S P Apparels (SPAL): Knitted for strong growth ?

Current price : 355
52 Week High / Low : 478 / 276
Market Cap : 895 Crores
9M FY 2017 EPS : 18 Rs

Disclaimer: This is not a recommendation to buy / hold / sell any securities mentioned in the blog post. The published post is for information purpose only. The intention to share write ups on this blog is to create a repository of ideas so that investors can have a look at various frameworks & approaches. Please read the detailed disclaimer at the bottom of the post. 

Textiles: India is at the right place right time

Our honorable Prime Minister Mr.Narendra Modi has brought a paradigm shift in the way we investors think. He has somewhere helped us all to look at broader themes (especially ones like us who used more bottoms-up approach) and work our thesis to spot ideas which fall within those themes. The themes that can be termed MODI-led are;

  • Smart-City
  • Housing for All
  • Infrastructure (Roads, Sagarmala, etc)
  • JAM Trinity (subsidy reforms)
  • Swachh Bharat

There are so many themes, that I can add here and the list can be pretty long. But amongst these themes one of the key one was Modi-Government’ focus on boosting employment growth rate and thus their thrust on MAKE IN INDIA theme. By 2025, India will have over 832 mn people in the working age group (18-59) as compared to 658 mn in 2011 (As per Census of India, 2011). Hence to avoid demographic disaster, Government has to take necessary steps to ensure ample employment opportunities for the youth.

Textiles is the 2nd biggest employment generating industry (agriculture being the first) and thus focus on this segment is amongst the core focus of the Government.

Mr. Narendra Modi realized the sector’s potential when he was the Chief Minister of Gujarat – one of India’s largest textile centres (textiles contributed more than 20-25% to the state’s GDP). The state’s 2012 textile policy gave incentives to both cotton growers and textile mills, including exemption from value-added tax. It also proposed setting up of 12 textile parks & gave financial support for technology upgrades with special focus on the garment segment, which it said was “the driving force behind the textile value chain”. As per Government estimates, every Rs 1 crore investment generate approx. 70 jobs in garment segment, 10 jobs in steel and 25 in auto industry.

On the National level, Mr. Narendra Modi has reiterated garmenting as a key segment and in June 2016, the Union Cabinet cleared a package of Rs 6,000 crore over 3 years for the garment manufacturing segment  (the biggest job creator in the textile value chain).

It is estimated that apparel sector generates 56-84 jobs per USD 0.15 mn investment as compared to industry average of 6 jobs generated per USD 0.15 mn investment. (Source:- Make in India website).

Thus garment industry is likely to stay buoyant in upcoming years.

Looking at this huge opportunity, it makes sense to identify listed companies who are dedicated garment manufacturers in India. We could identify three companies namely Kitex garments, KPR Mills and SP Apparel Ltd (SPAL). We liked SPAL as an investable idea and will share insights on the same…..

S P Apparels Limited (SPAL)

Company Background

S P Apparels (SPAL) was incorporated as a private limited company in Avinashi, Tamil Nadu in Nov 2005 (Previously business was conducted under Partnership model). The Registered Office of the Company is situated at Tirupur District, Tamil Nadu.

Experienced Management team

  • The team is led by the Chairman and Managing Director Mr. P. Sundararajan who has 31 years of experience in the garments industry.
  • The Chief Executive Officer of the garments division – Mrs. P.V. Jeeva, has been associated with SPAL since July 1, 1986 and has approximately 30 years of experience in the textile and apparel industry.

Business Overview

Company operates basically in 3 segments;

  1. Garment Division (manufacture and export of knitted garments for infants and children);
  2. SP (UK) – trading division of SPAL
  3. Retail Division (manufacture, distribution and marketing of products in India under the brand name ‘Crocodile’).

Garment division

SPAL is a leading Indian manufacturer and exporter of knitted garments for infants and children.

Company is only into high fashion segment (90-95% of the garments manufactured by SPAL are fashion products) for infants and children unlike competitors who also have presence in many other segments such as menswear, etc. Garments are manufactured at integrated facilities which allow them to provide end-to-end garment manufacturing services from greige fabric to finished products.

Customers:- Company sells directly to retailers globally. Currently it sells its products to International retail giants like TESCO, PRIMARK, ASDA, Mothercare and Dunnes Stores. Company as on date caters to only 5 key international retailers (some of which have been with SPAL for last 20 years).

SPAL does not have firm long term contracts from buyers, but every year, buyer gives next 3 years’ plan indicating their expectations from the company, capacities needed to meet their demand, etc.

Company Presentation

Download (PDF, 4.37MB)

Download (PDF, 474KB)

Manufacturing Capabilities:-

SPAL’s 22 operating manufacturing facilities are located in and around the region of Avinashi, Tamil Nadu, India & within a radius of approx. 125 kms of their registered Office. Company has integrated facilities for embellishments such as designing, embroidery, printing, sewing and cutting of the garments. Its manufacturing operations are supported by a wide range of infrastructure facilities.

Manufacturing capabilities  
Sewing machines 4,874
Cutting machines 8
Embroidery machines 79
Printing machines 17
Dyeing machines 22
Spindles 16,896

Manufacturing Process

It is a project based business model and thus each project is negotiated based on raw material required, other associated costs, currency, etc. Booking time taken is close to 2 months by the retailers, whereas  SPAL’s execution timeline is 90-120 days.

Rationale of having 22 factories:- Garment manufacturing is very labor intensive industry. Any big factory can mobilize only 1,000 – 1,200 people within a distance of 60 kms. If factory is at distant place, then company has to provide hostel facilities. Company is having both the options. However, most of the facilities are located near the village, where employees stay, making it easier to source the workers. Management believes that if an employee remains with the company for longer duration (4-5 years), then skills can be utilized more efficiently.

Company has centralized raw material procuring facility, where it is cut and supplied to different factories, who stitch the same and return back. Some big factories do cutting and packing in-house. Sourcing of yarn is centralized. Than it goes for dying. Entire dyeing (solid / piece) process takes place in-house. Yarn dyeing takes place outside the factory. Only stitching and packing is at different places. Management has done a commendable job in managing so many operations efficiently and consistently.

Impact of raw material price volatility not to impact SPAL:- Company’s orders are project based to manufacture fashion products for a particular season. Every time a new order is getting booked, management discusses the new styles & costing is negotiated based on prevalent yarn price, labour cost & exchange rate. Once the order is booked at negotiated prices, company will place the orders for the requisite raw materials at prevalent costs. Thus, raw material volatility does not impact them gravely.

Industry Overview

 

Why focus on Children and infant segment:- Children wear as a segment is recession proof and SPAL did not see its revenue dip even during the last financial crisis. Moreover this segment has less competition, better margins and lag time to gain customers is pretty long.

SP (UK) division (100% subsidiary)

SPUK is a different business model; it is a pure trading business. SPAL can’t handle small size orders (it does not have spare capacity nor does it make economic sense) from USA/UK. If SPAL avoided these small orders, then these orders were being catered by someone else. Thus management created SPUK (a trading arm of the company which also provides design support) to take orders from all small customers based in UK. SPUK than sources the products directly from Tirupur and supplies it to the customers. It is a good medium to add incremental revenues and develop customer ties as well. It is already catering to marquee names like Dunnes.

Company has tied up with new customers (Landmark, BHS International, Peacock) in UK in 9M FY 2017 and 2-3 customers are in the pipeline. Sales to these 3 customers has begun and now they cater to total 5 customers in UK.

Retail Division

SPAL has entered into a JV with Crocodile International Pte. Limited (Singapore) who has a licensee of the brand “Crocodile”. The JV “Crocodile Products Private Limited” (CPPL) has sub-licensed this brand from the Singapore entity. SPAL has 70% stake in this JV. The agreement is valid till 2020-2021 (renewable every 7 years).

SPAL sells innerwear (B2B business) and menswear (B2C business). SPAL manufactures innerwear (track pants, basics, vest, etc.) which it sells via B2B route. Whereas in case of B2C segment, SPAL outsources/imports the products and sells them via the retail outlets.

B2B business:- To promote the B2B business, company already has 80 distributors and has plans to significantly increase their distribution reach. Currently, they are concentrated in Southern & Eastern region. Management is targeting to add 30-40 distributors in next 12-18 months.

B2C segment:- SPAL has created a strong retail network (majorly South focused till now) across various formats;

Company is now looking to increase its penetration across various States and expansion will be through a mix of own stores and franchisee.

An average retail store cost structure:-

Average retail store Cost structure
Store size 2,800 sqft
Store set up cost:-
Interiors 22-23 lakh
Initial Rent 8-10 lakhs
Inventory 8-10 lakhs
Total store set up cost 38-43 lakhs


Royalty payment
:-

There is a technology license agreement entered into by CPPL (subsidiary of SPAL) with Crocodile International Pte Limited (CIPL) pursuant to which SPAL has rights in relation to the manufacture, distribution and marketing of menswear products under the ‘Crocodile’ brand in India until July 31, 2021.

CPPL is a JV formed between SPAL and Crocodile Singapore where 70% is owned by SPAL. This JV has sub-licensed the Crocodile brand to SPAL. The agreement is revalidated every year in July.

Royalty paid by SPAL to CPPL:

B2B:- approx. 3% of sales.

B2C:- approx. 6% of sales.

CPPL keeps 1% of the royalty and rest all is given to CIPL. Thus for instance, the retail sales is Rs 100 and if company pays Rs 3 as royalty. Rs 1 is held by CPPL (of which 70% is held by SPAL) and Rs 2 is given to CIPL.

Thus SPAL has now a focused 2nd business line which has very strong business prospects as Indian move towards being more brand-savy.

Investment Thesis

  1. Garment Business:-

India has an edge in garmenting (especially Infant segment) as compared to competing countries

Given below are the advantages India has over its competing countries & how the manufacturers are expected to leverage it

  • Cotton is a critical raw material for infant and toddler apparel. India is largest manufacturer of cotton and leading yarn manufacturer in the world. Thus garment manufacturers in India have access to high quality cotton and yarn all round the year thereby having an edge over Bangladesh & Vietnam – which need to import cotton and yarn. Complete backward integration helps in maintaining standardised quality of products as the company has complete control over entire value chain as well as aids in improving operational efficiency.
  • Unlike normal garments, children wear requires high degree of fashion elements, smaller batch sizes and wider product range. China and Bangladesh have mastered the art of producing huge lots of garments and simple products where the processes can run without breaks. That is where Indian garment manufacturers such as SPAL have created their niche by catering to smaller batch sizes and controlling multiple processes.
  • Stringent quality requirements and high compliance norms (Severe restrictions on the use of chemicals, dyes & other additives to prevent any side-effects on infants and children)
  • Access to skilled man power at competitive wage rates compared to other major cotton producing countries like China, Turkey etc.
  • Unlike before where Government used to incentivise only yarn manufacturers, the new garment policy (duty drawback rates have been increased by 3%-3.5%, higher capital subsidy, increase in overtime hours, etc.) aids in making Indian garment manufacturers more competitive as compared to Bangladesh, Vietnam or China.
  • With US backing out of Trans-Pacific Agreement (TPA), it now makes a level playing field for India (which was not part of TPA) against the likes of emerging garment manufacturing countries like Vietnam (part of TPA agreement).

 

  • On New Garment policy by Indian Government:-

Although India has lost its leadership position in apparel exports to countries like China, Bangladesh & Vietnam over past decade, now with Government backing and inherent advantages which India has – we will now see the Indian apparel manufacturers grow in strength and size.

Two reasons India lost out to competing countries were;

  • India exporters were not having a level playing field in US and EU, as they are levied with 9.5% duty (as India does not have an FTA with EU or US) as compared to Bangladesh or Vietnam who enjoy tax advantages while exporting to these countries.
  • Secondly, there was plethora of taxes at the State as well as the Central level in India. Exporters were given duty drawback to cover the Central levy but the State taxes were not being covered. Under the New Garment Policy, Government has set aside an amount of Rs 5,500 crore for duty drawback to cover the State taxes. In India we have taxes such as VAT, Central Sales Tax and electricity duty, which will now be covered under the duty drawback so that our country’s products will be competitive in the international market.

Thus, Government has announced its new Garment policy which covers these following points,

  • Duty drawback rates have been increased by approx 3-3.5% p.a. in addition to 7-8% p.a. benefits that garment manufacturers were already enjoying.
  • Fixed term workman to be considered at par with permanent workman in terms of working hours, wages, allowanced & other statutory dues. Government to bear entire 12% contribution to Employer’s Provident Fund Scheme which would be beneficial to new employees.
  • Increase in overtime hours (can work for 10 hours) – good for workers as their take home would be better.
  • Additional incentives under TUFF from 15% to 25% – applicable capital subsidy not necessarily to be used for capital / term loans. Purpose of the government is to increase the capacity.

With this policy, we believe there will be fresh investments in garment sector, which will aid India bridge the gap with competing countries in garment exports. SPAL considering has already established a decent name in this space is expected to be one of the prime beneficiaries of this policy.

2)  Capacity expansion:-

  • SPAL had approx. 3,460 sewing machines operating at over 85% utilization levels in FY 2016.
  • Management will be adding 2,000 sewing machines (58% increase in capacity) over 3 years at a capex of Rs 60 crore (adding 600 machines by end of FY 2017). Company will require 4,000-4,500 additional labor (approx. 2 labor per machine) to cater to this incremental capacity.
  • This entire expansion will aid the company to cater to growing needs of the existing clients as well as create the manufacturing base for the demand from the new customers.

3) Customer diversification:- 2-3 new customer addition expected in next 12-18 months

  • Company currently only has 5 key international retailers (all based in UK) & many of them have been with SPAL for last 20 years. Management plans to add 1 or 2 non-UK customers in medium term to deleverage its customer concentration.
  • Previously, company did not penetrate much in USA market because requirement of US clients is huge. If company had to supply to US market, then they would have to sacrifice on its set UK Business and old relation with marquee clients. There is substantial difference between designs in US and EU. However with the recent capacity addition, management is looking to diversify its customer base & is looking to add clients from other geographies to minimize its customer concentration risk as well as geography risk.
  • Samples have been sent to one of the prospective US client. Management is confident of receiving the purchase order anytime soon and expects first shipment to begin from July 2017. Volumes from this customer are expected to be significant (in line with PRIMARK). However, the ramp-up will be gradual. SPAL has had prior working relations with this customer (period before 2013) but had to discontinue supplies due to capacity constraints.
  • Company is also targeting another US based client & aims to add total 2 US based clients in FY 2018.

Needless to say new customers from non-UK region will not only provide volume fillip to SPAL but also help them reduce their over dependence on single geography (UK).

4) Long term plan to look out for other manufacturing destinations

For scaling up business, company is exploring the possibility of off shore production facility i.e. in other countries. Company is looking to set up factories in other countries (like Sri Lanka) for additional capacity. It would be on lease and company is not looking for buyouts. Company is still evaluating all tax propositions of each country and a viability study is being done and thus it is too early to comment on the same. This can be the long term expansion plan for SPAL.

At opportune time and after creating a strong footprint in kidswear, SPAL will explore opportunities in menswear and womenswear (which is a volume game business).

5) Backward integration

Company has closely looked at its operations and identified areas where it can improve its efficiency and improve its operating margins. SPAL has embarked on backward integration which will aid them in expanding margins by 200-300 bps over next 3 years.

Backward Integration plan:- utilizing IPO proceeds

Scheduled Plan Rs in crore
Increasing blow-room capacity 2.8
Preparatory machines 11.7
Spinning and compact machines (modernization & expansion) 9.8
Coner and auto coner 6.5
Ancillary machines 8.5
Others 5.7
Total Cost 45

A. Spinning:-

About 20% of the yarn produced by the company is consumed in-house (rest of the yarn produced is sold to 3rd parties as it is of higher count). Company has embarked on backward integration process whereby it is adding blow-room and spinning capacity.

  • Blow-room expansion:- Company produces both 45 count and 90 count yarn. It uses 45 count yarn captively while 90 count yarn is sold outside. Company had bottleneck on blowroom side and thus could not produce entire yarn of 45 count. Hence, company has plans to enhance (tripling) blow room capacity to 15,000 kgs per day (long term plan) so that it can increase production of 45 counts, which can be consumed in-house. In Phase I, SPAL has increased blow-room capacity to 4,800 kgs per day in 4Q FY 2017 from 3,200 kg in 3Q FY 2017. Once entire blowroom capacity expansion is in place (expected by Jan 2018), Management will be able to produce multiple counts from its yarn facility.

Impact of blowroom capacity expansion:-

  • With current 90s & 45s Yarn mix, 16,896 spindles can yield 1,190 tons per annum. Going forward with 30s Yarn, 16,896 spindles can yield 4320 tons Per annum.
  • Thus, additional capacity realized = 3,130 tons per annum.

Augmenting spinning capacity:- In terms of Spinning, company is adding 5,000 spindles to take its capacity to 22,000 spindles (16,896 spindles at present). The whole project is designed for 28,000 spindles and thus based on requirements capacity can be augmented without large capital spend. This entire spinning capacity when operated in 3 shifts will be suffice to meet most of the internal demand for yarn. Company wants to increase captive yarn consumption to 80% (20% at present).

However it must be noted that 100% backward integration in spinning is not possible for SPAL as the company will have to source special yarns from outside for some garments. However, whatever yarn will be produced will be consumed captively and yarn sales will not be there from FY 18.

B. Knitting:- SPAL today relies on 3rd party players for knitting and some of its spinning requirements. Company has already installed 20 knitting machines out of the 40 planned. Once all 40 machines (capex of approx Rs 20 crore) are put to use, company will be able to manufacture 10 tons a day whereas the requirement is for 26-27 tons a day. Knitting capacity works in 3 shifts which can accommodate 30 tonnes a day in totality. Thus, company will be 100% backward integrated as far as knitting process is considered. These 40 knitting machines will result in direct cost savings of atleast Rs 5 crore per annum. As these machines are being set-up closer to the spinning units, it will result in further improvement in operational efficiencies for the company – the benefits of which cannot be quantified as of now. (Company has created building complex which can house maximum 60 knitting machines, so further expansion can be taken up as and when required).

C. Dyeing:- Company has excess dyeing capacity and is outsourcing the same to Page industries as on date. Page Industries (“Jockey” brand) is putting up its own dyeing unit which will commence operations by March 2016. From FY 2019, they will stop purchases from SPAL. By that time, SPAL will require the entire dyeing capacity for captive consumption.

D. Processing:- Fabric processing is done 100% in-house. SPAL has surplus processing capacity and it won’t require additional capacity for another 2-3 years. Company has in house capabilities for placement printing. Fabric printing is a different technology which depends upon fashion and designs and hence is outsourced. It is just 5-10% of overall printing requirement; which SPAL may consider to invest in after 2-3 years. Embroidery and other such services (are considered under processing) is done in-house.

Backward integration plans have been slightly behind schedule due to delay in getting approvals from Tamil Nadu State Government for the facility/building. Management expects the same to commence operations only by March 2018.

6) Focus on improving efficiency per machine

Management is now more focused on improving efficiency per machine. Difficult designs require multiple breaks while sewing which reduces the efficiency of labor and machine. Instead they earn you better realizations. However, now Management of SPAL has realized that rather than only focusing on realizations, one should equally emphasize on efficiency of machines. Thus it has started taking large orders from customers which are relatively simple to manufacture.

For instance, margin earned by SPAL for manufacturing garments for Primark (since its styles are comparatively basic) will be marginally higher vis-a-vis other customers. This is because output per machine for PRIMARK will be relatively higher than for other customers. For eg., while Primark output per machine would be 3x of that for the likes of TESCO. Current product mix = 30% basic and 70% fashion. Management is targeting a mix of 50:50 mix going forward. Thus, profitability per machine in Primark would be better despite producing simple designs & having lower realization, owing to volumes and higher efficiency.

Retail Business:

Planned expansion to aid in regional diversification and scale:-

In retail, company will be adding 70 stores at capex of Rs. 28 crore over next 3-4 years. Company currently has 41 company owned stores, 3 franchise and expects to launch 5 new stores (2 in Chennai, 1 in Belgaum, 1 in Bangalore and 1 in Coimbatore) in 4Q FY 2017. Management targets to launch 10-20 stores via the franchisee channel (Franchisee margins range between 35-45%) in next 12 months.

Initial Plan of SPAL was;

Year Additional Stores Capex (Rs. Crore)
FY 17 20 7-8
FY 18 25 9-10
FY 19 25 9-10

However, on account of demonetization, SPAL’s retail expansion plans took a backseat in FY 2017. However, company intends to kick-start its expansion again in FY 2018 and remains confident of adding 20 stores during the year.

Company has also increased its presence also increased to 145 Large Format Stores in 3Q FY 2017 from 116 in 2Q FY 2017. Company plans to increase its presence in this format as well.

Store addition will help SPAL expand its network (crucial in retail segment) and focus is to venture into newer States and regions which will help them lower their dependence on Southern States (over 3/4th of stores are based in South).

Management is targeting to turnaround its retail operations by end of FY 2018:-

  • Retail division suffered an operating loss of Rs 5 crore in 9M FY 2017.
  • Company has created a strong backbone for this business by investing in technology (SAP) and creating back-end operations which can support huge retail store network. Thus, as per management assessment operating leverage will come into play once retail division revenue cross Rs 80-90 crore and it will break even at operating level. As on FY 2017, the retail division is expected to generate approx. Rs 55-65 crore.
  • Management is targeting to turnaround retail division in next 2-3 quarters (compared to previous expectation of achieving break even by end of FY 2017); which got delayed due to demonetization. At most the breakeven will be achieved by 4Q FY 2018.

Financials

 Historicals

Particulars FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 9M FY 2017A
(Rs in crore)
Consolidated revenue 400.6 428.5 450.9 472.6 533 478
YoY (%) 7.0% 5.2% 4.8% 12.8%
EBITDA 60.2 55.0 63.9 68.9 85 81
Margin (%) 15.0% 12.8% 14.2% 14.6% 16.0% 17.0%
Depreciation 16.3 16.9 17.6 20.0 20 15
Interest Cost 40.3 34.3 35.6 31.2 25 13
Adjusted PAT 9.7 2.4 6.7 10.0 36 46
YoY (%) -76% 182% 51% 255%
EPS 3.9 0.9 2.6 4.0 11.7 18.1
       
ROCE (%) 22.7% 26.8% 15.7% 20.5%
D/E (x) 5.6 4.7 4.4 3.4 2.2 0.5


Latest result Highlights:- segment wise

Reported Results 3Q FY 2017 3Q FY 2016 YoY 9M FY 2017 9M FY 2016 YoY
Total Revenue (Rs crore) 154.0 135.7 13.5% 490.0 384.8 27.3%
Garment Division 140.7 125.5 12.1% 448.5 360.4 24.5%
Retail Division 13.3 10.2 30.3% 41.4 24.4 69.6%
Reported EBITDA 33.0 28.5 15.7% 92.3 63.5 45.4%
Garment Division 35.7 27.6 29.4% 97.3 65.2 49.2%
Retail Division (2.8) 0.9 (5.0) (1.7) 189.0%
Reported EBITDA margin 21.4% 21.0%   18.8% 16.5%  
Garment Division 25.4% 22.0% 22% 18%
Retail Division -20.8% 8.9% -12% -7%
Depreciation 5.4 4.9 10.1% 15.4 15.0 2.6%
Interest Cost 3.1 4.9 -35.5% 13.4 18.6 -27.9%
PAT (Rs crore) 14.3 12.7 12.3% 45.6 23.9 90.7%

Guidance

Garment division

Revenue per sewing machine is a right matrix to look at garment business as compared to number of garments sold. SPAL’s revenue per sewing machine is expected to increase to over Rs 16 lakhs (annualized) in each of the next 3 years as compared to Rs 14.3 lakhs in FY 2016.

Volume growth rate based on customer profile:-

Existing matured customers:- Growth can be of 5% YoY,

Existing customers:-Growth can be of 10-15% YoY,

Existing customers (relatively new):– Growth can be of 20-25% YoY for next 2-3 years; and

New customers will be 10-15% of the business over next 1-2 years.

Garment division:- Rough estimates:-

^ FY 2018 garment revenue growth expectations are after factoring in the rupee appreciation impact.

Retail division:-

  • Retail division is expected to report revenue of Rs 55-60 crore in FY 2017, Rs 80 crore in FY 2018, Rs 120 crore in FY 2019 and Rs 150 crore in FY 2020. Revenue growth will primarily be fuelled by store expansion as planned by the Management. Management is targeting around Rs 200 crore topline for its retail business in 4 years.

Margin expansion:-

  • SPAL operating margins are expected to benefit from better performance from its 3 division- Garment division margins are expected to expand primarily driven by backward integration measures and operational efficiency which is likely to add another 200-300 bps over next 3-4 years. Retail division is expected to break-even by 4Q FY 2018 and SP (UK) operations break even was achieved within the first year of its commencement. Collectively, SPAL is expected to reap rich dividends over next 3 years.

Working capital cycle will get elongated post expansion:- Normal order cycle is for 90-120 days. Hence, inventory would be usually in stock for 120 days, receivables would be 45 days and 60 days creditors. Hence, net working capital days would be ~ 105 days.

Post expansion, creditors would come down to 40-45 days. Majority of creditors would be on cotton side. More reduction in creditors days, as its’ always better to take cash discount from the suppliers.

  • Tax rate:- Company is subjected to full tax rate of 33-34%.
  • Dividend policy:- 15% of the PAT will be paid out as dividend every year.
  • On Debt profile:- Debt of Rs 168 cr as on 3Q FY 2017. Current D/E is 0.5x.
  • Capex guidance of Rs 20 crore for FY 2018 and FY 2019.

Financial Guidance:-

A stable growth company catering to marquee clientele which is present in the top quartile of textile value chain coupled with debt free status and generating ROCE of over 25-30% can ideally be valued at P/E multiple of 15x FY 2020E EPS of Rs 49.3. This will give us a target price of Rs 739 which gives us an upside of 88% from CMP of Rs 393.

Key Risks

1) Currency risk poses the biggest challenge to long term growth and profitability of the company. Within a span of last 12 months, SPAL has to counter BREXIT impact (pound depreciation) and rupee appreciation challenges. Management successfully tackled the BREXIT challenge but now will have to face the rupee wrath. If Rupee continues on its appreciation trend, it can dent margins and our growth outlook.

 Currency exposure as on 3Q FY 2017:- USD is 55-58%, GBP – 33% and balance is Euro. The reference Sterling Pound rate for 3Q FY 2017 was Rs 85-86 and expected to be Rs 83 for 4Q FY 2017.

2) Operational turnaround of retail division is critical for SPAL and its long term margin expansion plans. If company fails to turnaround this division, it will not only hurt consolidated performance but will compel the company to make further investments into this business which will also dent the return ratios.

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Sintex Industries : De-merger To Unlock Value ?

 

Current price : 119
52 Week High / Low : 70 / 121
Market Cap : 6520 Crores
9M FY 2017 EPS : 7.5 Rs

Disclaimer: This is not a recommendation to buy / hold / sell any securities mentioned in the blog post. The published post is for information purposes only. The intention to share write ups on this blog is to create a repository of ideas so that investors can have a look at various frameworks & approaches. Please read the detailed disclaimer at the bottom of the post. 


PART 1 

Company Description

Corporate Film

SIL was incorporated in 1931 and commenced its operations with its textile mill as Bharat Vijay Mills Ltd. at Kalol, Gujarat. Company diversified into manufacturing of water storage tanks in 1975 and has over the years moved up the plastic value chain by offering several technology-intensive products and complete solutions including pre-fabricated structures, custom-moulded composites and monolithic constructions etc.

Sintex is one of the most integrated plastic processors in India, and an established brand name in plastic industry. SIL enjoys leadership position in water tanks and prefabricated structure (prefab) business in India. Its established presence in the water tanks business has made brand ‘Sintex’ a generic name.

Transformation over 85 years

Year Transformation
1931-1974
  • Incorporated as The Bharat Vijay Mills Limited, established composite textile mill in Kalol, Gujarat
1975-1990
  • Commenced manufacturing of plastic moulded polyethylene liquid storage tanks
  • Introduced new plastic products like; doors, window frames & pallets
1991-2000
  • Renamed to Sintex Industries Limited
  • Modernized, expanded the textile unit.
  • Commenced structured yarn dyed business
  • Entered into SMC moulded products, pultruded products, resin transfer moulded products and injection moulded products
2001-2004
  • Commencement of production of prefabricated structures
  • Entered into licensing agreement with Containment Solutions for sub- surface and underwater fuel tanks
2005-2008
  • Entered housing sector with monolithic construction
  • First international acquisition – 81% stake in Wausaukee Composites Inc., USA
  • Acquired automotive business division of Bright Brothers Ltd
  • Acquired 100% stake in Sintex NP (formally known as Nief Plastic SA), a French Company
  • Sintex Wausaukee acquired 100% stake in its competitor, Nero Plastics Inc., USA
2009-2016
  • Sintex NP acquired Groupe Simonin, France, NP Germany Gmbh & NP Polska
  • Reduced exposure to Monolithic business due to working capital issues (long payment time)
  • Sintex-BAPL brings Precision Technology, Thermo set and Light Resin Transfer Moulding (LRTM) to India
  • Sintex-BAPL signs a JV with Rototech commences production.
  • Phase I of Spinning goes on stream

Business Segments

On a consolidated level, Sintex has operations in 37 manufacturing locations across 12 countries. Post demerger these two companies will be listed.

Company Presentation

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Sintex Plastic Technology Limited 

This business have infra and plastic segment and generating ROCe (pre-tax) of around 17-18%. This business has two sub-business inside through subsidiaries –

  1. Custom Mouldings – Plastic and composite products moulded and fabricated across market segments such as aerospace & defense, automotive, electrical, mass transit, medical imaging etc.
  2. Building Products – Following are the sub-segment of Building Product:
  1. Prefab – Sintex makes prefabricated structures like classrooms, toilets, healthcare centres, sheds etc.
  2. Monolithic – Designs and constructs monolithic buildings in India to address mass and low cost housing requirements.
  3. Others (Retail) – Sintex manufactures a wide range of consumer focused retail products which include water storage tanks, cold storage facility, environment friendly products, sub-ground structures etc.

A. Custom Moulding

The company is equipped with diverse capabilities of customized moulding which find applications in many industries such as Automotives, Aerospace & Defence, Electrical, Mass Transit and Off-the-Road Vehicles, Medical imaging products etc. Sintex has presence in a diversified range of Technologies, Geographies and Industry Sectors/Customers i.e. no single customer contributes more than 5% of total sales.

                            Rs. Crore

Year

FY 16

FY 15 FY 14 FY 13 FY 12

FY 11

Revenue

3400

3108 2566 2359 1937

1860

India

1530

1270 1060 1061 822

670

Overseas

1870

1883 1506 1298 1115

1190

Blended EBIDTA Margins

15%

14.1% 13.3% 12% 14.3%

14.7%

EBIDTA

510

438.23

341.27

283.08 276.99 273.42

(source: based on Q4 filings, presentations and conference call)

The company uses more than 30 different custom moulding processes and technologies from blow moulding, open moulding, rotational moulding, Light RTM And Vacuum Bag Infusion Molding to ultrasonic welding to meet all types of customer needs and requirements. Sintex’s presence in custom mouldings in India and globally is through its subsidiaries. This segment is profitable and growing at 12-13% CAGR from last 5 years and company expect growth momentum will continue because of its technology edge and also guided for 25% ROCE from this business.  Margins in domestic market is high comparison to export market. Export market margins is around 9-10% while domestic EBIDTA margins are healthy 15-16%.

These subsidiaries are Sintex-NP, Sintex-BAPL, and Sintex-Wausaukee Composites Inc. These companies provide highly-engineered custom moulding solutions to large global and Indian brands with a presence in diverse sectors.

The company has a strong portfolio of OEM, as well as Tier-1 customers: Maruti Suzuki, Hyundai Motors, TATA Motors, Mahindra & Mahindra, Mahindra Navistar, General Motors, Force Motors, Honda Scooters, TVS Motors, Mobis, Visteon, Hanil, Shriram Pistons, Groupo Antolin, Mann + Hummel, Faurecia, Volvo Eicher, Borg-Warner, Donaldson, Schneider Electric, Legrand, ABB, Alstom, Valeo, Airbus, Safran, Stelia and Access to OEM Fortune 500 customer base.

  1. Sintex-Bapl Limited https://goo.gl/21S5jW
  2. Sintex NP https://goo.gl/vpgZfA
  3. Sintex Wausaukee Composites Inc. https://goo.gl/3GA0xp

Through these subsidiaries, Sintex is catering to wide range of industries which are as under:

Automotive Electronics Sports and Leisure / recreation
Aerospace Industrial truck and tractors Transportation
Building and Construction Mass Transit Telecommunications
Defence Medical and Medical Imaging Electrical and Power including Wind Turbine

Growth Drivers For Custom Moulding Business 

There is huge capex coming into domestic market which will drive the revenue of this segment for the company.

  • Electric car maker Tesla Inc. is likely to introduce its products in India sometime in the summer of 2017.
  • South Korea’s Kia Motors Corp is close to finalising a site for its first factory in India, slated to attract US$1 billion (Rs 6,700 crore) of investment. It is deciding between Andhra Pradesh and Maharashtra. The target for operationalising the factory is the end of 2018 or early 2019.
  • Several automobile manufacturers, from global majors such as Audi to Indian companies such as Maruti Suzuki and Mahindra & Mahindra, are exploring the possibilities of introducing driverless self-driven cars for India.
  • JustRide, a self-drive car rental firm, has raised US$ 3 million in a bridge round of funding led by a group of global investors and a trio of Y Combinator partners, which will be utilised to amplify JustRide’s car sharing platform JustConnect and Yabber, an internet of things (IoT) device for cars that is based on the company’s smart vehicle technology (SVT).
  • Ford Motor Co. plans to invest Rs 1,300 crore (US$ 195 million) to build a global technology and business centre in Chennai, which will be designed as a hub for product development, mobility solutions and business services for India and other markets.
  • Suzuki Motor Corporation, the Japan-based automobile manufacturer, plans to invest Rs 2,600 crore (US$ 390 million) for setting up its second assembly plant in India and an engine and transmission unit in Mehsana, Gujarat.
  • Mr Masayoshi Son, Chief Executive Officer, SoftBank Group, has stated that Ola Cabs may introduce a fleet of one million electric cars in partnership with an electric vehicle maker and the Government of India, which could help reduce pollution and thereby transform the electric mobility sector in the country.
  • China’s biggest automobile manufacturer, SAIC Motor, plans to invest US$ 1 billion in India by 2018, and is exploring possibilities to set up manufacturing unit in one of three states – Maharashtra, Andhra Pradesh and Tamil Nadu.
  • General Motors plans to invest US$ 1 billion in India by 2020, mainly to increase the capacity at the Talegaon plant in Maharashtra from 130,000 units a year to 220,000 by 2025.
  • FIAT Chrysler Automobiles has recently invested US$280 million in its Ranjangaon plant to locally manufacture Jeep Compass, its new compact SUV which will be launched in India in August 2017.

B. Infrastructure Business i.e. Building Products

The business vertical comprises of products that find application in residential, commercial and industrial structures. Sintex’s building material segment includes prefab , monolithic, infrastructure and storage tank. The company has now taken a strategic decision of shifting the monolithic and prefab and other govt. related business to its subsidiary i.e. M/s Sintex Infra Projects Ltd, which is aimed to sustain business profitability in the core segment & to avoid liquidity pressure due to delayed realization of receivables. However, SIL has to bid and execute big orders in this segment as M/s Sintex Infra Private Limited sometimes is not able to bid as it becomes ineligible considering its smaller balance sheet size.

 As of now (pre-merger), Sintex Infra Project Limited (SIPL) has 3 major projects on hand including one power plant. SIPL does not plan to undertake any new infrastructure related projects due to long gestation periods and would place itself as a plastic processing company.

With its strong distribution network of over 1,000 dealers/distributors and 20,000 retailers in the domestic market and diverse product portfolio, the company is a major beneficiary of government spending on healthcare, education, and corporate CSR initiatives. The company is focusing on cash flows resulting in controlled growth in monolithic and infrastructure. Sintex is a leader in the fast‐growing building material market. Sintex is in a leadership position for prefabs structures and monolithic construction materials through continuous introduction of new products. The government’s push for affordable housing with faster execution is positive for prefab and monolithic businesses. Monolithic has gained acceptability in the market and has latent demand from affordable housing due to cost and time benefits.

India needs ~ 7mn houses every year, almost 75% of which constitute affordable housing. The qualification with the governments is the primary entry barrier for monolithic construction and prefabs. Sintex is pre‐qualified with 17 state governments for its prefabs and monolithic construction panels.

Rs. Crore

Year

FY 16

FY 15 FY 14 FY 13 FY 12

FY 11

Building Product

3300

3176 2734 2272 2032

2190

Prefab

1800

1480 1174 973 722

650

Monolithic

1100 1350 1251 1029 1087

1340

Storage Tank and other retail product

400

346 309 270 223

200

EBIDTA Total

608

645 478 398 331

438

Prefab

390

385 223 185 188

129

Monolithic

182

180 164 185 185

284

Storage Tank and other retail product

36

42

31

27 27

26

Blended EBIDTA Margins

18%

20% 18% 18% 16%

20%

Prefab

22%

26%

19% 19% 26%

20%

Monolithic

17%

13% 13% 18% 17%

21%

Storage Tank and other retail product

9%

12% 10% 10% 12%

13%

(source: based on Q4 filings, presentations and conference call)

Growth Drivers For Building Products Business

Prefabricated Structures : These are completely knocked down plastic kits for enclosure, which can be assembled in six or seven days, making it the fastest and most cost effective construction solution. Company’s prefab business has opportunities in social infrastructure and other spending by government on structures such as class rooms, healthcare clinics, sanitations, army barracks, worker shelters, community structures etc). This business also supplies sandwich panels for large industrial buildings and cold chain infrastructure as walling and roofing material. Prefab business is generating sizeable revenue, facilitated by increased social spending by the government on healthcare and education.

Monolithic construction : Due to higher receivables period required for this segment and the past difficulty of the company in realising dues from these projects, Company has been consciously curtailing its exposure in monolithic construction space.

Water storage tanks : Company was a pioneer in plastic water storage tanks in India and it still commands leadership and premier position in the water tanks market with a substantial market share. It has a huge product range for a number of applications.

Interior and readymade doors : Extruded plastic sections, used in household/office interiors are positioned as an environment friendly replacement of timber, aluminium among others. Its USPs are low-cost maintenance, rust-proof, termite-proof, water-proof, light weight and easy to install. Company has strengthened the visibility of this product by a number of initiatives.

Sub ground structures : This is a new focus area for Sintex, comprising of draining and water treatment solutions which is high on government’s priority list. The Company’s product basket comprises Septic tanks, Packaged water treatment solutions, biogas units etc.


Sintex Industries Limited – Textile Business 

This will be part of Sintex Industries Limited. Sintex places itself in the niche category of manufacturing high-end structured shirting fabrics for men addressing the premium fashion segment marketed under the brand name Bharat Vijay Mills (BVM). The company primarily deals in the manufacturing of high end structured died yarn fabrics and corduroy fabrics. It sells most of its products to premium brands manufacturing mens shirts in India like Zodiac, Wills Lifestyle, Louis Philippe, Arrow and Van Heusen. In the export field the company sells this product to a number of reputed international buyers in Europe and USA. In the corduroy segment, Sintex is one of the largest producers in India. Exports made to countries like Turkey, UAE, Sri Lanka and Bangladesh constitute a significant part of total corduroy sales of the company.

SIL is also implementing its spinning project with 6 lacs spindle in two phases at Amreli, Gujarat. After setting up the project, around 50% of yarn project would be consumed captive and balance would be sold in the open market. The expansion will be eligible for getting interest subsidy of 7% as applicable for spinning units under the Textile Policy Scheme of The Gujarat State Government.

 

Year

FY 16

FY 15 FY 14 FY 13 FY 12

FY 11

Revenue

948

724 546 473 468

440

Blended EBIDTA Margins

22%

24% 25% 21% 22.9%

24%

EBIDTA

207 175 137 99 107

106

(source: based on Q4 filings, presentations and conference call)

In last 5 years Sintex spent close to Rs. 4100 Crore in Textile business (mix of debt and profit generated by plastic segment and textile segment). This business was generating a low single digit ROCe and dragging down the entire business valuation. Further, company is expecting capex of Rs. 1800-2100 Crore in this segment.

Company is trying to play with arbitrage (different subsidy from Gujarat government) which is not in commensuration with the Business risk as 6 lakh spindles are huge capacity and global market does not offer any great picture. We have to see how this business pans out going forward. If company is able to utlise 100% capacity in next two three years then this business performance may improve. With 100% capacity utilisation, this business has ability to generate Rs. 2000-2500 Crore sales and margins of around 13-15% which is again not a good ROI for the investment which is already done by the company.


Risks & Concerns 

  1. Corporate governance issues.
  2. Delay in demerger process.
  3. Excess net debt transfer to plastic technology company.
  4. Not aware about working capital allocation between different businesses, that is also a major risk in the evaluation.
  5. 54% of Promoter’s shareholding are pledged.

PART 2 

De-merger Scheme – Record Date 26th May 2017

Sintex Industries announced demerger scheme on 29th Sep, 2016. (http://bit.ly/2pYuqp8)

NCLT clearance In March 2017

Brief about Scheme

Sintex Industries is into multiple business Textile, Plastic and Infrastructure. Under the demerger scheme, it was decided to split the company into two listed entities which will carry the following business –

  1. Textile Business – Which will contain Fabric and Yarn (just started contribution from December Quarter)
  2. Plastic & Infra Business – ( Plastic business has custom moulding business and infra business is building material business)

Under the scheme of demerger,

  1. Demerger of “Custom Moulding undertaking” from Sintex Industries Limited into Sintex BAPL Limited
  2. Demerger of “Prefab Undertaking” from Sintex industries limited into Sintex Infra Projects Limited
  3. Both Sintex BAPL Limited and Sintex Infra Projects Limited will be wholly owned subsidiaries of Sintex Plastic Technology Limited (will be listed separately)
  4. Sintex industries become pure play textile play
  5. Shareholders of Sintex Industries will get 1 share of Sintex Plastic Technology limited. Ratio is 1:1.
  6. Total Gross Debt as on December, 2016 was Rs. 7653 Cr. As per management gross debt related with textile segment is Rs. 3600 Crore so Plastic and infra business will have Rs. 4053 Crore
  7. Cash in Balance Sheet as on Dec, 2017 was Rs. 1500 Crore
  8. It is expected that Rs. 1000 Crore cash will be part of part of Sintex Plastic Techology business while Rs. 500 Crore will be part of textile business (my assumption- Since textile business is asset burner business.)
  9. Both company will be listed eventually
  10. There is no change in shareholding pattern pre or post demerger. Promoter holds 32.47% stake in Sintex Industries and they will also hold similar stake in Sintex Plastic Technology limited post demerger.

Present Valuation

  • Currently, the market is valuing SIL at Rs.6520 Crore (market cap) and EV of about Rs.12, 700 Crore.
  • Used EV/EBIT multiple to value present business as this ready available figure for different sub segment hence easy to compare.
  • Market is valuing it at TTM 10.5 EV/EBIT (TTM EBIT of RS. 1196.6 Crore).

Past performance

Relative valuation (PE/ EV/EBIT etc.,) is a derivative of three important factors-

  1. ROCe
  2. Working Capital Management
  3. Growth Rate

The valuation multiples will be high if underlying business has high ROCe (potential to improvement), efficient working capital management and good growth outlook.

Historically, Sintex has always quoted at lower relative valuation multiple.

Company has been quoting in a band which is mostly like commodity companies. This is because of low ROCe generation by the company on a consolidated level and also high reinvestment into a textile business which is generating meagre ROCe. Company will be wealth de-structurer if they are not generating ROCe above their cost of capital.

Calculation of cost of Capital

Cost of capital will be combination of two factors :

  1. Cost of Equity and
  2. Cost of Debt

Cost of Equity can be calculated as:

Cost of Equity = (Beta x Risk Premium) + Risk Free Rate

 cost of capital aswath damodaran

Source : Aswath Damodaran


Beta of Sintex industries was 1.58 (as it contain plastic and textile business. Theoretically textile companies especially fabric or yarn companies have higher beta vis a vis plastic companies. Beta show the risk of the business which arises from the underlying business, capital structure and macro environment). Most of the plastic companies are showing beta between 0.50-0.75 while textile player’s beta is around 1.0-1.70 so it means textile business has high underlying cost of equity vis a vis plastic business. Sintex is AA+ rated entity so bond yield is good indicator for valuing debt portfolio. AA+ kind of bonds are valued at 10%-11% yield.

Cost of Equity = 17.34%

Cost of Debt = 10-11%

So blended cost of capital is around 14-15% so logically Sintex should generate ROCe of more than cost of capital to justify the business.  But Sintex industries is generating ROCe below its present cost of capital.


 

Snapshot at consolidated level

sintex ROCE ROE


What will happen post demerger? – Each business will show its true colors

Note:

1. Change in working capital is also part of reinvestment. Have no clue about working capital requirement from each business so ignored it for the ease of calculation.
2. There will be some realignment of business post demerger –some business will move from plastic to infra subsidiary but will be part of holding company only. Since, capital employed figures are not available so have taken the figures as it was reported in Q4, filings.
3. There was some unallocated heads which were allocated based on Sales Ratio of different segments.

Presently textile business is consuming 45% of total capital employed while contribution in EBIT is only 14% which is the reason company’s performance has been subdued as most of the investment is going into textile business which is generating single digit ROCe hence taking down the entire valuation of the business.

Post demerger each business will operate independently so valuation of each business will be derived based on underlying business performance and growth.


Valuation of both Businesses                                                                                                                                      (Rs. Crore)

 sintex valuations market cap

@ Market cap / sales is not the right measures as sales is contribution from equity as well as debt so logically should valued it EV/Sales or EV/EBIT but in both scenario expected market cap will be negative as there will be huge debt is there for textile segment. Company has done huge capex last year and also current year so debt overhang will be there till FY 19. Therefore used mcap to sales for textile valuation. 

# Assigned 11.5x EV/EBIT multiple because of underlying nature of the business similar to other plastic processing companies. This business is less capital intensive generate healthy ROCe. Presently plastic business include custom moulding, prefab, monolithic, storage tanks and other business. Going forward prefab, monolithic business will be merged into infra company.


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