Astral Ltd. (Earlier: Astral Poly Technik Ltd.) ~ Leading Pipes & Adhesives company

Stock Opportunities Not-so-Hidden Gems
222

all.Love

Hi Donald,

As always, big thanks for nice work on putting together coherent and very informative Q & A form Astral management. After going through I have following observations.

)- Apparently Astral has exclusivity for 3 products except for the flowguard. How long is this exclusivity validfor each of the products? Is it long enough to cover for the whole patented period? Is there any contractual arrangement on the same?

)- Is there any royalty payment/revenue sharing arrangement with lubrizol? Does this arrangement have timeline for re-negotiation or is the royalty (% or absolute amount)fixed for the period of engagement?

)- Kaneka is a credible competitor that combined with brand equity/reach of supreme can become a strong competitor for Astral.

)- Another threat that I see is the spoiled relationship with Lubrizol. Currently, everything is hunky-dowry. However what happens if the relationship turns sour? Does company have any risk-mitigation to this threat. I see this as one ofthe major threats because Astral derives significant strength from their relationship with Lubrizol andis a key differentiator. Without relationship with Lubrizol, it is a commodity market out there for CPVC segment.

With respect to allocation, let me pose a question to you why would one prefer Astral over Amararaja? Here are few points

)- Industrial and automotive battery market size is of the tune of 20,000 crores + and has potential to grow expoentially as automobile sales increases the market size widens. Moreover for all newly sold automobiles, there needs to be replacement demand every 3-4 years. This inherent characteristic can make the market size far larger than a product having life cycle of 15-20 years.

)- Astral is still building brand and reach while ARBL has over years done so which helps it gain pricing power. It has consistently maintend 25% ROE for last 5 years while Astral has though increased its ROE, further improvement is unlikely unless asset turns or debt increases. (as management has guided for 12-14% operating margin hence NPM may also settle down around current levels)

)- Global MNC (jhonsons control)has taken 26% equity which more closely ties it up with ARBL and on a longer term basis. For Astral the ties with Lubrizol is less strategic and more prone to break up. Additionally, global MNC being on board may be useful in maitaining corporate governance standards.

)- ARBL and Astral both can grow at 20+% in next 5 years (in my considered opinion)

)- Astral is available at 15 times TTM P/E while ARBL is available at 12.5 times P/E. For ARBL NPM and Asset turns are higher. Moreove inspite of lower debt, its ROE is better than that of Astral.

Eventhough, I toosee good upside in Astral even from current levels, I feel ARBL can be a very strong challenge to Astral in terms of garnering the largest share of capital allocation for a long term portfolio.

Will be glad to know your thoughts.

Best Regards

Dhwanil Desai

223

Dhwanil, Great post. In fact, these days I am going through Amara Raja and first opinion is it is very good. But more on that in its own thread.

Donald (& others), one more thing I looked at for Astral was Lubrizol’s patent for Blazemaster. It looks like a routine patent and not much “meat” in it to actually fend off potential threats. I will ask one of friends who is one of India’s leading patent guys to take a closer look and will comment back further. But prima facie, this does not look to be much of a moat!!

224

hi

went through the management q&a and i must say its a great job by donald.

Coming to specifics regarding investment in the company,

First of all I would consider astral as a company by itself AND not compare it with mayur in terms of investment worthiness.

Agreed about the future prospects and growth. It will continue to grow at the usual 25% cagr growth in the near future for next 2-5 years.

Story for Astral is good. Thats been good since a long time. Its been growing consistently.

Most of the business part is covered in the discussions earlier. No need to re iterate things again.

Coming to valuations part,

Topline has grown from around 192 crores in fy 09 to 582 crores in fy 12 whereas bottomline has grown from 14 crores to 40 crores during the same period. Market cap is 615 crores currently. HDFC research report projects fy 13 profits to be around 50 crores. Effectively I am paying 12 times projected earnings at current prices.

Coming to first quarter results, if one reads the auditors notes, there is clear mention that due to company not considering forex losses to the tune of around 12 crores, the net profit has been overstated by 12 crores. Now net profit for whole quarter is around 9 crores. Effectively company made a net loss of 3 crores in the first quarter which was reported as 9 crores profit. Company management has given an explanation to this but there would always be a counter argument to these claims.

The explanation for the above would be that the company considers all the implications at end of year. Now what happens if the rupee were to go up to 60 against the dollar by end of fiscal?

Plus company pays tax of around 20-24%. any chances of tax rates going up?

If I am to invest in a company so as to make it my top five holdings, I dont want too much by way of risks maybe forex or valuations.

Bottomline is that I find the company extremely attractive in terms of its business potential going forward, but do I find valuations attractive at the current juncture? Answer is NO. Its not unusual for Astral to correct all of a sudden due to one or other factor and it is at these times when I am in a dilemma what to buy, I would consider Astral.

225

hi dhwanil,

on ARBL, i see that although the net profits have trended higher over the long-term but we have seen fluctuations over time. net profit growth was negative in 2008-09 and then again 2010-11. what are reasons behind that? is that the raw material prices that increased and it could only be passed through with a lag? is ARBL seeing one of those good years at the current time and may see something similar to 2008-09 and 2010-11 in the near future which could provide attractive entry points?

all.Love

-Donald

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I went through the management QA, and find Astral an excellent business, where management expect a good growth of 20-25%, but the forex loss due to cheap 2% foreign currency loan, and higher valuation dampens the investment theme.

227

Hi Donald,

Went though the Mgmt Q&A of astral and Thanks for compiling this for the benefit of all.

Your conviction in astral makes me think that there has to be something here, however I am not able to build convition to that level. Request you to clarify the points below. The intent is just to get more clarity and objectivity.

Astral seems to be reasonably valued at this point of time and looks like a 25-30% compounder from here on. (like Mayur)

The business is also a manufacturing business with little moat in terms of

-brands(Don’t think they are important in plumbing, when do you remeber last visiting a hardware shop and asking a pipe/fitting from a particular brand),

-patents (Not sure how much commecial value blazemaster have as pointed out by Abhishek)

-and IPRs.

(like Mayur)

The growth is financed from the debt and hence the issues related to forex (unlike mayur where the growth is funded from the in house funds)

So what makes you think to allocate fresh money in Astral (and not in Mayur)

Disclosure: I am invested in Mayur and it is in the top 5 of my holdings. My views are likely to be biased.

228

Hi Donald,

Looking at your conviction level, I am quite sure you must have have extensive research on Astral. Can you please answer my queries regarding Astral.

1). I am not able to decide how much capital intensive Astral business is? Part of its business seems to be requiring negative capital, and part of its is extremely capital intensive. I just wanted to know how Astral’s capital requirement compares with Mayur, ARBL, Supreme, and similar stocks with good following of valuepickr. (I must agree I am bit nervous investing in capital intensive sector, when there is a high interest rate scenario)

2). Because of the extra smart 2% interest rate foreign currency loan, that astral has taken, it’s EPS are dependent on currency fluctuation. Have you done any analysis on how much forex loss they would incur vis-a-vis USD-INR conversion rate. This would help us predict the EPS at various USD-INR conversion rate, and take decision looking at currency movement.

3). Astral’s debt, D/E ratio seems to be increasing from last year. Any idea how much extra debt they are planning to take in next, next-to-next year

4). Astral has ignored forex loss incurred during last quarter, which eventually they have to show in their balance sheet. Any idea, on how much EPS minus they have to do in future for these forx losses.

5). Looking at the dependence of Astral’s earning on currency fluctuation, it make sense to project next 1,2 years Astral earnings at various USD-to-INR conversion rate (say 50, 55, 60, and 65). Have you made any such table.

229

Personally, I don’t think the currency is a great problem. The fluctuation is not a regular incident. If you remember, in the last 10-12 years, this has happened twice; in 2008 and 2012. If you even it out over the loan term, even with the currency loss, the loan would work out much cheaper than if they had sourced it locally.

230

Hi Abhishek,

25% depreciation in 6 month, followed by 10% appreciation in 1 month, seems to be a big fluctuation to me. Even if the interest rate is coming cheaper, then how come the forex loss, which they didn’t declare last quarter, almost eat the pie of EPS. That to me an thing to worry about.

I am still not able to answer how much capital intensive their business is?

Disc: With so many questions unanswered, I sold all my astral holding (just 4-5% of my holding), and converted to Ajanta, Mayur, Alembic, and Unichem. May add astral in future once I develop a comfort level with its business, its capital structure, and the bugging forex issue.

231

hi dhwanil,

on ARBL, i see that although the net profits have trended higher over the long-term but we have seen fluctuations over time. net profit growth was negative in 2008-09 and then again 2010-11. what are reasons behind that? is that the raw material prices that increased and it could only be passed through with a lag? is ARBL seeing one of those good years at the current time and may see something similar to 2008-09 and 2010-11 in the near future which could provide attractive entry points?

all.Love

-Donald

Hi Donald,

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Eventhough, I toosee

Best Regards

Dhwanil Desai

Hi Hemant,

In year 2008-09, drop in NP was due to forex losses that company booked of the order of 33 odd crores. A part of these forex losses was cash loss while the remaining loss was notional. However, if one goes through AR 2008-09, management has put it very clearly that due to unexpected movement in foreign exhange, these losses arose. They had an option of booking losses over a period of 3 years according to AS-11 relaxation given. However company took a conservative approach and booked all the losses in 2008-09 only. This means, company follows a fairly conservative accounting practices.

In FY 2010-11, losses were mainly due to pressure on margin in telecom market due to slow down in demand as telecom tower market is one of the largest contributor to their industrial battery segment revenue. Moreover AR 2010-11 indicates that their competitor (Exide) decide to cut margins in the business to gain share (as ARBL was about to displace or displaced Exide as leader in the segment). Is there any possibility of the same thing repeating? sure, I don’t think we can rule it out. Do I see, Exide happy to live with lower margin to maintain/gain market share over a long period of time? I would assume not as it will start a price war which will be detrimental to them also in the end. However, ARBL is focusing to increase its share in two wheeler OEM market, which till now has been ruled by Exide. So if ARBL starts getting strong traction at the expense of Exide, one may see similar actions from Exide. But, typically OEM markets are lower margin markets compared to replacement market ( and far larger too…). Considering that ARBL does not currently get any revenue from two wheeler OEM market, even with lower margin from this business, impact on overall margin will not be very significant.

So coming to your question, I don’t know whether, there will be better entry point in near future or not. But even at current level, on a longer term basis, it looks reasonably good entry point.

Best Regards

Dhwanil Desai

232

thanks dhwanil,

lets take this discussion forward on the arbl thread.

hi dhwanil,

on ARBL, i see that although the net profits have trended higher over the long-term but we have seen fluctuations over time. net profit growth was negative in 2008-09 and then again 2010-11. what are reasons behind that? is that the raw material prices that increased and it could only be passed through with a lag? is ARBL seeing one of those good years at the current time and may see something similar to 2008-09 and 2010-11 in the near future which could provide attractive entry points?

all.Love

-Donald

Hi Donald,

)- validfor

)- amount)fixed

)-

)- ofthe andis

)-

)-

)- control)has

)-

)-

Eventhough, I toosee

233

Atul/Subash/Dhwanil & others,

Disc: I am yet to firm up my opinions. I am still working on my hunches, and typically it takes me some time to reach where I can communicate effectively my conviction.

1). My first objective was to get people off the high-horse on Mayur. I was never writing off Mayur, just cautioning people on over-allocation because the tremendous mispricing (at 5x) was no more there at 12x - for a business like Mayur. Many were talking of 20-30% allocations, mostly above 15%, a few 40% plus, and the rare 65%!!

It was clear that objectivity was missing, and I had to get people do some thinking on their own before blindly jumping onto a bandwagon (no matter that its still good for a ride). Fortunately that objective has been met, there are questions raised - that form here its not a GIven! Let’s leave it at that.

2). Re: ARBL

I am sorry I haven’t got back to ARBL in the last 2 years. I have been told lot of things have changed things have changed. They have closed the gap with Exide on performance front (dealer feedback says its cheaper/better/user feedback is fabulous - lasts more/business performance is good) and seem better placed vis-a-vis the valuation gap. I haven’t looked at it. So it will be premature for me to offer any comments on comparative merits between Astral, ARBL & Mayur -at similar valuations. I will have a look week after next:) (limited bandwidth).

3). Re: Astral

We have to get some big picture facts right here; getting into the nitti-gritties first will lead you astray - miss the woods for the trees, so to speak.

a) If you try to look at Astral or Mayur from the viewpoint of a buyer of the whole business, a different picture may suggest itself. Think about it, Mayur has been valued at 5x for a long time (despite all the good numbers, etc.) till consistently outperforming results/quarterly dividends simply shook people out of that range. Astral despite not comparable numbers, has always been valued at that 10-12x range right from the IPO days

b) Perhaps that should make you think - Mr. Market seems to view this company differently, am I missing the bigger picture??

c) The Forex thing is a non-issue.Over the long term it is not material, it can be ignored.If the Management Q&A on the same is not convincing to you, then you still need to develop a feel for what is ignorable & what is not - looking at the big picture. Dont break your head over calculating various scenarios. Despite all that hullabaloo over Forex (by theoreticallly-struck investors, pardon my bluntness), Astral is not being penalised by Mr Market by what many find absolutely horrifying - hey the whole EPS can get wiped out by Forex Loss.

This is a feel thing - learning to listen to Mr Market also is important and question, why, why, why, is it getting stronger by the day? A food for thought thing. No one can really convince you here. If you are not comfortable just because of this Forex issue, stay off it.

d) Astral’s real competitive position in Indian market is unassailable. CPVC it will always stay ahead of competition by virtue of more products, negative working capital, and the CPVC compound edge, and exclusivity (do not ignore this). And a very very strong distributor-dealer team which works almost as hard and with as much ownership as the company. This last part unless you have met and talked to some dealers distributors on your own, and that of competition - you can’t even begin to comprehend what a big difference this is:).

PVC it is gaining share from others. who have been entrenched for much longer years. PVC is already 40% of the business> and this you can understand better if you go a little deeper into the product ranges - it continually manages to expand with regular new introductions. This is a big strength.

One more big picture, perspective

Not for nothing this is the only company in India, Buffet decided to invest in a JV after his visit. This is the only company in the world that Lubrizol has trusted with its patent-protected technology. This is the only company in the world that Lubrizol has licensed 4 of its products. Dont forget Lubrizol control’s 80% of the CPVC market. Despite the CPVC compound being off-patent for more than 30 years, no one has been able to diminish this dominance - not for want of trying, right. This isn’t a small point, it should get lot of weightage. (Think Page Industries).

I am not sure I have been able to bring enough clarity -am on the road; typing in a hurry; and without my own homework complete its tough to convey what’s still primarily a “feel thing” for me. But in a week, 2 weeks I hope to do more justice in terms of communicating the why’s better.

Till then think about the big picture points I have tried to raise. If you were to buy outright the whole company - what would you pay for Astral, and what would you pay for Mayur.

For me the answer is clear, even without the detailed investigation/homework/data points to back up this feel/conviction. To communicate it to the larger investment community, is an altogether different matter:). We struggled with that for Mayur for over 1.5 years - but when the larger investment community does get it - aha:) - seems like deja-vu again for me. We have to keep getting better at communicating the real Astral story - It is just not fully understood!!

-Donald

1 Like
234

Donald,

I understand and appreciate your inputs, esp the thought provoking questions.

I must confess, I am still theoretically biased. Having a feel of Mr Market is essential to move to next levels from novice to learner to stock picker and beyond.

In due course of time, with hardwork and help of seniors on this forum, I am sure to get in tune with Mr. Market.

In the mean time, I am thinking what should I pay for Astral and what for Mayur and what for any other company infact

What are the three most important things to consider while trying to find an answer to that question ?

is it long term sustainable moat…Growth Drivers…Target market size…??

what is it…and how to quantify (measure) it ?

Atul

235

Hi Donald,

Finally had a chance to look at Astral. Quite detailed study and discussions. Great work on the stock story and management QnA as usual. Thanks a lot for the detailed work.

**
**

**First **some facts, the Indian pipe market is 17,000 Cr growing at 12% annually. 2/3rd of total demand is from construction sector, balance from agriculture and energy sectors.
Current market split: GI Pipes 53%, PVC 42% and CPVC 5%.

However, the market is witnessing a strong shift in demand due to strong benefits such as lower corrosion, easier installation and lower pricing relative to GI pipes.

In the next 10 years, a projected shift in favor of plastic (PVC+CPVC) to 70% (from current 47%) would provide a growth opportunity of 34% CAGR.

What ideally Austral provides us is the ideal vehicle to ride on this growth bandwagon where the market itself will be growing at maybe 30%+. Very few such opportunities exist today.

**Second **point to note here is first mover advantage for Astral, with capacity ramp up and Lubrizol relationship.

Capacity ramp up from 11,800 MT (FY08) to 65,496 MT (FY12) to 105,496 MT (FY14E) will be hard to replicate given the RM constraints and product certification/approval delays. Couple with this the strong partnership and patented products from Lubrizol.

The Lubrizol advantage is more similar to ARBL’s Johnson Control’s linkage - the foreign partner (although without no equity stake unlike JC with ARBL) has undisputed market leadership in global market with strong R&D and IP focus.

Most people do not have much clarity on the Lubrizol advantage. Here’s a take on this from a major Pipe dealer in Gujarat,

_"…If you look at what Kaneka does, its is completely different from what Lubrizol does.

Kaneka sells just CPVC polymers which each manufacturer converts into compounds and builds pipes. More often what is witnessed is that each pipe manufacturer sourcing from Kaneka, mixes and matches in its own peculiar way which leads to sub-normal quality for pipes.
_

_Thus, although such pipes may be cheap, they donât serve the purpose.
(Remember what the Astral management referred to as local Jugaad in the Aug 2012 QnA)

In contrast, Astral makes products from finished CPVC compounds sourced from Lubrizol, under Lubrizolâs brands and specifications. Further, Lubrizol does a sample checking of Astralâs products at the dealer level and goes back to its facilities in US to confirm if the manufacturing is as per prescribed norms. Which other manufacturer is abiding to such stringent quality norms.

All major reputed developers are our clients and most high end buildings / bungalows prefer using only Astral CPVC pipes…"_

So this is **a very clear advantage which creates a different entry barrier of sorts. **

Third, what is critical along with a brand/product moat is the product life cycle (PLC) that makes all the difference.** PLC is the critical differential factor** when it comes to the replacement market.

Amongst the ones with strong brand moat, the ones with the shortest PLC ( HUL, Nestle, P&G, GSK) has the highest premium. The market premium decreases as it flows to players with shorter PLC (Gillette) to medium (Page Industries, Bata) to moderately long (Amara Raja, BKT) to longest (Astral Poly, Cera).

Here is where I feel a player like Astral is at a slight disadvantage [where PLC is very long for PVC (20-25 years) and CPVC (30-35 years) ] as compared to ARBL/BKT.

Market continues to value Astral at a premium ( 16x trailing, 12x forward) simply because this** being the best focused play on the PVC+ CPVC growth story for the next decade.**

The Forex concerns are all short aberrations, like in Hawkins AGM Mr. Vasudeva said there are some situations which arise may be once in a decade and companies pass through those to emerge stronger on the other side.

So in the last 12 years, Astral has been plagued by rapid rupee depreciation only twice in 2009 and now in 2012. So this may not be substantial in the long run.

For me understanding the story and growth ahead, and developing conviction thereupon is much more important, price is a much secondary issue.

The story and opportunity sure looks interesting, next focus will be on the risk part.

1 Like
236

Rudra,

Amazing clarity in thoughts, explained in an easy to understand fashion.

Superb…!!

Looking forward to your post on Risks.

Atul

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Hi Rudra, +1 to what Atul mentioned above. Like the way you dissect the opportunity.

An idea on the capacities of Ashirwad and Ajay who are also Lubrizol’s associates will be helpful so thatwe can roughly estimate the market share of CPVC going forward. For this its important to understand how successful Supreme will be in continuing its 60% growth in CPVC. By gut feeling is that Supreme will also be a strong competitor.

Regarding the high PLC, I think there will be a continous stream of products which will keep Astral going. Supreme is making Plastic cylinders for example.

Cheers

Vinod

238

Hi Rudra,

Me too doing +1 to Atul.

Your explanation seems like a totally new, and super clear perspective on Astral’s business opportunity. It will be great if you give us the reference from where you have gathered these data.

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The risks are lucidly put-up by HDFC sec

http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=2985972

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Rudra,

Great analysis. Keep up the good work.

Vivek

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Hi Rudra

PLC part is just great, we all knew it was relevantbut theclarity with which you have put forward is really amazing.

Regards