September 18, 2013

Analysis: Supreme industries

About
Supreme industries is a leader in the plastics processing industry and processed around 2.45 Lac metric tonnes in 2012. The company processes polymers and resins into various plastic products. The broad verticals for the company are as follows

  • Plastic piping including CPVC pipes
  • Consumer products such as molded furniture
  • Packaging products such as specialty and cross laminated films
  • Industrial products such as Industrial components and Material handling products
  • Construction business wherein the company has developed a corporate park on some excess land in Mumbai
The company has around 22 plants across the country which has helped it in reducing the transportation cost for the products (an important factor for operating margins).

Financials
The company achieved a topline of around 2900 Crs and is expected to close the current year at around 3500 Crs. In addition the company earned a profit of around 240 Crs (8% Net margins) and should be able to achieve a single digit growth during the year. The lower growth in net profits is due to lack of sale of commercial property in the current fiscal.
The company has been able to maintain an ROE in excess of 25% for the last 6 years. The debt equity levels have dropped from around 1.5 to around 0.6 during this. The company has also been able to improve the asset turns from around 2.5 in 2007 to 3.5 in 2012 as a result of an improvement in working capital turns (mainly driven by lower receivables as a percentage of sales).
The company has also improved its net margins from around 4% in 2007 to around 8% in 2012 driven by an improvement in overhead costs and depreciation as % of sales.

Positives
The company operates in a commoditized industry and as a result several products of the company earn low margins. The company is now focused on developing new products (called valued added products) such as CPVC pipes, cross laminated files and composite cylinders which have a higher operating margin (17%) than the other commoditized products such as molded furniture. The company plans to increase the contribution of these value added products to around 35% by FY15 and expects to improve the overall operating margins to around 15-16% levels

The company has a wide distribution and production network and well established brands in the plastics product space. The management has been able to use these assets effectively in entering higher margin products while exiting the commoditized segments at the same time.

The per capita consumption of plastics is around 7 kg versus almost 30-70 Kg in other countries. As a result, the industry is likely to see sustained growth for sometime as the per capita consumption increases with a rise in the income levels. In addition to the demand tailwind, companies like supreme are likely to benefit further as the industry continues to consolidate and the market share shifts to the organized players.

Risks
The company operates in a highly fragmented and commoditized industry. Although the company has been able to maintain the margins and a high return on capital by constantly introducing higher margin products, the moat or competitive advantage is not deep.
Brand name and a wide distribution network provide some level of competitive advantage, but the resulting moat is not wide and deep. As a result the company will have to constantly innovate to keep the return on capital high. The profitability could get hurt if there is a rapid commoditization of the various segments.

Competitive analysis
The plastics industry is a fragmented industry with a large unorganized sector, especially in commoditized products. The company has different competitors in each segment of operations.

In the case of PVC pipes the key players are finolex, chemplast sanmar, Jain irrigation, astral poly etc. In the packaging products there are around 6-7 large players and several un-organized ones. In consumer products nilkamal and Wimplast are the two key players. Finally in the industrial component segment there are a wide range of players ranging from Motherson sumi to Sintex industries.

Most major players earn an ROE of around 13-14%, with high leverage , except for astral poly which has an ROE of around 22% with low levels of debt (due its focus on a high margin and high growth product – CPVC pipes).
Overall the industry does not have high return on capital- due to the commoditized nature of the products. Supreme industries has been able to break away from the pack due to a portfolio approach to products (exit low margin products and move into high margin ones).

Management quality checklist

-          Management compensation – compensation is around 5% of net profits. This is on the higher side, though not excessive
-          Capital allocation record – The capital allocation record of the company has above quite good in the last 6-7 years. The management has been investing in high return projects and has also used some of the cash flow to reduce the level of debt. The ROE as a result has improved from the 20% levels to 30%+ levels in 2012
-          Shareholder communication – adequate. Management provides decent amount of disclosure in the annual reports and also conducts quarterly conference calls to discuss about the performance.
-          Accounting practice – appears conservative
-          Conflict of interest – none appear to be of concern
-          Performance track record – the management has been fairly transparent about its performance goals (growth and return on capital) and has been achieving them consistently in the last few years. In addition the management has been in this business for the last 40+ years and understand it very well.

Valuation
A discounted cash flow with conservative assumption of around 7-8% margins and 15% topline growth (10% volume growth + 5% inflation) gives a fair value in the range of around 530-570 per share. The growth assumption appears to be conservative as the company has delivered a 12% volume growth in the past. The risk is mainly around net margins which could come under pressure if there is faster commoditization in the industry.

The company has sold between a PE of around 8-9 and 18-20 in the past. The current PE of around 15 is at a midpoint and as a result the company does not appear to be overvalued.

Finally the company has shown a higher growth and Return on capital as compared to almost all other players in the industry (except astral poly) and hence has a higher PE (but not much) than others.

In summary the company does not appear overvalued and may be undervalued by around 30-35% from its fair value.

Conclusion
Supreme industries operates in a growth industry (due to increasing demand for plastic products) where the average profitability is quite poor. The company has been able to perform better than the other players by being focused on the newer and higher margin products. The management is as focused on ROC (return on capital) as on growth as compared to several other players who are pursuing growth at low returns.
Inspite of the above average returns and competent management, the company is unlikely to enjoy very high valuations like the FMCG industry as the overall profitability of the industry is low and the pricing power of branded products not very high. Supreme industries appears to be modestly undervalued and the returns are more likely to come from a consistent increase in profits than from revaluation by the market.


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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

17 comments:

Samir Shah said...

You need to be careful with supreme industries. Much of its product range is competitive, while much of its raw material is commoditized and linked directly to dollar prices of plastics.

This quarter, or the following one (depending on hedging) is not going to be pretty.

Rohit Chauhan said...

thats true ..but again that is the case with a lot of companies.

in addition it is constantly exiting the competitive segments and entering into the higher margin products like CVPC and LPG cylinders.

i dont expected the new few quarters to be good ...but then i am not looking at the company for a few quarters. the company should do well over the next 3-4 years

rgds
rohit

Anonymous said...

Can you share the DCF workings on an excel sheet on this site? Thanks. Ashish

Ravi said...

Nice write up Rohit. I have invested in this business for about an year and sitting with some decent paper profit as of date, but not convinced to increase my investment more yet because of the valuation, if you consider margin of safety. As Warren Buffet famously said, a horse that can recite 1 to 10 is a remarkable horse..not a remarkable mathematician, this is a very good company operating in a tough industry. Management is excellent which sets its goals higher and most of the time achieve it. However, the business is what it is.. Fragile Moat.. Astral gets a better valuation than Supreme because they have strong moat due to lubrizol in CPVC. Supreme is showing lot of promise in showing the commitment to move from low margin (furniture) to high margin business which is good. However, it is definitely not available at a cheaper valuation which gives very good margin of safety. Margin of safety looks good only if you speculate on the growth that you could get. In your opinion is there margin of safety if you consider just inflationary growth? The true psychology of all of us is, while we evaluate a stock based on 10 years earnings, our biases start working against us when a stock continuously under performs the market for 10 continuous months. I know that this is not right, but we are not Warren Buffet (with tons of patience and take controlling stakes) and that is the truth.
I am not negative on this business. Infact, I would buy boat loads of this stock if it corrects significantly, but I would just be cautious to buy a boat load at these levels to be honest.
Looking forward to hear from you.

Regards
Ravi

Anonymous said...

Hi Rohan,

I have read your post and without further resaerch I don't think that Supreme is a good investment case.
I mean, with a PE of 15 and products that are commoditized or that will be commoditized in the future, the margin of safety is not existent.

I like your blog and your thoughts, so I would like your opinion on: Premier Explosives Limited.
I think the recent tragic explosion at their factories and the subsequent bad quater they had, plus the stock price decline, represents a good investment opportunity.

I'm a european investor, thus I'm not able to easily invest on the indian stock market, just wanted to share the idea with you.

regards,

Laurenz Seiger

Anonymous said...

As the commentator above, from what you have written I don't see any margin of safety in Supreme Industries.

I have stumbled over a Indian stock while doing research for a European company. The company is called: Premier explosives limited.
It had a tragic accident at one of its factories, leading to a bad quarter due to inventory shortages. The stock declined subsequently.
I think there is an interesting opportunity here.

Take a look at it and share your thoughts!

regards,

Laurenz Seiger

Anonymous said...

Ques: In 80s and 90s. How many buildings had the cement pipes on outside walls.

Ans: All most everyone

Ques: How many do you see now?

Ans: Almost None.

We were in a transition phase where plastic is taking more share in everybody lives. Similar to the transition to ceramic tiles instead of marble flooring. Though I agree that it would not last forever but there is no denying that current going has been good.


On valuation front, it is a steal at 180-200, and fairly valued between 280-350 based on DCF (with 15% discount @ for 5 years with 15% real growth(10% volume + 5% inflation)and 2% terminal would give a value of 293.28.


Personally, I hold Supreme Industries and would hold it for next 5-10 years(till the time there is no visible threat). I keep on adding more around the levels of 315.

Rohit Chauhan said...

Hi ravi
the moat in this business is not the product - so an astral's moat is not the relationship with lubrizol or any kind of monopoly on CPVC

its is the brand/ mindshare with the users, which it is developing. the valuations are higher due to the growth

the same is the case with supreme - its moat is the distribution network and to a small extent the brands. the other advantage is its focussed management.

so supreme is not a page or a nestle, but it has a decent moat. the company can keep introducing new products and application and do well over time

why do you think other companies cannot replicate what astral is doing ...supreme has a 40%+ growth in the same segment.

this is a decent (though not spectacular) business at a fair price.

one cannot expect a multi-bagger, but good returns over time

rgds
rohit

Rohit Chauhan said...

Hi laurenz
the moat is not around products ...its the distribution, production network and the brands of the company. management is a plus too

the company is constantly exiting the commodity products and moving into high value products. there is enough visibility for the next few years in terms of demand. in india, plastics consumption is still very low

rgds
rohit

Rohit Chauhan said...

Hi anon
a DCF is good to do reverse analysis on the embedded growth, but i dont want to read too much into it.

at 15 times, it is not too undervalued, but not over valued too.

i agree with you in terms of demand. as new materials come in the company will find new applications and has the channel to sell it

look at composite LPG cylinders ...this is a completely new segments, can we call it plastics ?

if one expands the definition from plastics to composite materials (including plastics), the company has a long path ahead as long as it can keep investing in the channel for production and delivery at a competitive price

rgds
rohit

Nitin Mukhi said...

Hi Rohit,

I want to check with you one off the track question. this is with reference to Bajaj Investment Holding which owns ~30% of Bajaj Auto and ~40% of Bajaj Finserv. Still the market valuation of Bajaj Investment Holding is just 8500 crore? Why so less? The holding company has no debt on the B/sheet. And I am not even considering the market value of other investments that Bajaj Investment Holding Co. is currently holding.

Abhijeet said...

Dear Sir, Thank you for your wonderful analysis. Personally I feel Supreme Industries is very good but a little expensive, similar to Astral poly.

I had a question for you. Given eveything else being the same, what weightage would you give to below four parameters while valuing a company

Growth, Debt, Size, Profitablility

Please note, I am not saying these are only things we have to look at. I am asking this given everything else is same or for example if we want to shortlist the companies for futher research.

I would really appreciate your answer and thoughts on this.

Anonymous said...

I think Supreme's strength is its management which is in touch with abdconstantly responding to the opportunities and changes in the mkt and responding in a financially prudent way- look at its steady capital spend and low leverage. This is a steady solid performer which rewards its Sh holders too! PS- I invested in this in 2009 and will continue to hold !

Rohit Chauhan said...

hi nithin
bajaj investment is just holding structure ..how will the value get unlocked ..doubt the bajajs will sell the holdings. so the value may never come through

rgds
rohit

Rohit Chauhan said...

hi abhijeet
its difficult to give specific numbers ...debt upto a certain level is ok ...above a certain level is risky

profitability is important , but has to be seen in context of sustanbility. growth is good only if profitable ...finally size is usually important only if it helps in achieveing economies of scale

rgds
rohit

Rohit Chauhan said...

hi anon
you are right ..thats the key differentiator between supreme and other similar companies. if they continue work on similar lines, the company should do fine and will create wealth for its shareholders

rgds
rohit

Anonymous said...

Hi

Can you guys please look at IKF Finance. The Company is performing well and will do about 12 Cr of PAT this year and has mkt cap of ~45 Cr. It has BVPS of Rs 21 and the promoter is trying to delist the Company at Rs 15.5. Please have a look at the share.