SRF Limited

[Donald]

SRF Limited features in Vivek Sukhani’s Top 5 picks at the moment. I found it very compelling to investigate this further.

This is how Vivek introduced the SRF Opportunity.

1). SRF Limited: My reasoning here is pretty simple. Here is a company which is doing all the right things with the cash it is generating. It is doing buy-back, it is increasing its productive capital ( thats the term I use generally for fixed assets)at a brisk pace, it is distributing reasonable dividends and most importantly, its increasing its profits at a great pace.

Further discussions from that thread copied here, for us to take this up separately.

Posted byVivek Sukhaniat Thursday 15:08

Previously GreyFool wrote:

I was looking at SRF too earlier. Some things that were of concern for me were:

1). Big capex in Packaging film segment: I understand this is a commodity business and valuations are low for other players like Jindal Polyfilms, Cosmo Films. Also the cycles are typically short & volatile. Right now down cycle is starting.

2). Carbon credits: There was a proposal to cut annual quota’s by 50% last yr(not sure what current status is). Not sure how much of cash flows they contribute to SRF now. They were significant a few yrs back.

3). Nylon Tyre cord prospects: This is used in tyres for heavy duty Buses /trucks to strengthen them. With Indian roads becoming better steel radials will likely limit the use of NTC over the long term.

I think valuations are low but SRF seems to have only traded at 4-6 p/e in recent yrs. Couldn’t figure out why such low valuations for a co. with 22+ ROE.

Valid concerns. But capex is high because they are trying to utilise the cash flows to generate still higher sales. The way I look at capex is that it should result in significant turnover growth in future. And SRF has demonstrated that in the past. Infact, capex is what got me attracted to IGL. If the Capital expenditure can be done without significant increase in borrowings, that should ultimately good for the company in the long run.

With radialisation, demand for NTCF may reduce. But SRF has last year got into PTCF, which is used in radial tyres. Also, cross-ply tyres will not be out of production altogether.

Packaging films is tricky business for sure. But its a good business. So if you have the scale, this can be a cash-cow. If you dont have scale and versatility, its a cash-guzzler.

Carbon credits is an added advantage with SRF. Also, their market share in refrigerant business is close to 40 p.c. That should do fine in the coming years. Also, SRF is building a decent size state-of-the-art plant at Dahej. This should lead to even higher revenues.

[Donald]

I thought it was first important to understand the individual business segments of SRF. Then go into the sources of its profitability. And then sustainability of the same.

To bring everyone on the same page quickly:

SRF Ltd is engaged in manufacturing of chemical based industrial intermediates. The companyâs business has three verticals namely; Technical Textile Business, Chemicals & Polymers Business, and Packaging Films Business.

Technical Textile Business -Technical textiles are mainly used for non-consumer applications. For SRF this comprises Nylon Tyre Cord Fabrics (NTCF), belting fabrics, coated fabrics, laminated fabrics, fishnets and industrial yarns. SRF has manufacturing plants in India, UAE, Thailand and South Africa. SRF is reportedly a market leader in fishnet, belting fabrics and tyre cord manufacturing within the domestic markets.

Chemical & Polymers Business -The business derives itsrevenue from sale of fluorine-basedrefrigerants, chloromethanes, fastgrowingspecialty fluorochemicalsand the engineering plasticsbusiness. It also includes receiptsfrom the sale of CERs generated bydestruction of the greenhouse gasHydrofluorocarbon-23 (HFC-23) underthe Kyoto Protocol.

Packaging Films Business -Polyster PET films are used in packaging of food, cosmetics, personal and healthcare products. Reportedly SRF is second largest player in India for PET films.

Interesting to note

Over the last four years the company has made investments of around Rs. 1250 crore mainly in augmenting and upgrading production facilities in different businesses. Milestones

2004 Fluorospeciality Plant I - Projects R&D 2006 HFC 134a Plant - Chemicals Business 2007 2nd Metallised Film Plant - Packaging Films Business 2007 2nd Chips Compounding Unit - Engineering Plastics Business 2008 15 MW Wind Power Farm - Technical Textiles Business 2008 Fluorospeciality Plant II and Pilot Plant - Projects 2009 Polyester Industrial Yarn - Technical Textiles Business 2009 Fluorospeciality Plant III - Projects R&D 2010 2nd line of BOPET Film - Packaging Films Business 2010 Laminated Fabric Project - Technical Textiles Business

[Donald]

I did a little reading on NTCF vs Radial Tires. NTCF is mostly used for heavy duty buses and truck tires to impart strength and tenacity. The use of Steel radials in this segment is low. Steel radial are more used in Earthmoving and OTR Tires. NTCF use is still good to go for the next 20 to 30 years, even as steel radial use may grow.

NTCF use is roughly 18% by way of RM share in a heavy duty Bus or Truck tire.

Trying to find an authoritative source on this, industry publication, etc.

[Donald]

From AR 2011:

Tyre Cord Reinforcement

SRF manufactures a basket of reinforcement fabrics fortyres. Its main product Nylon TyrecordFabric (NTCF) is used in bias tyresof all categories from tyres for Buses& Trucks to tyres for cycles. Havingset up Indiaâs only polyester industrialyarn plant in 2009-10, SRF is poisedto serve the growing segment ofPolyester Tyrecord Fabric (PTCF) usedin the reinforcement of radial tyres forPassenger Car and Light commercialVehicles.

SRF is the market leader in NTCF andis now working closely with customersto develop new fabric styles, includingunique deniers. These developmentswould result in better usage of theassets.Having been a market leader in NTCFsegment for decades in the country,SRF would now focus on scaling upits PTCF business. SRF is makingprogress in getting approvals fromall the key tyre companies includingGlobal tyre majors. This would providethe platform for SRF to grow into asignificant global player in the âradialtyreâ segment of passenger cars andlight commercial vehicles in the comingyears through appropriate and timelycapacity enhancement.

[Donald]

More on the Outlook from the AR:

Outlook

The NTCF segment of TechnicalTextiles Business, the largest businessof SRF, mainly caters to the bus andtruck tyre segment, which accounts fornearly 60 per cent of SRFâs NTCF sales.The current radialisation in this segmentis 15 per cent. The investments in radialcapacities which were announced bytyre companies some time back, arefructifying. Post this development, itis estimated that radialisation wouldtouch a level of around 30 per cent by2013-14 and 50 per cent by 2017-18.It is projected to stabilse thereafter, ashas been observed in other developingeconomies of the world.

India is the second largest two-wheelerproducer in the world after China.This segment is growing at around 15per cent Compounded Annual Rateof Growth (CARG). The share of thissegment in NTCF consumption iscurrently 12 per cent and is projectedto reach 30 per cent by 2019-20.

With infrastructure & mining sectorsexpected to grow substantially in thecoming years, âOff the Roadâ (OTR)tyres, which are already witnessing ahigh growth are expected to grow indouble digits on a sustainable basisfor many years. These consume largeamount of NTCF thus ensuring areasonable growth rate.

It is, therefore, expected that in absolutequantity terms, the demand for NylonTyre Cord Fabric would grow or remainflat over the next five years, though theapplication portfolio would show a shiftfrom Buses & Trucks to two-wheelersand âOff the Roadâ (OTR) Tyres.

The passenger car (PC) tyreradialisation in India has reached amature level now (over 90 per cent),which predominantly uses PolyesterTyre Cord Fabric as carcass forreinforcement. The car industry isexpected to grow substantially incoming years and, therefore, offers anopportunity to SRF to provide PTCFfabrics for radial tyres.

Currently, SRF is the only company inIndia to produce Polyester Tyre cordfabric and is well positioned to benefitfrom the opportunity. Leveraging itsrelationship with the global majorson account of its Nylon business, itexpects to complete approval of itspolyester fabrics for worldwide usagein the coming years, giving it a growthplatform for radial tyre re-inforcementsglobally.

[Donald]

A look at Segment Revenues for last 2 years.

Segment Revenue
Technical Textiles Business (TTB)		Share		Share
- External sales	144529.76	46.54%	119967.58	53.34%
- Inter-segment sales	590.27		381.23
- Total	145120.03		120348.81
Chemicals and Polymers Business (CPB)
- External sales	74666.65	24.04%	65769.23	29.24%
- Inter-segment sales	0.42		6.77
- Total	74667.07		65776
Packaging Films Business (PFB)
- External sales	87131.26	28.06%	33648.16	14.96%
- Inter-segment sales - -	0		0
- Total	87131.26		33648.16
Total Segment revenue	306918.36		219772.97
Less: Inter Segment revenue	590.69		388
Net Sales / Income from Operations	306327.67		219384.97
Add: Unallocable Income	4234.76		5538.71
Total Revenue	310562.43		224923.68
		98.64%		97.54%

[Donald]

Packaging Films business had an extraordinary year last. FY12 should see Technical Textiles Business back in the 50-60% revenue share?

From 2011 AR on Outlook for PAckaging Business

Outlook

With the ban on usage of plastics in gutka laminates and large number ofexpansions coming up in India and globally, FY 2011-12 is expected tobe a year where supply will exceed demand and there will be a pressureon margins.

SRFâs strategy for the year will be to focus onincreasing exports especially to the developedworld where the margins are relatively lessvolatile, launch value added products and toprepare the business for global expansions.

Although we witnessed cyclicality in thisbusiness, the long term prospects areencouraging.

[Donald]

We should have looked at both Revenue and Profit contribution and growth figures for all the segments to draw proper conclusions. here's the compilation

SRF Limited (Consolidated)
Segment Contribution		FY2011		FY2010			FY2011		FY2010
Technical Textiles Business	Growth	Revenues	Share	Revenues	Share	Growth	Profits	Share	Profits	Share
- External sales	22.05%	185557.09	53.33%	152036.89	60.37%	-21.48%	18010.27	21.92%	22936.93	41.94%
- Inter-segment sales		590.27		381.23
Sub-Total		186147.36		152418.12			18010.27		22936.93
Chemicals & Polymers Business	Growth	Revenues	Share	Revenues	Share	Growth	Profits	Share	Profits	Share
- External sales	13.53%	74666.65	21.46%	65769.23	26.12%	6.18%	29392.33	35.77%	27680.69	50.62%
- Inter-segment sales		0.42		6.77
Sub-Total		74667.07		65776			29392.33		27680.69
Packaging Films Business	Growth	Revenues	Share	Revenues	Share	Growth	Profits	Share	Profits	Share
- External sales	158.95%	87131.26	25.04%	33648.16	13.36%	754.47%	34766.67	42.31%	4068.82	7.44%
- Inter-segment sales - -		0		0			0		0
Sub-Total		87131.26		33648.16			34766.67		4068.82
Total		347945.69		251842.28			82169.27		54686.44

[Donald]

My initial observations:

1). FY10 was an extraordinary year for PET Packaging business. In FY10, revenue share was 13% of overall revenues growing to 25% in FY11. While profit contribution of this segment was just 7.5% in FY10, it contributed 42% of profits in FY11. In absolute terms Sales grew 159% while Profits grew 755%!!

2). Technical textiles business grew 22% in Sales but suffered a degrowth in profits by almost 22%

3). Chemicals and Polymer business grew 13% in Sales, but only 6% in Profits.

FY11 results are completely skewed by the PET Packaging performance, but that’s cyclical, Management has already admitted to an oversupply situation. Main business lines are struggling for growth.

I was intrigued by the 51% PAT growth in the latest June Qr. but now it looks like this too must be driven by the PET Packaging division on its last legs!

Vivek - please comment.

[vivek]

@Donald

My initial observations:

FY10 was an extraordinary year for PET Packaging business. In FY10, revenue share was 13% of overall revenues growing to 25% in FY11. While profit contribution of this segment was just 7.5% in FY10, it contributed 42% of profits in FY11. In absolute terms Sales grew 159% while Profits grew 755%!!

Technical textiles business grew 22% in Sales but suffered a degrowth in profits by almost 22%

Chemicals and Polymer business grew 13% in Sales, but only 6% in Profits.

FY11 results are completely skewed by the PET Packaging performance, but that’s cyclical, Management has already admitted to an oversupply situation. Main business lines are struggling for growth.

I was intrigued by the 51% PAT growth in the latest June Qr. but now it looks like this too must be driven by the PET Packaging division on its last legs!

Vivek - please comment.

1).

2).

3).

I must appreciate that you are one of the most methodical investors I had ever come across.

See, at the end of the day, its an industrial company and as such, its fortunes are surely linked with industrial growth. And candidly speaking, I am not expecting any significant growth in the immediate period. All I want is 60 rupees as CEPS and that would be fine for me. Because, I am convinced that its sales is likely to register a significant growth because of its capital expenditure plans. It has executed its projects well in the past and I am expecting that once it reaches that level of 5000 crores turnover, profits will automatically start flowing. And by the way, how much are we paying for it…???

[ayushmit]

Hi,

One thing which I would like to highlight is - SRF has been one of the main beneficiary of extra-ordinary benefits of carbon credits (Kyoto Protocol) and the same may expire in 2012. One should consider the impact of this while investing in this co.

Regards,

Ayush

[vivek]

I havent checked that…and since I havent bet on SRF because of the CERs it receives periodically,so even if PBT comes down on account of it, I wont be too overly concerned. I am bullish on SRF because its making the best use of its cash flows. thats what makes me feel good about this company.

[rk1771]

Although SRF is an industrial, subject to industrial cycles- there are a few important points to be noted for the company. The raw material cost to the net sale is just above 50% in normal years like 2010 & 2011). It gives tremendous stability to the company in down years. It gives confidence that the company can withstand minor recessions without dipping into red. Further a diversified product portfolio also works as cushion.

Management expect a billion dollar sales by next year. Expansion plans are on track. The management is reliable- recently Forbes put the company in under billion best 200 asia pacific companies. Institutional holding in shares are negligible- Mutual funds hold just 4.8 lakhs shares at the end of June quarter.Company has capability to maintain the dividend- which gives almost 5% dividend yield tax free.

I dont think that the stock can be a high flier, but it can sustain a decent dividend yield with moderate capital appreciation.

[vivek]

SRF’s debt rating is also revised upwards.

@ Rajesh: Regarding the point you made about capital appreciation and dividend, it must be said that very few industrial companies can be high fliers under all situations. Capital appreciation depends a lot on the point of capitalcommitment. I, myself personally, had never bought SRF before 2008-2009, and had been a seller in SRF of the shares which my father had bought when SRF was quiting at 30-odd rupees a few years back. Then I added SRF in 08-09, first at 79-80 levels and then added again at 105-106 levels. Thereafter, I have been adding SRF till very recently.

The point I am trying to make is that while I have made nearly a 4-bagger on my purchase at 79-80 levels, I am making a very slight profit on my recent purchase. So, capital appreciation is a more a function of the point of capital commitment, more than anything else.

The thing is, markets take a longer period to understand the potential of an industrial company than a consumer company. So when I looked at how well SRF was utilising its cash flows, it made me go even at 300-levels. I know I have to wait to get what I am looking for, but given what the company is doing, I am reasonably confident that I will get to the point where I have set out for, until and unless something major adverse event(s) happens.

[rk1771]

I fully agree with you. I also hold the company for last 2 years, my purchase price has been a bit higher. And in this mayhem also the company is giving a decent capital appreciation, in addition to the dividend it gave. I really appreciate the management, particularly the SRF way process they have developed, and brand building exercise. The way they have turned around the recent acquisitions is commendable.

But at the end of the day, it is an industrial, engaged in business of selling commodities. Although it is a low cost producer, still cannot find much competitive advantage.

I look at the share price in isolation, and then relative price of the shares in portfolio. I have a feeling that now, on relative basis, it is becoming expensive with recent market fall, where many other hidden gems can be purchased at relative inexpensive price. Occasionally, switching from relative expensive stocks to relative inexpensive stocks in a portfolio can work. off course it increases the churning a bit more with additional transaction cost.

[vivek]

Hi Rajesh,

Its nice to be interacting with a like-minded person. I haven’t come across a person who has been in sync with me in my selling strategy. I follow a very similar formula as yours…of relative valuation in my buying and selling decision. So, if I get a stock with a higher book value( relatively), higher dividend paying (relatively), with a similar or better management( again, relatively speaking), I dont have hesitation in booking out and going for the better one. This is the way I reduce the riskiness of my portfolio. But in a way, this also stops me from getting into my favorite companies at exorbitant valuations. Thats why, I wasn’t able to load Apollo Hospitals in a significant quantity, although its perhaps one of those stocks, which if someone were to ask me which would be the one stock which I would love to hold if I had the choice of only one stock in the portfolio, would instantly come in my mind. I find no stock being as safe as Apollo, yet I couldn’t manage to buy a decent quantity because it always looked expensive. But nonetheless, I havebenefitedmuch more following this strategy than what I have lost.

So, coming to SRF, if you have stocks which look better at current prices, you should surely jump. As far myself, I don’t have many choices left, so have to remain saddled with SRF for the time being.

[cool_aksh]

This stock is on my radar for sometime now…and I think It offers very good value at the current price of 230…How many operating businesses are out there offering Dividend Yield > 6%, 10 year ROCE (30%) > ROE(27%) and available at P/E < 4, P/B < 1 (way below permissible limit of 22.5 by Graham)…For a change, compare it with Astral, Kaveri, Mayur Uni. etc…Think of the replacement cost…

very good thing is that while it’s earning is increasing, the price is decreasing…I like such stocks…

BTW…what is the percentage of carbon credit in total income?

Let me know if there are more such stocks out there…I just need 10 of this…

Happy Investing!

Aksh

[vivek]

Carbon credit income is fluctuating. SRF is not a company which will ever provide you with a linear kind of returns. Returns would be lumpy, say a 100 p.c. in a year and then a year with -25% return. The reasons are that firstly, its quite diversified and secondly, its always on the move…doing buyback, expanding capacity, getting into newer fields. so, when a company is aggressive there are bounds to be ups and downs. Its not a stable horse, but its a very strong horse. So, if you are a bit patient, and if you can time your jump, its a wonderful stock to be in.

[vivek]

September Quarter results are indeed disappointing. Whats more disturbing is the commentary where the management has said the near term outlook is also not very encouraging. Moreover, it seems that they are going to reduce dividend this year as well, going by their history of declaring two interim dividends of same amount. So, a 5 rupee interim dividend should mean 10 rupee total dividend…thats a decline of 4 rupees a share!!!

All this would suggest that all of a sudden I have turned negative about this company. But actually, I am not too surprised by the results. So while its true that I am majorly disappointed by the decline in turnover, but I am sure that this wont be a trend as turnover would pick-up once the new plants start delivering. And even with this kind of results, the company should do a cash EPS of about 60 rupees a share, which is not bad at all. The thing is, we are actually paying a price where negatives are built into it. There’s absolutely no reason why a stock should trade at a discount to book value for long, if it is not reporting losses. Profits increase book value, and discount to book value should increase if price doesnt move along with book value. Sure, such a phenomenon can last for some period, but eventually price catches up with book value.

Sure, there are companies which have consistently traded at discount to book value. But we wont come across many instances where a company has consistently produced profits and the price hasnt moved at all, or rather has gone down.

Now, one may be tempted to ask that what good is it serve an investor, if the price doesnt fall but also, doesnt go higher. After all, we are interested in appreciation over a period, and just remaining stuck. Well, SRF has all the attributes to deliver positive returns. Its going through a tough period, but tough times also come to an end. Its into businesses which are not in the sun-set phase. They have fairly decent potential. So, swinging back to growth phase wont be too much of a task once the recessionary phase gets over. Moreover, since the commodities have started to cool off, intermediate businesses tend to start doing well. So, margins should also improve, as raw material prices come off.

However, there’s little doubt that this stock isnt going to fly-off soon. But,its surely worth accumulation in this period of downcast and pessimism.

[cool_aksh]

Yes…the numbers are disappointing but it was expected looking at the current outlook and the kind of commodity business that SRF is in.

Good thing is that management is doing all the right things…they are reducing the debt, decreased the equity base by buying back etc. I think it only makes sense that they have reduced dividend as they are expecting some tough time ahead…

As Donald rightly commented, I just don’t understand why has it most of the time traded at Price < Sales? Is it because market is expecting this business to be in sun-set industry? if so, how come it has generated fantastic ROE over 10 years?