MUTHOOT CAPITAL SERVICES

Background

Muthoot Capital Services Ltd. promoted by Muthoot Pappachan Group is a deposit taking Non Banking Finance Company (NBFC) registered with the Reserve Bank of India and listed on the Bombay Stock Exchange. 

Established in 1994, Muthoot Capital Services Ltd offers vehicle loans – primarily 2 wheeler and 3 wheeler loans.


Main Products/Segments

Muthoot Capital AUM (Cr)
9mFY14
GNPA
Q3FY14
Sales (Cr)
9mFY14
 Contrib
%
2 Wheeler 504.54 1.01% 386.46 96%
3 Wheeler 105.41 4.86%    6.57 4%
Blended 609.95 1.68% 403.03
Muthoot Capital FY09 FY10 FY11 FY12 FY13 9mFY14 FY09-FY13
CAGR
AUM (INR Lacs) 7167 9669 17184 29578 45569  60995  58.79%
Disbursements (INR Lacs) 1044 4285 13835 28845 43117  40316  153.53%
Avg Lending Rate 24.25% 28.81% 28.74% 28.39% 28.79% 27.09%
Avg Borrowing Rate 10.72% 11.01% 11.08% 11.92% 12.83% 12.39%
NIM 13.53% 17.80% 17.66% 16.47% 15.96% 14.69%
Avg Loan Size (INR) 33405 33315 39391 43351 45139 42502 7.82%
Gross NPA 0.94% 0.81% 0.63% 0.26% 1.00% 1.84%
Net NPA 0.73% 0.63% 0.52% 0.20% 0.87% 1.61%
RoA 9.32% 8.43% 6.85% 6.24% 5.50% 3.89%
RoE 38.29% 38.29% 38.27% 26.71% 22.92% 19.51%
Cost to Income Ratio 0.44 0.38 0.39 0.42 0.45 0.46
Capital Adequacy Ratio 21.12% 20.86% 16.48% 28.56% 21.71% 19.61%
Total Customers 4343 15393 46589 99647 118568 212682 128.58%
Avg Monthly Disbursement 260 1072 2927 5545 7960 10540 135.23%
Salary Costs/Op Income 5.05% 11.15% 13.84% 18.22% 20.39% 21.90%
Sales (INR Lacs) 1712 2239 3770 6701 10664 11235 57.98%
PAT (INR Lacs) 542 717 967 1551 2176 1626 41.55%
Total Employees 55 207 505 1034 1626 2146 133.18%
Avg Employee Count 131 356 770 1330 1886
Sales/Avg Employee (INR Lac) 17.09 10.59 8.70 8.02 5.96
PAT/Avg Employee (INR Lac) 5.47 2.72 2.01 1.64 0.86

Source: Company

  • Group Branch Network: 3800 Fincorp branches -currently as cash payment collection points
  • Operations Network: 29 Hubs; 8 MCS owned and 21 shared premises with Fincorp
  • Dealer Points: – 1200 @2-3% commission; Usually 1 Customer Sales Executive (CSE) at dealerships
  • Disbursements Concentration 9mFY14 (FY13): Kerala 54% (60%), Tamilnadu 15% (14%), Andhra Pradesh 10% (9%), Karnataka 16% (13), Goa 0.6% (0.6%), Gujarat 2% (1.5%), Mahrashtra 2% (1.5%)
  • Group Customer Base: ~3.2 Mn Fincorp customers; Not much active cross-selling at the moment because of absence of unified database. (planned availability FY2015)

Main Markets/Customers

  • Strong Kerala Presence statewide – 20-25% market share. Competes strongly with IndusInd Bank and HDFC Bank. No#2 in Kerala just behind IndusInd Bank. Total Kerala market ~40,000 vehicles financed per month.
  • Muthoot Fincorp branches in Kerala are pretty much all leveraged by MCS. Fincorp has 900 branches in TN and around 600-700 branches in AP and KN each which leaves lot of space for leveraging on.
  • Nascent presence in Tamilnadu, Karnantaka, Andhra Pradesh (historical stronghold of Shriram City Union Finance?). These 3 states are traditionally huge markets for 2Wh financing. The company plans to grow Sales substantially leveraging existing Fincorp branch strength (without incurring much by way of fixed costs) – which is pretty entrenched in these 3 states.

Bullish Viewpoints

As on Mar 2013/
Dec 2013
Muthoot
Capital
SCUF SHTF Chola Sundaram MMFS Bajaj Finance
Size (AUM Cr) 610  15800 49700 19000 17600 27900 17100 Dwarfed when compared to Industry
Years in Business
(Effectively)
20
(6)
28 (11) 35 36 60 23 27 Miles to go before proving itself
Capital Adequacy 19.61% 23.3% 19.9% 17.1% 17.7% 19.1% 20.9% Adequate; may need replenishing
3Yr Earnings CAGR 50% 45%  19%  74%  20%  39%  58% Robust growth
Cost to Income 46% 37% 26% 50% 37% 33% 45% High
Cost of Funds 13.10% 12.6% 9.8% 10.6% 10.6% 9.9% 10.3% Industry Highest
Employee cost/Avg no of Employee (Lacs)  1.66  1.75  5.36  12.19 Industry Lowest
Business Size/Avg no of Employee (Lacs)  38  92  385  553 Industry Lowest
Margins 14.69% 11.2% 7.0% 7.6% 8.4% 9.4% 12.1% Industry Highest
Yield 27.4% 22.1% 16.3% 15.4% 17.7% 16.4% 20.7% Industry Highest
Gross NPA  1.68%  2.4%  3.2%  3%  2.5% Industry Lowest
RoA 3.89%  3.2%  2.9%  2%  3%  3.4%  3.6% Industry Highest
P/B (CMP 87) 0.88   2.2  1.8  1.5  2.4  3.05  1.6 Attractive
P/E (CMP 87) 4.57   12.7  10.37  10.6  15.14  14.35  11.24 Attractive

Source: Company, Annual Reports

  • High Growth – Earnings have grown at an impressive 50% CAGR over last 3 years next only to Bajaj Finance – albeit on a much lower base. There is huge headroom to grow -provided the funding constraints get adequately addressed.
  • Highest Yields & Margins in the Industry – Again despite a declining trend, Margins (14.69%) and Yields (27.4%) for 9mFY14 are the highest in the industry, although on a much lower base compared to bigger competitors.
  • Highest Profitability in the Industry – Even with a declining profitability trend over last few years, MCS RoA at 3.89%  (9mFY14) is the highest in the industry. With the steps Management has been taking, RoA looks set to improve in near to medium term.
  • Stringent Credit Policy – As per the Management the primary reason for its strong showing and low NPAs is very strict adherence to the robust and detailed credit policy laid down by the company – extensive covering of different models and different customer segments (salaried, income-based, Asset-based, or NO docs financing with higher down-payments). Different Loan to Value (LTV) levels apply for different customer segments.
  • 85% of Loans backed by “Own House” documents – This is probably unique to Muthoot Cap that 80-85% of its disbursements follow asst-financing model – loan to folks with own-house document proof – either the borrower or the guarantor (usually close relative). This helps the company in collection/recovery process – as borrower is reluctant to run the risk of property attachment in case of default – especially for small loan sums < Rs 40,000.
  • Lowest NPAs in the Industry – Gross NPAs at 1.68% is the lowest in the auto-financing industry. All auto-financiers including Bajaj Finance have been seeing a spurt in NPAs in recent quarters. MCS has been managing the NPA situtation admirably. Collection Executives are focused on bringing down the ~15.75 Cr of likley NPAs substantially down by 31st March 2014 or, Gross NPAs to <1.5% or less. Senior Management is focused on closely monitoring stressed A/Cs (likely to become NPAs) and Collections on a daily basis.
  • Extreme Focus on write-offs recovery – MCS is again probably unique in its focus of trying to ensure recovery of every rupee that is written off. Post Arbitration (company has appointed arbitrators) 3-4% of cases vehicles are repossessed and sold off. Cases are filed and in due course company is confident of recovering loan amounts due along with legal costs and charges.
  • Big Productivity Improvements likely in FY15 & FY16 – With enterprise-wide automation being introduced and Profit Center benchmarks being established, company is embarking on a productivity linked budgeting exercise from FY15 onwards. Management opines this will help the company monitor income and expenses more granularly and modify policies for getting the best productivity – locations-wise and team-wise.
  • Cross-selling within Fincorp customer base – Fincorp has a customer base exceeding 3.2 Mn Customers today. Effective cross-selling may become possible once Fincorp group database becomes available (post automation) in FY15 and may provide a kicker to Sales growth.
  • Attractive Valuations – MCS is currently (CMP 87) trading at a discount to Book and ~4.5x PE with a 4.8% dividend yield – which looks reasonably attractive.

Bearish Viewpoints

  • Declining profitability trend – While 5 year Sales or Profit CAGR may look healthy, and FY14 Sales may register 40%+growth, FY14 PAT is likely to register flattish or negative growth. Return on Assets (RoA) have consistently declined and halved from ~9% levels 5 years back.
  • Employee Productivity bottleneck – If we examine the reasons, what strikes immediately is the nearly ~3 to 5-fold drop in Sales and Profitability per employee. The situation has got accentuated on 2 fronts. First, disbursements didn’t keep pace with recruitment leading to under-utilisation. Company was doing ~60 Cr disbursement by Mar 2013, but in 9MFY14 has managed to disburse only ~400 Cr. Secondly there is enormous duplication of excel-based data-entry work between Operation Hubs and Back-Office in the absence of enterprise-wide automation. Company has been cognizant of the second front and has been working to introduce fully-automated Loan Origination System covering Sales, Operations and Credit processes from April 2014 -planned to be fully operational by end of Q1FY14.
  • Delay in Bank Funding – Disbursements have been hampered by delayed funding availability from Banks. Typically Bank Limits are enhanced based on the current Balance Sheet. The BS gets ready by April/May with Banks taking another 2 months. So while company had a disbursement run-rate of 60 Cr by Mar 2013, it could disburse only ~40 Cr in Apr-Aug’2013 (up to 50-60 Cr for Sep-Dec’13) despite otherwise having ready sales/operations personnel – leading to under-utilisation. In earlier years this hadn’t proved a bottleneck (probably shareholders equity sufficed for first few months till enhanced bank borrowings kicked in) but it certainly has impacted disbursements and profitability significantly in FY14. For FY15 Company expects to kickstart approval process with banks within Q4FY14.
  • Deteriorating 3 Wheeler Market/Portfolio – MCS 3 Wheeler Loan market (primarily Kerala) has been steadily deteriorating. Monthly Sales at 7500 vehicles is now down to 3500 vehicles per month. Reportedly daily earnings of 3-wheelers down to 450/- from Rs 850/- earlier. The 4 wheelers Tata IRIS/ACE has also started doing well. 3 Wheeler Associations have written to prominent vehicle finance companies to stop issuing 3 wheeler loans in Kerala. Debt servicing capability of borrowers is badly dented and gross NPAs are on the rise [~5% in 9mFY14]. However, 2 Wheeler gross NPAs remain firmly under control and are probably the best in industry at ~1%
  • High Cost of Funds – MCS Cost of Funds is the highest in the industry at 13%+. Dependency on Bank Funding is high and  current A (negative outlook) rating by CRISIL (clubbed with Muthoot Fincorp) isn’t helping either. Public NCDs/other options are probably restricted till a ratings upgrade is in place.
  • A (Negative Outlook) CRISIL Rating – While the reasons and rating sensitivity cited by CRISIL in its negative outlook are mostly attributable to the Gold Loan business of Muthoot Fincorp, declining profitability on MCS count has not helped either. Senior Management is strongly of the view that they have proven in last 6 years that MCS 2Wheeler/3Wheeler Auto Financing is a successful, sustainable, and scalable business model. They have moved out completely from the Gold Loan business. They deserve a standalone MCS rating which they feel merits much better rating – that may alleviate its funding constraints in a major way. Discussions are on with ICRA and CARE.
  • Single Product dependency – MCS product portfolio currently comprises of only 2 wheeler and 3 wheeler loans. With 3 wheeler NPAs rising company is consciously cutting back on 3 Wheeler loans. Dependency is very heavy on 2 wheeler loans. Any adverse developments in the industry/economy could significantly affect the company’s fortunes. Going forward the company has to look at product diversification for better risk-adjusted growth profile.
  • Funding constraints – Tier I & Tier II Capital – Currently Capital Adequacy stands at ~19% (Min CAR of 15% as per RBI). If MCS continues to grow at 40-50% rates, it will need capital infusion in the form of Tier I or Tier II Capital pretty soon. Raising Tier I (Equity Capital) is probably not an active option for the company (cf. current valuations). For Tier II Capital MCS has options of either going the route of Sub-ordinated Debt or Preference Capital – which may get decided based on Group liquidity levels in 2015/16.
  • Hero/Honda Company Financing – MCS is hugely dependent on financing for Hero and Honda 2 wheelers. In the event that either of these start their own financing arms – and provide preferential access to financing from their dealerships – MCS prospects can be affected significantly.

Barriers to entry

  • Unique/Flexible cash payment schemes – Customers can pay from any Fincorp branch anywhere in the country. A web-based collection module of MCS provides access to customer details and payment schedules, etc. for all Fincorp branches. Customers can choose to pay the monthly EMI say Rs 1500/-, in even Rs 200/- or Rs 300/- flexi-instalments. Fincorp collects 0.5% (up from 0.2%) as collection fees from MCS from FY 2013.
  • Leveraging widespread Fincorp network – With a growing pan-india network of more than 3800 branches – this is at the heart of the efficient collection system for MCS. MCS can simply piggy-ride this expanding retail network and does not really need to set up this infrastructure of its own as it scales up. MCS does not need branch offices as sales originate primarily from Sales Executives placed at Dealer Points. [Operational Hubs are required for managing every 30-40 Dealer points – where again shared (but separate) premises with Fincorp is the norm. Out of 29 Operational Hubs only 8 are MCS-owned including the Head Office location.]

Interesting Viewpoints

  • Started taking Deposits – MCS has recently started taking 1-3 year deposits at upto 12% rates through Muthoot Exim which acts as the broker. ~40 Cr deposits have been mobilised so far. The company seems confident of mobilising ~150-180 Cr (the max limit – 1.5x Net Owned Funds) within FY15. This will go way a long way in ensuring Margin Requirements with Banks and pave the way for enhanced Term Loans availability for the company.
  • Impending introduction of Automation – As per the company major automation in Loan Origination System (LOS) – covering Sales, Operations and Credit processes – is set to be introduced across all company Hubs and Offices in 1QFY15. Part of a much larger group automation project standard operating procedures (SOPs) have been defined by IBM in consultation with functional departments over the last 2 years. 3I Infotech is the major vendor and implementation partner. Apart from providing single-source unified MIS views, this is likely to bring in huge operational efficiencies and savings in FY15.
  • Muthoot Fincorp Sales Agency model – With Gold Loan business volumes coming down, Muthoot Fincorp has started proactively sourcing customers for MCS on commission basis (2%). Started only a year back, all Fincorp branch personnel have now been trained. With Muthoot Fincorp intrinsically incentivised (low Gold Loan Sales) this is expected to be rolled out to all 3800 branches in FY15 – reducing the dependency and large costs incurred by MCS on Sales Executives at Dealer points. Model is working well and expected to start delivering ~7500 vehicles (avg 2) a month.

Disclosure(s)

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


SHRIRAM CITY UNION FINANCE

Background

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

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

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

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


Main Products/Segments

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

Source: Company, CRISIL

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

Main Markets/Customers

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

Bullish Viewpoints

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

Bearish Viewpoints

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

Barriers to entry

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

Interesting Viewpoints

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

Disclosure(s)

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


Avanti Feeds

Background

Avanti Feeds is one of the largest manufacturer of Shrimp Feeds and Shrimp Processor and Exporter from India


Main Products/Segments

Shrimp Feed

Processed Shrimp export


Main Markets/Customers

  • The feeds are used by shrimp farmers.
  • The processed shrimps are exported to countries like US, Europe, Japan etc.

Bullish Viewpoints

  • The aquaculture industry was having a very bad time till 2007 as the quality of earlier species – Black Tiger was not good and hence un-remunerative.
  • Since then the industry introduced a new variety of shrimp – Vannamei(white shrimp), this variety though generally smaller than tigers, are more resistant to disease, have higher survival rates, cost less to feed and tolerate higher stocking densities. And they grow faster.
  • India is one of the cheapest shrimp producer and with the increasing adoption of Vannamei species, the shrimp exports from India have picked up sharply[Business Line]
  • Avanti Feeds has grown at 75% CAGR for last 3 years. The turnover grew from 73 Cr in 2009 to 393 Cr in 2012. Similarly profits have grown from a loss of 7 Cr in 2009 to a net profit of 28 Cr in 2012.
  • The industry is expected continue growing at 20-25% for next 2-3 years and if so, then Avanti Feeds can grow at 30%+ rates. The latest annual report is very optimistic and co has undertaken some major expansions
  • During the year the company has doubled its capacity by replacing old machinery with the new ones and constructed new godowns to handle increased volumes.The capacity has increased to 1,10,000 Mts p.a from 52,000 mts p.a.
  • The shrimp processing capacity has increased to 8000 Mts p.a from 2720 mts p.a.
  • As the demand anticipated by the company is slated for a big jump in a couple of years from now, further expansion would be needed as current capacities would be insufficient. Therefore, 4.94 acres of land near their current plant of Kovvur is already bought for expansion.
  • It is operating a Vannamei hatchery on a leasehold basis producing Vannamei seed to supply good quality Vannamei seed to the farmers. It is in process of buying a land near Chennai to set up hatchery in collaboration with THAI UNION for building hatcheries. This will reduce the return of export consignments due to quality reasons, reduce the risk of shrimp getting damaged due to diseases and will improve its operating efficiency as it is a significant addition in the value chain.
  • US government has raised the anti-dumping duty on import of frozen shrimps from India. The average duty has been increased  to 2.51 per cent  from 1.69 per cent. This would have little impact on seafood exports to the US as DoC has decided to calculate the weighted-average margins of dumping and anti-dumping duty assessment rates in a manner that offsets non-dumped comparisons while using monthly average-to-average comparisons in reviews. This may lead to de-minimum duty (below 0.5 per cent), which in effect carries zero anti-dumping duty on exports to the US. This decision of DoC will be effective from 2013, when the seventh administrative review completes. This is a great boost for the exporters and Avanti Feeds being the market leader will benefit significantly from it.
  • The dividend has been increased to 65% in FY 2012 from 10% in FY 2011.
  • India’s Competitive Advantage in shrimp industry is that the Competing countries now have to pay a higher anti-dumping duty as compared to India.

Bearish Viewpoints

  • Dependency on climatic conditions makes it unpredictable. Natural calamities like floods, cyclones, during the culture season can have serious impact.
  • Shrimps getting affected by virus and diseases also is a threat.
  • The margins may soften going forward.
  • Trade restrictions in importing countries can unsettle the industry as US  did in the past by applying anti dumping duty.
  • lack of diversification in the export destination.

Barriers to entry

  •  Thai Union Frozen Products PCL (the worlds largest seafood company) holds a 25% stake in Avanti Feeds. This relationship provides them the lead in terms of research and better quality.
  • The company has its own brand and distribution and farmers don’t switch the product quickly.
  • Though the shrimp cultivation is a very unorganised segment of the industry, the processing and export segment is an organised segment. The company through the technical support to the shrimp farmers and the good quality seeds has built a relationship with the farmers, which ensures a regular supply of good quality shrimp.
  • The leasing out of hatchery has added another tire to its value chain which is going to yield economies of scope. It will further strengthen its position once it builds its own hatchery.

Interesting Viewpoints

  •  Thai Union Frozen Products PCL holds a 25% stake in Avanti Feeds and hence they have access to latest research and quality requirements.
  • Avanti is one of the top three producers in India.
  • The company has low debt and strong cash flows.
  • The promoters have a good track record of being transparent and investor friendly.
  • The company also has investments of about 30 Cr in two power projects from which it gets regular dividends.

Disclosure(s)

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


Kaveri Seed Company

Background

Kaveri Seed Company is in the business of producing and selling of hybrid seeds, micro-nutrients, and premium vegetables/herbs (Kexveg new initiative in FY12). Incorporated in 1986, the company completed 25 years in the Indian market. Listed in 2007, it is one of the fastest growing seed companies in India.

Kaveri seeds has invested in an extensive R&D facility with a company owned land bank of ~ 600 acres and a Germplasm gene bank exceeding 11,000.

159 lines/hybrids registered with PPV&FR, of which 39 have undergone DUS test and 15 are in line for certification.


Main Products/Segments

Kaveri Seed has a diversified portfolio of Corn, Pearl millet (Bajra), Sorghum (Jowar), Rice, Cotton and Sunflower premium hybrid seeds with genetically superior traits for high yield, pest resistance, and drought tolerance. [FY12 Sales 349.5 Cr ~93% Sales]

BT Cotton Hybrid forms over 50% of Sales. The BT Cotton gene is licensed from Mahyco-Monsanto JV (to which it pays royalty of Rs 180 per bag) with which it has produced a highly successful BT Cotton Hybrid by using separate male & female lines form its Germaplasm gene Bank.

Started in 2002, the Microteck division provides micro-nutrients and organic bio-pesticides /fungicides to increase crop yield. Foliar sprays, Soil applications, Plant defense, Bio-pesticides & Bio-fungicides. [FY12 Sales 23.5 Cr ~7% of Sales.]


Main Markets/Customers

Kaveri Seeds has a well established distribution network catering to the farmers. Over 60% of the company’s revenue is recorded in Q1. Karnataka and Andhra Pradesh contribute highest sales.

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).  Aside from Kaveri, the notable seed companies in India include Pioneer, Mahyco, Monsanto India, ProAgro, Syngenta and Nuziveedu Seeds. Total Market size in 2012 is estimated to be ~8000-9000 Cr in India.
The Company’s major competitors are Monsanto and its subsidiaries, Pro-Agro (a Bayer Crop Science subsidiary), Pioneer (a Dupont subsidiary), Syngenta, Nuziveedu, Vibha and Rasi Seeds.
Brand conversions in crops like corn, cotton and sunflower are very high. Companies which develop effective hybrids are able to garner market share. BT Cotton has been the primary driver in the Indian Seeds market for the last few years. Nuziveedu Seeds reportedly has the largest 40% market share [Product Mix 90% Cotton]. Reports suggest Kaveri Seeds has been ramping up market share rapidly from 5.5% in FY11 to 11% in FY12.

Bullish Viewpoints

  • Huge potential for Hybrid seeds – because of lower acreages & requirements of higher yields, pesticide/herbicide resistance, lower water consumption, drought resistance
  • BT Cotton led volume growth – Rapid market share growth, to 11%  in FY12 from 5.5% a year back on the back of its differentiated BT Cotton Hybrid. BT Cotton forms 50% of Revenues
  • Corn led margin growth – Corn is the next highest segment, with higher margins
  • Paddy Hybrids – Future growth driver

Bearish Viewpoints

  • Weather-Related risks
  • Longer debtor days
  • 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
  • Regulatory Risks – Agri sector
  • Political Interference – Price capping. AP Govt has capped price of BT Cotton in AP
  • Aggressive shift in Crop patterns by Farmers

Barriers to entry

  • Big Germaplasm Bank – Kaveri has amassed a huge breeder base ~11000 over the years for producing hybrids with required traits for local market. It has also established cold storage and Seed Bank facilities at Gowaram to now preserve these as “Gene Bank”.
  • Huge Land Bank – The Seed business needs huge land banks for experimentation and commercial production for Sales. Kaveri Seeds has ~600 Cr land bank
  • Long development time – Coming up with a differentiated effective hybrid usually takes 5-6 years
  • Diversified Portfolio – 50% of revenues come from BT Cotton. Corn, Bajra and Sunflower are other major contributors. Jowar & Rice are the other premium hybrid seeds
  • Strong Distribution Network – ~750 distributors across the country
  • Intellectual Property –  159 lines/hybrids registered with PPV&FR India, of which 39 have undergone DUS test and 15 are in line for certification.

Interesting Viewpoints

Monsanto’s Corn hybrid – Dekalb –  is 100 years in existence. This is the Power of a good differentiated hybrid!!  Kaveri also has good hybrids in Corn. It has reportedly increased its Hybrid Corn pricing 16% on a compounded basis over last 20 year


Disclosure(s)

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


Ajanta Pharma

Background

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

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

Main Products/Segments

Main Generic Brands:

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

Main Markets/Customers

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

Bullish Viewpoints

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

Bearish Viewpoints

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

Barriers to entry

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

Interesting Viewpoints

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

Disclosure(s)

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


Oriental Carbon & Chemicals

Background

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

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

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


Main Products/Segments

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

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

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

Exports constitute ~64% of Sales in FY12.


Main Markets/Customers

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

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


Bullish Viewpoints

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

Bearish Viewpoints

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

Barriers to entry

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

Interesting Viewpoints

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

Disclosure(s)

Donald Francis: No Holdings in the Company;


NESCO

Background

Established in 1939 as the New Standard Engineering Co. Ltd. the company is now known as NESCO Ltd and is a diversified player across Industrial Capital Goods, IT Parks & Realty and Exhibition and Convention Centers.

In 1959 it moved to a 70 acre estate on the Western Express Highway at Goregaon in Mumbai.
In 1986, the company diversified into the realty business by developing and providing customized built-up space for multinational companies and leading corporates at Goregaon.

In 1992, the company setup an exhibition centre – known as the Bombay Exhibition Centre – at its complex on the Western Express Highway at Goregaon, Mumbai. Starting with a hall area of 200,000 sq feet, this has now been expanded to over 500,000 sq feet. This venue holds the distinction of being the largest exhibition center promoted by the private sector in India and has hosted over 500 national and international exhibitions,trade fairs, and events since inception.


Main Products/Segments

  • Exhibitions, Trade fairs & Events – The Bombay Exhibition Center (BEC) has over 500,000 sq feet of exhibition space. Since it was established, BEC has hosted over 500 national and international trade fairs, exhibitions and events. This is the mainstay segment for NESCO and generated over 54% of Sales in FY12.
  • Commercial Towers/Realty – NESCO has leased two IT buildings for premium office space to companies like TCS, Schlumberger and others. Total leased space is 300,000 sq feet. It has also other Realty projects. Together this segment accounted for 19% of Sales in FY12. The share of this segment is slated to go up as IT Building III is now ready with 660,000 sq feet leasable space which could start generating revenues in FY13.
  • Industrial Capital Goods – This division generated 25.44 Cr in net Sales for FY12 and constituted ~18% of FY12 Sales. It contributed negligibly to EBIT in FY12 (2.5%) and has also incurred loss in FY11.
  • Investments & Other Income – With a cash chest of 210 Cr parked in Current Investments, this is a sizeable source of revenue for NESCO. In FY12 this segment contributed 8% of overall revenues

Main Markets/Customers

Exhibitors at Trade Fairs and Events

IT Building Leasers


Bullish Viewpoints

  • Great Margins and Profitability – NESCO has a stellar record on the margins and profitability front. EBITDA margins touched 79% and Net Margins touched 52% in FY12. These have seen a consistent upward curve for the last many years. FY08 EBITDA margins were at ~56% levels while Net Margin was at ~37%. RoE and RoCE have been consistently over 35% and 50% for the last 5 years and more.
  • Monopolistic Exhibition Business – The exhibition business segment enjoys a virtual monopoly because of its large size and locational proximity to airport and highways. Over the years BEC has been able to steadily increase utilisation and lease rates. Currently holds exhibitions on ~180 days for the year with partial occupancy on most days. Extrapolating FY12 Sales implies ~127  per sq feet per month lease rate in FY12 (~109 in FY11) which is much ahead of comparable office lease rentals at ~100 per sq feet per month.  The clientele is also pretty diversified with no client contributing more than 5% of the business. This is testimoney to the quality and durability of this business (sans force-majeure kind of scenarios).
  • IT Park/Realty Business – The IT Park project is planned for a total construction area of 35 lakh square feet. IT Building III recently completed had total constructed area of 8 lakh sq feet. With 660,000 sq feet lesable area, this can bring in additional 50-60 Cr in annual revenues from FY13. IT Building IV is reportedly in planning/design phase with Larsen & Toubro.
  • Exhibition Center Expansions – NESCO has plans of expanding BEC exhibition space from 500,000 sq feet to a Million sq feet. It is also trying and hopeful of getting approvals for FSI=2, which will enable it to build additional exhibition space over a second floor.
  • Vacant unused land – Apart from BEC and the IT Park, NESCO has upwards of 40 Acres of unused land. The healthy cash flows generated from the business can be used to gradually develop the remaining land parcels. The company has been very conservative in its approach. All above factors may ensure steady growth for NESCO for the next 10 years.

Bearish Viewpoints

  • Inordinate delay in Leasing out IT Building III – The Management had indicated in FY11 AR that construction is over and internal finishing was going on, and that they expected some revenues in FY12. The company has not been able to book any revenues from IT Building III.
  • Slackening Growth – NESCO registered a sales growth of only 9.83% in FY12 and degrowth in Operating and Net Profits levels. While the Exhibition Center BEC registered a Sales growth of ~16%, the IT Park/Realty segment suffered a degrowth of over 20% in FY12. The Industrial capital goods section registered a ~49% growth in FY12, but this should be seen in light of the poor base in FY11 where it had suffered a degrowth and incurred losses. At the EBIT level BEC and IT Park/Reality segments together registered a growth of less than 9%
  • Low dividend Payout – Though the company has improved its dividend paying record over the last 5 years, the payout is abysmally low at ~6% of Earnings. In absolute terms though dividends have increased at a CAGR of 49% over last 5 years. (4.23 Cr in FY12 vs 0.85 Cr in FY08)
  • Concentration of business in one location – BEC and IT Park/realty business is conducted from its 70 Acre premises in Goregaon and constitutes ~74% of its total revenues in FY12. This high concentration exposes it to risks like major terrorist attacks and other acts of nature, which does affect its business. The 2008 terrorist attacks in Mumbai dented the BEC segment business significantly.

Barriers to entry

  • Largest Exhibition space – Bombay Exhibition Centre (BEC) is the largest exhibition centre in Mumbai, spread over 450,000 sq feet  on Western Express Highway at Goregaon, near Mumbai airport and has become a permanent venue for conventions, exhibitions and trade fairs in India. Bombay Exhibition Centre (BEC) is the only place in Mumbai where large scale exhibitions can be held. The nearest competitor has only 25,000 square feet space
  • Expansions awaited – NESCO is awaiting approvals to expand this to 1 million square feet of exhibition space
  • Prohibitive cost of Land – While the cost of Land (part of 70 acre land back acquired in 1959 at throwaway prices) is low for NESCO, any new Entrant in Exhibition business will find it very difficult to acquire such a large land bank with similar logistics (on the highway and near the airport). And if it does manage, the cost will be prohibitive and strain the economics of the business – to be anywhere as competitive.
  • Strong Client Relationships – Decades of strong relationships with Global exhibition majors like United Business Media (UBM), Reed Exhibitions, and Messe Frankfurt, and Messe Dusseldorf who prefer holding their India exhibitions at BEC. It will be very difficult for a new player to get these majors to switch and gain market share at the cost of BEC

Interesting Viewpoints

  • Market Value of Land – NESCO has 70 acres of land in Goregaon, on the Western Express Highway and in close proximity to the Airport. At 40 Cr per acre, this translates to 2800 Cr, or Rs 1987, a share
  • Market Value of IT Buildings – with IT Building III (660,000 sq feet leasable space) completed, the total leasable space for the 3 buildings come to 960,000 sq feet. At 12000/- per sq feet rates for Goregaon office complexes, this works out to 1152 Cr, or ~ Rs 817, a share
  • IT Building III – IT Building III has 660,000 sq feet space ready that could be leased out in FY13. At Rs 80 per sq feet per month, this might bring in additional revenues of ~63 Cr on an annual basis. Most of it would add straight to the bottomline
  • Oshiwara Railway Station – This new railway station was proposed to come up between Jogeshwari and Goregaon railway stations, right behind the NESCO complex. This project cancelled in 2010 due to delays seems to have been revived again in May 2011. When completed this would allow easy accessibility to NESCO’s BEC and IT Park projects complex may provide a big boost.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Ador Fontech

Background

Ador Fontech, an associate company of Ador Welding (formerly Advani Oerlikon), was incorporated in August 1974, as Cosmics Fontech. It subsequently changed its name to Ador Fontech. In 1992, it acquired Fist India (P) Ltd and Kostech India Pvt Ltd. These companies were subsequently merged with the company. The company was listed on BSE in 1995.

Ador Fontech focuses on preventive maintenance and repair of industrial machinery, which is a niche segment requiring specialised skills. It offers products and solutions for reclamation welding and recycling of vital machinery components. The company operates 2 manufacturing plants in Peenya, Bangalore and a Reclamation Service Center in MIDC, Nagpur.

Ador exclusively represents many reclamation and surfacing product/solution partners such as Sulzer Metco, Alloy Steel International, Dellero Stellite, EWM, Microtherm, Protector, Cepro, CEA, Gasflux, York and Euromate products in India.


Main Products/Segments

The company’s product basket includes filler wires, welding equipment/accessories, wire feeders, wearplates and cladded pipes. Apart from manufacturing these products, Ador Fontech also acts as a value-added reseller for Alloy Steel International, Australia; Berkenhoff, Germany; CEA, Italy; Cepro, Netherlands; Degussa, Germany; Euromate, Netherlands; Gasflux, US; Protector, Australia/Singapore; and Sulzer Metco, Swiss /US, Bedra and Woka, Germany for their products in India. It also offers a high temperature process for maintenance products from Aremco, US.


Main Markets/Customers

Ador Fontech supplies products and services to almost all the core sectors and several engineering industries. The focus of its activities is to provide metal joining, reclamation welding and surfacing solutions for improving, updating and reworking parts so that they equal or exceed the useful life of the original part.

Its major customer base includes mining industries, steel and other metallurgical complexes, power plants, railways, road transport workshops, shipping industries, sugar mills, cement plants, fertilizer and chemical plants, oil drilling and refining sector, defence units and a number of engineering industries.


Bullish Viewpoints

  • Consistent Growth – Sales have grown at a steady 5yr CAGR of 16% plus to reach ~150 Cr in FY11 from about 80 Crs in FY07 . But Net profits have galloped away at a 5yr CAGr of over 37%. This has been possible on the back of consistent improved performance by the company in last 2 years.
  • Big Margin Improvements – The track record on the Margins front has been spectacular. Operating margins were ~12% in FY07 and has now climbed to over 18% in FY11. And Net Margins have almost doubled going upto over 12% in FY11 from ~6.5% in FY07
  • Debt Free – This is one of those rare completely debt-free companies!
  • Free Cash Flows – The company generates very healthy free cash flows. Capex requirements have always been mimimal for the company -between 1-3 Cr. In FY11 the company has made the largest investment in Capex in bolstering its Service centre in Nagpur again completely from cash flows generated. FY11 Cash flow/Sales was at 3.5% while traditionally it has hovered between 7-11% of Sales
  • Good Dividend Payouts – The company maintains a dividend payout ratio between 20-35% in the last 5 years till FY11. The company used to maintain a much higher dividend payout ratio in the earlier years
  • Duopoly – The Repair & refurbishment market for Industrial machinery is dominated by mainly 2 players. Ador Fontech and the unlisted EWAC Alloys. Players like Esab and Ador Welding (a group company) cater mainly to the Fabrication market who do nopt have the expertise to cater to the Repair & Refurbishment market (specialised knowhow, specialised metallurgical skills, specialised alloys and welding equipments)
  • Huge Investment in Reclamation Service Centre – This Nagpur facility has seen huge capital investment of Rs. 12 Cr plus in FY11. The whoile set-up has been modernised and recreated, with new facilities added. As per the company the capacity to service is now 4x what existed hitherto.
  • Promoter share going up – Promoter share in the company has been going up steadily in the company in the last 5 years from abbout 24% to about 35% in FY11

Bearish Viewpoints

  • Sales growth is muted – This has been the main objection against Ador Fontech so far that Sales growth is not in the same league as other small companies of similar size. It did not seem capable of growing Sales at more than 15% CAGR
  • Margin Growths cannot compensate forever – While expanding margins have taken care of the relatively poor Sales growth, this picture may not be sustainable, if the company does not find a way to accelerate Sales.
  • Exclusive relationships at risk _ The bulk of company’s sales comes through consumables sales for many of its exclusive distributor relationships. This poses a significant risk. Some of these majors do have India presence and may decide to enter the Indian market for consumables by themselves.
  • Keeping pace with technology improvements – This is a niche technology field requiring one to keep abreast with Advances in Metallurgy and Alloys and Refurbishing equipment. Keeping pace with the same and moving up the value chain may require increasing investments from the company.

Barriers to entry

  • Niche Segment – This is a highly specialised field requiring years of experience in the preventive maintenance and repair of industrial machinery. An  ever-growing knowledge on metallurgy and wear phenomena coupled with  a broad range of product/solutions to wear-related problems is needed to effectively service the industrial customer base. Very few players in organised sector. Only known competitor is  EWAC Alloys Limited, a joint venture of the Larsen & Toubro, India & the Messer Eutectic Castolin Group, Germany.
  • Long-Term Customer relationships – Customer relationships are built over years here. Industrial machinery serviced many times are mission-critical in nature and customers are reluctant/wary of changing service providers.
  • Exclusive Reclamation & Surfacing Product Relationships – Access to specialised solutions is restricted. Ador Fontech has invested and built-up these relationships over the lat 25 years and more. It enjoys exclusivity with some 12 major reclamation and surfacing product partners.
  • Industrial Certifications – A number of certifications are necessary before one can participate in industrial scale reclamation projects.

Interesting Viewpoints

  • Improving Operating Margins – This consistent upward trend in operating margins is worth noting, as the company has moved from over 11% OPM in FY07 to over 18% in FY11, step by step in the last 5 years. Unlisted competitors like EWAC reportedly enjoy OPMs in the 24-25% range.
  • Reclamation Services Center enjoys superior margins – Located at Nagpur, this facility has been continuously expanding its capacity of taking up customer-specific and heavy duty reclamation jobs. State-of-the-art welding and metal spray processes are used to repair, reclaim and rebuild vital machinery parts for thermal power stations, cement plants, mining, steel and several other core industries. The capacity has been augmented 4x in FY11 by incurring Capex of over 12 Cr. This seems a significant bet taken by a normally conservative company.
  • Industrial Growth in India – Long Term growth in Power, Mining, Shipping and other Industries in India augurs well for Ador Fontech

Disclosure(s)

Donald Francis: No Holdings in the Company;


Indag Rubber

Background

Indag Rubber Limited (IRL) was incorporated in July 1978 as a joint venture between Khemka group and M/S Bandag Incorporated, USA, one of the biggest players in the US retreading industry. The company was listed on the Bombay stock Exchange in 1984. In 2006, the above joint venture was terminated with Bandag’s 38.3% shareholding taken over by the Khemka Group.

Manufacturing plant is at Baddi (Himachal Pradesh) with a capacity of 13,800 MT for tread rubber, 1,800 MT for rubber strip gums and 300 KL for rubber cement. The company had one other plant at Bhiwadi (Rajasthan), which is shut since 2006.


Main Products/Segments

The company manufactures precured tread rubber, un-vulcanized rubber strip gum, universal spray cement and tyre envelopes for the tyre retreading industry.

Close to 90% of the company’s revenue is generated from the sale of precured tread rubber.


Main Markets/Customers

Indag Rubber caters largely to LCVs and Trucks & Buses segments.

Midas Treads, Vamshi Rubber, Elgi Rubber International, MRF Ltd, JK Tyres and Indag Rubber are the significant players in the organized sector. These players supply their tread material to unorganised players who retread tyres.

Retreading is a process in which a new tread is applied on top of worn out tyres. In the precured retreading process, a precured tread strip is applied to the surface with a thin layer of bonding gum. Indag Rubber sells its products through its own depots/franchisees (C&F agents) appointed all over the country while the actual retreading operation is carried out by the retreaders. This apart, it also routes its sales to State Transport Units on a Tender-ed basis. Nearly 10-15% of Sales comes from this lower-margin tender business.

The company has ~25 depots pan India, which sell to retreaders. Some of these depots are owned and operated by Indag Rubber while the rest are operated by franchisees.


Bullish Viewpoints

  • Decent growth record – In the last 5 years Indag Rubber has clocked a 25% plus CAGR in Sales. Sales touched ~150 Cr in FY2011 from ~60 Cr in FY07. Profits have grown along similar lines with a ~26% CAGR growing from 4.2 Cr in FY07 to 10.75 Cr in FY11. In the same period book value has compounded by over 35% CAGR growing to ~44 Cr in FY11from ~13 cr.
  • Superior Margins & Returns – Indag Rubber enjoys industry beating margins and returns. RoE and RoCE have generally been in the 25%-30% plus range beating competitors by a wide margin. Similarly operating margins have been in the 12-15% range. FY11 was an aberration year for Indag as it had to pass on price hikes as high as 30% to partially offset the abnormal hikes in raw material prices, suffering volume and margin pressures. This was impacted further with tax free status changing to a 22% tax rate in FY11. To its credit H1FY12 has seen margins climbing back and volume growth kicking in.
  • Strong Balance Sheet – Indag Rubber has a robust balance sheet. Debt has been progressively brought down from ~13 Cr in FY07 to about ~7 cr in FY11, with debt-to-equity ratio standing at a low 0.16 in FY11. For the last 3 years Indag has only been securing working capital requirements through loans from Banks, not needing any Term Loans. Capex requirements between ~2-6 Crs have been funded through internal accruals.
  • Strong Free Cash Flows – Indag has been generating stronger free cash flows over the last 5 years recording a  CAGR of over 54% . Free Cash Flow has increased from ~0.57 Cr in FY07 to about 3.22 Cr in FY11. FY10 was the only exception when the company decided to go in for aggressive expansion in order to take advantage of tax and duty exemptions valid till 2015. With no expansions needed/foreseen in next 2-3 years, the company will is set to continue generating free cash for some years.
  • Robust recent financial performance – The first half of FY12 has seen Indag clocking an excellent growth track. While Q1 had seen a 33% sales growth with a 90% Net Profit growth, Q2 results have made everyone sit up and notice the exemplary 51% growth in sales and a 135% growth in Net Profits! Margins have been helped along by the softening in raw material (natural rubber) seen in Recent months.
  • Good dividend payouts – Starting in 2008, the company has been gradually increasing dividend payouts. Dividend per share has increased from Rs 2 to Rs 4 per share with dividend payouts increasing from ~13% in FY08 to ~20% in FY11.
  • Attractive Valuations – at CMP of 140, the stock is quoting at <7x trailing and <5x 1 year forward. Dividend Yield at ~2.86% adds to the comfort.

Bearish Viewpoints

  • Limited presence outside North India: The company’s limited presence in alternative growth belts of Southern and Western India can be a limiting factor in the company’s growth attempts. Some of the companys competitors are better entrenched in these markets – e.g. Midas, Vamshi Rubber and MRF in the Southern belt.
  • Intense Competition – The retreading sector is highly fragmented reportedly with over 10,000 players in the unorganised sector and ~6 players in the organized sector. Midas Treads, Vamshi Rubber, Elgi Rubber International, MRF Ltd, JK Tyres and Indag Rubber are the significant players in the organized sector. These players supply their tread material to unorganised players who retread tyres. Nearly 70% share of the total retread industry (hot and cold) is accounted for by the unorganised sector.
  • Cheaper Chinese Imports – Cheaper Chinese tyres are a source of competitive challange to the Retread industry, especially in times of slowdown in economic activity. In 2007-08, this shift from retreading to buy cheaper Chinese tyres had garnered lot of momentum. However with the government imposing a duty on Chinese tyre imports and customer experience with low product quality has meant these have lost much of the sheen. Demand for quality retreads from players like Indag is expected to remain firm.
  • Lower-Margin State Transport Retreading business: Sales to State Transport Undertakings (STU) account for a significant 15% of the company’s sales. Gujarat, Maharashtra, Andhra Pradesh, Tamil Nadu, Karnataka, Uttar Prradesh and Himachal Pradesh are some of the states where IRL has significant salesto STUs. Tender based competitive bidding can erode margins, if the proportion of STU sales increase.
  • Low Capacity utilization: Historically capacity utilisation has been low. FY06 had seen a capacity utilisation of only 42%, which has only gradually moved up. Only once in the last 5 years has capacity utilisation touched 60%. The FY2010 expansion to 13800 MT capacity from ~9000 MT capacity again has meant utilisation falling below 60% to ~56% levels. However this should be seen in the context of availing tax exemptions on the entire exempted capacity completed by FY2010 for the next 5 years. This also means that IRL can scale up production with demand as needed, without incurring any significant capex for the next 2 years or so.
  • Volatility in raw material prices: Raw material constitutes between 70-75% of Sales. Natural and synthetic rubber account for 60-70% of raw material, both of which are vulnerable to global supply and demand, and crude movement. To its credit, Indag Rubber has been seen to be able to pass on the price increase to its customers, with a lag effect.

Barriers to entry

  • Strong distribution network – Indag has set up a strong distribution network over the years in its stronghold northern and eastern markets. And slowly expanding its presence in the Southern and Western belts. It has 25 depots and some 350 strong franchisee retreader network.
  • Strong State Transport Undertaking business – The company sells its products to State Transport Undertakings (STUs) via a tender system. Gujarat, Maharashtra, Andhra Pradesh, Tamil Nadu, Karnataka, Uttar Pradesh and Himachal Pradesh are some of the states where IRL has significant sales to STUs. Sales to STUs have been increasing, now accounting for ~15% of the company’s total sales.

Interesting Viewpoints

  • Land at Bhiwadi, Rajasthan: IRL’s Bhiwadi plant located near Alwar in Rajasthan is shut since 2006 when the Himachal Pradesh (HP) plant went on-stream. All workers at Bhiwadi have been relieved. The Plant & Machinery has been shifted to the HP plant and there are no plans of restarting this plant. The possible sale of this land or putting it to alternative use could unlock value going forward though the timing of this is uncertain at this point.
  • Ability to pass on price increases – With severe spikes in Natural rubber prices seen in FY11, Indag Rubber was forced to effect a 30% hike in retread prices. The company could manage a 34% hike in sales revenues with margiunal erosion in profits. This is testimony to the company’s ability to pass on price increases and protecting profitability to that extent. ICRA has upgraded the rating of Rs.14.50 crore fund based facilities of Indag Rubber Limited (IRL)† from [ICRA] A (pronounced ICRA A) to [ICRA] A+ (pronounced ICRA A plus) rating on long term scale. The rating has been assigned a stable outlook.
  • Stake sale by promoters: Promoters presently hold 77% stake in the company. As per SEBI regulations, they will have to bring down their stake to 75% by March 2013. This could create some uncertainty and consequently have an impact on the share price.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Atul Auto

Background

Incorporated in 1986, Atul Auto is a leading manufacturer of 3-wheeler commercial vehicles based out of Gujarat. Passenger auto rickshaws (3-6 seaters), pick-up vans and delivery vans (diesel, cng and lpg) are manufactured in a large number of variants.

Atul Auto’s Manufacturing plant situated at Shapar, 18 Kms. away from Rajkot has a production capacity of 24000 vehicle per annum on single shift basis. It is equipped with CNC machines, fabrication shop, high quality paint shop and test house. Atul auto’s R&D center is based in Pune.

Atul Auto has wind turbine generators of 1.25 MW capacity at Village Soda, near Jaisalmer, Rajasthan and another of 0.6 MW at Village Gandhavi, Jamnagar Gujarat.


Main Products/Segments

The Rear-Engine 3-wheeler Atul Gem is its fastest growing platform comprising ~57% of Sales in FY11. The front-engine 3-wheeler Atul Shakti is the other main platform bringing up ~42% of Sales in FY11. Atul Smart is a new brand of front-engine 3-wheeler launched in FY11.


Main Markets/Customers

Autorickshaw operators, transport operators and Corporates


Bullish Viewpoints

  • Growing 3-wheeler segment – This is a segment that has many growth drivers going for it. The government’s focus on road infrastructure development, restriction of heavy vehicles in the city, and the growing rural economy are important growth triggers. Over the years, Atul Auto has developed itself as a one-stop source for all 3-wheeler needs. It has made it’s versatile platform highly customizable to suit almost every kind of need and budget.
  • Impressive Growth -In FY11 Atul Auto registered a 68% growth in Sales and over 107% growth in Net Profits. 1QFY12 has seen the growth momentum continuing with both Sales and Net Profits registering ~56-60% growths. The company has guided for 40% growth in sales for FY12.
  • Reducing Debt – Debt is down to just 6 Cr in FY11 from ~23 Cr in FY10. That such stupendous growth is being achieved while reducing debt is heartening to note. Debt-to-Equity stands at just 0.15. With the ongoing rights issue proceeds, the company intends to repay its term loans and become a DEBT-FREE company in the near future, as per its 2011 Annual Report .
  • Reducing Working Capital requirements – Working Capital/Sales reduced to an astonishing 3.38% in FY11 as compared top ~15% of Sales in FY10. This is achieved on the back of increasing dealer advances and is a positive trend.
  • Increasing Cash Flows – Atul Auto has been increasing its cash flows handsomely in recent years. Cash flows from Operations grew to 16.72 Cr in FY11 from 9.58 Cr in FY10. With Bulk of the Capex undertaken in FY07-09 (~8 Cr each year), the company has been registering good levels of free cash flows. Capex requirements for existing platforms looks to be easily funded from current cash generation levels.
  • Increasing Dealer Network – With a current market share of less than 3% of total 3-wheeler market in India, Atul Auto is striving to increase its distribution reach beyond Gujarat. The company is expanding its presence in Andhra Pradesh, Rajasthan and Maharashtra while entering new markets such as Kerala, Karnataka, Bihar and Assam.
  • Export Foray – Atul Auto Ltd has started exports in Nigeria, Kenya, Egypt, Tanzania and some other African countries. It has also recently introduced Atul Gem Diesel & CNG variants in Bangladesh. Exports touched 3.2 Cr in FY11.
  • Expansion Plans – Atul Auto has been actively exploring expansion plans. It is in the fray to acquire the ailing Scooters India Ltd which also manufacturers front-engine 3-wheelers. It is also actively looking for technology partners for manufacturing 4-wheeler LCVs.
  • Strong sales in Q2FY12- Atul Auto Ltd has informed BSE that the Company has recorded total Sales of 6794 Vehicles in the quarter of July -September 2011, as against 4814 Vehicles of July-September 2010 Quarter, or a 41% growth in number of vehicles sold. This is on the back of the ~60% sales growth registered in Q1FY12.
  • Increasing dividends & yield – The company has consistently increased dividends in the last 2 years leading to a 5yr dividend CAGR of over 44%. At CMP of 98, the dividend yield is 3.27% (post rights capital basis).

Bearish Viewpoints

  • Heavily dependent on Suppliers – Atul Auto sources its engines from Greaves Cotton. Although this has been a long-term relationship, this complete dependence on one supplier can be a big risk.
  • Aggressive expansion plans – Although nothing concrete has yet been announced but the company’s expansion plans are a source of concern – whether it is acquiring the ailing Scooters India or investing into greenfield 4-wheeler LCV manufacturing, a much more competitive and technology intensive segment. There are big execution and market risks associated.
  • Litigations against the Company – 67 cases of litigation is filed against the company totaling 12.83 Cr. Of this 11.17 Cr is against one case filed by Lombardini, Italy with whom the company had entered a technical collaboration in 2006. To be fair, the company itself has filed a litigation against Lombardini for 43.08 Cr. The company had suffered heavy damages and had to recall and replace eventually some 8500 engines by 2009, due to this ill-fated venture.

Barriers to entry

  • Entrenched Players – The 3-wheeler market is dominated by entrenched players like Bajaj and Piaggio. Setting up manufacturing and a country-wide dealer network from scratch is an uphill task for new players.

Interesting Viewpoints

  • Strong Dealer Advances – As on 31st March, 2011 the company has 3.37 Cr as advances from dealers against 36 lacs in the previous year. This reflects good acceptance of Atul’s products in the market and is a very positive development for the company. If sustained, this could be key to reduced working capital needs of the company.
  • Rear-Engine 3 wheeler growth – India is pre-dominantly a Rear Engine 3-wheeler market. Atul had started with Front-Engine technology (Atul Shakti) and introduced rear-engine 3 wheelers in 2007-08 in collaboration with Lombardi which faced trouble with the engines (Read this case study for a great backgrounder on the company). These problems seem to have been bested and the rear-engine 3-wheeler Atul Gem (recorded a 144% growth in Sales in FY11.

Disclosure(s)

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