Summary of discussions with Pondy Oxides & Chemicals (POCL) Management on Sep 22 & 23 in Chennai. Sep 22 discussions in Corp Office and Sep 23 we did a visit to the Smelter Plant in Sriperumbudur. As per Pondy Oxides, this is one of the most modern, fully environment regulations compliant, technically advanced smelter plants in the country, built at probably half the cost of other comparable units -due to in-house design & fabrications skills.
Management answered all questions that we posed to them, transparently and frankly, even the inconvenient or tough ones. They admitted the mistakes & learnings from the dismal FY09 performance and how that have emerged stronger & refined systems & processes (especially in pricing/business models) that have helped them reap the benefits in FY10. It was heartening to see them mention that FY11 is a year of consolidation and again they will perhaps need to review & refine to eliminate other vulnerabilities in their business.
Our concerns -that we wanted addressed:
1). Management Intent - This is still a small company, family run-business. What are the company’s plans, where do they want to go from here, are there signs of share-holder friendliness or is it the reverse?
That they still paid dividends in a loss-making year (their first in the 15 years of existence) so that their dividend paying record is not impaired is an indication. The levels of salary drawn by Directors of POCL is another indication; that Lohia Metals a 51% subsidiary (acquired from extended Promoter group) was valued at only land & building cost is another indication. The office/plant environment was simple, clean and functional -nothing flashy. They welcomed deep questioning and did not gloss over any objections raised.
2). RM price volatility exposure: POCL admitted they were caught unprepared - with huge inventory pile up, high open positions in the spot markets.Anyone else in the Metals market could not have done any significantly better.The kind of steep RM volatility seen in FY09 was never seen before. They shifted to a LME (London Metals Exchange) based pricing model, got key supplier buy-ins -linked purchase to sales, included monthly LME based price revisions in contracts. And capped open positions to only 15-20% for spot markets. This was retained so they could still take advantage of price swings when availble but cap the risk exposure
3). Surge in working Capital: yes there was a surge in working capital -inventory days doubled from 21 to 42 days sales and debtor days went from 29 to 50 in FY10. This was essentially because of a shift in product mix towards metal exports. On absolute basis these are probably not bad numbers for a manufacturing firm, the company maintained. Its likely that inventory & debtors will remain at these levels. But financing cost will come down by 15-20% easily the company maintained as they now have better terms on FCPC (Foreign currency packing credits) $ credit norms -Libor+200 bps. Q1FY10 interest costs was down to 1Cr from 1.96 Cr on sales of 60 Crs. The company maintains that financing costs in subsequent quarters will not exceed these levels.
4). Low Promoter equity: Company maintained that taken together with associates, the shareholding was somewhere near 43%. they plan to augment this by another 10% as soon as they can. They could have done so at many points in the past year but for the fact that substantial personal funds (all funds at their disposal) had beencommittedto safeguard/maintain the business in FY09 and were stuck.
5). High debt - The company pointed out that of the 60 Cr total debt in FY10, 53 C was on account of working capital. Long term secured funds from banks was 1.44 Cr, another ~1 Cr unsecured loan from Banks, and ~5 Cr of loans form directors, relatives & others. Itspracticallya debt free company with enough leverage in the balance sheet to fund future expansions.
Growth Potential - we wanted that mapped:
1). Where do they want to be - a 500 Cr company by FY12-13. Thats a very open stated goal in thecompany. Several initiatives are on which might unfurl during FY11/12 - They have applied for Land/bid for prime land for big ramp up in capacities, considering diversification toAluminiummetal to spread risks and the next growth drivers, etc.
2). FY10 performance - was this a flash in the pan, or is this sustainable. The company maintained export led growth is the main performance driver. Ashish Bansal -the young dynamic director has been instrumental in opening up the export markets for POCL in the last 3 years or so. POCL brand is now on the approved list of major battery manufacturers in Korea, Indonesia, Malaysia, Srilanka, Vietnam & Japan. For e.g. they got YUASA account in Japan before they had Tata-YUASA in India! FY10 saw only 6 months of large scale metal exports. FY11 will be the first year to reap the full year benefits of large scale exports. They are now recording about Rs.20 Cr a month in Sales.
3). PAT margins will be maintained at FY10 levels, the company is hopeful
Any entry barriers -we needed to know:
1). Lead metal refining/smelting needs licensing and environmental clearances. It is increasingly becoming tougher for new entrants to enter this market. More importantly lead scrap, ore, battery plates import licensing is also heavily restrictive.
2). Pondy Oxides in-house process design & fabrication skills have resulted in very low cost plants, at half the cost of other leading smelters, the company claims.
1). Lot of embedded value in land & buildings. 4 factories & a 13000 sq ft office space in Harrington Raod, most premium location in Chennai.
I may have got biased:). In my opinion, except for RM volatility, all other concerns are addressed satisfactorily and cease to be concerns. RM volatility should now be managed much better and the risk of open positions are capped at 20%, which is reasonable. The growth performance in FY11 will continue strongly. Margins may be slightly better due to lower finance costs, and Sales & Marketing overheads getting spread over large order sizes. downsides may not be much from here, upsides should be strong.
Please give this a hard objective look and identify gaps in the information set. Start shooting questions, we are assured the company will respond to our requests for info/clarifications.
I will take some time to capture this and some more in our stock story and stock analysis templates for wider consumption.
Disc: I hold Pondy Oxides and have hiked my initial exposure by 50%