Forced to look closely at Indag Rubber, post the excellent results over last 2 quarters. Well-meaning friends like Ayush and Viraj have been nudging me for months:). We already have 2 excellent companies in the rubber industry -BKT, and Gujarat Rubber followed well at this forum. Makes sense to add another seemingly promising(?) candidate from the industry - easier to track and understand!
Selected Extracts from a Nov 4, 2011 HDFC Sec report on Indag. Think this can bring all of us quickly on the same page:)
Indag Rubber Ltd (IRL) was incorporated in 1978 in collaboration with Bandag USA who provided technical assistance to thecompany till H1FY07, when the promoters bought back Bandagas 38.3% holding. The company is in the business ofmanufacturing precured tread rubber, un-vulcanized rubber strip gum, universal spray cement and tyre envelopes. IRL sells itsproducts through its own depots/franchisees (C&F agents) appointed all over the country while the actual retreading operation iscarried out by the retreaders. The company provides the franchisees not only with the retreading material but also with supportservices and training. The company is concentrating on utilizing the full potential of the existing depots/franchisees and settingup new depots/franchisees in unrepresented areas so as to have a larger and more efficient network.
IRL has two plants, one at Bhiwadi (Rajasthan), which is shut since 2006 due to labour problems, and the other at Baddi(Himachal Pradesh) with a capacity of 13,800 MT for tread rubber, 1,800 MT for rubber strip gums and 300 KL for rubbercement. Close to 90% of the companyas revenue is generated from the sale of precured tread rubber. The company has ~25depots pan India, which sell to retreaders. Some of these depots are owned and operated by IRL while the rest are operated byfranchisees.
Retreading is a process in which a new tread is applied on the body of worn tyres. The retreading sector is highly fragmentedwith over 10,000 players in the unorganised sector and ~6 players in the organized sector. Midas Treads, Vamshi Rubber, ElgiRubber International, MRF Ltd, JK Tyres and Indag Rubber are the only significant players in the organized sector. Theseplayers supply their tread material to unorganised players who retread tyres.
In the precured retreading process, a precured tread strip is applied to the casing with a thin layer of bonding gum. Close to 75%of the total truck operators in India are small fleet operators. Retreading by small fleet operators is high as they operate overshorter distances. Organized fleet operators that operate over large distances prefer buying new tyres to retreading as the costof breakdown is high. Old tyres of organized players are often retreaded and sold to smaller operators. The cost of retreading is~20-25% of the cost of a new tyre and its life is ~50-60% that of the life of a new tyre. Average life of a new tyre is 60,000-65,000 kms while that of a retreaded tyre is 30,000-35,000 kms. However, IRLas precured retread costs ~30-35% that of a newtyre and has a higher average life of ~70% that of a new tyre subject to standard loading, good road condition and standardpressure maintenance of the tyres.
A tyre can be retreaded 2-3 times depending on the quality of the casing. Demand for retreading is dependent on the economicscenario. Transporters tend to retread more during economic downturns due to the cost advantage. Retreading is moreprevalent in the Southern region due to better condition of the casing due to better road conditions and driving habits. The totalsales in acold retreada market of the industry are estimated at ~Rs.2,700 cr with a volume of 8,000 tonnes/month. aHot retreada(an older technology) sales are estimated at ~12,000 tonnes/month.
Some interesting pointers
**Replacement tyre demand to remain high till FY13: **
Replacement tyre demand grew at 22.7% in FY10 and ~6.0% in FY11 and is expected to grow at ~14% in FY12 and ~10% inFY13. A healthy growth in OEM tyre demand in FY10 and FY11 due to an increase in sales of vehicles will lead to an increasein replacement demand in FY12 and FY13. Replacement tyre demand is expected to account for ~70% of the total tyre demandin these two years. Levels of radialization, increase in transport and replacement cycles affect the growth in replacementdemand. The growth in replacement tyre demand will lead to higher demand for retreads as well.
Land at Bhiwadi, Rajasthan:
IRLas Bhiwadi plant located near Alwar in Rajasthan is shut since 2006 when the Himachal Pradesh (HP) plant went on stream.All workers at Bhiwadi have been relieved. The Plant & Machinery has been shifted to the HP plant and there are no plans ofrestarting this plant. The possible sale of this land or putting it to alternative use could unlock value going forward though thetiming of this is uncertain at this point.
IRL has not been using its plant to maximum capacity. The plant was only ~56% utilized in FY11. Utilization levels have beenhigher in the past but the plant has never been used at full capacity. We expect the company to increase its utilizations slowlygoing forward with increasing demand. The company also shut down its plant at Bhiwadi (Rajasthan) in 2005-06 and transferredthe equipment to its plant in Himachal Pradesh.Going forward, IRL may not need to invest in fixed assets for 2-3years and may have more free cash.
Low debt but high interest expense and low cash:
IRL has a low gearing ratio of 0.2 with total debt of Rs. 7.2 cr on a net worth of Rs. 44.4 cr. However, interest expense in FY11was Rs. 1.1 cr indicating an interest rate of ~15.5%. Interest expense in H1FY12 has been higher than normal at Rs. 0.8 cr onan outstanding loan of only Rs. 5.7 cr at the end of H1FY12. This could indicate additional borrowings during the quarter andrepayment before the end of the quarter. Debt equity at the end of H1FY12 was 0.1. IRL has no term loans. An increase inworking capital loans is normal during upswings in the business. The company has low cash on its books (Rs. 1.3 cr in FY11and Rs. 1.5 cr in H1FY12). Net change in cash is negligible every year (Rs. 0.2 cr in FY11 and no change in Y10) however,cash earning per share is good (Rs. 24.2 in FY11 and Rs. 25.2 in FY10). Most of the cash generated so far has been used tofund fixed assets and/or working capital (mainly inventories).
Y-o-Y: IRLas Q2FY11 net sales grew by 51.8% to Rs. 54.1 cr from Rs. 35.6 cr in Q2FY11. The company reported a 110.1%growth in operating profit, from Rs. 3.6 cr in Q1FY12 to Rs. 7.6 cr in Q2FY12. The total expenditure as a % of net salesdecreased from 90.3% in Q2FY11 to 86.1% in Q2FY12. The operating margins rose by 300 bps to 14.1%. Interest expense(which increased by 56.5% from Rs. 0.3 cr in Q2FY11 to Rs. 0.4 cr in Q2FY12) and depreciation expense (which increased by18.1% from Rs. 0.5 cr in Q2FY11 to Rs. 0.6 cr in Q2FY12) were higher but in line with growth in sales. PAT increased by135.7% to Rs. 5.2 cr from Rs. 2.2 cr in Q2FY11. The tax rate in Q2FY12 (21.3%) was significantly lower than that in Q2FY11(23.0%). PAT margins improved by 350 bps to 9.7%. EPS for the quarter stood at Rs. 10.0 vs. Rs. 4.2 in Q2FY11.
Q-o-Q: Sequentially, the net sales increased by 12.5% from Rs. 48.1 cr. The operating profit & PAT increased by 28.0% &37.0% respectively. OPM rose 170 bps from 12.4% while PAT margins improved by 170 bps from 8.0%. The rise in OPM can beattributed to lower raw material cost.