Supreme Industries – well-run plastics company, is the stock a Buy?

In this article I will analyze Supreme Industries Ltd. one of India’s largest plastics manufacturers. Its a mid-cap company with a market capitalization of Rs. 3700 crore. Dive deeper to see a research report on how the company is managed and whether the stock is a good buy at current levels!

 

Qualitative Analysis

1. What is the business?

Supreme Industries Ltd. processes over 240,000 MT annually across 19 manufacturing facilities. They have the following business verticals:

  • Plastic Piping
  • Consumer Products (plastic furniture)
  • Packaging Products
  • Industrial Products
    • Industrial Components (Consumer appliance body manufacturing)
    • Material handling components (soft drink crates, pallets)

Revenue breakup for FY12 for Supreme Industries is shown below.

Supreme Industries - Revenue breakup - FY12


Supreme Petrochem, in which SIL has around 30% stake, is the largest single site polystyrene (PS) producer with a capacity of 272,000 tonnes per annum for polystyrene, accounting for 2% of the global capacity and 60% of the domestic installed capacity

Supreme Industries owns 29.88% equity of Supreme Petrochem as per the September 2012 shareholding pattern filing with the exchanges. (R. Raheja Investments Pvt. Ltd. owns another 29.88%)

Supreme had land in Andheri, Mumbai. They have developed a commercial complex on their own.

  • Total Saleable Area : around 280,000 sq. ft.
  • Total Project Cost : about Rs. 155 crores
  • Company has sold 95,000 sq ft for a total consideration of Rs 150 crore
  • Balance two-third area should net another Rs. 300 crore if we assume the same selling price.
  • This is an non-core area and opportunistic initiative (in the positive sense)

2. What is the company’s bargaining power with suppliers?

Polymers like polyethylene, polystyrene, and polypropylene, and resins are inputs for Supreme’s business. Polymer and resin prices are linked to crude oil prices. It does not have too much flexibility and has to take prices from suppliers. Around 40% of raw materials have to be imported. Forex fluctuations affect Supreme Industries’ purchases.

3. What is the company’s bargaining power with customers?

Management has spoken in earnings call transcripts about their pricing policy. Plastic pipes are the biggest segment by revenue for Supreme Industries. Plastic pipes prices are updated daily based on input price fluctuations. Other product price changes are passed on to customers with a lag of 2-3 weeks. Supreme Industries seems like a price-setter than a price-taker.

Cash outstanding from customers seem to be pretty well managed indicating that they have relative power in the market as compared to customers.

4. How is the company placed against competitors?

Some of the big listed players in plastics are given below. Most do not have exact businesses like Supreme. They compete in different segments as the case may be.

  • Time Technoplast – material handling equipment
  • Finolex, Astral Poly, Jain Irrigation – Plastic pipes
  • Nilkamal – Plastic furniture, it is the leader in India
  • Cosmo Films. Max India – Films segment

Supreme industries has superior return on net worth ratios as compared to competition.

CompanyRoNW – FY11RoNW – FY12
Time Technoplast13%15%
Astral Polytechnik22%21%
Cosmo Films17%13%
Nilkamal15%15%
Finolex Industries12%11%
Supreme Industries31%33%

 

5. What is the market share if data is available?

SegmentMarket size (in Rs. crore)Supreme’s share of total market
Plastic pipes13,5009%
Consumer products (furniture)2,00013%
EPE Foam32536%
Air bubble film24018%
Cap cell16030%
XLPE6050%
Industrial products1,16015%

 

XLPE = cross-linked polyethylene

EPE Foam = expanded polyethylene foam

6. Is the company innovative? Does it work on adding new product lines or service lines?

In past investor communication, the management has constantly spoken of increasing share of value added products which yield higher margin and they have added product lines in different business divisions.

  • The annual report for FY06 mentions how Supreme Industries was the first company in India to install a 7 component 7 layer film line. Subsequently this has worked well for the company.
  • Only Indian company to have the technology to manufacture Patented Cross Laminated film Products under Brand name Silpaulin. It is one-seventh the weight of conventional cotton tarpaulin, but has a high strength-to-weight ratio.
  • The company is riding the changing preferences of using plastic pipes in building construction, irrigation and other applications instead of galvanized iron (GI) pipes which have a lower life due to corrosion.
  • The company is making Chlorinated Polyvinyl Chloride (CPVC) pipes and is seeing high growth rates as per an earning call transcript from October 2011. CPVC pipes have better performance as compared to regular PVC pipes
  • To improve security, Mumbai introduced plastic see-through dustbins at railway stations. Supreme Industries was the supplier.
  • Recently they are working on setting up a production line for composite gas cylinders which are an alternative to metal cylinders. Metal cylinders are comparatively heavy and expensive.

These are a few examples I picked from their communication and news. Various annual reports talk of the company talking to customers and coming up with new products as per changing requirements.

Overall, I get the feeling that the company keeps adapting to customer requirements.

The latest investor presentation (August 2012) talks of the following areas where they want to develop/ introduce innovative products for new applications

  • Immediate Focus Area – Composites
  • Electrofusion & compression moulded fittings for Infrastructure & Gas Distribution
  • Manhole & underground sewer systems
  • Second generation Cross Laminated Film Product licensed to the Company by the Collaborator
  • Additional system in Plastic pipe Segment for replacing conventional material pipes

Supreme Industries seems to have the characteristics of an innovative company that Phil Fisher talks of in his superb book Common Stocks, Uncommon Profits,

7. Is management compensation reasonable or too high?

The Taparia family who have been managing the company for more than 44 years, has taken home close to Rs. 13.2 crore in FY12 in salaries and commissions. This amounts to 0.44% of sales of Rs. 2968 crore in FY12. It does not ring alarm bells.

8. What are the sustainable advantages or moats that the company enjoys?

  • Distribution – 2,000 channel partners and over 25,000 retail counters
  • Ability to absorb new technology and launch new products, on their own or through technical collaborations and stay at the leading edge.
  • The “Supreme” brand name is widely known across India.
  • Use of patented technology (for which they are paying royalty) in multiple products
  • In certain segments, the company is trusted enough to co-develop / co-manage products. e.g. in packaging

 

Sector Analysis

9. What are the factors that affect this sector?

The growth of plastics in the country is usually correlated with GDP growth. Their annual reports state that plastics consumption growth increases by 1.5 times the GDP growth. But there are exceptions. In the financial year 2011-12, consumption grew by only 6%. An earlier annual report for FY04-05 also talks of a 1% growth in plastic consumption in India in what was

“…the worst year in the history of plastics consumption growth in the country in the last two decades.”

On the input side, crude oil prices affect raw material prices putting pressure on margins of plastics manufacturers in general. Supreme Industries is doing a good job of protecting and growing margins.

10. What are the prospects for this sector for the future?

Plastics are not a fad. They touch our lives in almost all aspects. I cannot think of a day in which we go through without using a single object that is not made from plastics.

I agree there are environmental concerns on the use of plastics in that they are not usually bio-degradable. I say usually because there are biodegradable plastics too.

But they cannot disappear all at once. New technologies may come in, but I do not foresee a plastic-less future.

 

Quantitative Analysis

11. Is return on net worth at least 20%? What is the trend in return on equity over the last 5 years?

Average return on net worth over last five years has been 32%. Some companies take on high debt and can give high return on net worth at the cost of added risk to the company’s balance sheet. In contrast, Supreme Industries has reduced debt and still increased return on equity.

12. Does the company manage working capital efficiently?

Working capital for Supreme Industries is efficiently managed. They collect cash from customers in around 21 days (if you look at last 4-5 years). This has a big role to play in maintaining strong operational cash flows.

Supreme operated with 34 days of working capital (on Revenue) in FY12. Its a good number for a manufacturing company.

13. What is the company’s dividend paying history?

Dividend payouts have more than tripled in the last 5 years. They increased from 80% of face value to 300% of face value from FY08 to FY12.

14. What is the dividend yield?

Dividend yield which is dividend divided by market capitalization is 2.1% considering closing price as of 30 October 2012.

15. Is the company making good use of the retained earnings?

The company has incurred capital expenditure in all of the last 5 years. There have been additions to the fixed assets. With superior return on net worth ratios, I would be happy to see the company retaining more earnings in fact and deploying them productively. I am willing to forsake dividends in a company like this if they are generating 30% plus return on net worth every year.

16. What is the amount of debt as compared to equity?

Debt equity ratio has reduced to 0.4 in FY12 from 1.2 in FY08. This gives greater comfort to an investor.

The interest coverage ratio (Operating profit/Interest) is a healthy 8.7.

Debt management appears to be prudent.

17. What are the growth rates of sales, operating profit and net profit in the last 5 years?

Revenue more than doubled in the last 5 years. Operating profit (EBITDA) more than tripled in the same period and net profits grew by more than 4.5 times. Margins are improving and its a positive point for an investor.

18. What is the amount of free cash flow in each of the the last 5 years respectively?

Free cash flow has gone up and down over last 5 years because they are adding to capacity every year.

Supreme Industries - free cash flow to firm - FY08-12

19. Is the operating cash flow at least equal to net profit?

In the last five years the total operating cash flows have been higher than reported net profit numbers.

20. Is net profit growth matched by EPS growth or is growth at the cost of dilution of equity?

The company conducted a buyback in FY09 and reduced shares outstanding. EPS growth has been higher than net profit growth.

SIL has not raised equity capital in 15 years which is a good feature. It is conservatively managed.

21. What is the trend in operating profit margins and net profit margins respectively over the last 5 years?

Operating margins have increased from 11% to 16% in the last 5 years. Net profit margins have increased from 4% to 8%.

Value added products share has been growing steadily from 15% in FY07 to 29% in FY12. The management defines value added products for the company as those products which have an operating margin of greater than 17%.

Financial snapshot of Supreme Industries (figures in Rs. crore)

FY08FY09FY10FY11FY12
Revenue1,3161,6612,0202,4742,968
EBITDA150244303362475
PAT5491156196242
EPS 3.9 6.4 12.3 15.4 19.0
Revenue growth26%22%22%20%
EBITDA growth63%24%19%31%
PAT growth69%72%26%23%
EPS growth64%93%26%23%
Operating margin – EBITDA (%)11%15%15%15%16%
Net profit margin – PAT (%)4%5%8%8%8%
WC days(24)(3)(2)5034
Return on Equity20%30%38%36%35%
Return on Capital Employed12%22%25%25%33%
Debt/equity ratio1.10.80.60.80.4
Cash2911191414
Interest coverage ratio (EBITDA / Interest)3.94.59.28.58.7
Operating cash flow106189146170294
Net capital expenditure1431297324733
Free cash flow to firm (FCFF)-376072-77261

 

Growth Analysis

22. What are Supreme Industries growth plans?

  • The existing capacity is to to be enhanced to 630,000 MT by 2015-16.
  • It will need Rs. 1100 crores of capital expenditure
  • Company intends to enhance the overall contribution of value added products from 29% to 35%
  • Company aims to grow to Rs. 6000 crore turnover by 2015-16. This implies a 20% compounded annual growth rate in revenue. Over FY07-FY12 they grew at 23%. So this is a fair projection by the company.

 

Risk factors

23. What are the risks that this sector faces?

  • Possible regulation in use of plastics in the country and the world
  • Crude oil price shocks

24. What are the specific risks that Supreme Industries faces?

  • Competition is heating up – companies like Astral are increasingly getting stronger in areas like PVC pipes for which they have tie-ups with Lubrizol. They seem to have an interesting range of products which I could not see on the Supreme website.
  • There will be a limit to how much they can increase the share of value added products in total revenue. This increase has helped improve the financial profile of the company till now. Beyond this it cannot give massive improvement in financials like it has in the past.

Valuation

25. What is the valuation in terms of price to earning ratio and price to book ratio? How does it compare with historical  ratios respectively?

The last 5 years price to earning ratio for the company has been as follows.

For price I have taken average price for the year in numerator and EPS for the year in denominator.

Supreme Industries - Price to earning ratio - FY08 - 12

 

Average price to earning ratio (P/E) for Supreme Industries has been 8.91 in the last 5 years.

If I include the September 2012 result,  the earning per share for last 4 quarters is 19.17. At a closing price of Rs. 290.60/- on 30 October 2012, we get a P/E ratio of 15.16.

Irrespective of the fact that the financial performance has been good, I would consider this P/E to be on the higher side, beyond my comfort zone.

Price to book ratio (P/B) is a relatively high value of 5.30 as of 30 October 2012 when you consider that  P/B for the Nifty or Sensex is around 3.5 over long-term.

There does not seem to be a margin of safety if you invest at current levels.

I would be alright with paying 10-11 times earnings for a company which seems to be running well and looks like it is in steady hands for the future. That means a drop in valuation by around 25-30% from today’s valuations. I like to buy cheap and then get benefits of earnings growth and price to earning ratio expansion.

But that’s me! Your views may be different and you may be willing to place a wager on growth expectations. I do not look at forward numbers usually!

26. What are the results of the discounted cash flow analysis (DCF)?

Average free cash flow to firm over last 5 years has been affected by recurring capital expenditure. My guess is that they will not have too much free cash in the coming 4 years at least. They plan to undertake around Rs. 1100 crore of capex. They had an operating cash flow of Rs. 294 crore in FY12. If we assume they have average Rs. 275 crore capex each year for next 4 years, that does not leave too much free cash flow to firm.

The company is in a growth phase and I would not want to stick my neck out with a DCF analysis for the sake of doing one.

 

Market Analysis

27. Where is the market right now as compared to long-term averages for valuation?

As I covered in a recent article, small cap stocks and mid cap stocks seem to be heated right now as is evident in broader small cap index and mid cap index valuations which are beyond 20 for trailing price to earnings.

Caution is needed at these levels.

 

Conclusion

I quite like Supreme Industries Ltd. as a company. It looks like a good company to own for the long-term.

But, as a stock, it looks expensive at current levels. In current market conditions, quality companies are getting high valuations compared to their past trading history. Therefore, Supreme Industries might continue to trade at these valuation levels. I will cautiously hold. I will buy if valuations dip by 25-30% as I wrote above.

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Useful resources

Annual Reports

For Investor presentation – August 2012 click Others once you go their website through the same link that you use for Annual Reports.

A free CRISIL report dated September 2012

 

I hold a position in Supreme Industries. Please read the disclaimer.

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Comments

  1. Anil Kumar Tulsiram says

    Excellent Kunal

    From your writeup, I could see how in-depth analysis you carry out for any company and I am particularly pleased with your risk and valuation section. I generally follow contrarian approach and currently invested in solid companies but at cyclical low and special situations. But decided to venture into growth stocks now. Apart from risk factors for me the deal breaker is the point that currently it has become darling of institutional investors and the moment they see growth slowing down or margin pressure because of competition intensifying or crude oil shock they will dump the stock and then it will be time to buy the stock.

    • says

      Thanks Anil, our thoughts are similar. I did mention that I probably would not add more to my holding in Supreme Industries but rather wait for a better price. You are right in that institutional investors are gradually noticing Supreme and that they can be impatient.

      I also don’t like to be dogmatic and say that only value investing is good or growth investing is better. Each of us has our area of expertise. Let us make the best use of our skills in the way we can.

      Its great to see investors like you who invest with their thinking caps on! I hope that we will interact more ahead on Capital Orbit. If you haven’t signed up for my mailing list, you can do so. See you around!

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