Mayur Uniquoters Management Q&A: Jun, 2011

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 4^th coating line starts, we will be able to shut off this 1^st 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.