HIL – Eco (onomic) friendly way to play rural prosperity in India


(Varadharajan Ragunathan) #1

Folks

This is my first “starting new thread” on valuepickr. Am very excited to be here and my work is greatly inspired by David Einhorn.

I am attaching my analysis on HIL

CMP : Rs. 560

Target Price : Rs. 1000 (12- 18 months)

One of the books that left quite an impression on me was Peter Lynchâs âone up on wall streetâ which espouses the idea of digging into the popular products and services that you see around you and then locate the company behind them.

So, it seems, when my friend who is a small time builder was complaining about how it is difficult to get aerocon blocks for constructing new houses, I decided to do a âscuttle buttâ and speak to a few people in the know, posing as a customer.

I spoke to 4 aerocon dealers in Chennai, Bangalore and in Delhi and the opinion was unanimous HIL has the largest set of factories across India â 13 factories, 45 warehouses and 2500 stockists. The brand Aerocon is almost synonymous with light weight, eco criendly concrete blocks and slabs (donât take my word for it â do a dip stick yourself) and the other brands are buildcon (owned by the Thapar group).

Governance & heritage:

HIL was founded 60 years back by CK Birla group to manufacturer asbestos sheets (yes, thatâs a legacy business) under the brand Charminar and then diversified onto other building products.

HIL has three strong brands :

Building products group (80% of the turnover):

_Charminar brand _( 65% of revenues and growing at 10-12%) of fibre cement roof sheets. These are the eponymous sheets that one finds in practically every factory shed, two wheeler stand across India. Again opinion is divided as to whether this should be still sold as the product is banned in other developed countries. The

_Aerocon blocks and pre-fabs _(~ 15% of the revenues and growing at 30 % +): Primarily driven by aerated, light weight concrete blocks which are now starting to replace red bricks everywhere

_HYSIL _: A calcium silicate insulation that is used in energy intensive industries to reduce heat loss and leakage. This is still a very small business

Growth drivers:

For the fibre cement industry, increased rural demand and an uptick in capital expenditure by industry will be a key growth driver. This is what I got for a quote â

âSirâa few years back there were other companies in this space which were also very strong - Everest industries was doing very well and Charminar was second largest brand. Of late, there are some quality issues with Everest brand of roofs and Charminar people are very aggressive in providing us branding support. Most customers these days ask for Charminar roofs. After election, we are seeing a 20% increase in offtake (since May â14).â

My estimate is that HIL has a near 25% market share in roofing solutions and has an installed capacity of about 1,000,000 tonnes which is roughly 20% higher than its other key competitor â Everest industries.

The moat in this business is the brand and the massive sales and distribution network that the company has built up over the last 60 years. Just ask any one in a village about a Charminar roof and you will know what the brand stands for.

Aerocon blocks :

This is a game changer in my opinion. Based the considerable time I spent on the field talking to a mason (who fills in walls with bricks/tiles) and with three builders (in Delhi and in Chennai). The dynamic is such that an Aerocon block which is about 60% costlier than its brick equivalent results ina 40% saving on unskilled labour (which is often as big as a cost as a raw material on filling up a brick wall). Add to that the superior thermal efficiency and the lesser cost involved in storage and transportation, the 15-20% premium commanded by an Aerocon block (in terms of overall cost of ownersip) is turning out to be positive in terms of overall perceived utility.

This, I believe is quite a tipping point and this is going to translate into runaway growth in the years ahead given the size of the red bricks market and how little of that has become organized. I think a Rs. 200- 300 Cr. Business in the next 2-3 years (a 1 cu. m block costs Rs. 140-150).

The moat in this business is the early mover advantage and the near universal recognition of the Aerocon brand coupled with the massive sales and distribution network where it is easy to upgrade capacity without having to worry about throughput.

Lubrizol tie-up

After having seen the success of Astral Polytechnik, HIL management has woken up to the size of the big opportunity in CPVC pipes (which are replacing steel pipes everywhere). I do not expect a lot of revenue traction from this but given the near universal brand recognition of Aerocon and the strong trust that the plumber/mason community has with the brand, it might be able to push some volumes through. I have assumed a revenue of about INR 500 Mn in two yearsâ time for this.

As always, Like howard Marksâ says, â Now. Who does not see that ?â and let me dive straight into the valuation.

Valuation:

I prefer to always look at balance sheet metrics like cash flows. Receivables etc. A deep dive into the annual report of FY 14, shows an OCF yield of 27% (INR 1,300 MM of OCF). With the company having invested heavily in capex in FY 12 (which was the reason for the decline in profitability in FY 13 and FY 14), one has the opportunity to own a valuable building materials franchise at less than 5 x FY 15 OCF and about 10-11 x FY 15 FCF.

The other thing I look for is an improvement in credit cycles and working capital and I was quite surprised to find that in FY 14, the company has considerably shortened its WC cycle and that has improved cash flows substantially.

Bake in the optionality of the Lubrizol tie-up and all of this points out to a 2-3 bagger in the next 18- 24 months.

At the CMP of INR 565, the stock is trading at 4 x FY 15 PE. For a company that is professionally managed, has a been a part of a respected conglomerate for 60 years and has possibly two of Indiaâs most valuable building materials brands, I think itâs a steal.

I do not do a lot of DCF, but a quick back of the envelope calculation points to a target price of INR 1000 based on a 8 x FY 15. Based on Q1 FY 15 results and EPS of INR 130-150 is eminently possible and given the head room for capacity utilization next year, an EPS of INR 200 for FY 16 should be a 70 % + probability event, as things stand.

Risks:

  • Variation in global prices of chrysotile â key ingredient of fibre cement roofs.

  • Change in regulation related to asbestos â looks unlikely in India, given the strong lobbying capabilities of the industry, led by HIL CEO himself.

Scuttlebutt done :

)- Spoke to 4 distributors/retailers of building material products across Chennai, Bangalore and Delhi

)- Spoke to a builder to understand the drivers of aerated concrete blocks

)- Spoke to a mason/contractor to understand the value proposition of concrete blocks versus red bricks

)- Dip sticks of brand recognition in a couple of hardware stores in rural India in Tamil Nadu

)- Inputs from asbestos sheets dealer

HIL.docx (17.5 KB)


(Varadharajan Ragunathan) #2

Sorry, also forgot to attach indianivesh’s report on HIL - I used some data points from the report but also verified a lot independently through scuttle butting.

Brickbats are welcome !


(Punit) #3

Hi Varadharajan

Thanks for the analysis and bringing up a new investment idea.

I havent done in-depth analysis so you can happily ignore my comments. I read first few pages of the annual report and had a quick glance at the financials, and i didnt find anything exciting. On the contrary, the annual report highlights few concerns:

1). The fibre cement business may grow at a modest 3% coz of the change in consumer preference

2). The AAC block business has very low entry barrier and seems to be competing on price. So the company does not seem to have any pricing power and consumer seem to prefer the lowest cost product

3). The Aerocon panels and thermal insulation business seems to be cyclical and dependant on the economic cycle

4). They are entering into new businesses which I think is diworsification at best.

Financials look lumpy and will need in depth analysis to understand the same. Dividends are falling.

Overall your optimism seems to be around rerating of the stock from 4x 2015PE to 8x 2015PE which may not be the right approach to look at stocks.

As i said, feel free to ignore my comments completely as you seemed to have done more work on this stock and you may have better understanding of the company.

Best- PJM


(Varadharajan Ragunathan) #4

Punit

Thanks for the feedback - I love counterviews - helps me become a better inveeror.

1). Yes - but

2). do not agree. speak to any hardware dealer and he will tell you aerocon comes at a small premium 5 % to regional brands because it is more consistent, edges are better finished. The other moat is the 13 factories HIL has that makes it easy to ship the product from the closest hub - an important factor in a bulky product like AAC. overall, it is a modest moat but I am sure it’s growing.

3). yes

4). why do you say its diworsefication ? pipes go through the same distribution channel and having an additional product helps increase share of wallet of the contractor. Also, lubrizol is a very respected name and for them to tie-up with HIL after astral, I am sure they would have done their DD.

the other factors that are soft but tail winds are :

)- HIL is HQ-ed in hyderabad which had a lull in economic activity. With the split, things are moving again.

)- both TN, AP had some issues last year - TN - had heavy power issues which is improving; AP - political issues. both are experiencing a bounce back in construction activity - it’s evident in the numbers of repco etc.

The bet is that with good governance, strong cash flows, the stock should get back to its historical average of 8-9 (low because of the asbestos legacy) and if this scales up well, it should trade at at least 12-13.

Think about it, when plywood manufacturers are trading at 20-25 and sanitaryware at 30x, is it reasonable to expect a 8 x on a clean, well managed company in the same space ?

As always, welcome a discussion.


(Sambath) #5

Hi Varadharajan,

Thanks for spending a good amount of time in creating this report.

Like peter Lynch says it is better to look at a stock which is in a boring industry and HIL definitely falls into that category.

This is the main reason i like this stock story.

Whenever i look at a stock,first thing that comes to my mind is: Will it be in the business for atleast next 5 years?

Being in this business for 6 decades,i am sure HIL is not sunsetting anytime soon.

If we look at the revenue break-up,Charminar is 65% and Aerocon is 15%.It would have been much better if the ratio is other way around.Reason being,in case if government passes regulations to stop selling fiber cement sheets,it will be a heavy blow on this stock.Looks like that is not going to happen anytime soon.Other reason is growth in Aerocon is much better.

Outside of that,I see a lot positives on this stock atleast for the next 2-3 years.One of the reasons is their capacity expansion during the slow down.Now if the utilisation goes up and economy starts growing back above 5% levels,company will post good numbers.

Already we are seeing this in June quarter results where they posted EPS of Rs.41.Even if they post EPS of 20 for each of the next 3 quarters(usually august to November is rainy season in most places which reduces construction activities),annual EPS would be around Rs.100+.If we assume a PE of 10,then we are looking at Rs.1000+.

Worst case if we assign a PE of 5 which is quite unlikely, gives the price at Rs.500,there is a margin of safety here for sure.

I am planning to take a small exposure,if the story unfolds well and next quarter results look good,I will add more.

I have also asked my friend (who is into real estate) about his opinion on these products.He has not responded yet.

Usually people grade this stock as Cyclical since end of the day it depends on the construction sector growth,i dont disagree.But even if it is cyclical,i dont care as long as there is a margin of safety and growth visibility.

One question,in case if the input costs(chrysotile) increases,can they pass it to the consumer? Because it affects the entire industry and not just HIL.

Thanks,

Sambath.


(Varadharajan Ragunathan) #6

Sambath

yes - if they move their product mix to aerocon blocks and pipes/panels, then they could trade in excess of 10-12.

Agree - margin of safety IMHO is both a strong EPS growth and a very low PE - so that you can make money through both re-rating and fundamental growth.

As for the asbestos, since HIL’s CEO is the chief lobbyist, seems unlikely anything will happen.

They can pass on 5-10% variations in prices to customer - anything more will be a challenge.


(N Sood) #7

Hi VR,

I spoke to a builder relative about light weight concrete blocks (ie aerocon) … He said he would strongly recommend them for inner walls but not for outer since they are not very strong. He takes govt contracts and said that they are mandated to use fly ash bricks only because of pollution control norms etc. (biltech)

Did you happen to do a cost benefit analysis of fly ash vs aerocon blocks ? Does aerocon qualify to be a green building material? If it not good enough for outer walls, the thermal insulation bit goes for a toss. I do know these things are pretty easy to work with, drill holes etc which makes it good choice for contractors but I’d rather have tough brick walls for my home rather than crumbly ones.I did happen to use these blocks for raising the height of a room. These blocks are called ‘khangar’ in local parlance and it’s pretty tough to find ‘dealers’. When you do find, they will offer you local stuff as the cost differential is steep. I guess you cant really tell what is branded or local. They also come in black - wonder what that is. They are also pretty easy to break and are crumbly.

I am into stocks so dont go to construction sites :wink: but have you noticed these being used by builders instead of bricks ?

Biltech Building Elements Limited is into the unique process of utilising fly ash generated from thermal power plants to manufacture lightweight autoclaved aerated concrete (AAC), a certified green building material which is resistant to termite, water, fire, sound and earthquake. The companyâs plants are located in Palwal, Haryana, and Bhigwan, Maharashtra.With a capacity of over 3,00,000 cu.m. per annum, Biltech Building Elements is the largest producer of AAC in India, controlling over 40% of market.

Also, couldnt find any mention of a lubrizol HIL tie up anywhere ?

Disc :burnt my hands in everest once.


(Varadharajan Ragunathan) #8

lubrizol tie-up is there in AR 14.

Buildcon and aerocon blocks are both made from fly ash and to that extent are environment friendly and are a must for LEED buildings

Sorry, I do not know about these bricks. However, I do not know that aerocon blocks are still not preferred for external facing walls - that should change as it is only a perception issue.

Remember that with land cost increasing as a % of building, turnaround of construction is becoming an ever increasing factor. For eg., if someone has bought land for Rs. 200 Cr. in mumbai and is constructing a 50 storied building, if he can save on 20-30 days on brick laying, he is saving 1/12th of Rs. 100 Cr. at his cost of capital which is typically 13-14% for a builder which is almost a crore of free cash.

In exchange, if he has to spend a little more on aerocon blocks vs bricks, he might be willing to do it.

From what I understand, in urban areas, this equaation is changing in favour of aerocon blocks givne high land acquisition costs.


(manish) #9

The stock does look attractively priced and downside risk seems limited too.

I had looked at HIL several times in the past and ignored due to its presence in slow growing industry and lack of pricing power.

However, the management feels to be ethical and the diversification into other products should help.

Also the govt plans to give lot of impetus to housing for all which should help the entire sector and HIL seems to be reputed name.

I don’t consider this as a high quality business but more of an undervaluation play.

Also as far as I know, nowadays houses and buildings are constructed on RCC pillars and they are the load bearing members, the bricks in the walls is filled in the later stages. So even if you break a brick wall, the building or the house will remain intact as the load is on the concrete. So, using AAC blocks either externally or internally should not be a problem.

Also the fact that use of such blocks is being mandated due to pollution norms is a positive.

I am not sure that the stock would post an EPS of 100 but even if it posts 80-90 , then in present market conditions and kind of PE rating, the stock can still give decent returns. If it posts more thenðŠðŠ. if it fails then the downside should be minimal.

Disc : have initiated a small position


(Varadharajan Ragunathan) #10

if this product mix becomes in favour of pipes/aerocon panels, this stock could get re-rated to double digits. There is a lot of overhang because of the asbestos legacy.

I have heard that CK birla group is professional, hands-off and shareholder friendly - their customer service was top notch (tried out personally).

sure, its not a strong moat but its a growing one and they are in a sun rise industry - concrete blocks, pipes (lesser extent) and green building materials. That has all the trappings of a large market size, huge head room for growth and a potential for a PE re-rating.

based on Q1 results, they are also delivering well - I cannot see a significant downside from here and things like telegana split, recovery in economy should all play to their tail.

thenðŠðŠ.


(Bravo) #11

Varadharajan,

It seems that the industry can not pass on increased raw material costs to the end customers. Cost of raw material is increasing faster than sales across. Cement and fibre comprise 30% and 53% of FC sheet by volume but value keeps on changing. You can refer to the following article that tracked wholesale prices for sheets and compared them with raw material prices over the years. The data is a bit dated but it covers the industry dynamics.

http://www.derivatives.capitaline.com/newsdetails.aspx?sno=478287&opt=cn&secid=21&subsecid=0&SelDt=

In case of HIL, COGS increased slightly higher than revenues. IR highlighted that they face similar dynamics for Aerocon blocks. Moreover, the industry always have asbestos risk overhang. HIL tried a substitute from Reliance but could not get satisfactory results.

I checked some local sites in New Bombay to understand the construction trend. It seems fly ash bricks are replacing bricks on a scale as blocks definitely have better economics. However, it is more a local play. For example,Siporex (Pune based company) is dominant in New Bombay area.

HIL is dominant in South and West as they have two plants in these areas - one in Chennai and another one in Golan (Gujarat), which are running on 60% capacity. I am not sure how the distribution works in construction materials. My guess it is largely dependent on local manufacturing base. However, among peers HIL definitely has better margin and also margin of safety.


(Varadharajan Ragunathan) #12

Bravo Alpha

I do agree with your thesis - this somewhere between a commodity and a brand - do agree on the asbestos thesis but that’s why the stock is inexpensive inspite of a good growth over 5-7 years.

From the scuttlebutt I did, they are able to increase prices also have higher volumes in south.

It’s an average moat but one that’s growing and relative to that I feel a 5-6x FY15 PE is low. Of course, the asbestos overhang could keep it that way.

Thanks for your inputs - I quite like healthy, constructive discussions


(seshukumar) #13

Dear varadharajan,

Pe rerating of this stock will not happen till aero con contributes more than asbestos to its bottom line. You can see the performance of asbestos companies in developed markets - they were exposed to endless litigations till they either closed or changed the product lines or shifted their manufacturing base and registered offices to relatively safe countries. the decision on investing in this stock should be purely based on eps growth.


#14

Varadharajan Please consider the following :

1). Entry barrier is low and almost all the units in and around chennai operating @ 50% capacity.

2). The units need to locate near the power units as well as the market. It is very difficult. Of late, getting fly ash or fly ash ( pond) is becoming difficult. It is a long tendering process as majority supply comes from PSU’s. Again, whether it is Indian coal or imported coal makes a difference to the quality of fly ash.

3). Equipment is from Chinese ( German is expensive) and capacity can be increased in a jiffy without much problem. Anybody can increase the capacity just like that.

4). Aerocon Competiton from different sources : Red bricks, fly ash bricks ,etc. These are less capital intensive and cost of the final product is less by 30%. Mind you 30% is a huge differnece in this industry.

5). So, one faces threat in the beginnig RM and the end Market.

I have done a feasibilty study for a Rs 40 cr project and then recommeded for dropping as there are so many issues to tackle apart from Market and RM. The points listed above are the crucial ones and we decided not to put up the project. It was also vetted by a technical guy who worked with Aerocon for 20 years.

In any investment, business analysis preceeds the financial analysis. FA is only a resultant of BA. If business is not good, no amount FA or number crunching will help. There may be expansion in ROE or EBITDA margin but it will not last long.

Guys can make their own conclusion now. I am in Chennai and happy to meet with you for any investment analysis.

Rgds


(Varadharajan Ragunathan) #15

Thanks Sethuraman

)- these are valuable inputs - I have PM-ed you asking for your number. I do agree with your concerns - it seems like the only margin of safety is EPS growth for this year.

I spoke to a sales guy in HIL and he was talking about a 12 % growth in charminar and 45% growth in aerocon for this year and he sees that as being sustainable. That’s why I developed conviction - of course, tough to envisage competition and their movement here.

1).

2).

3).

4).


(manish) #16

Thanks Sethuraman for the inputs. that was really helpful.

Company has also mentioned in AR that entry barrier is low which is clearly a negative.

I was not taking it as a long term play. However, since the company has expanded capacity and was using less of capacity, future demand could have resulted in higher capacity utilisation and increase in the margins. But if others players are also running on lower utilisation levels then its not good news.

Also difference of 30 % in end product is huge. But what about savings in the labour cost and time saved as it would enable the developer to complete in shorter time and launch another project. Understand even with these 2 points the cost of construction with aerocon would still be higher.

I also was not considering any PE re-rating as present growth and returns are not very exciting.

As per screener,

past growth in revenues is lack luster.

This seems a cyclical stock to me, presently the opm is at lower end. ( highest being in 2005 - abt 12% and now at less than 6 %). I expect with improvement in economy and govt thrust on housing and improvement in rural income, this should come to 10%.

To me the downside seems to be low as the company is already operating at low margins.


(kishore dalal) #17

HIL had mentioned in its last AR that they had comissioned a project to manufacture plastic

building products (similar to ones made by Astral Poly).

Does anyone have any info on how the Company is doing on this new area ?


(Varadharajan Ragunathan) #18

kishore

I am told they are not doing well since NCR market is at a stand still on new property development. my sense is they will do about Rs. 15-20 Cr, this year


(RH) #19

Hi VR,

Very good thread.

Do you have a view in Visaka Industries which operates in similar segment? Did you look at other listed players like Visaka? If yes then could you plz share your views.

Regards,

HR.


(Varadharajan Ragunathan) #20

I looked at visaka and ramco and thought HIL was better than them. I have not done too much work on visaka - if view, would love to hear it.