by 40-50%? That will have a cascading pattern?

Yes it is possibleThere are some players who are carrying 2-3 years inventory.

7. COTTON SEED PRODUCTION PATTERN

Can you please explain how do you go about sowing/procuring the required production seed quantity?

Sowing time is generally between February to October – at different times in different regions – to spread our risks on the weather/climatic front. Usually it takes 120-140 days for seed to be available – harvesting, ginning for seed, and quality control.

So July-Aug, the first seeds become available, and we continue to get seeds till May.

8. KAVERI INVENTORY PICTURE

Is it correct to say 2nd batch from Jan-Mar is usually much larger?

Actually most of the seeds, 80% is in by December.

209 Cr – 2H Inventory; 179 Cr – Q3 Work in progress; totals 389 Cr; plus Q4 inventory; Totally looks like 400-500 Cr Inventory??

One can forward project anything! The key thing to see is how much we can sell. And that picture looks like 20-25% higher over last year.

What if Kaveri underachives targets?

We are reasonably confident of achieving 20-25% higher sales

9. FUTURE – GROWTH

How does the future of hybrid seeds look?

We see growth continuing for at least a decade.

Any impact of new technologies? Others are experimenting with Closer Density plantations and mechanical plucking/cutting?

Yes. These will probably start getting introduced 2-3 years later. We are also working with closer density planting. Mechanical plucking/cutting  work with mostly varietals (non-hybrids), short-duration crops with 1 time harvesting, etc.

10. FUTURE – HYBRID RICE

2.5 mn hectares – mostly North India? Why not in South India?

Currently hybrid rice is available in thicker rice varieties. In South India, slender rice – Sona Masuri varieties are more preferred.

How far from solving Quality issue? We have heard hybrid rice is mostly sticky rice?

Stickiness problem is already solved. Much of the technical challenges are being solved. Yield is much higher – minimum is 20%. Work is going on in Draught resistance – where once a week watering will be enough. Resistance to pests is being brought in. Unlike Maize (7 mn hectares) Rice is grown in 40 Mn hectares in India, so the potential is big.

So are we going to see widely acceptable commercially available products in 2-3 years?

More like 5-7 years.

11. FUTURE – MAIZE GROWTH DRIVERS

Poultry Consumption/Paddy or Cotton Conversion/Easy cultivation/Mechanisation/2 crops in a year – many advantages. Do you see major shifts from Cotton to Maize

Maize is cultivated in 7 million hectares. Poultry and starch industries are main drivers for maize cultivation. Some of the other drivers you cited augur well for the future of Maize cultivation in India. So a stable picture for Maize seeds demand is envisaged. It is a high margin business, as prices are market determined, with no price caps. Monsanto dominates the Corn business. We are among the Top 3. But Maize is also a very sensitive crop, if it doesn’t rain, the crop suffers.

125 Cr FY13, FY14E?

It should see normal 10-15% growth

12. TAXATION

Unlike your company, Some Seed companies are still paying Taxes at full rates? Like DCM Shiram on Seed division income? What are the risks of taxes being levied retrospectively?

Yes, and there are many others who are of the view that taxes are not applicable for this sector. Recent court orders have vindicated this stand. Tax Laws are the same. It’s interpretation cannot/shouldn’t be different for different Assessment Officers. Monsanto is not paying these taxes. Our view is simply this – We have paid full tax in earlier years. We then claimed Refund as per the existing law, and we got back the full amount from the government. That kind of settled it for us.

13. REGULATIONS

The Maharashtra Government order cancelling the company’s (Mahyco) licence? Last time round you were pretty confident of the order getting reversed. What’s the latest status?

If we look at this objectively, with this government order, who’s suffering? It’s the farmer. The farmer needs to have access to good quality seeds. If it comes to that, the farmer can always buy the seeds at the border.


Disclosure(s)

Tirumal Rao: More than 5% of Portfolio in the Company; Holding for more than 1 year;
Davuluri Omprakash: No Holdings in the Company; ;
Vinod MS: More than 5% of Portfolio in the Company; Holding for more than 1 year;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years;

Poly Medicure Management Q&A: Oct, 2012

Management Q&A

1. FOREX DERIVATIVE CONTRACTS – OUTSTANDING?

Please explain the current situation on Forex derivative contracts.

This is over. We have paid back all outstanding. 15th October was the last payment tranche. This was a significant drag on the performance of the company with almost 3Cr/month of losses. Now this will add straight to the bottomline.

2. MAIN PRODUCT SEGMENTS

Kindly tell us more on your main product segments.

IV Cannula account for 50% by Quantity. Rest 50% is from other products. We are manufacturing as many as 93 different products.

In Value terms IV Cannula (45%), Safety IV Cannula (6-7%), Blood Bags (10-12%).

How much do you expect Safety IV Cannula to contribute eventually?

Eventually this segment should contribute 10-15% of Sales

3. US CONTRACTS

What is the current status of the US contracts bagged by the company?

There are actually two contracts. The first one is for Blood Bags and that is going on as scheduled. The 2nd one is for Safety IV Cannula. This needed some design change and the project was pushed back by 6-8 months.

This is back on schedule now. Supplies should commence from Q1FY14.

How much this likely to start contributing?

About 20-30 Crs

4. MARGINS/PROFITABILITY IMPROVEMENT

If we were to remove the effects of the Forex derivatives losses, there seems to be big jumps in operating margins? Is it the right picture?

In previous years the company implemented measures for improving growth and profitability through backward integration and cost cutting mechanisms.

This year the company focused on plugging leakages and cutting wastage. There was a big drive in FY12 in improving profitability, driven mainly by the pressure from the losses on derivative contracts which was significant. But because of the drive there are now long term benefits.

We identified Raw Materials (RM) as a big area for cost-savings. We improved our sourcing significantly (from China and the sourcing knowhow from there), plugged leakages.

In our plant we used to have 6-7 hour powercut at times. The moulding material in the moulding machines would get stuck. There was wastage as well as delays due to this. So we invested in heavy-duty UPS (25-30 lakh) systems for uninterrupted operations. Earlier we had 32 cavity moulds. We have replaced them with 64 cavity moulds. We made big investments, but these will come with long term benefits.

Are the higher margins sustainable?

Like I said before, there are long term benefits. Should be sustainable because of operating efficiencies coupled with economics of scale. We are investing significantly on automation front.

Any new expansion will have significant automation. For example the next expansion at this plant (Faridabad) is an expansion cum automation plant. From 40 operators/line this will be down to 20/line. We will also be setting up a fully automated IV plant. from 53/line this will come down to 3/line. This will not only add capacities, reduce variable costs, but also increase consistency & quality.

5. LITIGATION WITH B. BRAUN – SAFETY IV CANNULA

What’s the latest status? Have there been significant costs?

Cases have been filed in many countries. Its moving through the legal/Appeals process. Everywhere we have won. We have won in Germany Apex Court. We have won in Italy and Malaysia. There have been significant costs yes, but at some places we have got back with costs.

As you are aware the Safety IV Cannula cost us some 5-6 Cr in development costs. RM addition is just 20 paise per unit. But Safety Cannula we are able to sell at Rs 15-17 per unit versus Rs 5.5 per unit of normal IV Cannula. The needles used to be imported earlier, now we make them here at 1/4th the cost. RM is still imported.

6. DOMESTIC BUSINESS THRUST

From recent announcements/expansion plans we are seeing some focus on the domestic market? Kindly elaborate.

Yes, we are expanding capacities to cater to the surging demand in domestic market as well. You see the ROMSONS group altogether (6 group companies) is doing a Rs 300 Cr Turnover in India. In contrast we hardly do 50-60 from this market, so there is a lot of scope.

So what are the new initiatives?

We used to mainly participate in Tendered business. NACO (National Aids Control Organisation) and other Tenders. There are few players in blood bags, not huge competition.

In the last 6-8 months, we have now appointed some Super Distributors, some 10 in the country. These are working well.

7. LOCAL COMPETITITION

Kindly give us a sense of the competition in the domestic industry?

Hindustan Syringes – This is the pioneer and 50 year old company in the medical disposables business. Primarily (90%) into Syringes. So some 10% of our products are common

Eastern Medikit – This company 5 yrs back was doing very well at Rs 250 Cr turnover. we were only 100 Cr then. There were some labour problems, and there were questions/ qualifications on balance sheet. This company has closed down recently.

ROMSONS – This is also a 50 year plus company, actually 5-6 group companies in the disposable medical & surgical devices segment in India. They currently have combined gropup turnover of ~300 Cr.

8. JAIPUR FACTORY

Kindly explain the move to Jaipur?

Well as you might be aware there is no space for expansion at Haridwar or Faridabad plants. We have applied for another plot in HSIDC, Faridabad. The Jaipur facility allows us some diversification (plant+labour and other fronts). Senior Management is already present in Jaipur managing 2 group companies so adequate management bandwidth is already available. Besides Rajasthan has a few companies in medical disposables space like Ahlcon Parenterals (catering to Blood Bags) recently acquired by B Braun.

What will the Capital expenditure required?

Roughly 20-22 Cr. 6-7 Cr for land and 15 Cr plant & machinery.

There was an announcement of Rs 100 Cr Capex spend?

That is for the overall Capex envisaged spread over next 1.5 to 2 years. The other locations will also see expansions/additional spends. As mentioned before we have another plot applied for in HSIDC, Faridabad.

9. PATENTS

There are so many manufacturers of products like IV Cannula and other such disposable products, and each have claims to 100s of patents? What’s the real use of these patents?

We use patents worldwide. We apply for patents only if we are having sales in that country. These serve the purpose of only a restrictive mechanism – so direct identical copy of any product cannot be made & sold; some redesign will have to be done before selling in the same country a similar product.

10. ENTRY BARRIERS

So what really are the entry barriers in your business?

a) There is heavy upfront capital investment. 95% of machines are imported
b) Huge focus on innovation – You have to keep innovating to survive
c) Regulations are becoming stricter

So what is your unique selling proposition (USP)?

In one word “Innovation”. We have been continuously investing in R&D. R&D spend in FY2012 was ~3Cr, up from ~70 lakh levels a few years back.

11. FOREX AND HEDGING POLICY

Kindly explain the Forex derivative contract, due to which you faced such heavy losses. Now that is behind us, what is the current hedging policy?

You see last 2 quarters, US$ – Rupee has been at ~52-57 levels. As per our derivative contracts, delivery was at 40-to the US$. Hence the big losses.

Current hedging is on Net Exposure. 60% is open and 40% hedged.

12. EXPORT BUSINESS

Kindly give us a sense on the Export Business. How much of it is based on long term contracts, and how do you ensure payments/receivables?

Yes, long term contracts work best for us on the payments front. In countries with geopolitical RISKS, we work only on advance payment/cash basis. Rest of the countries, its regular LC basis.

What is the effect of Europe region slowdown?

You will be happy to know we are in a different business. There is no effect in a slowdown/recession scenario. Medical sector does better sometimes.

13. US MARKET

When are we going to see Poly Medicure’s entry in the largest Medical market, the US?

We have some ~95 products. As of now the Safety feature is incorporated only in 3-4 products. And as you are aware, you can’t sell in the US Market w/o safety features. We are looking to incorporate safety feature in a few more products, then introduce as a basket – may be after a year or so.

You had acquired an US subsidiary/factory? what are the plans?

No plans of operations. May be use that company for Marketing set-up.

14. EGYPT SUBSIDIARY

What’s the status on this subsidiary? How is it doing?

This JV is doing well. We have an equipment supply arrangement with the company. Currently we do ~20 Cr worth of supply annually with assured margins.

15. MEDIUM TERM OUTLOOK

Kindly give us a sense where the company is headed in the medium term?

We should do well and keep growing at 20-25%. Margins will improve. Cash Flows will improve significantly. In 2-3 years we should be in a happy cash-surplus situation.

Disclosure(s)

Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 1 year;
Donald Francis: No Holdings in the Company; ;
: ; ;
: ; ;

Kaveri Seed Company Management Q&A: Sep, 2012 

Management Q&A

  1. TOTAL MARKET OPPORTUNITY

The Indian seed market is among the top ten largest in the world, estimated to be about US$1 billion in 2005. (Source: ISF Secretariat). Total Market size in 2012 is estimated to be ~8000-9000 Cr in India. The Indian hybrid seed industry is expected to grow at 12-15% annually in the coming years.

The total market for hybrid seeds is ~Rs 8000 Cr today. Cotton contributes 50% of that market with 40-50% being produced in Maharashtra, and the balance in AP & Gujarat. Next is Corn which is primarily produced in AP, Karnataka and Bihar. And then is Paddy which is grown in low-lying coastal areas mostly. The overall market for Hybrid seeds has been growing at 12-15% on an annual CAGR basis.

2.    KAVERI’S JOURNEY

Kaveri has blazed an exemplary track record in the last few years. Kindly ake us through the initial years and the recent journey.

In 1976, GV Bhaskar Rao, a young agriculture scientist graduate, built on his farm in the village of Gatla Narsingapur, Andhra Pradesh, a small seed production unit for public bred varieties of rice and corn. GV Bhaskar Rao also worked with some MNC companies engaged in the Corn Business. Kaveri Seeds was incorporated in 1986 as a private limited company, with a seed processing unit commissioned at Bellary, Karnataka. By the 90’s the company initiated extensive R&D on hybrids.

What you are seeing today is the result of a planned journey over the last 30-40 years. It took us 30yrs to reach a turnover of 30 Cr in 2004.

Getting to pure quality hybrids is both a Science & an Art form. There are seven steps to identify a good hybrid by crossing the right male & female varieties that have some sustainable traits (Yield, draught-resistance, flood-resistance, pest-resistance, etc.). The higher the contrast, brighter are the chances of a quality hybrid. This requires a huge number of permutations/combinations. One out of 10,000 times may yield a successful product.

It takes 6-7 years to get to a quality Hybrid (R&D phase). And another 3-4 years to build up the Volumes for the market (Multiply – scaling up production phase; Breeder Seed), Processing and then Marketing it (Foundation Seed). We have been in Cotton Hybrids for the past 13 years, since 1998-99. But we started seeing market success only in the last 3 years.

Typically a successful hybrid enjoys a 4-5 year run before Nature throws up new challenges in the form of new Pests or climatic changes, or both. For example the Cotton Hybrid Seeds market is finding a new challenge in the form of Sucking Pests!

3.   COMPETITIVE LANDSCAPE

Aside from Kaveri, the notable seed companies in India include Pioneer, Mahyco, Monsanto India, ProAgro, Syngenta, Nuziveedu, Vibha and Rasi Seeds. Any trade magazines/industry publications to validate industry figures and market share?

Nuziveedu Vibha Rasi Mahyco Pioneer Syngenta Monsanto
Primary Segment COTTON COTTON COTTON

CORN

CORN CORN CORN
Other Crops Corn,Veg Seeds Corn,Veg Seeds Corn,Veg Seeds Cotton,Veg Seeds

Cotton is the biggest market. Most players have a presence in all segments – Cotton, Corn, Vegetable Seeds, Paddy. The MNC companies are very strong in Corn Hybrids. Monsanto, Syngenta and Kaveri are the main players.

Cotton is the biggest market with annual 3.8 Cr packets sold. Only Nuziveedu has sold over 1 Cr packets – so that accounts for 25-30% of the market. Next is Rasi Seeds with 50-55 lakh packets. We did about 34 lakh packets. Tulsi & Vibha Seeds may be having similar figures.

The Vegetable Seeds market is 1500-2000 Crs annually, mainly concentrated near Urban centres. Enjoys high Gross margins (60%). 80% of this market is derived from Tomato, Chilli and Bhindi seeds. The balance 20% is Watermelon & other seeds. Namdhari Seeds is the market leader in Watermelon with some 100-120 Crs.

4.  BUSINESS GROWTH DRIVERS

BT Cotton. How much of BT cotton hybrid sales was led by volume growth? And how much by Price growth?

As mentioned before, most of the growth comes from the very aggressive volume growth registered. Only 5-10% may have been due to price increases.

Corn. Margin led growth?

Corn has higher margins but low volumes.

5.   KAVERI PRODUCT SEGMENTS/REVENUE CONTRIBUTION

BT COTTON

Well we did about 480 Cr in 1st Qr this year. And cotton is ~325 Cr, so that’s about 68%. For the full year too, Cotton share should be at similar levels.

BT Cotton overall market is declining (-12% in FY12?); Whom are you taking market share away from?Why is Competition not able to match up? Sales have been doubling every year? How long before the trend reverses for Kaveri? Penetration of Cotton Hybrid seeds 90% plus?

Success depends on a number of factors. First you must have the right product. And then you need to have the ability to scale up production and supply all the demand that the market can absorb. As mentioned before only Nuziveedu has been able to do more than 1 Cr packets. Rasi has done 50-55 lakh packets. We hope to grow our share.

We heard there is some shortage of Cotton Seeds? Mahyco? Is that true?

Mahyco seems to have some challenges with the Hybrid – that has scaling up issues.

CORN

We did Corn sales of ~100 Cr; ~20% of Sales

BAJRA

Less than 40 Cr: ~10% of Sales; but on an all India basis share of Bajra acreage is coming down because of others like Guar Guam.

RICE

Less than 40-50 Cr

How do you foresee the market in the next 2-3 years? Where will the growth come from?

We do not see any change for the next 3 years. The segment contributions will remain more or less the same. We should be able to grow our business at a 20% CAGR basis.

MICROTECK

Where does the company stand currently in terms of competition. If and when company expects it to scale up and start contributing meaningfully to sales and profits?

This segment comprises of micro-nutrients, bio-fertilisers and bio-pesticides. The micro-nutrients segment has no technology barriers or other edge. Margins are around 15%. 85-90% of the turnover comes from AP. Unlikely to see any significant growth.

The bio-fertiliser and bio-pesticides segments may reach significant size in 5 years.

VEG SEEDS

This segment is at a nascent stage. Unlike others, these require controlled farming and is capital intensive ~50lakhs/acre. This also requires skilled labour. However we have seen vegetable prices continually going up.

The payback is in 3-4 years, while the investment lasts you 25-30 years. Margins are high and there is good export potential.

6.   INTELLECTUAL PROPERTY

11000 Germaplasm Bank; What does it take to build this huge a bank; Is this across crops? Across soil conditions? Pests; Drought resistance patterns: Briefly explain what does this take?

We never gave out a figure for our germaplasm bank.

168 lines/hybrids registered with PPV&FR, 54 DUS test cleared, 15 in line for certification. 14 Registrations. How long for the 15 in line for Certiification to Commercial availability?

The registrations are an investment for future intellectual property protection of parental lines and hybrids. There is no commercial significance.

R&D to Registration to Commercial Process. R&D Team strength? Skills? R&D Spends as % of Sales?

We have a ~100 member R&D team. The strength has doubled in the last 5 years. Each crop has a Team leader. 

R&D to Commercial success is long.

Cotton – 8 years; Breeding can be for 15-20 years

Maize – >10 years; breeding can be for 75 years

Reverse-Engineering Risks? Partner Farmers? Smaller competition stealing a successful hybrid line?

Seeds can not be technically cloned. The original parental lines for the hybrid matters. If stolen form production, impurities crop up in next season and the resultant seed’s effectiveness is not the same.

How does Kaveri’s Pipeline compare with those of competitors who have already filed for approvals? Any serious competition coming up?

Registration pipeline has no commercial launch significance. Visibility about competition hybrids is reported from the field.

Dupont Unit accuses Kaveri of Gene Piracy in 2011? Any other Litigations? What are the liabilities if you were to lose any of these cases? Please react.

We don’t think there can/will be any liabilities. We are marketing this product for over 7 years. The Dupont case is about a hybrid having similar traits. The case is about IPR violation. The courts cannot rule on that. It will have to refer to the IPR authorities who have to test both the products, establish originality of parental lines, and revert back with the results. The time needed for this is probably much more than the life-cycle of the hybrid.

7.   CROP SHIFT PATTERNS

Farmers are known to aggressively shift crops depending on their expectations of realisations. Risks?

Not really. The picture has not changed dramatically over the years. Cotton hybrids have remained the mainstay and has only grown in acreage over the years to reach 90% penetration. Maize has remained at 40-50% penetration. In between Sunflower seeds had their time briefly but that has died down. Rice hybrids have potential and a long way to go still.

Depending on the monsoon, some shifts happen to other crops like Pulses. Some shifts have happened to Guar. But this has not caused any dramatic shifts in cropping patterns.

The acreage under cultivation for any crop sees a 5-10% change at most from year to year, usually.

8.  FUTURE GROWTH DRIVERS: 2-3 YEAR TIMEFRAME

As mentioned before, Cotton will continue to be the mainstay, followed by Corn, and Paddy.

9.   SEED PRODUCTION MODEL

600 Acres Company owned Land. Bulk of the production is carried out through leased land/contract farming. Do you really need that much land for R&D?

We have always looked at land as an investment. We have acquired land when it was 5000/- per acre to when it was 10,000/- acre to even 30 lakhs/acre – this was the last transaction undertaken by us in 2008. As you mentioned for R&D purposes you dont require so much land, 50-100 acres may be enough.

So what do you do with the 600 Acres?

We have been able to use for different crops and crop cycles. We rotate crops better.

State govt acquiring land from Kaveri in FY 2012 (as much as 124 acres) does not augur well. If this recurs, how does it affect your research/operations?

AP Government wanted to make that area as Reservoir and notified it. They have not been able to do so, and we are still using the land. We have not been compensated for it either. But we have provided for it.

~75000 Acres under Seed Production totally!! all for 350 Cr Sales? Outsourced Farming/Risks? “Much of our seed production is carried out on leased land and through production growers. The company enlists loyal production growers – 100,000 such growers – and offers them attractive remuneration.” Please elaborate manageability & scalability of the same.

The area under lease by us is now ~100,000 acres. Nothing special is done. It has to be in-line with industry practices. Better pay and incentivised for production performance.We have a 100 member Team closely planning/monitoring the performance.

We heard 85% of hybrid rice seeds production in India happens in AP by 40 different companies?

Indeed Andhra Pradesh accounts for bulk of the seed production.

All of Sunflower

50-60% of Cotton

70% of Paddy

70% of Corn

70% of Bajra

Doesn’t that create huge pressures on available land? And does that create entry barriers for new folks entering the game?

The land is leased for each crop cycle, and renewed every cycle. As mentioned before better pay and production incentives matter. The farmer has an in-built interest in going with where he can get better yields, right. Relationships also matter a lot.

So how do you do your advance planning for the next year Production/& Sales?

Actually we start planning 3 years in Advance. In fact we are now preparing for 2015 June, within a +/- 20% range.

What about the costs incurred? How realistic is this? What if something goes drastically wrong in-between?

3 years are needed to build up to the volumes desired. 95% of the cost is actually incurred in the year before Sales. So for 2015 June, 95% of the cost will be incurred in 2014. We have just started the process in 2012, only 5% of the costs will be spread over these 2 years. We have enough time to do course corrections, as needed.

10.   MAHYCO-MONSANTO RELATIONSHIP

Rs. 180/- per bag: Sales Price Rs.930/bag. What are the Terms? Royalty Increase risks? As per some WTO norms Monsanto can increase royalty by?

Over the years this has evolved to a win-win relationship. The government has increased the price cap from Rs 750-930. However the Royalty has gone up only from Rs. 165 to 180, but that has been more than made up by the surge in volumes.

How does it monitor under-reporting?

They generate 500-600 Cr Sales only by Auditing! So they make sure they do a very good job of auditing. Their audit process is more thorough than the I/Tax dept!

11.   SALES: DISTRIBUTION/DEALERSHIP NETWORK

15000 Retailers; Distributors/Dealers pay months in advance. How do you nurture and incentivise this critical part? Are they exclusive to Kaveri?

There is no Exclusivity. Every retailer stocks most products that sell. Exclusivity is not preferred. The farmer also sows 2-3 different hybrids from different companies.

90% of Sales are due to to your Products merit. Channel push can only account for 10% of Sales. Key is in having the right product.

Debtor days have improved drastically from 138 days in FY08 to 28 Days in FY12? What are the reasons for this drastic improvement? Is it sustainable?

Seeds are procured before Monsoon. In the case of Corn & Sunflower there are Government subsidies which accrue after 4-5 months. In Cotton there are no government subsidies. The reduction in debtor days is a reflection of the increasing proportion of Cotton seeds in our product mix.

Inventory Buildup to cater to the huge demand in Q1? Please explain your inventory valuation policy?

Inventory Quantity decides. Valuation is based on Cost Incurred basis on actuals as paid to farmers (includes compensation).

What is the % of advance which customers need to pay at the time of order booking and by what time advance should be paid for availing delivery in the June quarter? Advance depends on credit profile of customers or its same for all? Advance only for BT Cotton or for all seeds?

For Cotton 30% Advance by Dec/Jan. Supply by May June. Sales continue til July 15.

Farmers buy 1 day prior to sowing. Pays 30% within 15 days of sowing. Another 35% within a month. 20% is the trade discount. Balance 15-20% is what shows as Debtors – carried forward as a Credit Note for Sep, Rabi season. The terms vary from crop to crop.

We have distributors mostly in the 5-10-20 lakh category. Very few 1 Cr plus distributors.

Is it correct to say the advances from dealers that show up in Kaveri’s balance sheet at March 31st every year is a good predictor of the following year’s revenue?

Advances vary between 25-30% but depends really on the demand supply situation. For example we had advances of 170 Cr as on 31st March 2012, but we did a business of 325 Cr in June 2012. Taking 30% advance level as the indicator would have been erroneous!

A better indicator could be the Inventory Levels as on 31st March. That may indicate our plans- we may or may not be able to execute on that! Could be 20% higher or lower. If we have planned for 100, Sales of 90 is considered very good performance. Below 80% Sales, there may be losses.

12.   ENTRY BARRIERS

~600 Cr land; 11000 Gene Bank; 159 filings; Which is the biggest barrier?

We have never mentioned any figures – how big our Germaplasm bank is.

Biggest barrier is TIME, supported by the Germaplasm/Success in R&D. You may have success in AP, but if you have to market in Punjab you got to spend time & effort before you can see success there.

Is it correct to say, once you have has success with one hybrid, chances of more successes are higher?

For new parental lines of course one has to go through the full hybrid success process. Once you have a successful hybrid, then the next successful hybrid can be with a slight change e.g. with “sucking pest” resistance. You may have a slight advantage there, as there may be higher chances of success with slight modifications.

We are usually not worried about competition hybrids. We are worried about making our successful hybrids work with slight changes. We are now seeing much better success than “Jadoo”, with “ATM” which we introduced 3 years back. We have introduced 3 new Cotton Hybrids.

13.   MEDIUM TERM OPERATIONAL OUTLOOK

CAPACITY. 62 MT/hour total average throughput; 8330 MT total cold storage capacity; 2,000 MT/cycle in-house drying capacity; 25 MT/day environment-friendly cotton delinting capacity; 30 MT/day ginning capacity. Please demystify this for us.

Dont worry about these figures. We have spent about 160-180 Cr in Capex so far. Fy12 Capex was about 8 Cr. We will be needing about 5-10 Cr Capex every year for the next 5-6 years. No big recurring Capex is envisaged.

The 60 crore capex in FY 10-11 was good enough to take the revenue to 400 + cr, what is the next growth plan ? The capex in FY12 was just 11 cr.

As mentioned before we are looking to double the turnover in next 3 years, with no big recurring Capex. 5-10 Cr additional capex every year.

TAXATION. How does the company view the tax rate it currently pays? Any chances of tax rate increasing going forward? Is there any litigation with tax authorities on the tax rate the company pays?

If you look at FY10-11, we have actually paid tax at 30%. Some amount was refunded adjudging our Income as Agricultural income, which we reflected back in “Other Income”. The company does not have any litigations on Tax issues.

Low tax rates by Seed Industry- disputed by Income Tax Department. Favourable judgement in lower courts face risk of being overturned in High Court/Supreme Court? How does the company view the latest judgement in favour of Advanta?

Yes, recently the High Court of Karnataka ruled in Advanta’s favour, classifying that as Agri Income. Infact all the cases filed so far has been lost by the I/Tax dept. The only case where I/Tax dept got a ruling in their favour was against a company in Karnataka – where I believe the company had flouted some Karnataka state norm on maximum lease holding. Even that case is on appeal.

What about the analogy being highlighted of the Tea Industry where companies are taxed at different rates for “ tea production” and higher rates for “tea processing”.

Yes for “Processing” the analogy could perhaps be made with a) Rubber and b) Tea Industry. In natural rubber the processed output is distinctly different in size and shape. In Tea also the size and shape of processed Tea is different from the Leaf. However in the case of Seed processing, the Input/Output is the same. Saleable product is not changing shape.

REGULATIONS. Does the company need any regulatory approval before launching seeds in a new state once it has been successfully launched in another state? Is there Price capping in any other state than AP?

Once a state has capped the price at 930, why would anyone buy at a higher rate from any other state. They can all come to AP to buy at that rate, right. So the price cap effectively is pan-india! Prices vary from Rs 930 to 1000.

The Maharashtra Government has recently issued an order cancelling the company’s(Mahyco) licence to sell and distribute genetically modified BT cotton seeds in the cotton producing states of Maharashtra. How much of your BT Cotton Sales come from Maharshtra, and from Andhra Pradesh?

This is an unfortunate development. And the Government Order is inconsistent with the facts of the case. Mahyco Seeds had a production/multiplying challenge. If supply drops from 33 lakh packets to 2-3 lakh packets what can happen? There are some farmers, esp in the Warangal belt, who wanted only that product and would go to any lengths to procure that product. The black-market pushed prices up from Rs 1100 to 2000 to 2500.

The company did not get any benefit! The company’s price to the Dealer remained the same. All seed manufacturers are opposed to this arbitrary move. It should get reversed through court decision.

But the judicial process does take it’s time?

There is 1 year time! Till the next season. We are pretty confident.

QTRLY RESULTS/ SEASONALITY MITIGATION

3.4 Mn Cotton packets. Total market 38-40 Mn packets? So a 10% market share? Was Q1FY13 an extraordinary quarter in terms of demand supply mismatch for BT Cotton seeds?

We should do a 20% growth.

Any effort by management to make the 2nd, 3rd and 4th quarter of financial year more productive in terms of sales and profits?

What can we do here! (Smiles).

25-30% annual growth sustainable for next 2-3 years?

We are confident of a 20% growth for next 2-3 years, or a turnover of 850-900 Cr

14.   LONGER TERM VISION

To become the No #1 Seed Company in India

15.  BRAND BUILDING. PROMOTIONS

Mainly Sales promotions/demos. We have 10 Tata Aces going around doing local promotions in local languages. We don’t do any aggressive promotions/brand building. The products need to perform.

16.   RISKS? ANY NOT DISCUSSED SO FAR?

For sure not Monsoon!! Cotton Seeds have

a) longer time frame, affects only if say rainfall is below average -90%

b) initial 2 showers are enough for sowing, doesn’t need huge rainfall

c) can always transfer for next season sales; we have cold storage facilities

d) delay in monsoon can cause shift in crop patterns – we have a diversified seed basket

In any case the shifts are 5-10%; we need to be worried if only there is a 20% plus shift.

17.   DIVIDEND POLICY

Esp now as there is surplus funds and are investing it in mutual funds. 100 Cr CASH. Company made provision for diminution in value of investment of INR 3.5 Cr. Similarly there are investments of INR 2 Crs in equity and the company has already made provision for diminution of value of equity by INR 1.5 Crs.

The way we see it, the Promoters will be the biggest beneficiaries of a hefty dividend payout. We have been increasing Dividends for the last 3 years, in line with our profits growth. Yes Dividend Payouts are currently on the lower side.

But please see this in the context of the nil/low debt situation. At this stage of our growth and in our kind of business we need to maintain enough Cash on the books. When we are comfortable on that front we will look to improve things on this front. Infact we might actually prefer a buyback of shares to increase shareholder value


Disclosure(s)

Tirumal Rao: No Holdings in the Company; ;
Davuluri Omprakash: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
: ; ;

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; ;
: ; ;
: ; ;
: ; ;

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 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; ;
: ; ;
: ; ;

Ador Fontech Management Q&A: Mar 2011

Management Q&A

1.  ADOR FONTECH HAS HAD A DECENT RUN OVER THE LAST DECADE. RECENTLY THE COMPANY ACHIEVED A TURNOVER OF OVER 150 CR WITH EXCELLENT MARGINS AND RETURNS. 

Congratulations! Kindly take us through the Journey and key success factors

Let me give you a backgrounder on the company and its business first. Ador Fontech has been in this business since Dec 1979. We are like Doctors to industrial machinery. With a salesforce of over 150 we service the entire infrastructure sector in India, for repairs. Cement, Steel, Mining Plants and Refineries.

We provide the Services necessary for resurfacing, refurbishing and repair of industrial machinery. We manufacture much of the consumables required and have partnerships (many are exclusive distributorship agreements) for some special consumables that are not economical to manufacture (market size small).

Let’s take the Mining industry – say Coal or Iron Ore. Typical equipment used are Dumpers and Drag Lines which can be of BEML, Caterpillar or Komatsu make. Each have different levels of wear & tear. Its like Cars from Fiat & BMW (latter may need very little maintenance).

Now why go for refurbishments? While refurbishments are gone in to extend life, Cost and Availability play a big hand. Sometimes maybe custom components are required, or very old components, or the technology may have changed meanwhile.  Sometimes availability is like 6months/1 year. This proves very expensive for customer. So he may go for a temporary solution/ or a permanent solution too.

The repair service industry is small. Let’s take Cement industry – people know each other. They go by Testimonials. They know our capabilities. For particular type of critical jobs, they will come to us. This is a knowhow-based, specialised skills niche industry. We maintain a big Documentation and Training Center (Cumulative Knowledge base of Case Studies).

What are the future plans? Where does the company see itself in the next few years? What are the key success factors and what are the challenges that lie ahead?

The infrastructure sector in India, say Cement or Steel is miniscule, when you compare with any developed economy standards, say US or China. Plants are small and fragmented. Let’s take power boilers. We have from 22 to 62, 100, 200, moving upto 770 MW, whereas the Developed world works with 1000 or 1200 MW boilers.
You can afford a shutdown of small boiler for days. But a large scale boiler you cannot afford a shutdown for even a few hours. the losses will be enormous. So, with larger equipment is associated Superior quality. Downtime is small. Losses are large.
The numbers involved changes quite a bit. It all depends on how Industry shape in India changes, and how fast. It is no more economical to put up a 15 Mn Tonnes Steel Plant. Everybody talks about setting up a 150 Mn Tonnes Steel plant! And in an environment of slower growth, everyone defers Maintenance!
Training people and retaining people are the big challenges. In our industry its a new Learning every time. The machine may be same 2 year old, but the situation (wear & tear) is completely different.

2.  ADOR FONTECH IS IN A BUSINESS THAT IS NOT CAPITAL INTENSIVE. YOUR AVERAGE CAPEX HAS BEEN IN THE RANGE OF 1-3 CR OVER THE LAST FEW YEARS. HOWEVER FY11 HAS SEEN MAJOR CAPEX BEING INVESTED IN THE COMPANY ~12 CR

Kindly explain the reasons for this major investment in a single year? Are we seeing a shift in gears with the company adopting a more aggressive gameplan form here on?

We had like a small “clinic” in Nagpur. We have now converted that into a Hospital. We are spotting an increasing trend of “outsourcing” repair services in the industry as opposed to maintaining big in-house repair services teams.

We have increased the capacity by some 4x times. Earlier we could service small shafts, gears, impellers. Now we can service bigger components like Cement Kilns. new specialisations have been added. Emphasis is on more value-adds.

3.  YOUR TRACK RECORD ON THE MARGINS FRONT IS EXEMPLARY. WE DON’T FIND MANY BUSINESSES THAT CAN BOAST OF IMPROVING MARGINS ALMOST 2X IN 5 YEARS. OPERATING MARGINS HAVE GONE UPTO ~20% FROM 12% IN FY07, AND NET MARGINS HAVE IMPROVED FROM 6.4% IN FY07 TO ~13% IN FY11

Kindly take us through the dynamics of your business, and what makes this kind of a performance possible?

The answer is simple. The business profile and mix has changed over the years. Earlier we were doing mostly Trading. Increasingly we have been Manufacturing our own consumables. And now there is an increasing component of Services.

What is the contribution of Services segment currently?

Well, it should be about 12-13% of overall revenues.

In view of your recent Services capacity expansion, is it fair to say Margins uptrend looks set to continue?

In a “Normal” environment, Yes. We have metal prices and imports volatility to contend with also.

With a 4x increase in Service capacity, are we going to see a corresponding increase in Service segment revenues? By when?
(TBD)

4.      “LIFE ENHANCEMENT OF INDUSTRIAL COMPONENTS”. THIS IS A NICHE SEGMENT THAT ADOR HAS BEEN SERVICING OVER THE YEARS.

Kindly educate us on the Total Market size in India and the nature of competition that you face.

Repair Services is roughly a 450 Cr Annual market in India currently. Competition is from a few other organised players.

Is it true that effectively this is a Duopoly. Ador Fontech and EWAC are the only two players?

There are effectively 3 players. EWAC Alloys (235 Cr), Ador Fontech (150 Cr), and Diffusion (60 Cr). EWAC is 100% L&T owned – Production by EWAC and Marketing by L&T. Diffusion is a Nagpur based player, breakaway group from L&T.

What about players like Esab and Ador Welding? Are they not competing in the same market?

Esab and Ador Welding cater to the “Fabrication” services market (new). We are into “Repair” Services for old equipment. There is some overlap sometimes, but very little.

Is it true that EWAC enjoys operating Margins in the range of 24-25%? Why are they doing a better job than Ador Fontech? Will Ador eventually catch up on the margins front?

When you are comparing EWAC with Ador Fontech, you are not comparing Apples to Apples. EWAC did not have any Marketing overheads on its books – everything was taken care of by L&T. Also their volumes are bigger. But from this year onwards, Marketing will also be completely be with EWAC. So a better timeframe to compare will be 1 or 2 years down the line.

5.  EXCLUSIVE DISTRIBUTOR RELATIONSHIPS – SULZER METCO, ALLOY STEEL INTERNATIONAL, DELLERO STELLITE, EWM, MICROTHERM, PROTECTOR, CEPRO, CEA, GASFLUX, YORK AND EUROMATE PRODUCTS IN INDIA

Kindly give us an idea of the role these exclusive distributor relationships play in the sustainability of your business. Which are your top 3 relationships, and what is the current contribution form your top 3 product relationships?

Partner relationships help us move up the technology curve to High-End repair services. Low-end repair service is commoditised. There is no money, too many players to service.

With Sulzer Metco we have a relationship going back some 26 years. We are their Agents and also stock & sell their consumables and spares in India. We also sell & service Sulzer Metco equipment. They are the specialists in Plasma spray or thermal spray solutions – used for Turbines/Engine components.

Dellero Stellite is another partner we are working with for some 18+ years. They are specialists for Cobalt & Nickel Alloys used in high temperature applications like Engine Valves.

EWM, manufacturers of High-tech welding machines is another partner with a relationship that goes back some 7-8 years. These are needed in higher quality fast welding applications.

Please give us an idea of Revenue/Sales contribution from top 3 Partners

(TBD)

What does an EWAC do for say Sulzer Metco products? Are there equally effective alternate sources?

Yes, there are multiple vendors for most applications.

6.  ENTRY BARRIERS. SUSTAINABILITY OF COMPETITIVE ADVANTAGE

Kindly educate us on the Entry Barriers? Do you think these are strong enough to help you sustain your competitive edge for a number of years, and why?

You may like to see it like this. If you are a senior person and need some cardiac intervention/repair, you will go to a Specialist for the job. You will not bargain!

So, for some specialised jobs, proprietary technology remains with you, for some time. You are usually the first choice. And if the number of such jobs are small, no one else is likely to jump in.

Our entrenched customer relationships help. Our partner relationships help, they act like our extended Sales Team.

What kind of certifications, if any are necessary before one can service industrial reclamation projects?

Certain certifications that we have from BHEL, WRI (Welding Research Institute) add value. Nuclear Power Corporation has recently approved us.

7.  POWER, SHIPPING, MINING AND OTHER CORE SECTORS AND ENGINEERING INDUSTRIES. THE CANVAS IS HUGE, ESPECIALLY IF WE LONG AT THE LONG TERM GROWTH PROSPECTS OF THESE SECTORS IN INDIA

Which are your top sectors? Are you strategically aiming at developing expertise in certain core sectors? Kindly educate us more on the company’s vision for the long term.

Cement, Steel, Mining and Refineries are top sectors. The nature of industrial components are similar – boilers, turbines, kilns, gears, shafts, etc. But, sizes are changing. And volumes are changing too!

8.  THE COMPANY’S TRACK RECORD HAS BEEN EXEMPLARY ON MARGINS AND PROFITS. THE SAME CANNOT BE SAID HOWEVER OF THE TRACK RECORD ON SALES PERFORMANCE.

While everyone agrees that Ador Fontech is a well managed company, Investors also feel the company has been too risk averse? That your are over-selective in choosing contracts to participate in? What can otherwise explain the pretty average record on the sales front?

(TBD)

Considering that this is effectively a duopoly in your niche, could you not have grown faster?

(TBD)

9.  CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

Who are your top customers/ What contribution comes from your top 3 customers?

(TBD)

10.  RISKS FROM EXCLUSIVE DISTRIBUTOR RELATIONSHIPS

What is the company’s views on risks from exclusive relationships. What can change the nature of the relationships? Some of the players have India presence, why will they not think of setting up their own service organizations.

The market size is currently too small.

11.  RAW MATERIALS – WIRES, METAL STRIPS & FLUXES, WEAR PLATES

Kindly explain the process followed on raw material management front? Are there any constraints/challenges on the sourcing front and price volatility faced, etc.

We do not normally face challenges on sourcing.

12.  IMPORTS. HEDGING POLICIES

Ador Fontech has a sizeable Import Bill. ~35 Cr in FY11 or almost 25% of Sales. Kindly explain how do you manage the risks on the currency fronts. What kind of hedging policies are followed by the company?

We do not do any Hedging. But are open to look at it.

13.  SALES DISTRIBUTION & SERVICE NETWORK. TENDER BASED BUSINESS

Kindly explain your sales and service network in place. How do you go about securing and managing business from customers? How much of the business is from tendered business?

As mentioned before we have a salesforce of over 150 trained people. They are in the field and in touch with major customer segments on a regular basis.

Significant portion is tendered business.

14.   PACE OF TECHNOLOGY CHANGES. KEEPING PACE

Kindly explain how the company manages to stay on top of technological challenges? What kind of a R&D set up does the company maintain and nurture?

We have a big Documentation and Training Center for continuously building on the metallurgy and wear & tear knowhow base. We have a team to continuosly look at quality improvement solutions.

15.   LOW PROMOTER HOLDING. WHILE PROMOTER HAS BEEN GOING UP FROM 24% IN 2007 TO OVER 35% IN 2011, THIS IS STILL VERY LOW COMPARED TO OTHER GROUP COMPANIES. ADOR WELDING HAS ALWAYS HAD PROMOTER HOLDING ABOVE 50-55%.

Kindly comment on the relatively low promoter holding in this company. Is this lack of confidence in growth prospects earlier? And has this changed for the better considering there has been a steady acquisition over the last few years.

All I can say is this is there because of historical reasons.

16.  DIVIDENDS. DIVIDEND POLICY. PAYOUTS

Kindly elaborate on the dividend policy followed by the company. Why is the company not doling out higher payouts considering the excellent profitability and low capex/funding requirements?

No, we do not have a dividend policy.

17.  CHALLENGES BEFORE THE COMPANY

Kindly elaborate on the main challenges faced by the company in view of the huge opportunities that lie ahead. When can we see Ador Fontech touching 500 Crs in revenues?

Good Question. 500 Cr in turnover – is that a prime objective at this point? No, keeping a healthy bottom line, is. But we do keep looking at Opportunities.

Disclosure(s)

Manu Dev: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
: ; ;
: ; ;

Atul Auto Management Q&A: Jan 2012

Management Q&A

Concall with Mr. J V Adhia, Vice President, Finance – Atul Auto

[Conducted and shared by active ValuePickr Ayush Mittal. His Value Investing blog is a prolific source of winning stock ideas in most market conditions!]

A brief background on the company shared by Mr Adhia, before taking up our questions.

Atul Auto has been in this business for almost 3 decades now and were pioneers in low cost vehicle known as “Chhakada”, introduced in year 1975. To make a better multi-purpose vehicle, they set up a plant in the year 1991. In 1992 the production had started and the vehicle was known as Mark 2. They were quick to understand the changing needs of industry and could foresee need for lighter and better vehicles – the 3 wheelers we see today. In 2000 the production of 3 wheelers of 350-500 kg capacity started and they along with Piaggio were the early players.

Questions for Atul Auto Management

1.     IF WE LOOK AT 2007 -2010, SALES HAVE BEEN RATHER FLAT AT ~120 CR. HOWEVER ATUL AUTO HAS BEEN REGISTERING HEADY GROWTH OVER THE LAST 2 YEARS. 68% IN FY11 AND 1HFY12 HAS SEEN SALES GROWTH OF OVER 56%.

Kindly take us through this journey of the last 5 years. What has the company done differently in the last 2 years? What are the main contributors to this recent success?

The right way to look at our company would be to look at it from 2001 when the actual 3 wheeler production started. During the period 2001-06 the company had been growing at about 70% p.a. Till then we were a front-engine 3-wheeler company. In 2007 we decided to go pan India and introduced the more predominant rear-engine 3-wheeler segment by sourcing engines from Lombardi.  Some things went wrong and the company faced a rough patch, and that is the reason you notice stagnant sales for the period 2007-10. However in June 2009 period we introduced Atul Gem the rear-engine vehicle (with engines sourced from Greaves Cotton), and it has been received very well in the market. The growth is back on track.

2.     ATUL SHAKTI (FRONT ENGINE 3 WHEELER) AND ATUL GEM (REAR ENGINE 3 WHEELER, INTRODUCED IN FY09) COMPRISE ~94% SALES. THE CONTRIBUTION OF ATUL SHAKTI HAS COME DOWN FROM 63% IN FY10 TO 43% IN FY11. ALSO IN VOLUME TERMS ATUL SHAKTI HAS GROWN ONLY BY 6% OVER FY10. SEEMS LIKE ATUL GEM IS A SPECTACULAR SUCCESS, AND THE PRIMARY DRIVER OF GROWTH FOR THE COMPANY.

Kindly explain the dynamics of the 3 wheeler market. Why is a rear-engine 3 Wheeler preferred over front-engine 3 wheelers?

Technology wise there is not much to choose between Front Engine & Rear Engine vehicles. However there are very distinct market-specific preferences, for e.g. Gujarat, Rajasthan & some parts of UP usually have front engine vehicles while most of the other states have preferred rear engine vehicles.

It’s also a mind-set thing. There is more use of front-engine in Cargo (the payload at the rear will balance out) and rear-engine vehicles are more used for passenger vehicles. But overall 91% of the total autos are rear-engine vehicles.

If rear-engine 3 wheeler is a overwhelming favourite, why did the company work on introducing front-engine 3 wheeler (Atul Shakti)– especially when market leaders like Bajaj, Piaggio always had only rear-engine 3 wheelers?

Unlike other player in the industry, we were very small players with limited resources. We could do things, only gradually. Our home base is Gujarat, naturally first focus was Gujarat & neighboring markets, and hence we first introduced atul Shakti – the front-engine 3-wheeler.

Our rear-engine 3-wheeler Atul Gem introduced in 2009, as we expanded to other markets. It scores very well on most of the parameters when compared to competition. It has been about 2.5 years now in the market. The response is overwhelming and we have seen exploding growth in that segment.

What is the Sales mix between Passenger and Cargo Vehicles? Is it any different for front-engine and rear-engine vehicles?

About 70% is towards passenger and rest towards cargo.

3.     THE 2006 COLLABORATION WITH LOMBARDI DIDN’T WORK OUT. THE PROJECT WAS A FAILURE AND THE COMPANY HAD TO RECALL AND REPLACE ENGINES IN NEARLY 8500 VEHICLES EVENTUALLY.

What went wrong? What are the lessons learnt by the company? How did you handle the financial impact?

Yes, it was a really challenging and rough time for the company. The company had done all the initial homework like road-testing, etc on assembled vehicles with Lombardi engines. The first lot was imported from Italy and those were good engines and passed all the tests. But later with engines sourced from Lombardi’s initial local production in Aurangabad, the quality didn’t match up and there were several issues. Production volumes had to reach certain levels, before quality issues could stabilize.

What is the legal situation on the court cases filed by both sides? What’s the company’s view on risks posed by the contingent Liability of ~11 Cr?

The company has filed cases against Lombardi worth 40 Cr. The legal system, the way it is, Lombardi has also filed ounter-cases. Lombardi’s claim is of hardly 2-3 Cr (vs 11 Cr shown) due to interest cost, C form requirements, etc. We don’t see much risk on this front.

How did you solve the technology/engine sourcing problem subsequently?

Atul Gem – assembled with Engines sourced from Greaves Cotton worked perfectly!

Greaves Cotton supplies all your engines today – and Atul is on a spectacular growth trajectory – why has this alliance worked out so well?

Greaves Cotton is the best and has a sort of monopoly in these engines. Our company has a good relationship with them for over 30 years, on many products.

What is the nature of relationship with Greaves Cotton on this front? Without any binding contracts, how do you mitigate risks on this front? Are there any competing 3-wheeler manufacturers also sourcing engines from Greaves Cotton?

It’s a very good relationship. All the auto companies expect Bajaj & TVS (as they are lower payload, different category) source from Greaves Cotton. After M&M & Piaggio, we are their 3rd biggest customer. M&M & Piaggo have their own plants to manufacture engines. Atul Auto has no such potential conflict of interest. We don’t see any risks.

4.     COMPETITION. ATUL COMPETES AGAINST BIGGER AND MORE ESTABLISH RIVALS IN THE 3 WHEELER SPACE LIKE BAJAJ AND PIAGGIO. IN GUJARAT ATUL AUTO IS #1 3 WHEELER MAKER AND ITS #2 IN RAJATHAN.

Apart from the home advantage in these 2 states, what are the factors that has helped Atul best competition in these 2 states?

The company has had small beginning and limited resources unlike competition since the very beginning and yet we have managed to do very well. Our focus has only been 3 wheelers unlike competition who have a basket of products. Also 3 wheelers is a small portion of their overall business.

With our single-minded focus on the 3-wheeler segment, we provide more value to the end user in terms of better products, pricing, cheaper spare parts, quality after service etc.

What are the key technology parameters that serve as Sales drivers – Load-bearing capacity and mileage? Do Atul products offer any advantage vs competing products on these 2 fronts?

Yes, mileage of Atul Auto 3-wheelers is better than competitors. The  vehicle scores better than the competitors on several parameters.

How does the company keep pace with technological advances in its field? How strong is the Pune R&D facility? Please give an idea of the quality/skill levels of the R&D team? Any new models planned for launch soon?

The facility at Pune has experts from the automobile sector who in past have been in the field of product development and improvement. It has about 12 people.

5.     IN RURAL MARKETS, 3 WHEELERS – ESPECIALLY IN CARGO SEGMENT- ARE ROUTINELY ABUSED. ROAD CONDITIONS ARE BAD AND ALMOST ALWAYS VEHICLES ARE OVER-LOADED. DESPITE THIS ATUL AUTO OFFERS EXTENDED WARRANTY OF 2 YEARS, WHILE COMPETITION OFFERS ONLY 6 MONTHS WARRANTY.

Is this correct? How long has Atul Auto been providing the 2 year warranty and what has been the experience so far?

Yes, as compared to others, Atul Auto offers 8 month manufacturer warranty and the rest is provided by insurer. The market has given a good response to these schemes.

How does Atul balance the trade-off risks?  If Insurance covers are the answer, that will only inflate the cost (known risks), why are competing companies not following suit?

Our experience has been good. So far, we have not had major liabilities on account of the extra 2-month warranty. Can’t say why Competition has not followed suit.

6.     INDUSTRY GROWTH. THE ENTIRE 3 WHEELER MARKET IS GROWING AT A MUCH FASTER PACE IN THE LAST 2 YEARS. THIS WAS NOT THE CASE IN EARLIER YEARS.

What are the reasons for the change in fortunes? Is it because the rural economy is growing much faster due to govt-funded schemes like NREGA, increased spends on improving rural infrastructure like better roads & connectivity?

Yes, industry has in-itself grown over the years and lot is due to the infrastructural development etc. There is need for low cost transportation for the masses.

What are the main growth drivers for Atul Auto for the next 2-3 years?

Yes, the market has enough demand and is growing. As of now, the only limitation is production. The company has been taking a very cautious approach since the 2007 debacle and hence taking every step with lot of caution. We are in process of ramping up capacities by way of de-bottlenecking. We can also increase no. of shifts to increase production, as needed.

7.     SALES & DISTRIBUTION NETWORK. THE COMPANY HAS BEEN FOCUSING ON INCREASING ITS DEALER NETWORK IN THE LAST 2 YEARS.

Kindly elaborate on your Sales & Distribution model. In how many states are you present? Other than Gujarat and Rajasthan, which is your next biggest market and why?

The company leads in Gujarat & Rajasthan. We are No #1 in Gujarat with about 44% market share & No #2 in Rajasthan with about 30% market share. Kerala & Assam are our next big markets.

What are the challenges when you try to expand into a new state? Aren’t there permits/controls imposed that vary from state to state. Usually these come with political patronage, and competitors we assume are already entrenched. How do you tackle these issues when expanding into a new territory?

The company has all the national approvals and presence in the following states: Bihar, Jharkhand, Chattisgarh, Assam, Some part of UP, Punjab/Haryana, J&K, Andhra Pradesh, Kerala, Karnataka & Maharashtra.

For Cargo vehicles, national level approvals are enough. But for passenger vehicles, yes, state level permits come into play.

What is the current Dealer network strength? What are the plans for the next 2 years?

Current dealer newtwork is about 120 dealers. A year back we had 100 dealers but only 30-40% were active! Now more than 80% are active. Plan to have 140-150 dealers by this year end and 250 in 2 years.

What kind of incentives do you offer to new dealerships while entering a new market? What kind of market mapping exercise is done within the company before you take a decision to enter a new market?

Incentives are decided on market to market basis. Atul’s dealers provide all the services like arranging finance, RTO work etc so they get benefit in that work also. Plus servicing is a good area and 3 wheelers require the same due to high wear and tear.

8.     DEALER ADVANCES ARE NOW A SIGNIFICANT FACTOR IN IMPROVED WORKING CAPITAL SITUATION.

Kindly explain your Dealer Advance Policy. Why has it shot up from 36 lakhs to 3 Crs in FY11?

100% Dealer Advance indicate strong demand and product acceptance? Are you meeting with the same success in all the new markets you have entered?

The dealer deposit/security is not high – at about 2 lac. As of now the company is seeing a very strong demand and there is a waiting period of about 10 days. As per policy the company is taking orders on advance basis only. Hence the high advances on Balance Sheet.

Do you foresee this happy situation as an established aspect of your business model from here on? Is this likely to continue for the next 2-3 years? Will the Advance base keep growing as you expand into newer markets and appoint more dealers?

The base will probably keep growing as we expand the dealer network.  But you need to keep in mind the current Advances situation is because of the waiting period! Once we have expanded capacities, this may not remain at same levels.

2Q Fy12 saw Working Capital situation turning negative. Is this sustainable?

Covered above.

9.     PRODUCTION CAPACITY. THERE WERE PRESS REPORTS AND ARTICLES QUOTING THE COMPANY WANTING TO DOUBLE ITS PRODUCTION CAPACITY FROM EXISTING 24000 VEHICLES CAPACITY.

Kindly inform on the progress on the same? Is this being done in existing location or this is a new location being planned?

All expansions are planned at existing location. Our plant is on 13 acres and we have sufficient spare land. As mentioned before, we are expanding capacities by ongoing de-bottlenecking exercises. We are already at 20-25% higher production and the rest of the de-bottlenecking increases should happen over next 3-6 months.  Also as mentioned before, we have options of introducing a double shift, as and when deemed necessary.

What is the outlook for FY13 on the production front? Will it be able to match rising demand from the expanded sales & distribution network? What kind of Sales growth is the company aiming for in FY13?

We can discuss on this aspect later, during March.

What is the outlook on the margins front? Are operating margins sustainable at the current 9-10% range for the next 2-3 years?

We think current margins are sustainable and can only get better as operational efficiencies kick in.

10. 1000 CR TURNOVER TARGET BY FY2015-16. A 5 FOLD INCREASE IN 5 YEARS.

Is this a realistic target for a company of your size? What will be the main growth planks and what are the milestones to be achieved along the way?

Yes, it is quite a realistic target for us and we are gearing up to achieve the same. Majority of the growth should come from 3 wheeler space itself.

What contribution is expected to be forthcoming from your Sri Lanka and Bangladesh forays?

The initial response has been very good from both the areas. The company has already appointed a dealer in Bangladesh who has been trained over last 6 months to assemble the SKD there and sell forward. The dealer should set up a facility there soon. Sri Lanka has immense potential as a market for us, but the plans are under process.

We have often heard of the company’s LCV plans. Given that there are entrenched players in this segment – there are products like Tata Maxis, and Magic 4 wheelers –positioned well for the rural/semi urban market, what are the companies strategies for the same?

To put it simply, the company is planning 3 wheeler with one more wheel. We are targeting – Ultra low cost CV – in between Tata ACE and current 3-wheelers. We believe this will be a viable new segment. We have done our research and groundwork. This may take another 2 years for us as land acquisition has been a hurdle.

Bajaj Auto has recently launched the RE60, exactly for this segment. They are saying don’t call it a Car – It’s a 4-wheeler but not a car! Your comments, and does this require any modification of plans, especially as you say you are atleast 2 years off!

Atul’s presence is more into open heavier 3 wheelers which are used for low cost bulk transportation i.e. about 8-10 people sit in. The RE 60 can at max accommodate 3-4 people so it will cater to a totally different category. In a country like India, there is a huge demand for low cost of transportation.

Talking about company’s LCV plans, RE60 is of lower tonnage while we are targeting the commercial vehicles segment. So the right comparison would be to the likes of Tata Ace etc.

Technology collaboration would be necessary for the company’s entry into LCV segment. Has the company tied up with any technology partners? Or, is the company planning to enter this market on its own home-grown technology? How far are we from some action on the ground on this front?

Things are under process and all options are open.

What kind of Capital Expenditure will be necessary for the LCV project? How has the company planned to fund this?

As of now things are open and under-consideration. The total cost is estimated to be about 200 Cr.

11. RIGHTS ISSUE. 1 EQUITY SHARE FOR EVERY 4 EQUITY SHARES HELD. 14,62,880 EQUITY SHARES AT RS.30 FOR RS. 4.39 CRS. ONE SHARE FOR EVERY 4 SHARES HELD. RECORD DATE 15TH SEP, 2011.

As of Sep 30, 2011 the company had negligible debts of 3.75 Cr coupled with a healthy Current Liabilities (Payables) position of 32.25 Cr! Kindly explain the rationale for the rights issue.

We had applied for the rights issue in June 2010 and expected to get clearances in a couple of months.  But it took more than a year!. The cash flows and debt position were very different then from what it looks now.  We had almost 15 Crores in debt as on 30 Sep 2010!

So after getting the approval as most of the work had already been done and it was a small issue, we decided to go ahead. In a way it was also to reward the small shareholders.

This is a substantial 20% dilution for just Rs. 4 Cr (which the company did not need at the time of offer). This is a very expensive deal for any company. You could have chosen to defer/scrap the rights issue. Kindly comment

From a strict financial standpoint, you are right. Would we have gone for a rights issue in the current financial situation, at these terms? Absolutely not!

However you may like to see it in the right context. When we applied for the rights issue in June 2010, it made sense. The company had debts of ~15 Cr, we were thinking of raising money for Capital Expenditure. The prevailing share price of the company was ~40-50, and we offered the rights issue at a discounted price of Rs.30. You can’t find much fault with this, right?

Now when the approvals came a year late, one point of view was to scrap the rights issue. The other viewpoint that also emerged was that it is good for small shareholders, especially as the share price had appreciated a lot since then. That the company should keep in mind small shareholders who have stayed with the company for several years. We did sample surveys with small shareholders in Ahmedabad. The results seemed to indicate that they welcomed the rights issue.

The company decided to go ahead with this option.


Disclosure(s)

Ayush Mittal: Less than 5% of Portfolio in the Company; Recent Entry;
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Astral Poly Technik Management Q&A: Dec, 2011

Management Q&A

Questions emailed to Astral Poly Technik CFO Hiranand Savlani. Telephonic Update

1. FOREX FLUCTUATION IMPACT ON OUTSTANDING ECB BALANCES. AS ON SEP 30, TOTAL DEBT IS 53 CR.

How much of this is ECB? And what are the interest costs and repayment terms. 

5 years with quarterly repayment instalments at roughly Libor +3%.

And what is the quantum of this ECB?

Majority of the debt is ECB.

That’s more like close to 50 Cr?

Yes

2. YOU HAVE MENTIONED A M2M LOSS OF ~8 CR FOR 1HFY12 – LOSS ARISING ON FOREIGN EXCHANGE RATE FLUCTUATION ON OUTSTANDING BALANCES, WHICH WILL BE ACCOUNTED FOR AT THE END OF THE FINANCIAL YEAR.

This can at best account for 4-5 Cr of loss on ECB loan outstanding balances. Does this mean the 8 Cr loss includes losses from the Payables as well, how much?

Yes, this is on account of M2M accounting for both ECB loans outstanding as well as on the Payables front, because of the steep Rupee depreciation. Together the M2M loss has been put at 8 Cr.

So is it right to say ECB Loans would have accounted ~5 Cr and the balance would be on account of Payables?

Roughly, it should be around that.

3. AS PER AS-30 ACCOUNTING NORMS, ASTRAL WOULD ALSO HAVE THE FLEXIBILITY TO CAPITALISE THIS (INCLUDING INTEREST OUTGO). MANY COMPANIES SPENDING ON CAPEX EXPANSION HAVE DECIDED TO CAPITALISE THIS – BALKRISHNA INDUSTRIES, PI INDUSTRIES, FOR EXAMPLE.

Why is Astral not considering capitalising this part – Is that not an option at all?

We are also thinking considering on those lines as majority of the expenses is related to Capital Expenditure. The options are open. We will take a call at the year end.

Is partial hedging also an option? Why, or why not?

We do take near term hedge. So 1 year equivalent of installments are hedged. So till March 2012, we are safe. Beyond March 2012, we will have to see what measures to take.

If that is the case that you are hedged on installment repayments, why was there exceptional items (1.22 Cr) loss due to changes in Forex rates on repayment of borrowings accounted for in Q2FY12?

That was on account of payments due…Buyers Credit dues. You see the Buyers Credit rollover is in 6 months.

We thought your credit terms with Lubrizol was 120 days, not 6 months?

Lubrizol credit terms are 120 days. But we had switched to 6m Buyers Credit. Current borrowing costs are 13-14% to take advantage of that.

Why the shift from 120 days Lubrizol credit to 6m Bank Buyers credit? What’s the advantage?

Well we get another 2 months extra credit isn’t it? Isn’t it better to extend the payment for 2 more months and have more funds available for Working Capital requirements. We need to pay 2.5%-3% for the buyers credit in lieu of the current 13-14% interest norms. We end up saving a flat 10%!

So, why don’t we hear more of the 6M Buyers Credit facility? Why is it not that common?

It is very popular. Out of 100, 95% of the companies will be taking this route.  In a Rupee stable situation, the flat 10% gain works to everyone’s advantage. And everyone is prepared for temporary spikes. Not for steep hikes.

But now the Rupee has depreciated by 16% meanwhile?

Yes, it doesn’t look so good now. Look, this is an extreme situation that has happened. You do business planning based on normal business forecasting. Normal forecasting or what anyone was prepared for was 4-5% moves. No one could have been prepared for a 10% plus or 16% plus depreciation, and that too in so short a duration!

We do business planning based on normalised situations. We can’t plan for extreme situations, can we?

Even from here if the Rupee remains stable at 52 to a US$, it will work out very well.

4. Q2 CONCALL MENTIONED RAISING ANOTHER 15-20 CR ECB AT LIBOR +3%.

What further tranches has the company drawn in Oct, Nov and so far in Dec? and at what rates respectively?

We raised $2 Mn in Dec and maybe we will raise another $2 Mn in Jan 2012.

And you did not draw any money earlier? In October, November?

$1 Mn in November

So totally some $5mn more has been drawn since September 2011?

Yes.

5. THE RUPEE HAS SINCE APPRECIATED TO 52 TO US$.

Is it correct to surmise that if the Rupee remains at ~52 to US$ till the year end, there will be additional liability of another ~4cr that will need to be accounted for by 31st Mar 2012, on the loans till Sep 30 alone?

See the situation is very dynamic. Everyday the positions change. Payments need to be made in between. We made some payments $1-2 Mn at 51.70 a couple of days back, and today when I check it has changed to 52.40.

Instead of trying to take a call on the direction, we try to participate at every level. So we participated at 51.40, 51.70, and we had participated at 51.20 levels too.

Now that the Rupee is at 52 to US$ and assuming that it remains there till Mar end 2012, is it fair to say that another 4-5 Cr liability will acoount both on payables and ECB loan outstandings?

Its very difficult to give exact figures, situation is too dynamic.

But given that $ has moved from 50-52 since Sep, i.e  a Rs 2 difference, and in September there was a Rs 4-5 differential, isn’t an additional 4-5 Cr a fair ball park estimate?

That is correct.

6. FOREX FLUCTUATION IMPACT ON PAYABLES. LIABILITIES AS ON 30 SEP 2011 – 136.88 CR

Forex paybles were at what levels on 30 Sep? 50-60 Crs?

Don’t have exact figures, right now.

But is it roughly in the 50-60 Cr range, or higher?

No, it will probably be higher.

7. 120 DAYS CREDIT TERMS WITH LUBRIZOL. THIS NORMALLY WOULD WORK TO ASTRAL’S ADVANTAGE. BUT IN THE FACE OF THE RAPIDLY DEPRECIATING RUPEE THIS MIGHT BE POSING A CHALLENGING SITUATION.

Kindly explain the hedging policies followed by Astral on Payables. Do you hedge fully your net outflows, or partially? How much?

(missed this totally, TBD)

8. RUPEE HAS DEPRECIATED ONLY STARTING SEP 2011. IMPLICATIONS ON FOREX LOSSES IN FY12 ON ACCOUNT OF UNHEDGED PAYABLES.

Since 120 days credit terms are in place, is it right to say that in Oct-Dec FY11, you will be paying for payables of Jun-Aug FY11? And since rupee had not depreciated till August, there is no impact on this front? Does this mean there will be a big impact in Q4 as the full impact of rupee depreciation from Sep till date will need to be accounted for?

Already covered above.

9. ACCOUNTING NORMS

As per accounting norms, aren’t you required to account upfront -even if the payables are due months later? If so, what is the likely impact respectively in Q3 and Q4 FY12?

As discussed Payables that become due need to be paid as and when they become due. But M2M accounting for the same has to be done on a regular basis. We have taken the decision that we will take a final call at the end of the year how to account for the same, depending on the situation prevailing then.

10. THE RUPEE HAS SINCE APPRECIATED TO 52 TO US$

Is it correct to surmise that if the Rupee remains at ~52 to US$ till the year end, there will likely be another hit of ~6-8 Cr on the payables front (if fully unhedged)?

(TBD)

11. MARGIN PRESSURES FROM RUPEE DEPRECIATION. RAW MATERIAL IMPORTS FY11 146 CR. THIS IS ~50% OF RM AND ~36% OF SALES. RUPEE HAS DEPRECIATED BY MORE THAN 16% SINCE SEP 2011.  ASTRAL HAD TAKEN A 3.5%-4% PRICE HIKE IN Q2. IN OCT YOU HAD TAKEN A 2.5% HIKE AND EXPECTED 3-3.5% IN NOV.

What is the cumulative price hike effected by the company in FY12 till date? Is it already at ~10% price hike levels!

Actually we have taken another 5% price hike in December.

So cumulatively is that a 15% hike effected so far in FY12?

Whatever that adds up to. See we are very clear that ultimately input price hikes have to passed on. Maybe with some time lag, but we have to pass that on, else our survival will be at stake.

But how do you take the price hike decisions? Do you wait to see what the market is doing, competitors like Ashirvad what steps they are taking?

Well we take our own decisions based on our business situation. We dont look for cues from others.

Can’t that be used by the competitors to gain/wrest away market share from you in certain markets, say where they are not dominant?

Well if someone wants to pick up business at a loss, that is their call.

If Astral made sale of 100, Its RM import would be 36. Depreciated 16% (~42) would mean your margins reduce by 6%.  Since you have affected a 10-15% price hike spread over Q2 & Q3, does this mean you are more or less protected on the margins front from the rupee depreciation effect so far? (Margins may well slide for other operational issues)

Given the current situation, we feel we will be more or less covered on that front.

Should the Rupee depreciate further, is there room for more hikes, how much can you really pass on? Have you taken any more hikes beyond the 10% already?

Like we discussed before a 5% hike is taken in December. This is a business reality – we got to pass on the hikes, there are no two ways about it.

12. STABLE MARGINS IN FORESEEABLE FUTURE. MARGINS HAVE BEEN ON A DECLINING TREND OVER THE LAST FEW YEARS. FROM 18%  IN 2008 TO 13-14% IN FY11. AND FY DOES NOT LOOK TO DELIVER MORE THAN 12%

Where do you see margins stabilizing in the near to medium term?

18% days were in those days when we were not growing this fast. Growing at 40% in these times is not an easy task. In recent times, we have been prepared to shed a couple of percentage points in pursuit of higher growth. But we hope to see uptrend in margins as we start producing at full capacity utilisation. Operational efficiencies will go up as economy of scale effects kick in.

So in the medium term, where do you see margins stabilising at?

It will probably be in the 12-14% range.

13. COMPETITION. SUPREME TIE UP WITH KANEKA. MEGHAMANI JV/FACTORY WIH KANEKA FOR 20000 MT

Please give us your sense of market developments. Who do you see as your most significant competition, and why? How’s it on the pricing front with Kaneka sourced products? Do you see any margin pressures developing due to heightened competition?

Well the Kaneka plant is not coming up before 2014, probably 2015. By year-end we will be at 65-70000 MT levels. And we will not be staying still till then. We will be making our own plans. We will also be somewhere else.

See there is a problem with the sourcing of CPVC compound from non-Lubrizol sources. Otherwise things would have changed long back. Competion plans, our business plans are never static. Everybody assesses the situation and takes measures appropriate to ensure survival and growth.

We read somewhere, Kaneka’s global production of CPVC is 46000 MT is that correct?

Well I don’t have those details. But this is for sure, Kaneka’s commitments in other markets will not allow it to significantly change the dynamics in India atleast in the next 2-3 years. 

Nothing remains static, right. By that time ….Lubrizol will also take some steps, isn’t that likely.

So you don’t see any significant competition in the next 2-3 years?

I didn’t say that. Competition is a part and parcel of life. There is no monopoly, right. But everybody is growing, there is enough room for everyone to grow…the market is big enough for more. Forget CPVC, look at the PVC market. In every small nook and corner they are making PVC. Despite that everybody is growing.

By 2013-2014 we will also be a certain size. We will be much stronger. You can put your own numbers if we continue to grow at current rates.… We will be able to dictate certain terms.

14. REALTY/INFRASTRUCTURE SLOWDOWN

Have you seen any impact on the ground so far? 

Look we are getting our Orders regularly and without any interruption. Supplies are being made. Uptil now we have seen no discernible effect on the ground.

So, how confident are you of delivering 30-35% growth in the coming 2 years?

We are certainly hopeful of maintaining the growth trends. The interest rate and credit availability cycle reversal may start sooner than later. If we go by the recent statements from RBI, these is coming soon.

And when that happens, demand will start groing faster. Because the main hindrance to this sector, is the finance rates. 

15. PROMOTER SHARES CHANGING HANDS. MR NIMISH DALAL SELLING HIS STAKE TO MR ENGINEER IN OPEN MARKET TRANSACTION.

Mr Nimish Dalal had also earlier tendered his resignation as a director of the company. Is this a fallout of the Lubrizol relationship? Kindly explain the reasons behind the transaction and the timing of these transactions.

Not at all. Why should Lubrizol be in the picture? Se they are family members. They have a family understanding within which the stakes have changed hands within the family. See Mr Dalal is Mr Engineer’s Uncle. The family will be together for a lifetime.

But Mr Nimish Dalal is employed with Lubrizol, right?

No, Mr Nimish Dalal is not with Lubrizol. He is a Doctor!
Mr Girish Dalal, who is Nimish’s father was with Lubrizol. Kabka retire ho chuke!
In the market people will talk all sorts of things without verifying back with the Management!

But Mr Nimish Dalal also resigned as a Director from the Board? Why did he need to do that?

Well these are not related. Mr Nimish Dalal is a US resident and was not very active.

16. Lubrizol relationship

Do you have anything to report on developments on this front? When can we expect a formal announcement of progress on this front?

The relationship is strong and progressing well. What do we have to report on that

We meant, the proposed investment from Lubrizol taking the relationship to the next level?

That’s and ongoing thing. Negotiations going on…studies going on from Lubrizol side…there is no formal agreement.

Moreover, we have already said that we signed an NDA with them on project confidentiality. It’s not that we don’t want to share any progress, we can’t. Till there is any formal agreement signed, there can be no clarification form Astral. This is to protect the interests of the company.

Things may or may not happen. That is why we had to issue a formal clarification that look these things are very far away. There is nothing material at the moment. If investors took a call on the basis of that Lubrizol announcement that would have been sort of misleading. In order to protect the interests of the investors in our company, we issued that clarification – that don’t make an investment call based on any announcement like that, it will be entirely misleading to do that.

So, do we take it that no news is good news?

We would like the long-term investors in the company to take conservative calls on the company. As and when things happen we will come up with appropriate announcements, at the right time. If something does not happen, then also we have to make the appropriate announcement!

One appeal to long-term investors in Astral. Don’t listen to market rumours. People will say all kinds of things. If you have any questions or want to understand anything about the company, please approach us directly. Talk to us, we will be happy to provide you all the details that we can share.


Disclosure(s)

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