Hi Kiran,
Thanks for the ground work from Bangalore. I too agree with your take on playing the ‘CPVC growth segment’. A a mix of Astral-Supreme will be the best way forward.
Also apart from a) and b) which you have mentioned, Astral is constantly introducing newer products which increases the addressable size of the market.
Another interesting aspect is the workshop conducted with plumbers. Here they are adding a ‘PULL’ to the demand cycle where plumbers are asking for Astral pipes rather than dealers forcing a sale. Could be interesting.
Now coming to the RISKS.
a) Raw Material prices and dependence on Lubrizol / Reliance :
The bargaining power of sellers her is High. For Astral, majority of inputs are sourced from two major behemoths - Lubrizol for CPVC compounds and Reliance Industries for PVC. The company is a price taker, as opposed to being a price setter, and has no bargaining power.
CPVC resin and PVC resin are priced at ~$2.9/kg and ~$1/kg currently. Astral has been successful is passing on the price increase from the RM front (2 price hikes in FY12 (total ~10-12%) and one in Q1FY13 (hike of ~5%) and another in Q2FY13).
It seems that despite the company being at the mercy of suppliers, it can pass on the RM price hikes, albeit with a lag, and able to protect margins to that extent.
b)Forex Risk:
APTL uses forward contracts to hedge its currency exposure but that does not mitigate risk completely. As dissected in the management Q&A also, the company has extended the 120 days credit period from Lubrizol to 180 days by taking buyer credit at 2%.
Given this $ exposure in terms of short term borrowing (payables being converted to loan)
there are apparent risks in a rupee depreciating environment.
What this creates is a lot of volatility on the bottom line and hence price movements, but should not be deterrent to the long term story. Any short term price falls from this should be looked into as additional opportunity to buy on dips.
c)Seasonality:
APTL operates in a seasonal industry as its sales are highly correlated to growth in real estate development. Q1 is traditionally the dullest quarter for the industry and APTL and Q4 is usually the best
Not much to read into this, as long as the annual (YoY) topline growth remains intact, nothing much to consider here.
**d) Business Continuity Risk **: A potential Black Swan - Positive or Negative ???
Positive Black Swan
While the possibility of a stake buy in APTL by Lubrizol could be a big trigger. Already in Sept 2011 there were preliminary talks on Berkshire (Lubrizol) investing in a JV with Astral investing 1200 Crores to production of CPVC resin and products in India. The market responded with a 20% rise on astral the very next day.
Another aspect of Mr. Market’s premium allocation to Astral can be derived from this potential opportunity. If this goes through Astral would jump leaps ahead ( With risk a) mitgated to a large extent and potential sales/margin enhancement.) Astral’s competition will be taken by storm and reduced greatly.
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Negative Black Swan
An equally large concern is the possibility that Lubrizol sets up its own manufacturing facilities in India or buys a stake in one of APTLâs competitors (Ashirvad Pipes and Ajay Pipes)
In any of those cases, Lubrizol could eat away APTLâs business as it would have direct access to raw material and at the same time could cut supply to or increase prices of raw material for APTL. In any ofthese scenarios APTL could be in deep trouble.
Scenario Analysis:
Now of the two which is more logical. In a market like India, the dealer/distributor network and relationships are of prime importance, rather than capacity/cost etc.
If we go by large deals from Abott-Piramal to Kraft-Cadbury to Danone-Wokhardt every case is a example of the foreign player paying a hefty premium to the distribution network. So it is unlikely that Lubrizol will play in India on their own. Also given the Indian Oil JV in the lubricant space, they will most likely choose a partner with wide reach.
So logical question is a Finolex/Supreme is a much better fit than Astral in this regard. Now Lubrizol had approached them in the first place but when the biggies refused it was Astral which came forward to take the risk and introduced CPVC in 1999. With a strong 12 years relationship and Lubrizol having licensed several products to them, Astral seems a more fitting choice.
Also Astral has more widespread relationship with large no of foreign players which adds to their credibility and business reputation. It is highly unlikely unlisted players like Ashirvad / Ajay would be a preferred partner over Astral.
So all in all, the chances of the positive outcome seems more likely that the latter. The possibility of negative outcome exists; however, probability is negligible.
e) Slowdown in housing
About 70% of the demand for the companyâs products comes from the new construction segment, which is heavily dependent on the countryâs economic condition and pace of activity in the housing sector. A slowdown in housing could result in a reduction in demand for pipes.
This is more of a generic risk. As seen in China, housing spend as %age of GDP should rise drastically in India as more and more people aspires self owned living space.
f) Underperformance of subsidiaries and JV:
Astral Biochem has been non-operational and Advanced Adhesives Ltd is currently loss making. Advanced Adhesives was set up only in FY11. APTL also has one JV in
Kenya â Astral Technologies Ltd, which has also been loss making. If the subsidiaries/JV continues to underperform it could hurt APTLâs consolidated earnings.
This is a close monitorable item, although contribution from these subsidiaries is minimal at present to create a cause of concern. But going forward if things don’t turnaround by FY13-Fy14 can dent the bottomline.
g) Failure of new products could be costly:
Inadequate or delayed offtake of any of these products could affect revenue growth.
Although this appears to be a risk, given the companies strong focus on R&D and quality adherence, the timely introduction of newer products will only increase the addressable market size. Blazemaster sales outside India have already begun and have got good momentum, so these opportunities can create surprising upside on the bottom line.
Given the above risks and their implications in the current environment it seems the possible rewards from taking part in this opportunity will far outweigh the risks,
A staged purchase is more advisable given the current scenario with chance of short term corrections arising from rupee depreciation.
Disc: No positions as of now, most likely will buy in a staggered manner.
