Pondy Oxide & Chemicals

Ayush has done a small post on the company -http://dalaal-street.com/pondy-oxide/

and invites views. For complete details see this post.

We are always in search of undervalued and under-researched mid/small caps. Pondy Oxide appears to be one!

**Pondy Oxides and Chemicals (POCL)**is one of the Indiaas leading metallic oxides and plastic additives producers. Its products are Zinc Oxide, Litharge, Grey Oxide & Red Lead. These products are used in battery industries and automobile sector. India has been witnessing a steep growth in the usage of Lead consumption due to sharp rise in use of Lead acid batteries in automobiles, invertors and UPS. POCL specializes in refining of Lead and related metals.

POCL extracts lead and other metals from scrap batteries and re-uses the same after refining. POCL has been able to refine Lead to 99.99% purity through its R&D department. This form of lead is being imported in India for manufacturing of VRLA batteries.

POCL has a impressive growth track record a the company has been grown from just 20 Cr turnover in 2001 to 230 Cr in 2010. Still the company is available at a M Cap of just 30 Cr.

POCL has 3 business segments a 1). Metals 2. Metal Oxides 3. Plastic Additives

The company is one of the major player in the Metal Oxide Segment. It ranks among the top 10 players in India.

The company claims to be having a**30%+ market share in Plastic Additives segment in India.**POCL has been innovative and develops new products through itas R&D department to stay ahead of the competition.

POCL caters to the top players of the battery industry a Exide Ind, Amara Raja, HBL power etc.

Trigger:

POCL has a subsidiary Lohia Metals Pvt Ltd. The company holds 51% stake in it. In FY 2010, the company did about 75 Cr of turnover and posted a NP of 6.50 Cr. Therefore on the consolidated basis POCL is having an EPS of 12.25 vs EPS of 5.74 on standalone basis.

Valuations at CMP of Rs 30:

  1. The company has been growing at a CAGR of 30.69% for last 10 years. Turnover has grown from 20.81 Cr in 2001 to 232 Cr in 2010.
  2. The stock is available at 1.2 times standalone BV of about 25 and 1 times consolidated BV of 30.
  3. The stock is trading at aPE of 5 on standalone earning and a PE of just 2.5 on consolidated earnings.
  4. POCL has a fantastic track record of consistent high dividend. The stock is still available cum dividend of 12%. Giving a highdividend yield of 4%
  5. The company has posted a very strong Q1. The standalone turnover has increased from 26.51 Cr to 60 Cr. If the company is able to repeat the trend, POCL may be able to do a turnover of 250 Cr vs 150 Cr last year on standalone basis.

So here is a strong growing company available at cheap valuations.

Risks:

  1. Being a metal sector company, it is prone to risk of high volatility in metal prices. For eg in 2008-09 when the metal prices tumbled sharply, the company had to suffer inventory losses and the profits were wiped out for the year.
  2. As per FY 10 Annual report, company has raised loans for expansion hence Debt Equity ratio is high at 2:1.

Company Website

3 Likes

Pondy looks too good to be true kind of stock story.

Till the market “discovers” this one, its accumulation time. I bought this one too.

Technically, there was a strong multimonth resistance around 27-28 which is convincingly crossed and so I think there could be good upsides. Targets could be around 44-45.

1 Like

Excerpts from an HDFC Securities report on Pondy Oxides, Dec 30 2009

Triggers

Stability in the metal prices (especially lead) could lead to better volumes and consistent profits.

The business of POCL to a large extent is dependent on the metal prices especially lead as huge fluctuations in the metalprices create pressure on the margins of the company. Lead is a very corrosion-resistant, dense, ductile, and malleable bluegraymetal. The metal prices have been quite unfavorable for POCL during FY09 and therefore led to fall in its overall marginsduring the period. The metal prices have stabilized since the start of this fiscal and hence has led to high volumes. POCL isalso dependent on Zinc to some extent though lead is its main product. POCL buys/imports lead ore from Africa, Indonesiaetc and also buys/imports lead bearing scraps. It converts this into pure lead metal and later part of it into lead alloys/leadoxide. The volatility in lead prices seen in FY09 hit its profitability as POCL was saddled with high cost inventory, which it hadto liquidate at lower prices. Even its 51% subsidiary Lohia Metals Pvt Ltd faced a similar issue and incurred loss of Rs 5.93 crsin FY09. POCL also incurred loss of Rs 3.05 crs (before extra ordinary items of Rs 1.86 crs) in FY09 due to similar reasons.With prices of lead stabilizing and change in pricing system for raw material and finished goods implemented from FY10,things could improve on the profitability front. Its lead metal order book is full till December 2010.

The above chart shows the movement of Standard Lead prices since December 2007 till date. It can be seen that post July2009 the prices of lead has been stable compared to the previous period.

Higher focus on exports could lead to better margins and efficient working capital management

POCL is also into export sales, mainly of lead metal. The exports have not been very high till now, for instance the first half ofFY10 saw export sales of ~Rs 10 crores. The company is in H2FY10 focusing on improving on this front and increasing itsexports sharply. POCL expects exports to form 50% of the total revenues in H2FY10. Exports form a key to the overallbusiness structure of POCL. The robust export situation in H2FY10 could lead to better topline and bottomline for FY10.Export realizations are based on LME prices, while domestic prices at times quote lower than LME prices. Further export salesare made against sight L/C and receivables are realized faster.

Higher utilization of capacities to lead to economies of scale and spread of fixed costs

Till H1FY10, POCL did not utilize its plants to its full capacity. At the end of FY09, POCL had installed capacity of 33,460 MTof Metals and Metallic Oxides and 6,000 MT for Plastic Additives. It manufactured 10,104 tonnes of metals & metallic oxidesand 4105 tonnes of plastic additives in FY09. Post H1FY10, it has started to utilize almost 100% capacity in the metals andmetallic oxides segment. This will enable the company to reduce its per unit cost and also lead to a spread of fixed costs whichcould eventually lead to better margins for the company.

Shift to LME based pricing for sales and purchases to help POCL earn stable profits

Earlier, POCL used to make its sales and purchases on a spot market basis and hence there was no assurance ofmaintainable profits, as the raw material price fluctuation could not always be passed on to its customers. In FY09, POCL tooka hit on its profits because of this reason, as, the huge volatility in the raw material prices especially lead metal could not bepassed on to its customers leading to a fall in its profits.

POCL has in FY10 based its pricing for sales and purchases based on the LME monthly average prices. This could lead toless volatility in the prices and profits. Currently one of the issues that POCL is facing is the quarter-to-quarter variation in theprofits where in one quarter the company earns profits and the other it sees a fall. In order to prevent this from happening infuture and to maintain sustainable profits going forward, it has taken up this initiative of linking its purchases and sales to themonthly average price on LME. This move will enhance the profitability of the company and one could see the positive impactof this by the end of FY10.

Turnover in the 51% subsidiary could lead to lower/no hit on the consolidated financials of POCL

POCL has currently two subsidiaries namely M/s Baschem Pharma Ltd and M/s Lohia Metals Pvt Ltd. Baschem Pharma Ltd isa 100% owned subsidiary of POCL and is currently not into any production. It is into some trading activity, which is negligible.

POCL though has the advantage of utilizing its closed factory for the capacity expansion planned going forward.

The other subsidiary, M/s Lohia Metals Pvt Ltd is 51% owned by POCL (the balance being held by the promoters of POCL).Till FY08, POCL only had about Rs 0.03 crs investment in Lohia Metals, which by FY09 increased to Rs 2.17 crs. Lohia Metalsis mainly into exports of lead metal. The activities in Lohia Metals include refining and alloying of Lead. This subsidiaryrecorded losses in FY09 due to the severe volatility in the lead prices. FY10 has proved to be a relief for POCL in terms of theperformance of Lohia Metals. Going by the current indication, the subsidiary will by end of FY10, almost recover all its previouslosses and it is expected that by the end of FY10, Lohia Metals could be in the positive. The stability in the raw material priceshas enabled Lohia Metals to see resurgence in its business and this turnaround could lead to lower/no hit on the consolidatednumbers of POCL for FY10. The subsidiary has also benefited out of robust exports and change in pricing of raw materials /finished goods adopted in FY10. The profitability of Lohia Metals going forward could be however be lower than POCL as itdoes not have a smelting unit.

Dividend Yield, strong book value and cash per share show that the stock is currently under priced

POCL has paid dividend regularly since inception. It has been declaring dividends in the range of 12 a 15% over the last fewyears. Even though the company did not have a good FY09 in terms of its topline and bottomline, it declared dividend of 5%for the financial year ended 31st March 2009. The company also has a book value of Rs 20.84 as on the 31st of March 2009.The gross cash per share of POCL as on 31st March 2009 stands at Rs 10.58 per share. If H2FY10 turns out to be good,POCL may go back to paying 12-15% dividend resulting in attractive yield of 5.5% - 6.8%.

2 Likes

Excellent. Thanks Donald this coverage by HDFC is quite detailed and increses the confidence in an unknown company. My respect for HDFC securities find goes up…they called it so right that teh 51% subsidiary results might be a significant trigger (in results).

Ayush - what a find, Sir!have bought into the story.

The valuations are unbelievable. It looks like the market does not know of the consolidated results at all. As Hitesh said this is accummulation time:) I

1 Like

I have also bought into this one. Given the strong Q1results, good dividends, cheap valuations I had to overcome my inhibitions of not having done enough diligence on the stock.

Let’s continue digging more. Ayush did you establish contact with management?

Ayush - just curious, just how did you get whiff of this one?

Donald

There are times when you just have to take the plunge and too much analysis will often lead to paralysis.

Thanks Ayush for bringing this one out and I would like to commend donald’s resourcefulness in digging out this hdfc report. I also think hdfc seems to be tops in uncovering small cap stocks.

Thanks Donald & Hitesh,

I’m also trying to dig more and look into negatives, if any.

Yes, HDFC Sec does comes out with good small cap ideas.

@ Donald, I had bought this stock at close to Rs 26-27 after their Q1 nos. My interest grew after receiving their latest annual report and looking at the consolidated nos.

Regards,

Ayush

1 Like

aYUSH tHANKS I HV TAKEN A SMALL POSITION in this stock at 30.3 today.

Your writups are really nice .keep up the good work.

Incidentally in Pennar Industries there have been a flurry of FII buying in last 1 week.Citibank & Monsoon capital have bought in to the stock.Hence the stock seems to be moving into next orbit

Thanks Ayush ,Hitesh & Valuepickr for enabling my entry in Pondy Oxides.

Greta surge today.

Hope the momentum keeps improving thanks to better visibility

Hi Aysuh,

Don’t you think that P/E is the wrong way to look at a highly leveraged company like Pondy. If i use the more appropriate valuation metrics like EV/EBIT the stock doesn’t appear as cheap as it was initially. EV/EBIT for consolidated numbers comes to 7.4X at today’s market price. So its not really as cheap as it appears to be although i would like a higher multiple due to its ROCE(& good dividend record), but again that is lumpy & not consistent. Need to read more to convince myself though.

Hi

I think markets are at a stage when people will only look at pe and not at debt etc. You are right in your assessment that PE is not the right way to go about looking at companies with high debt. But that is what you and me and a few others know. So when the collective wisdom of the markets decide to value stocks only in a certain way, there could be some money to be made if you time your entry and exit right.

regards

1 Like

Hi Hitesh,

That is an interesting point and i am sure you know better than me. I have not yet seen a raging bull phase given my limited time in the markets and so i am ready to believe you . What that means then as you rightly said is one has to watch closely & time the entry exit right and its definitely not a company where i can invest & forget for some time. So in that case why should i choose this over say a company like Gujarat Heavy chemicals available at standalone P/E of 3.26 & Div yield of 4.13 & much higher market cap??

Hi Aysuh,

**

Hi

I right.

regards

**

1 Like

Good question Siddharth. These kind of queries help us achieve greater clarity in our decision-making, one way or the other. Please keep these coming.

Let me add a few comments for perspective:

1). Its all about the odds!

At a consolidated P/E of <2.5x, div yield >4%, growth visibility of 100% in standalone sales, good RoCE (with high debt), and all indications of alround improvement, this company was a steal! Pondy Oxides looked mispriced to me.

2). GHCL was a woefully declining business till FY09. poor growth, declining margins and returns. FY10 has seen degrowth in Sales, but has done better on margins. returns decline has been marginal over FY09. Its probably cheap for a reason?

Business prospect-wise, just from a look at the numbers, its evident where the odds are stacked -Notwithstanding the risks of high debt, metal price volatility. This is where we have to keep refining our mental models and become better at!

Donald

Disc: I hold Pondy and have added more recently. This is a Chennai based company, and we are contacting Management for a visit and discussions.

1 Like

Pondy Oxides stock story created. Please have a look.

Apart from high debt, inventory levels have gone up hugely, even ignoring the low base effect of FY09. Couple this with higher debtor days and working capital management is stretched. The company registered negative operating cash flows in FY10 after some 3 years.

A quick update on interactions with Pondy Oxides Management.

1). Long Term debt is very less. Of the total 60 Cr debt in FY10, 53 Cr was for Working Capital

2). Debtors & Inventory Levels went up drastically because of the sales mix shifting in favour of metals. The change was drastic but on an absolute basis 42 inventory days and 50 debtor days are not alarming for a manufacturing company, by any means. Growth is coming mainly from the Metals segment, so this may not see much downward revision

3). There will be positive changes in financing costs. FCPC Credit is available now in $terms, Libor+200 bps; Finance costs will see a much lower levels as reflected in Q1 (1 cr vs.1.96 cr Q4FY10)

4). Growth is being driven primarily by export sales. POCL has created a brand pull in Korean, Indonesian,Malaysian, Vietnam & Srilanka markets. Q1 levels are sustainable.

5). PAT levels should remain at FY10 levels, will not be lower.

6). Exposure to Raw material price volatility is now capped at 10-20%. Post the severe dips in FY09, the company has effected major changes in its business/pricing models. prices on LME are monitored closely. Only about 20% of positions are kept open to take advantage of market swings. Sale prices are linked to RM booked based on LME rates. The company can pass on rate hikes on a monthly basis

7). The company has 5 factories and a Corporate office space (13000 sq ft) in prime Harrington Road in Chennai. 4 fatcories are owned by POCL, and 1 by Lohia metals. Lot of embedded value in the Real Estate.

Pondy Oxides stock story here

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.

Downside protection:

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.

Rgds

Donald

Disc: I hold Pondy Oxides and have hiked my initial exposure by 50%

2 Likes

A few questions (sorry if they have been answered before but have been very very busy lately so have not had the time to go through completely):

  1. Who are their main competitors?

  2. What % of their revenue comes from exports?

  3. What % of their revenues come from “new” lead (made from ore) and how much from re-processed lead?

  4. What is the price difference for customers to buy re-processed lead versus “new” lead?

  5. NPM is 3.8%. Isn’t that ridiculously low?

I will go through the ARs and post if I have any more questions.

Abhishek,

Welcome back:) we need some naturallyskepticguys to pick holes!

Hindustan Zinc is the biggest player. Aside from Hindustan Zinc, Pondy Oxides is the biggest organised player in Lead & Alloy-Lead. Hindustan Zinc does not make alloy-lead. Battery manufacturers require both pure lead and alloy-lead.

~25% was exports in Fy10. It should be 50% plus in FY11 which will see the full year export benefit for the first time.

Lead & alloy-lead is required at a certain 99.97% purity. The source does not matter …even ore can be rich or poor in lead. Lead from scrap, batter plates, ore, et all is melted and extracted in the Smelter.

No price difference, therefore.

Margins fluctuate from Qr to Qr as RM is close to 80% of sales. However full year FY10 OPM ~10% and NPM 5.31%. There is also a big drop in Q1FY11. We will need to see a few Qrs.

Last 3 yrs ARs at Acrobat.com shared workspace. You have access already. Anyone who needs access can send me an email.

-Donald

I can see big risks, many ofwhich have already been identified above, but not yet yet addressed to satisfaction. I see this as a small company in a commodity space, which could not manage market fluctuations just one year back, and is going for significant growth by increasing working capital and at the same time increasing short-term loans (big no-nos both).

Isn’t it always a risk/reward trade-off?

available at <3 consolidated PE, almost 4% div yield, 1.2x BV (actually land & building value itself is atleast 2-3x). Metal processing and metal import is a severely restricted license due to pollution & environmental norms; so there is also a lot of embedded licence value, for a metals player.

Remember 6 months of 100% growth is already in the bag; debtor/inventory days at 40/50 days is comfortable for any manufacturing firm. All export sales are against LCs. Export contracts also have monthly LME based price variation pass-ons. Don’t see this working capital increase as a real issue, because of above.

FY09 was bad, but they have learnt the lessons, implemented counter-measures like only 20% open positions, rest are contractual, shifted to LME based pricing with monthly price escalation clauses- measures that helped them come back to regular 20% plus Roe/RoCE levels.

let’s discuss specific risks like the surge in working capital. any others?

-Donald

ofwhich