August 23, 2010

Borrowed Idea – Gujarat reclaimed rubber products

A disclosure first – This is a completely borrowed idea. I originally saw this idea on Ayush’s blog and started investigating it on my own. I had some discussions with him on the phone and liked the story behind the company.

The idea is a borrowed one, though hopefully the thinking is not (Ofcourse if the idea succeeds it would become my original idea as i would conveniently forget the source in due time :) ). I personally have no qualms of borrowing ideas from other smart investors like ayush (would highly recommend following his blog), though I will provide due to attribution to the original idea if I post about it.

I will not repeat some of the analysis here as ayush has done a great job of it. You can find the analysis here. Let me add some additional thoughts to the analysis

Competitive analysis
The Company has been able to sustain a fairly high growth and profitability for the last 8-10 years. The company currently enjoys a 35%+ market share in its business niche which is characterized by a large number of players from the unorganized sector.

The company has been expanding rapidly and is now enjoying the benefits of scale in production and sales. The Working capital turns have been going up steadily over the years which is an indication of the operating leverage (Fixed asset turns have not increased as much due to constant capacity addition). The company is now one of the largest company in its sector and is now exporting almost 57% of its total turnover. An effective sales and marketing organization is required to develop and sustain an export business as it requires a close relationships with the OEMs (tyre manufacturers and other users of rubber)

The competitive intensity from any large players is likely to low as this is not a big and attractive segment for any big player. The company enjoys a substantial competitive advantage over smaller player due to economies of scale, customer relationships, strong sourcing network (for waste rubber) and ability to invest in research.

Risk
The main threat is low cost import of tyres from china which can hurt the OEMs directly and Gujarat reclaim indirectly. In addition this is a very competitive industry with a lot of competitors and it is unlikely the company can earn very high profits for a long time.
The price of rubber also plays an important part in the profitability. As the price of virgin rubber has increased, the substitution by reclaimed rubber has gone up too. The substitution effect may slow down once the price of rubber starts dropping.

Competition
The company does not seem to have any major listed competitors, though there seem to be a lot of
smaller competitors. A company like Indag rubber is not really a direct competitor even though they operate in the tyre industry. Gujarat reclaim provides cheap substitution of a raw material used in tyres, whereas indag provides a substitute for the end product – tyres itself (via re-treading).

Valuation
The fair value of the company can be estimated to be between 1700-2000 with an assumption of 8-9% net margins and growth in the range of 10-11 %. The company is selling at a decent discount to fair value and would be quite attractive if the price drops below 800.

Disclosure: I have a position in the stock. Please read disclaimer at end of the blog.

18 comments:

Pradeep said...

That was a good pick from Ayush. I too invested in it after doing some research. Was lucky to invest in it at 770s.

Kiran said...

Now that Govt. favors the import of rubber, will this stock come down, I wonder.

Anonymous said...

hi

whats the basis of your price target. how do you come to a discount to fair value

Rohit Chauhan said...

hi pradeep
yes ayush does a great job on picking good companies. makes sense to follow him

rgds
rohit

Rohit Chauhan said...

Hi kiran
cant say about the stock price. but GRRL is benefiting from the susbtitution and as long as the price differential with virgin rubber exits, it should maintain its margins

rgds
rohit

Rohit Chauhan said...

Hi anon
I have not given any price target here..i never do and am against the idea of price targets

fair value is based on DCF calculation and discount if the difference between the current price and fair value

Avadhut said...

Hi Rohit,
Really goo company based on strong financials. Can you please mention your fair value calculation for this company?

Anonymous said...

Nice to see this name. The business idea was sold to me by my Gujrati friend who was planning to do some manufacturing business in reclaimed rubber. I drilled through the companies and in Jan 2010 came with these numbers :-

28th Jan -2010
Looks great on paper and the product [recycle rubber] it makes.

Has a Market Cap of 84 Cr (CMP of 635 and Shares = 13.3 Lakhs), with Sales of 130 Cr and Cash of 50Cr and Debt of 16 Cr. OPM is 18% with consistent growth in Revenue, Profit and EPS.

The EBITA is around 20Cr on an Avg, they cover there Interests by about 10 times [so no problem of debt not being paid off].

The risk is it’s a small cap with extremely low volume even though Public Share holding is 46%. It is in T segment. The Management is extremely good in paying dividend that is rising consistently in proportion to growth in EPS.
================
With the same on your post I shall accumulate on dips.

sandy said...

hi rohit,

how did u ascertain the market share? and whether it provides some advantage of scale in a small niche market? i am not sure whether a 30% market share would really provide any moat. The nos look good but i dont see some strong moat here and also its not dirt cheap that one can ignore the absence of moat.

Multibagger said...

Hi there

Jayendra discovered this stock in 2006 on the equity desk. I discovered this in 2009.

Regards

Amit

Rohit Chauhan said...

hi avadhut
i have used discounted cash flow with various net margin and topline growth scenarios to come up with a fair value range. it would diffcult to give the complete workings of the calculations in the comments alone

rgds
rohit

Rohit Chauhan said...

hi anon
yes the numbers look good. remains to be seen how the company performs in the future

rgds
rohit

Rohit Chauhan said...

hi sandy
the company has an article posted on their website which discusses about the company's market share

the moat is not wide and big, but scale gives some advantages and if the company executes well, the intrinsic value should improve. at current prices the company is not a complete bargain, but should give decent returns

rgds
rohit

Rohit Chauhan said...

hi amit
then you and jayendra found an attractive idea before me and benefited from it

rgds
rohit

Multibagger said...

Hi Rohit,

It worked indeed. Hope it continues its steady compounding.

Regards

Amit

Puneet Singhal said...

Hi Rohit

1) What is the moat in this business? What is preventing dozens of entrants to make an entry?

2) Why do the OEM tyre companies like ceat, apollo, mrf etc not enter the reclaim business?

3) What is the growth potential of sales expected for next: 5 years, 10 years, 15 years? Are we in dynamic growth phase or nearing saturation in growth?


4) What are the fortunes of this business linked to ?

B/R
Puneet Singhal

jagan said...

hey rohit what are your thoughts on indag rubber. Why is it being valued at very low price. low pe under 5. low debt. higher roe that grrp

Anonymous said...

How can a company with such a small size be the largest in Asia in the reclaimed rubber segment? Is the segment itself quite small? Given the kind of demand for rubber, it would be quite surprising if this segment were indeed so small.