ValuePickr Forum

Pennar Industries Limited

have u pennar shares info?

I had contacted the investor relations, they said it is still pending. How come some of the investors have received it? I am planning to approach SEBI this week.

I haven’t received the shares yet. I have been mailing/calling my Broker (ICICI Direct), Karvy, Pennar IR, but no result. ICICI keeps asking me to contact Karvy.

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Sorry for not updating but the process is still not complete . It is showing as pennar industries but the shares are not tradable . Process should be completed soon.

I got this reply from investor relations:
We have filed the Corporate action with NSDL and your shares of Pennar Industries Ltd will be credited shortly.

I expect Pennar to grow its revenues at an average CAGR of 16-18% over the 4 years (conservative assumption). Taking the rule of 72 into account the revenues should double in the said timeframe. Management though has guided for 5000 Cr+ revenue, aggressive growth of 20-25 in the next 3-4 years.

Bulk of the revenues should come from:

Railways - Company is expanding into railway interiors (setting up SS steel tube line for this, already commisioned) and bogey frames etc by setting up a new facility in ABA Rail Park next to Rae Bareli. They are also expanding existing facilities in Chennai and Hyderabad. In the next three years their main objective is to make complete coaches. They are targeting 20 coaches per month. Indian Railways is also planning corporatization of train coach, locomotive factories to drive in investments. History suggests that whenever actions like this have been undertaken it attracts massive investments into the sector. Management is very bullish on this vertical.

Hydraulics (Industrial Comonents) – Very bullish on this business unit of the company. They enjoy margins of 15%+ on products. Very customer centric / driven business with great deal of after sales service. Products are not standardized and each product is made according to needs of the customer which is a big plus point. I feel Pennar has some degree of Moat in this business and it is very difficult for another player to break into the business. There is more than a 6-8 month testing period of products before a customer actually approves them. They have expanded capacities by 5 times at Chennai. Channel checks and industry sources suggest that the business unit head Mr. Shivakumar kappana is an asset and the main driver behind this unit. I expect this BU to generate yearly revenues of 450 Cr + in the next 4 years. I expect Pennar to gain market share in this business over the next 4 years.A Shift from component manufacturing to complete sub assembly manufacturing should further drive up revenues

PEBS – Company has expanded capacities to 125000MT. Expanded structural steel. This is a sunrise sector which has not been noticed by the market place yet. I feel Pennar has a strong advantage in this business compared to others because of its extremely strong engineering and design team. They are able to complete projects using less tonnage leading to cost savings for the customers. Channel checks reveal that satisfaction levels of customers who have worked with PEBS pennar are very high. Company is targeting high rise buildings, cold form structures for low cost housing. The only drawback to this business is that if there is a sudden increase in steel prices then it hurts the company but they somehow mitigate this with quarterly pricing contracts. With the capex cycle picking up this vertical should scale very well. I Feel that over the 4 years the capacity of this business unit will be expanded to 175000-200000MT+ and revenues would be in excess of 1300-1400CR++

Engineering Services: This is small Business in terms of revenue but a deadly one in terms of EBITDA Margins. Company enjoys very high ebitda margins of 45-50% in this business. I believe that the world is an oyster for pennar in this business i.e. they can expand this business anywhere (the main raw material is the cost of design engineers, software, rent. Currently they are outsourcing these orders from NCI in USA. In the current year the business is growing at 50%. Current year revenue should be 6 million.
Pennar is contemplating of converting these outsourcing engineering orders into manufacturing by setting up a manufacturing base in the USA in order to increase profitability. They are acquiring a business in USA and the term sheet for the same has been signed which I think they will intimidate to us in the next concall. I feel that they can scale revenues of 100 -120Cr+ in this vertical in the next 4 years. This is the only BU in which I think they can scale revenues of 35-40% CAGR over the next 4 years. P.S – The cost to hire design engineers abroad is very expensive and it is way cheaper to export engineering services out of india earning high ebitda margins

Solar: Company was negative on this vertical whole of last year but they have changed their stance currently. They foresee good growth in vertical in coming years as mentioned in AR and believe it will one their main revenue drivers. They have expanded capabilities by adding a Solar PV modules manufacturing unit at Sadashivpet. They are intending to do complete EPC in solar projects thereby increasing the addressable market

Enviro: They are planning to standardize their water treatment plants which will be pre engineered in nature. I think this is a good move which will shorten their delivery cycle and not stretch their working capital in this vertical. I don’t think the company is interested in taking up big EPC municipal projects, we all know the current status of Va Tech Wabag (their working capital is stretched as you cannot trust the government with these big epc tenders. Company is appointing dealers for this vertical and they intend to scale the dealer network in the coming quarters which should augur well they plan to expand this overseas as well. I would not want to assign a revenue target for this vertical but I feel it can scale revenues in excess of 300-350 cr in 4 years.

Tubes: They manufacture ERW and CDW. ERW is basically for captive use and eventually converted in CDW. They plan to scale the CDW division to 2500Mt by 2021-2021. SS Tube with capacity of 2400MT has also been started. Currently the division has yearly sales of 250-300Cr+. I expect it to double in 4 years.

Steel BU- This is a legacy business. Company is concentrating more on special grade steel to drive revenues.

Retail Initiative – The Steel BU also houses their retail initiative Pennar Build360. Currently the company operates 15 stores. They are actively looking to scale the retail iniative by entering other states like tamil nadu, kerala, Telengana and expand the store count. Company currently enjoys a ROCE of 35% in the business. The revenue clearly depends on how fast they can scale up their store count (they actually want to scale it up to 42 stores by 2020-2021) and business. The closest competitor to this business I can think of is shankara buildcon. So far Pennar has been selling its own products enjoying good margins. Further they would also like to sell third party products

What amazes me is the kind of valuation / pe multiple a company like shakara enjoys with a ebitda of 6-7% and a pat of 2% currently. I agree Shankara’s retail play is way way bigger but are these valuations justified.

I would like some more inputs from boarders on this vertical and where they think it is headed.

VALUATION:

My Gut Feeling Tells I that Pennar is capable of earning a 12% EBITDA margins (Ex – Depreciation) in the near future 4-5 years due to continuous value addition in high margin products. I am not taking 12% into account and rooting for a more conservative 10% Ebitda (Ex Depreciation) with a 4 year view.

I feel that in 4 years Pennar revenue would double to 4000CR and taking a 10% EBITDA (Ex Depreciation) that would work out to an EBITDA of 400CR.

Interest Cost works out 3.3% of Gross Sales. Management has guided that the 3.3% figure would decrease in the coming years to 2.5 and lower, I am not even taking that into account. I am assuming a gross of 4600CR, 3.3% of which works to 150 CR.

Implied Tax Rate of 30% on (400-150) = 175CR PAT

EPS = 175 /15.23 = 11.5

I Honestly Feel that in 4 years Pennar would command a multiple of 13-15X and the price targets would be Rs 150 (13X)and Rs.172 (15X) respectively.

PS- I like to keep calculations simple and it’s always worked for me. Even if my calculations are a little off target I am quite confident that in 4 years this company would be trading at a price Rs 120 Minimum which is 4.5X the share price of today (Rs. 27)

Even after all this I am still of the opinion that this company is capable of achieving a 12% Ebitda Margins (Ex-Depreciation) but only time will tell (I feel Engineering services, PEBS, Hydraulics & railway will have a big role for them to get to this 12%). We will have to wait for 4-5 years. If this were to play out then I would readjust the figures accordingly I would assign a PE Multiple of 17-20X

MANAGEMENT

I have spent the last many months trying to find out anything negative about the management of this company from the industry (dealers, suppliers, employees, other industry heads and so on, but it is just not possible. They actually command a solid reputation in the industry that they operate in. They treat their employees with the utmost respect; regularly incentivize them for their efforts. Plus their working ethics are not very rigid, they give employees, BU heads the freedom to grow as they want and in turn reward them for their efforts. They utilize capital efficiently and have strict working capital controls which augur well for health of the company in the long run

MERGER
The main reason behind the merger was to eliminate the holding company discount as the subsidiary structure did not allow proper value recognition. Pennars Market Capitalization would have never realized its true value if this move was not done. Everything else they have mentioned you can take it with a pinch of salt.

My views are very biased

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Their debt appetite is more…they don’t serve debt in frequent intervals…which i feel negative

Please correct me.if my understanding is not correct

@axiskumar , if you simplify the question, cant really figure out what your actually trying to ask.
thanks

The primary reason why the stock trades at a discount is because the company is not able to generate free cash flow and their working capital is stretched.

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I completely agree with you. How do you except the company to generate FCF if it is expanding/deploying capex at such rates

Capital deployment / capex cannot continue forever every company goes through this phase of capital deployment , at some point in the future maybe 2-3 years hence it will cool down and company will start spitting out enough cash.

The trick is to buy it now / if the company was generating good FCF then it would not be so cheap and there would hardly be any value to make a meaningful investment.

With regards to the working capital cycle that should improve in the coming days by inventory management and decreasing debtor days.

Term loan is only 100 cr / 3 cr interest per quarter

Most of the debt is working capital debt which is capped at maximum 3.3% of gross sales and that will increase in line with revenue growth with a positive bias towards reduction over the quarters

I don’t think that is something to eagerly worried about


From past three yrs not paid single ruppe?

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For the past 5 years I haven’t generated any free cash flow and as per mgmt it’s working capital intensive business. Hopefully as you say in the coming years it generates free cash flow…

To answer your Q,

Their term debt is only 100cr, debt/EBITDA is 0.6. They have ample space on their balance to take on further capex

Most of their debt is working capital debt . As their revenue increases this will increase in line with their revenue. They have capped interest cost at 3.3% of their gross sales which I think is reasonable and over time they have guided to a reduction.

Even if they were to knock off their short term borrowings it would not help or make sense , if they buy steel from a steel company they have to give a LC , if they purchase a machine worth say for 15cr they have to give LC, for everything they do LC will be required so knocking off short term borrowings does not really help

I can’t figure out why debt repayment is bothering you, term debt is only 100 cr , they are deploying more than 100 cr is capex each year , they generate high cash profit each year which is re deployed to generate a higher eps.

Company is in a stage where they are deploying all cash profit to build more capacities plus to fund this capacity they borrow working capital

A time will come when there capex plans are complete and they will not deploy cash for capacities, when that time comes can you IMAGINE the kind of FCF they would generate???

you are wrong please check the FCF for the last 5 years. please check it FY ending march 2016

Chirag - Hyderabad factory land sale of ~Rs.300 Cr. (in medium term - 3/4 years) and corporate tax rate coming down in India to 25% are 2 other factors you have not considered. Aditya Rao has already indicated plans of disposing the land on the con call.
With sale of factory land, Pennar can pay off its long term debt and fund its capex for a year or two.
Medium term with capex moderating, Pennar should be able to distribute Rs.3/4 per annum as Dividend also which should be icing on the cake.

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Not taking any of these special situations into account .

Most of the new capex over the next 3 years will be added at more than 15% margins. So on a blended basis their margins should also increase (I have not taken that into account also) I’m rooting for a solid 10% ex depreciation (probably works out to 11% EBITDA if you were to calculate with depreciation)

Majority of people who know this company are really worried about their short term borrowings, even I was concerned at first until a few helpful boarders clarified the same.

I know it’s absolutely not right to look at investment decisions this way but just something to think of , SAIF partners invested in this company at rs 40 , 8-9 years back , there is definitely something that these guys are seeing , such a big decision on merger could not have been taken without their consent . My investment decision is not based on this but it’s just food for thought

investors who have invested in Pennar in 2013-14 have lost their money and have made no returns. The important thing to note is has company grown revenue & Profits and does it look like it would continue to grow them.
Only way Pennar is going to give multibagger returns is it becoming an engineering company from a commodity steel company.

completely agree. being recognized as a full fledged engineering firm is still some time away. they need to double revenues in each segment. their profitability is directly linked as to how much and how fast they can scale revenue without loading the balance sheet too much. Im assuming a great deal of operating leverage will play out in the process.