Glad to see a thread on Faze Three on VP. I initially got attracted to this company as it was one of the few textile manufacturing companies which were in segments that were not already dominated by India: bath rugs (synthetic and cotton), area rugs, pillow covers, comforters, etc; leading to a strong China + 1 growth narrative. Being a yarn supplier to Faze Three, we were also impressed with their sourcing capabilities which, despite their smaller scale were arguably on par/better than their larger counterparts. Lastly, next-gen was in the management team and seemed quite hungry to grow the business while doing things the right way. These three factors along with the low valuations, were enough to initiate a position.
Since then, the story has gotten better and better:
- They announced a large capital expansion: increasing capacities by 2-3x for an outlay of just 70 cr. I was puzzled by this. If you see peers, normally they need to spend 100’s of crores to enhance capacity even a little bit. If you see, the further down you go in the textile value chain: the less asset intensive the processes become. Spinning being the most capital intensive. Faze Three doesnt invest there. It pretty much does only tufting, processing , cutting and sewing. It seems they had some spare processing capacity and also rugs doesnt require much dyeing and finishing. Hence, the asset turns are extremely healthy.
- Doing some basic numbers: If we assume the new capacity can enhance revenue by 400-500cr, at 20% EBITDA margin; EBITDA can increase by 80-100 cr for an increase in capital employed of 270-320 cr (including WC at 180 days). Incremental ROCE on this investment looks like 25-30% which would make it among the most capital efficient textile companies.
- While I am concerned about competition, the company clearly has a head start. It will take 2-3 years for larger peers to setup their own facilities, commission and do sampling during which Faze Three can take substantial share from China/Turkey.
- Q3 results were also very suprising. The larger textile companies struggled to pass on the increasing costs and we saw a margin hit. On the other hand, Faze Three was able to largely mantain margins. Why should this be the case? The reason is because while the larger companies mainly do replenishment program based orders where prices need to be passed on, Faze Three largely does one time/promotional orders where pricing is negotiated every time; making it much easier to pass on rising costs.
- This also means that there is a large growth opportunity ahead for Faze Three by tapping into some of these replenishment program orders for their categories. If they can get 2-3 of these programs while there is limited capacity for their products available in India; that is your doubling of revenue right there. Need to watch out for management commentary on the same.
- ALong with the above, the company is also investing in technology/ERP, etc as mentioned above which is required to scale up.
All in all, looks like one of the best textile stories in the market today. 25% incremental ROCE and 30-35% growth expected over the next 3 years. Paying 20x PE seems more than reasonable. A screener search for companies that have delivered the above throws up a lot more expensive names.