Relaxo Footwears – A Value for Money Investment

 

  • Date: 4th Nov 2017
  • Industry: Footwear
  • CMP: Rs. 581
  • P/E: 56.4 and P/B: 11.5 times
  • Mid Cap: 7,003 crore mkt cap
  • Advice: BUY with a target price of Rs. 905 by May 2019
  • We prefer this stock to an IPO open currently.

Summary

  • Overview: Relaxo Footwear is a firm into footwear products for over 40 years; is India’s largest footwear maker and sold 13.5 cr. pairs in FY17. RXO offers comfort, style and affordable footwear. 70% of RXO’s sales is from the
  • RXO’s revenue in FY17 was Rs. 1,741 cr. and profits Rs. 123 cr. Revenues, EBITDA and PAT have grown at 19.8%, 24.1% and 30.9% CAGR from FY09-FY17.
  • Key new trends include growth in non-leather footwear and eCommerce. The firm is going to expand faster using the franchise model. Margins and volumes are likely to improve this year due to reduced interest & tax costs, new value added products and a favorable macro environment. RXO has adapted itself over the years to changing consumer needs.
  • Risks: The key risk is a rise in raw material prices could impact margins.

Here is our report on RXO Footwears Ltd. (RXO)

Relaxo Footwear – Description and Profile

  • RXO is engaged in the mfg. and sale of footwear products made of textile, rubber, PU (synthetic leather) and EVA (ethylene vinyl acetate). Today RXO is India’s largest footwear firm.
  • RXO’s revenue in FY17 was Rs. 1,741 crores and profits Rs. 123 cr. It has 4,855 employees.
  • RXO has its HO in Delhi and mfg. at Bahadurgarh (H’yana), Bhiwadi (Raj.) and Haridwar (U’khand).
  • RXO stepped into the footwear industry in 1976 when brothers Mukund Lal Dua and Ramesh Kumar Dua started off with the mfg. of slippers and subsequently expanded the range.
  • At present, RXO makes 6,75,000 pairs per day with capacity utilization of 60%. Products include slippers, canvas shoes, flip flops, PVC DIP shoes, sport shoes and sandals. The brands are Bahamas, Flite, Casualz, Schoolmate, Sparx, Elena, Mary Jane, Kidz Fun and Boston.
  • Unlike Bata and Metro Shoes, RXO has taken a conscious decision to stay away from leather products where the prices may be higher but the market size is much smaller.
  • RXO sells its products through 275 exclusive COCO stores {Company Owned and Co. Operated}, large format retail stores and e-commerce. However, the majority of company’s business comes from general trade, with 800 distributors and 50,000+ retailers across the country. 75% of the COCO stores are located in north India particularly in UP, Delhi, Haryana and Punjab.
  • As a part of its product positioning, RXO offers a combination of comfort, style and affordable footwear. See Fig 1. RXO has 6,000 SKUs and 400 articles (products).

jainmatrix investments, relaxo footwear

Fig 1 – RXO Product positioning; Fig 2 – RXO Geographical presence; Fig 3 – Brands  

  • RXO brands are promoted by Salman Khan, Akshay Kumar, Shahid Kapoor and Shruti Haasan from the film industry. Fig 3 highlights the positioning and target market of each brand.
  • Key Executives are: Ramesh Dua (MD), Mukund Lal Dua (Whole Time Director), Sushil Batra (CFO), Gaurav Dua (ED Marketing) and Ritesh Dua (ED Finance, Exports and HR).
  • Shareholding pattern % is: Promoters 74.9, DII 1.8, QFI 4.5, Individuals 5.0 and Others 13.8.

Business Notes, Strategies and Events

  • RXO reported a 1% rise in profit YoY at Rs. 37 cr. in Q1 FY18. Revenues grew by 19% to Rs. 483 cr. in Q1 FY18 YoY. Revenue growth was high in Q1 FY18 due to pre-ponement of sales prior to implementation of GST. However, the same kind of growth is not expected in Q2 FY18, but it may revive in subsequent quarters. This PAT growth was flat due to sharp increase in cost of materials by 37.1% YoY.
  • Management expects double digit revenue growth (mid-to-high teen) for FY2018 driven by improvement in sales volume and better realization (due to improvement in revenue mix).
  • GST has improved prospects as footwear priced up to Rs. 500 is now taxed at 5% (earlier 9.5%) and the rest at 18% (earlier 23.1-29.5%). This is a positive for organized footwear players.
  • RXO changed its 40-year old logo in Jan 2017 to stay relevant amid the changing consumer preferences.
  • RXO has always owned the resources like land, machinery, factory etc. to keep a check on quality. It has recently adopted the franchise model to accelerate reach in untapped markets.
  • In 2009 Bata had filed a case against RXO in the Delhi HC accusing it of infringement of its brand Sparx. The issue was settled out of the court in 2015 in favor of RXO.
  • RXO is setting up its 9th mfg. unit in Bhiwadi, Rajasthan with a capex of Rs 100 cr. to make the Hawai brand of footwear as current capacity is fully utilized. This should boost revenues.
  • eCommerce is an important channel with an Online Presence with shopatrelaxo.com and Online Shopping Websites like Amazon, Flipkart, Snapdeal, Jabong, etc.

Industry Outlook

  • The total footwear industry is of Rs. 55,000 cr. and organised sector is of Rs. 10,000 cr.
  • Relaxo has a 3% market share within the entire industry and 20% of the organized footwear market in value terms, and 5-6% in volume terms. It sold 13.5 cr. pairs of footwear in FY17.
  • The domestic footwear market in India is projected to grow at a CAGR of 15% from FY16-20. The key drivers for the footwear segment will be: a) increased adoption owing to versatility in usage, and b) shift from unbranded to branded.
  • Men’s footwear dominates this market with 54% share, next is women (37%) and children/ school (9%). But women’s segment will outpace Men’s to take 41% of the market by FY 2020.
  • Branded footwear market is expected to grow at a CAGR of 20% to account for 50% of the organized market by FY 2020 from current 40%.
  • Footwear market is among the most organized categories in the country with 26% of the organized share with presence of EBOs (Exclusive Brand Outlets). The unorganized pie of 74% will grow at 14% while the organized market will grow at 18% CAGR to account for 29% of the market by FY21. (Source RHP)
  • Bata India has the largest store network followed by Khadim’s and Liberty Shoes. See Fig 4.
  • 54% of the retail stores sales are under the Rs. 500 category and 30% in the range of Rs. 500-1000. See Fig 5. 70% of Relaxo’s sales is generated from the

jainmatrix investments, relaxo footwear

Fig 4 – Store network of footwear brands / Fig 5 – Average Selling Price and Shares

Stock Evaluation, Performance and Returns

  • The share price has grown at 54.2% CAGR over 5 years and at 34.6% over 2 years. This includes a split in Nov 2013 (FV 5 to FV 1) and a bonus in July 2015 (1:1). See Fig 6.
  • The FY17 remuneration of Mukund Dua and Ramesh Dua is high at Rs. 9.12 cr. each. Under Companies Act, the ceiling in pay to key managers is 10% of profits. This limit is being given as remuneration.

jainmatrix investments, relaxo footwear

Fig 6 – Price History

  • Revenues, EBITDA and PAT have grown at 19.8%, 24.1% and 30.9% CAGR from FY09-17. We can see improvements in Operating & Profit margins even as Revenues grew steadily. See Fig 7.
  • Dividend growth has been good. RXO has generated positive Free Cash Flow in the last 8 years indicating conservative financial management, Fig 8.

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Fig 7 – Quarterly Financials / Fig 8 – Cash Flow 

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  • The historical average for PE is at 37.6 times of the last 5 years. However in the last 2 years, it has risen to 45.2 times, implying a re-rating. Currently RXO has PE of 56.4 times and is the top quadrant. See Fig 9.

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Fig 9 – Price and PE Chart / Fig 10 – Price and EPS TTM Chart

  • The earnings of RXO grew 4x from Jan12 – Jan16. In Fig 10, we show the EPS growth in a channel. Employee costs rose sharply from Mar 2016 affecting the EPS growth. Later demonetization also affected business.
  • ROCE and ROE are 25.7% and 22.6% respectively which is robust.
  • The D/E of the firm has fallen from over 0.96 to 0.38. This is a positive. As per mgmt. in Q1 FY18, RXO’s interest costs fell over 50%. This is likely to drive the margins up.
  • However earnings revival will be witnessed now due to benefits arising from GST, fall in interest costs, premiumization of product portfolio and adoption of the franchise model for faster expansion.

Benchmarking and Financial Estimates

We present a benchmarking exercise with listed peers in similar product categories. Since Mirza Intl. is focused on exports, it is not strictly comparable. See Exhibit 11.

  • In terms of P/B the valuations appear high. However this is explained by RXO strategy of owning the mfg. plants. P/E appears little high. RXO has good growth and a low D/E ratio compared to the peers.
  • RXO leads on margins, which reflects on good sales and costs controls. They are likely to improve as the management continues to focus on premiumization products while also focusing on cost reduction.
  • The return ratios are robust with a leading RoE score. The dividend yield is fair.
  • In all we can conclude that RXO looks more attractive than Khadim whose IPO is due.

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Exhibit 11 – Benchmarking / Exhibit 12 – Two year Projections  

Financial Projections: We present 2 year financial projections for RXO, see Exhibit 12.

Strengths                                                     

  • Key new trends include growth in non-leather footwear and eCommerce. RXO has only a small fraction of leather, and may benefit from this. On eCommerce RXO has its own website and tie ups with popular portals to grow online presence.
  • Strong brand equity strength & Celebrity endorsement: RXO has many brands, and has created good brand equity by endorsing celebrities to connect brands with customers, like Salman Khan, Akshay Kumar, Shahid Kapoor and Shruti Haasan. These activities positively impact volume growth.
  • GST: 70% of RXO’s sales falls in < Rs 500 price which has been positively impacted by lower GST.
  • Improved Financials: RXO has reduced debt over 5 years and current D/E is at 0.2 times, lowering interest costs in Q1 FY18. Along with premiumisation these will improve margins in the medium term.
  • RXO is a well-managed firm financially. The return ratios have historically been high and the cash flow management is good. This is a positive from an investment perspective.
  • Exports is a priority and will help RXO ramp up volumes in future.
  • RXO owns all its mfg. facilities. This allows better quality control and higher returns.
  • While the two brothers have been running the firm for 40 years, the next generation appears to have smoothly taken charge along with senior professionals. There should be continuity at RXO.
  • Focus on fashion: The key driver at RXO is to be in-sync with changes in fashion for consumers. Many of the new brands, design changes and premiumization initiatives are to tap consumer behavior. The new logo of Relaxo has also been created to appeal to the younger crowd.
  • A fall in rubber and raw material costs in recent times has helped RXO to improve margins.
  • The initiative around franchisee network growth will help RXO expand reach and availability.
  • Capacity utilization at RXO is 60% so there is ample room to grow volumes.

Risks and Challenges

  • The IPO of Khadim which is ongoing may throw a spotlight on the sector, and make valuations expensive. RXO has already gained close to 20% in the last 1 month.
  • Also some investors in Relaxo may like to exit it and enter Khadims.
  • High valuations – at a PE of 56 times, a lot of growth and profitability expectations are baked into the price. Any non-delivery of such performance will result in a big correction of price.
  • Any change in Govt. policies, and GST tinkering can affect the company’s performance.
  • Rubber and crude oil prices volatility can affect the costs structure and margins. The key raw materials, ethylene vinyl acetate (EVA) etc., are crude derivatives and hence prices follow the crude cycle with a lag effect. A sharp rise in these crude prices could significantly affect input cost.
  • Intensifying competition – entry of MNCs such as Nike, Adidas, Puma and many top brands can affect RXO. However our feel is that currently these firm’s products are priced much higher and so will not affect RXO.
  • Macro-economic factors like a downturn in the economy, unforeseen political and social upheavals, natural calamities and below normal monsoon can affect RXO.
  • Any sharp fluctuations in dollar price can adversely impact the cost of imported raw materials.
  • In family owned businesses there is always a risk of breakups and business separation.
  • High promoter compensation – it is at prescribed limits.

Overall Opinion, Outlook and Recommendation

  • In India the per capita consumption of footwear is 1.66 per year compared to 3 pairs globally and 6-7 pairs in advanced countries. This indicates high potential demand.
  • RXO has a positioning of a Value for Money but visible and good quality footwear. There is a massive unorganized sector in footwear. With GST and other tax initiatives, RXO may capture a lot of marketshare vacated by unorganized sector while taking up premiumization and brand strengthening.
  • The management is planning to expand faster using the franchise model. FY17 was flat financially on account of demonization and higher employee expenses. The margins and volumes are both likely to improve this year on account of reduced interest & tax costs, introduction of more value added products and a favorable macro environment.
  • RXO has adapted itself over the years to changing consumer needs and preferences. This financially reflects well on the company in terms of superior return ratios and good cash flow management.
  • Valuations are expensive at P/E of 56.1, but good companies tend to be richly valued for long durations.
  • We project a target price for RXO of Rs. 905 by May 2019, a rise of 55% absolute and 33% annualized.
  • Investors can BUY this share with a 2 year investment horizon.

Disclaimer

  • This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same.
  • The basis for the Financial Projections in Exhibit 12 and Target Price are revenue growth per footwear pair at 8% p.a. for FY18-20, volume growth of 11% p.a. for FY18-20, margins at Q1FY18 levels, a P/E target of 50x, management commentary and analyst judgement.
  • Punit Jain has no position in Relaxo Footwears. In addition, JM has no known financial interests in Relaxo Footwears or any related group.
  • Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of Investments can go down as well. The suitability or otherwise of any Investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

 

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IRB Infra Developers – In InvIT we Trust

  • Date 25th July 2017
  • CMP: Rs 217
  • Mid Cap with Rs 7,600 cr. Mkt Cap
  • Industry – Infra/ Roads
  • Advice: BUY

Summary

  • Overview: IRB Infra is a top 5 roads & highway construction firm. It has a good portfolio of legacy and current projects, including Mumbai-Pune expressway and Ahmedabad – Vadodara highway. The 10 year growth in revenues, EBITDA and profits are 25.1%, 23.8% and 21.2% CAGR resp. With tight internal financial controls, this is a well-run business. They bid for larger BOT road projects and are able to execute successfully and within timelines.
  • Why Buy Now: 1) With the IPO of the IRB InvIT, IRB’s debt to equity fell from 3:1 to 1.8:1. The firm will now move to a more profitable period. 2) The sector outlook is good with revival of many stuck road projects, good budget allocations and a fast moving ministry 3) Attractive valuations.
  • Key risks are: 1) Political and legal risks of this sector. Criminal investigations pending against the top IRB executives 2) Periodic protests against toll collection on some roads.
  • Advice: The valuations are attractive at a P/E ratio of 9.9. IRB is a Medium Risk, High Gain stock. BUY with a 2 year perspective.

Additional Notes

  • A report on IRB was published for paying subscribers in Apr 2016.  We revisit the firm as it is once again attractive at these levels.
  • SIGN UP for the investment service subscription to gain exclusive access to such high quality investment reports.
  • We’ve been tracking this firm for 5 years, see our 2012 report – IRB Infra Developers – A Rising Road Star  

Here is a note on IRB Infrastructure Developers (IRB).

IRB Infrastructure Developers – Description and Profile

  • IRB is a Mumbai based road construction firm which does EPC and BOT projects.
  • FY17 revenues were Rs 5,846 crores & PAT 715 cr. The Revenues, EBITDA and Profits grew by 25.1%, 23.8% and 21.2% CAGR over 10 years.
  • IRB constructs Highways. The revenue segments are EPC (60%) and BOT (40%). It developed India’s first BOT project (Thane Bhiwandi Bypass) and operates Mumbai – Pune expressway. It has one of the largest BOT portfolios as it has constructed 11,828 km. of road so far. It has a 20% share in the golden quadrilateral (highways between 4 metros).
  • IRB has 6,000 employees. The order book stands at Rs. 9,959 cr. (FY17).
  • IRB operates in 2 models, BOT and EPC. The govt. in FY16 launched the hybrid annuity model, however IRB intends to focus on BOT toll road projects.
  • IRB launched India’s first Infrastructure Investment Trust (InvIT) in May 2017 which had an IPO. Through the trust, IRB (Sponsor) is holding 6 operational NHAI toll road assets with 3,645 lane km of highways across 5 states in west and south India. These assets are operational and generate income through inflation-linked tariff hikes. InvIT Investors are expected to be offered returns in the form of dividend, interest and buyback for holding units in the InvIT. The IRB InvIT CMP is Rs 97.5.
  • Leadership is V Mhaiskar (CMD), Ajay Deshmukh (CEO), and Anil Yadav (CFO)
  • Shareholding pattern % is: Promoters 57.4%, DII 7.4; QFIs 27.9, Individuals 4.4, others 2.9%.

irb infra, jainmatrix investments

Fig 1 – FY17 Order Book/ Fig 2 – State wise BOT portfolio

Business Model

  • In Build, Operate and Transfer (BOT) it constructs a road and then maintains it for a ‘concession’ period (15-30 years) while collecting toll, before handing it back to the govt. BOT projects involve upfront premium payment; revenues start once toll collection starts, and construction is internally funded, so loans have to be tied up (financial closure).
  • The Engg., Procurement and Construction (EPC) model involves the construction firm executing the project and collecting payments on achieving milestones of quantity and quality. On completion, the firm hands over the asset and collects all payments.
  • However the BOT model which was common earlier has faced high failure rates recently. To revive the road sector, the govt. decided to switch back to the proven EPC model. In Apr 2015, the govt. launched a hybrid annuity model. Under this, the govt. provides 40% of the project cost to the developer to start work while the remaining investment will be made by the developer.

IRB Infrastructure Investment Trust (InvIT) IPO

  • SEBI introduced infrastructure investment trust (InvIT) regulations keeping in mind the huge funding needs for infra.  InvIT enables developer-owners of infra assets to monetize their assets by pooling projects into a Trust, having an IPO and attracting better investors.
  • InvITs have to distribute 90% of their net cash flows to the unit investors. There is a cap on exposure to under-construction assets for publicly placed InvITs. The sponsor of the InvIT is responsible for setting up the InvIT and appointing the trustee. The sponsor (say IRB) has to hold minimum 15% of the units issued by the InvIT with a lock-in period of 3 years from the date of issuance. The InvIT regulations specify 80% of investments in completed and revenue-generating assets.
  • The IPO of IRB InvIT Fund opened on 3rd May, 2017. IRB InvIT was the first Indian company to list an InvIT. It was subscribed 8.57 times. Institutional investors who participated in the anchor book allocation included foreign investors such as the govt. of Singapore, Schroder Asian Asset Income Fund, Deutsche Global Infra Fund and Jupiter South Asia Investment Co. as well as DIIs such as Birla Sun Life MF, HDFC Standard Life and Birla Sun Life Insurance.
  • IRB received Rs. 2,600 cr. for sale of equity in 6 project SVP’s transferred to IRB InvIT fund. The consideration was as follows: 1) Rs. 1,681 cr. upfront 2) Units in IRB InvIT Fund worth 889 cr.
  • The funds will be used for new projects and to reduce debt. Post the launch of InvIT, IRB’s net debt to equity fell from 3:1 to 1.8:1. IRB expects a rating upgrade because of the same.
  • The following operational project assets were transferred to the InvIT:

irb infra, jainmatrix investments

Exhibit 3 – Operational projects transferred to IRB InvIT

  • InvITs have a minimum investment limit of Rs. 10 lakh per investor. The InvIT generates income on these assets is in the form of toll collection from road assets and interest on cash in the books. The Trust distributes at least 90% of this cash to the unit holders in the form of dividend, which is tax free. The dividend yield was estimated to be close to 12% at the upper price band of IPO (Rs. 102).
  • IRB has a 15% stake in IRB InvIT. Future projects by IRB can also be sold to InvIT.

Industry Outlook

  • The transport sector constitutes 6% of the country’s GDP. India has an extensive road network of 33.4 lakh kms. which is the 2nd largest in the world.
  • According to the 12th Five Year Plan, India transports 57% of goods by road, as compared to 22% in China and 37% in USA. Despite the performance of the road transport sector, the sector faces slow technological development, low energy efficiency, pollution and slow movement of freight and passenger traffic. GoI has now launched an initiatives to upgrade & strengthen highways.
  • There are 96,261 km of national highways in India, constituting less than 2% of India’s entire road network but carrying approximately 40% of total road traffic.
  • The National Highway Authority of India (NHAI) and the Ministry of Road Transport & Highways had sanctioned projects for 3,161 km’s in 2014-15. & 2,337 km’s in 2015-16. A solid 10,098 km’s and 16,031 km’s, respectively, were awarded during FY16 and FY17.
  • The list of Peers of IRB is over 50 Listed firms, plus diversified and unlisted firms. Competition includes Reliance Infra, Jaypee Infra, IL&FS Transportation, GMR Infra, Lanco Infra, L&T, IVRCL, Ashoka Buildcon, etc. However in the BOT segment, we believe qualified firms are few.
  • Our quick estimate is that IRB has about 4-6% market share, by revenues. In terms of quality of projects and proven expertise, IRB definitely falls in the top 5.
  • For FY16, an outlay of US$3.8 bn. was provided for the highway sector.

Business Notes, Recent events and Strategies

  • Recently after the listing of IRB InvIT, other sector players like GMR, IL&FS Transp. Networks and L&T also plan to set up their InvITs.
  • The Q1 FY18 Revenues and PAT were Rs 1870 cr. (up 21% YoY), and 238 cr. (up 31% YoY) resp. The results were good largely on account of execution pickup and InvIT listing.
  • D/E Ratio is reduced from 3:1 to approx. 1.8:1; this may lead to a credit rating upgrade. IRB had declared an Interim Dividend of Rs. 2.5/- per share for FY18. The board approved offering of Pathankot – Amritsar project to IRB InvIT Fund.
  • IRB and MSMRM were registered under a case for not taking safety measures while carrying out widening work on NH66 in March 2016.
  • In Jan 2016 IRB bagged the Rs.10,050 cr. Zojila Pass tunnel road project in J&K, the country’s biggest road project. But in Mar 2016 the project was cancelled, due to some political issues. Now the project has opened for re-bidding. Reliance Infra, Jaypee Infra, IL&FS Trans. and L&T are bidding.
  • In Nov 2016, currency notes of 500/- and 1000/- were demonetized and the govt suspended the user fee collection on National Highways from 09th Nov to 2nd Dec 2016. NHAI had later said that they would compensate infra companies for the loss of toll collections. IRB received Rs. 30-35 cr. cash compensation in Q3 FY17 itself which was adjusted against payment to NHAI. A similar amount of compensation is expected to be received soon.
  • IRB has guided that revenue and EBITDA would be flat for FY18 as 6 operational assets have been transferred to the InvIT, however PAT may go up because of reduction in interest payment on lower debt. IRB has also guided that they have identified 18,000 cr. of projects where they are qualified to bid and they will do so as and when it comes up for bidding.
  • They have guided a 6-7% traffic growth in FY18 and a 10% revenue growth in construction order book for FY18. Also a 2-2.5% inflation in ticket prices could be witnessed.
  • IRB approved acquisition of 34% stake in its arm Aryan Infrastructure Investments Pvt Ltd (AIIPL) from promoters to make it a wholly-owned subsidiary in Mar 2017.
  • About 0.14% of the equity base has been pledged by the Promotor & Promoter Group.

Stock evaluation, Performance and Returns

irb infra, jainmatrix investments

Fig 4 – Price History / Fig 5 – Quarterly Financials 

irb infra, jainmatrix investments

 

  • The price history in Fig 4 shows that the share price had touched a 1 year high of Rs. 272.
  • This was ahead of the launch of the InvIT and the share had a low of Rs. 178 post demonetization. The share price is currently 21.7% below the peak and 19.7% above the low.
  • Investors in IRB have got a return of 9.7% CAGR over 5 years and -4.5% CAGR in the last 2 years.
  • Revenues, EBITDA and Profits of IRB are up by 25.1%, 23.8% and 21.2% CAGR over 10 yrs., see Fig 5. EBITDA is in 50% range while Profit margins are in 12% range.
  • Fig 6 indicates Free Cash Flows for the period FY09-16. The company has not been able to generate free cash flows to equity shareholders given the nature of business. This is a negative. However the cash flow situation should improve as the capital investments get freed under the InvIT ownership.
  • Current P/E is 9.9 of TTM earnings, while the Price/ Book is 1.35 times. This is low and attractive.
  • Debt equity ratio is 1.8:1 (May 2017) which has reduced drastically after the launch of InvIT.
  • Beta of the stock is 2.12 (Reuters) indicating high volatility. Thus any positive or negative news can move the share price sharply in those directions.
  • Dividend yield of 1.88% currently is good as compared to its peers.

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Fig 6 – Cash Flow / Fig 7 – Booked to Billing ratio

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  • The Orders Booked to Billing ratio (BTB) for IRB is in Fig 7. Order Booked position at IRB was 9,959 cr. (FY17), and the 1.7 years of Booked to Billings is low. This may improve in the near time. The Zojila tunnel project cancellation severely impacted the ratio. IRB has guided that there are Rs 18,000 cr. of projects where they are qualified to bid and they will do so as and when it comes up for bidding.
  • The PE ratio has a historical range of 5-25 over 9 years, and the average is 15 times. It is now at 9.9 (Fig 8) and so IRB appears undervalued. The EPS charts in Fig 9 shows that EPS grew rapidly in 2008-11, then flattened out in the high interest rate / low economic growth situation of 2011-14 and now appears to be recovering on the backdrop of govt. initiatives coupled with favorable macro-economic factors. The recent fall in PE is caused by good growth in EPS and flat market price range.

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Fig 8 – Price and PE graph / Fig 9 – Price and EPS graph

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 Strengths of IRB

  • IRB has a good reputation with high quality BOT assets and financial and execution capabilities.
  • The InvIT model is excellent for IRB to monetize its operational BOT assets. With the only successful InvIT in India in place, IRB has been able to reduce debt substantially. BOT assets will also attract right investors who are looking for steady returns over 10-30 years.
  • IRB is in a unique position to sharply focus on construction efficiencies. With a sharp reduction in debt and improvement in reserves, IRB is in a position to reduce interest costs compared to earlier and to bid for new BOT projects without funding constraints.
  • IRB has a diversified project portfolio and revenue base currently spread over 8 states.
  • Current valuations look very attractive for fresh investments.
  • The Roads sector is on a big upswing with NHAI and govt. ramping up on an infra push.

Weaknesses and risks with IRB

  • Even at 1.8 times, D/E is high for IRB, and the focus needs to be to sell assets to the InvIT.
  • In BOT projects, toll revenues depend on toll receipts, which, in turn, depend on toll fees and traffic volumes on the toll roads, and factors which may be outside of IRB’s control, including, fuel prices in India, the frequency of traveller use, the number and affordability of automobiles etc.
  • There is a 2009 pending criminal investigation – a case was registered at Lonavala police station against IRB top executives, alleging illegal purchase of govt. land in villages Pimploli & Ozarde, District Pune on the basis of fake and forged documents. Later on 13th Jan 2010, the related RTI Activist was murdered. In the event that there is any adverse finding in the land acquisition matter or in the murder case, the reputation of the IRB and its business may be adversely affected. However roads is a tough sector, and there will be much litigation as part of the business.
  • Political and legal risks are high in this sector.
  • There have been periodic protests against toll collection on some roads.
  • So far, IRB has only bid for larger and more profitable projects. In future, to keep its growth trajectory in place, it will have to bid aggressively for more projects.
  • So far IRB has been strong in West India: Mah., Raj. & Guj. It has to develop a more national profile.

Benchmarking

In a Benchmarking exercise, we have compared IRB to other infra companies, in Exhibit 10.

irb infra, jainmatrix investments

Exhibit 10 – Benchmarking

  • We can see that a few of the companies in the roads sector are in financial distress. We added Adani Ports to bring in the perspective of a well-run Indian infra company.
  • IRB stock appears to be on the attractive side in terms of P/E and to a lesser extent P/B.
  • It also leads on margins. It has performed average in terms of growth of sales and profits. However this can change with a good business outlook. Dividend yield is good. Asset turnover may improve as more operational BOT projects are handed over to InvIT.

Opinion, Outlook and Recommendation

  • There is an urgent need to upgrade Indian infrastructure such as roads and highways. This was reflected in the Feb 2017 Indian budget announcements. We can see that on one side highways have improved a lot in the last decade. At the same time it seems that in a short while after new roads are opened, they seem to be crowded and used to capacity!!
  • The sector is seeing clear signs of improvement with the govt. making progress in reviving old stuck projects as well as opening bidding for many new ones.
  • IRB has a good reputation in the roads sector, with an excellent portfolio. It bids for larger projects and is able to execute within timelines. It is well managed financially with a fair balance sheet.
  • The roads sector recovery has been slow so far with bottlenecks, but we believe that the introduction of the InvIT structure is a game changer.
  • IRB is the first to successfully launch InvIT fund. It has been able to bring down the debt which will help in freeing up capital for fresh investments. In the last 3 years, the average earnings growth stands at 16% p.a. Reduced interest cost, traffic volume growth and faster churn of new projects is likely to aid earnings growth.
  • The valuations are attractive at a P/E ratio of 9.9.
  • IRB is a Medium Risk, High Gain stock. BUY with a 2 year investment horizon.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has been a long term investor in IRB Infra since Feb 2008. Other than this, JM has no known financial interests in IRB Infra or any related group. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

IndiGo Airways – Flying High, Wide and Handsome

  • Date: 30th May, 2017
  • CMP: Rs 1,060
  • Advice: HOLD
  • Industry – Airlines
  • Large Cap – 38,500 cr. mkt cap 

Overview:

  • Overview: IndiGo is the market leader in Indian aviation with a low cost carrier model. They have a leading domestic market share of 40.4%. The revenue and profit were Rs 19,370 crores and Rs 1,659 cr. resp. for FY17. The Income, EBITDA and profits have grown 32.7%, 25.6% and 19.4% CAGR over 8 years. Aggressive growth plans are in place for capacity addition.
  • Key risks: 1) Competition has intensified in the domestic market, weakening pricing power 2) A sharp rise in fuel prices is a risk to profitability. As a result EPS has reduced recently.
  • Opinion: The valuations are rich currently and hence investors are advised to HOLD the stock until earnings recovery process begins.

On 5th Feb, 2016 we had published a report for subscribers for a BUY call at Rs. 829 after sharp share price fall on account of a one-time event. The share price is up 21.8% since then and is now being released for public viewing. SIGN UP for the investment service subscription to gain exclusive access to such high quality investment reports.

Here is a note on the IndiGo Airlines (IGO).

Description and Profile

  • IndiGo is a low-cost carrier airline based in Gurgaon, India in operation since 2006,.
  • IGO’s revenue and profit were Rs 19,370 crores and Rs 1,659 cr. resp. for FY17.
  • Market share based on passenger volume was 40.4% in FY17 for the domestic market.
  • Owned by InterGlobe Enterprises, IGO operates 896 daily flights to 44 destinations including 6 abroad of Bangkok, Dubai, Kathmandu, Muscat, Singapore and Doha. It has its primary hub at Indira Gandhi Intl. Airport, Delhi and operates 131 aircrafts all of which are Airbus A320.
  • IGO’s domestic ASKs (Available Seat-Km.) increased from 530 crore (FY09) to 5458 crore in FY17, growing at 33.8% CAGR. It has an aggressive growth plan, with a current order book of 400 A320 neo aircrafts.
  • IGO added 5 new aircrafts in Q4 FY17. It is also venturing into regional routes, and has signed a term sheet for the purchase of 50 ATR’s (small aircraft). Deliveries will start in Q3 FY17, and by FY19, it will be a fleet of 20 ATRs.
  • IGO’s maintenance costs are the lowest among Indian carriers.
  • Leadership team is Aditya Ghosh (President), Riyaz Mohamed (Aircraft Acquisition/ Financing), Ankur Goel (Director) and Rohit Philip (CFO).
  • Shareholding in % is: Promoters 85.88, QFI’s 6.42, DII 1.65, Individuals 3.40 & others 2.65.

Business Notes, Strategies and Events

  • IGO declared a final dividend of Rs 34/share which is a payout ratio of 90% and yield 1.4%.
  • IGO plans to use ATR-72 planes to feed its mainline network in a hub and spoke model. Recently it announced a provisional order for 50 ATR-72 planes valued at $1.3 bn. IGO expects deliveries to commence from 2017-end. The new aircrafts will be used to launch flights under the government’s regional air connectivity scheme, UDAN (Ude Desh Ka Aam Naagrik).
  • IGO reported a 24.6% fall in the Q4 FY17 net profit at Rs 440.2 cr. against Rs. 583.7 cr. posted during the same period last year. Its total income was up 18.5% at Rs. 4,848.2 cr. against Rs 4,090.6 cr. YoY. The PAT fell sharply on account of higher fuel prices.
  • IGO recently partnered with Australian flight training institute, Flight Training Adelaide (FTA), to provide training to its pilot cadets.
  • The management of IGO is looking to convert some of its Airbus A320neo planes to A321neos that will allow it to fly more passengers per flight and increase flight range.
  • Engine Problem: Pratt & Whitney 1100G engines of Airbus A320 neo faced technical issues recently. The engine is facing twin problems. One in the combustion chamber and the other is with the third bearing of the engine. IGO executives expect A320 neo engine-maker Pratt & Whitney to provide a solution to the combustion chamber problem by Q4 2018.

Indian Aviation Industry Review

  • The Indian aviation industry is the 9th largest market globally. Total passenger traffic stood at 22.36 cr. in 2016 and there were 85 international airlines connecting to over 40 countries.
  • In terms of number of seats per capita, India is quite low – India has 0.08 domestic seats per capita, while Philippines (0.29), China (0.31), Indonesia (0.41) and Thailand (0.48) are much higher. (FY15)
  • Domestic air passenger volumes are likely to grow 25% for FY18.
  • The Airline industry is a very tough globally, characterized by high airplane costs (the Airbus and Boeing duopoly), high fuel costs, parking, airport and MRO charges. Costs are largely fixed. On the other hand, demand is cyclical and varies by season & economic cycle.
  • Anecdotal evidence shows that the sector is a destroyer of value. Many countries support their national carriers, even though there are losses, as it may be a matter of national prestige.
  • Industry market shares in Mar 2017 are presented in Fig 2. (Source DGCA).

jainmatrix investments, indigo

Fig 1 Industry Market Shares /Fig 2 – IGO Operational revenues

  • The Indian aviation industry has been aided by a slow moving Indian Railways, that is losing market share, had weak capacity growth, poor passenger service levels and slow trains.
  • Indian aviation is expected to become the 3rd largest market by 2020. Indian carriers plan to increase their fleet to 800 aircrafts by 2020. (Source: GoI/ DIPP).
  • A number of foreign investors are present in India including Airbus, Boeing, AirAsia, Singapore Airlines, Rolls Royce, Frankfurt Airport Services, Honeywell Aerospace, Malaysia Airports Holdings, GE Aviation, Airports Company South Africa and Alcoa Aerospace.
  • Indian aviation is experiencing dramatic growth with the emergence of LCC, as well as new carriers, and a growing middle class ready to travel by air for business and leisure.
  • Growth in airlines is causing demand growth for MRO (maintenance, repair and overhaul) facilities. Indian authorities plan to double the number of airports to 250 by 2030.
  • The failure of Kingfisher Air indicates the market is not ready to pay prices of 2-3X of LCC tickets.

Stock Evaluation, Performance and Returns

jainmatrix investments, indigo airways

Fig 3 – Price History

  • See price history detailed in Fig 3. The IPO was in Nov 2016, at an issue price of Rs. 765, and the share price has appreciated 38% generating good returns.
  • We can see that the share price had an all-time high of Rs 1,396 in Jan 2016 and a low of Rs. 702 in Feb 2016. Today the share price is 31.7% below the peak and 51% above the low.

jainmatrix investments, indigo airways

Fig 4 – Indigo financial performance

  • The annual and quarterly financials of IGO in Fig 4 reveal a steady increase in revenues. Margins and PAT have fallen in FY17 on account of high crude prices.
  • The Income, EBITDA and profits have grown 32.7%, 25.6% and 19.4% CAGR over 8 years.
  • The total debt by end FY17 was Rs. 2,596 cr. The entire debt for IGO is aircraft related. IGO does not have any working capital debt. The D/E of the firm is high at 3.16 times. This is a negative.
  • The margins are moderate with Operating and Profit margins at 15.1% and 8.6% for FY17.

jainmatrix investments, indigo airways

Fig 5 – Cash Flow Position 

jainmatrix investments, indigo airlines

Fig 6 – Price and PE graph / Fig 7 – Price and EPS graph

  • The business has generated free cash flows throughout in the last 6 years. This is a positive.
  • The share has traded at an average PE of 18.12 times since listing. Today it is at 24.70 times, so valuations are above historical average. See Fig 6. However trading history is short.
  • The EPS TTM has fallen in the recent quarters, see Fig 7. This is on account of fall in demand post demonetization, higher fuel costs & engine rentals and greater competition.

jainmatrix investments, indigo airways

Fig 8 – Financial Metrics

  • In the airlines sector, fuel costs are a significant proportion of overall revenues. In this context, we can see IGO’s ratio has been volatile and is high currently. See Fig 8. The aircraft fuel expenses and engine rentals have risen sharply in 2 years. The load factor has been flat over the last 8 quarters.
  • From the chart below we can see that the yield has fallen significantly over the last 8 quarters. In the recent quarter, the yield was impacted on account of fall in consumer spending post demonetization. However the management in confident of fast recovery in yields. See Fig 8.
  • With load factor 86.1% recently and rising, IGO is performing impressively.

Benchmarking

jainmatrix investments, indigo airlines

Exhibit 9 – Benchmarking

We benchmark IGO against listed peers and an Infra asset firm. Based on Exhibit 9, we conclude:

  • Sales and PAT Growth has been impressive at IGO over the last 3 years.
  • Debt is high and that is expected in this industry. With cash flow improving in recent quarters, we can expect that they would be able to control debt while investing in capacities.
  • Margins are moderate, however leading amongst the listed Indian peers. Dividend yield is high. This is positive. The valuations appear expensive, both in terms of P/E and P/B ratio.

Positives of the firm

  • IGO dominates with a large market share in one of the largest & fastest growing aviation markets.
  • It’s a successful implementation of the LCC business model with single aircraft type, high aircraft utilization, high operational reliability, no-frills product, and low distribution & maintenance costs.
  • IGO is a strong brand developed with good advertising & marketing strategies.
  • It has maintained consistent profitability and strong cash flow generation in the last 6 years.
  • By placing a large Airbus aircraft order, IGO has gained a structural cost advantage with favorable terms on aircraft, engines and components, and got a young, modern and fuel-efficient fleet.
  • On delivery, the aircrafts are sold and leased back. This arrangement is efficient as it converts fixed costs into variable. The asset light approach keeps capital expenses under control.
  • Experienced management with US background, has executed well so far in the Indian context.
  • IGO has been fast to plan for UDAN, which is a new opportunity in regional connectivity.

Risks and Negatives

  • The quality issues with newer airplane deliveries can threaten operations and services. The management feedback is that in 1-2 quarters the issues will be handled by the vendors.
  • Depreciation of the INR against USD may have an adverse effect on IGO’s operations and costs. This has worked in favor of IGO with rupee strength in last 1 year.
  • Crude oil prices are a high cost component, that is outside management control. Prices have risen sharply in the last 1 year and they can further rise again. IGO does not hedge for fuel cost volatility, hence if fuel costs rise further, it could further impact financial performance.
  • Competition may intensify with the entry of Air Asia and Vistara, which have strong backgrounds, and capacity expansions of Spice Jet and Jet Air.
  • Any production delays with ordered aircraft would affect IGO’s expansion plans.
  • IGO’s international routes expose them to higher operational risks. However it is believed that these routes have higher profit potential compared to domestic routes.
  • IGO’s financials may fluctuate due to seasonality as well as economic cycles.
  • There may be a skills shortage in areas such as airline pilots, maintenance engineers, etc. In the past airlines needed to hire expatriate staff at high costs to overcome this.
  • Airlines are a cause of pollution due to usage of fossil fuels. There may be increasing pressure on airlines to reduce this in terms of capacity limitations or carbon credit requirements.
  • IGO, like other airlines, faces operational risks such as accidents and terrorism.
  • There are high regulatory challenges for IGO including DGCA and AAI compliances, policies and execution and ATF taxes. However the business climate in India is improving.

Opinion, Outlook and Recommendation

  • There’s no doubt that the Airline industry in India is at a early phase of growth. With high population and weak railways execution, growth will track economic growth and affluence in India.
  • IGO has a strong brand with a commanding domestic market share, consistent delivery and high growth. It has a good track record of profitability and free cash flows. It has executed well on its LCC strategy. IGO has expanded the market with its growth.
  • We feel that IGO will continue to dominate Indian skies due to network effect and good capacity additions. Any fall in crude prices can provide high upside risks to IGO profitability.
  • While IGO has been in profits consistently, the margins depend inversely on crude prices.
  • The valuations are rich currently and hence investors are advised to HOLD the stock until earnings recovery process begins.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports

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  2. Hudco IPO – Sector Uncertainties, AVOID
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  4. Vikas Ecotech – Get ‘Vikas’ for your Investments
  5. CPSE ETF FFO 2 – An Energizing Offer – BUY
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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in IGO or Interglobe Aviation or any related firm. Punit Jain has however flown Indigo Airlines several times as a paying customer. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Eicher Motors – It’s Firing on Both Engines 

  • 16th May 2017 
  • CMP: Rs 28,890 
  • Sector – Automotive
  • Large Cap with Mkt Cap Rs 78,575 crores 
  • Advice: Investors can BUY now with a 2 year perspective

Summary

  • Overview: Eicher Motors is an auto firm making commercial vehicles and two wheelers. The iconic Royal Enfield bikes business has been growing rapidly and they are selling as fast as they can be produced. The CVs business includes great technology from partners Volvo and Polaris of USA. Revenues, EBITDA and Net profits have grown at 28%, 53% and 45% CAGR over the last 7 years from 2009 through 2016.   
  • Why Buy Now: 1) The recent FY17 results confirmed another record year of all round growth and profitability 2) Capacity expansion plans for two wheelers funded by internal accruals could power a robust volume growth in 2 years 3) The so far underperforming CV business is now seeing improved traction and recovery. 
  • The main risks are international markets growth in bikes, and a continued recovery in CVs. 
  • This report on Eicher Motors was published for paying subscribers on 26th May, 2016 and is now being released for public viewing. It has given them 55.9% returns in the last one year. SIGN UP for the investment service subscription to gain exclusive access to such high quality investment reports. 

The rest of this report is available in PDFs report format below for your reading.

https://drive.google.com/file/d/0B5I507JrtYiCYlN4RjN2T19rY3c/view?usp=drivesdk
Notes and Disclaimers

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has a small personal shareholding (<1%) in EM as on May 2017. In addition, JM has no known financial interests in EM Motors or any related firm. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) and compliant with SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Hudco IPO – Sector Uncertainties, AVOID

  • 9th May 2017 
  • Industry – Loans PSU
  • IPO Open 8-11th May at Rs. 56-60  
  • Large Cap: Rs 11,611 crore Mkt cap 
  • P/E 16.52 times and P/B 1.30 times 
  • Retail investors and employees get a discount of Rs. 2/share 
  • Advice: The IPO is rated AVOID   

Overview: HUDCO is a PSU engaged in providing loans for housing and urban infrastructure projects in India. HUDCO primarily lends to state governments and their agencies. 69% of HUDCO’s loan portfolio is in the urban infrastructure segment and the remaining 31% is in the housing finance loan segment. It’s revenues, EBITDA and PAT have grown at 4.8%, 4.2% and 6.8% CAGR over FY12-16. Revenues for FY16 were Rs. 3,350 cr. and profit Rs. 810 cr. It has 874 full time employees. 

Key risks: 1) HUDCO has weak growth in a recent environment of shortages and massive demand 2) High GNPA’s and NNPA’s 3) It’s a weak institution and performance is unpredictable. Clearly the activities are not commercially driven, so how can investment results be attractive? 4) It is far better to own a wonderful business at a fair price than a fair business at a wonderful price”. We feel that HUDCO is an average business available at a good price.

Opinion: This IPO offering is rated AVOID, and investors may look elsewhere for long term gains.

The detailed report will be attached soon for your reference.  

For full report, see LINK 

Disclaimer 

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in HUDCO or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Vikas Ecotech – Get ‘Vikas’ for your Investments

  • Date: 24th Apr 2017
  • CMP: Rs. 21.25
  • Small Cap – Mkt Cap is 610 crores 
  • Industry: Specialty Chemicals
  • Target price is Rs. 52.7 by May 2019, a growth of 143% over 25 months 
  • A High Risk but High Gain opportunity for aggressive investors

Summary

  • Overview: Vikas Ecotech is engaged in mfg. and trading of specialty chemicals. It has factories in Shahjahanpur (Raj.) and J&K. The FY’16 revenues and profits were Rs 312 cr. and 26 cr. and these have grown 21% & 29% CAGR over 6 years. Products are niche, high value and eco-friendly, many are import substitutes. Exports are growing and are 49% of revenues. Current operations are lean.
  • Why buy now: VET is commissioning new plants in Noida SEZ, Kandla SEZ and Dahej (Guj) as well as extensions at Shahjahanpur. It expects a revenue growth of 35% CAGR in the next few years as outlook is strong.
  • Key risks: 1) Competition from large Indian players or Chinese firms can affect business. 2) The raw materials for VET are crude derivatives and any rise in crude oil prices will increase input costs. 3) VET has been free cash flow negative for 5 of the last 6 years. This has raised debt.
  • The Target Price is Rs. 52.7 by May 2019, a growth of 143% over 25 months. This is a High Risk but High Gain opportunity for aggressive investors.

Here is a note on Vikas Ecotech Ltd. (VET).

VIKAS ECOTECH – DESCRIPTION AND PROFILE 

  • VET does mfg. and trading of specialty polymer compounds & additives like Polymer compounds, Organotin stabilizers, Plasticizers and Flame retardants.
  • The FY’16 revenues were Rs 312 cr., profits Rs 26 cr. and market cap is Rs 610 cr.
  • Located in Delhi, VET has factories located in Shahjahanpur (Raj.) and Samba (J&K).
  • VET started as a trader/ agency for chemical products, then expanded into mfg.
  • VET has 250+ work force and products are exported to 20 countries, like B’desh, Pakistan, Sri Lanka, China, UAE, Turkey, Spain, S’pore, Germany, Ukraine and USA.
  • VET makes chemical products used in Agricultural Pipes, Auto Parts, Wires & Cables, Artificial Leather, Footwear, Organic Chemicals, Polymers, Pharma and Packaging, and distributes specialty chemicals and polymers of MNCs. 3 categories:
    • Specialty Additives – toxin free high perf. additives for mfg. applications.
    • Plastic Compounds – polymer compounds like Thermoplastic Rubber (TPR), Thermoplastic Elastomer (TPE) and Specialty compounds of PVC, PET and EVA.
    • Recycling – It recycles material to create virgin-grade PVC compounds.
  • Clients – RR Kabel, Relaxo F’wear, Liberty, Escorts, KEI, Havells, Apollo Pipe & SRF.
  • In FY15, VET sold stake (and exited) from a subsidiary, Moonlite Technochem. It also acquired the balance 25% stake of Sigma Plastic Industries thereby having 100% stake. By Q4FY15, VET became a standalone firm without any Subsidiary. In 2015 the firm rebranded itself from Vikas Globalone to Vikas Ecotech Ltd.
  • Leadership team is Vikas Garg (MD), Vivek Garg (Dir.), Ashutosh Verma (CEO), and Pankaj Gupta (CFO). Vikas Garg has been with VET (group) for 18 years and provides hands on leadership.
  • Shareholding % is: Promoter and Group-41.6%, Institutions-29.25%, individual-8.9%, others-20.25%.

JainMatrix Investments, Vikas Ecotech

Fig 1 – Segment and Geographic Revenue

Recent Events, Business Plans and Strategies

  • VET commenced construction of a mfg. plant and R&D center at Dahej, Gujarat. It will provide import substitution for additives and stabilizers. The plant will add capacity and produce 6,000 MT of organotin stabilizers (methyl tin mercaptide or MTM) and 5,000 MT of specialty polymer compounds annually. The plant cost is Rs. 30 cr. Production was to start by Apr2017, but a delay in environmental clearances may delay it by 6 months.
  • VET is also setting up plants at Noida SEZ and Kandla SEZ Guj. as well as extensions at Shahjahanpur (Raj.) to handle higher volumes and get exports benefits at SEZs.

JainMatrix Investments, Vikas Ecotech

Fig 2 – VET Capacity Growth  

  • Prince Pipes and Fittings Pvt Ltd’s CMD, Jayant Chheda, and his associates have acquired, in their individual capacity, 2.63 crore shares of VET or over 8%. PPF is a strategic customer of VET. The funds received of Rs 34 cr. are to be utilised for expansion of R&D facilities, new plants and marketing for domestic and exports.
  • VET formed a strategic tie up with PPF, India’s 3rd largest PVC pipes mfg. firm for supply of specialty chemicals to replace current with eco-friendly variants.
  • VET produces Organotin Stabilizers which are required to produce Lead free non-toxic, safe and eco-friendly PVC pipes. It’s a valuable tech. available with only few producers worldwide.
  • VET aims to produce bio plastic by using waste cooking oil through a technology called Wastol-P, and grow as one of India’s leading eco-friendly firms. It has entered into a contract with Haldiram, the large snack mfg. for supply of waste cooking oil.
  • Exports may grow around 30-40% for FY17. VET expects revenues to grow 35% CAGR for a few years, as per management.
  • VET’s mfg. plant in Raj. was affected by a fire in Apr2017. But damage was limited to only one building that housed the polypropylene section and a material warehouse; 4 other units in the same factory are safe and fully operational. The unit contributes 3% to sales. It may take 4 months to restore full production. According to estimates, damages could be Rs. 15-20 cr. but the factory is fully insured.
  • During the current year VET’s market share in India for Organotin Stabilizers was 10%. Their vision is to attain 25% share of the expanded market in the near future.
  • VET allotted 2.56 cr. equity shares of Re 1/- each at a premium of Rs. 16/- in Mar2017 to non-promoters on preferential basis. Promoter holding fell 4% in the Company.
  • Crisil rated VET a BBB for long Term Borrowings; A3+ for Short Term in Feb2017.
  • In Feb2016 Merrill Lynch Capital Markets bought 19 lakh shares of VET.
  • Employee strength has grown rapidly from 63 (FY15) to 81 (FY16) and 250+ today.

Industry Outlook

  • The Indian Specialty Chemical Industry is experiencing a good growth and is fast emerging as global specialty chemicals mfg. hub. Total production was 2.1 crore tons in FY’16. Industry delivered 13% growth over the 5 years led by domestic consumption; more recently it was 30% growth over FY13-15 to $2.67 bn.
  • India is 3rd after China & Japan in Asia and 6th globally in volumes.
  • The Industry is expected to grow at CAGR of 15% for next 5 years.
  • Indian specialty chemicals firms will gain over China due to strict implementation of environmental norms & safety standards there, which may lead to closure of many firms. Exports have already slowed. This may help boost exports from India.
  • Make in India initiative will facilitate growth and flow of FDI to this sector.
  • Indian specialty chemical firms will have 6-7% share globally by 2023, double the current level.
  • The India demand for Organotin Stabilizers at 6,000 MT p.a. (growth 20%) and PVC heat stabilizer (60,000 MT p.a.); and global PVC heat stabilizer market demand are growing fast, and VET expansion plans are in line with domestic and int’l. demand. This year VET’s market share in India for Organotin Stabilizers was 10%. The vision is to attain 25% share of the expanded market in the near future.

Stock Evaluation, Performance and Returns

JainMatrix Investments, Vikas Ecotech

Fig 3 – Price History

  • See VET’s 5 year price history in Fig 3. Investors for 5 years gained by 51.4% CAGR.
  • The share price shot up sharply in 2015. The recent one year low is Rs. 10.85 in Jun 2016, and the high was Rs 23.3 in Mar2017. The share price is 9% below this high.
  • Dividends have been consistent for 4 years at 5% giving 0.24% yield. This is low.
  • The Revenues, EBITDA and Profits have grown 21%, 35% and 29% CAGR over 6 yrs.
  • In Q3 FY17 VET had revenue of Rs. 84.8 cr. and growth of 0.3% YoY due to demonetization and fall in trading. But the mfg. revenue grew 17%. See Fig 4.
  • DE ratio is 1.41 which is high. VET will fund expansions through internal accruals.
  • Note: VET data in Fig 4 is consolidated until Mar 2015 and standalone thereafter.

JainMatrix Investments, Vikas Ecotech

Fig 4 – Quarterly Financials/ Fig 5 – Cash Flow  

JainMatrix Investments, Vikas Ecotech

  • VET has weak cash flow position. It has been FCF positive only in 1 of last 6 years. This is a negative. See Fig 5. However the reason is investments in R&D and mfg. capacities. The firm raised funds through preferential stock issue and promoter holding dilution. As a result the debt position is still moderate.
  • In Fig 6a, the 6 year PE chart for VET has a historic average PE of 15. Current P/E is 15.74 times (TTM earnings), while the P/B is 8.25 times. In Fig 6b we see that EPS TTM had an upward trend in last 2 years in a channel. But in Q3FY17 there was a drop due to challenges like demonetization.

JainMatrix Investments, Vikas Ecotech

Fig 6 – a) Price and PE Chart Above and b) Price and EPS Chart 

  • The DE ratio reduced in Mar’16, Fig 7. Interest coverage ratio improved. The inventory turnover ratio rose, operating & profit margins are higher, ROCE doubled to 32%. Similarly RoNW. These are positive.
  • Beta of the stock is 0.93 (Reuters) which is indicates low volatility.

JainMatrix Investments, Vikas Ecotech

Fig 7 – Financial Metrics

Benchmarking and Financial Estimates

Exhibit 8 – Financial Benchmarking

In a benchmarking exercise we compare VET with listed peers in similar businesses.

  • In terms of valuations, VET has a low PE ratio in spite of a recent rise in the share price. However P/B is high at 8.25 times. VET has the lowest dividend yield, however this is OK for a high growth company. D/E ratio is high among peers, however it is at manageable levels.
  • VET’s 3 year CAGR PAT has grown at 86.8%. This is good, but on a small base. VET has return ratios over 35%, that are likely to sustain. This is excellent.
  • The numbers show that the firm that is moving to a high growth / high profit phase.

Exhibit 9 – Projections  

The financial projections have been made based on following assumptions.

  1. Production starts at Dahej plant in mid FY18 and ramps up to full capacity in 2 years. Noida and Bhuj plants too start contributing to revenues in FY18.
  2. Exports and domestic demand continue to grow at a combined 30-35%.
  3. R&D continues to develop new products; demand for lead free chemicals grows; eco-friendly mfg. processes for PVC compounds from recycled materials gain in visibility and demand.
  4. Analyst judgement.

Strengths of Vikas Ecotech

  • Good R&D that works with prospects and customers to develop new products & solutions. The recent revenue upswing was the result of years of R&D work.
  • Capacity additions will start from Dahej, Noida and Bhuj plants in FY18.
  • A domestic focus on substitution for expensive imported niche chemicals.
  • Exports focus will continue and build on the current 49% share of revenues.
  • There exists a good synergy between trading chemicals business and mfg.
  • Remarkable cost consciousness including salaries for promoters and employees.
  • Current customer base is derisked across a large number of firms and industries, providing stability.

Weaknesses and Risks

  • The raw materials used by VET are crude oil derivatives. Any rise in crude oil prices will increase the input cost and margins. However crude is in a 45-55 $ range.
  • VET has weak cash flow position. It has been FCF negative. The D/E ratio at 1.4 times is moderate, but any further capital raise can push D/E to excessive levels.
  • Promoter shareholding is low at 42%. However the promoter has sacrificed holdings to raise funds for expansion. He may be in a position to raise this in a few years. He still has sufficient holdings today that provide him a good incentive to grow and develop the firm VET.
  • In terms of valuation, the P/B ratio looks expensive.
  • VET’s mfg. plant in Raj. suffered in a fire in April 2017. The damage could be Rs. 15-20 cr. But these assets were insured. One plant in J&K is in a sensitive area, there have been terrorist attacks recently.
  • Chinese chemical producers can be competitive on price and volume. The other massive player in the sector is Reliance Industries. VET has potential as a niche chemicals player as long as other larger players do not enter these segments. However these segment volumes may not be attractive for RIL.
  • VET can in future be a takeover target by large players. But it will benefit investors.
  • VET sales are B2B, used as raw material, so it’s difficult for analysts to verify & validate output.

Opinion, Outlook and Recommendation

  • The chemicals sector is a massive market, and specialty chemicals can be a valuable and large niche within this. India offers many competitive advantages to this sector.
  • VET has taken this strategy and has ample room to grow in this niche.
  • VET is rated highly on lean business operations, aggressive growth – both mfg. capacities and workforce, good R&D team, eco-friendly products and growth in domestic & export markets.
  • Valuations are reasonable as VET is a largely undiscovered firm. With a turnover of Rs 312 cr., VET has ample room to grow in domestic and exports markets.
  • Key risks are: 1) As VET is a small firm, competition from larger players or Chinese firms can affect business. 2) The raw materials are crude derivatives and any rise in crude oil prices will increase input costs. 3) VET has been free cash flow negative for 5 of the last 6 years. This has raised debt.
  • The target price is Rs. 52.7 by May 2019, a growth of 143% over 25 months.

JAINMATRIX KNOWLEDGE BASE 

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Disclaimer and Additional Details

The target price basis is 1) Financial projections – Exhibit 9, 2) A target P/E of 20 times, higher than current 15.74 times 3) Analyst judgement.

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain and JM have no current shareholding, and no known financial interests in Vikas Ecotech & Co or any related firm. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. Equity investments are subject to market risks. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, we recommend that investors looking to invest in equity should take advice from a Registered Investment Adviser. Punit Jain is certified and registered under SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com