SHILPA MEDICARE 2015 AGM MANAGEMENT Q&A

Management Q&A

SHILPA MEDICARE 2015 AGM 

Shilpa is an API provider of oncology molecules and other niche molecules. Much of the API provider’s revenues depends on the fortunes of the formulator whom he supplies. For eg: formulator may have FDA issues, plant upgradation, may decide to get out of some formulations etc which in turn affect the demand of Shilpa’s APIs. To overcome this, Shilpa has decided to get into formulations of some of the molecules which may give it better control over the molecules to target.

Shilpa does not work with innovator/originator currently. Predictability is little less in generic business. Hence, Shilpa refrains from giving numbers.

This year there was more talk of First to Files (FTF) for formulations. Shilpa will be filing its first FTF this year (own name, however, it has filed FTFs for its partners). Shilpa management feels it has the strength in molecules to file FTFs in its own name.

Shilpa has taken significant capex and investments last few years and the revenues will come from 2017-18. Shilpa has around 400 R&D engineers (300 at Vizag and 100 at Raichur) and has filed around 175 patents of which 75 have been filed last year. However, it can be that one molecule itself can have up to 5 – 10 patents.

RAICHEM MEDICARE LIMITED (JV with ICE and PCA, Italy)

PCA is a subsidiary of ICE Italy (was acquired by ICE). ICE manufactures cholic acid while PCA manufactures deoxycholic acid and its derivatives like ursodiol etc. Cholic acid is used for manufacturing deoxycholic acid. PCA also manufactures the API and is not into formulations. ICE and PCA over a period of 50 – 60 years have worked on only this molecules and have an edge over any other company (ICE controls 70% of the world’s cholic acid demand while PCA controls 45% of the world’s demand for deoxycholic acid) which primarily is in R&D and sourcing as it is naturally produced (ox bile, chick bile etc). ICE and PCA can increase prices of this molecule as and when required. Shilpa just provides the CRAMS for manufacturing of ursodeoxycholic acid where raw material, process, technology etc are provided by ICE only.

The current market for this API is 1500-2000 tonne which is around Rs.2500 crore in value terms. Currently, Shilpa has 8-10% of the API market share while the JV will have 2 – 2.50 times the existing capacity of Shilpa for manufacturing the product. There is a lot of shortage of this molecule worldwide. Shilpa has orders up to two years from ICE. However, due to supply constraints it is not able to fulfill the demand. ICE does not want to expand in Europe due to high costs and other issues. Scaling up will be easy for the company here and through JV their interest and longevity will be higher. ICE has 50% stake in the JV. It will be ICE’s only facility outside Italy. The reason for ICE to stick with Shilpa is trust. The benefit for Shilpa in the JV is it is de risk its major revenue source and freeing up capacity at its API plant for other business divisions. Shilpa also has contract for selling this API in few markets like India. Once this JV plant is functional, this will be a separate profit center for Shilpa (kind of self pilot mode).

The plant is a world class one and took almost two years for construction. The plant is in final stages of construction and will be ready in one – two month’s time. The company has already started working on exhibit batches and by June, 2016 the company will have 9 – 10 months of stability data after which it will file for DMF in Japan. This will start yielding revenues in FY17 but majority of it will come in FY18 after all the shifting has been done from the standalone API facility. It might happen that due to shortage of this molecule, Shilpa on standalone basis might continue to supply for few years too.

ANTIRETROVIRAL (ARV)

Earlier, the vacated facility for manufacturing of ursodeoxycholic acid was proposed to be used for manufacturing of ARVs. However, due to less clarity on the issue of when the manufacturing of ursodeoxycholic acid will stop in standalone operations, the plan has been put on hold. If Shilpa starts constructing a new block for ARV and all the transfer happens to Raichem JV soon, it will lead to idle capacities. The company will take a decision on this in short term (three to six months). Apart from the four molecules (QUAD), the company has also worked on few other molecules at R&D stage. Company has plans to go into formulation also in the long term for ARVs.

JAPANESE CRAMS

Shilpa Medicare has ventured into CRAMS with a Japanese pharmaceutical company to produce tranexamic acid. The company is dedicating an entire block for this arrangement, the construction for which is expected to be completed by December 2015. The total cost incurred on the capex was Rs.31 crore. The manufacturing of the exhibit batches will start from January, 2016 onwards. The capacity for this block will be 100 tonnes and can result in revenue of Rs.50 crore. However, it will have higher margins compared to the current arrangement with ICE as Shilpa will procure raw material directly and will have its own manufacturing process. Shilpa has also got license to sell it in few markets (not regulated markets like US or EU). Like ICE, the partner has expertise in the manufacturing of this molecule and has extensive experience in it.

Shilpa’s management views this a stepping stone with relationship with Japanese Generic players. Shilpa is the only company whose API is registered in the Japanese markets. Establishing relationship generally takes a long time and they initially start with only small volumes and scaling up happens over a longer period. A few large oncology companies have also visited Shilpa’s facility. A lot of patience is required for working with Japanese partners and there is no room for short cuts. This can be a sustainable model after 5-10 years and a separate revenue stream.

Unlike US, the Indian pharmaceutical companies except for Lupin haven’t been able to make a mark in the Japanese markets. Reva Pharma, a sister concern, is an official advisor for Indian Government for Japanese pharmaceutical companies. It has been instrumental in asking PMDA, the pharmaceutical regulatory authority of Japan to set up an office in India. Japanese market has very low generic presence which is expected to increase significantly going forward benefitting Indian pharmaceutical companies.

REGULATORY APPROVALS

API Facility: The USFDA inspected the plant in March, 2015 and there have been few observations. However, none of them are related to data integrity, which has been a major concern for the pharmaceutical companies. The company has replied to these observations. The company has been regularly writing mails and following up with the authorities and expects an outcome by October/November.

Formulation Facility: Shilpa’s Jadcherla formulation facility was inspected by USFDA recently. The management was expecting the inspection after January, 2016 but an ANDA getting into bio-equivalence/ later stage of approval triggered the inspection. The inspection happened over 10 days and there were few 483 observations. However, there are no data integrity issues. Shilpa has responded to these observations and is expecting FDA approvals for this plant by around mid 2016 after which it is expecting to get ANDA approvals one by one. Shilpa Medicare has shared these observations with its customers and they are confident of getting the FDA approval soon. Many of the issues related to regulation are because of lower level employees taking short cuts. Shilpa has taken many steps to address this including hiring an ex-FDA inspector (who charges USD 280,000 annually) consultant to visit the plant and give inputs and training.

Shilpa has got approval from Brazilian, Mexican and EU authorities (that Slovenian approval was for whole of EU). Argentinean regulatory approval has also been triggered and they might come for inspection.

As per the management, USFDA is trying to categorize pharmaceutical companies into various grades and the grades will decide the frequency of USFDA audit going forward.

APIs

The company has 20 DMF filings in the US markets. The same molecules have been filed in the EU market as well. The company has a hybrid approach for development of new molecules – sometimes R&D employees find a molecule lucrative, sometimes customers approaches and few of the times the management finds a molecule to work on. Shilpa is even working on few molecules which have expiry in 2025 – 2027 or are currently undergoing clinical trials. The key here is non-infringing patent and being able to tie up with formulator. The company has worked on 35 molecules out of which 17 have been commercialized till date. In APIs, Shilpa has a lot of strength in few of the molecules where it can impact the prices of it. However, the company does not have a philosophy of gaining market share by reducing the prices. Competitive intensity of a particular molecule decides the step taken to manufacture it. If it’s a competitive molecule, R&D people start from the scratch and work from N – 5 and N – 4 stage to reduce cost while in not so competitive molecule the company goes back to just N – 2 stage as well. China is expected to be the biggest oncology market in the medium term. In US, out of every 10 new molecules being approved by USFDA, seven are in oncology. Few molecules which were discussed:

  • Capacetabine: Shilpa has expertise in this molecule and has begun expanding the capacity four fold. Post the expansion, Shilpa will have around 25% of the world’s capacity. Although, the prices have come down, Shilpa will still be able make decent profits and benefit from increase in volumes.
  • Gemcetabinie: Intas had completed expansion at its plant last year. So they took less quantities from Shilpa in FY15. As many finished players have entered the European market, production has fallen by a third. Capecetabine is expected to make up for this.
  • Bortezomib: Shilpa is expected supplying to many formulators as it has a patent for the molecules under which it works (stability) even in some specific temperatures.
  • Imatinib Mesylate: This will be the next big molecule for the company after Capecitabine. Company has an edge in this molecule.
  • Ambroxol: Shilpa also wants to diversify into non-oncology molecules. They have expanded capacities in this molecule four fold. The capex for the expansion was around Rs.30 crore. Although, the molecule has lot of competition and is not difficult to manufacture, they have lot of experience in it, more filings and better quality. The market for this molecule is expanding. Other companies are decreasing the price while they are increasing it.

On being asked about the molecules which they are currently working on (taken from Karvy report and company’s website) have a market size of more than USD 5 billion, the management said that they are also working on bigger molecules than the ones mentioned. Post approval from USFDA, Shilpa might take further increase in capacities for the US market. The company works at various levels to ensure that its process and molecules are non-infringing. Shilpa had won a case against Bristol Myers Squibb (BMS won against Dr. Reddy’s, Natco and Hetero) in India for a molecule despite the company assuring BMS that they don’t have plans to launch it in the domestic market. Pfizer had also launched a case against Shilpa for a molecule in India. However, after Shilpa told them that they won’t be launching that molecule in the Indian markets, they withdrew it.

FORMULATIONS

USA

Shilpa has filed 13 ANDAs as on date. Out of these 13, 5 have been filed in Shilpa’s name while 8 have been filed by the partner. The marketing arrangement for this filing is:

  • Own filing: Shilpa will incur the R&D costs and tie up with the partners at various stages of development of the molecule. If Shilpa ties up with partner at the beginning of development of molecule, they will have lower profit share while if they tie up after the filing of ANDA, it will have higher profit share. Out of the 5 filings in its own name, it has mix of all. Shilpa has a marketing arrangement with the partners where they sell our products in the US market. Shilpa will be filing our first FTF this year in our name. Typical cost of filing an ANDA is Rs.5 – 6 crore plus litigation costs. Going forward, Shilpa will try to file new molecules in our name. Shilpa had filed its first ANDA in its own name in Dec 2013.
  • Filing in partner’s name: Here the strategy is to work on CRAMS basis (cost plus profit). R&D expenses, litigation cost etc are incurred by the partners. The main purpose of this model is to hedge its API supplies also. For off patented molecules, Shilpa ties up with 3 – 4 formulators while for FTFs, they exclusively tie up with just one formulator (the company has filed for few FTFs through its partners). The partners chosen are good in marketing and have capability of garnering good market share.

The company currently has one line for manufacturing tablets and one for injectable at it formulations plant. The company has fully tied up for its existing lines for manufacturing of tablets and injectables. The company is constructing one more line for tablets and one for injectable at its formulations plant, the cost for which is expected to be Rs.30 – 40 crore. The construction for the new lines is expected to be completed by December – January. In oncology, there has been gradual shift towards tablets from injectables (unlike other segments). The company is also planning to build third dry powder injectable line at its existing facility. It will be first such dry power line for oncology products in India. The total capex for the line is expected to be Rs.200 crore. The company might go for another expansion in three to four years which along with the dry powder line will cost around Rs.450 crore. For third or future lines, the company might tie up for innovators also. The company might go for equity dilution for the capex in near to medium term.

For formulation facility, the company has tied up with new customers. In FY16, the company has plans to file five ANDAs (one in its own name and four in the partner’s). The company is not looking to file for biosimilars currently due to high cost involved (USD 15 million per molecule) as well as lack of clarity from the regulatory authorities. However, there seems to be some clarity emerging from the regulators and the company might plan to go for its manufacturing in the long term.

EU AND OTHER ROW MARKETS

Company has filed or planning to file five dossiers for the five ANDAs it has filed in the US in its own name in European market too. The approval from the EU regulators usually takes less time of around one year as compared to more than two three years for the US markets. The company’s partners are filing for formulation drugs in Mexican and Brazilian markets.

Going ahead formulations will be major revenue generator for Shilpa. The Jadcherla plant is being setup with advanced machinery which will have lesser chances of recalls. Shilpa had made investments of around Rs.250 crore in this facility. Shilpa Medicare has got a strong IPM department which will help decide which molecules to pursue.

FUNDING GROWTH/EQUITY DILUTION PHILOSOPHY

Shilpa does not like to take too much debt. If a company has too much debt, the focus is on repaying debt instead of thinking of new ideas. Besides, having cash in the bank helps Shilpa to fund its new R&D proposals. Hence, all the capex will be funded with mixture of debt, equity and internal accruals. Equity dilutions might be done at good valuations (most probably for future capex) which can lead to less dilution. The company has a philosophy of funding big capex with a mix of internal accruals, debt and raising more equity.

TALENT RETENTION/IP RISKS

As per the management, Shilpa does not have problem of retaining top talent. Shilpa’s R&D head has been with the company for more than 20 years. There is a bit of attrition of lower levels like chemists. However, top level R&D scientists continue to stick with Shilpa. Most employees get between 15-30% hikes every year. They are given a free hand in R&D projects with management supporting innovative proposals. One of the reasons is that Shilpa management likes to keep cash in bank instead of borrowing too much. It can fund these small R&D proposals easily and not wait for funding. Shilpa is thinking of ESOP incentives for retaining top talent. Salary is in line with the best in the industry. Sometimes people leave at 3x salary. However, this has no impact on Shilpa. They file a patent at initial stages for the idea on feasibility analysis. This prevents the new company from filing patents for these ideas once the chemists leave.

JOINT VENTURES/SUBSIDIARIES/INVESTMENT PHILOSOPHY

Shilpa is keen to fund smaller companies (startups) with good people and good technology. This requires management with VC kind of mindset. This keeps the company abreast with new technologies and new ideas like nano technology etc and new drug delivery systems (NDDS). NDDS will help Shilpa in future projects through launch of its own formulation through them.

MAIA Pharma: Shilpa funded initial round and recently there was another round of dilution in which Shilpa did not participate at around four times the valuation at which Shilpa had invested earlier. They are filing a 505(b) (2) and Shilpa will be providing API too.

INM Technologies: It is working on nano technology. The company is based out of Bangalore. The company also bought an R&D center at Bangalore for this technology.

Shilpa has funded Rs.8-10 crore last year in these ventures and is looking to fund the same amount in next 2-3 years. The company has philosophy of funding new ideas with good technology and not spend too much money on a single idea.

Loba continues to be in red and seems to be a mistake committed by the management. There are lot of regulations in the market and management is trying to make it self sustainable.

OTHER POINTS

  1. All revenues are in USD and thus not exposed to Euro depreciation
  2. Admired Alembic and Torrent apart from Natco
  3. No targeted R&D/sales ratio. Everything is based on requirements
  4. Most of current Oncology molecules are Injectables. But after 5-6 years most expiring molecules are Orals.
  5. The company won an award for Patent work recently and shared the stage with big pharmaceutical companies like Divi’s and Aurobindo.

Disclosure(s)

Ankit Gupta: More than 5% of Portfolio in the Company; Holding for more than 1 year; No transactions in last 30 days
Ananth Shenoy: More than 5% of Portfolio in the Company; Holding for more than 1 year; No transactions in last 30 days
Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 2 years; No transactions in last 30 days
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Astral Poly Technik Management Q&A: Dec, 2011

Management Q&A

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

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

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

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

And what is the quantum of this ECB?

Majority of the debt is ECB.

That’s more like close to 50 Cr?

Yes

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

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

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

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

Roughly, it should be around that.

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

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

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

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

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

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

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

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

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

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

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

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

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

But now the Rupee has depreciated by 16% meanwhile?

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

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

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

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

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

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

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

$1 Mn in November

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

Yes.

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

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

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

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

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

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

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

That is correct.

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

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

Don’t have exact figures, right now.

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

No, it will probably be higher.

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

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

(missed this totally, TBD)

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

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

Already covered above.

9. ACCOUNTING NORMS

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

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

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

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

(TBD)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

14. REALTY/INFRASTRUCTURE SLOWDOWN

Have you seen any impact on the ground so far? 

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

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

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

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

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

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

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

But Mr Nimish Dalal is employed with Lubrizol, right?

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

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

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

16. Lubrizol relationship

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

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

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

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

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

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

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

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

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


Disclosure(s)

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


Mayur Uniquoters Management Q&A: Jun, 2011

Management Q&A

1.     MAYUR UNIQUOTERS HAS MADE RAPID PROGRESS OVER LAST 5 YEARS. SALES HAVE GROWN AT A CAGR OF ALMOST 40% TO TOUCH 270 CR WHILE EPS HAS GROWN AT AN AMAZING 75% CAGR. CONGRATULATIONS!

Kindly share with us this journey and the key factors responsible for such an impressive growth performance. What have been the main drivers of this growth?

You need to understand that Synthetic or Artificial Leather today is everywhere – quality has improved tremendously in the last few years – in design, texture, colour matching, tensile strength, abrasion tolerance, etc. Daily use products like footwear, ladies bags, furnishings, upholstery, and automotive seats are using artificial leather predominantly. You will be surprised to know that 90% of leather used in footwear and furnishings today is artificial leather. Even in Leather products – say a leather sofa -the main seating area & backseat is pure leather, the sides and bottoms use matching colour artificial leather. In leather shoes you may see inners and sockings using artificial leather. Genuine Leather has become prohibitively costly. The synthetic leather industry has been helped by market forces at work!
There are 3 or 4 main contributing factors.
Firstly economics of scale have kicked in with our fixed costs getting spread over increasing volumes. Secondly product mix has been changing for the better with higher value added products leading to better realisations. The third factor that has worked for us in the last few years is the gradually increasing input prices, which in our industry we 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)
Delivering consistent quality, ability to scale up in tune with customer demands while maintaining solid financial discipline has helped us leverage on our best customer relationships. Today the business/customer is very savvy, appreciative of their best vendors and the marriage is usually very strong, as they cannot afford to expose their production lines to inconsistent quality. Is it in any wonder that bulk of the business goes to their best vendors? Our nearest competitor does roughly about 50% of our business levels.
We have also done lot of market development work especially in Southern market. This has included right from introducing the customer to new product design & innovations to helping them with sourcing the right technology (machines) and raw material partners.

2.     IF THE GROWTH TRAJECTORY HAS BEEN AMAZING, THE QUALITY OF THE GROWTH ACHIEVED IN WHAT MUST BE A DIFFICULT INDUSTRY, HAS MADE EVERYONE SIT UP AND TAKE NOTICE. THERE HAS BEEN A MAJOR SHIFT IN THE QUALITY OF EARNINGS OVER THE LAST 2-3 YEARS. WORKING CAPITAL/SALES AT 14-15% IS ALMOST HALVED FROM EARLIER LEVELS. OPM (16%) AND NPM (10%) HAVE JUMPED UP BY 5-6% IN THE LAST 2 YEARS AND SEEM TO HAVE STABILIZED AT THESE LEVELS.

This is not just economics of scale at work. Mayur Uniquoters has clearly shifted gears and is operating at a different level today. Kindly share the key changes that have happened over the last 2-3 years in the company. What changes have you effected in your business model to bring about this focus on improvement in operational efficiency?

I would again say the factors cited above are responsible. Also new product development and innovations have helped us move up the value chain with better price realisations. We have also consciously been moving the customer/segment mix and volumes towards higher margin segments like automotive replacement market and automotive exports.

3.    SALES GROWTH VS PRODUCTION GROWTH. WHILE PRODUCTION IN FY11 HAS GROWN BY ~18%, SALES HAVE GROWN ALMOST 3X BY ~53%.

This is an exceptional performance, which needs to be properly understood. You have mentioned higher input cost, better price realisation, value additions as factors. Kindly elaborate on the extent of contribution from each of these factors.

Well last year was another extraordinary year. Higher input costs to the extent of 18-20% is what we mainly benefited from to see such an order of Sales performance. If we see similar escalation again this year, I am not sure all our customer segments can absorb another such steep hike in rapid succession. Volume off-takes and Margins could well be effected.
This year so far it has been okay but this is a key risk and we have to see how the situation develops for the rest of the year. We are hopeful that the situation will moderate soon.

4.     PRODUCT SEGMENTS AND CONTRIBUTIONS

Kindly give us an idea of the revenue contribution & margins from major product segments. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why?

There are 5-6 main segments. Footwear, Furnishings, Automotive OEM, Automotive replacement market, and Automotive Exports. We are trying to open up a new segment in Automotive OEM Exports Replacement market.
The philosophy of the company has been to achieve growth more from new segments that allow us to leverage our consistent quality, ability to innovate and demonstrate better value-addition to our customers, and get better realisations. In doing this we also are spreading the risk across segments. Eventually we are trying to see that no segment has more than 25% revenue contribution. Margins are more or less the same across most segments.
All segments are growing well and the potential is good. Automotive OEM exports and Automotive exports replacement market will see increasing focus. But this will take time – We have slowly leveraged on the Chrysler relationship which has grown multifold. Quality requirements are stringent and rejections carry the risk of considerable penalties.

5.     CUSTOMER SEGMENTS

Kindly share with us the quality of business and the level of business with your major customers. How much do your top 3 customers contribute to revenues? Is there any single customer contributing more than 10% of Sales?

The 80:20 rule applies to us, as in most businesses. 20% of our customers get us 80% of the business. No single customer accounts for more than 4-5% of our revenues.

6.     EXPORT SEGMENT HAS ALMOST TRIPLED FROM ~17 CR IN FY10 TO OVER 48 CR IN FY11. YOU WERE ALREADY SUPPLYING TO FORD & CHRYSLER. THE COMPANY IS EXPECTING TO START SUPPLYING TO GM & TOYOTA. BMW & MERCEDES APPROVAL PROCESS IS ON.

Kindly share with us your successes and plans on the exports front. What will it mean to have GM as a customer? What is the scale of opportunity with a customer like GM? Do you enjoy superior margins there?

As I mentioned Chrysler relationship is growing stronger. They have increasing confidence in us. Two new programs with Chrysler will start later this year. They have again called us to US to discuss participation in another new program. They are very happy with the quality we have been able to consistently deliver. 80% of current OEM exports are to Chrysler and 20% to Ford.
Ford, Toyota. GM relationships will be leveraged as we put up additional capacity. But again we will be going slow in first stabilising the processes for optimum efficiency and quality. It will take us a full year before we stabilise and run the new coating line continuously on 24 hour 3 shifts basis.

The vision of the company now states “to be a preferred supplier of artificial leather to the leading automotive OEMS in the world”. So has the focus decisively changed towards automotive exports? What is the kind of growth that is expected from automotive exports segment?

Each of these 6-7 big automotive OEMs have annual artificial leather buys in excess of 500-600 Crs today in the developed markets like US and Europe. Our estimates tell us that this is a 3000-4000 Cr market across US & Europe.
We should be able to get 500 Cr -1000 Cr business from automotive OEM exports and Exports replacement market eventually. But this is a slow climb, it takes 2 years of constant engagement to break in for these majors to even entertain us. We also need to strengthen the organisation to scale up to meet the challenges thrown up by these opportunities in front of us.

What will be the effect on the product mix as footwear segment used to contribute some 55% of sales and was a significant counter against cyclicality of auto sector?

As mentioned before we would like revenue contributions to be no more than 25% eventually from any segment. Risks get spread across segments – not just auto sector cyclicality. And as mentioned before automotive replacement market is big and is getting bigger by the day as new vehicles get added every year. In the next few years the replacement market will be much bigger than the OEM market. If you recall in the FY09 auto recession we were not really affected.

7.    SALES & MARKETING SETUP & PROCESSES FOR DIFFERENT SEGMENTS. EXPORT AGENTS

Kindly explain your sales and marketing processes & set-up for the different segments.

We have Agents in developed markets on retainer basis for the automotive OEM exports. Even  in India we work through Agents for some major OEMs like Mercedez Benz.

For the Auto OEM segment, once product approval is received from say GM, who places the order on Mayur Uniquoters – GM, or their Car Seats vendor/assembler? Who do you supply to? How is price negotiation done and by whom?

Once an OEM like Chrysler selects us for a Program (say a new model), it instructs its leading automotive seat vendors to procure from Mayur Uniquoters. The price baseline is fixed by Chrysler. The seat vendor then contacts us and places orders. Some negotiation around the baseline is inevitable.

8.   INDUCTING PROFESSIONALS IN SENIOR MANAGEMENT CAPACITY. MR. RAMDAS U ACHARYA SENIOR VP (TECHNICAL) AND DR. V K KHANNA SENIOR VP (OPERATIONS).

This is a very welcome step. Kindly comment on the significance.  Should we take this as a signal of the confidence Management has in the scalability of this business?

Definitely Yes. A couple of years back we would not have been able to even afford to have such experienced professionals on board. 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.

They are critical cogs in our plans to build scalabilty in the organization teams/processes to be able to address major opportunities before us. If we have to meet stringent export market norms with any consistency, our Operations and Quality processes need to be strengthened. Similarly R&D efforts will need significant  bolstering to offer new product development and innovations for attracting new business from customers.

Given Mr Ramdas Acharya’s extensive experience with different product lines for auto OEMs in developed markets, is there hint of product diversifications in the coming future, or settting up JVs for the same?

[ValuePickr: Sorry we missed asking this directly in the informal discussion flow. Mr Acharya is recruited directly from the US market after pursuing for 3 years we were told. His rich experience in Automotive OEM synthetic leather market and contacts with industry players will be very useful for opening up new opportunities – Automotive exports replacement market could be one such initiative, we were given to understand. Mr S K Poddar categorically told us that within 2 years the company would like to be in a situation where most of the day-to-day operations are run by professional management and the Owner-Management (Mr S K Poddar, his son Manav Poddar, and son-in-law Arun Poddar) devote only 10% of their time in day-to-day operations and are free to spend their time on strategic areas.]

9.   THE PU/PVC SYNTHETIC LEATHER MARKET. THE SIZE OF THE OPPORTUNITY BEFORE MAYUR UNIQUOTERS.

What is the size of the current market being addressed? Where do you see the company 5 years from today? What are the major challenges to reach there?

Let’s look at the Indian market first. Our internal estimates show current synthetic leather production in India caters to roughly ~2000 Cr. Another 700 Cr is met by way of Chinese Imports. 50% of the market probably is catered to by the unorganized sector. 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. Our nearest competitor has less than 50% of our capacity.

About the automotive OEM export market we talked at length before. We reckon that US and European synthetic leather market together is worth not less than 3000-4000 Cr annually.

We should definitely double our Sales in next 5 years!

[ValuePickr: Management likes to talk very conservative. Mr S K Poddar was quoted in this Dec 2010 CNBC interview of doing Rs.48-49 EPS in FY12. They achieved that (Rs. 46 EPS) in FY11 itself. When reminded of this by us, Mr S K Poddar laughed and said we believe in under-promising! Today we have a much greater responsibility as more people like you and analysts have started talking to us regularly. Let our performance do the talking for us!]

10.   PU/PVC SYNTHETIC LEATHER MARKET WOULD SEEM TO BE A LOW-BARRIER-TO-ENTRY MARKET. BUT YOUR DOMINANT PERFORMANCE SEEMS TO BE TELLING A DIFFERENT STORY.

What is the level of competition you face today both domestically and in exports. Who are these players? Would you continue to enjoy a sustainable competitive edge, and why?

Domestically as I mentioned there are about 5-6 bigger players in the organized sector. The customers in the organized sector also like to deal with these bigger players for reasons as mentioned before. Jasch Industries, Polynova, Royal Cushion Vinyl, Fenoplast are some of these players. Our nearest competitor has roughly ~50% of our capacity.

Other than Mayur Uniquoters, no Indian synthetic leather manufacturer has been able to penetrate automotive OEM export 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!

If Mayur Uniquoters is a leading vendor with major customers today, it is for a reason. A certain financial strength and stability is needed to be able to invest in supplying bulk order quantities. Backed up by consistent quality and the ability and willingness to engage customers with new product ideas and innovations. We have developed more than 500 product varieties and are continuously adding to this. Our capacity utilization rates are the highest in the industry. While we derive roughly 4.5-4.75 linear lakh meters/month from one coating line I would hazard a guess that most others are not deriving more than 3-3.5 lakh linear meters/month. We invest continuously in machine and process upgradation. A small example – a leather roll changeover that used to take 45 minutes earlier, today takes less than 5 minutes! 

11.   CAPITAL EXPENDITURE. GROSS BLOCK ADDITIONS IN LAST 5 YEARS IS ~25 CR, BULK OF IT SOME 10 CR ADDED IN FY11. CAPITAL WORK IN PROGRESS WAS SOME 3CR. IN THE SAME TIME SALES HAVE INCREASED BY ~200 CR.

No wonder Fixed Asset Turnover has doubled form 4x to ~8x in last 5 years. Again maximum improvements have come in last 2 years.

As mentioned before, one thing you need to appreciate is that Sales growth has not been led by volume growth as much as by better price realizations (value additions and higher input prices). Having said that, once a coating line stabilizes, our utilization is very high – at 100% levels -24 hours, 3 shifts a day.

This looks almost like an asset-light business model? What’s going on? Is this sustainable ~8x fixed asset turnover for a manufacturing business?

You should also recognize that some our assets are very well depreciated. The first coating line is almost 15 years old and still going strong. The good part is much of the parts can be periodically replaced/upgraded and we have been doing that. Once this 4th coating line starts, we will be able to shut off this 1st line for a few days and carry out some upgrades. Please take into account with new investments of some 50 Crs being made over the next 3 years, these figures may/will temper down.

Please share the company’s philosophy, processes, and how you have gone about implementing such extraordinary productivity and efficiency improvements.

Well the answer to that is our Hunger. And the Ambition. Who sets the benchmarks here? We set them –right? There are no cut off –figures! We are a process industry. Seemingly small but continual investments in processes upgradation is a Mantra with us. If you ask me, if I were to grade us where we are today from where we would like to be I would say we are operating at 60% efficiency!
 

[ValuePickr: Mr VK Khanna and Ramdas Acharya had also joined us by now. Mr Khanna chipped in saying while CMD’s assessment is at 60% , my own assessment is that we are at 40% today!! There is a lot to do and achieve. We are hoping that the next plant that we are coming up with will be a quantum jump over our efforts today. Next time when you visit we would like to showcase to you a world-class facility. Let’s see.]

12.   BACKWARD INTEGRATION.  KNITTED FABRICS UNIT INCURRING 15-18 CR CAPEX

Has this been completed? Is this only for captive use for the exports segment or for generating additional sales as well? What kind of capex will be required going forward?

The land has been acquired. Unfortunately it has taken us 9 months to get the land converted for Industrial use. Construction has started now.

This investment in knitted fabrics is necessitated because of the quality issues being faced by us especially for export markets. We wanted to have this key raw material under our control. Initially much of this will be for captive use, but we also see increasing possibilities of opening up a new market segment for us!

Knitted fabrics has much wider ranging applications than synthetic leather. This market in India alone is a 50,000 Cr annual market! That will bring its own challenges, but show me a business today that does not have intense competition. There are no easy lunches. We are quite sure if there is an opportunity, we will find our own way, albeit gradually.

How much was the expense incurred in Knitted fabrics RM as a percentage of Sales? What will be the contribution towards margin expansion, if any, on account of this?

[ValuePickr: Sorry we missed asking this directly in the informal discussion flow. Will get this answered for you, soon]

13.   RAW MATERIALS – CHEMICALS, KNITTED FABRICS, OTHER FABRICS

RM constitutes some 70-75% of Sales. Kindly explain how the company manages raw material price volatility risks. Are you able to pass on price increases? What is the process with auto OEMs? How often have you resorted to price increases in FY11? What is the outlook for FY12?

Our suppliers are some of the biggest players in the world. They set the prices based on the demand equation and crude situation. We are completely dependent and vulnerable to RM price hikes. The good part though is that we are generally able to pass on the price hikes to our customers. For some of them we have regular price escalation clauses in the agreements. While for some of them we need to go back and negotiate. As mentioned before in our industry we are usually 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).

If it is a gradual hike, usually price increases have worked for us in enabling higher sales. But as mentioned before I am not sure if we see another 18-20% hike in input prices again this year on the back of last year, something has to snap – not all our customers can absorb/pass on such steep hikes!

14.    FOREX RISKS. YOUR RM IMPORTS WERE ROUGHLY 69 CR WHILE EXPORTS CONTRIBUTED ROUGHLY ~48 CR IN FY11.

This picture may substantially change with rising exports in FY12. Will the natural hedge between imports & exports be maintained? What are the measures the company is taking to mitigate risks on this front?

The natural hedge works for us. At the moment we do not see an issue here.

Disclosure(s)

Nagabrahma: More than 5% of Portfolio in the Company; Holding for more than 1 year;
Nitin Jagtap: No Holdings in the Company; ;
Manish Kulkarni: No Holdings in the Company; ;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months;

Astral Poly Technik Managament Q&A: May, 2011

Management Q&A

Astral Poly Technik Stock Story will leave you impressed. It has made some rapid strides in the last few years. It’s a leader in its niche CPVC Pipes & Fittings industry segment. It continues to grow robustly with compounded annual growth of over 50% in Sales over last 5 years!

With its excellent fundamentals, Astral Poly Technik made it easily to our shortlist of promising small-cap stocks – that our in-depth process for hand-picked stock-picks throws up.

There are a few questions that came up during our detailed analysis on Astral Poly Technik, its prospects, and risks as we see it. (of course that is entirely based on published sources and without the benefit of a meeting/interview with Management).

We put forward these questions to Astral’s Management with a request for a meeting/visit to its premises. We visited and talked with CFO Hiranand Savlani for over 2 hours, who patiently answered all that we posed.


1.     ASTRAL HAS HAD A BLAZING RUN OVER THE LAST DECADE. SALES AND PROFITS HAVE GROWN AT OVER 40% CAGR. APL WILL PROBABLY DO OVER 400 CR IN FY11. THAT’S A SUPER ACHIEVEMENT. CONGRATULATIONS!

What are the future plans? Where does the company see itself in the next few years? We have heard the company talking of maintaining a 30%+ growth rate and a 1000 Cr turnover goal – Kindly explain what it will take to achieve this and what are the important milestones in this journey?

The market is huge and there is enough space for more players. we see us growing at 30-35% CAGR for the next few years. If we execute well, a Rs. 1000 Cr turnover is achievable within the next 3 years. New innovative product introductions and maintaining the quality of our distribution network and strengthening it will be key factors.

We ask all our shareholders to be long-term investors, and stay invested for the next 5 years. It will be a rewarding journey for all of us stakeholders in the company.

2.     CPVC RESIN SEEMS AVAILABLE FROM MULTIPLE SOURCES; CPVC COMPOUND AVAILABLE FROM NOVEON USA & AKREMA, FRANCE. NOVEON PATENTS ARE SET TO BE EXPIRING/EXPIRED

Please demystify this market for us. What is really patent protected, and for how long? Apart from Noveon and Akrema are there other licensors of CPVC compound? Are people able to make CPVC pipes with CPVC resin and indigenous compound knowhow??

Patents have expired. But the availability of the compound is a key constraint. Apart from Lubrizol, there are some 3 other known manufacturers. Akrema of France, Kaneka and Sekisui of Japan.

There some 20 CPVC pipe manufacturers in India today. Most of the non-Lubrizol licensee capacities are at a nascent stage and in 100s of tonnes. The largest may be some 3000 tonnes. The availability of the CPVC compound (other than Lubrizol) is a key constraint. Many are experimenting with in-house compounds, but are not able to scale up majorly without a guaranteed RM source.

3.     GI PIPES & STEEL PIPES ARE STILL THE MAINSTAY OF PLUMBING AND FITTINGS MARKET IN INDIA. SOME STUDIES ESTIMATE GI PIPES CONTINUE TO HOLD OVER 50% MARKET SHARE, WHILE THE PVC/CPVC MARKET IS STILL SOMETHING LIKE 5% OF THE MARKET.

Kindly give us your estimate of the current Indian market for plumbing & fittings. How do you see CPVC/PVC market growing in the next 5 years? Is CPVC likely to replace PVC totally or both will continue to co-exist.

This is difficult to put an exact figure on. By all accounts this is a huge market. The GI market itself a Rs 7,000 Cr market as on today. SWR pipes (PVC based) is reportedly a Rs.3000 cr market today. One Mumbai distributor alone is doing a Rs 50 Cr business just from SWR. Then there is Underground drainage systems which is big. There is Blazemaster potential market of atleast 700 Cr. In all, the total market for pipes and fittings in India is by some accounts a Rs. 20,000 Cr market, today.

GI Pipes days are over. The organised construction players have already switched. End users are aware, depending on the location and corrosiveness/water properties the life varies form 7-10 to 12 years for GI. Whereas CPVC has no such problems.

The plumbing community is a big pusher towards CPVC. Their productivity has gone up as the handling/fitting is much easier (Just an adhesive glue, rather than threading and refitting and the like). If they could construct  one GI bathroom a day, they are able to finish 3 bathrooms today in the same time. They also find the product, fittings & installation hassleless and are the biggest promoters for CPVC pipes & fittings.

4.     EXPORT MARKET POTENTIAL. 30% IN KENYA JV. LUBRIZOL LICENSING POLICIES

Exports are a very small market for Astral today. Are there any ambitions to scale up this segment? Tell us more about the Kenya JV, Is there any strategic intent, and why Kenya? What is Lubrizol licensing policy for markets other than India? Do you have any leeway for south asian and middle-east markets or are they subject to separate licensing?

The Kenya market license is with Astral Poly Technik and we have extended it to the JV. It is Lubrizol which asked us to look at that market and we preferred to set it up jointly with another entity where the risks are spread. As you might have seen we have increased the stake, and have the rights/mechanism to increase the stake in proportion to market development.

We have a very big domestic market to take care of, first.

5.     OTHER NOVEON LICENSEES IN INDIA INCLUDE AJAY INDUSTRIAL CORP AND ASHIRVAD PIPES PVT LTD. ASHIRVAD PIPES HAS OVER 50,000 MT CAPACITY AND A 2008 RECIPIENT OFNATIONAL AWARD FOR OUTSTANDING ENTREPRENEURSHIP IN MEDIUM ENTERPRISES. AJAY INDUSTRIAL CORP HAS OUTSTANDING GROUP COMPANIES LIKE PRECISION PIPES (LARGEST SUPPLIER OF AUTOMOTIVE EXTRUDED PARTS) AND AJAY POLY (LARGEST SUPPLIER OF EXTRUDED REFRIGERATION SEALING SYSTEMS)

These are pedigree companies. How serious is the competition? Is it head-to-head in Flowguard Sales, or do you/they have an edge in some segments within Flowguard range. If you have any competitive advantage over these two, what would those be? Does your/competition distribution network play a significant role? Are there any regional markets that you/competition dominate?

These are also big players in this market and there is room for all to grow. Both are unlisted players and we are not aware of much details on their dedicated CPVC capacities. We have strong presence in West and South markets and now turning the focus to North and East.

6.     CPVC LICENSING AND MANUFACTURING.

Kindly explain the role that Lubrizol & Specialty process LLC plays. What is the kind of relationship that you enjoy with them, and are you deriving any competitive advantage from the strength of these relationships today? Why aren’t say established PVC/GI players moving fast in CPVC? What prevents them from approaching Lubrizol with bigger plans than yours? What about manufacturers setting up plants in say Nepal and target Indian markets?

Lubrizol has policies that are licensee-friendly and protects the licensees that take the initial market risk with them. In a market like US, they have appointed only 4 licensees over the last 42 years. That speaks a lot for their policies.

When we take initial market risk for a product and are the first licensee, usually we are assured of a 5yr exclusivity. I am not just taking the license, I am spending money and effort in UL certifications (where they stress the product in test conditions for over 18 months) and other market development activities. Lubrizol has an equal stake in making us succeed -those who take the early risk.

Q: So, did you get an exclusivity on Flowguard license?

Yes, The others have the license only since the last 6 years. We have had that for the last 11 years.

For the Indian market Lubrizol had first approached the established bigger players like Supreme and Finolex in 1998-99. However when they did not take up on that offer, an unknown entity like Astral Poly Technik came forward and took on that initial market risk.

Like for any other market, Lubrizol understands the peculiarities of the Indian market. We have taken the early risks and have developed the market from scratch and we have had their constant support. We have a strong relationship. It is unlikely to jeopardise a relationship that goes back so many years, especially when we are giving them high growth. Peculiarities of the sub-continent are not unknown to them! Anyone getting a license for manufacturing in Nepal or other such places is probably remote.

7.     BLAZEMASTER FIRE SPRINKLER SYSTEM – YOU HAVE THE LUBRIZOL LICENSE SINCE 2008. DESPITE HAVING THE NSF & UL CERTIFICATION, LOCAL BIS CERTIFICATION IS YET TO BE RECEIVED, FOR WHICH APL HAS BEEN DOING THE GROUNDWORK FOR LAST 2 YEARS.

Kindly explain the importance of Blazemaster to product plans and future growth of the company. Realistically when do you see a pan-India launch? While this will give you an edge over other Noveon licensed CPVC manufacturers, how long do you expect to sustain this first-mover advantage? All your groundwork in getting local approvals actually works to the advantage of the guy moving in next after you! Lubrizol must be aware of the situation – what kind of guarantees do you have from them for protecting you on this front for the Indian market.

Blazemaster Fire Sprinkler system has very big potential and it has ready acceptance from the corporate segment. We are hopeful of an early launch. There is a review slotted in May/June by the standardisation body. It may or may not come through this time. But we are almost there, all the groundwork is done.

Blazemaster should also enjoy a 5yr exclusivity.

8.     NEW PRODUCTS SWR PIPES, UNDERGROUND DRAINAGE PIPES, FOAM CORE PIPES, MANHOLES AND INSPECTION CHAMBERS.

Kindly explain the process of new product introductions in the Indian market. Do you require to take specific BIS/ISI approvals for each of these products. What is the status on pan India launch for all these products? Currently what is the revenue contribution from new products?

Blazemaster is the only product for which BIS approval is required as Fire Sprinkler is a category that needs to go through the standardisation process. None of the other products require such approvals.

Pan India launch and availability is a long slow process. It usually takes from 3-4 years. Most of the new products are finding good acceptance and growing very strongly. SWR Pipes is doing very well. It will be some time though, before we have significant revenue contributions from new products.

9.     PRODUCT SEGMENTS, GEOGRAPHICAL SEGMENTS, REPLACEMENT MARKETS

Kindly give us an idea of the revenue contribution & margins from major product segments, also rural and urban markets, and replacement market. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why? How much do the brands Flowguard and Corzan contribute today to revenues and going forward what’s the scenario? How big is the lead free PVC segment?

CPVC Pipes & fittings contribute 65% of the Sales mix. PVC products bring up the balance 35%. Pipes contribute 55-60%, while fittings contribute 35-40%, rest is from others. Traded goods constitute roughly 10% of Sales -mostly Solvent Adhesives and some fittings where the volumes do not justify manufacturing. We are manufacturing some 700 varieties of fittings ourselves, today.

10. CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

What is the revenue split between residential and commercial projects currently, and how is it expected going forward? Does this business lend itself to deeper relationships with reputed builders/contractors? Who are your top customers in FY11

Our sales are distributor driven and is difficult to give any breakups. Most of the revenues come from the residential segment and if were to put a figure it could be around 60-65%. This year we have started focusing on the replacement market too. Usually big builders have repeated us in subsequent projects.

11. COMPETITION STRATEGIES

Sooner or later bigger players with stronger brands (like Finolex, Supreme) will move into the CPVC market. It’s quite possible that these brands will have much stronger customer acceptance & pull than first-mover Astral. Kindly explain the company’s current thinking, brand building exercises undertaken and future plans.

As mentioned before, there are some 20 CPVC manufacturers in the country today. And all of them are playing a role in expanding the market as today everyone has good things to say about CPVC. In the earlier days the bigger PVC players were not so generous. We are happy about that.

Most of the non-Lubrizol licensee capacities are at a nascent stage and in 100s of tonnes. The largest may be some 3000 tonnes. The availability of the CPVC compound (other than Lubrizol) is a key constraint. Many are experimenting with in-house compounds. Also they have not been able to meet Lubrizol’s price point, and in a price-conscious market like India, that is often the bottomline!

12. CAPITAL EXPENDITURE. TO GROW SALES, ASTRAL NEEDS TO CONTINUALLY INVEST IN CAPACITY EXPANSION. WE HAVE HEARD CAPACITY EXPANSION PLANS TO 60000 MT FOR FY12.

What kind of capital expenditure will be required for this latest expansion. Some of the private players like Ashirvad Pipes Pvt Ltd. reportedly have expanded capacities to 70000 MT. How strong is the demand position? Is there a likelihood of overcapacity in the short to medium term?

Ashirvad Pipes is also a strong player. How much capacity is dedicated to CPVC I am unable to comment. There is enough demand for all of us to grow strongly in this market. We are looking to expand to 70,000 MT by this year end.

As you know we have acquired land at Dholka, Gujarat and a leased facility is available in Hosur, Karnantaka. We also have another 75000 sq mt of land in Dahej under our subsidiary Astral Biochem. Land is a key constraint in expansion plans, we have enough land acquired to meet our expansion needs for the next 4-5 years.

The Dholka plant will be a 25000 MT expansion which will come up in FY12. Hosur facility may be taken up subsequently as we need more capacity. The existing plant which has 45000 MT capacity can accommodate another 15000 MT or so.

Capex is done in a phased manner. We usually try to create capacity that we will need for the next year, a year ahead. You may have noticed most of the capex happens in the last one or two quarters of the financial year. Funding is not an issue today as we have strong cash flows and strong balance sheet, that we can leverage judiciously.

13. BACKWARD INTEGRATION.  IN OCT 2010, APL BOUGHT 85% STAKE IN ADVANCED ADHESIVES PVT. LTD. THE SUBSIDIARY COMPANY WILL MANUFACTURE SOLVENT CEMENT IN INDIA.

What are the plans on this front? Is this only for captive use or for generating additional sales as well? What kind of capex will be required going forward?
How much was the expense incurred in Solvent cements RM as a percentage of Sales? Is it mainly used for pipe fittings? What will be the contribution towards margin expansion, if any, on account of this?

Solvent cements accounted for roughly 6% of Sales as an expense item. This will be used for captive use and also supply to local players.

14. MARGINS – SUSTAINABILITY. THERE HAS BEEN A SLIDE IN MARGINS EVERY QUARTER FOR THE LAST 4 QUARTERS. OPERATING MARGINS (EXCL OTHER INCOME) HAS ACTUALLY SLID FROM OVER 16% TO JUST OVER 11% IN Q3FY11 – A SIGNIFICANT CONTRACTION OF OVER 5%! (RAW MATERIAL/SALES HAS REMAINED BETWEEN 64%-66.5% ROUGHLY)

Kindly explain the circumstances leading to this. Is this a short-term scenario and have we seen a good reversal in Q4 given that historically this is your best quarter? What levels do you see margins sustaining in the next 2-3 years?

PVC market is a highly crowded space and the OPM levels are not more than 8-10%. It’s a sort of a commodity business now. With more acceptance of CPVC and competition coming in, would it happen for CPVC market also…if not why? Where do you see margins sustaining over the next 2-3 years?

What you are comparing is sequentially quarter on quarter basis. A better comparison would be comparing annual figures where there has been a smaller decline. We should be within the historical 13-15% range on annual basis.

Whenever we introduce new products in the market, we go aggressively after market share. FY10 and FY11 has seen many new product introductions and therefore there is a dip in margins. We believe that at the rate we are growing, we have to take some margin pressure along our stride, as long as we stay within the historical range. Eventually economies of scale will deliver.

15. RAW MATERIALS – CPVC COMPOUND, PVC RESIN. RISK MANAGEMENT

With a rising crude prices scenario, raw material pries must be a cause for strain. Kindly explain how the company manages raw material price volatility risks. Does it get any advantage from sourcing majority of RM from Lubrizol? How often does it revise prices? Are you able to pass on price increases? How often have you resorted to price increases in FY11? When crude had crossed $150 in 2008, were you able to raise prices? What is the outlook for FY12?

How much is CPVC compound as a percentage of total RM? Do you see any risks in being tied to a single supplier (Lubrizol) for majority of RM requirements? Where do you source your PVC requirements from – RIL?

We used to get 180 days credit from Lubrizol earlier. Now it is 120 days. They do not revise prices often. Earlier it used to be once a year. With the current volatility it is more like once in 6 months. It is unlike the PVC supplier quotes which react instantly on spot rates and updates are sent on SMS! About 60% of RM is on account of CPVC.

16. FOREIGN CURRENCY – IMPORTS & FCNR LOANS. RISK MANAGEMENT.                       APL HAD INCURRED A LOSS OF RS.13.44 CR ON EXPOSURE TO FOREX DERIVATIVE CONTRACTS. IN FY10, THE FCNR LOAN STOOD AT 23.5 CR AND IMPORTS AT 104 CR.

What is the current FCNR loan position? Have all forex derivative contracts expired in full? After the FY09 experience, can you confirm that forex risk management practices adopted by the company are more conservative now?

There are no outstanding long-term contracts. FY09 was a difficult year. Forex volatility Management is part of regular business, we do not foresee extreme impact like that experienced in FY09.

17. SALES DISTRIBUTION NETWORK. DISTRIBUTION POLICY. 250 DISTRIBUTORS, 5500 DEALERS. TYPICAL OTHER EXPENSE SPENDS ARE 12-15% OF SALES.

How strong is the dealer/distribution network today? How important is the distribution network to sales growth for Astral? How does the company support this distribution network? Typically what kind of budgets do you allocate for Sales & Marketing spends?

We have 350 distributors and 7000 dealers today and we are constantly looking at strengthening this network. We believe this loyal distribution network is a core strength. The direct sales force works to nurture this network, as all sales incl. project sales are also routed through this network. We help dealers penetrate new markets by sharing promotional costs. We have recently taken on Mudra as the Ad agency for a promotional campaign with a 1cr budget. There is no fixed budget allocation for Sales & marketing spends, but is decided based on the targets set for the year.

18. DIVIDENDS. DIVIDEND POLICY. PAYOUTS

The company has started distributing dividends since 2008, Dividend payouts as a percentage of net profits has been rising, but still pretty low at ~8%. Kindly elaborate on the dividend policy followed by the company.

As you know we are growing at a strong pace, and we need all the cash that we generate and more. There is no enunciated dividend policy as such, and dividends are likely to remain at similar levels for next 2-3 years.

19. WARREN BUFFETS TAKEOVER OF LUBRIZOL.

 Any likely impact on the relationship? Please comment.

Our relationship goes back 11 years. We have seen four changes in ownership in these many years. From BF Goodricke, to Noveon, to Lubrizol and now Berkshire Hathway. Our relationship and support from Lubrizol has been very strong. We expect the same policies to continue for our markets.

20. CHALLENGES BEFORE THE COMPANY

Kindly elaborate on the main challenges faced by the company in view of the huge opportunities that lie ahead. How confident are you of reaching the turnover of Rs 1000 Cr an by when?

As mentioned before we should do Rs. 1000 Cr within the next 3 years. There are several big application markets that we need to tap effectively. Blazemaster is one, Solar applications is another. Along with the results, we will announce a few new initiatives!

Results on 20th May 2011. Analyst Meet on 25th May, 4-6 PM, Trident, Mumbai. Please be there!

 


Disclosure(s)

Nagabrahma: No Holdings in the Company; Recent Entry;
Janak Merchant: No Holdings in the Company; ;
Donald Francis: Less than 5% of Portfolio in the Company; Recent Entry;
: ; ;

Astral Poly Technik Management Q&A: Aug, 2012

Management Q&A

  1. TOTAL MARKET OPPORTUNITY

While there are no industry published figures, several estimates by analysts have pegged the annual market for Plumbing Pipes in India anywhere between 20000-30000 Crs. Of these 6000-7000 Cr is still GI use. Another 1000 Cr is for specialty solutions like Fire-Sprinklers, etc. About 30% is Replacement market.

  1. EXISTING PRODUCTS COMPETITIVE LANDSCAPE

In the CPVC Lubrizol segment as you are aware Ahshirwad, Astral and Ajay are the only Players. Ashirwad is a big well-established player. Ajay is yet to show any significant volumes.

In CPVC Generic segment there are several players. But they still are facing issues on the RM (compounding) stage. Kaneka is supposed to set up a manufacturing plant by 2014 end.

There is a 6-7% price differential with the generic players. But if you look at it, pipes constitute only about 1-1.5% of overall cost of the plumbing solution. We haven’t seen any impact, our volumes are not dropping. There is room for everyone to grow.

Doesn’t Kaneka supply the CPVC Compound too?

Well they do. But in India everyone wants to be able to do the “jugaad”; people try to make their own compounds; that can save them some 5-7%. But that has not been working out.

And the PVC Segment?

PVC is a huge market by itself. But there is high competition. We are not present in the Agri segment which sees cut-throat competition, with very low margins. Players like Finolex dominate this segment. Then there are players like Supreme who are present in both Agri & Plumbing.

With the Hosur Plant in South India, we will be able to compete more effectively, as transportation costs are high; adds up another 7-8%.

  1. BUSINESS GROWTH DRIVERS – PLUMBING SOLTION BASKET

Last time we understood …..End customer is really the Plumber, serviced by Large Distributors. The Plumber usually buys the entire solution basket -from one Brand. So large distributors can be attracted and retained – if you are able to offer a) complete solution basket, b) More number of solutions

We have about 300-350 distributors. All the states put together, no of dealers will be 9000-10000. Distributors keep 3-4% and the Retailer retains on an average 7-8% margins.

Project Sales are handled by Distributors with some 8-10% margins. Support is provided by the company for Project Sales..

We continuously try to interact & educate Focus groups. Consultants, Architects and Builders for Project Sales and Plumber Groups for Retail Sales. In the Southern Market we have seen Plumbers are more educated. The West market requires huge training. We conduct almost 3 trainings every week there.

Our product basket is widening and we are able to provide solutions for most requirements from the Astral brand umbrella. This helps our distributors and dealers as builders or retail customers usually like to source from one place.

CPVC

As you know we have 4 products licensed from Lubrizol. Flowguard, CORZAN, Blazemaster and Bendable. Ashirwad & Ajay have only the Flowguard license.

PVC

We have Aquarius (lead free PVC) brand. SWR. Column Pipes is what we have recently launched and expect to be able to do about 40-50 Cr from this segment. In 3 years we are looking to do 300 Crs from this segment. Ashirwad has a virtual monopoly and derives 300 Cr from this segment of the ~500 Cr Column Pipes annual market.

Ashirwad claims some patent for Column Pipes?

These are Marketing tactics everyone employs! In terms of technology/design barriers there is no impact or value derived from these. You might be aware some other CPVC player also claims patent-pending Alignment technology!

SOLVENT CEMENT

As you are aware this is handled through a 100% subsidiary. We have plans to supply for the Generic players needs; also open to White-Labelling.

We have launched this for PVC segment. This is slow-moving, we are doing 8-10 Cr from this segment. Margins are better than existing products. In Q3, we will also be launching Solvent Cement for CPVC segment. There should be some positive impact on the bottomline, as this will be an import substitute.

  1. NEW PRODUCTS

BENDABLE

This is a patented product from the Lubrizol stable. 3-4 years have gone in the R&D and commercialisation phase. So another 16 years of patented life exists. Astral is the only licensee of this product currently. Exclusivity for Indian market. We may be able to export some.

These products are good for Solar Applications. Because of thermal expansion properties of water, you may have seen the pipes become zig-zag and eventually break. So Bendable pipes come with a metal support, so the thermal expansion does not happen. Gas application is another market.

Limited market size. Currently metal pipes are used, only Copper, plastics are of no use. So Bendable offers a much cheaper solution. This will have better realisations, but initially market development efforts may require offering lower.

We have set up capacity of 11000 MT and are perhaps looking at 60-70 Cr turnover. Currently wen have tooling for 1/2”, 3/4” and 1”. We have ordered tooling for 1/4”, 1 1/2” and 2” that will complete the solution basket.

BLAZEMASTER

This is a CPVC solution for Fire Sprinkler system. Fire Sprinklers have the additional complexity of having continuous water, so there is heavy corrosion. So GI solutions are not very good here. Every 5-6 years you will have to paint/repair; there is replacement headache, besides all the transportation & handling. GI has been also banned in developed countries.

This is a very promising product line. Fire Sprinkler systems are becoming mandatory for commercial buildings, malls, hospitals. This is projected as a 700-1000 Cr annual market.

Astral is the exclusive licensee of Lubrizol in India.

  1. LUBRRIZOL RELATIONSHIP

Nothing to add really. The relationship is going strong. We are the only Licensee in the world to have 4 products form the Lubrizol stable. Bendable, their patent-protected technology – Astral is the first and only licensee globally.

  1. MEDIUM TERM OPERATIONAL OUTLOOK

We have always tried to communicate, ours is a Growth-led strategy. Consistent Margin expansion is NOT our focus. We are happy to achieve a 25-30% growth rate consistently and at 12-14% sustainable EBITDA margins.

FOREX MANAGEMENT

There are no easy solutions here. You must have seen everyone struggling to manage the extraordinary volatility. In Astral’s history, this is the first time we have seen 20-25% depreciation of the Rupee (versus the US $) in 6 months and a 10% appreciation back in 1 month.

We need to weigh the Forex Loan (2%) versus the domestic Interest cost (13%). So there is an 11% interest cost arbitrage available which needs to be weighed against the liability size of possible Forex loss.

We had taken a Forex currency loan of 15 Cr in 2003. We have been taking Forex currency loans. For the next 6-7 years this has worked hugely to our advantage, as the currency movement was only of the order of 5%. But this is obviously not working in the current environment of extreme movement.

Despite the 20% depreciation in currency and the M2M loss, the cost of Forex Loan over its full tenure will work out cheaper than our domestic rupee loans.

And the forex payable to Lubrizol for the 120 days credit terms? Why don’t you hedge this?

In a stable environment the 120 credit period from Lubrizol has been a great advantage to us – leading to negative working capital for the CPVC side of the business. If we were to hedge the payable, we would have to pay a 4-5-7% premium and this will take away the credit period benefit and impact our margins.

As a corporate we make long term strategies and work on it…when such extreme currency movements happens which are beyond anyones imagination, its obviously tough to handle. We need to understand what’s going on and revise strategies, and tweak them to see what works. Everybody faces the same choices – including the Generics. Strategy can’t be based on Abnormal conditions.

M2M ACCOUNTING

If you look at it properly, there is undue focus on the 1 to 1.5% drop in EBITDA margins. We can actually take a 60-90 day cover and there will be no change in EBITDA level, will you be happy with that?

From our perspective, it is also not correct to look at it from a Quarterly basis,either. In Q1 there was some M2M, in Q2 there was Zero M2M. And in Q4 everyone was hugely surprised to see the 18% EBITDA margin – no one had expected this. This was because of the price hikes we had taken, the lag effect and the effect of currency appreciation. In Q2 we had taken a 6-7% price hike, overall for the year 13% price hike.

We have tried to explain this to everyone. 18% EBITDA levels are not sustainable, 12-14% is. No need to be happy about the 18% EBITDA margin in Q4. No need to be PANICKY either. Better be prepared for reasonable margins of 12-14%.

Overall we don’t think all this is such a problem. Quarterly adjustments do not provide the right picture. So we have opted to adjust on a yearly basis at the year-end due to reasons mentioned above.

CAPACITY

We are at 65000 MTPA today in Gujarat. We are incurring 40-50 Cr Capex for putting up another 15000-20000 MTPA capacity at Hosur. This will be available by the year end.

  1. LONGER TERM OUTLOOK

Ours is a simple Pipes business. The Indian plumbing market is growing at 12-15% annually. We are capable of growing at 25-30% rate consistently, which we should be happy for. The growth drivers are Capex and Working Capital. One part of the business CPVC (60%) is Working Capital negative. And another part PVC (40%) has huge working capital requirements. For a couple of more years we will need to keep borrowing to finance this growth.

Do not jump to conclusions based on Q1 results. Our business is slightly seasonal. 1st half delivers 40% and the 2nd half 60%.

This is a very simple business. Any player can grow in this market. It’s a Capacity game. It’s a New Products game. It’s an Asset Turnover game. What goes to our advantage is Asset Turns of 5x. Supreme Industries is a live example in front of you.

In 2007, we were preparing for an addressable market (ours) of 1000 Cr. We are now preparing the plants for addressing a market of 2000Cr.

8. BRAND BUILDING. PROMOTIONS

We have been building up the Astral brand with our target customer base – Plumbers, Architects, Consultants, Builders/Project segment.

We will next attempt on educating the CONSUMER directly. There are some mass media events planned in October/November timeframes.

Astral products have typically been behind the Wall. There is no aesthetic appeal per se. We are trying to formulate plans for future products which will come in Front of the Wall. Since the customer segment and typical distribution network is the same, it may make sense for us!


Disclosure(s)

Vinod Ms: No Holdings in the Company; ;
Gaurav Sud: No Holdings in the Company; ;
Ayush Mittal: Less than 5% of Portfolio in the Company; Holding for more than 1 year;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years;

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


Astral Poly Technik

Company Background

 

Astral Poly Technik (APL) has its production facilities at Gujarat and Himachal Pradesh to manufacture plumbing systems from ½” to 8” diameter. 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 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 15.xx% ownership in APL. APL claims to be the only Licensee of Lubrizol in India and neighbouring countries for the use of the trademarks ‘‘BlazeMaster” (since 2006), “FlowGuard” (1998) and “Corzan” (1998).

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 a larger diameter from Harvell Inc. (USA).

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 CPVC products are approved by Nations Sanitary foundation (NSF) USA. Astral recently received ISI approval for its CPVC products in the country.

APL’s manufacturing facility at Barotiwal-Solan District (H.P) 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.

 


Growth Snapshot

We can’t just look at a series of past growth rates and assume that they will predict the future – if investing were that easy, money managers would be paid much less, and this stock analysis would be much shorter. It’s critical to investigate the Sources of a company’s growth.
Variable FY06 FY07 FY08 FY09 FY10
Sales Turnover (Rs. Cr.) 58.19 101.70 144.53 205.25 304.52
Sales Growth Year on Year 79.47 40.71 42.30 50.15
3yr Average Sales Growth 54.16 44.39
3yr Sales CAGR 58.91 41.50 46.17
5yr Average Sales growth 53.16
5yr Sales CAGR 52.41
Profit After Tax (PAT) (Rs. Cr.) 4.02 9.11 17.07 14.19 28.03
Adjusted EPS 1.79 4.05 7.59 6.31 12.47
EPS Growth Year on Year 126.62 87.38 -16.87 97.53
3yr Average EPS growth 65.71 56.01
3yr EPS CAGR 106.06 24.81 28.14
5yr Average EPS growth 73.66
5yr EPS CAGR 62.50

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Profitability Snapshot

Profitability is the second, and in many ways, the most crucial, part of our Analysis framework. How much profit is the company generating relative to the amount of money invested in the business – the returns? This is the real key to separating a great company from average ones -the higher that return, the more attractive that business. Net profit Margins and comparing cash flow from operations to reported earnings per share are good ways to get a rough idea of the company’s profitability (because cash flow from Operations represents real profits!). But neither account for the amount of capital that’s tied up in the business, and that’s something we cant ignore. We need to know how much economic profit the company is able to generate per dollar/rupee of capital employed because it will have more excess profits to re-invest which will give it an advantage over less-efficient competitors.
Variable FY06 FY07 FY08 FY09 FY10
Operating Profit Margin 13.76 14.10 15.23 11.54 14.45
Net Profit Margin 7.47 9.44 12.57 7.34 9.66
Fixed Asset Turnover 2.35 3.13 3.30 2.45 3.30
Asset Turnover 1.70 1.05 1.21 1.47 1.83
Return on Assets 12.68 9.90 15.24 10.77 17.68
Financial Leverage 2.29 1.36 1.40 1.42 1.34
Return on Equity 29.03 13.48 21.37 15.30 23.73
Return on Capital Employed 20.60 13.75 19.74 16.36 24.33
Debtor Days 64.54 76.92 88.42 77.96 84.82
Inventory Days 115.01 96.49 99.96 117.11 112.53
Cash from Operating Activities (Rs. Cr.)
Operating Cash Flow to Sales
Capital Expenditure 11.85 28.91 32.74 17.73
Free Cash Flow
Free Cash Flow to Sales
Equity Dividend (Rs. Cr.) 0.00 0.00 1.13 1.12 2.25
Dividend per share 0.00 0.00 0.50 0.50 1.00
Adjusted DPS 0.00 0.00 0.50 0.50 1.00
Dividend Growth Year on Year -0.88 100.89
3yr DPS CAGR 41.11
5yr DPS CAGR
Dividend Payout 0.00 0.00 6.62 7.89 8.03

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Common size P&L Statement

Can we dig deeper to see what else we can understand about how this company makes money? A good way is to look at the common size profit and loss statement. Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of Sales.
Variable FY06 FY07 FY08 FY09 FY10
Common Size Sales 100.00 100.00 100.00 100.00 100.00
Common Size Raw Material 58.70 72.79 67.41 75.46 73.34
Common Size Power & Fuel 1.92 1.97 2.04 2.41 2.44
Common Size Employee Cost 4.28 3.54 3.69 3.18 2.84
Common Size COGS 62.50 76.11 71.22 79.89 77.94
Gross Profit Margin 37.50 23.89 28.78 20.11 22.06
Common Size Depreciation 2.55 2.28 2.40 3.20 2.96
Common Size Interest Cost 2.34 1.95 1.98 2.75 1.67
Common Size SG&A 28.21 15.62 16.71 15.80 12.09
Operating Profit Margin 13.76 14.10 15.23 11.54 14.45

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Financial Health Snapshot

Once we have figured out how fast (and why) a company has grown and how profitable it is, we need to look at its financial health. Even the most beautiful home needs a solid foundation, after all.
Variable FY06 FY07 FY08 FY09 FY10
Financial Leverage 2.29 1.36 1.40 1.42 1.34
Debt to Assets 0.51 0.27 0.29 0.30 0.25
Debt to Equity 1.18 0.36 0.40 0.42 0.34
Interest Coverage 4.93 6.73 8.22 4.06 7.97
Interest Cost to Total Debt 7.73 7.68 8.37 13.60 11.98
Current Ratio 2.11 3.42 3.74 2.09 1.96
Quick Ratio 1.15 2.59 2.63 1.16 1.14
Cash to Assets 3.91 39.86 23.11 1.66 2.38

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Mayur Uniquoters

Company 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 1.2 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. 

 

Mayur Uniquoters concentrates mainly on 3 segments. Footwear (55%), Auto (25%), Furnishing (10%). Others bring up the balance 10%. Exports (10% of Sales in FY2010) is spread among above segments. Automotive OEM exports have begun in FY11 to GM & Chrysler. Other international OEMs like BMW, Mercedes and Ford have put Mayur Uniquoters on the approved vendor list, and orders are awaited.

Major customers include Bata, Liberty and Action in Footwear and Maruti, Tata Motors, GM in Automotive segments. Recent breakthroughs include international OEM customers such as Chrysler & GM in US.


Growth Snapshot

We can’t just look at a series of past growth rates and assume that they will predict the future – if investing were that easy, money managers would be paid much less, and this stock analysis would be much shorter. It’s critical to investigate the Sources of a company’s growth.
Variable FY07 FY08 FY09 FY10 FY11
Sales Turnover (Rs. Cr.) 71.70 97.81 123.13 176.15 269.14
Sales Growth Year on Year 36.18 27.50 43.20 50.87
3yr Average Sales Growth 35.62 40.52
3yr Sales CAGR 31.76 35.12 46.99
5yr Average Sales growth 39.44
5yr Sales CAGR 39.17
Profit After Tax (PAT) (Rs. Cr.) 2.65 5.11 6.06 16.22 25.27
Adjusted EPS 4.90 9.45 11.20 29.98 46.71
EPS Growth Year on Year 92.83 18.59 167.66 55.80
3yr Average EPS growth 93.03 80.68
3yr EPS CAGR 51.22 78.16 104.20
5yr Average EPS growth 83.72
5yr EPS CAGR 75.73

 

Mayur Uniquoters has made steady progress over last 5 years. The company has roughly tripled its sales to reach Rs.176 cr in FY10 and EPS has gone up roughly 6x in the same period. Sales have grown at ~30 percent CAGR while EPS on an adjusted basis has grown at over 57 percent CAGR.

Sources of Growth

1. Mayur Uniquoters dominates the PU/PVC Synthetic Leather Market. The customer list straddles all the major footwear brands and major automotive OEMs in India, the main segments the company concentrates on. At 1.2 million meters/month they enjoy some economies of scale, as the nearest competitor has only about half the capacity.

2. Special products for Automotive OEMs in Europe and USA, which satisfies world class quality standards for synthetic leather. Investments in Analytical Labs (for raw material quality inspection) and special plant & machinery enabled them to develop the artificial leather for GM, Chrysler and Ford in USA and Mercedes Benz and BMW in Europe. As per the company, this type of material has been developed for the first time in India, and no other leather cloth company has been able to develop such products.

3. Large variety of products  – Mayur Uniquoters has developed nearly 400 different varieties of synthetic leather to offer for diverse requirements, while the nearest competitor can offer only about 50 varieties.

4. Three main segments contribute to the Sales mix. Footwear (55%), Auto (25%), Furnishing (10%). Others bring up the balance 10%. Exports (10% of Sales in FY2010) is spread among above segments. The company reportedly supplies 75% of Bata India’s requirements. 


Profitability Snapshot

Profitability is the second, and in many ways, the most crucial, part of our Analysis framework. How much profit is the company generating relative to the amount of money invested in the business – the returns? This is the real key to separating a great company from average ones -the higher that return, the more attractive that business. Net profit Margins and comparing cash flow from operations to reported earnings per share are good ways to get a rough idea of the company’s profitability (because cash flow from Operations represents real profits!). But neither account for the amount of capital that’s tied up in the business, and that’s something we cant ignore. We need to know how much economic profit the company is able to generate per dollar/rupee of capital employed because it will have more excess profits to re-invest which will give it an advantage over less-efficient competitors.
Variable FY07 FY08 FY09 FY10 FY11
Operating Profit Margin 9.51 11.18 10.39 16.13 16.05
Net Profit Margin 4.00 5.66 5.27 9.85 10.17
Fixed Asset Turnover 4.16 4.23 5.08 7.12 7.94
Asset Turnover 2.19 2.72 3.13 3.55 3.61
Return on Assets 8.75 15.40 16.46 34.91 36.73
Financial Leverage 1.56 1.37 1.27 1.10 1.13
Return on Equity 13.61 21.12 20.93 38.57 41.42
Return on Capital Employed 17.01 27.64 29.20 57.21 57.20
Debtor Days 92.60 82.52 68.41 56.79 46.39
Inventory Days 61.07 36.20 28.77 28.71 27.86
Cash from Operating Activities (Rs. Cr.)
Operating Cash Flow to Sales
Capital Expenditure 6.11 3.25 2.50 13.93
Free Cash Flow
Free Cash Flow to Sales
Equity Dividend (Rs. Cr.) 0.75 1.00 1.91 2.71 5.42
Dividend per share 1.50 1.92 3.53 5.01 10.02
Adjusted DPS 1.39 1.85 3.53 5.01 10.02
Dividend Growth Year on Year 33.33 91.00 41.88 100.00
3yr DPS CAGR 59.58 64.62 68.45
5yr DPS CAGR 63.96
Dividend Payout 28.30 19.57 31.52 16.71 21.45

This is as pretty a picture as you can find – with a caveat. This achievement is on a very small base, and typical risks associated with small companies of this size, apply. Please see Bearish Viewpoints in our stock story section, for the overall picture.

On the margins front, Operating Profit Margin (OPM) has remained between 10-11% for the most part, in the last 5 years. Only in FY10, operating margins have seen a big jump to over 16%. This is on the back of a ~1% drop in raw material prices, and a big 3% drop in Selling, General & Administrative (SG&A) costs, and other efficiencies achieved on power & fuel costs (as a percentage of Sales, see Common size P&L statement below) in FY10.

The Net Profit Margin (NPM) record is far better, showing a somewhat steadier climb form 4.5% to ~10% in FY10. this is on the back of a steadily reducing interest burden and debtors and inventory levels. Its great to see debtor days consistently coming down from ~96 days in FY06 to ~56 days in FY10. Similarly Inventory days have halved from ~57 days in FY05 to ~28 days in FY10. This is a great record in working capital management for a company as small as Mayur Uniquoters and speaks a lot about the Management focus on operational efficiency.

It is also great to see a steady rise in Asset Turnover – rising from ~2x in FY06 to over 3.55 in FY10. Few manufacturing companies manage such a steady rise – tells me that capacity expansions have been judiciously planned and executed, in tune with rising demand. This coupled with the rising net profit margins have ensured that Return on Assets (RoA) climbed from ~9% in FY06 to over 16% in FY09. In FY10 RoA climbed to ~35% on the back of doubling of net profit margins. We can think of ROA as a measure of efficiency. Companies with high ROAs are better at translating Assets into Profits.

The rising net profit margins and asset turnover (with a gradually declining Financial Leverage) has ensured Return on Equity (RoE) has climbed from ~14% to over 20% till FY09. In FY10 RoE has jumped to ~39% on the back of almost doubling of net profit margins. RoE is a good measure of overall profitability as it measures the efficiency with which a company uses shareholders’ equity. We can think of it as measuring profits per rupee of shareholders’ capital. The Return on Capital employed record is similar going up from 18% in FY06 to ~29% in FY09, before jumping to over 57% in FY10.

The company has an even better track record in steadily increasing Operating Cash flows. Operating Cash flow/Sales more than tripled from ~4% in FY06 to over 13% in FY10. The Free Cash Flow (FCF) record is even better recording almost a 6x increase from ~2% in FY06 to ~12% in FY10. Free Cash flow at over 10% of Sales for a manufacturing company that has grown sales at a ~30% 5yr CAGR is a very rare achievement. It needs to be noted that Capital Expenditure (Capex) of some 15 Cr is slated for FY11 on a backward integration project. Further Capex of another 8-10 Cr will be needed for capacity expansions, sooner than later. If these are not exceeded, the Cash on balance sheet and the healthy cash flows are perhaps adequate to fund the upcoming capex requirements.

And when we find a company with a high RoE and high FCF combination, it is said to be in a sweet spot, and reason to track this company as a potentially excellent business to invest in, but at the right valuation.

Also one must not forget the consistent dividend payment track record. Dividend payments have been steadily rising to register a 5yr DPS CAGR of over 52%. Again a good record for a company of Mayur Uniquoters size.

For Mayur Uniquoters FY10 has been a year of stupendous achievement. We may argue that till FY09 the performance was not exemplary and one may not have taken much notice, it is only FY10 performance that has made us sit up – Will the high OPM & NPM margins be sustainable? The odds are on, to that settling down at slightly lower levels, perhaps.

An objective look back at this profitability analysis tells us that softening raw material prices played only a small part, and it is the operational efficiency improvements on most fronts that has propelled the company to greater heights.


Common size P&L Statement

Can we dig deeper to see what else we can understand about how this company makes money? A good way is to look at the common size profit and loss statement. Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of Sales.
Variable FY07 FY08 FY09 FY10 FY11
Common Size Sales 100.00 100.00 100.00 100.00 100.00
Common Size Raw Material 78.84 77.63 74.15 72.96 74.13
Common Size Power & Fuel 1.24 1.10 1.14 0.93 0.65
Common Size Employee Cost 4.11 3.44 3.37 3.11 2.50
Common Size COGS 81.90 80.46 77.09 75.85 76.68
Gross Profit Margin 18.10 19.54 22.91 24.15 23.32
Common Size Depreciation 2.29 1.54 1.38 1.32 1.08
Common Size Interest Cost 1.81 1.30 1.13 0.81 0.75
Common Size SG&A 10.32 8.66 11.17 8.41 7.81
Operating Profit Margin 9.51 11.18 10.39 16.13 16.05

This section has got covered mostly in the profitability analysis, as we looked for reasons behind the good performance.

Raw material prices seem to have softened over the last 4 years, when seen as a percentage of Sales. Power and Fuel costs have also come down. As per the Annual Report FY10, online embossing process improvement led to reducing 1 complete process in the chain with significant power savings. Employee productivity seems to be improving over the years as employee costs as a percentage of Sales has been gradually coming down. Selling, General & Administration expenses have also come down as a percentage of Sales.

This common size P&L statement points to a company getting more efficient over the years. We have also seen earlier in the profitability analysis consistent improvement in working capital management as the company has steadily brought down debtor days and inventory days.

is Mayur Uniquoters becoming a more efficient company, as it is growing? The track record of last 5 years certainly points to a strong management focused on improving operational efficiencies.


Financial Health Snapshot

Once we have figured out how fast (and why) a company has grown and how profitable it is, we need to look at its financial health. Even the most beautiful home needs a solid foundation, after all.
Variable FY07 FY08 FY09 FY10 FY11
Financial Leverage 1.56 1.37 1.27 1.10 1.13
Debt to Assets 0.36 0.27 0.21 0.09 0.11
Debt to Equity 0.56 0.37 0.27 0.10 0.13
Interest Coverage 4.29 7.84 8.27 19.84 21.16
Interest Cost to Total Debt 11.10 13.03 16.56 30.39 23.91
Current Ratio 1.88 1.56 1.66 1.82 1.99
Quick Ratio 1.32 1.24 1.34 1.52 1.60
Cash to Assets 3.76 13.29 15.65 42.14 33.19

Mayur Uniquoters Financial Heath track record is the best testimony perhaps, for the company.

Any which way you look at it, this is a great record. Debt to Equity has steadily been decreasing over the years. From 0.64x in FY06 it is practically debt free in FY10 at 0.10x. Financial Leverage and Debt to Assets mirror the same trends. Interest Coverage has been steadily rising over the years from 4x in FY06 to ~20x in FY10, and thus its unlikely that it will run into difficulty in meeting debt liabilities if earnings should fall unexpectedly.

Liquidity measures like Current ratio and Quick ratio are comfortable, showing that the company is able to source enough cash to meet near-term liabilities. Cash to Assets has steadily risen over the years and is at a very high 42% of Assets. The company plans to utilise the cash for the announced backward integration plans of setting up a knitting fabric plant (a key raw material) in FY11. 

The only blip that shows up is a high Finance cost to Total debt of over 30% in FY10. This is a sudden rise on account of high bank charges (~35 lakhs) and other finance charges (36 lakhs) adding to the ~60 lakhs interest cost. It is possible that the Total debt was reduced (4.41 Cr in FY10 from 7.85 Cr in FY09) at the fag end of the year, leading to the higher charges. 

Overall the picture that emerges is, Mayur Uniquoters has a strong clean balance sheet and is in a very comfortable situation, on the financial front. Again the record speaks highly of Management excellence.

Shilpa Medicare

Background

Description of the main business of the company and brief history of its journey since incorporation.


Main Products/Segments

Oncology APIs, Custom Synthesis, Bulk Drugs, Nutritional Supplements, Drug Intermediates.


Main Markets/Customers

The company is currently exporting the APIs to European countries.

Customer List – Actavis, Ratio Pharma, Sandoz, Intaas Pharma, Dr Reddy, Cipla etc


Bullish Viewpoints

  • Shilpa has created a niche area for itself by taking a lead into manufacturing to high quality Oncology APIs and Custom Synthesis.
  • The Oncology space is the fastest growing segment in the Pharma industry worldwide. Domestically the sector is expected to grow at CAGR of 25-30%+ for next few years.
  • The entry barriers are high as this segment needs a lot of expertise and years of research. Therefore the margins are very lucrative – as high as 40-45%.
  • Shilpa Medicare has an excellent past track record. The company has grown at a CAGR of 53% over last 5 years. From a turnover of 49 Cr in 2006 to 260 Cr in 2010.
  • Shilpa is the largest Oncology API manufacturer in India
  • The company has excellent margins of 30% and nice Balance Sheet.
  • The company keeps debts under control. The company is expected to have reduced debt from 115 Cr in 2009 to under 60 Cr in 2010.
  • The company keeps a tight check over inventory and debtors. Historically both these items remain less than 15% of turnover.
  • Oncology drugs worth $ 9 bn will loose market exclusivity between 2009-13. Many of these products are on Shilpa’s product list.
  • In Custom Synthesis, the company has entered into a JV with its long time customer, ICE Italy. ICE Italy is one the largest manufacturer of Bile Acid derivatives.

Bearish Viewpoints

  • Going ahead competition should increase as more players are entering the lucrative Oncology segment.
  • Being major turnover coming from exports, Exchange fluctuations are major risk.
  • Delay in off-take from European Customers

Barriers to entry

  • Barriers to entry are high as this space needs lot of knowledge and involves complex chemistry.
  • It took Shilpa 8 years to get hold of Oncology API space.

Interesting Viewpoints

  • Fast growing companies in Sunrise Sectors usually get very steep valuations – generally more than 25-30 times PE multiples.
  • Shilpa Medicare is still available at about 15 times earnings.
  • The company is expected to again double its Net Profits (from current 45 Cr to 90 Cr) in next 2 years backed by ongoing expansions and JV.

Disclosure(s)

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