Mid-Cap Consumer September 27, 2011 Pidilite Industrieswebambit.ambit.co/reports/Ambit_Pidilite_Initiation_27Sept2011.pdf · Mid-Cap Consumer September 27, 2011 Pidilite Industries

Mid-Cap Consumer September 27, 2011

Pidilite Industries Bloomberg: PIDI IN Equity Reuters: PIDI.BO

Accounting: GREEN Predictability: GREEN Earnings Momentum: GREEN

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BUY

Exhibit 1: Key financials (` mn)

Year to March FY09 FY10 FY11 FY12E FY13E Operating profit 2,105 3,769 4,508 4,972 6,060 EBITDA 2,218 4,103 4,940 5,491 6,683 EBITDA margin (%) 10.6 17.2 17.0 16.0 16.5 EPS (`) 4.4 5.4 6.1 6.8 8.1 RoE (%) 16.9 34.8 31.7 28.7 29.0 RoCE (%) 13.3 26.0 31.5 31.7 33.9 P/E (x) 37.3 30.5 26.8 24.2 20.2 Source: Company, Ambit Capital research

INITIATING COVERAGE

Rakshit Ranjan, CFA Tel: +9122 3043 3201 [email protected]

Shariq Merchant Tel: +9122 3043 3246 [email protected]

Recommendation

CMP: `164

Target Price (Period): `181

Previous TP: NA

Upside (%) 10%

EPS (FY12E): `6.8 Change from previous (%) NA

Variance from consensus (%) -1%

Stock Information

Mkt cap: `85bn/US$1,713mn

52-wk H/L: `183/123

3M ADV: `43mn/US$0.9mn

Beta: 0.8

BSE Sensex: 16,051

Nifty: 4,835

Stock Performance (%)

1M 3M 12M YTD

Absolute 6.8 3.0 7.9 9.6

Rel. to Sensex 5.5 15.0 27.9 31.4

Performance (%)

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28-Sep-10 17-Feb-11 12-Jul-11

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190

Sensex Pidilite Inds 1-year forward P/E

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Source: Bloomberg, Ambit Capital research

Strong…Even Under Pressure Pidilite is a defensive play in the consumer space with a presence in niche markets and with resilient product sales. Strong brand recall, the lack of organized competition and high customer loyalty provide the group with high pricing power. This enables Pidilite to maintain its operating margins across the economic cycle. Despite that, its shares trade at 5%-10% discount to peers. We initiate coverage with a BUY.

Pidilite is the market leader in the adhesives, sealants and specialty chemicals segment. The group controls over 60%-70% market share in the bulk of its product categories with its input costs being exposed to volatility in commodity prices (including crude oil prices). We expect steady operating margins with net sales CAGR of 18% over FY11-FY14 (16%, 24% and 21% CAGR achieved over the past 3, 5 and 8 years respectively) based on the following:

Strong brand in niche markets: Over 80% of the distribution channel in Pidilite’s targeted markets, including furniture and plumbing, is unorganised. Through media advertising, training programmes and by providing ancillary benefits for the families of carpenters, plumbers and civil contractors, the group has created strong brand awareness. This gives Pidilite significant competitive advantages versus its competitors which include global players such as 3M, Kores, Huntsman, HB Fuller and Bostik Findley.

Sustained product demand across the economic cycle: With products like adhesives contributing to less than 5% of the total cost of a furnishing project, Pidilite’s targeted market faces a shortage of branded substitutes. Consequently, the group enjoys sustained demand from refurbishment activities, maintenance and repairs even when the broader Construction/Real Estate sectors are going through cyclical troughs.

High pricing power: Given the lack of cut-throat competition and given brand loyalty, Pidilite has historically been able to pass on the volatility in its input costs to its customers. Consequently, even in the current inflationary environment, the group has been able to achieve price escalation of 5%-10% over the past six months whilst maintaining high sales growth rates (21% YoY in 1QFY12).

Valuation: Our DCF model, using a risk free rate of 8.5%, an equity risk premium of 7% and a beta of 0.8, translates to a valuation of `181- 10% higher v/s the current price. Based on its FY13E earnings multiple, the stock is currently trading at a 10% discount to the blended peer group average of FMCG and Specialty Chemicals players. We have not assumed any sales contribution from the group’s Elastomer project, (expected to be completed towards the end of FY2013). This could provide further 7% upside to our base case valuation.

Pidilite Industries

Ambit Capital Pvt Ltd 2

Company Financial Snapshot

Profit and Loss (` mn)

` mn unless stated o/w FY11 FY12E FY13E Net sales 26,439 31,032 36,770 Optg. Exp(Adj for OI.) 21,499 25,541 30,086 EBITDA 4,940 5,491 6,683 Depreciation 595 650 800 Interest Expense 314 320 259 PBT 4,031 4,521 5,625 Tax 947 1,085 1,406 Adj. PAT 3,084 3,436 4,218 Profit and Loss Ratios EBITDA Margin % 17% 16% 16% Adj Net Margin % 12% 11% 11% P/E (X) 27 24 20 EV/EBITDA (X) 19 17 14 Dividend Yield (%) 1.1% 1.2% 1.3%

Company Background

Pidilite was launched in 1959 by the Parekh Group tocapitalize on the potential market for synthetic resinadhesives in India. The group’s product range includes Adhesives and Sealants, Construction and PaintChemicals, Automotive Chemicals, Art Materials,Industrial Adhesives, Industrial and Textile Resins andOrganic Pigments and Preparations. The group’s flagship brand, Fevicol, accounts for over 60% of the overall adhesives market in India.

Through a series of acquisitions over the past decade,the group has expanded its presence into geographiessuch as Brazil, USA, Middle East and the Far East.

Balance Sheet (consolidated) (` mn)

` mn unless stated o/w FY11 FY12E FY13E Total Assets 20,399 22,783 25,852 Net Fixed Assets 9,138 10,989 12,189 Current Assets 9,556 10,090 11,958 Other Assets 1,705 1,705 1,705 Total Liabilities 20,399 22,783 25,852 Networth 10,847 13,107 16,010 Debt 3,356 3,200 2,350 Current Liabilities 5,774 6,054 7,069 Deferred Tax 423 422 422 Balance Sheet Ratios ROE % 32% 29% 29% ROCE % 31% 32% 34% Net Debt/Equity 0.2 0.2 0.1 Equity/Total Assets 0.7 0.8 0.9 P/BV (X) 7.7 6.4 5.3

Cash Flow (consolidated) (` mn) ` mn unless stated o/w FY11 FY12E FY13E Operating Profit 4,508 4,972 6,060 Other Income 432 519 623 Interest (314) (320) (259) Tax (699) (1,085) (1,406) Change in Wkg Cap (961) (330) (478) CF from Operations 2,967 3,756 4,541 Capex (1,287) (2,500) (2,000) Investment 912 - - CF from Investing (375) (2,500) (2,000) Change in Equity - 1 13 Debt (1,321) (156) (850) Dividends (885) (1,178) (1,329) CF from Financing (2,206) (1,332) (2,166) Change in Cash 386 (76) 375

Historical revenues vs gross margin trend for Pidilite

YoY change in input costs (dotted line) vs YoY change in final product pricing (solid lines) for Pidilite

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Source: Ambit Capital

Pidilite Industries


Background Pidilite was launched in 1959 by the Parekh Group to capitalize on the potential market for synthetic resin adhesives in India. As shown in the table below, the group’s product range includes adhesives and sealants, construction and paint chemicals, automotive chemicals, art materials, industrial adhesives, industrial and textile resins and organic pigments and preparations. The group’s flagship brand, Fevicol, accounts for over 60% of the overall adhesives market in India.

Exhibit 2: Product Portfolio (FY11 Standalone)

Segment Share in Pidilite’s total revenues (standalone) Targeted industry Key brands

Consumer and bazaar

Adhesives & sealants 49% Household Care Fevicol, M-Seal, Fevi Kwik

Construction & paint chemicals 19% Construction & Paint Dr. Fixit, Roff

Art materials & others 9% Art & Stationary, fabric care, car care

Hobby Ideas, Fevi Stik, Ranipal, Cyclo

Specialty industrial chemicals

Industrial adhesives 8% Packaging, cigarettes, footwear

Fevicol

Industrial resins 7% Paints, textiles, leather Pidicryl

Organic pigments and preparations 8% Textiles Acrolite

Total 100%

Source: Company, Ambit Capital research

Through a series of acquisitions, the group has expanded into several geographies and products. Pidilite’s key brand acquisitions over the past ten years are highlighted in the table below.

Exhibit 3: Key brand acquisitions

Acquisition Year Amount paid (` mn) Description

M-Seal (India) FY00 NA Leading brand of epoxy compounds acquired from Mahindra Engineering and Chemical Products Ltd.

SteelGrip (India) FY02 90 Leading PVC insulation tape brand in India was acquired for `90mn from Bhor Industries

Roff (India) FY05 138 Roff is a pioneer in construction chemicals in India and was known for modern tile fixing solutions like tile-on-tile and waterproof tile joints. Was acquired for `138mn.

Tristar Colman (USA) FY06 18 Pidilite acquired Tristar Colman brand and business for `18mn, now known as Colstar. Tristar Fine Art, is a leader in brushes for drawing and painting while Tristar Colman is a brand for canvas and student art colours.

Sargent Arts Inc (USA) FY06 NA Acquires, through Pidilite USA Inc, businesses and assets of Sargent Art Inc., makers of art materials in the USA

Cyclo (USA) FY06 NA Makers of automotive maintenance products. The product range includes maintenance, performance and appearance products for DIY (do-it-yourself) and professional car care segment sold in the USA and over 50 other countries

Pulvitec (Brazil) FY07 531 Pidilite Brazil [Pidilite Do Brasil Desenvolvimento De Negocios Ltda] acquired Pulvitec, an adhesives & sealants company in Brazil. The company was acquired at a cost of around `531mn.

Holdtite (India) FY08 118 Pidilite acquires Holdtite business of Hard Castle Ltd. (sealants). Cost of acquiring all assets including Holdtite, Rustolene and Leakguard was around `118mn.

Woodloc FY09 NA Pidilite acquires Woodlok, retail wood working brand of Henkel


Whilst these foreign subsidiaries contribute to around 11% of the group’s total consolidated revenues, most of these entities are yet to break even. Beyond issues around the lack of scale and brand penetration, the performance of these subsidiaries in the recent past has also been affected by the difficult global economic conditions, the adverse political climate and high input costs. We believe that management bandwidth is also likely to be a drag on the profitable expansion of these subsidiaries.

Pidilite Industries


Exhibit 4: Growth trends of Pidilite’s foreign subsidiaries (` mn)

Revenues Net Profit

Subsidiary Country FY08 FY09 FY10 FY11 FY08 FY09 FY10 FY11

Pulvitec do Brasil Industria e Comercio de Colas eAdesivos

Brazil 680 802 1,141 1,316 (29) (200) (8) (88)

Pidilite USA USA 857 1,251 1,114 1,220 (97) (90) (47) 14

Pidilite Bamco Ltd Thailand 142 154 170 185 (6) (27) (4) (6)

Pidilite Specialty Chemicals Bangladesh Bangladesh 11 - 40 119 0 - 0 5

Jupiter Chemicals UAE 94 194 188 106 (24) (54) (63) (87)

PIL Trading Egypt Egypt NA NA 28 69 NA NA (2) (21)

Pidilite Industries Egypt Egypt 0 - 16 60 (1) (2) (27) (20)

Pidilite Innovation Centre Singapore 19 25 25 54 1 (1) (5) (9)

Bamco Supply Services Thailand NA 5 15 23 NA 1 1 1

Pidilite Middle East UAE 0 3 - - (1) 3 0 (242)

Source: Company, Ambit Capital research; Note: NA = Not applicable

Exhibit 5: SWOT Analysis for Pidilite Industries

Strengths Weaknesses

Dominant market share: Pidilite controls over 60% of the market in most of its adhesives and sealant products

Strong brand recall: With a significant focus put on increasing brand awareness amongst carpenters, plumbers and civil contractors, Pidilite has established its brand even in an unorganised market

Large distribution network: The company has a pan India distribution network with its retail distribution crossing 300,000 points of sale

Pricing power: Due a combination of significant trust built amongst its customers and lack of competition from branded products, the group has pricing power on its products

Lack of management bandwidth to manage international operations: The group has struggled to manage its international subsidiaries, with most of them still posting losses

Constant delays in Elastomer project: The management has missed its initial deadline of FY10 and is now targeting a FY13 completion

Opportunities Threats

Successful implementation of the Elastomer project: Despite its numerous delays, the elastomer project can provide a substantial boost to the company’s revenues and margins

Leverage brand value in international operations: The company has leveraged the fevicol brand across its product categories and can now capitalize in international markets

International operations: With the global economy showing further signs of weakness, foreign subsidiaries may struggle to break even

Potential Competition: The expansion of HB Fuller and 3M into the Indian market can pose a threat to their market share

Source: Ambit Capital research, Industry, Company

Pidilite Industries


Resilient sales with steady operating margins As shown in the charts below, even during periods of weak economic growth, demand for Pidilite’s products has remained strong. Also, despite significant volatility in raw material costs, the group has been able to maintain steady gross margins and EBITDA margins over the past ten years.

Exhibit 6: Historical revenues and gross margin trends

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Exhibit 7: Historical EBITDA margins and ROE trends

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EBITDA Margins ROE Source: Ambit Capital research, Company

Historically, Pidilite has been able to maintain such robust performance due to a combination of three factors: a) Strong brand recall in niche markets; b) Low direct exposure of its products to economic volatility; and c) High pricing power.

Strong brand recall in niche markets The bulk of Pidilite’s products, especially in the adhesives and sealants division cater to niche markets like furniture and plumbing. For these products, over 80% of the distribution channel is unorganized where brand recall with carpenters, plumbers and civil contractors is crucial for product penetration. Pidilite has in the past focused considerably on increasing its brand awareness through media advertisements, training programs for carpenters and plumbers, and through other channels like vocational training for spouses and children, introduction of furniture design books, social networking clubs, free health check-ups for carpenters, and festive celebrations.

Consequently, as shown in the table below, whilst the group faces competition from global players such as 3M, Kores, Huntsman, Bostik Findley, HB Fuller, etc. for some of its products, eg. the bulk of its adhesives and sealant brands, there are no major organized competitors.

Exhibit 8: Key competitors

Brand Segment Competing products

Fevicol Adhesives Camel glue, 3M

Fevikwik Adhesives Araldite

Fevistik Adhesives Kores Glue, Faber Castell glue stic, Scotch glue stick

M-Seal Sealant No major competing product

Dr Fixit Water proofing Local products

Steel Grip Electric insulation Various smaller products

Roff Tiling solutions No major competing product

Hobby Ideas Art materials Faber Castell, Kores, Camlin


Pidilite Industries


Low direct exposure to economic volatility Although Pidilite’s products are used in the construction sector, a large part of its product demand is driven by the more resilient industry segments such as refurbishment activities, household care and maintenance requirement (see table on the left). Also, given that adhesives contribute to less than 5% of the total cost in a furnishing project, users of Pidilite’s products are unlikely to go for inferior quality unbranded substitutes during periods of decline in consumer spending.

Consequently, even during periods of weak real estate/construction activity in the past, sales volumes for the group’s products have continued to grow, albeit at reduced rates compared to periods with economic booms.

High pricing power Pidilite’s products use the following as raw materials: Oil based chemicals, acrylics, vinyl acetate monomer (VAM) and other monomers. Therefore, the group’s costs are significantly exposed to the price of certain commodities including crude oil. As shown in the chart on the left, the input cost of VAM closely follows the trends in crude prices with a 1 quarter lag. However, Pidilite has been successful in changing the price of its final products (and thus maintain steady gross margins) across the various phases of the commodity cycle (see chart on the right).

Exhibit 9: YOY change in unit price of input and finished products

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Note: VAM is based on financial year ending while Brent crude is based on calendar year ending. Consequently, there is a 1 quarter lag in the data; Source: Ambit Capital research, Company, Bloomberg

We expect the group’s pricing power to sustain going forward based on:

The lack of strong competition and thereby the lack of high quality substitutes for Pidilite’s products.

The trust that Pidilite has built with customers due to the group’s willingness to pass on the benefits of input price declines to customers when possible.

Over FY01-FY11 Pidilite has reported net consolidated sales CAGR of 18% which, as shown in the table below, is a combination of around 3% CAGR in product prices with the balance being driven by growth in sales volume. Also, product prices have increased in line with input cost inflation over this period.

Targeted industry for Pidilite’s products

Target industry% of FY11 revenues

Household care 68%Stationery/fabric care 9%Packaging 8%Paints and textiles 15%

p


Pidilite Industries


Exhibit 10: FY03-FY08 CAGR in input costs v/s finished product prices

FY03-11 CAGR

Unit price Volume

Chemicals (Kilo Ltrs) 3.7% 17.3%

Chemicals (Metric Tonnes) 2.6% 14.6%

Dyestuffs (Metric Tonnes) 3.3% 12.6%

Average for finished products 3.2% 14.9%

VAM 3.1%


Historically, the group has had an adverse impact of input costs on its gross margins only once, when in quarter ending December 2008, gross margins declined from an average of around 45% down to 36.6% (see chart below). This was due to a sudden 40% rise in input costs (driven primarily by crude price rise in 4QCY08), which led to the group accumulating inventory at significantly high prices. The increased input cost was not passed onto the customers through product price increases instantly. Thereafter, a complete reversal in input costs in the quarter ending March 2009 led to a recovery in margins to 46.3%. Consequently, except for FY09, when gross margins dropped from 46% in FY08 to 41%, the group has never reported a significant change in gross margins YoY.

Exhibit 11: Pidilite's quarterly gross margin trend for the past seven years

36%38%40%42%44%46%48%50%52%

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In 1QFY12, after around a 20% (YoY) increase in overall raw material costs, Pidilite witnessed a 340bps gross margin compression YOY. Following this, the group has increased its product prices by over 5%, the effect of which is expected to be fully reflected in 2QFY12 numbers. Also, given that the rate of rise in input costs earlier this year and consequent rate of decline more recently has not been as rapid as it was in 3QFY09, we do not expect significant gross margin volatility.

Pidilite Industries


Accounting analysis There are no direct competitors for Pidilite given its focus on only niche products in the adhesives, sealants and chemicals markets. Consequently, we compare Pidilite with a blended group of chemicals firms such as BASF India, 3M and Clariant Chemicals on the one hand and FMCG goods including Hindustan Unilever and ITC on the other.

As shown in the table below, with regards to RoE and PAT margins Pidilite has consistently outperformed peers in the chemicals sector whilst performing broadly in line with its FMCG counterparts. However, the group’s asset turnover appears to lag that of peers significantly and the group has consistently run higher levels of financial gearing versus peers. Pidilite’s debt/equity ratio rose from 30% in FY07 to 90% in FY09 due to two strategic initiatives taken over the past five years:

The group launched the Elastomer project in FY08 (see project details on page 13) on which a capex of `3bn has already been incurred and further `2.5bn is yet to be incurred over the next two years.

The group carried out acquisitions of brands in countries like Brazil, USA and the middle east (see exhibit 3 on page 3) where the total consideration paid was in excess of `700m.

Exhibit 12: DuPont analysis of RoE

RoE (%) PAT margin (%) Asset turnover Financial Leverage Company/metric

FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11

Pidilite Industries 17 35 32 5.6 12.4 11.7 1.5 1.6 1.8 2.1 1.8 1.5 3M India 18 24 20 7.7 8.5 8.4 2.1 2.5 2.1 1.1 1.1 1.1 Clariant Chemicals 22 33 31 7.3 11.7 11.5 2.9 2.6 2.6 1.0 1.1 1.0 BASF 14 16 13 3.7 5.9 3.9 3.4 1.9 2.8 1.1 1.4 1.2 HUL 137 90 85 12.2 12.2 11.7 7.9 6.6 7.2 1.4 1.1 1.0 ITC 25 29 32 20.1 21.8 22.5 1.2 1.3 1.3 1.1 1.0 1.1 Peer group median 22 29 31 7.7 11.7 11.5 2.9 2.5 2.6 1.1 1.1 1.1 Divergence with peer group median (%) -5 6 1 -2 1 0 -1.4 -0.9 -0.8 1 0.7 0.4 Note: Clariant Chemicals data is calculated from CY08-10; 3M India and HUL were 15 month financial years in FY10 and FY09 respectively; Source: Company filings

We find Pidilite’s cash conversion over the past three years to be consistently better compared with that of most peers. The group’s CFO/EBITDA ratio is better versus both FMCG as well as chemicals manufacturers. This ratio shows a declining trend for Pidilite since CFO/EBITDA in FY09 was boosted by a step change in inventory days (down from a steady level of 62-64 days over FY05-08 to the current levels of 50-53 days) as the group tightened its inventory related working capital efficiency (see chart below).

The group has reported higher debtor days and lower inventory days compared to its FMCG counterparts whilst its performance on this front is broadly in line with peers in the chemicals sector. These divergences versus the FMCG players in terms of inventory and debtor days are justified by the product profiles of the respective firms.

Pidilite Industries


Exhibit 13: Historical trend in average inventory days for Pidilite

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Exhibit 14: Working capital cycle

CFO as % of EBITDA Average debtors days Average inventory days

YoY change in CFO as % of

EBITDA Company/metric

FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11 FY10 FY11

Pidilite Industries 107 90 60 48 49 44 53 48 49 -17 -30 3M India 1 67 21 45 52 51 41 47 42 66 -46 BASF India 60 88 26 56 47 52 44 47 66 28 -62 Clariant Chemicals 62 93 89 48 52 50 40 34 30 31 -4 HUL 63 116 60 10 12 16 47 47 45 53 -56 ITC 58 66 64 13 12 12 68 65 62 8 -2 Peer group median 60 88 60 45 47 50 44 47 45 31 -46 Divergence with peer group median (%) 47 2 0 1 2 -6 9 1 4 -48 16 Source: Company filings

Pidilite’s loans and advances as a proportion of net assets is currently the lowest amongst its peers. Even more comfortingly, we note that loans and advances to related parties are also low.

Exhibit 15: Loans and advances for FY11

Company/Metric Loans and

advances as a % of net assets

% of loans and advances

to related parties

Loans and advances to

related parties as a % of net assets

Pidilite Industries 6 3 0 3M India 13 0 0 BASF 21 0 0 Clariant Chemicals 21 9 2 HUL 25 5 1 ITC 8 15 1 Peer group median 21 5 1

Divergence with peer group median 15 2 1 Source: Company fillings

Pidilite’s provisions as a percentage of gross debtors over the past three years has remained broadly in line with that of peers as shown in the table below.

Pidilite Industries


Exhibit 16: Provisions in respect of doubtful debtors

Company/metric As % of gross debtors As % of gross debtors o/s for more than 6 months

FY09 FY10 FY11 FY09 FY10 FY11

Pidilite Industries 3 4 4 33 51 70 3M India 4 4 2 68 63 38 Clariant Chemicals 6 3 4 103 83 91 BASF 2 2 1 69 73 75 HUL 12 11 5 71 52 33 ITC 6 6 5 43 53 53 Peer group median 6 4 4 69 63 53 Div. with peer group median (%) 3 0 0 36 12 -17 Source: Company fillings

Pidilite Industries’ contingent liabilities as a percentage of net worth have declined from 16.2% in FY07 to 11.2% in FY11 on a standalone basis. On a consolidated basis, contingent liabilities as a percentage of net worth have declined from 16.5% in FY07 to 11.8% in FY11. The bulk of the group’s contingent liabilities includes either tax related liabilities or guarantees by the company.

Exhibit 17: Contingent liabilities not provided for (` mn)

Consolidated Standalone

Description FY10 FY11

As a % of net worth

(FY11) FY10 FY11

As a % of net worth

(FY11) Guarantees given by banks in favour of Government and others

50 54 0.5 49 54 0.5

Guarantees given by company 647 597 5.5 647 597 5.2 Disputed liabilities in respect of Income Tax, Sales Tax, Central Excise and Customs (under appeal)

324 543 5.0 324 543 4.8

Claims against the company not acknowledged as debts

81 82 0.8 81 82 0.7

Total disclosed disputed liabilities 1102 1276 11.8 1101 1276 11.2

Source: Company fillings

Applicable tax rates on Pidilite’s earnings have been low in the past because some of its manufacturing units were under the umbrella of a 5-year tax holiday period. However the consolidated tax rate has been increasing over time as and when this tax holiday period expires for some of its units.

Exhibit 18: Tax expenses as % of PBT

Standalone Consolidated Company

FY10 FY11 FY10 FY11

Pidilite Industries 12.1 23.6 13.1 23.5

3M India 34.0 33.2 NA NA

Clariant Chemicals 33.8 32.1 NA NA

BASF 36.1 21.8 36.2 NA

HUL 23.9 21.1 24.2 21.5

ITC 32.5 31.4 32.6 31.8

Source: Company filings, Ambit Capital research

Pidilite Industries


Key assumptions and estimates Exhibit 19: Key assumptions and estimates (all figures in ` mn unless otherwise mentioned)

FY09 FY10 FY11 FY12E FY13E Comments

Income statement

YoY growth in Consumer & bazaar sales (%)

15.5% 14.9% 22.3% 18.5% 19.0%

Growth rates have been highly resilient in the past with an eight year FY03-11 CAGR of around 20%. YoY 1QFY12 growth rate has been high at 22%. We have assumed moderate growth rates in FY12 and 13 given the current economic situation, bearing in mind that FY09 and FY10 witnessed mid-teens growth rates.

YoY growth in Specialty Chemicals sales (%)

13.7% 14.2% 22.8% 17.5% 19.0% Given FY06-11 CAGR of around 18% and 19% growth rate in 1QFY12.

Other sales (` mn) -19.2% -83.2% -35.5% 20.0% 20.0%

This segment predominantly includes the production of vinyl acetate monomer (VAM) which the group stopped producing after FY09. In future this segment is likely to include contribution from the Elastomer plant. However, we do not expect any sales from the Elastomer plant in our base case scenario given that production is not likely to start before the end of 2013.

YoY growth in net consolidated sales (%)

16.3% 10.3% 20.6% 17.4% 18.5% We forecast 17.9% CAGR over FY11-13 and 18.0% over FY11-16. These are conservative forecasts given historical experience of 24% over FY06-11 and 21% over FY03-11.

Consolidated sales 19,863 21,916 26,439 31,032 36,770

Gross margin (%) 41.3% 48.0% 46.9% 46.5% 46.5% Due to a high pricing power, the group is able to pass on any volatility in input costs to customers, thereby maintaining a steady gross margin of 46% over the past eight years.

Gross profits 8,201 10,525 12,392 14,430 17,098

EBIT margin (%) 8.2% 15.7% 16.4% 15.6% 16.0%

Due to a 200bps+ gradual reduction in marketing spend (as a % of sales) and 100bps+ reduction in processing and packaging costs (as a % of sales), the group’s EBIT margins have increased gradually over time to reach 16.4% in FY11. However, given the lag in the group’s ability to pass on input cost inflation to customers in FY12, we expect a drop in margins this year.

EBIT 1,517 3,103 3,913 4,322 5,260

Tax rate (%) 13% 13% 23% 24% 25%

Some of Pidilite’s manufacturing units had the advantage of a five year tax holiday period. As this holiday expires for the different units, the group’s tax rate is expected to increase in the period ahead.

Net profit margin (%) 5.6% 12.4% 11.7% 11.1% 11.5% A declining trend due to rising tax rates and steady EBIT margins

Net profit 1,103 2,701 3,084 3,436 4,218


Pidilite Industries


Exhibit 20: Key assumptions and estimates for Pidilite (all figures in ` mn unless otherwise mentioned)

FY09 FY10 FY11 FY12E FY13E Comments

Balance Sheet

Capex (` mn) -2,025 -865 -1,301 -2,500 -2,000

The group expects `1bn of capex for its ongoing business during FY12. The Elastomer project is expected to consume a capex of `2.2-2.5bn, of which management expects `1.5-`1.7bn to be spent during FY12 and the remainder in FY13.

Working capital days (including cash)

90 46 52 47 49 The group has maintained a stable working capital cycle in the past and we expect no significant changes in operational efficiency in the future

Average Debtor days 48 49 44 43 41

Historical average has been 46 days with a tight range of 42-50 days being maintained since FY04

Creditor days 52 62 63 55 55 Creditor days have increased gradually from 31 in FY04 to 57 in FY11

Average Inventory days

53 48 49 49 46 Inventory days have remained between 48 and 57 with an average of 53 and a declining trend recently. We assume a steady rate of 46 days ahead.

Net debt to equity

0.6

0.5

0.2

0.2

0.1

US$37m worth of FCCBs are present as debt on the balance sheet for conversion at `101 per share by December 2013. We expect these to get converted, reducing the debt/equity ratio in FY13

Cash flows (` mn) Net operating cash flows

2,370 3,690 2,967 3,756 4,541 Given steady working capital cycle, cash flows are expected to increase with sales and earnings as highlighted above.

Free cash flows 148 479 2,592 1,255 2,541 Free cash flows decline slightly in FY12 due to a `1.2bn increase in capex. The increase in FY13 will likely be driven by a decline in capex and earnings growth rates as explained above.


Pidilite Industries


Valuation

Absolute valuation Given the cash generative nature of the group’s core business and variable levels of capex involved in the setup of its planned Elastomer manufacturing unit, we use a three-stage DCF for Pidilite. Our model discounts the group’s free cash flows using a weighted average cost of capital (WACC) of 12.5% (see table below) and a perpetuity growth rate of 5%.

Exhibit 21: Calculation of WACC

Item Value

Risk free rate 8.5%

Beta (2-year weekly data) 0.79

Equity risk premium 7%

Cost of equity 13.5%

Cost of debt 12%

Debt/Equity ratio 20%

Tax rate 30%

WACC 12.5%

Source: Bloomberg, Ambit Capital research

Our base case model does not include any contribution to the group’s sales or earnings from the planned Elastomer project although we have included the expected capex of `2.2-`2.5bn in our FY12 and FY13 cash flow forecasts. With conservative assumptions around total sales and earnings as highlighted in the previous section, our model gives a valuation of `181 per share, i.e. a 10% upside from current levels with cash flow profiles as shown in the charts below.

Exhibit 22: FCF vs RoE profile

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12EFY13EFY14E

15%

20%

25%

30%

35%

40%

Free Cash Flow to the Firm (Rs bn) ROE (%)


Pidilite Industries


Exhibit 23: Capex spent by Pidilite over the past 4 years

FY07 Total capex of `743m for setting up of a new manufacturing unit at Kalam, Himachal Pradesh and for modernisation/expansion and for other assets

FY08

`900m on fixed assets on various manufacturing units, offices, laboratories and warehouses `1,053m on the Elastomer project mainly towards acquisition of IPR, technology, fixed assets and towrads dismantling and shipping of plant and machinery from France `118m on acquisition of brands, know-ow, technology etc from Hardcastle and Waud Manufacturing Company Ltd. `390m of fixed assets acquired on demerger of VAM manufacturin unit from a 40% owned subsidiary into the Company w.e.f. 1st April 2007 Total Capex incurred of `2,484m in FY08

FY09

`614m spent on fixed assets for various manufacturing units, offices, laboratories and warehouses

`1120m spent on the Elastomer project (shipment of plant and machinery from France was completed during the year)

Total Capex incurred of `1,734m in FY09

FY10

`187m spent on fixed assets for various manufacturing units, offices, laboratories and warehouses and on IT

`472m spent on the Elastomer project

Total Capex incurred of `680m in FY10

FY11

`712m spent on fixed assets for various manufacturing units, offices, laboratories and warehouses and on IT

`459m on the Elastomer project

Total Capex incurred of `1,236m during FY11


Best case scenario – Elastomer project and foreign subsidiaries deliver Pidilite acquired a synthetic elastomer manufacturing plant in FY2008 from Polymeri Europa Elastomers, France. Synthetic elastomer is a kind of synthetic rubber used extensively as a raw material input by auto component and adhesives manufacturers. In FY08, the group had targeted completion in FY10 with an estimated capex of `4.5bn. However, the project has been significantly delayed and is now expected to be completed by the end of FY13 with capex of around `2.5bn remaining to be incurred over the next two years after having incurred `3bn of capex over FY08-FY11. The group expects to consume 10% captively, while a majority of the balance is expected to be exported.

Pidilite Industries


Exhibit 24: Elastomer project valuation - bull case scenario

Management's targets

Sales volume at full capacity (tonnes p.a.) 20,000

Expected revenue per tonne (US$) 5,600

Revenues at full capacity (` mn) 5,040

EBITDA margin 30%

Ambit's bull case forecasts

Total capex incurred (` mn) 5,500

Revenues (` mn) 4,000

EBITDA @ 30% margin 1,200

Depreciation 800

PAT 280

EPS contribution 0.55

P/E multiple (using FY13 peer group average) 20

Incremental valuation (` per share) 11


As shown in the table above, using conservative estimates relative to management’s guidance, we estimate the project to add around `280mn to earnings for FY14 onwards, which translates to around `11 per share. However, as highlighted previously, our base case assumptions do not include any earnings contribution from this project.

Relative valuation Due to Pidilite’s presence in niche markets with a mix of consumer driven adhesives and sealants divisions on the one hand, the group lacks a direct relevant peer group for comparison of relative valuation multiples. Also, the group’s product mix includes roughly 75% revenues from the ‘Consumer and Bazaar’ division where players in the FMCG sector can be treated as the relevant peers. The remainder of the group’s revenues relate to ‘Specialty Industrial Chemicals’ divisions where chemicals players such as BASF can be considered as relevant peers. Moreover, the proportion of revenues from its ‘Consumer and Bazaar’ business (bottom three components in the chart below) has increased from 72% to 77%.

Pidilite Industries


Exhibit 25: Revenue composition for Pidilite showing share of Consumer led and Specialty Chemicals products

0

10

20

30

40

50

60

70

80

90

100

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Industrial Adhesives(Spec Chem)

Organic pigments(Spec Chem)

Industrial Resins(Spec Chem)

Art material(Consumer) & Others(VAM)

Const./Paint chem(Consumer)

Adhesives &Sealants (Consumer)


Consequently, our relative valuation analysis attaches a 80% weightage for FMCG players and 20% weightage for chemicals firms to compute the peer group average for Pidilite.

Exhibit 26: Relative valuation table for Pidilite

Company name Share Price Mcap P/E(x) EV/EBITDA EPS growth

EBITDA growth

(in Local Currency)

(USD mn) FY11 FY12E FY13E FY11 FY12E FY13E (FY11-

FY13) (FY11-FY13)

Pidilite Industries 165 1,701 26.8 24.2 20.2 19.0 17.2 13.9 15.0 15.9

Chemical companies (India)

Asian Paints 3,125 6,084 35.5 29.4 24.0 22.7 18.9 15.5 21.6 21.1

BASF India 607 533 22.4 15.7 NA 7.2 NA NA NA NA

Godrej Industries 192 1,239 20.8 15.2 10.9 38.0 18.5 11.3 38.2 83.6

Avg for chemical companies (India) 20.1 17.5 18.7 13.4 29.9 52.3

FMCG companies (India)

ITC LTD 192 30,169 29.3 24.7 21.1 19.4 16.2 13.9 17.9 18.0

Hindustan Unilever 333 14,592 31.6 29.8 26.0 25.4 23.2 20.1 10.3 12.3

Godrej Consumer Products 415 2,726 25.8 23.1 19.1 23.6 18.8 15.6 16.0 22.9

Avg for FMCG companies (India) 25.8 22.1 19.4 16.6 14.7 17.7 Weighted Average (20% Chemical companies, 80% FMCG companies) 24.7 21.2 19.2 15.9

Chemical Companies (Global)

Clariant Chemicals 8 2,495 5.9 6.8 6.5 7.5 4.6 4.4 21.0 13.4

BASF 44 54,392 6.5 7.0 7.3 5.9 4.6 4.4 10.7 2.1

Akzo Nobel 30 9,438 9.6 8.9 8.2 6.8 4.9 4.6 13.6 7.1

Avg for chemical companies (Global) 7.6 7.3 4.7 4.5 15.1 7.5

FMCG Companies (Global)

Huntsman Corp 10 2,481 8.0 5.9 5.3 7.5 5.0 4.5 91.9 26.4

3M Co 74 52,499 12.5 12.0 10.9 NA 7.0 6.6 8.5 8.0

Henkel AG 39 20,081 13.5 12.2 10.9 10.2 7.2 6.7 17.3 10.9

Avg for FMCG companies (Global) 10.0 9.0 6.4 5.9 39.2 15.1

Source: Company, Ambit Capital research, Bloomberg

Pidilite Industries


As shown in the table above, Pidilite is trading at a 5%-10% discount to its peer group’s average earnings multiples for both FY12 as well as FY13. Given high EBITDA growth rates over these years (18% FY11-FY13 CAGR for Pidilite v/s 15% for its peers), and given a gradual shift in its earnings composition away from chemicals and towards consumer led products, we believe that the discount rating is not justified.

Exhibit 27: 1-year forward EV/EBITDA

0

5

10

15

20

25

30

Apr

-05

Aug

-05

Dec

-05

Apr

-06

Aug

-06

Dec

-06

Apr

-07

Aug

-07

Dec

-07

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

Jun-

11

Source: Company, Bloomberg

Exhibit 28: 1-year forward P/E

0

5

10

15

20

25

30

35

40

45

Apr

-05

Aug

-05

Dec

-05

Apr

-06

Aug

-06

Dec

-06

Apr

-07

Aug

-07

Dec

-07

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

Jun-

11

Source: Company, Bloomberg

Exhibit 29: Explanation for our forensic accounting scores

Segment Score Comments

Accounting GREEN

Pidilite has in the past, reported high cash conversion, efficient management of working capital and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to the quality of its accounting.

Predictability GREEN

Due to a combination of high pricing power, presence in niche product markets and product exposure predominantly to consumer activity led sector of the economy, earnings demonstrate stability across the economic cycle. Hence visibility of cash flows in future is high.

Earnings Momentum GREEN The group has had a PAT CAGR of 23% over the past eight years, 29% over the past five years and 22% over the past three years.

Source: Ambit Capital research

Pidilite Industries


Balance sheet Year to March (` mn) FY09 FY10 FY11 FY12E FY13E

Shareholders' equity 253 506 506 508 521 Reserves & surpluses 6,688 8,213 10,341 12,599 15,489 Total networth 6,941 8,719 10,847 13,107 16,010 Minority Interest 7 2 2 1 1 Preference share capital 0 0 0 0 0 Debt 6,089 4,686 3,356 3,200 2,350 Deferred tax liability 434 417 421 421 421 Total liabilities 13,470 13,824 14,625 16,729 18,782 Gross block 9,273 9,808 10,599 11,599 17,599 Net block 5,512 5,462 5,639 5,989 11,189 CWIP 2,819 2,928 3,500 5,000 1,000 Investments 254 2,678 1,705 1,705 1,705 Cash & equivalents 1,601 449 1,039 963 1,338 Debtors 2,876 2,959 3,460 3,826 4,533 Inventory 2,798 2,979 4,092 4,251 5,037 Loans & advances 788 994 925 1,000 1,000 Other current assets 224 52 41 50 50 Total current assets 8,286 7,432 9,556 10,090 11,958 Current liabilities 2,804 3,696 4,590 4,676 5,541 Provisions 597 980 1,184 1,378 1,529 Total current liabilities 3,401 4,675 5,774 6,054 7,069 Net current assets 4,885 2,757 3,782 4,036 4,889 Miscellaneous 0 0 0 0 0 Total assets 13,470 13,824 14,625 16,729 18,782 Source: Company, Ambit Capital research

Income statement Year to March (` mn) FY09 FY10E FY11 FY12E FY13E

Operating income 19,863 21,916 26,439 31,032 36,770 % growth 16.3% 10.3% 20.6% 17.4% 18.5% Operating expenditure 17,758 18,146 21,931 26,060 30,709 Operating Profit 2,105 3,769 4,508 4,972 6,060 % growth 10.6% 17.2% 17.0% 16.0% 16.5%

Depreciation

588

666

595

650

800 EBIT 1,517 3,103 3,913 4,322 5,260 Interest expenditure 361 329 314 320 259 Non-operating income 113 333 432 519 623 Adjusted PBT 1,269 3,109 4,031 4,521 5,625 Tax 167 408 947 1,085 1,406 Adjusted PAT/ Net profit 1,103 2,701 3,084 3,436 4,218 % growth -35% 145% 14% 11% 23% Extraordinaries 6 44 0 0 0 Reported PAT / Net profit 1,109 2,745 3,084 3,436 4,218 Minority Interest -7 1 0 0 0 Share of associates 4 24 17 0 0 Adjusted Consolidated net profit 1,119 2,769 3,100 3,436 4,218 Reported Consolidated net profit 1,119 2,769 3,100 3,436 4,218 Source: Company, Ambit Capital research

Pidilite Industries


Cash flow statement Year to March (` mn) FY09 FY10E FY11 FY12E FY13E

EBIT 1,630 3,437 4,345 4,841 5,883 Depreciation 588 666 595 650 800 Others 39 -401 -264 -320 -259 Tax -106 -695 -699 -1,085 -1,406 (Incr) / decr in net working capital 218 681 -1,011 -330 -478 Cash flow from operations 2,370 3,688 2,967 3,756 4,541 Capex -2,025 -865 -1,301 -2,500 -2,000 (Incr) / decr in investments -220 -2,380 1,108 0 0 Other income (expenditure) 9 24 -195 0 0 Others 14 11 14 0 0 Cash flow from investments -2,222 -3,209 -375 -2,500 -2,000 Net borrowings -86 -1,448 -1,635 -476 -1,109 Issuance of equity -28 0 0 1 13 Interest paid 361 329 314 320 259 Dividend paid -513 -518 -885 -1,178 -1,329 Others 0 0 0 0 0 Cash flow from financing -266 -1,638 -2,206 -1,332 -2,166 Net change in cash -118 -1,159 386 -76 375 Closing cash balance 1,601 444 830 963 1,338 Free cash flow 148 479 2,592 1,255 2,541 Source: Company, Ambit Capital research

Ratio analysis Year to March (%) FY09 FY10E FY11 FY12E FY13E

EBITDA margin (%) 10.6% 17.2% 17.0% 16.0% 16.5% EBIT margin (%) 8.2% 15.7% 16.4% 15.6% 16.0% Net profit margin (%) 5.6% 12.4% 11.7% 11.1% 11.5% Dividend payout ratio (%) 46% 32% 33% 34% 31% Debt: equity (x) 0.88 0.54 0.31 0.24 0.15 Working capital turnover (x) 4.1 7.9 7.0 7.7 7.5 Gross block turnover (x) 2.1 2.2 2.5 2.7 2.1 RoCE (%) 13% 26% 31% 32% 34% RoIC (%) 16% 38% 40% 41% 30% RoE (%) 17% 35% 32% 29% 29% Source: Company, Ambit Capital research

Valuation parameters Year to March (` mn) FY09 FY10E FY11 FY12E FY13E

EPS (`) 4.4 5.4 6.1 6.8 8.1 Diluted EPS (`) 4.0 5.3 6.0 6.6 8.1 Book value per share (`) 14 17 21 26 31 Dividend per share (`) 0.88 1.50 1.75 2.00 2.20 P/E (x) 37 30 27 24 20 P/BV (x) 12.0 9.5 7.7 6.4 5.3 EV/EBITDA (x) 42 23 19 17 14 EV/EBIT (x) 55 26 20 19 15 Source: Company, Ambit Capital research

Pidilite Industries


Institutional Equities Team

Saurabh Mukherjea, CFA

Managing Director - Institutional Equities – (022) 30433174

[email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking / NBFCs (022) 30433239 [email protected]

Ankur Rudra, CFA Technology / Education Services (022) 30433211 [email protected]

Ashvin Shetty Consumer / Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Chandrani De, CFA Metals & Mining (022) 30433210 [email protected]

Chhavi Agarwal Construction, Infrastructure (022) 30433203 [email protected]

Dayanand Mittal Oil and Gas (022) 30433202 [email protected]

Gaurav Mehta Derivatives Research (022) 30433255 [email protected]

Hardik Shah Technology / Education Services (022) 30433291 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin Construction / Infrastructure / Cement (022) 30433241 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Parita Ashar Metals & Mining / Media / Telecom (022) 30433223 [email protected]

Puneet Bambha Power / Capital Goods (022) 30433259 [email protected]

Rakshit Ranjan, CFA Mid-Cap (022) 30433201 [email protected]

Ritika Mankar Economy (022) 30433175 [email protected]

Ritu Modi Cement (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Vijay Chugh Consumer (incl FMCG, Retail, Automobiles)

(022) 30433054 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / Europe (022) 30433053 [email protected]

Pramod Gubbi, CFA India / Asia (022) 30433228 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Pidilite Industries


Explanation of Investment Rating Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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Documents

Mid-Cap Consumer September 27, 2011 Pidilite Industrieswebambit.ambit.co/reports/Ambit_Pidilite_Initiation_27Sept2011.pdf · Mid-Cap Consumer September 27, 2011 Pidilite Industries