Paper Felts & Fabrics– A Subscription Opportunity in the Old Analog World

MyCapitalNotes · April 27, 2021, 8:51pm

There has been some discussion around playing the paper cycle (a contra bet), lumber prices soaring, etc. But is there a more peaceful way to play the paper trade?

Summary + Hypothesis:

Paper Felts and fabrics are an incredibly important component in the process of paper manufacturing. Manufacturing literally cannot take place without it. It’s a business that has high stickiness because of the customized nature of the orders for felts combined with other allied factors (machine manufacturer, assembler, etc.).

The industry brings together two components – subscription + Goldminer phenomenon.

It is a business whose fortunes are decoupled from that of its customers – paper manufacturers have cyclical issues, raw material issues, etc. Also given the consumable nature of the product, repeat orders at frequent intervals are required. Combined with the stickiness, this brings in an element of subscription.

They are linked directly with the capacity of the industry. Unless there is a major change in the way paper is made, there is no threat to the product. As the business and margins are steady coupled with the fact that the cost of raw materials is also low, (based on how the company’s affairs are managed) it is a highly profitable business. Given all this, it is a low volatility way of compounding over long periods. (Definitely no 10 baggers here. But a See’s Candies type is possible).

What Are Paper Felts And Fabrics?

Since paper felts and fabrics are products that we’re not used to seeing often, it’s not very intuitive to understand what exactly the product is and does. It’s better to break it down into smaller questions.

Q1. What are these felts/fabrics?

Felts and fabric layers are primarily used in the paper industry. They perform 2 roles main – absorb water and act as conveyors. There are certain specific functions that they perform based on where they are used (we’ll get to that in the next question). It is a consumable in the process of production of paper. Paper manufacturing cannot take place without it.

Q2. Where is it used in the process of paper manufacturing?

Papermaking can broadly be broken down into 3 stages – pulping, paper making, and finishing.

Pulping (where the pulp is made)
- Debark logs
- Chipping
- Chemical pulping (breaking down lignin – an organic polymer)
- Final pulp (a thicker, less refined version of paper)
Paper Making (where the paper is made (no points there))
- Sheet formation (the fibers spread out and take the form of a think sheet)
Press section (fed into press section at 90 KMPH to squeeze out 50% of water).
- Dryer (the paper is run over cast iron cylinders heated up to 100 degrees Celsius with the felt in-between)
Finishing (finishing is not made but created on the paper surface)
- Calendering
- Winding

It’s in the second stage where felts play a critical role. They essentially absorb the water in different stages and act as conveyors.

Based on the above, you can link the different types of fabrics to their respective sections:

Forming Fabric – for the forming section
Press Fabric – wet paper application in the Press section
Dryer Fabric – for the dryer sections (no points for guessing)
Roll Covers, QualiFlex sleeves for shoe press, and Doctor Blades – Stage 2/3 application

Source: Valmet Source: Multicopy

Images to be read left to right

If you’re like me and are looking into all this for the first time, it helps to be able to see all this. Here is a video that could help you visualize this: Papermaking process

(More resources are available at the end)

Q3. What are felts and fabrics made of?

In the old days, metallic screens were used to drain out water. With the advent of mechanized paper manufacturing, there was a transition towards wool/yarn/cotton while also using metallic screens/wires. With the rise of synthetic materials, felts are largely made of polyester or nylon fabrics with some addition or wool or yarn in certain segments. These materials help provide – better efficiency (in draining water – we’re talking of managing 100,000 liters of pulp per minute), higher life (they are used in an extreme pressure situation where machines are working under extreme heat (150^oC-500^oC), speed (2-2.5km per minute) and force) and better and more consistent sheet quality.

Q4. How frequently are they replaced?

Given that they are used in extreme stress environments, based on which section they are used in, they last between a few days to a year and a half.

Source: Albany International Investor Presentation

Felts are highly machine and use specific. Thus, they are customized to a very large extent. If an issue is found or some level of wear and tear beyond acceptance is noticed, the fabric must be replaced immediately otherwise it impacts the quality of the paper.

Large companies pour resources into R&D focusing on improving the life of the product. However, there are limits to how much it can be extended and this isn’t a very big/major risk (the above figures have barely crept up in the past 2 decades).

Q5. How much do felts cost?

“A paper machine costs several hundred million dollars to build which makes the cost of downtime very high. Therefore, efficient operation of the machine is extremely important which demands high quality fabrics with long life at high speeds and harsh environmental conditions such as high temperature, tension and humidity. Depending on the size of the paper machine, the cost of one complete set of clothing on a sizable machine can be approximately a million dollars.”

Paper Machine Clothing by Sabit Adanur

Before we move onto the next section, let’s take stock of the main takeaways:

Highly critical component (manufacturing literally cannot take place without it)
Consumable used under extreme stress environments (cannot be recycled or reused. New line need to be put) in 3 sub-stages - Forming, Pressing, and Drying.
Made of synthetic material (monofilament polymers)
Made to order based on customer requirement (machine, type of paper being manufactured, process, etc.)
Costs negligible compared to the output.

Now that we’ve understood what the product is and how it’s used, let’s move onto the next section of understand the macro view of the product.

The Macro View

The Global paper felt/fabric industry is estimated to be around $2 Billion based on data points from 10K filings of Albany International Corp ¹. AIC has a 30% market share globally followed by the next two players having a market share of 15% each. One of them is VOITH (the global parent for our India entity).

In the Indian context, the entire market is incredibly small. My estimates range between Rs. 350-600 crores² (based on the method, the figures differ (each has its weakness). But the main takeaway is that the market is tiny).

The growth of the market is driven by 3 factors:

Production capacity increase/decrease
Capacity utilization
Price increases

The relationship between these factors is pretty straightforward. With new production coming online, the demand for felts and fabrics increases (relatively permanently). As capacity utilization increases or decreases, this impacts the wear and tear of the felts. The life of a felt is reported to be between 45-60 days (some have claimed 60+ days as well. Depending on the section, the lifespan ranges between 40 days to 18 months). Price increase is another factor that drives the market size.

The growth of the felt industry in aggregate (not a specific player), cannot be greater than that of the paper industry over long periods (then the cost percentages increase beyond what they are right now).

With smaller mills, owners are relatively less sensitive to brand/anything. It completely depends on the vendor/person who assembled the machine in which the felt is used. With the larger and organized players, felt quality is a major component of their decision making and they are sensitive to brands.

In a cyclical cost-sensitive industry such as paper, felts that can bring about cost savings by way of efficiency for the user are recognized by the larger customers.

In India, there are 3 listed companies:

Voith Paper Fabrics India Ltd.
Shri Dinesh Mills
Wires & Fabriks S A Ltd

Most people who have used a screener with cash as a % of market cap or any such variant would have comes Voith in the list. Most 90s kids would remember the Dinesh Suitings ads on TV and in theaters. Shri Dinesh Mills owns the brand (at least they used to. It was shut down recently).

Wires & Fabriks S A Ltd has a chemicals business as well. They have a huge debt problem among other issues. Since it is not an investment opportunity for me, I am keeping it aside.

From 2016-2020, Voith has managed to grow its sales from Rs. 75 crores to Rs. 117 crores while Shri Dinesh Mills (SDM) (felt only) has held stead from Rs. 48 crores to Rs. 46 crores in the same period.

Voith and SDM couldn’t be more different in their approach and growth trajectories. These are two very different stories. More detailed analysis on these two to follow in individual/combined posts.

The Edge

Small investors have a huge advantage in this space:

The companies are either too small or their free float is also too small for any institutions to enter.
Most of the people who you are transacting with have no idea what the product is or the nature of some of these companies. The companies are often confused with the parent or a fellow subsidiary. (Happens very often in the case of Voith).

Examples:

Here’s a Morningstar report that lists JK Paper as a competitor (it should ideally be a customer). Firstcall Research Report lists Sutlej Textiles, Bannari Amman Spinning Mills and Garware Wall ropes as peers. None of them have touched upon listed peers who have been around for ages. (The point isn’t to call out their mistakes, but rather to highlight the fact that even people with far more resources than an individual investor find this sector more trouble (pain to find any info) than it’s worth (limited opportunities)).

3. Illiquidity! The counters are very illiquid. Tiny changes in quantity are enough to drives prices in either direction. This keeps a lot of people at bay. A double edged sword!

Risks

The biggest risk to the industry is if there is a fundamental change in the way paper is made. It’s been over 2000 years that the macro approach to papermaking has largely been the same. The risk from this is very low.
Not many people knowing about this industry also leads to difficulty in accessing information and the latest developments in the industry. Companies in the industry have moved from being very open to revealing as little information as possible. This could lead to investors being caught unaware of certain developments.
The free cash generated from the business tempts one to look at other avenues that may or may not work out, in effect leading to the felt business subsidizing other business lines.
China Factor – the China factor is always there everywhere. But the effect is less pronounced in this industry and certain pockets given the customized nature of the final product.
Illiquidity can be a problem with large positions while exiting.

Notes:

1 – Total Market Size = Albany Revenue*(100/Global Market share)

2 – The various approaches are:

Method 1 : Cost of felt as % of Revenue*Paper Market size

Method 2 : Global Felt Market Size*India's Share of Global Paper Production Market Share (Production)

Method 3 : Sum of 3 public Players turn over * factor

Resources:

Mechanical view of papermaking 1and 2 (these are videos by Voith based on the work they’ve done)

Convergence Training by Vector Solutions has some really useful training videos on paper manufacturing, Tissue making, pulp mill, and box plants. One specific video that is useful to understand how felts work. There are videos on the technicality of felts as well.

How are felts made

Understanding sleeves

Forming

Dryer

Roll cover

SWICOFIL has a good overview while also covering aspects on materials used .

Albany International’s materials – Investor Presentation, Con call, 10K, etc. are really useful. Albany is also an interesting story – how they’ve used this cash to pivot into another segment.

Paper Machine Clothing by Sabit Adanur is the most comprehensive one-stop resource on this entire industry and process! It was amazing reading this book.

Disclosure: I have positions in Voith and SDM (from lower levels). I am not a SEBI registered adviser. All the information provided by me is for educational/informational purposes only. Please do your own research before investing (especially in these crazy markets).

hcpl2000 · April 28, 2021, 2:44am

Absolutely amazing write up !
Never seen something so good for Voith.

But on any time frame it is a value trap…

MyCapitalNotes · April 28, 2021, 4:34am

Thank you so much! I must admit I have my doubts at times too, but overall I feel there is value there. A 2-3x opportunity over 7 years seems possible. I’m working on articulating my thoughts.

Would love to hear why you think it is a value trap.

hcpl2000 · April 28, 2021, 8:30am

So the positives,

it sells for close to cash value
It has almost a 4 X plot in NCR for the factory. Four times then it can ever be used.

Rest business wise you have already pointed out the size and challenges/ opportunities.

It will be a great un lock if Faridabad town kicks them out of the area for any reason and RE unlocks…

Would love to hear more…when you do your further analysis

RajeshNarang · May 1, 2021, 8:22am

It’s really rock solid share with limited volatility. Paper industry growth is likely to be limited. Hence potential for growth unless company adds new lines.

MyCapitalNotes · May 2, 2021, 5:04pm

In the first post above, we looked at what paper felts and fabrics are and how they are used. The main takeaways are:

They are incredibly important products in the process of manufacturing paper. Paper manufacturing cannot take place without them.
They are consumables and need to be replaced frequently. (no question of recycling or reusing).
The annual cost of felts is insignificant to the entire process and needs to be custom made based on the machines, paper type, etc.
These businesses are delinked from the fortunes of their customers.
Therefore, they combine 2 desirable qualities – subscription (repeat orders frequently) + gold miners (fortunes are delinked in a cyclical industry).
While there are no multi-baggers (10x, etc.), we’ll find our See’s Candies here.

The focus of this post is Voith Paper Fabrics India (VPFIL/Voith). VPFIL is part of the Voith Group, a diversified German conglomerate with interests in Hydropower, Paper Making among other things. VPFIL was started in 1968 and came to be part of the Voith Group in 1999 via an acquisition of Porritts & Spencer.

VPFIL covers all segments of the paper industry - tissue machine, board and packaging, graphics, newsprint, currency, etc. They also cover all the processes of paper manufacturing – forming, pressing, drying, Roll Covers, QualiFlex sleeves for shoe press and Doctor Blades.

Most of you would have come across Voith in a screener with cash as a % market cap filter or debt-free with a decent ROE filter. Perhaps the best place to start would be the dynamics of the company.

The Dynamics – Sales, Capacity, and Financials

Let’s start with sales.

Figures in crores	FY17	FY18	FY19	FY20
Sales	89.34	95.07	110.70	116.35
Sales Growth		6.41%	16.44%	5.10%

Sales growth impact in FY20 was primarily because of the lockdown in the last quarter. Otherwise, cumulative Q3 growth YoY was at 13.6%.

Geographic Split	FY18	FY19	FY20
India	89.7	104.8	103.1
Europe	0.4	0.3	4.2
East Asia	0.0	0.0	0.2
South East Asia	1.6	2.0	3.8
Middle East	0.0	0.0	0.0
North America	0.0	0.0	0.2
South Asia	3.5	3.5	5.0
Total	95.1	110.7	116.4

Figures in crores

Voith’s main market is India with a focus on exports via sales to fellow subsidiaries/group companies. Exports will continue to be through group companies as “our business is not only supplying a product and then forget about it. We have to give after-sales care, we have to optimize the product, we have to work with machine settings, so the after sales service is very important. We can only take care of Indian market that is our core market, rest of the market what we are trying to do off-late, is to utilize resources available with our Group Company and service those customers through them. We have accelerated this Group activity that is why off late we are able to sell to Europe or any other market through the Group Company, not directly. Directly, we will not be able to sustain”

With India being the core market and based on the estimates of market size (350-600 crores) and the FY20 India sales figure, Voith’s market share is anywhere between 17%-29%. As per the management, “(i)n our core products, we have very high market share compared to competition. We are not seeing any dumping on our products in the market..”

While sales and sales growth is one way of looking at things, another way is to look at Voith’s production statistics and their revenue realization (a possible proxy for price).

There are 2 major ways in which the company makes money – 1) Manufacturing and selling felts 2) Traded goods i.e. buying them from fellow subsidiaries/group companies and selling them here at a markup. (The third way is selling scrap, etc. which isn’t a significant thing).

In the below chart, the focus is solely on manufacturing and selling.

With India being the core market and based on the estimates of market size (350-600 crores) and the FY20 India sales figure, Voith’s market share is anywhere between 17%-29%. As per the management, “(i)n our core products, we have very high market share compared to competition. We are not seeing any dumping on our products in the market..”

While sales and sales growth is one way of looking at things, another way is to look at Voith’s production statistics and their revenue realization (a possible proxy for price).

There are 2 major ways in which the company makes money – 1) Manufacturing and selling felts 2) Traded goods i.e. buying them from fellow subsidiaries/group companies and selling them here at a markup. (The third way is selling scrap, etc. which isn’t a significant thing).

In the below chart, the focus is solely on manufacturing and selling.

Source: Up until December 2018, Voith used to provide monthly production statistics to the exchange as a disclosure. Subsequent calculations are based on energy figures in the annual report. For realized revenue, the FY from FY16 is the normal April-March cycle. The numbers before are based on Voith’s reporting. FY21 capacity is based on Voith’s claim of 30% expansion in 3 years in FY18.

The main takeaways from the above chart are:

Estimated realized revenue has more or less been range-bound (10% variation).
Voith has been able to use up most of the additional capacity within 3/4 years of expansion.

The implication of this is that we could potentially see another round of capacity expansion in the next few years.

It’s important to keep in mind that the impact of external business conditions on felt companies like Voith is always lagged by a few quarters. However, the impact is relatively mild (you will never have a scenario where orders go to zero. Paper mills need to run (irrespective of what capacity they are running at) and they need to frequently change their felts). Sales can decline if the mill isn’t being used.

One advantage that Voith has over most of its peers is the group’s integrated operations. Whenever Voith Paper India sells a paper machine, the supply of felts will most likely be tagged to Voith Paper Fabrics. Voith is also able to leverage the R&D developments that happen at the parent level reducing the financial requirements on the business. In return, Voith only has to pay technical royalties.

Financials

A superficial glance at the company’s financials gives you the following impression:

Decent revenue growth
PBT margins of 26-27%
PAT margins of 19-20%
Debt-free
Rs. 150 crores cash balance

Things look good.

But when you look at the details, you seem to notice that 7-8% of the revenue comes from interest income generated on the Rs. 150 crores cash literally sitting in the bank. This goes straight to the bottom line and inflates both figures – revenue and profit. This doesn’t mean things are bad, but let’s try and understand the business itself and keep the interest income aside.

There are 2 major ways in which the company makes money – 1) Manufacturing and selling felts 2) Traded goods i.e. buying them from fellow subsidiaries/group companies and selling them here at a markup. (The third way is selling scrap, etc. which isn’t a significant thing).

Let’s start with the traded goods. The below table shows the movement in sales, expenses, and margins. All in all, it is a growing business with good margins.

TRADED GOODS	FY17	FY18	FY19	FY20
Sales	6.04	13.71	20.96	19.30
Expense	5.13	10.87	17.32	15.06
Profit	0.91	2.85	3.64	4.24
*Margin*	*15.1%*	*20.8%*	*17.4%*	*22.0%*
*Sales Growth*		*127%*	*53%*	*-8%*

Figures in crores

This is a simplistic view. There are other expenses that also get tagged on, but at a basic (gross) level, this is how it works.

Let’s look at the complete business now.

Figures in millions	FY17	FY18	FY19	FY20	FY17	FY18	FY19	FY20
Sales of Manufactured Goods (A1)	792.83	804.39	889.81	963.65	88%	83%	79%	82%
Sales of Traded Goods (A2)	60.44	137.13	209.58	192.98	7%	14%	19%	16%
Total sale of services (B)	40.15	9.19	7.65	6.90	4%	1%	1%	1%
Other operating revenues (C)	7.44	13.82	13.25	12.55	1%	1%	1%	1%
Total Revenue From Operations (A1+A2+B+C)	900.85	964.53	1120.29	1176.08	100%	100%	100%	100%
EXPENSES
Cost of materials consumed	169.42	199.57	241.04	267.98	19%	21%	22%	23%
Purchase of stock-in-trade	51.31	108.65	173.17	150.59	6%	11%	15%	13%
Changes in inventories	-6.48	6.63	-6.79	-22.93	-1%	1%	-1%	-2%
Excise Duty	85.65	23.41	0	0	10%	2%	0%	0%
Employee benefits expense	108.65	123.44	135.44	151.42	12%	13%	12%	13%
Other expenses	239.83	254.44	284.54	312.64	27%	26%	25%	27%
Depreciation expense	59.57	58.45	55.63	65.96	7%	6%	5%	6%
Total expenses	707.95	774.59	883.03	925.66	79%	80%	79%	79%
Operating profit	192.89	189.95	237.26	250.42	21%	20%	21%	21%
Exceptional items	0.00	0.00	0	-8.53	0%	0%	0%	-1%
Profit before tax	192.89	189.95	237.26	258.95	21%	20%	21%	22%

While we’ve understood the revenue bit, let’s understand the expenses. The raw material used is relatively inexpensive. The polymers (materials consumed) constitute about 19-23% of revenue. The cost of materials consumed plus the purchase of stock in trade (for traded goods) adds up to about 32-37%. The other major head of expenditure is employee expenses. The other expenses are an amalgamation of contract labour expenses, power, royalties, etc.

The raw material is mostly imported and imported in substantial quantity (hence the large inventory figure on the balance sheet). This is done possibly to keep transaction costs low.

Continuing the same line of thought of looking at the business without cash, what would the return ratios be without the cash balance (assuming 15% of balance with a corresponding impact on reserves)? You get an ROE of about 20% from FY17-20. i.e. the company is able to deploy additional capital at the same rates of return in a stable manner, which isn’t an easy thing to do. (You could take higher numbers, but the point would remain the same).

Let’s quickly take stock of the main points so far:

German parent company which is a diversified conglomerate.
VPFIL has a presence across the entire paper industry and the different stages.
The main focus is on the Indian market and exports are to group companies or via group companies for after-sales services.
Realized revenues per kg have largely been flat for a decade and Voith has been able to use up the entire capacity expansion with 3-4 years.
It’s sitting on Rs. 150 crores of bank balances. The interest income shores up the revenue and profit figures while the cash balance brings down the return ratios.
It has two ways of generating revenue a) manufacture and sell; b) import from a fellow subsidiary and sell (traded goods)
Looking at the basic functioning of the business, Voith is able to deploy additional capital at the same rate of return in its manufacturing business.

We’re also able to deduce that:

The company is financially very very conservative.
The fundamentals of the business are desirable – decent margins, niche space.
The business is stable and has the potential to grow

Keeping in line the See’s Candies expectation, all the above factors seem to suggest a desirable business. But there are 2 parts left to be addressed.

At what price does the desirability manifest?
What are the risks/challenges?

Valuation and Price Trends

Since 2014, the stock has returned over 400%. While there has been a case of earnings growth, it has also been a case of multiple expansion.

What would be the way to value the company?

In the context of Voith, given the capacity situation above, it’s not possible to simply draw take a straight growth rate and apply it throughout the period (well, you can and that is sort of what I’ve done. But it also has to be done keeping in mind capacity and capacity expansion). Let’s look at capacity and the maximum realizable revenue.

With capacity expansion being completed in FY21 and an estimated revenue drop of 6% for the full year, their utilization levels should be around 75%. With 7% growth YoY, they would be above 90% in FY24 and would require another round of capacity expansion spread over 2/3 years. This pattern would hold till around 2030 as well. This essentially is a repeat of the last decade in terms of capacity expansion (30% each time). On the traded goods, assume a 7% growth rate as well. Plus interest income on the cash balance of Rs. 150 crores with a yield of 5%, we have a range of Rs. 190-210 crores (discounted). Add the cash balances, this gives us a market cap between Rs. 340-360 crores and a price range of 770-820 (this would imply a PE between 14-15 now). With the average realization hovering around 2000 the past few years (also the decade), considering this in the context of the capacity gives the upper limit on the manufactured revenues.

(The real estate of 30 acres is recorded at historical cost of Rs. 18 lakhs (1970s). While it may never be monetized beyond the current status of renting out some place to Voith Paper India, this does exist. I had always overlooked the land. User @hcpl2000 brought this issue up).

To put these figures in the larger context - with these figures, we’re also looking at a market size range of 580-860 crores in 2031 based on various market share scenarios ranging from 20-30%. (This would imply a paper industry of around Rs. 1.5 lakh crores vs the estimate of Rs. 70,000 crores in 2018/19 making this estimate in line with the 6% growth estimate of the paper industry).

A larger capex scenario could push the numbers upwards while impacting interest income but I haven’t really factored this in as it is a welcome development. Based on production numbers for FY21 and FY22, we’ll know the trajectory. But it does seem like the issue of capacity is being thought about by the management (context below). The above is of course the treadmill scenario where a small incremental capacity expansion of 30% every few years (seems most likely based on past behavior). Other scenarios could be a significantly large capex at one shot and so on.

Risks/Challenges

The Cash

Perhaps the biggest concern most investors have is of the Rs. 150 crores cash. That’s roughly 30% of the market cap and Rs. 340 per share. Every AGM, investors bring up the issue of the cash balance and increasing dividends and the management remains non-committal. What if something were to happen to it (obviously it’s not going to run away on its own)? What can they do with the cash?

Let’s think through the options and see the implications:

Option 1: Distribute the cash back to the investors as a dividend? According to the AGM transcript, the management claims that while the cash appears to be large, the cash needed for expansion is also significant.

“If we really go for a new line with the latest manufacturing machines from OEMs, the cash lying with us is not enough, even to take up one project. That is why, we are conservative in our approach and I am telling that, yes, we will definitely give dividend for the stakeholders but we request you to remain invested in the normal business, which is remunerative in the normal course of business.”

Based on the capacity and product graph above, they do seem to be able to utilize their capacity pretty quickly and reach close to the limit. This would make capacity expansion a rather frequent thing (every 3-5 years). The recent 30% capacity expansion has cost them about Rs. 43 crores from FY19 till FY20 (add to this the FY21 figure that will come out). It certainly is an expensive affair. For a company averse to taking on debt and having to rely solely on internal accruals, conserving resources seems to be the only way forward. The company is conservative and has set expectations fairly (although a few more words of clarity would most definitely have helped). This also rules out buybacks. (There was also talk of bonus issue as well, but that’s fairly useless to the investors if the payout remains the same. Apart from some impact in terms of additional liquidity on the market, the impact would be limited).

Option 2: Buying another company (M&A). This is not an option. I don’t see the point in any acquisition. An acquisition is either for customers or technology. They’ve been able to grow organically and their product is superior to most. Shelling out a premium for an acquisition of something that is happening organically doesn’t seem appealing.
Option 3: Increase payout at least? This would be an ideal outcome, but it is unlikely to happen because of the explanation in option 1.

So cash is just going to sit there until it’s used up for the next capacity expansion. This begs the question, how long are they going to keep expanding capacity? It appears there certainly is a limit. When and how will we reach the limit, I don’t know. But we are on the journey towards reaching that limit and we’re far closer than we were say 5 years ago. Once that is reached, then what? The cash has to go somewhere. (unless the treadmill is scenario is carried on forever). That’s when it will become a See’s Candies variant (paying out most of its profits).

Increase in pay outpacing growth

There is a significant gap in pay among the ranks. This is going to exacerbate the growth in salaries leading to a scenario where the growth in salaries is higher than the growth in sales. This has already happened to a certain extent.

	FY17	FY18	FY19	FY20
Sales Growth (Manufactured + Traded + Services)	8.4%	6%	16%	5%
Salary Growth (median)	13.94%	14.55%	22.01%	16.58%
Salary Growth (average)	8.94%	12.69%	14.34%	13.24%

Here’s an extract from the FY20 annual report:

“As at 31st March, 2020 there were 129 employees on the rolls of the company. For the financial year ended on 31st March, 2020, median remuneration of the employees of the company was Rs. 946,224/-.

The ratio of remuneration of the Managing Director, Mr. R. Krishna Kumar to the median remuneration of the employees of the company was 18.05 times…….

The percentage increase in the median remuneration of all employees for the year ended 31st March, 2020, over last year’s median remuneration was 16.58%, whereas during this period the company has registered a growth of 28.37%...

In case of the CFO, Mr. Kalyan Dasgupta and the Company Secretary, Mr. C.S. Gugliani, the increase in remuneration was 8.28% and 10.85% respectively. Whereas, the average increase in remuneration of employees of the company was 13.24% which is in line with the policy of the company and prevailing market conditions.”

Designation	Salary (Million)
MD	17.079
VP	5.026
VP	4.339
DGM	3.297
DGM	3.114
Chief Manager	2.597

Fun Fact – Rs. 1.7 crores comes upto Rs. 3.88 at the EPS level (pre-tax) and 11.3% of the Employee Benefits Expense for FY20. (The 28.37% growth might be a typo I guess?)

Low Volumes and IEPF

The promoters own 74.04% of the outstanding stock with 3855 individuals owning the remaining 25.96%. In the past 7 months, 1.27 lakh shares have been traded (8.8% of the free float). While the stock is illiquid, the problem is compounded by IEPF becoming one of the largest shareholders (among the lot). This would only increase the pressure on free-float. In March 2021, IEPF jumped from 0.72% to 1.09%. This number would only increase with time to a possible upper limit of 1.7% (that’s the number of shares that haven’t been dematerialized yet). Plus the large shareholders (top 10) have mostly been acquiring or sitting tight on their 5.2% stake.

Note:

These are my personal notes and is not investment advice. A large chunk of the figures are estimates/guesstimates based on numbers from the annual report and my own calculations. Please do your own research and calculations.