Buy at the CMP and add on declines to the Rs. 98 – Rs. 106 band for sequential price targets of Rs. 145 and Rs.164 over next 2 quarters
We had initiated coverage on Astral Polytechnik Ltd (APL) in April 2007 at Rs. 84.0. The stock touched a high of Rs. 240 in January 2008. In our Q4FY08, result update we had asked investors to book profits in the Rs. 196 – 215 band. We present an update on the company post the Q1FY10 results and a discussion with the management.
Company Background
Astral Polytechnik Ltd (APL) is a manufacturer and provider of Chlorinated Polyvinyl chloride (CPVC) and Polyvinyl chloride (PVC) piping and plumbing systems in India since 1999. The company has production facilities at Gujarat and Himachal Pradesh to manufacture plumbing systems with diameter ranging from ½" to 8". The products include CPVC pipes and fittings for hot and cold water plumbing systems, industrial piping system for transportation of hazardous and highly corrosive chemicals, and lead free PVC system for cold-water application.
CPVC is polyvinyl chloride chlorinated via a free radical chlorination reaction. CPVC has become a popular engineering material for its properties. CPVC is significantly more ductile than PVC, allowing greater flexure and crush resis tance. Its mechanical strength makes it a viable candidate to replace many types of metal pipes in conditions where metal's susceptibility to corrosion limits its use. CPVC can withstand corrosive water at temperatures upto 90°C. CPVC is widely used in a variety of industrial applications where a high functional temperature and resistance to corrosive chemicals are desirable. In use as a plumbing material, CPVC exhibits comparatively high impact and tensile strength and is non-toxic, making it fit for water piping systems in residential as well as commercial construction. APL enjoys countrywide presence through its extensive distribution network comprising of more than 200 distributors and 3,000 retail outlets. Its products are very well accepted in all parts of the country though southern and western India contributes to more than 75% of its business. APL enjoys tax benefits at its Himachal Pradesh facility till FY2010. APL currently has a total installed capacity of 26,000 TPA as opposed to 11,800 at the end of March 2009. The capacity expansion carried out in FY09 has come on stream and is fully operational. APL spent about Rs. 65 cr on the same over the past 2 years.
Investment Rationale
· APL is the first licensee of Noveon, USA to manufacture and market CPVC piping and plumbing system in India. To strengthen its business plan, APL entered into a techno-financial joint venture with Specialty Process LLC of USA for manufacturing CPVC pipes and fittings for home and industrial applications.
· With a concept of providing a one-stop source for all the plastic piping systems, the company also began trading in products such as:
o CPVC and PVC fittings, flanges and valves from Spears (USA),
o Solvent cements for joining pipes and fittings from IPSC (USA)
o Underground specialty fittings from Hunter (U.K) and
o CPVC and PVC plastic pipes of a larger diameter from Harvell Inc. (USA)
· APL imports CPVC from Lubrizol, which is the leading manufacturer of this specialized polymer and controls over 80% of the global CPVC production. APL is the only large Indian company in the manufacture of CPVC pipes that has exclusive access to raw materials from the world leader Noveon-USA (Lubrizol) who holds patents for these products. This exclusivity acts as a barrier to entry for new players and gives APL a competitive advantage.
· APL’s raw material costs are dependent on crude oil prices and to a certain extent the INR/USD movement. The sharp fall in crude oil prices and stabilization of the INR vs the US$ in the Rs. 48-50 range reduces the raw material price volatility. Astral imports CPVC resin from Noveon Inc (Lubrizol) as mentioned earlier, while it procures PVC resin locally from Reliance Industries and IPCL.
· APL has strong promoter backing with the requisite expertise in the field. The promoters hold a 63.81% stake in the company. Of this, foreign promoters hold 25.61% while the Indian promoters hold 38.2%. IDFC Small & Midcap Equity (SME) Fund holds a 2.3% and the rest is largely held by the public. The promoters largely comprise of three groups - Specialty Process LLC (who hold around 14.1%, Engineer/Mehta Family (holding 38%); Dalal Family (holding 11.5%). APL is in a joint venture with Specialty Process LLC (manufacturing CPVC plumbing system since more than 25 years) to incorporate la test technology and quality control programs, which are widely accepted at global level, and to manufacture and market the most advanced CPVC plumbing system for the first time in India. Personnel from Specialty Process visit India at regular intervals and assist in new product development, selecting of machinery, product/ process development etc. Next, Mr. Sandeep P. Engineer (Managing Director) aged 48 Years, is a qualified Chemical Engineer and has been the promoter Director of the company. He has been pivotal in bringing the company to its current position and scale. He is also a director on the Board of Astral Technologies Limited (A JV Company), Astral Biochem Private Limited (Subsidiary Company), and Kairav Chemicals Limited. Lastly, Mr. Kyle A. Thompson, aged 48 years, is an Associate in Electronics from United States of America. He is also present on the board as non-executive director. He was earlier a Director in Thompson Plastics Inc., a CPVC manufacturing Company, situated at USA, promoted by his father Mr. Bernard Thompson. Presently he is consultant in CPVC manufacturing Company in United States of America.
· Traditionally, specific materials such as galvanized iron (for water transportation), PVC (for irrigation), FRP and stainless steel (for transportation of corrosive chemicals) are used for pipe manufacturing in India. However, the scenario is changing with the arrival of better alternatives, which often carry a price advantage as well. Currently, almost 70% of the demand for PVC pipes comes from agriculture sector. However, the demand from construction sector comprising sanitation and plumbing system is growing up rapidly with rising demand for urban housing and commercial and retail properties. CPVC pipes are also witnessing an increasing use in industrial applications. FY09 was a bad year for the Construction/Infrastructure Industry worldwide and India was no exception. Inspite of this, APL put up a decent performance. APL reported a 43% increase in topline to Rs. 194.22 cr and a 60 bps expansion in operating margins (to 15.8% in FY09). However, forex loss to the tune of about Rs. 13 cr (on imported raw material and buyers
credit) due to the deprecation of the INR against the USD impacted the bottomline. PAT fell 16.7% to Rs. 14.2 cr. However, things are looking up for APL now. The Rupee is range bound (it appreciated in Q1FY10), raw material prices have come down and there are signs of revival in the housing market, with most debt-trapped real estate companies raising cash. Moreover, the management expects the newly elected Government will spend more on education and health care, which will lead to creation of new infrastructure by way of schools, colleges and hospitals in the country. This will indirectly increase the demand for APL’s products. All these factors could augur well for APL.
· APL is likely to benefit from its reputed client base, which includes many large players in hotels, hospital, construction and chemical industries. Nagarjuna Construction, Shobha Developers, Kalpataru Homes, Cadila Healthcare, Hindalco, NTPC, Engineer’s India, East India Hotels etc to name a few.
· The recently completed capacity expansion is expected to add to volume, topline and profit growth. Additional capacity would augment its existing product range such as CPVC pipes & fittings, PVC pipes & fittings and new product range such as underground piping system, SWR piping system, and blaze master. The latest round of expansion is likely to allow the company to
grow in the next two years without any additional capex. However, the management has indicated that if the current run rate is anything to go by, then APL may need to consider expanding capacity soon.
· Starting from merely hot and cold water system, the company has expanded its product portfolio to include industrial piping, leadfree PVC plumbing, ABS pressure pipes, CPVC aluminium bendable pipes, sewage, waste and rain water management systems and underground drainage system. APL has added SWR Pipes, Underground Drainage Pipes and Foam core pipes to its bouquet of products. As per the management, the SWR pipes are doing well while the response to Foam core pipes has been in line with expectations. Trials of these products have been well accepted in the market and production of these products is expected to be ramped up in H2FY10. APL expects to launch Blazemaster Fire Sprinkler System, SWR Variants, Manholes and Inspection chambers later during the year.
· APL is also focusing on expanding its distribution network and increasing its distributor strength across the country, which will increase the awareness of the ASTRAL brand within the country.
· The company has successfully procured the approval of NSF (National Sanitary Foundation) for its Flowguard Products. The approval from UL (Underwriting Laboratory) for Blazemaster Pipes has also been received. Next, APL has also received the ISI certification for its SWR pipes. These approvals (from builders, government organizations and others) further certify the commitment of the company to producing quality products and will help in supplying these products to organizations that insist on these certifications.
· In FY08, APL had entered the overseas markets and started exporting its products to Nepal, Bangladesh and Srilanka by appointing local distributors in the respective countries. Next, in FY09 APL signed a Joint Venture agreement with a Kenya Based Group. A new entity has been formed under the name ' Astral Technologies Ltd’ and APL has taken a 26% stake in the said JV.
The new Company is based at Nairobi and has started its trading operations from October - 2008 by purchasing the products from Astral, India. This Joint Venture Company shall be the first step in establishing recognition of Astral’s products in East African Territories. While it is too early to comment about the success of this venture, the prospects look good.
· Sales revenue jumped 23.2% to Rs. 51.8 cr in Q1FY10 compared with Rs. 42 cr in Q1FY09 due to a doubling of capacity y-o-y. Sequentially though the sales were lower by 12.1%. This is because Q4 is the best quarter for the company. APL books about 35% of its overall revenue in the last quarter of the financial year like many other Indian corporates and thus to that extent quarterly sales sequentially are not comparable. In terms of volumes, APL reported a 28.6% jump y-o-y to 3,022 MT (On a q-o-q basis, output fell 19.3% in volume terms). The lower growth in topline in comparison to volume growth y-o-y is partly due to the sharp correction in crude prices (and hence its raw material) versus that prevailing in June 2008. The capacity expansion of 26,000 TPA has been completed and the management has indicated that it has been running its expanded capacity near full capacity utilization.
· The operating margins for the quarter stood at 15.2%, down 50 bps y-o-y and 30 bps q-o-q. This can be attributed to the following – depreciation of the Rupee y-o-y hence an increase in raw material costs as a % of sales (q-o-q though the Rupee appreciated and this is reflected in a fall in the raw material costs as a % of sales from 65.4% in Q4FY09 to 57.9% in Q1FY10), increase in staff costs y-o-y and q-o-q (APL has increased is staff strength by about 60-70 people during the quarter as a result of the expansion) and increase in other expenses q-o-q (Other expenses were low in the March 09 quarter due to year end adjustments).
· Other income fell y-o-y as Q1FY09 included interest earned on unutilized funds raised through initial public offering. On a q-o-q basis, other income has fallen sharply (719.4%) as Q4FY09 includes the write back of some discounts provided in the books.
· Interest has increased y-o-y due to capitalization of loans used to carry out capex. On a q-o-q basis, interest costs have come down as a result of a fall in interest rates. Long-term interest rates are down from 12% last ye ar to 8.75%. Further, APL has recently converted Rs. 25 cr of Rupee denominated loan into forex loan. The interest cost including hedging cost for this loan is about 8%. This could bring down the interest cost for the company in the quarters to come. APL has about Rs. 15 cr of buyers credit and Rs. 8 cr of working capital loan outstanding at the end of Q1FY10. The total loan amount outstanding is about Rs. 65 cr. APL booked gains of about Rs. 0.2 cr in Q1FY10 on the buyers credit repaid.
· Depreciation has increased to Rs. 2 cr for the quarter, up 80.3% y-o-y and 6.2% q-o-q due to the capex carried out by the company.
· APL reported a PAT of Rs. 4.4 cr for the quarter, down 5.7% y-o-y due to lower operating margins, lower other income and higher interest and depreciation charges. EPS for the quarter stood at Rs. 3.9. On a q-o-q comparison, PAT increased 15.9%. Q4FY09 includes a loss on buyers credit facility to the tune of Rs, 4.3 cr due to the depreciation of the INR.
· APL has provided tax at about 11.2% in Q1FY10. The full year tax rate was 11.8% in FY09 and the management has indicated that in FY10 the effective tax rate could be about 17%. Hence, the tax outgo could increase over the next few quarters.
Concerns
· CPVC is not as tough as copper or galvanized steel. Because of its flexibility (which can be an asset), it needs more support often than copper or galvanized steel at every 32 to 36 inches.
· Emergence of a potential substitute for CPVC with better physical and chemical properties could affect the business prospects of APL over the medium term.
· Non-renewal of joint venture agreement with Specialty Process LLC USA could affect the technical and marketing strength of APL temporarily.
· Any adverse movement in the Rupee Dollar rate (esp. weakening of the Rupee) could affect the profitability of APL as APL imports raw materials and avails buyers credit facilities, which are USD denominated. While the company also has forex loans outstanding, they have been hedged.
· Under-utilization of capacity due to a further slowdown in the real estate, construction and industrial sectors could impact APL’s performance. Capacity additions can also result in temporary surplus of production over demand, resulting in higher inventory carrying cost, which may adversely affect the operations of APL.
· Emergence of a competitor internationally to Noveon USA in CPVC and/or granting of licenses to other Indian Manufacturers could affect the competitive strength of APL.
· The new products proposed to be introduced by APL system could take time to be popular and APL may have to spend considerable time and resources for the purpose affecting its top and bottom line.
· Increase in crude oil prices could impact the raw material costs and in turn impact APL’s margins. However, in FY09, APL has proved its mettle, as operating margins were not impacted very sharply despite spiraling crude prices during the first half of the year.
· HP unit tax benefits are only available till March 2010. As a result, the company’s tax rate could increase in the subsequent years and hence affect profitability.
· Low liquidity in the stock could make the purchase of large quantities difficult due to large bid-ask spread.
Recommendation
APL’s products enjoy good acceptance in the market. Further, a revival in the real estate markets augurs well for the company in view of the growing acceptance for cheaper and better piping products. APL has continuously expanded its production capacity since inception. In the past five years alone, its capacity has gone up at a cumulative annual growth rate (CAGR) of 70.5% to 26,000 TPA from 1,800 TPA by end FY05. Due to strong demand in the past, the company may be able to fully utilize its additional capacity in FY10/FY11 itself. The latest round of expansion is likely to allow the company to grow in the next two years without any additional capex. However, the management has indicated that if the current run rate is anything to go by, then APL may need to consider expanding capacity soon.
The company is also expanding its distribution network in India, which currently stands at around 200 distributors and nearly 3000 dealers. It has set up a joint venture in Kenya to enter the African market and has plans to set up another plant in southern India. APL also intends to import machinery worth Rs. 2 cr by October 2009, which could increase the pipe manufacturing capacity by another 2,000 TPA. APL intends to carry out capex of Rs. 10 cr in FY10. Thus, one can expect APL to benefit from volume growth, which could translate into topline, and bottomline growth for the company. During FY09, APL achieved a 43% topline growth to Rs. 194 cr. However, its net profit fell by 16.7% during the year to Rs. 14.2 cr. The fall in rupee increased the company’s import costs and repayment liability on foreign currency buyer’s credit. Both put together, the company lost nearly Rs. 13 cr during the year. The recent rupee strength / stability is set to boost the company’s future performance. This will lead to volume driven revenue and profit growth in coming years. APL declared a dividend of Rs. 1 per share in FY09. We expect APL to report sales of Rs. 256.5 cr in FY10, a 33% growth y-o-y. This could translate in to a PAT of Rs. 21.7 cr (no forex losses assumed). At the current market price of Rs. 125.3, APL quotes at 6.5x its FY10 (E) earnings per share of Rs. 19.3. Investors could consider buying the stock at the CMP and add on declines to the Rs. 98 – Rs. 106 band for sequential price targets of Rs. 145 (7.5x FY10 (E) EPS) and Rs.164 (8.5x FY10 (E) EPS) over the next two quarters.
Source: Internet (Valuenotes by HDFC Securities)
