Current installed capacity of the company = 53000 MT
Looks like capacity will be increased to 73000 MT in another 6-12 months going by the reports. Another 25000 MT expansion planned in South India, game plan appears to be take the capacity to 100000 MT by end of 2019. As per 2017 numbers the realization is in the range of 85000 - 86000 per MT which is what one would expect for this business at this scale.
In short in 6 months the company can do upwards of 520 Cr sales if they were to run at 85% utilization. At a 7% PAT (which is doable since the debt levels are very hygienic) that translates to a potential PAT of 37Cr for FY2019. Of course this will not happen so soon, one cannot build an investment thesis purely on this.
What I have understood from looking at multiple companies in this sector, one will end up spending approx INR 20000 per MT of Capex. Given the WC needs of Apollo currently, approx 18-20% of sales will end up in the working capital bucket per annum. Hence for INR 85000 of sales, one needs a total capital outlay in the range of 35000 - 37000 per MT. At an EBIT of 9%, the ROCE will be very healthy at 20% and above. This unit economics is what ensures that most companies in this segment have healthy return ratios and have traditionally been able to scale without taking on too much debt. The larger players are all free cash flow engines. An FCF company usually looks cheaper in the reverse DCF model than it does on a P/E basis, hence I am more inclined to see how the reverse DCF numbers look like for this one.
At CMP of 700, the stock price appears to be discounting a high growth rate of 25-30% over the next 3 years followed by a 15% growth rate for the next 5 years (I usually run with a 8 year model). Working capital will keep scaling at approx 18-20% of sales over the time frame. My sense is that free cash flows will start accruing from 3-4 years, till then we may see some debt build up but nothing considerable that could worry us. Don’t think this will exceed a D/E of 0.5
The big levers in this case are -
Greater scale leading to lower cost of RM (Prince Pipes does gross margins in excess of 30% at a scale that is 2.5X that of Apollo)
Product portfolio and increased realization leading to better EBITDA margins (I find it surprising that Apollo has higher margins than Prince Pipes, I would be surprised if Apollo can do more than 13% in the long run unless they start making the compound themselves like Astral and FIL)
The ability to ramp up distribution network quickly leveraging the APL Apollo brand and goodwill in the community
Ramp up in sales coupled with higher utilization leading to very high incremental ROIC in the first 3-4 years (likely to do 45%+ and then approximate ROCE at 30% over the medium term)
Each one of the above has a decent enough likelihood of happening is my reading. What can make things tougher for them in realizing this scenario is -
Every large player is adding capacity (Supreme adding 150K, FIL adding 150K, Prince likely to add 150K, Skipper and Oriplast planning to add 50K each in addition to the usual run rate of Astral). Effectively almost 600K of additional capacity will come on board over the next 18-36 months on an installed industry capacity of 1.8 to 2 Mn MT. That is a 30% increase which is fine given that the volume growth rate in the industry is expected to be in double digits. At some point of time all the players will get hungry to sweat their assets and price competition may intensify unless unorganized players get hammered from here
Almost every large player is pursuing the same strategy - add more distributors to get national level scale, get higher share from construction segment and CPVC, increase proportion of fittings to 15%+. One cannot really find too many distinguishing features either in terms of product portfolio or in terms of operations. Every one is entering each other’s turf (Astral getting into agri), FIL tying up with Lubrizol - there aren’t any niches to be seen anymore
The key question will be if all of this can make pricing more competitive and put a lid on how much one can squeeze off customers. Distributors will need to be incentivesed to push products, would not be surprised if BTL shows a spike for all players. I don’t think one will see cut throat competition since there are no concentrated buying centers here like an e-commerce player who can squeeze out margins from OEM’s over time.
My base scenario is that Apollo Pipes in 7-8 yrs time will more or less attain Prince Pipes level of scale at approx 1200 Cr and 80+ Cr of PAT. It will be very interesting to see what Prince will list at, it is a 700 Cr IPO with 200 Cr going to promoters, my guess is it may list between 2500 - 3000 Cr market cap.
I would be fine paying around 600 Cr for Apollo Pipes considering all the possibilities and astute business sense promoters have shown in the case of APL Apollo. CMP is 25-30% higher than that and I will think hard about this one, may initiate a tracking position and wait for more data to confirm to my hypothesis before I build a large position. From current levels I cannot expect an IRR of more than 20% unless something changes big time over the next 2 years and the company scales to a level way beyond than I can envisage now. APL Apollo was a screaming buy since they have virtually no competition and were the only player expanding, Apollo Pipes does not have the luxury and will need to compete with much bigger players to hang onto their market share even if the current base is low.
Big risk is that if aggressive growth in sales does not materialize in the next 2 years, the stock price has nowhere to go but down unless the entire market continues to go bonkers.