PI Industries - Superior Business Model

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@Mahesh, to my mind, your reasoning does not hold good logically. Q2 is part of the kharif season. if others can do well in Q2, PI should have also done well. Are you implying that that the Q1 growth was abnormally high? No one (including you) mentioned that before the Q2 results!!! The point here is that the weather was the same for all the participants, yet a few did better than the others. We need to find out why…

@Donald: I looked at the forex calculations again. There is no way a net exporter can lose money if they are not doing fancy things with their forex trading. Just by hedging their positions using naked call/put options you cannot make such substantial losses. So, either the CFO was playing “forex trader” and lost or they have a partial hedging strategy, i.e. they only hedge part of their exposure. Take a look at all the IT/ITES companies this quarter. Everyone has made money in forex hedges. Only the importers have suffered badly.

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Hi Abhishek,

Just like greyf., you are also looking at my reply in isolation to my previous posts… You both are not getting the point which I am trying to make… Bothyou guysqueries are distinct from each other and while replying to greyf. if he had asked rgdg. this I had replied to that point too which I am doing just now…

I am not atall saying that when PI can outperform other players exceptionally well in Q1 it can’t repeat such outperformace in Q2… Not atall, that was not my point… The point I am trying to make is that when you look at a company in agri space you need to look at its performance season-wise if you want to compare it to peers otherwise what will happen is based on one qrtr. performance you will feel one co. is better and in the next qrtr. you will feel other co. is better… That is not the right way to look at things… Also, product-mix as well as favourable weather conditions for majorly contributing products on a monthly basis plays critical role in performance during a particular quarter… Hence, in Q1 the conditions were so favourable for the products of Pi that it exceptionally outperformed others in Q1 while in Q2 conditions were not that much favourable so it underperformed… product-mix will always play critical role in performace of agri cos… the talent lies in exploiting the favourable conditions to the fullest while maintaining status-quo in bad times…This is where management role comes into picture and on that count I feel PI has done very well and thats the reason why on H1 basis or kharif season basis, it has outperformed all listed players… If Q2 had been favourable then it would have been great but if you ask me that with this bad Q2 for agri segment does PI-story has some risks which were not present before… I will say No…PI is still the best bet on agrichem sector…

Feel free to ask any query you have…

Rgds.

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Link to latest PI Industries report by Edelweiss – Target 670 :

http://www.scribd.com/doc/72764230

Link to latest PI Industries report byDolat Capital-- Target 570 :

http://www.scribd.com/doc/72764247

185

That is exactly what I want to understand. What is the difference in product mix that resulted in PI’s underperformance this quarter. According to the con call and the research reports, PI has migher margin liquid products compared to lower margin granules available from competitors. And due to heavy rain, the farmers decided that the lower cost granules would be a better choice. Here are a few questions that comes to my mind:-

1). Why doesn’t the farmer always choose the lower cost alternative?

2). Why doesn’t PI have a lower cost version (probably because it does not want to cannibalize it’s own higher cost ones, but there are lot of companies in other sectors who successfully manage various products at differing price points)?

3). What gives the management the confidence to say that their will be back to normal next quarter/year?

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Good questions Abhishek. I think its important to include this product mix question to PI Management and get to understand some intricacies of the business, at a 2nd level. It will help us understand the sensitivity to monsoon factors, and help differentiate form competition too.

re: the Forex loss scenario, I made some calls to various folks. The understanding as of now is:

a) Any Exporter who hedges 90-100% of total net forex inflow in simple forward contracts- is bound to incur M2M losses in a suddenly depreciating rupee scenario. if you have hedged at ~45 to a dollar (to protect your margins at current rates) and it goes to 49 to a dollar, there are no two ways but M2M losses. Forward contracts are usually 1 year,. some take 6-9 months duration too. M2M loss/gain is always calculated for the full contract (duration) and accounted in the BS. And this offset partially by the actual loss/gain of forex coming in for that quarter!

b) so PI with 1 yr forward contracts worth $20 mn as on 31st March hedged(I am assuming a similar figure as on 30 Sep, would have to account for 4Rsx20 mn =8 Cr as M2M. This will be partially offset by the actual forex that came in for the quarter, actually in Sep at 49 or 50 to a dollar

c) The reason additionally $6.4 mn forex currency is hedged is probably for offsetting the interest liability arising of the Forex loan $32 mn - that is left entirely unhedged.

d) In an earlier thread you had mentioned no IT exporter made M2M losses. As we discussed (want to share for others) thats because none of the IT players including the biggies hedge more than 50% of net Exposure. typical figures are between 25-30-50% of net forex exposure

e) As Viraj pointed out, we need to also find out why Balkrishna made no M2M losses. How much does it hedge its net exposure? Partial hedging is the only answer we have for those who have not made any M2m Losses in Sep Qr

Any subject matter experts, care to comment?

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mahesh,donald,

the price seems to be falling steeply,not sure if the falling rupee impacts them,do we have again mtm losses this quarter otherwise there is something seriously worng with their hedging policy orwe are at a total loss in understanding their P&L statement,again mtm losses of 4 cr 20mn*2 going by the argument above,how do we know what are their future currency contracts

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Hi biju,

The price fall is a normal phenomenon as its not falling irrespective of the market… if you see some of the small and mid cap cos. they are just butchered and thats one of the reason why whereever one will find some profit will exit it to make good the loss the other…If you observe closely, delevery % has not been high in yesterday’s fall relative to what we see normally in the counter which is a positive sign as someone is making use of illiquid nature of the counter coupled with market conditions to hammer down the prices and while doing so is covering his sell at every fall and selling again at a lower rate… Its more of the matter of lack of buying than genuine selling and once the buying comes the stock should rise equally sharply… In illiquid counters this is normal…

with rgds. to forex losses and hedging especially wrt. to PI, I think its not a major issue and indian corporates will find one way or other to protect profits… Its a temporary phenomenon andshould pass on without affecting PI much…If there was any concern in core businesses then that would have been a genuine concern but thats not the case so in PI so I feel its the best opportunity to load up some more of PI…

Rgds.

mahesh,donald,

…

189

Updated Questions for PI Management Q&A )- Expected early next week

Some of these may trigger new angles/deeper probes?Please have a look and help improve. Those interested may respond latest by Sunday 20th evening for inclusion.

Significant changes from the last revision outlined, as below for your quick perusal:

1). Nominee Gold (Bispyribac Sodium) In-licensed from Kumiai Chemicals. Bayer had also in-licensed this from Kumiai Chemicals and has registrations (active 2009) for Greece, Italy, Portugal, Turkey, Romania, Bulgaria, Phillippines, and several other countries.

Kindly explain the in-licensing arrangement/country registration process with Kumiai Chemicals, and validity/tenure of patents/trademarks/registrations for Nominee Gold.

Why do you think Bayer did not in-license this for Indian market, for itself? Is it correct to say they missed spotting the growing use of Herbicide trend in India catching on, something that PI spotted. And now Bayer has partnered with PI for Nominee in India? Kindly share the terms of this partnership, and what does PI get out of this a access to Bayeras larger distribution network?

Is it correct to say certain factors like Labour Shortage (increasing rural MNREGA led economy) has contributed significantly to growing Herbicide use in India and led to Nomineeas success.

Have your other Herbicide brands like Altrazine, Fenoxaprop, Pretilachlor, Thiobencarb seen similar growths? Have Monsantoas Butachlor/Alachlor grown as well? If not, kindly explain why?

Nominee Gold is aimed at the Rice crop a Please educate us on the annual Herbicide spend on Rice crop in India.

_2._Custom Synthesis SEZ project - Jambusar, Gujarat. 22.3 acre land acquired. A total investment of Rs. 125 crore earmarked for this of which 55-60 Cr is already utilized.

What is the progress on this front? Have you secured any funding for the same? What are the terms? Is the balance 65-70 Cr to be utilized in FY13 only?

New CSM multi-product plant a Please give us an idea of the size/revenue generating capacity vis–vis existing CSM capacity

Please indicate typical stabilisation timeframes post commissioning. And capacity utilization time-slate thereafter?

Is existing capacities of CSM fully utilized? At full utilization what could be the revenue generation of existing as well as new plant separately, on a full year basis?

When do you expect the next cycle to begin? Is it FY15 or earlier?

_3._Agro Chemicals a 2 New in-licensed molecules commercially launched in FY12 under co-branding arrangement with MNCs

Insecticide a co-branded with Bayer a Tea & chilly crops -whatas the Brand name?

Fungicide a co-branded with ? Vegetable crop a brand name?

Please elaborate on the co-branding strategy. Is this the likely road from here on for new introductions? Who gains what from the partnership? Who is the registered owner of the brands in India?

Assume these are from the in-licensed innovative molecule pool, kindly educate us on the unique functionality/application that these will bring to the market.

Do your market studies indicate as big a market size as Nominee Gold for these 2 products?

Do you expect any significant revenue contribution in FY12? Does your 40% Sales guidance for FY12 factor in any contribution from the same?

_4._Agri Chemicals business mix a Generics vs Innovative plays (60:40?). Focus on introducing innovative molecules where there are only 1 or 2 sources worldwide.7-8 innovative molecules under active scrutiny, registration, test marketing.

Kindly educate us on the current business mix between generics & innovative molecules in this space. Given that you had substantial success with introducing blockbusters like Nominee Gold, is the focus shifting towards greater share of Innovative molecules?

With the introduction of 2 new innovative molecules in Q2FY12, is this revenue mix strategised/foreseen to be changing significantly by FY13? Where will this mix be by FY2015?

_5._Agri-business a The three drivers a Normal Monsoon, higher crop acreages, high agri-produce prices. We have seen Margins and volume growth affected in Q2. Continuous rainfall conditions in later part of Q2 led to a sub-optimal optimal product mix.

Kindly explain the components of this sub-optimal product mix.

We heard farmers opted for granules, which accrue lower margins (instead of high-margin liquid products). Why does the farmer not always opt for lower cost granules? Does PI have granule based products in its portfolio?

This may not be the first time PI has faced extended monsoon conditions! Could it have been better prepared?

Some of the other pesticides companies like Insecticides and Dhanuka didnat seem affected by the monsoon a they posted robust Q2 numbers. What do you think is different in their product mix/strategy?

Do you see all drivers as favourable for H2FY12? Or are we more cautious now? And are we better prepared the next time similar conditions prevail?

_6._EBITDA margin expansion guidance of 18.5% for FY12 (17+1.5). Q2 EBITDA @15% - performance has not matched up. However, you have maintained the EBITDA guidance on a full year basis! And combined sales of Rs 895 Cr (575+320).

While you had guided for a 40% growth in Sales for FY12 in the Q1 conference call, it looks like the outlook has been tempered down to more like a 25% growth for the full year. On a reduced revenue base, how confident are you really of achieving the EBITDA guidance?

Given that CSM business is more or less steady-state (ignoring the forex M2M for now), it would seem that you are pretty confident of the Agri-Chem sector outperforming in H2FY12. Please share the rationale for the confidence/optimism.

What, if any, could go wrong?

_7._Forex Management. Forex mark-to-market loss of 8.85 Cr in Q2. Hedged Forex contracts outstanding as on 31Mar US $20 mn and Euro 8 Mn. Hedged Foreign Currency exposure as on 31st Mar 2011 US$ 6.4 Mn and Euro 0.4 Mn. Unhedged foreign currency exposure US$ 32.4 Mn and Japanese Yen 58 Mn.

Please elaborate on Forex hedging policies followed. Do you hedge 100% of net Forex inflow?

Please give us a break-up of the 8.85 Cr M2M loss in Q2. Assuming you hedged at Rs.45 to US$, at 49 to US$, the M2M loss would be 4x20 ~8 Cr!

As on 30 Sep, what is the quantum of firm contracts outstanding, and hedged contracts outstanding. How much is the net forex inflow expected? What is the hedged foreign currency exposure? Finally, Why do you need to hedge foreign currency a to mitigate foreign currency interest payout impact?

If the rupee keeps depreciating further, what can we expect? In Q2 Concall you have mentioned that being a net exporter, on a longer time horizon, PI stands to gain if rupee depreciates. Under current hedging policy/practice please explain how that would be achievable?

-Donald

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Hi Donald, the questions you are asking are fairly pointed and are very interesting. From what seems to me is the major bearish points for this company is its increase in working capital and forex impact. Though forex impact, we cant do much except other than have prudent hedging, the reason for working capital surge has been outlined in its conference call of April 2011.

However that being said, I am heavily interested in a few generic questions:

1). If some time in distant future, if you are having good amounts of idle cash in your books, would you be more interested in :

  • diversifying your company’s operations or

  • distributing it by dividends.

  • Or share buybacks?

  • Any other

Choose either of these three. If any other please explain:

2). Lets assume in the distant future, the company’s business comes under serious threat, which sees margins eroded, ROC diminishing due to unforeseen, unanticipated events over a reasonably long period of time (2-3 years),even with numerous different product launches. What will be your preferred plan of action ?

  • Keep fighting the competitor/the alternative. Business is war!

  • Align capital and business focus to new areas where ROC is very attractive. “Evade when the “enemy” is more powerful than you” ~ Sun Tzu

  • Liquidate the Operation and return money to investors. We are here to add value to our investors and if we cant we better return back the money.

Please explain as well, your choice.

3). Can you please talk about your management succession plans or rather, how does career progess takes place for an able intelligent employee of your organisation

Soham

191

One last question, and I would like to have a feedback from Donald as well, if this question should be asked or not- I am highly interested in it, because a good dividend yield often acts as a catalyst for correction in stock price

Normally we see, companies in India yield very low dividends for comparatively high amounts of Free Cash Flow to its Equity. How much of Free Cash Flow to each Share are you willing to give back as dividends?

Soham

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@Soham - Thanks for your questions, but came in too late. We had the meeting Monday first hour. Next time I will put you onto my priority Qns mailing list:), so you have advance notice.

We spent some 2.5 hours discussing threadbare everything that I could throw at PI. Management came across as transparent and patiently, meticulously answered all questions. I liked the way the company’s process orientation, strategising came out in every aspect. Today’s success (both segments) is by design, and laid more than a decade back!

I will take a couple of days to reproduce the PI Industries Management Q&A, as well as Indag Rubber’s. For the moment suffice to say, I am excited by PI Industries, while Indag was on expected lines, good and undervalued yes, but perhaps not much x-factor!

-Donald

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Don

If anything, your questions are very nuanced and shows a huge amount of insight into the company(more on this later).
But my whole focus was in ascertaining where does the focus of the management lie- in increasing shareholder value or elsewhere.
So, if you do believe that the management is highly focussed on enhancing shareholder value, I am okay.

Continuing on the insight you developed into the company, can you give me a way to contact you personally, because I would like to learn more about your research process.

Soham

sohamdas@gmail.com

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@Soham - Happy to see you contributing! The quality, insightful Q&A you refer to is as much a result of the enthusiasm we bring into our research process, as well as meaty contribution from very knowledgable ValuePickr members! Have sent you a mail, lets talk more.

Members - You can keep checking the PI industries Management Q&A, for periodic updates spread over the day - as & when I connect successfully to the net. Q1 details are already in, it should be inspiring to read that:) so the eager beavers can jump in periodically to check. I am on a train to Blore from Delhi, so patience pays:)

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Hi Guys

PI Industries Management Q&A is updated. (might go through notes and make minor revisions in a couple of days, but the meat is in).

Please carry forward the discussions.

I would like all of us to try and pick holes in the story. Is this too good to be true, or this is indeed a blockbuster of a company in the making??

We, the optimists have done our job:) Where are the natural sceptics - time for you to take over and dissect this threadbare? Where are the downsides? what can go wrong?

Abhishek, Yogendar, Siddharth, Manish Kulkarni, Soham, Rohit Chauhan, Neeraj Marathe, Janak Merchant, DeepInsight, others - let’s have more frequent show of hands and get counted in our collaborative efforts!!

Cheers

Donald

196

Hi Don!

Fantastic effort on the management Q&A!

Cheers

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Donald,

great effort/questions were good and pointed,from what i could gather the forex contracts losses would appear in this years P&L,ony if the expected orders dont materialize,otherwise it would be good as it is a net exporter,however if PI was a net exporter he would hedge only if he expected the rupee to appreciate and it has gone the other way,so i still feel there would be some losses,maybe some of the experts could help out.

2.in the agri-chem space if he is only licensing/cobranding what MNC’s are making,what is the moat,Dhanuka or insecticides can do that,isnt it?the products have not been discovered by PI.From the first para,is it correct that MNC’s may be introducing products here which they cannot use in Europe due to regulatory issues,just trying to find out if they have got a competitive sustainable advantage over others in the field

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HI mahesh/donald

What kind of margins does the company enjoy in the innovated molecules as compared to generics in the agrichem space?

The management tone seems to be indicating a strategic shift towards innovative molecules.

And great effort donald for the q&a post.

PI seems to be a company with a difference due to the presence of the CSM business, which seperates it from the run of the mill agrochem companies like dhanuka etc.

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@ Biju - keep pegging away. I like your line of questioning!

1). Hedging - When a company takes 12 month forward hedges on outstanding contracts…the objective is to protect its margins at the current level… without needing to bother what happens to rupee-dollar. If they hedge up or down, then they are taking a call on the direction…which is speculative in nature. I think all Indian Corps learnt the less on last time round rupee instead of going to 35 to a dollar went to 50 to a dollar…and most of them suffered form the speculative greed!

My impression is that PI is taking hedge at current levels only…there is no element of speculation…especially as contracts are pass through in -terms of forex movement. There is no question of a P&L loss over the operating period. We will only know when it actually plays out! but I was comforted by the pointed answers…there was no hedging:), or beating about the bush!

2). If you read the text clearly, you will notice PI is launching an in-licensed broad spectrum insecticide in Q4 FY12, and they have high expectations from the same. As per their current pipeline and progress of registrations…they expect to launch atleast 1 in-licensed molecule every year. When they say they will launch atleast 2 products in FY12, they meant 1 in-licensed and 1 co-branded. [ this is important and needs to get captured back in the Q&A - thanks for pointing it out]

Why do you think the co-branding offers are pouring in? my educated guess is that’s because of the strength of current portfolio Nominee Gold+ Kitazine, and the pipeline. every MNC wants a piece of that action. PI is very confident of their mapping exercise and a prioritised pipeline in terms of potential of these molecules.

Now if I have the same set of customers I am targeting and I can leverage my existing market set-up, will I be happy to have a much bigger product basket to offer? By the looks of it there are atleast 7-8 co-branded currently under discussion/negotiation.

Why will a MNC offer co-branding? only to someone they consider an equal. Will a Dhanuka and Insecticide get these offers? not unless they have something unique to offer…generics will not get them there.

Invite more questioning on these lines! by everyone.

but also be prepared that I did not try to get the inner working details of these partnerships, or the scale of a particular product -which we have clearly seen the company is uncomfortable sharing- from the concalls. We need to respect the business advantage confidentiality… Kucch jaan ke chalo…kucch maan ke chalo:).

by all means the normal growth has been more than satisfactory. the bonus-es need not be factored in to the last detail.

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Just trying to understand the hedging business after reading a few books,im jusr putting a hypothetical case(similar to the PI case),this is only for general understanding, experts also can add their thoughts so that we can decipher financial statements confidently

suppose PI is expecting 50$ net inflow over this year and they wnat to book the revenues ,they enter into a fwd contract to be exceuted in March 12 to sell 50$ at 48 rs ,the prevailing fwd rate.now suppose the 50$ comes in,they have the money to sell the 50$(there is no loss)and if they get only 25$ during the year,they have to buy the rest 25$ from the open market at 52rs and sell it at 48.(a loss).

If they were unhedged they would have gained with the rupee depreciating,with the hedging they are in no loss-no profit situation if the expected orders come thru.

another idea from the book is that generally larger companies dont go for hedging,wheras companies where currency fluctuations can affect cash flow and cause financial distress go for it,however there is a cost component to it and hedging could go wrong also(due to managers overconfidence/personal agenda etc).

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I think one reason why MNCs are coming to PI vs Dhanuka and their likes is the fact that PI has an established track record of respecting intellectual property. I have worked very closely with IP in the IT field (in fact one of my best friends is the director of IP for one of the top 4 IT companies now). The top MNCs are mortally scared of Indian/Chinese generic players’ ability to reverse engineer their patented molecules and sell at a fraction of the cost. So, they will not let anybody in on the in-licensing if they are even remotely suspicious of their intent. Also, its easier to partner (co-brand) with those companies where they have in-licensing deals with. So, for example, Bayer having an in-licensing deal with PI may easily look at doing a co-branded deal with them.

The moat here is in the reliability that is built up over the years. And with each passing deal, that getsstrengthened.

Look at the Sony deal, PI has put in all the money for setting up the research facility, hiring researchers from India etc and is doing it on a fixed fee basis. however, whatever comes out of it, Sony takes the patent. But PI gets the manufacturing rights. Over time this can be a very valuable model for a small coming to get into the big league.

I am particularly impressed by the work that PI is doing in the CSM space. Overall, good company and a very interesting business model.

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