Indag Rubber

Background

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

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


Main Products/Segments

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

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


Main Markets/Customers

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

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

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

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


Bullish Viewpoints

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

Bearish Viewpoints

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

Barriers to entry

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

Interesting Viewpoints

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

Disclosure(s)

Donald Francis: No Holdings in the Company;


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