PI Industries

Background

PI Industries (earlier Pesticides India) incorporated in in 1947, has Agrichemicals and Custom Synthesis as main business segments. It operates 5 multi-product plants at Gujarat & Jammu and one R&D unit in Udaipur, Rajasthan.


Main Products/Segments

Agrochemicals Product basket includes – Insecticides, Herbicides, Plant Nutrients and Fungicides. Insecticides contribute more than 50% of revenues, while Herbicides and Plant Nutrients contribute over 30% revenues. Rice crop and the Fruits and Vegetable segment are the top contributors, Cotton being the other significant segment. PI  Industries has over 50 years of experience of manufacturing & marketing Agrochemicals in India.

PI Industries entered the Custom Synthesis business in mid 1990s. The custom synthesis business caters to process and manufacturing requirements of Innovator companies in the Agrochemicals, Pharma Intermediates, and Specialty Chemicals sectors.


Main Markets/Customers

Agri-Inputs: ~60% of overall Sales in FY11, caters to Farmers through an extensive 2500-3000 dealer distributor pan India network. Five zonal offices, 24 branches, 220 sales staff, and 800 field staff support this pan India network.

From being a generic manufacturer of the reverse engineered off-patent agro-chemical products, PI has made the transition to in-licensing innovator company products for exclusive marketing rights to distribute their products in India. As per the company 40% of Agri-Inputs business is contributed by in-licensed products currently, and the mix is likely to go upto 50% with newer launches. PI purchases in-licensed products from the principals at a certain price and creates formulations/further manufacturing activities on these products to pack them under its own brand, and sells them in India. Most of it is branded sales, no bulk supplies to other players.

PI has a strong association with reputed companies such as Bayer, BASF, Chemtura and also a robust pipeline of exclusive co-marketing arrangements with top Japanese agro-chemical companies.

Custom Synthesis: ~35% of overall Sales in FY11, 100% exports catering to innovator companies from developed economies mainly Europe, Japan, and a small presence in US. 90% of these are all early stage, patented molecules.

With over 14 years of experience in custom synthesis business, PI has acquired strong competencies and proven its capabilities by working with more than 300 molecules at various stages of process development with up to 15 stage chemical reactions.

PI’s transparent non-compete and IP driven business model has earned it the confidence of clients while its core competence in process research and manufacturing has helped it partner global MNCs and Innovator companies -some ~30 active clients currently for agro-chemicals, pharma and specialty chemicals. As per the company, PI has more than 100 researchers and chemists to handle these assignments.


Bullish Viewpoints

  • Solid Track record – PI Industries have grown solidly over the last several years. Last 5 yrs have seen it clocking a compounded annual growth rate (CAGR) of 22% clocking ~720 Cr in Sales in FY11 from 318 Cr in FY07 . Operating profits have grown at a 5yr CAGR of 42%, while Profit after Tax has grown at an astounding 5yr CAGR of 73% to touch 64 Cr in FY11 from 7.19 Cr in FY07, or 9x in the last 5 years.
  • Consistent Improvement in Margins – Its good to see consistent upward trend in Operating and Net Margins in the last few years. FY07 and FY08 had Operating margins around 10%, going up to 14% in FY09, to 16% in FY10 and over 17% in FY11. 1QFY12 saw Operating Margins climbing to ~21%. As per the company, this is on the back of economies of scale with fixed costs getting spread over a larger base, and improving product mix and realisations in both its business segments. Clearly PI industries is operating at a different level, today.
  • Fast growing blockbuster brand(s) – During FY10, PI launched a new rice herbicide in India – Nominee Gold which had got a tremendous response from the farming community and has even been actively recommended by many state agricultural universities for adoption in rice cultivation. PI is expecting this product to achieve status of the largest rice herbicide in the coming years, contributing significantly to the growth of the company. With a portfolio of solidly growing products in-market and a pipeline of exciting new products, PI is poised to further scale up its business in FY12.
  • Innovative in-licensing model – PI works on an in-licensing model that helps it test market and work extensively in field promotion for newer innovative products, before looking to commercially launch the products. As per the company, there are 7-8 molecules in the pipeline under evaluation and registration stages and is targeting to launch 2 new products in FY2012. These are broad-spectrum insecticides with large market potential. All in-licensed products are based on long-term agreements and none of the products are due for expiry within next 5 years. Most of them have usage life of 15-20 years.
  • Agri growth drivers in place – As per the Management key drivers are quite positive. The Met department is expecting a normal monsoon. Early estimates of crop acreages are high and the agri produce prices are also running at an all time high. These are three key indicators which suggest that FY12 is expected to be a better year for the Agri-Input industry.
  • Strong order Book in Custom Synthesis – Current order book (1QFY12) is in excess of US$ 340 million with tenure of execution ranging from 2-4 years depending on different products. Most of the products are at start-up volume levels and are expected to ramp up significantly with time. As per the company, currently 14-16 products are in commercial scale, while some 24-26 products are at developmental Pilot & R&D stages. 65-70% of the Order book is from Europe, 20% from Japan, and the balance spread out.
  • Huge Capacity Expansion – PI Industries spent ~91 Cr on capital expenditure in FY11 mainly on expanded capacities at its Ankleshwar facility. It is also developing a SEZ project for Custom Synthesis at Jambusar in Gujarat on the back of the expanded order book, for which it has acquired 22.3 acre land. A total investment of Rs. 125 crore has been earmarked for this of which 75-100 Cr may be utilised in FY12, and the balance 25-50 Cr in FY13. As per the company this additional capacity may have a revenue generation potential  ~325-350 cr.
  • Robust recent financial performance – Agri business had grown ~38% over FY10 and custom synthesis business logged a 23% growth over FY10. Overall Sales grew by over 32% in FY11 to ~719 Cr from 543 Cr in FY10.  EPS on an adjusted basis grew by 57% to 51.19 from 32.69 in FY10. 1QFY12 registered a 59% increase in Sales to clock ~207 Cr (130 Cr) despite the polymer business sell-off, while EPS (adjusted for extra-ordinary income) surged 159% to over Rs. 20 (Rs. 7.8).

Bearish Viewpoints

  • Execution Risks – The main risks are on proper execution of expansion projects. Any delay in setting up enhanced capacities may impacted projected growth from custom synthesis business segment.
  • Effect of Monsoon – The Agri-Inputs business is largely dependent on the monsoon. While the FY12 Rabi crop (sown in winter months and harvested from May onwards) has reportedly been good, the Kharif crop (sown in the rainy season Jun-Sep) may still get affected by poor monsoons in the remaining months.
  • Sharp increase in Working Capital in FY11 – Working Capital/Sales shot upto ~29% in Q4FY11 as compared to ~22% in Q4FY10. Debtor days shot upto 90 days in Q4FY11 from 52 days in Q4FY10. Inventory dayssimilarly had climbed up to 72 from 52 days. The company maintained peak sales shift form Q3 to Q4 in FY11 responsible and normal working capital trends will resume in a couple of months. 1QFY12 indeed has seen debtor days down to 59, though Inventory days have increased somewhat to 75 days.
  • Huge increase in debt Levels in FY11 – Total debt sharply increased from 150 Cr in Q4FY10 to 248 Cr in Q4FY11. Company maintained this was mainly on account of short term unsecured loans to cover higher working capital requirements in Q4FY11. That this was not representative of the full year, company cited Interest costs for FY11 (18.19 Cr) being lower than FY10 (18.31 Cr). As Working capital normalises and sale proceeds of Polymer division (April 2011) accrues this would be brought down. 1QFY12 has indeed seen debt levels coming down sharply to 133 Cr. However going forward, additional capex requirements of ~75-100 Cr for SEZ project during the year is going to see increased debt levels.
  • Forex fluctuations – The Rupee/US$ fluctuations may effect custom synthesis business
  • Poor Liquidity – As on 1QFY12, Promoters hold 63.66%. Of the balance FI & FIIs hold 3.87%, Corporate Bodies hold 9.49%, Foreign Corporate Bodies hold another 12.85%, with Directors, relatives and Friends holding another 1.46% – totaling 27.67%. Effective float is just 8.67%. This implies significant impact on bulk entry and exit costs.

Barriers to entry

  • Unique Non-Compete model  – From inception PI has made trust-building the cornerstone of its strategy in custom synthesis and has refused to market competing products. As per the company, PI is the only Custom Synthesis business in the country where more than 90% of the molecules are patented or are at early stage of commercialization.
  • Strong Customer lock-ins – In the custom synthesis business, Innovator companies as a prudent strategy do not keep a single source. But usually for new products, for IP protection, and for other confidentiality issues they also do not keep more than two sources. If it is a huge global blockbuster kind of thing then they may have three sources, but usually not more than two sources.
  • Strong Brands – PI Industries has made the transition from being a generic manufacturer of the reverse engineered off-patent agro-chemical products, to in-licensing innovator company products with exclusive marketing rights to distribute their products in India. As per the company, PI brands are usually #1 or #2 brands in their categories.

Interesting Viewpoints

  • Strong Guidance from Company – On the back of a good monsoon for Agri-Input business and strong execution in custom synthesis segment, the company has guided for a 40% growth in Sales and an EBITDA margin expansion of 1.5% in FY12 (17.19% in FY11).
  • Sale of Polymer business – PI achieved successful closure of the sale of PI Polymer to Rhodia SA for 76 Cr. Post this transaction PI is completely focused on agri inputs and custom synthesis, both high margin and highly scalable businesses. PI booked 30 Cr of the proceeds as Extraordinary Income and the rest to be used to fund growth plans of existing business and/or bring down the debt. The disposal of the low-margin (EBITDA 10%) Polymer business is also expected to provide a fillip to overall margin expansions.
  • Joint Research Centre with Sony Corporation – PI industries signed an agreement with Sony Corporation to set up a joint research centre at Udaipur, named as PI-Sony Research Centre, it was formally inaugurated in January 2011. This R&D Centre will be engaged in developing commercially viable processes for molecules invented by Sony. These researched chemicals are expected to find use in futuristic products like flexible television, solar cells etc. This is a big testament on PI Industries custom synthesis capabilities. Work on several new molecules has already started, and revenue visibility is reportedly from FY13.
  • Currently India is amongst the lowest per capita consumers of pesticides at 380 gms per hectare while it is 2 kg/ha for China, 1.9 kg/ha for Europe and 1.5 kg/ha for the US. Also, out of the total crop area for rice, wheat and cotton in India, only 35-40% is treated with pesticides which indicates that the low penetration is likely to drive consumption of pesticides in India. [Source: Agrochemicals Market in India, FY11]

Disclosure(s)

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


Mayur Uniquoters

Background

Mayur Uniquoters, a PU and PVC synthetic leather (artificial leather) manufacturer, was established in 1992 by S.K. Poddar, an industry veteran trader in PVC Leather line.

It has 3 manufacturing facilities at Jaipur with an installed capacity of about 1.4 million linear meters/month, from where the company manufactures a wide range of premium products for Footwear, Apparel, Luggage, Furniture, Leather Goods, Upholstery and Automotive Industries.

Chemicals (~64%), Knitted Fabrics (~16%), Other fabrics (~14%), Release paper (~6% which is reusable) are the main raw materials.


Main Products/Segments

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

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


Main Markets/Customers

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

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

Opportunity size

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

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

Competition

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

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

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


Bullish Viewpoints

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

Bearish Viewpoints

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

Barriers to entry

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

Interesting Viewpoints

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

Disclosure(s)

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


Gandhi Special Tubes

Background

Gandhi Special Tubes was set up in technical collaboration with BENTELER of Germany for manufacturing small diameter welded and cold drawn seamless steel tubes. The plant situated at Halol, Gujarat, started commercial production in April 1988.

Gandhi Special Tubes Ltd. have also started manufacturing of Cold Formed Tube Nuts for Fuel Injection Tube Assemblies as well as Hydraulic Tube Assemblies. This is a pioneering effort in India as hitherto tube nuts were being manufactured by machining.

Gandhi Special Tubes (GSTL) product focus is in import substitution. With the focus on Quality (ISO/TS 16949 : 2002 as well as ISO 9001: 2000) they have been successful in winning over most OEMs hitherto importing, and enjoy a large market share in their niche product segments.


Main Products/Segments

Welded Steel Tubes [32.60%] – (3.1-12.7 mm OD) – These tubes find applications mainly in refrigeration and automobile industry.

Seamless Steel Tubes [55.33%] – (3-75 mm OD)- These tubes find applications in high pressure fuel injection tubings and hydraulic tubings -mostly in diesel engines.

Cold Formed Nuts/Scrap [9.84%] – These nuts find applications as Coupling Nuts for fuel injection tubes and Coupling Nuts for hydraulic fittings.

Wind Power [2.23%] – 5 plants based in Gujarat & Maharashtra totaling 5.35 MW


Main Markets/Customers

Seamless Steel Tubes – Customers include automobile OEMS like Telco, Tisco, Ashok Leyland, M&M, Simpson, Kirloskar Oil Engines, Mannesman Rexroth, HMT, L&T, etc. and ancillaries like Imperial Auto.

Welded Steel Tubes – Refrigeration Industry customers include Godrej, Voltas, Electroloux, Carrier, etc. Major automobile/engine manufacturers like Telco, Ashok Leyland, M&M, Simpson, Kirloskar Oil Engines , Maruti Udyog, etc or their ancillaries.

Cold Formed Nuts – Automobile OEMS for seamless steel tubes as above

Wind Power – Captive consumption (Gujarat plants) & supply to State grid (Maharashtra plants)


Bullish Viewpoints

  • Good track record – GSTL has a good track record over the last 10 years. Operating profits (~7 Cr in FY2000) and Net Profits (~3.5 Cr in FY2000) have clocked a CAGR of over 20% to reach over 41 Cr and 25 Cr respectively.
  • High profitability with consistently expanding Margins – Net margins have moved up from over 13% in FY2000 to over 30% in FY10. Operating Margins have moved up from ~27% in FY2000 to over 50% in FY10. This trend has accelerated in the last 5 years, as the company has perhaps consolidated its position as the leading supplier of seamless & welded tubes and cold formed nuts to the automobile OEMS, refrigeration and general engineering industries. Return on Capital employed has been high, in the 30-35% range.
  • Good Free Cash Flows, Completely Debt free – GSTL has the unique record of remaining largely debt free and funding all its capital expenditure requirements out of internal accruals, without resorting to long term debt or equity dilution. Having completed major expansions in FY07 and FY08, capex in last 2 years has been minimal. Free Cash flows as a percentage of Sales has climbed to over 25% in FY10. This would seem sustainable for the next 2-3 years as Sales growth has not kept pace.
  • Great Dividend track record – Dividend Payout has consistently been increasing from ~18% of earnings in FY06 to 29% in FY10. 5 yr DPS CAGR is 25% while it has accelerated in the last 3 years to clock a DPS CAGR of over 41%
  • High Dividend yield – at CMP of Rs 115, the stock provides a dividend yield of over 4% which provides good comfort. However it should be noted there was a special silver jubilee dividend declared in FY10, so sustainable yield is more like 2%

Bearish Viewpoints

  • Sales growth track record has been faltering – If you ignore a stupendous FY10 performance (on the back of a poor FY09), GSTL Sales growth record has been far from impressive. GSTL has only tripled its Sales in last 10 yrs from 25 Cr in FY2000 to over 75 Cr in FY2010 recording a 10 yr Sales CAGR is ~13%; 5yr Sales CAGR is poorer at 8.6%. While the company has been served well by margin expansions over the last few years, Sales growth lagging substantially behind earnings growth is not a very welcome sign.
  • Gross Block additions higher than Sales growth – Gross Block has moved from Rs 55 Cr in FY06 to Rs 87 Cr in FY10 and Sales from Rs 64 Cr to Rs 84 Cr in the same period. Sales to Capex ratio in last 5 years is < 1.Asset Turnover has been below 1 for last 2 years, improving from 0.66 in FY09 to 0.74 in FY10
  • Recent Financial performance – Going by 9m FY11 performance, GSTL has recorded an 18% increase in Sales coupled with a modest 2% rise in Earnings. This is on the back of higher raw material and other expenditure costs. Full year FY11 picture is unlikely to be much different.
  • Higher Working capital requirements – Debtor days has climbed to 71 days (41days) and Inventory days have risen to 171 days (131 days) – significantly up from levels prevalent 2 years back.
  • High Management Compensation – For a company of its size (<100 Crs) GSTL Senior Management is taking in over 15% of the Net Profits of the company. (3.77 Cr, 25Cr in FY10, 2.49 Cr, 15 Cr in FY09). No doubt, the Management has driven the high performance and great margins for the company, but this level of compensation seems high especially on peer comparison with companies of similar sizes that have registered much better growths.
  • Raw material volatility – While raw materials constitute ~30% of Sales, it must be noted that over 50% of the raw material is imported (FY10) and exposes the company to forex volatility risks on top of raw material risks. Exports are minimal.

Barriers to entry

  • Technology Intensive – Small dia seamless and welded tube manufacturing is a technology intensive process refined through decades of experience, going down to the quality of raw material – specialty steels, used. In FY10, over 52% of raw material was imported by GSTL.
  • Product Line extensions – Manufacturing Cold Formed Nuts with superior reliability and tensile strength as opposed to machined nuts (a first in India) used in fuel injection and hydraulic tubings also helps GSTL in its quest for niche domination

Interesting Viewpoints

  • Zero debt and no equity dilution – GSTL has increased its Net Worth almost 5 times over the last 10 years. Reserves & Surplus have gone up over 6 times. Gross Block has gone up from some 30 Cr in FY2000 to ~87 Cr in FY2010. It has funded all capital expenditures out of internal accruals (over 50 Crs). Not once has it resorted to long term debt or equity dilution.
  • Consistent Margins expansion – GSTL boasts of an envious record in margin expansions especially over the last few years. Operating margins have shot upto over 50%. Is this an oligopoly kind of situation developing?

Disclosure(s)

Donald Francis: No Holdings in the Company;


Vinati Organics

Background

Vinati Organics Limited was promoted by first generation entrepreneur Vinod Saraf in 1989 to manufacture specialty organic chemicals. Vinati is a niche player but has already achieved global recognition and size.

With ATBS, Vinati has broken into the exclusive club of ATBS manufacturers. There are only three other manufacturers of ATBS globally viz. Lubrizol (USA) ~14000 TPA, Toagosei (Japan) ~8000 TPA and a Chinese company with small capacity of ~2000 TPA.


Main Products/Segments

  • Iso Butyl Benzene (IBB) – largest manufacturer – 14,000 TPA – 60% global market share
  • 2-Acrylamido 2-methylpropanesulfonic Acid (ATBS) – 2nd largest manufacturer – 12,000 TPA -25% global market share.

In FY 2010 IBB contributed 54% , ATBS contributed 44% while Others contribute 2% of the Sales mix. Contribution from ATBS has been steadily growing over the years and in 1Q FY 2011, ATBS has already overtaken IBB contributing ~57% to the Sales mix.


Main Markets/Customers

Domestic market for its products is small, the Company exports bulk of its products to USA, Europe, Australia, Middle East and China. Export contribution in FY 2010 is ~75%

  • IBB – is the primary raw material for the popular painkiller Ibuprofen – supplied directly to Ibuprofen manufacturers like BASF (largest Ibuprofen manufacturer), Shashun Chemicals, Biocause (China) the other large scale Ibuprofen Manufacturers.
  • ATBS, Na-ATBS and other derivatives that the Company makes are specialty monomers having wide applications mainly in acrylic fibre manufacturing, adhesives, and personal care products. These are supplied to polymer manufacturers who then sell the polymers to users through their distribution channels. Direct sales of ATBS are only to acrylic fiber industry.
  • New Applications like Enhanced Oil Recovery & Water Treatment hold substantial potential for growth of ATBS and global demand is expected to go up 2-3 fold (Source: company)
  • Some of the key clients are BASF, AkzoNobel, Ciba, Perrigo, Rohm & Haas, Clariant, NALCO, Shasun Chemicals

Bullish Viewpoints

  • Competitive edge in niche specialty chemicals – Cost leadership & scale economies in IBB and technological entry barrier in ATBS are strategic advantages. VOL is making its presence felt in specialty chemicals where there is less competition globally, technology is not easily available and large players are probably not interested due to relatively smaller global market size of the products.
  • Most impressive track record in last 5 years – The growth snapshot shows while Sales have grown at a compound annual growth rate (CAGR) of 41.78%, EBITDA has grown at an accelerated pace of 73% CAGR over the last 5 years. EPS (adjusted for stock splits) has galloped away at over 112% CAGR on expanding margins. The profitability analysis shows Operating Margins have gone up from 10% in FY 2006 to over 22% in FY 2010. Net Margins have done better going up from 3.4% in Fy 2006 to over 17% in FY 2010. RoEis over 40% and RoCE at ~34% in FY 2010 from single digit figures in FY 2006.
  • Ranked #14 among India’s top 100 fastest growing companies -Economic Times, Oct 2009
  • Focus on high-margin ATBS – The worldwide demand for ATBS is about 30,000 TPA and is growing at about 10-15% annually.  Vinati has seen its ATBS business growing at 40%  in FY10 and sees this trend continuing in FY11. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. Plans are on to expand ATBS capacity to 18000 TPA from current 10000 TPA by December 2011. Margins from ATBS are around 25-30% while those for IBB are around 15-20%.
  • Backward Integration into Isobutylene – The company has completed a backward integration project of ATBS by manufacturing Isobutylene (IB) a key ingredient. The IB plant with a capacity of 12000 TPA has commenced production in June 2010. Hitherto IB was imported from Europe & Taiwan in pressurized tanks. The freight cost per kg of IB is about Rs. 20. One kg of ATBS requires about 0.35 kg of IB. In FY11, VOL’s demand for IB could be atleast 3,000-4000 MTPA. Thus, the cost savings based on freight and captive consumption of IB alone could be to the tune of Rs. 6-8 cr.
  • Replace Import demand of IB in domestic market – ~4000 TPA of IB would be used for captive consumption while the remaining would be sold off in the market. Currently, the only domestic manufacturer of IB is Savla Cemicals who has a capacity of 5,000 MTPA. The demand for IB in the domestic market (not including VOL’s demand) is about 10,000 MTPA. The demand supply mismatch is currently being met by imports.
  • New products to add to revenue stream –  Several new products in pipeline are also coming onstream in 2HFY11 which include ATBS capacity expansion, Tertiary Butyl Acrylamide (TBA), Tertiary Octyl Acrylamide (TOA), Di-Acetone Acrylamide (DAAM). The new capacities of TBA, TOA and DAAM could help the company to improve turnover significantly by FY12.
  • Proximity to Mumbai and JNPT port – greater ease of logistics and access to advanced infrastructure facilities.
  • Environment-friendly operations include waste product recycling. With the aim to be a zero-effluent company, VOL has focused on recycling and monetising waste byproducts of ATBS like TOA, TBA, and DAAM as mentioned above.

Bearish Viewpoints

  • Highly dependent on two products – Currently VOL derives its revenue from two products – namely IBB and ATBS. Thus the company is highly sensitive to any additional capacities, market changes etc. affecting either of these two products.
  • Muted growth for IBB – IBB is the primary raw material for Ibuprofen a mature product with expected growth of ~3-5% CAGR. Capacity expansion and newer capacities from players like IOL Chemicals & Pharmaceuticals limited (6000 TPA) has started impacting margins.
  • Lower than expected offtake of IB – VOL has a 12,000 TPA facility of IB. Requirement for captive use of IB in ATBS is 3000-4000 MT. This is expected to go upto 6000 MT when ATBS capacity reaches 18000 MT by FY11 end. The company has been unable to sell the balance in the domestic market. Savla Chemicals the other domestic manufacturer of IB is a competitor.
  • Aggressive Capex plans – As per FY 2010 Annual Report, VOL is carrying out capex of about Rs. 77 Cr in FY 2011. Also there is a 5MW co-generation plant (coal based) expected to be operational by end of FY11 involving a capex of around Rs. 33 Cr. While operational leverage takes time to kick in, there is a possibility of increased interest and depreciation costs, and lower capacity utilisations having a negative impact on bottomline. Execution risks remain significant as more aggressive plans have been announced and re-iterated in this August 2010 Analyst Meet.
  • Higher Tax payout from FY 2012 – ATBS manufacturing facility at Lote, Maharashtra enjoys 100% EOU tax exemption. Such tax breaks are available till March 2011. From FY12 onwards tax payout will see a big jump which will impact net margins significantly.
  • Volatility in crude oil prices – The main raw materials required for the manufacture of IBB and ATBS are crude oil derivatives such as toluene and propylene. Any major fluctuations in the prices of crude oil could adversely affect VOL’s performance (due to the 3 months time lag in passing on the increase in cost to its customers) especially for fixed price orders.
  • Foreign currency fluctuations – VOL exports ~75% of Sales. Thus, it is a net receiver of foreign exchange. It procures raw materials through imports and local purachases, where local purchases track import parity price.Thus raw materials and the FCNR loan it has taken provides a partial natural hedge. Unforeseen sharp fluctuation in the value of the Rupee could affect its realization and margins at least temporarily. Long Term contracts have provisions for shared currency risks.

Barriers to entry

  • ATBS technology is exclusively licensed from National Chemical Laboratories (NCL) Pune. The process developed by NCL is protected by two US patents (6,504,050 and 6,660,882). A third PCT application has been filed. Development of Process Technology for SMAS & ATBS
  • IBB technology is licensed from Institut Francais du Petrole (IFP) France. With 60% market share VOL enjoys cost leadership & scale economies in IBB
  • Its not easy to manufacture these products to exacting requirements of quality. It took Vinati 4 years to get the quality right on ATBS.
  • Since these are niche products with only a few large scale suppliers, major customers usually enter into long term contracts. BASF had entered into a 5yr contract for IBB (till FY 2011). ATBS contracts are of 1-3 years durations.

Interesting Viewpoints

  • The worldwide demand for ATBS is about 30,000 MTPA and is growing at about 10-15% p.a. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. (Source: company, HDFC Securities)
  • Backward integration into IB may assist in VOL’s quest for leadership position in ATBS
  • The company is further de-risking its product profile by investing in a new product Para Amine Phenol (PAP). A key ingredient in manufacture of paracetamol, PAP is being produced in a pilot plant using a new NCL Pune developed technology, (single step catalytic hydrogenation of nitrobenzene) since there are issues of large amount of effluent generated and technological gaps in the existing conventional technology. The technology is meant to be environment friendly and competitive internationally with other technology
  • The company has already invested around Rs 4 crore on R&D and hopes to complete the pilot trials on PAP by October 2011 when more clarity would emerge. Once the pilot runs are successful, VOL could set up the plant which would take another 18 months to go onstream. If successful the prospects of VOL could further improve from here on.

Disclosure(s)

Donald Francis: No Holdings in the Company;


GRP

Background

Gujarat Reclaim and Rubber Products Ltd. (GRRPL) produces reclaim rubber from scrap of whole tyres, tread peelings, natural rubber tubes, butyl tubes, moulded rubber products for different applications in both tyre and non-tyre rubber products.

Established in the year 1974, Gujarat Reclaim started production with a modest capacity of only 2400 MT. After years of steady growth, it has increased its capacity by many folds (40,000 MT in FY10), and has widened its geographical presence in India and abroad (supplies across 45 countries). GRRPL operates from three locations in India’s north-west (Ankleshwar, Panoli) and south-west (Solapur).

Gujarat Reclaim has acquired a 3.6 MW windmill in the last quarter of FY10 in Gujarat. For the power units generated by windmill, the company gets credit in the electricity bill of its Panoli plant in Gujarat.


Main Products/Segments

Today Gujarat Reclaim has emerged as the largest manufacturer of reclaim rubber in the country and among the top 3, globally. Of total sales of Rs.140.67 Cr for FY10, domestic sales comprise Rs. 61 Cr (43.36%) and Exports comprise Rs.79.67 Cr (56.64%).


Main Markets/Customers

Major user industries are Automotive tyres & tubes, belts, automotive & industrial hoses, adhesives & sealants, civil construction applications.

Overall growth projected by the Rubber Board for the reclaim rubber industry for the next 4-5 years is at 8-10% year-on-year. If prices of virgin rubbers escalate at the current rates, this growth could easily be higher. Reclaim rubber is preferred for industrial use to the traditional virgin polymer because of its several advantages. Reclaim rubber is readily available in the country, is energy saving & the price of reclaim rubber today is around 25-30% of the polymer prices.

Exports contributed 57% of Sales in FY10.


Bullish Viewpoints

  • Good Industry prospects – Reclaim rubber is an eco friendly industry and with the rising prices of natural rubber, demand for reclaim rubber should increase going forward.
  • Consistent Margins and Profitability – Gujarat Reclaim has a neat track record of consistent growth and profitability. 5 Yr CAGR has been about 24% and 10 Yr CAGR has been at about 28%. Operating Profit Margins have generally been in the range of 16-19% and Net Profit Margins in the range of 9-11%.
  • Good Dividend record – Gujarat Reclaim is shareholder friendly and has a track record of continuously increasing dividends. 5yr DPS CAGR is 19% wheras 3yr DPS CAGR is almost 22%. Dividend payout ratio currently is about 19%.
  • High Returns – The business model is strong and the co generates high ROCEs. While it used to enjoy 40%+ returns, the last 2 years has seen returns 30%+ which is pretty good given the prevailing economic scenario.
  • Steady Growth – The company maintains that the new challenge before GRRPL is to maintain annual growth in excess of 30% and at the same time not waver from its path of building and consolidating trust among its growing number of stakeholders.
  • Recent Financial performance – For 9m FY11 Gujarat Reclaim has done Net Sales of 139 Cr (104 Cr 9m FY10) and PAT of 13.69 Cr (10.83 Cr 9m FY10). The company looks set to register a healthy 25-30% growth in FY11
  • Decent Valuations – at 915 CMP, the stock is available at ~7x FY11 EPS and 1.9x BV

Bearish Viewpoints

  • Capacity constraints – For the last 3 years installed capacity of reclaim rubber is stagnant at 41000 MT. In FY11, the company reportedly has expanded capacity at its Panoli plant by 6000 MT and a new plant is being commissioned at Solapur.
  • Expanded capacity utilisation – Increased capacity that is reportedly coming onstream by FY12 may lead to underutilisation and impact near-term profitability.
  • Raw material prices – Raw material/Sales has been steadily going up over the years. From roughly 40% in FY06 this is up over 45% in FY10. The rise has however been gradual and generally been offset by improvements in sales general & administration (SG&A) costs, power & fuel costs, etc. without really affecting operating margins.

Barriers to entry

  • In FY10 the installed capacity of reclaim rubber in India is estimated to be 150,000 tonnes, of which nearly 60% is manufactured by small scale industrial units, many of them maybe having obsolete machinery and processes.
  • Gujarat reclaim with an installed capacity of 41000 MT is the largest manufacturer and exporter of reclaim rubber in the country. Exports contributed 57% of Sales in FY10
  • 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 in India, the United States, Australia, France, Japan, Korea, Spain, and United Kingdom, among others.
  • One of the key strengths of GRRPL is that it has developed a wide network for raw material procurement and built an extensive chain of raw material suppliers. They are supported in procuring waste tyres from various state transport companies and other local collection sources. The suppliers act as agents of the company in reaching out across cities they operate in, to district and village level centres gathering the 45,000 tones of materials required at GRRPL factories.

Interesting Viewpoints

  • Gujarat Reclaim is focusing on sales of synthetic rubber reclaims which command higher value and realisation compared with the Natural rubber based reclaims. GRRPL has been a pioneer in the manufacture of reclaimed rubber from synthetic rubbers such as butyl, EPDM, nitride, etc. With increasing emphasis in the use of virgin synthetic rubbers for rubber compounds the world over, the future holds immense potential for the consumption of synthetic reclaim rubber, mainly in the non-tyre rubber goods manufacturing. The synthetic rubber reclaims business has grown significantly over the last few years and contributes approximately 45% of GRRPL’s total revenues.
  • Depending on the tyre type, reclaim rubber in a tyre can be as low as 0.5% to total polymer (in case of high performance PCRs) to as high as 12% to total polymer (in case of OTRs) and a further high of 35% (in case of cycle tyres). The Indian tyre industry as a whole consumes 4% reclaim rubber of total polymer. But individually, certain companies are also experimenting at levels of 6-7%.
  • The generation of scrap tyres and other waste tyres is a global phenomenon. Whichever country or region that has sufficient volumes of such scrap generation has an opportunity to have a reclaim industry. However, the consumption and market for reclaim rubber will depend upon where the production of reclaim rubber is. The global reclaim rubber industry has grown from being 2% of total polymer consumption in early part of last decade to close to 5% currently. China leads the way with the largest base for reclaim rubber manufacturing and also the highest consumption as proportion to virgin polymers.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Astral Poly Technik

Background

Astral Poly Technik (APL) has its production facilities at Gujarat and Himachal Pradesh to manufacture plumbing systems from ½” to 8” diameter.

APL was the first licensee of Lubrizol (formerly B. F. Goodrich), USA to manufacture and market CPVC (patent protected) piping and plumbing system in India in 1999. APL entered into a techno-financial joint venture with Specialty Process LLC of USA, which provided the required technical expertise for manufacturing CPVC pipes and fittings for home and industrial applications. Specialty Process LLC, USA has 14.08% ownership in APL as part of the Promoter group. APL claims to be the only Licensee of Lubrizol in India and neighbouring countries for the use of the trademarks ‘‘BlazeMaster” (since 2006), and “Corzan” (1998). “FlowGuard” (1998) license is also available with2 other unlisted players  Ashirvad Pipes (Bangalore) and Ajay systems (Delhi).

APL has ISO 9001:2000 certification for manufacture and supply of CPVC and PVC pipes and fittings for plumbing systems and industrial piping system. Astral is the only company in India whose manufacturing plant is approved by NSF, USA. The NSF certification represents the highest standards in public health & safety and environment protection. The NSF mark is recognized for its value in international trade around the world and is respected by regulatory agencies worldwide. Astral recently received ISI approval for its CPVC products in the country.

APL’s manufacturing facility at Barotiwal-Solan District (HP) enjoys tax benefits/ concessions, relating to duties of Sales Tax, Excise and Income Tax. Overall tax rate for the company in FY2010 was 16.90%. These benefits are expected to continue till FY15.


Main Products/Segments

Main products include Chlorinated PVC (CPVC) pipes and fittings for hot and cold water plumbing systems, CPVC industrial piping system for transportation of hazardous and highly corrosive chemicals, and lead free PVC systems for cold water application.

APL introduced a new product range in lead free PVC pressure pipes and fittings in 2004, again a first in india. With the concept of providing a one-stop source for all plastic piping systems, APL also began trading in products such as CPVC and PVC fittings, flanges and valves from Spears (USA), solvent cements (adhesive solutions) for joining pipes and fittings from IPSC (USA), underground specialty fittings from Hunter (U.K) and CPVC and PVC plastic pipes of larger diameters from Harvell Inc. (USA).

CPVC product segments contribute roughly 65% of Sales, balance is from PVC products.


Main Markets/Customers

  • Astral Flowguard & Astral Acquarius – for usual hot and cold water plumbing solutions
    • Residential Housing Projects
    • Hotels, Hospitals, Malls, SEZs, Airports – Construction projects
    • primarily sold through the distribution network
  • Astral Corzan – for transportation of highly corrosive industrial chemicals and gases
    • Industrial projects
    • primarily marketed by Direct Sales as it requires concept selling
  • 65-70% of Sales are reportedly from the Residential Housing sector. Balance from Commercial
  • Main demand is from Metros & Tier1 cities. However as per the company FY10 saw increase in demand from Tier2 & 3 cities.
  • As per the company increased focus on Replacement market (10% of CPVC Sales which has huge future potential especially in infrastructure, hotels, hospitals) and Projects in FY11
  • Some major customers in FY10
    • Bangalore – Apollo Hospital, Columbia Hospital, Hotel Novatel
    • Delhi/Gurgaon – Medicity, Max Hospital, Delhi international Airport

Bullish Viewpoints

  • Proxy play on the growing domestic construction sector – 26.53 million dwelling units housing shortage in India by 2012 is the estimate by a Technical commitee of the Ministry of Housing and Urban Poverty Alleviation. The plumbing segment is expected to grow between 15-20% annually for next few years based on demand from new residential, commercial and industrial projects. Apart from this, incremental demand also comes from the replacement of GI pipes installed in the existing projects. APL with its strong product basket catering to a diverse demand base (residential, hotels, malls, SEZ, airports, and replacement market) should do well.
  • Excellent growth – Check out the Astral Poly Technik Growth Snapshot here. Sales over last 5 years has grown at an astonishing 52% CAGR to clock ~300 Cr in FY10 from little over 58 Cr in FY06. And Earnings have grown at a much higher 62% CAGR going up over 7x in 5 years from ~4 Crin FY06 to over 28 Cr in FY10. Starting out in 1999, the company has set a scorching pace and is likely to cross 400 Cr Sales in FY11 in just 12 years.
  • Quality of growth – The rapid growth has been achieved with decent returns and margins. Check out the Astral Poly Technik Profitability snapshot here. Normalised Return on Equity (RoE) and Return on Capital Employed (RoCE) is 20% plus. Operating margins have been between 13-15% generally.
  • Timely expansions have propelled growth – Capacity has been gradually but regularly scaled up by APL from 4000 MT in FY05 to over 30000 MT in FY10, or over 7x in 6 years. Reportedly this has been enhanced further to over 45000 MT by FY11 end. Capacity utilisations have generally remained over 75%.
  • Strong Balance Sheet – APL had raised ~Rs 34 Cr in March 2007 as IPO proceeds to part finance its expansion plans. It is pleasing to note that the balance sheet has been progressively strengthened while this stupendous growth was being achieved.  Check out the Astral Poly Technik Financial Health Snapshot here. Debt-to-Equity has come down from 1.18 in FY06 to 0.34 in FY10.
  • Backward Integration may help shore up margins – In Oct 2010, APL bought 85% stake in Advanced Adhesives Pvt. Ltd. The subsidiary company will manufacture Solvent Cement in India. Equity base of the company is around Rs 5 lakhs and expected to incur Rs 4 crore of capex. Solvent Cement hitherto purchased by APL used to be ~6% of Sales.
  • New product launches to be growth drivers – APL has a good track record in regularly launching new products and bringing in advanced technology into the country. In FY10 various products launched by the Company were SWR Pipes, Underground Drainage Pipes, Foam Core Pipes etc. These products were extended pan India in FY11 apart from new launches in FY11 like Manholes and Inspection Chambers. Blazemaster Fire Sprinkler system slated to be launched in FY12 is anticipated to lead to huge growth in volumes as these are becoming compulsory for multistoried buildings, Hospitals, Hotel, Malls, Airports etc. It has UL approval and awaiting BIS approval for launch. Fire sprinkler systems will require many more pipes & fittings than conventional.
  • Strong distribution network – A distributor in every state. APL has set up an extensive distribution network having India wide presence with 250 distributors and 5500 dealer network. They have an access to large numbers of resellers across the territory and enjoy good relationships with architects, consultants, plumbers, builders, etc.
  • Recent Financial performance – In 9mFY11, APL has already done 269 Cr in Sales (187 Cr in 9mFY10) clocking over 43% growth. This shoould be maintained for full year FY11 as the second half traditionally records higher sales. However earnings growth will probably be in the lower 20% range (9m earnings growth is 26%).
  • Further expansion plans – The company has purchased land in 2 more places as part of its FY12 expansion plans. 44,000 square yards in Dholka (Gujarat) and Hosur (Karnataka). Capacity is indicated to be ramped up to 60,000 MT by FY12 end.

Bearish Viewpoints

  • Over-dependence on a few suppliers to meet raw material requirements. APL largely depends on a few suppliers to meet its raw material requirements. CPVC is the primary raw material for manufacturing operations. 60-65% of raw materials are sourced from Lubrizol, USA. Any disruptions or changes in supply terms may adversely affect its operations and profitability of business.
  • Foreign currency fluctuations – APL imports raw materials, finished products and machinery. It also has FCNR loans. Both these involve risks associated with foreign exchange fluctuations, and in extreme situations as in FY09 have drastically affected the revenues and profitability of operations. Despite an excellent 42% sales growth, APL had registered degrowth in profitability for FY09. The US$ had increased from Rs. 40 to Rs. 52 level which resulted in a loss to the tune of Rs.7.34 Cr in foreign currency loan liability and Rs. 6.10 Cr on account of cost of import of raw material. In aggregate, APL had incurred a loss of Rs.13.44 Cr due to foreign exchange fluctuation. In FY10, the FCNR loan stood at 23.5 Cr and RM imports at 104 Cr.
  • Aggressive expansion plans carry execution risks – The only way APL can keep growing is continuous expansion. So far APL has managed this judiciously. However any slippages in execution or reversal in demand situation, can pose serious risks.
  • Stronger Competition – Its a matter of time before the Indian market for plumbing & fittings solutions, esp. growing CPVC markets attract the attention of other global/bigger players in the Indian plumbing & fittings market. Other CPVC compound suppliers could start focusing on India and license bigger players/suitors from PVC or GI segments. Even Lubrizol could license other new players setting up bigger capacities.
  • Recent performance on margins front needs watching – Operating profit margins have been coming down sequentially since last 4 Qrs. APL had registered OPM of 16.19% in Q4 FY10. Since then OPMs have sequentially been 14.49%, 12.40%, and down to 11% in Q3 FY11. Thats a significant drop of over 5% in the last 4 quarters. RM as a percentage of Sales meanwhile has gone up but only by 2.5% or so. This may need watching over next few quarters to see if things revert to normalised levels.

Barriers to entry

  • First mover advantage – First licensee of Lubrozol in India for its main brands “FlowGuard”, “Corzan” and BlazeMaster”. To set up a facility for manufacturing CPVC it requires typically 18 to 20 months. Approval from various authorities like UL, BIS and NSF typically takes another 24 months.
  • Company continues to have strong support from Lubrizol, with which it has right to receive the CPVC-resin, key raw material to manufacture CPVC in India. Lubrizol doesn’t revise the prices of raw materials more than 3 times in a year, which gives time for the company to adjust unlike for other raw material producers of PVC business which change prices frequently.
  • Astral has historically maintained stringent working capital cycle especially in the CPVC business. The company gets around 120 days credit from the supplier i.e. Lubrizol for the raw materials. It gives around 45 days credit to its distributors. The conversion time from raw material to pipes/fitting is just around an hour so the inventory days are mainly a function of transit period. Whatsoever working capital the company requires is mainly to fund its PVC business.
  • New product launches seem to be planned well in advance in this company. For e.g it had licensed Blazemaster (Fire Sprinkler system) from Lubrizol in 2006 itself and applied for UL certification which it has recieved. Local approval is awaited
  • Astral is now in a position to provide the complete solution for Plumbing which covers Drinking Water, Sanitation,Waste Water, Rain Water Harvesting, Hot Water and Transportation of Chemicals, etc.
  • Strong brand image and distributor pull – Regular product launches – Innovative product introduction, technologically advanced products, NSF and UL standards compliant products, coupled with a broad product basket has created a strong brand image and distributor pull for the company.

Interesting Viewpoints

  • Sourced from Draft Red Herring Prospectus 2006, Astral Polytechnik
    • CPVC Technology – CPVC Resin technology is patented by B. F. Goodrich of USA, which has been taken over by Lubrizol. This technology enables enrichment of the chlorine content in PVC by chlorination. This modifies some of the root characteristics of the polymer and results in an altogether new range of polymer called CPVC. The characteristics like tensile strength, capability to withstand high-pressure, impact strength, capability to withstand high temperature; anti-flaming characteristics etc. make CPVC very different from other plastics. PVC can not withstand temperatures of more than 55◦C, whereas CPVC can carry liquid upto 93◦C. The density and viscosity of the material is increased substantially but yet it is capable of extruding and moulding like PVC.
    • CPVC vs PVC – PVC is one of the most used plastics in piping and plumbing systems. However, PVC has much lower tensile strength, capacity to bear pressure and temperature resistance as compared to CPVC. Hence, it is not recommended to be used for high pressure applications, hot water applications and also in concealed environment. CPVC is also more UV resistant as compared to PVC, which renders it more suitable to applications where the piping system remains exposed to sunlight for long time. Similarly CPVC is truly fire retardant material whereas PVC is not. Thus for all purposes, CPVC is a better material as compared to PVC and both are not comparable on most grounds. Thus there is a very limited area of competition between PVC and CPVC which is low pressure, low UV exposed, non concealed, cold water application segment.
    • Competition in PVC Market – PVC pipes and plumbing is a highly crowded market. The market is highly fragmented by many small and regional players. However, there are many established players such as Supreme Industries, Finolex Industries, Prince, Kisan and more. PVC piping system is increasingly becoming popular amongst Indian housing sector for transportation of cold water in low pressure environment. Being fragmented in unorganized sector like GI, the quality varies in wide range from organized sector players to small local players. Most PVC pipes manufactured in India are made out of compounds containing some lead elements.
    • Tin Based – Lead Free PVC – is a chemical compound prepared by APL, investing in in-house research and development. Presently most of the PVC pipes available in India are made of lead based compounds. This tends to render them unhygienic for applications, which involve direct or indirect human consumption. World Health Organisation (WHO) has also prescribed lead free systems for transportation of potable water. APL has developed a lead free compound and introduced the same through its plumbing solutions under its brand name of “Astral Aquarius”.
    • Competition with other CPVC pipe makers in India – There are two other manufacturers of CPVC apart from APL in India. Ashirvad Pipes Private Limited, originally a PVC pipes manufacturer is manufacturing CPVC systems for residential and commercial plumbing out of Bangalore and Ajay Industrial Corporation manufactures CPVC systems out of Delhi. APL claims it is the first licencee of Noveon to introduce CPVC systems to Indian plumbing market in 1999.
    • Other sources of CPVC compound – Other than Lubrizol, there are few other manufacturers of CPVC. Further, at present demand for CPVC in India is still in its initial stage and therefore very small as compared to Europe and North America. The prices of the end product are also low as compared to North America and Europe. It is for these reasons that other players have no focus over Indian market for now. However, as the size of CPVC market in India grows, other players may start focusing on this market and this may give rise to new competition in coming years.
    • Raw Material – There are two major raw materials required in the products manufactured by APL, CPVC and PVC. APL imports CPVC from Lubrizol, USA. PVC is generally purchased from Reliance Industries Limited from their Gujarat plant. Apart from that APL requires some chemicals, which are easily available, locally both in Gujarat and Himachal Pradesh.
    • CPVC vs Galavanized Iron (GI) – Worldwide, CPVC is replacing various traditional / legacy piping systems such as Galvanized Iron (GI) or Copper tubes. Thus the primary competition is with incumbent dealing in legacy materials. India is predominantly a GI user. Even today GI enjoys a lion’s share in the plumbing market. A very small market share is shared amongst Copper and various Plastic polymers such as PVC, CPVC, PPR, ABS etc. Amongst all the polymers or non metallic material CPVC is the only polymer which overcomes all the limitations of GI and other metals. It is comparable in terms of tensile strength of GI, it is UV resistant, Fire retardant, resistant to high pressure and high temperature and carries anti scaling and anti corrosion properties.
    • GI business is highly fragmented amongst large number of players in unorganized sector; however, some of leading brands are Tata, Jindals etc. CPVC is different from GI in terms of the features and characteristics. In terms of price, in 2011, CPVC was available 20% cheaper than the prices of branded GI materials. Thus, CPVC is competing GI in upper strata of residential and commercial construction market. CPVC is expected to compete with GI even in the middle segment of the residential and commercial construction market.

Disclosure(s)

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


Suprajit Engineering

Background

Incorporated as a Private Limited Company in 1985, Suprajit Engineering Limited started manufacturing high quality liner cables to exacting Japanese standards for the automotive industry in 1987.

Currently catering to a wide spectrum of automotive and non-automotive cable requirements, Suprajit Engineering has achieved phenomenal growth and has cemented itself as India’s largest manufacturer of automotive cables with a capacity of over 150 million cables a year.


Main Products/Segments

  • Control Cables, Speedometer Cables, Speedometers, etc for 2 wheeler and 4 wheeler industry
  • Automotive Cables, Non-automotive cables, instruments

Main Markets/Customers

  • Over 60% market share in automotive cables for 2-wheeler segment
  • 60% Sales from 2 Wheeler segment, 40% from 4 wheeler segment
  • Main Customers : TVS, Bajaj, Hero Honda, M&M, General Motors, Suzuki, Piaggio, Tata
  • Main Competition: Remsons Industries, AC Engineering And Madhusudan in 2 wheeler segment and Tata Ficosa, Hilux (Japan), and Infat (Samyeong, major suppliers to Hyundai) in 4 wheeler segment

Bullish Viewpoints

  • Largest automotive cable manufacturer in India having a capacity of 75 Mn cables (FY10) – spread over 10 strategically (close to major customers) located plants
  • SEL enjoys over 60% market share in the two-wheeler automotive cables segment for OEMs
  • Currently sole supplier to TVS, 80% of Bajaj motorcycles & 80% of Hero Honda requirements
  • Aggressive expansion – Total cables capacity likely to touch 110 Mn by Dec 2011 (new chakan plant, non-automotive expansions, and Sanand plant for Tata Nano)
  • Increasing presence in 4 wheelers – customers include Tata Motors, Mahindra & Mahindra, Hyundai, Ford and General Motors- It outbid 5 competitors for Tata Nano Cable supply for which it is the sole supplier
  • Major Export customers include General Motors in US, Suzuki in Hungary, Piaggio
  • New customer additions- Volkswagen (Polo in India), Arvin Meritor, Brozer (Germany), BMW (for Germany & Europe), Nissan (Chennai plant), Palio. BMW, Volkswagen, Nissan are all initial orders, when implemented successfully, can add momentum in FY12
  • Auto Replacement market growing strongly – Contribution likely to double to 25 Cr in FY11 and further to 50 Cr in FY12 on the back of investments made in establishing pan India distribution network – a distributor in every state, 2-3 dealers in every district
  • Non-automotive business growing strongly – Expected to double – Sole supplier to John Deere, the world’s leading manufacturer of farm equipment -the 100% EOU unit for non-automotive cables caters to this customer & others newly added like Kubota, Club Car, EZGo, Jacobson, JCB, L&T
  • 7 yr I/tax and excise duty exemption for the recently completed Haridwar plant (catering mostly to Hero Honda’s requirements). 5yr I/tax holiday for the Pantnagar plant (catering to Bajaj Auto). Effective Tax rate is ~29%

Bearish Viewpoints

  • Large exposure of over 60% to the 2-wheeler segment
  • Top 3 clients contribute over 50% of revenues
  • Export markets may not recover anytime soon – growth may be tempered
  • Raw material price volatility – Raw materials like Steel wires, Steel, PVC, Brass, Alumunium & Copper constitute 60-65% of Sales typically. 50-60% of RM is steel & steel wires
  • Increased use of electronics in 2-wheelers replacing traditional control & transmission products, even speedometers are turning to LCD displays
  • Significant competition in 4-wheelers, presence of MNCs
  • Needs continuous investments in Capex to grow

Barriers to entry

  • Strong Customer Relationships – virtual customer lock-ins in 2-wheeler industry
  • Location – Suprajit has set up capacity at 8 different locations across the country to be close to its main customers in the North, West and Southern belts. Haridwar plant next to Hero Honda, Pantnagar plant next to Bajaj, the planned Sanand plant next to Tata Nano, etc.
  • Cost leadership – Focus on cost & quality leadership – Successful in pursuing new product development strategy for initial orders with multiple clients with – TVS, Tata Nano, John Deere for non-automotive cables, Volkswagen, Nissan

Interesting Viewpoints

  • Company maintains it is progressively de-risking its business model vis-a-vis Auto-Industry cyclicality with following measures:
    • Growing Non Automotive Cables market – is tripling production capacity and is confident of doubling contribution from this segment in FY12 to 25-30 Cr. (FY11 expected 12-15 Cr)
    • Growing Higher-Margin replacement market – Suprajit currently gets only 6% of its revenues from this segment (12-13 Cr in FY10), but is confident of doubling this to 25 Cr in FY11, and 50 Cr in FY12. As a premium cable supplier Suprajit should eventually get to 20% of this estimated 400 Cr market, currently it gets just about 5-6% of this market
    • If the contribution mix of domestic auto OEM:Others is 85:15 today, this is changing to 75:25 tomorrow and 60:40 in 2-3 years time
  • Company maintains it will be able to sustain margins over its historical 15% OPM levels due to following:
    • Growing contribution from higher-margin replacement & non-automotive markets (if auto OEM market is 15% OPM, these are more like 20%)
    • A Rs. 25 cable (or Rs.150 for a cable set in a Mobike) is a low value item -typically under the radar-of OEMs. Even a Rs 1 push-in on end-price per cable is like 4-5% increase
  • Raw material sourcing from China (mainly steel) -10-15% of requirement
  • Huge Relationship potential with major OEMS – does not happen overnight though. new platform product development cycle is 18 months, existing platform new sourcing takes 6-9 months (like in BMW)
    • John Deere -Total annual cable purchase is 20 Mn, Suprajit is just doing 0.5 Mn from a 1year old relationship; John Deere team is expected to come negotiating for a large chunk of business
    • GM global cables buy – atleast 60 Mn, Suprajit does only 2 Mn
    • BMW, Nissan, Volkswagen – all initial orders, big potential from all

Disclosure(s)

Donald Francis: No Holdings in the Company;


Poly Medicure

Background

Incorporated in June 1995, Poly Medicure started manufacturing medical disposables like IV cannula, blood bags, in 1997 under the brand name Polymed. It currently produces over 40 different types of medical disposables at its manufacturing facilities spread over 180,000 sq ft in Faridabad.

Today it is the leading supplier of Intravenous (IV) Cannulae, Safety IV Cannuale, IV infusion sets and blood bags. Exports contributed to ~58% of Sales in FY10. It faces competition from Hindustan Syringes & Medical Devices Ltd., Eastern Medikit Ltd., and Romsons.

The company had acquired a subsidiary in USA, US Safety Syringes Co., LLC, USA in 2007. This company is yet to start business activities. Poly Medicure (Laiyang) Co. Ltd, China is another subsidiary which started commercial production during FY10 and achieved a turnover of Rs. 1.18 Cr but is currently making losses. The company expects the China subsidiary to break even in FY11.

The company has one Joint Venture in Egypt Ultra for Medical Products, Egypt. The Company has achieved sales of Rs. 28.45 Cr during the year ended 31st December 2009.


Main Products/Segments

Intravenous (IV) Cannulae, Safety IV Cannuale, IV infusion sets and blood bags.


Main Markets/Customers

Disposable Medical Device OEMS and hospitals.

Exports contributed to ~58% of Sales in FY10


Bullish Viewpoints

  • Expansion programme – The company was in the process of expanding its installed capacity by around 20% in FY11 to meet the increased demand at a capital cost of Rs. 30 Cr. FY10 installed capacity was 36.40 Cr pieces. (in 3 shifts).
  • Successful backward integration – Poly Medicure successfully indegenised production of needles used in IV Cannula and blood bags (earlier imported from Japan) resulting in major cost savings and control over product quality. The needle capacity is ~ 100 mn pieces per annum.
  • Product Innovation – Innovated manufacture of Safety IV Cannulae (with retractable needle that lowers risk of contamination to nurses/doctors administering patients) and successfully defended patent infringement suit brought on it by German major B. Braun. In developed markets like USA, only Safety IV Cannulae can be used. This is potentially a very big opportunity for the company and a growth driver for the future.
  • Turnaround in last 2 years – After a dismal FY09 and FY08 (where the company suffered degrowth in net profits on account of forex derivative losses), Polymedicure posted excellent results in FY10. Sales grew at 21% (136 Cr) y-o-y while Net Profits grew at 177% (16.43 Cr). Turnaround achieved on lower forex losses, successful backward integration, and other cost efficiencies achieved. In FY11, the company is on course to register a ~25% increase in Sales.
  • Return to High Margins & Profitability – Poly Medicure registered an Operating margin of over 22% and Net Margin of over 12% in FY10. Return on Equity (27%) and Return on Capital Employed  (25%) are back to robust levels. Going by 9m of FY11, this record is likely to be sustained in FY11. Most of the long term Forex derivative contracts entered into earlier have expired. Only 2 contracts remain, which the company assures it has learnt its lessons, and are adequately hedged and the impact will be limited if any.
  • Excellent Track Record – Its a young company – just 15 years old and starting from scratch, the company has come a long way. In Yr 2000, the turnover was just 10 Cr and this year the turnover is expected to be above 170 Cr.
  • Good team – The promoters are well qualified, young and ethical. The company has Mr. D R Mehta as its chairman and he is well renowned for his dynamism, honesty and fairness towards small shareholders.

Bearish Viewpoints

  • Forex Derivatives contracts – A major source of risk for the company has been the unexpired derivative contracts entered into by the company to hedge the risk of changes in Foreign Currency Exchange Rate on Future Export Sales against existing long term contracts. Outstanding as at March 31, 2010 for hedging currency related risk aggregate to Rs. 118.54 Cr (Previous year Rs. 197.73 Cr). The company has been accounting for the losses or gains on maturity of the contracts. The Mark to Market notional losses as on March 31, 2010 are of Rs. 15.43 Cr (previous year Rs. 41.10 Cr) and with the considerable volatility in foreign exchange rates, the impact may increase or decrease.
  • Raw Material prices – The company faces fluctuation in price of raw materials – which are crude derivatives (plastic granules, PVC rigid films, IV components). Raw material/Sales is ~43% in FY10
  • Company needs to keep developing new products also to maintain long term growth.

Barriers to entry

  • Backward Integration – Successfully indegenised production of needles used in IV Cannula and blood bags (earlier imported from Japan) resulting in major cost savings and control over product quality. The needle capacity is ~ 100 mn pieces per annum.
  • Product Innovation -Innovated manufacture of Safety IV Cannula and successfully defended patent infringement suit brought on it by German major B. Braun
  • Economies of scale – With an installed capacity of 36.40 Cr pieces, Poly Medicure is the largest exporter of IV Cannualae and other disposable medical products from the country.

Interesting Viewpoints

  • Poly Medicure wins patent infringement battle against German major B. Braun for its safety IV Cannula product in both German & Indian courts. The German major is free to appeal and/or initiate further legal proceedings against the company.
  • USFDA approval for its Faridabad plant (Dec 2010) is a big development. The company is aiming to enter the market by the middle of next year. Distribution partnerships will be key
  • Consolidating on this development, Poly Medicure expects to seal secured multi-year supply contracts for the US market from some major OEMs

Disclosure(s)

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


Relaxo Footwear

Background

Relaxo Footwear Ltd. (RFL) is a part of the “Relaxo Group” which was founded by Late Shri Mool Chand Dua. The company was incorporated in September 1984 as Relaxo Footwear Private Limited and was subsequently converted into a public limited company in March 1993. RFL started off as a marketing company for the Relaxo Group and subsequently ventured into manufacturing of Hawaii slippers in 1995.

The company has established 7 manufacturing plants spanning North India. These are located in Delhi, Bahadurgarh (Haryana) and Bhiwadi (Rajasthan). With a cumulative area of over 120,000 sq. feet, these units have a huge set up enabling massive production. Each manufacturing unit is equipped with world-class machinery and hi-tech product testing laboratories. Current capacity is 3.35 lakh pairs a day resulting in an annual capacity of more than 100 million pairs.

RFL’s key raw materials include Natural rubber (31% by Qty), Synthetic rubber (7%) & EVA (62%). There is a direct co-relation between raw material price rise and operating margins.


Main Products/Segments

RFL produces different products under different brands. It produces Hawaii slippers branded as “Relaxo” whereas the light slippers segment is branded  “Flite”. The school and sports shoes segment is branded Sparx for which brand ambassador is model and actor Neil Nitin Mukesh. All three brands – Relaxo, Flite and Sparx are quite well known and well accepted in the market.

IN FY11, Hawaii slippers could contribute ~35% of sales, Light slippers  ~35% and Sports shoes and sandals and others ~30% of sales.


Main Markets/Customers

RFL caters to the retail footwear industry. It is a key player in the organized slippers market with a wide distribution network, particularly in north India. It also trades into the entire production of group companies.

It also has set up 100 company owned retail outlets covering NCR, Punjab, Haryana, Uttaranchal and Gujarat. This is part of company’s endeavor to create many more one-stop shops displaying thier entire range of footwear. The company believes the roll-out of these retail outlets is directly influencing consumer demand and turnover of the Company.


Bullish Viewpoints

  • Accelerating Sales & Earnings growth – RFL has ramped up nicely in the last 5 years. Sales have gone up form 200 Cr in FY06 to 553 cr in FY10 registering a 29% CAGR over 5 years. Over last 3 years it has registered an even higher 35% CAGR. Earnings have far outstripped Sales growth going up from 3.26 Cr in FY06 to over 37 Cr in FY10 – a more than 10x increase or a CAGR of over 80%. This has been achieved in the backdrop of increasing share of high-margin products, tremendous improvements in Working Capital management over last 5 years, reduction in power costs and a gradual softening in raw material prices over the years. Year on year EPS growth in FY10 was ~165% on the back of huge decreases in RM prices. However the situation has got reversed in FY11 with RM prices hardening significantly and FY11 is set to see EPS degrowth. However this should be seen in the context of a very high base effect.
  • Great Working Capital management – While Sales have gone up more than 2.5x in 5 years, working capital/Sales is just over 5% in FY10 coming down from 7.5% in FY07. Debtor days are at an unbelievable 14 days in FY10, down from 32 in FY06. This shows a management focused on improving operational efficiencies. 90% of the business is driven through its retail distribution network (balance from the company owned stores numbering 100) and this indicates strong acceptance and brand pull in the market.
  • Large player in retail footwear – RFL is one of the largest players in this sector. Other big names in the footwear industry are Bata India, Liberty Shoes and Lakhani Footwear of which Lakhani is not a listed peer. Bata India cannot be compared to the business of RFL as Bata follows a different business model and valuations reflect impact of real estate play. RFL enjoys a very good market share especially in the northern part of the country. RFL has the capacity to manufacture over 100 million pairs per annum, and is second only to Bata India. Its capacity to manufacture 200,000 pairs of Hawaii slippers per day is one of the highest in the footwear industry. A strong network of 350 distributors and 30,000 retailers operating across India ensures good reach.
  • Increasing share of higher margin products – RFL began by manufacturing and selling Hawaii slippers. Over the years it has invested in brand building and added products to its portfolio that contribute more to the bottomline – light slippers and shoes & sandals. In terms of perception of trade, it has moved up the value chain. Design, product development, quality and affordable price – the four cornerstones of footwear business – RFL is well placed in all of these. Light slippers and shoes give RFL a higher margin compared to the hawaii slipper. The recent increase in profitability is partially explained by the higher proportion of shoes and light slippers in the product mix of late.
  • Established, Quality Brands – RFL produces different products under different brands. It produces Hawaii slippers branded as “Relaxo” whereas the light slippers segment is branded  “Flite”. The school and sports shoes segment is branded Sparx for which brand ambassador is model and actor Neil Nitin Mukesh. All three brands – Relaxo, Flite and Sparx are quite well known and well accepted in the market.
  • Relentless capacity expansion – RFL has been making relentless investments in adding capacity to cater to growth. From 2.85 lakh pairs a day in FY09, current capacity is 3.35 lakh pairs a day. RFL currently has 7 own plants, and uses production of 3 plants owned by group companies. These plants of the company are spread across the states of Haryana, Uttaranchal and Rajasthan. Currently, the company has a facility of producing about 2 lakh pairs of Hawaii slippers per day, which is one of the largest in the industry. It has a capacity of producing about 105,000 pairs of Flite per day and about 30,000 pairs of Sparx (shoes & sandals) per day. In FY09, 2 plants manufacturing Flite went into production. Set up at a cost of Rs 55 crores, these units also cater to exports and produce sports and school shoes named Sparx. In FY10 the company increased production capacity by 15,000 pairs per day in existing plants and 10,000 pairs per day by putting up a new Plant at Bahadurgarh, Haryana.
  • Growing share of exports – The company over the last two-years has also shown increase in its exports from just Rs 1.5 crores in FY08 to Rs 7.1 Crores in FY09 to Rs. 10.58 Crores in FY10. The current exports are to Europe (~70%) and the Middle East (~30%). The Company intends to increase its revenue from exports further with the 2 new plants.
  • Good Industry Outlook – The Indian footwear retail market is expected to grow at a CAGR of 18% for the period spanning from 2010 to 2013 as per CARE Research and a few other studies.

Bearish Viewpoints

  • Recent financial performance (3Q FY11) – There has been a steady decline in margins and profitability over the past 3 quarters. Operating margins have slipped from 13.6% in Q1 to just over 9% in Q3. This is primarily on account of steep increases in RM prices which seem set to continue in Q4. Net margins have been dented badly slipping from 5.6% in Q1 to just over 2% in Q3 on the back of progressively increasing debt burden funding capacity expansions.
  • High Leverage – RFL’s debt on books is about Rs. 167 cr with debt-to equity at 1.32 (Q2 FY11). Judging from higher interest costs Rs.4.45 Cr in Q3 (up 19% from 3.74 cr in Q2) the debt burden has only increased. This could stretch its balance sheet and also increase the company’s exposure to interest rate risk. Higher interest costs coupled with higher raw material costs continue to put severe pressure on margins.
  • Raw material price risk – RFL’s key raw materials include Natural rubber (31% by Qty), Synthetic rubber (7%) & EVA (62%). There is a direct co-relation between raw material price rise and operating margins. Starting late FY10, FY11 has seen relentless rise in natural rubber prices, and RM/Sales has moved up from 41% of Sales in 4QFY10 to 47% of Sales in 3Q FY11. With RM prices (natural rubber) still moving upwards in 4Q FY11, this is a big concern and coupled with higher interest costs margins will be under pressure.
  • Brand Risk – The flagship Sparx brand is involved in a trademark dispute with Bata since 2009. Bata claims to have registered this product in India in 1978 and uses this brand in 27 countries. Relaxo filed a petition praying that the rights of Bata over Sparx should lapse as the company has not used the brand in India at all while Relaxo has been investing in Sparx brand since 2004. They have also started investing in an alternate brand Spark with similar styling. The matter is in the courts and can pose a big risk on teh future of this brand for the company.
  • Forex risk – RFL imports Ethyl Vinyl Acetate (EVA) for the production of FLITE brand. Any depreciation in the rupee would impact the margins of the company. Currently its forex earnings are one-third its imports. (FY10 forex earnings of Rs 10.58 crores vs. forex spend of Rs 31.43 crores)
  • Over-concentration in North India markets – RFL sells almost 65% of its products in the north Indian market thereby creating a very high dependence on the states of north India. It is unable to reap the benefits of a wider market and diversified geographical base as its network in other regions is not as strong.
  • Retail business still losing money – The retail business of the company is currently running into losses. Only 50% of the retail shops have managed to break even while the remaining continues to make losses. RFL currently has 100 retail stores across the country and is in the process of adding another 25 taking the total tally of retail stores to 125 by March 2011. These are mainly spread across Delhi, Punjab, Haryana, Western UP and certain areas in Gujarat. These stores operate from rented premises, have low running costs and typically achieve break-even in 18-24 months. The retail spread helps the company in creating brand awareness and in pushing sales to wholesalers.
  • Relaxo brand not wholly owned – The Relaxo brand is jointly owned with a group company. However no royalty is currently being paid by RFL
  • Related Party Transactions – There are related party transactions such as purchase of goods from the company’s associates that could raise doubts about arm’s length pricing of these transactions. Also certain group companies are engaged in similar business thereby posing a threat as conflict of interest could take place.
  • Low Free-Float & trading volumes – The public shareholding in RFL is 25% of which Corporate bodies have been holding close to 17% over the last 5 years. FIIs hold 1%, another 14% is held VLS Finance & VLS Securities. So effective free float on the stock is less than 8% of the total shareholding. This reduces the scope for further institutional participation. The scrip is listed on BSE and does not generate large volumes on a consistent basis. This could lead to higher impact costs.

Barriers to entry

  • Economies of scale – Total capacity of 3.35 lakh pairs a day, second largest after Bata. It enjoys highest EBITDA & PAT margins in the industry as compared to Bata, Liberty Shoes
  • Wannabe Brand play – Well established brand in North India; slowly making its mark in Gujarat & South India; share of branded footwear on the rise; Sparx/Flite are the main brands advertised on national media. Customers ask for the brands requiring retailers/distributors to stock.

Interesting Viewpoints

  • 60% of the business is done on advance basis. This has brought debtor days to as low as 14 days. While there is not much pricing power with the company, such amazing brand pull augurs well for working capital requirements as the company grows.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Riddhi Siddhi Gluco Biols

Background

Riddhi Siddhi Gluco Biols was promoted by the Ahmedabad-based Chowdhary family traditionally engaged in trading sago and tapioca starch, with its first manufacturing unit at Viramgram, Gujarat in 1994.

In 2010, it is already India’s largest wet-corn miller engaged in the manufacture of a wide range of starches and related value-added products like liquid glucose, maltodextrin, dextrine monohydrate, dextrose syrups, high maltose corn syrups, gluten, germs and corn fibre, among others. It has 3 manufacturing units located in Viramgam (Gujarat), Pantnagar (Uttarakhand) and Gokak (Karnataka), close to major maize growing regions and markets.

Gokak and Pantnagar plants enjoy tax and excise benefits. Gokak plant also enjoys sales tax deferment 2014. Effective tax rate is currently 21%.

French company Roquette Freres world’s 4th largest corn processing company holds 14.93% stake in the company (bought in 2006), which provides the company access to high-end starch derivatives technology. This relationship is set to be strengthened with Riddhi Siddhi deciding (Mar 31, 2010) to demerge the business pertaining to its units at Viramgam, Gokak and Pantnagar into a wholly owned subsidiary of the Company, and enter into a joint venture with Roquette Freres in the said subsidiary to avail of latest technologies and for more sustainable growth in those lines of business. Necessary agreement to this effect has been entered into with Roquette Freres.

Riddhi Siddhi also amended the objects of the company (24 Sep, 2010) to enable it to foray into power sector -mainly wind and solar, over and above the existing business. The company has moved quickly on this as Q2FY11 results announced mention paying an advance of 42.13 Cr as advance to suppliers for setting up 30-33 MW wind power generation facilities across 3 locations Tirunelveli (Tamilnadu), Pachav (Gujarat) & Satara (Maharastra). Total investments projected is 250 Cr.


Main Products/Segments

Riddhi Siddhi Gluco Biols manufacture a wide range of starches and related value-added products like liquid glucose, maltodextrin, dextrine monohydrate, dextrose syrups, high maltose corn syrups, gluten, germs and corn fibre, among others.


Main Markets/Customers

Food & Confectionery, Pharmaceuticals, Paper and textiles form the bulk of its customer segments. Prominent clients include Nestle, Hindustan Unilever, Cadbury, Cipla, Biocon, P&G, BILT, TNPL, ITC, Amul, Venkateswara Hatcheries among others.

Food & Confectionery and Pharmaceuticals sectors growing well over 15% CAGR augurs well for the company’s products.
Exports are across 25 countries and contribute less than 10% of total sales.

Bullish Viewpoints

  • Sector Potential – Global starch consumption is estimated around 62mn mtpa and is projected to increase to 70 mn mtpa. The consumption of starch in countries like USA, Japan, China is likely to register the growth of 1%,2%and 4% respectively. India’s per capita starch consumption is still less than 1 kg, compared with the US (64 kg) and the global average (6 kg). Corn starch industry is at very initial stage of business cycle in India so there is lot of room for improvements. The Indian starch industry is producing starch 1800 crs tons. 65% of the total production comes from organized sector and remaining 35% by unorganized players. Organized sector comprises of 6 players, 16 manufacturing units and around 40 products compared to 1000 starch products available across the globe. (Source: Company AR, India Infoline)
  • Market dominance – Riddhi Siddhi is the largest corn starch producer in the country with 2000 tpd (44000 tpa) capacity. The company, enjoying over 25% domestic market share and 45% market share in North India, has a product basket of over 40 products such as corn starch powder, modified starches, liquid glucose, high maltose corn syrup, dextrose monohydrate, maltodextrine, gluten, germs, dextrose syrup and allied by-products. These products are used in food and food processing, pharmaceuticals, paper, textiles and adhesives sectors. Company’s key clients include include Nestle, Hindustan Unilever, Cadbury, Cipla, Biocon, P&G, BILT, TNPL, ITC, Amul, Venkateswara Hatcheries among others. Closest competitors are less than half the size of the company viz., Sukhjit Starch and Anil Starch.
  • High growth – Riddhi Siddhi has grown at a rapid pace in the last 5 years. Net Sales have more than tripled from 229Cr in FY06 to 746 Cr in FY2010 at a 5yr CAGR of 34%. Earnings per Share (EPS) has grown at a slightly lower 27% CAGR and gone up 2.6 times in 5 years. For FY10, the company recorded a turnover of Rs. 746 crore and net profit of Rs. 39 crore, earning net margin of 5.3%. EPS for the year was Rs. 34.78 on a low equity of just Rs. 11.14 crore, while cash EPS was Rs. 56.97.
  • Excellent first half FY11 – For the first six months of FY11, the company’s financial performance improved significantly. Although revenues grew to Rs. 409 crore, the net profit shot up sharply to Rs. 55.77 crore, which is more than the full year profits of FY10. Net margin for the half-year jumped to a whopping 13.6%, while EPS and cash EPS for H1FY11 stood at Rs. 49.88 and about Rs. 59.61 respectively.
  • Excellent Working Capital Management – Its great to see debtor days consistently coming down from ~80 days in FY06 to ~42 days in FY10. Similarly Inventory days have more than halved from ~115 days in FY06 to ~53 days in FY10. For a company growing as rapidly as Riddhi Siddhi, this record speaks well about Management’s focus on operational efficiency.
  • Increasing Cash Flows – The company has a good track record in steadily increasing Operating Cash flows. Operating Cash flow/sales increased from 7.5% in FY07 to ~ 13% in FY10 to be at 95 Cr. (one needs to ignore FY08 in this picture because of the fire at Gokak plant in FY08, see below – else it might cloud the judgement). The Free Cash Flow (FCF) record in recent years is also good, with Free Cash flow/Sales increasing from 6% in FY09 to 8% in FY10 to 62 Cr.
  • Crisis Handling capacity – Riddhi Siddhi had suffered a major fire at Gokak plant in FY08. This brought production at Riddhi’s largest facility constituting around 50% of their total output to a halt for seven months.  Corrective steps were taken and expanded Viramgam facility ramped up to ensure that supplies to most of their customers remained on track. Operations resumed at the Gokak plant in the third quarter of 2007-08. Despite the main plant remaining unoperational for 7 out of 12 months, Riddhi reported only a marginal decline in topline and EBIDTA in FY08. 
  • Diversification into Wind Energy  – The company is foraying into wind energy business. It plans to establish 30-33 MW windmills by March 2011 in Tamil Nadu, Gujarat and Maharashtra, with an investment of Rs. 250 crore to be funded by debt and internal accruals. This will be a big tax shelter for the company in FY11/12 as it will be able to claim 80% depreciation benefits in first year. (The company now pays tax at an average rate at 21.50%). Riddhi Siddhi has a good track record of managing debt so far, progressively lowering debt -from a high 1.75 debt-to-equity  in FY2006 down to 1.07x in FY2010.
  • Good Valuations – Riddhi Siddhi dominates its niche, is approaching ~1000 Cr turnover in FY11, has reported excellent first half FY11 results, with improving margins, returns and cashflows with good growth, but is available at a PE of 5-6x FY11 estimated earnings, Price to Sales 0.69, Price to cash flow 5.46, Price to book 1.98 (CMP 264, 16 Nov 2010)

Bearish Viewpoints

  • High Debt -The company’s debt exposure is high. As on 30 Sep 2010, the company had 230 Cr of debt on its books. This will be compounded by the additional debt of ~250 Cr that the company will be incurring in 2HFY11 for the wind mills diversification project taking debt-to-equity ratio past 1.8x. It must be mentioned to its credit, that while growing at a fast pace, Riddhi Siddhi has a track record of progressively lowering debt – from a high 1.75 in FY2006 debt-to-equity in FY2010 was down to 1.07x. Also the full debt may not be incurred in FY11 if project execution spills over into FY12.
  • Forex exposure – The company is having $29.4 million (~ 132 Cr @44.92) forex loan in its books. This exposure is un-hedged so its prone to the risk of adverse movement of currency like in FY 09 where the company had to pay higher interest cost which dented its margins badly.
  • Raw material prices – The raw material (maize) accounts for 60-65% of the total operating cost of the company. The prices of corn (maize) is dependent upon the many factors like rain, international demand and nowadays corn is also used for Bio diesel so prices of this commodity is also affect by the prices of crude in international market. Though the company has efficient procurement processes in place to cope up with price hike, still uncertainty regarding the prices of corn is a concern.
  • Wind Power foray – The wind mills foray seems like an unrelated diversification exercise. After years of not-so-good results, just when it seemed the existing corn-starch business is stabilising and started producing high margins and returns (9% plus NPM, 20% plus RoCE in 1HFY11), the company goes ahead and plunges into another line of business with no prior experience -taking on high levels of debt and making it vulnerable to business cycles.
  • Capacity constraints – Due to high growth in demand, the company is already operating at 95% plus of recently upgraded capacity. Further capacity additions and/or funding plans for the same are unknown as late as Q3 FY11. Company’s claims of 30% CAGR growth for the next 5 years (AR 2010) may be hit if the company doesn’t move on upgrading capacity by Dec 2010. It will take atleast 5-6 months to augment capacity by 30% at existing facilities.
  • Roquette Freres deal overhang – Roquette Freres, 3rd largest corn-processor in the world, already holds 15% stake in Riddhi. Instead of Roquette Freres hiking the stake to 51% in the listed entity as initially reported in the press in May 2010, as per this announcement to the exchanges, the company had decided (Mar 31, 2010) to demerge the business of all its plants into a wholly owned subsidiary of the Company, and enter into a joint venture with Roquette Freres in the said subsidiary. It is likely that Roquette will not settle for anything less than a controlling stake in the subsidiary if this is its vehicle for entering the Indian market. In which case existing shareholders in Riddhi Siddhi may be left with the fledgling wind energy business and a minority stake in the subsidiary. This may be a big overhang on valuations for the company going forward.
  • Low trading volumes – The scrip listed only on BSE does not generate large volumes on a consistent basis. This could lead to higher impact costs.

Barriers to entry

  • Customer relationships – Riddhi enjoys strong revenues from existing customers and has been able to penetrate deeper into major accounts. More than 70% of revenues come from customers more than 5 years old (Source: 2010 Annual Report)
  • Largest wet-corn miller with 2000 tpd capacity, more than double that of the nearest competitor Sukhjit Starch. Capacity further augmented by 30% at Pantnagar plant.
  • Strategic partnership with Roquette Freres (4th largest corn starch producer) with a portfolio of 650+ starch varieties, places it ahead in the technology & knowhow upgradation cycle and has enabled it to expand product range.
  • Location advantage – The plants are locate within 350 kms of the main maize producing regions in the country. Andhra Padesh (15%) and Karnataka (18%) are close to Gokak plant, while UP (9%) and Bihar (9%) are close to Pantnagar plant. (Source: company)
  • Tax Advantage – Gokak and Pantnagar plants enjoy tax and excise benefits. Gokak plant also enjoys sales tax deferment 2014. Effective tax rate is currently 21%.

Interesting Viewpoints

  • Riddhi Siddhi is confident of growing revenues at a CAGR or 30% for the next 5 years  (Source: Annual Report 2010)
  • The company is likely to get close to a 1000 Cr turnover in FY11 (full benefits of capacity expansion and 2H is historically better for Riddhi Siddhi). If achieved, this will demonstrate the company successfully transitioning from a relatively small company with potential to one that has achieved scale and critical mass. Apart from the improvements in profitability and returns that might bring the stock and the sector into notice, closing in on a 1000 Cr revenue size might also trigger a re-rating!
  • JV with Roquette Freres is expected to be concluded in near future. This will bring in additional funds, ensure technology & knowhow transfer, and launch of higher-margin, value-added starch derivative products by the company. This might propel the company to a higher growth and profitability trajectory, than hitherto possible.
  • While the JV deal structure is still not clear, it will entail some equity dilution for common shareholders

Disclosure(s)

Donald Francis: No Holdings in the Company;